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INDEPENDENT BANK CORP - Quarter Report: 2014 September (Form 10-Q)

Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________________________________ 
FORM 10-Q
___________________________________________________
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
Commission File Number: 1-9047
___________________________________________________
Independent Bank Corp.
(Exact name of registrant as specified in its charter)
 ___________________________________________________
Massachusetts
04-2870273
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Office Address: 2036 Washington Street, Hanover Massachusetts 02339
Mailing Address: 288 Union Street, Rockland, Massachusetts 02370
(Address of principal executive offices, including zip code)
(781) 878-6100
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark 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  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer
x
Accelerated Filer
o
 
 
 
 
Non-accelerated Filer
o
Smaller Reporting Company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of November 1, 2014, there were 23,958,212 shares of the issuer’s common stock outstanding, par value $0.01 per share.
 



Table of Contents


 
Table of Contents
 
PAGE
 
 
Consolidated Balance Sheets - September 30, 2014 and December 31, 2013
Consolidated Statements of Income - Three and nine months ended September 30, 2014 and 2013
Consolidated Statements of Comprehensive Income -Three and nine months ended September 30, 2014 and 2013
Consolidated Statements of Stockholders’ Equity - Nine months ended September 30, 2014 and 2013
Consolidated Statements of Cash Flows - Nine months ended September 30, 2014 and 2013
 
 
 
 
 
 
 

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Table of Contents
 
 
 
 
Exhibit 31.1 – Certification 302
 
Exhibit 31.2 – Certification 302
 
Exhibit 32.1 – Certification 906
 
Exhibit 32.2 – Certification 906
 

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PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
INDEPENDENT BANK CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited—Dollars in thousands, except share data)
 
 
September 30,
2014
 
December 31,
2013
Assets
Cash and due from banks
$
98,810

 
$
168,106

Interest-earning deposits with banks
126,522

 
48,219

Securities

 

Securities available for sale
361,455

 
356,862

Securities held to maturity (fair value $373,465 and $346,455)
372,418

 
350,652

Total securities
733,873

 
707,514

Loans held for sale (at fair value)
12,580

 
8,882

Loans
 
 
 
Commercial and industrial
842,833

 
784,202

Commercial real estate
2,338,641

 
2,249,260

Commercial construction
276,593

 
223,859

Small business
81,435

 
77,240

Residential real estate
536,822

 
541,443

Home equity - 1st position
509,903

 
497,075

Home equity - subordinate positions
344,743

 
325,066

Other consumer
16,885

 
20,162

Total loans
4,947,855

 
4,718,307

Less: allowance for loan losses
(55,005
)
 
(53,239
)
Net loans
4,892,850

 
4,665,068

Federal Home Loan Bank stock
33,233

 
39,926

Bank premises and equipment, net
64,186

 
64,950

Goodwill
170,421

 
170,421

Identifiable intangible assets
10,450

 
12,221

Cash surrender value of life insurance policies
108,895

 
100,406

Other real estate owned and other foreclosed assets
9,632

 
7,633

Other assets
122,976

 
105,888

Total assets
$
6,384,428

 
$
6,099,234

Liabilities and Stockholders' Equity
Deposits
 
 
 
Demand deposits
$
1,493,116

 
$
1,369,432

Savings and interest checking accounts
2,070,617

 
1,940,153

Money market
1,066,237

 
933,205

Time certificates of deposit of $100,000 and over
268,965

 
297,984

Other time certificates of deposits
403,499

 
445,644

Total deposits
5,302,434

 
4,986,418

Borrowings
 
 
 
Federal Home Loan Bank borrowings
60,127

 
140,294

Customer repurchase agreements and other short-term borrowings
153,192

 
154,288

Wholesale repurchase agreements
50,000

 
50,000


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Junior subordinated debentures
73,741

 
73,906

Subordinated debentures
30,000

 
30,000

Total borrowings
367,060

 
448,488

Other liabilities
87,752

 
72,788

Total liabilities
5,757,246

 
5,507,694

Commitments and contingencies

 

Stockholders' equity
 
 
 
Preferred stock, $.01 par value. authorized: 1,000,000 shares, outstanding: none

 

Common stock, $.01 par value. authorized: 75,000,000 shares, issued and outstanding: 23,911,678 shares at September 30, 2014 and 23,805,984 shares at December 31, 2013 (includes 254,030 and 268,290 shares of unvested participating restricted stock awards, respectively)
237

 
235

Shares held in rabbi trust at cost: 175,219 shares at September 30, 2014 and 178,765 shares at December 31, 2013
(3,591
)
 
(3,404
)
Deferred compensation obligation
3,591

 
3,404

Additional paid in capital
308,723

 
305,179

Retained earnings
320,226

 
293,560

Accumulated other comprehensive loss, net of tax
(2,004
)
 
(7,434
)
Total stockholders’ equity
627,182

 
591,540

Total liabilities and stockholders' equity
$
6,384,428

 
$
6,099,234

The accompanying condensed notes are an integral part of these unaudited consolidated financial statements.


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INDEPENDENT BANK CORP.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited—Dollars in thousands, except per share data)
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
Interest income
 
 
 
 
 
 
 
Interest on loans
$
49,514

 
$
47,019

 
$
147,111

 
$
141,717

Taxable interest and dividends on securities
4,563

 
3,763

 
13,903

 
10,798

Nontaxable interest and dividends on securities
36

 
10

 
110

 
32

Interest on loans held for sale
159

 
156

 
306

 
661

Interest on federal funds sold and short-term investments
96

 
79

 
203

 
134

Total interest and dividend income
54,368

 
51,027

 
161,633

 
153,342

Interest expense
 
 
 
 
 
 
 
Interest on deposits
2,735

 
2,649

 
8,314

 
7,857

Interest on borrowings
2,070

 
3,182

 
7,095

 
9,812

Total interest expense
4,805

 
5,831

 
15,409

 
17,669

Net interest income
49,563

 
45,196

 
146,224

 
135,673

Provision for loan losses
1,901

 
2,650

 
8,653

 
7,050

Net interest income after provision for loan losses
47,662

 
42,546

 
137,571

 
128,623

Noninterest income
 
 
 
 
 
 
 
Deposit account fees
4,656

 
4,604

 
13,478

 
13,164

Interchange and ATM fees
3,375

 
2,845

 
9,672

 
7,934

Investment management
5,016

 
4,175

 
14,755

 
12,417

Mortgage banking income
1,015

 
1,843

 
2,379

 
5,794

Loan level derivative income
381

 
1,331

 
1,452

 
2,679

Increase in cash surrender value of life insurance policies
774

 
793

 
2,217

 
2,325

Gain on extinguishment of debt

 
763

 

 
763

Gain on life insurance benefits

 

 
1,964

 

Gain (loss) on sale of equity securities, net
67

 

 
138

 
(4
)
Other noninterest income
1,814

 
1,776

 
5,414

 
5,473

Total noninterest income
17,098

 
18,130

 
51,469

 
50,545

Noninterest expenses
 
 
 
 
 
 
 
Salaries and employee benefits
23,651

 
22,654

 
69,574

 
66,963

Occupancy and equipment expenses
5,027

 
4,573

 
16,474

 
14,742

Data processing and facilities management
1,178

 
1,179

 
3,609

 
3,564

FDIC assessment
957

 
898

 
2,828

 
2,653

Advertising expense
1,179

 
759

 
3,252

 
3,410

Consulting expense
737

 
914

 
2,105

 
2,291

Debit card expense
552

 
766

 
1,694

 
2,209

Loss on termination of derivatives

 

 
1,122

 

Merger and acquisition expense
677

 
366

 
754

 
2,465

Software maintenance
579

 
599

 
1,850

 
1,878

Other noninterest expenses
8,070

 
8,014

 
24,212

 
25,630

Total noninterest expenses
42,607

 
40,722

 
127,474

 
125,805

Income before income taxes
22,153

 
19,954

 
61,566

 
53,363

Provision for income taxes
6,415

 
5,299

 
17,699

 
13,698

Net income
$
15,738

 
$
14,655

 
$
43,867

 
$
39,665

Basic earnings per share
$
0.66

 
$
0.64

 
$
1.84

 
$
1.73

Diluted earnings per share
$
0.66

 
$
0.64

 
$
1.83

 
$
1.73

Weighted average common shares (basic)
23,911,678

 
22,946,308

 
23,876,391

 
22,886,521

Common shares equivalents
90,685

 
100,806

 
95,320

 
72,799

Weighted average common shares (diluted)
24,002,363

 
23,047,114

 
23,971,711

 
22,959,320

Cash dividends declared per common share
$
0.24

 
$
0.22

 
$
0.72

 
$
0.66

The accompanying condensed notes are an integral part of these unaudited consolidated financial statements.


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INDEPENDENT BANK CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited—Dollars in thousands)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
Net income
$
15,738

 
$
14,655

 
$
43,867

 
$
39,665

Other comprehensive income, net of tax
 
 
 
 
 
 
 
Unrealized gains (losses) on securities
 
 
 
 
 
 
 
Change in fair value of securities available for sale
(810
)
 
(148
)
 
3,544

 
(5,517
)
Less: net security gains (losses) reclassified into earnings
40

 

 
82

 
(3
)
Net change in fair value of securities available for sale
(850
)
 
(148
)
 
3,462

 
(5,514
)
Unrealized gains (losses) on cash flow hedges
 
 
 
 
 
 
 
Change in fair value of cash flow hedges
149

 
(411
)
 
(315
)
 
350

Less: net cash flow hedge losses reclassified into earnings
(429
)
 
(866
)
 
(2,400
)
 
(2,557
)
Net change in fair value of cash flow hedges
578

 
455

 
2,085

 
2,907

Net gain (loss) during the period and amortization of certain costs included in net periodic retirement costs
(39
)
 
30

 
(117
)
 
73

Total other comprehensive income (loss)
(311
)
 
337

 
5,430

 
(2,534
)
Total comprehensive income
$
15,427

 
$
14,992

 
$
49,297

 
$
37,131

The accompanying condensed notes are an integral part of these unaudited consolidated financial statements.


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INDEPENDENT BANK CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited—Dollars in thousands, except per share data)


Common Stock Outstanding
 
Common Stock
 
Value of Shares Held in Rabbi Trust at Cost
 
Deferred Compensation Obligation
 
Additional Paid in Capital
 
Retained Earnings
 
Accumulated Other
Comprehensive Loss
 
Total
Balance at December 31, 2013
23,805,984

 
$
235

 
$
(3,404
)
 
$
3,404

 
$
305,179

 
$
293,560

 
$
(7,434
)
 
$
591,540

Net income

 

 

 

 

 
43,867

 

 
43,867

Other comprehensive income

 

 

 

 

 

 
5,430

 
5,430

Common dividend declared ($0.72 per share)

 

 

 

 

 
(17,201
)
 

 
(17,201
)
Proceeds from exercise of stock options
24,609

 
1

 

 

 
582

 

 

 
583

Tax benefit related to equity award activity

 

 

 

 
438

 

 

 
438

Equity based compensation

 

 

 

 
2,075

 

 

 
2,075

Restricted stock awards issued, net of awards surrendered
55,675

 
1

 

 

 
(644
)
 

 

 
(643
)
Shares issued under direct stock purchase plan
25,410

 

 

 

 
959

 

 

 
959

Deferred compensation obligation

 

 
(187
)
 
187

 

 

 

 

Tax benefit related to deferred compensation distributions

 

 

 

 
134

 

 

 
134

Balance at September 30, 2014
23,911,678

 
$
237

 
$
(3,591
)
 
$
3,591

 
$
308,723

 
$
320,226

 
$
(2,004
)
 
$
627,182

Balance at December 31, 2012
22,774,009

 
$
225

 
$
(3,179
)
 
$
3,179

 
$
269,950

 
$
263,671

 
$
(4,526
)
 
$
529,320

Net income

 

 

 

 

 
39,665

 

 
39,665

Other comprehensive income

 

 

 

 

 

 
(2,534
)
 
(2,534
)
Common dividend declared ($0.66 per share)

 

 

 

 

 
(15,128
)
 

 
(15,128
)
Proceeds from exercise of stock options
76,253

 
1

 

 

 
1,993

 

 

 
1,994

Tax benefit related to equity award activity

 

 

 

 
412

 

 

 
412

Equity based compensation

 

 

 

 
1,923

 

 

 
1,923

Restricted stock awards issued, net of awards surrendered
89,431

 
1

 

 

 
(670
)
 

 

 
(669
)
Shares issued under direct stock purchase plan
19,594

 

 

 

 
656

 

 

 
656

Deferred compensation obligation

 

 
(165
)
 
165

 

 

 

 

Tax benefit related to deferred compensation distributions

 

 

 

 
105

 

 

 
105

Balance September 30, 2013
22,959,287

 
$
227

 
$
(3,344
)
 
$
3,344

 
$
274,369

 
$
288,208

 
$
(7,060
)
 
$
555,744

The accompanying condensed notes are an integral part of these unaudited consolidated financial statements.

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INDEPENDENT BANK CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited—Dollars in thousands)
 
 
Nine Months Ended
 
September 30
 
2014
 
2013
Cash flow from operating activities
 
 
 
Net income
$
43,867

 
$
39,665

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation and amortization
8,451

 
6,268

Provision for loan losses
8,653

 
7,050

Deferred income tax expense
459

 
5

Net (gain) loss on sale of equity securities
(138
)
 
4

Net loss on fixed assets
505

 
27

Gain on extinguishment of debt

 
(763
)
Loss on termination of derivatives
1,122

 

Net loss on sale of other real estate owned and foreclosed assets
361

 
47

Realized gain on sale leaseback transaction
(775
)
 
(775
)
Stock based compensation
2,075

 
1,923

Excess tax benefit related to equity award activity
(438
)
 
(412
)
Increase in cash surrender value of life insurance policies
(2,213
)
 
(2,325
)
Gain on life insurance benefits
(1,964
)
 

Change in fair value on loans held for sale
(1
)
 
(274
)
Net change in:
 
 
 
Loans held for sale
(3,697
)
 
37,794

Other assets
6,321

 
43,094

Other liabilities
(3,320
)
 
(14,264
)
Total adjustments
15,401

 
77,399

Net cash provided by operating activities
59,268

 
117,064

Cash flows used in investing activities
 
 
 
Proceeds from sales of securities available for sale
945

 
169

Proceeds from maturities and principal repayments of securities available for sale
35,936

 
69,732

Purchase of securities available for sale
(36,577
)
 
(34,864
)
Proceeds from maturities and principal repayments of securities held to maturity
32,864

 
39,713

Purchase of securities held to maturity
(54,681
)
 
(179,226
)
Redemption of Federal Home Loan Bank stock
6,693

 
3,093

Investment in Low Income Housing Projects
(5,566
)
 

Purchase of life insurance policies
(10,116
)
 
(219
)
Proceeds from life insurance policies
6,309

 

Net increase in loans
(242,207
)
 
(44,975
)
Purchase of bank premises and equipment
(5,987
)
 
(6,121
)
Proceeds from the sale of bank premises and equipment
1,064

 
19

Payments on early termination of hedging relationship
(1,122
)
 

Proceeds from the sale of other real estate owned and foreclosed assets
4,269

 
7,119

Net capital improvements to other real estate owned
(1,772
)
 
(2,035
)
Net cash used in investing activities
(269,948
)
 
(147,595
)

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Cash flows provided by financing activities
 
 
 
Net decrease in time deposits
(71,164
)
 
(61,509
)
Net increase in other deposits
387,180

 
272,141

Net repayments of short-term Federal Home Loan Bank borrowings
(75,000
)
 
(6,507
)
Repayments of long-term Federal Home Loan Bank borrowings
(5,000
)
 
(73,134
)
Net increase in customer repurchase agreements
3,904

 
10,821

Net decrease in other borrowings
(5,000
)
 
(12,000
)
Proceeds from exercise of stock options, net of cash paid
583

 
1,994

Restricted stock awards issued, net of awards surrendered
(643
)
 
(669
)
Excess tax benefit from stock based compensation
438

 
412

Tax benefit from deferred compensation distribution
134

 
105

Proceeds from shares issued under direct stock purchase plan
959

 
656

Common dividends paid
(16,704
)
 
(10,070
)
Net cash provided by financing activities
219,687

 
122,240

Net increase in cash and cash equivalents
9,007

 
91,709

Cash and cash equivalents at beginning of year
216,325

 
215,474

Cash and cash equivalents at end of period
$
225,332

 
$
307,183

Supplemental schedule of noncash investing and financing activities
 
 
 
Transfer of loans to other real estate owned & foreclosed assets
$
5,039

 
$
2,346

Capital commitment relating to Low Income Housing Project investments
$
22,273

 
$

The accompanying condensed notes are an integral part of these unaudited consolidated financial statements.

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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION
Independent Bank Corp. (the “Company”) is a state chartered, federally registered bank holding company, incorporated in 1985. The Company is the sole stockholder of Rockland Trust Company (“Rockland Trust” or the “Bank”), a Massachusetts trust company chartered in 1907.
All material intercompany balances and transactions have been eliminated in consolidation. Certain previously reported amounts may have been reclassified to conform to the current year’s presentation.
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial statements, primarily consisting of normal recurring adjustments, have been included. Operating results for the quarter ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 or any other interim period.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission.

NOTE 2 - RECENT ACCOUNTING STANDARDS UPDATES

FASB ASC Subtopic 205-40 "Presentation of Financial Statements - Going Concern" Updated No. 2014-15. Update No. 2014-15 was issued in August 2014 to provide guidance in U.S. Generally accepted accounting principles ("GAAP") about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. In doing so, the amendments should reduce diversity in the timing and content of footnote disclosures. The amendments in this update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position.

FASB ASC Subtopic 310-40 "Receivables - Troubled Debt Restructurings by Creditors" Update No. 2014-14. Update No. 2014-14 was issued in August 2014 to address the diversity in practice related to how creditors classify government-guaranteed mortgage loans, including Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA) guaranteed loans, upon foreclosure. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The objective of this update is to reduce that diversity by addressing the classification of certain foreclosed mortgage loans held by creditors that are either fully or partially guaranteed under government programs. The amendments in this update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position.

FASB ASC Topic 718 "Compensation - Stock Compensation" Update No. 2014 -12. Update No. 2014-12 was issued in June 2014 to resolve the diverse accounting treatment of share-based payment awards that require, as a condition to vesting, achievement of a specific performance target after the requisite service period. Many reporting entities account for these performance targets as performance conditions that affect the vesting of the award and, therefore, do not reflect the performance target in the estimate of the grant-date fair value of the award, while other reporting entities treat those performance targets as nonvesting conditions that affect the grant-date fair value of the award. This amendment requires that these performance targets that affect vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718 "Compensation - Stock Compensation" as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in this update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position.

FASB ASC Topic 860 "Transfers and Servicing" Update No. 2014-11. Update No. 2014-11 was issued in June 2014 to respond to stakeholders' concerns about current accounting and disclosures for repurchase agreements and similar transactions.  The amendments in this Update require two accounting changes.  First, the amendments in this Update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting.  Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement.  The amendments

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in this Update require disclosures for certain transactions comprising (1) a transfer of a financial asset accounted for as a sale and (2) an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. For those transactions outstanding at the reporting date, the transferor is required to disclose certain information by type of transaction.  The amendments in this Update also require certain disclosures for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The accounting changes in this Update are effective for public business entities for the first interim or annual period beginning after December 15, 2014. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application for a public business entity is prohibited. For public business entities, the disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The disclosures are not required to be presented for comparative periods before the effective date.  The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position.

FASB ASC Topic 606 "Revenue from Contracts with Customers" Update No. 2014-09. Update No. 2014-09 was issued in May 2014 to address the previous revenue recognition requirements in GAAP that differ from those in International Financial Reporting Standards (IFRS).  Accordingly, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public entities, the standard is effective for annual and interim periods beginning after December 15, 2016, and calendar year-end public entities will apply it in the quarter that ends March 31, 2017.  Early adoption is not permitted.  We are currently assessing the potential impact of this amendment on our consolidated financial position.
    
FASB ASC Subtopic 310-40 "Receivables - Troubled Debt Restructurings by Creditors" Update No. 2014-04. Update No. 2014-04 was issued in January 2014 to reduce diversity by clarifying when an in substance repossession of foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The amendments in this update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in the update should be applied prospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position.


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NOTE 3 - SECURITIES
The following table presents a summary of the amortized cost, gross unrealized holding gains and losses, other-than-temporary impairment recorded in other comprehensive income and fair value of securities available for sale and securities held to maturity for the periods below:
 
September 30, 2014
 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross Unrealized
Losses
 
Fair
Value
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross Unrealized
Losses
 
Fair
Value
 
(Dollars in thousands)
Available for sale securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency securities
$
41,357

 
$
23

 
$
(93
)
 
$
41,287

 
$
41,331

 
$
3

 
$
(885
)
 
$
40,449

Agency mortgage-backed securities
224,336

 
6,397

 
(1,529
)
 
229,204

 
232,742

 
6,405

 
(4,556
)
 
234,591

Agency collateralized mortgage obligations
66,244

 
285

 
(943
)
 
65,586

 
58,765

 
490

 
(1,102
)
 
58,153

State, county, and municipal securities
5,125

 
128

 

 
5,253

 
5,439

 
1

 
(28
)
 
5,412

Single issuer trust preferred securities issued by banks
2,925

 
14

 
(16
)
 
2,923

 
2,960

 
14

 
(22
)
 
2,952

Pooled trust preferred securities issued by banks and insurers (1)
7,961

 
32

 
(2,607
)
 
5,386

 
8,083

 

 
(4,242
)
 
3,841

Equity securities
11,173

 
851

 
(208
)
 
11,816

 
10,997

 
762

 
(295
)
 
11,464

Total available for sale securities
$
359,121

 
$
7,730

 
$
(5,396
)
 
$
361,455

 
$
360,317

 
$
7,675

 
$
(11,130
)
 
$
356,862

Held to maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
1,010

 
$
50

 
$

 
$
1,060

 
$
1,011

 
$
31

 
$

 
$
1,042

Agency mortgage-backed securities
164,531

 
3,511

 
(42
)
 
168,000

 
155,067

 
1,917

 
(1,033
)
 
155,951

Agency collateralized mortgage obligations
199,950

 
1,821

 
(4,494
)
 
197,277

 
187,388

 
824

 
(6,176
)
 
182,036

State, county, and municipal securities
424

 
9

 

 
433

 
678

 
7

 

 
685

Single issuer trust preferred securities issued by banks
1,500

 
30

 

 
1,530

 
1,503

 
23

 

 
1,526

Corporate debt securities
5,003

 
162

 

 
5,165

 
5,005

 
210

 

 
5,215

Total held to maturity securities
$
372,418

 
$
5,583

 
$
(4,536
)
 
$
373,465

 
$
350,652

 
$
3,012

 
$
(7,209
)
 
$
346,455

Total
$
731,539

 
$
13,313

 
$
(9,932
)
 
$
734,920

 
$
710,969

 
$
10,687

 
$
(18,339
)
 
$
703,317

(1)    Gross unrealized gains and gross unrealized losses include $1.1 million and $2.3 million of net non-credit related OTTI at September 30, 2014 and December 31, 2013, respectively.
When securities are sold, the adjusted cost of the specific security sold is used to compute the gain or loss on the sale. The Company realized net gains of $67,000 and $138,000 on equity securities classified as available for sale during the three and nine month periods ending September 30, 2014, respectively. The Company had no realized gains or losses during the three month period ending September 30, 2013 and realized a net loss of $4,000 during the nine month period ending September 30, 2013 on equity securities classified as available for sale. There were no gains or losses realized on sale of nonequity securities for the periods ending September 30, 2014 and 2013.
 
The actual maturities of certain securities may differ from the contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. A schedule of the contractual maturities of securities available for sale and securities held to maturity as of September 30, 2014 is presented below:


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Table of Contents

 
Available for Sale
 
Held to Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
(Dollars in thousands)
Due in one year or less
$
118

 
$
124

 
$
199

 
$
204

Due after one year to five years
37,513

 
38,373

 
5,492

 
5,674

Due after five years to ten years
92,385

 
91,581

 
32,731

 
33,115

Due after ten years
217,932

 
219,561

 
333,996

 
334,472

Total debt securities
$
347,948

 
$
349,639

 
$
372,418

 
$
373,465

Equity securities
$
11,173

 
$
11,816

 
$

 
$

Total
$
359,121

 
$
361,455

 
$
372,418

 
$
373,465

Inclusive in the table above is $34.1 million of callable securities in the Company’s investment portfolio at September 30, 2014.
The carrying value of securities pledged to secure public funds, repurchase agreements and for other purposes, as required or permitted by law, was $352.3 million and $360.1 million at September 30, 2014 and December 31, 2013, respectively.
At September 30, 2014 and December 31, 2013, the Company had no investments in obligations of individual states, counties, or municipalities which exceeded 10% of stockholders’ equity.
Other-Than-Temporary Impairment ("OTTI")
The Company continually reviews investment securities for the existence of OTTI, taking into consideration current market conditions, the extent and nature of changes in fair value, issuer rating changes and trends, the credit worthiness of the obligor of the security, volatility of earnings, current analysts’ evaluations, the Company’s intent to sell the security, or whether it is more likely than not that the Company will be required to sell the debt security before its anticipated recovery, as well as other qualitative factors. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment.
The following tables show the gross unrealized losses and fair value of the Company’s investments in an unrealized loss position, which the Company has not deemed to be OTTI, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
 
September 30, 2014
 
 
 
Less than 12 months
 
12 months or longer
 
Total
 
# of holdings
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(Dollars in thousands)
U.S. Government agency securities
25

 
$
33,836

 
$
(93
)
 
$

 
$

 
$
33,836

 
$
(93
)
Agency mortgage-backed securities
54

 
44,458

 
(60
)
 
45,437

 
(1,511
)
 
89,895

 
(1,571
)
Agency collateralized mortgage obligations
15

 
34,062

 
(345
)
 
104,095

 
(5,092
)
 
138,157

 
(5,437
)
Single issuer trust preferred securities issued by banks and insurers
1

 
1,083

 
(16
)
 

 

 
1,083

 
(16
)
Pooled trust preferred securities issued by banks and insurers
2

 

 

 
2,580

 
(1,512
)
 
2,580

 
(1,512
)
Equity securities
17

 
935

 
(26
)
 
4,052

 
(182
)
 
4,987

 
(208
)
Total temporarily impaired securities
114

 
$
114,374

 
$
(540
)
 
$
156,164

 
$
(8,297
)
 
$
270,538

 
$
(8,837
)


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Table of Contents

 
December 31, 2013
 
 
 
Less than 12 months
 
12 months or longer
 
Total
 
 
 
# of holdings
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(Dollars in thousands)
U.S. government agency securities
39

 
$
39,950

 
$
(885
)
 
$

 
$

 
$
39,950

 
$
(885
)
Agency mortgage-backed securities
124

 
202,004

 
(5,217
)
 
5,108

 
(372
)
 
207,112

 
(5,589
)
Agency collateralized mortgage obligations
19

 
183,721

 
(7,278
)
 

 

 
183,721

 
(7,278
)
State, county, and municipal securities
13

 
3,838

 
(28
)
 

 

 
3,838

 
(28
)
Single issuer trust preferred securities issued by banks and insurers
2

 
1,341

 
(22
)
 

 

 
1,341

 
(22
)
Pooled trust preferred securities issued by banks and insurers
2

 

 

 
2,300

 
(1,913
)
 
2,300

 
(1,913
)
Equity securities
22

 
2,376

 
(90
)
 
3,520

 
(205
)
 
5,896

 
(295
)
Total temporarily impaired securities
221

 
$
433,230

 
$
(13,520
)
 
$
10,928

 
$
(2,490
)
 
$
444,158

 
$
(16,010
)
The Company does not intend to sell these investments and has determined based upon available evidence that it is more likely than not that the Company will not be required to sell the security before the recovery of its amortized cost basis. As a result, the Company does not consider these investments to be OTTI. The Company made this determination by reviewing various qualitative and quantitative factors regarding each investment category, such as current market conditions, extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, and current analysts’ evaluations.
As a result of the Company’s review of these qualitative and quantitative factors, the causes of the impairments listed in the table above by category are as follows at September 30, 2014:
U.S. Government Agency Securities, Agency Mortgage-Backed Securities and Collateralized Mortgage Obligations: This portfolio has contractual terms that generally do not permit the issuer to settle the securities at a price less than the current par value of the investment. The decline in market value of these securities is attributable to changes in interest rates and not credit quality. Additionally, these securities are implicitly guaranteed by the U.S. Government or one of its agencies.
Single Issuer Trust Preferred Securities: This portfolio consists of one security which is below investment grade. The unrealized loss on this security is attributable to the illiquid nature of the trust preferred market in the current economic environment. Management evaluates various financial metrics for the issuer, including regulatory capital ratios of the issuer.
Pooled Trust Preferred Securities: This portfolio consists of two below investment grade securities both of which are performing. The unrealized loss on these securities is attributable to the illiquid nature of the trust preferred market and the significant risk premiums required in the current economic environment. Management evaluates collateral credit and instrument structure, including current and expected deferral and default rates and timing. In addition, discount rates are determined by evaluating comparable spreads observed currently in the market for similar instruments.
Equity Securities: This portfolio consists of mutual funds and other equity investments. During some periods, the mutual funds in the Company’s investment portfolio may have unrealized losses resulting from market fluctuations as well as the risk premium associated with that particular asset class. For example, emerging market equities tend to trade at a higher risk premium than U.S. government bonds and thus, will fluctuate to a greater degree on both the upside and the downside. In the context of a well-diversified portfolio, however, the correlation amongst the various asset classes represented by the funds serves to minimize downside risk. The Company evaluates each mutual fund in the portfolio regularly and measures performance on both an absolute and relative basis. A reasonable recovery period for positions with an unrealized loss is based on management’s assessment of general economic data, trends within a particular asset class, valuations, earnings forecasts and bond durations.

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Table of Contents

The following table shows the total OTTI that the Company recorded for the periods indicated:
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Gross change in OTTI recorded on certain investments
$
235

 
$
303

 
$
1,264

 
$
674

Portion of OTTI recognized in OCI
(235
)
 
(303
)
 
(1,264
)
 
(674
)
Total credit related OTTI losses recognized in earnings
$

 
$

 
$

 
$

The following table shows the cumulative credit related component of OTTI for the periods indicated:
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Balance at beginning of period
$
(9,997
)
 
$
(10,847
)
 
$
(9,997
)
 
$
(10,847
)
Add
 
 
 
 
 
 
 
Incurred on securities not previously impaired

 

 

 

Incurred on securities previously impaired

 

 

 

Less
 
 
 
 
 
 
 
Securities sold during the period

 

 

 

Reclassification due to changes in Company’s intent

 

 

 

Increases in cash flow expected to be collected

 

 

 

Balance at end of period
$
(9,997
)
 
$
(10,847
)
 
$
(9,997
)
 
$
(10,847
)


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Table of Contents




NOTE 4 - LOANS, ALLOWANCE FOR LOAN LOSSES, AND CREDIT QUALITY
The following tables bifurcate the amount of allowance allocated to each loan category based on the type of impairment analysis as of the periods indicated:
 
September 30, 2014
 
 
(Dollars in thousands)
 
 
Commercial and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small
Business
 
Residential
Real Estate
 

Home Equity
 
Other Consumer
 
Total
 
Financing receivables ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans by group
$
842,833

 
$
2,338,641

 
$
276,593

 
$
81,435

 
$
536,822

 
$
854,646

 
$
16,885


$
4,947,855

(1
)
Individually evaluated for impairment
$
7,592

 
$
33,765

 
$
311

 
$
1,244

 
$
15,503

 
$
5,492

 
$
974

 
$
64,881

  
Purchase credit impaired loans
$

 
$
15,071

 
$
184

 
$

 
$
9,784

 
$
241

 
$
5

 
$
25,285

 
Collectively evaluated for impairment
$
835,241

 
$
2,289,805

 
$
276,098

 
$
80,191

 
$
511,535

 
$
848,913

 
$
15,906

 
$
4,857,689

  
 
December 31, 2013
 
 
(Dollars in thousands)
 
 
Commercial and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small
Business
 
Residential
Real Estate
 

Home Equity
 
Other Consumer
 
Total
 
Financing receivables ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans by group
$
784,202

 
$
2,249,260

 
$
223,859

 
$
77,240

 
$
541,443

 
$
822,141

 
$
20,162

 
$
4,718,307

(1
)
Individually evaluated for impairment
$
9,148

 
$
39,516

 
$
100

 
$
1,903

 
$
15,200

 
$
4,890

 
$
1,298

 
$
72,055

  
Purchase credit impaired loans
$
1

 
$
18,612

 
$
197

 
$

 
$
10,389

 
$
326

 
$
19

 
$
29,544

 
Collectively evaluated for impairment
$
775,053

 
$
2,191,132

 
$
223,562

 
$
75,337

 
$
515,854

 
$
816,925

 
$
18,845

 
$
4,616,708

  
 
(1)
The amount of net deferred fees included in the ending balance was $2.7 million and $2.3 million at September 30, 2014 and December 31, 2013.
The following tables summarize changes in allowance for loan losses by loan category for the periods indicated:
 
Three Months Ended September 30, 2014
 
(Dollars in thousands)
 
Commercial and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small
Business
 
Residential
Real Estate
 

Home Equity
 
Other Consumer
 
Total
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
15,929

 
$
25,095

 
$
3,757

 
$
1,154

 
$
2,879

 
$
4,969

 
$
755

 
$
54,538

Charge-offs
(504
)
 
(691
)
 

 
(73
)
 
(199
)
 
(160
)
 
(279
)
 
(1,906
)
Recoveries
6

 
57

 

 
29

 
178

 
67

 
135

 
472

Provision
91

 
1,248

 
356

 
45

 
(36
)
 
71

 
126

 
1,901

Ending balance
$
15,522

 
$
25,709

 
$
4,113

 
$
1,155

 
$
2,822

 
$
4,947

 
$
737

 
$
55,005



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Table of Contents

 
Three Months Ended September 30, 2013
 
(Dollars in thousands)
 
Commercial and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small
Business
 
Residential
Real Estate
 

Home Equity
 
Other Consumer
 
Total
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
14,325

 
$
23,029

 
$
3,422

 
$
1,295

 
$
2,959

 
$
7,267

 
$
679

 
$
52,976

Charge-offs
(866
)
 
(209
)
 
(308
)
 
(84
)
 
(210
)
 
(420
)
 
(273
)
 
(2,370
)
Recoveries
24

 
89

 

 
47

 
5

 
22

 
119

 
306

Provision
1,531

 
2,069

 
387

 
(43
)
 
141

 
(1,555
)
 
120

 
2,650

Ending balance
$
15,014

 
$
24,978

 
$
3,501

 
$
1,215

 
$
2,895

 
$
5,314

 
$
645

 
$
53,562


 
Nine Months Ended September 30, 2014
 
(Dollars in thousands)
 
Commercial and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small
Business
 
Residential
Real Estate
 

Home Equity
 
Other Consumer
 
Total
Allowance for loan losses
 
Beginning balance
$
15,622

 
$
24,541

 
$
3,371

 
$
1,215

 
$
2,760

 
$
5,036

 
$
694

 
$
53,239

Charge-offs
(1,757
)
 
(4,273
)
 

 
(469
)
 
(653
)
 
(562
)
 
(908
)
 
(8,622
)
Recoveries
213

 
322

 

 
168

 
368

 
215

 
449

 
1,735

Provision
1,444

 
5,119

 
742

 
241

 
347

 
258

 
502

 
8,653

Ending balance
$
15,522

 
$
25,709

 
$
4,113

 
$
1,155

 
$
2,822

 
$
4,947

 
$
737

 
$
55,005

Ending balance: Individually evaluated for impairment
$
541

 
$
315

 
$

 
$
10

 
$
1,521

 
$
269

 
$
43

 
$
2,699

Ending balance: Collectively evaluated for impairment
$
14,981

 
$
25,394

 
$
4,113

 
$
1,145

 
$
1,301

 
$
4,678

 
$
694

 
$
52,306

 
Nine Months Ended September 30, 2013
 
(Dollars in thousands)
 
Commercial and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small
Business
 
Residential
Real Estate
 

Home Equity
 
Other Consumer
 
Total
Allowance for loan losses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
13,461

 
$
22,598

 
$
2,811

 
$
1,524

 
$
2,930

 
$
7,703

 
$
807

 
$
51,834

Charge-offs
(2,591
)
 
(812
)
 
(308
)
 
(505
)
 
(457
)
 
(954
)
 
(794
)
 
(6,421
)
Recoveries
263

 
97

 

 
123

 
91

 
73

 
452

 
1,099

Provision
3,881

 
3,095

 
998

 
73

 
331

 
(1,508
)
 
180

 
7,050

Ending balance
$
15,014

 
$
24,978

 
$
3,501

 
$
1,215

 
$
2,895

 
$
5,314

 
$
645

 
$
53,562

Ending balance: Individually evaluated for impairment
$
1,174

 
$
2,150

 
$

 
$
111

 
$
1,651

 
$
112

 
$
83

 
$
5,281

Ending balance: Collectively evaluated for impairment
$
13,840

 
$
22,828

 
$
3,501

 
$
1,104

 
$
1,244

 
$
5,202

 
$
562

 
$
48,281

For the purpose of estimating the allowance for loan losses, management segregates the loan portfolio into the portfolio segments detailed in the above tables.  Each of these loan categories possesses unique risk characteristics that are considered when determining the appropriate level of allowance for each segment.  Some of the risk characteristics unique to each loan category include:

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Table of Contents

Commercial Portfolio
Commercial and Industrial: Loans in this category consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital and/or capital investment.  Collateral generally consists of pledges of business assets including, but not limited to: accounts receivable, inventory, plant & equipment, or real estate, if applicable. Repayment sources consist of: primarily, operating cash flow, and secondarily, liquidation of assets.
Commercial Real Estate: Loans in this category consist of mortgage loans to finance investment in real property such as multi-family residential, commercial/retail, office, industrial, hotels, educational and healthcare facilities and other specific use properties.  Loans are typically written with amortizing payment structures.  Collateral values are determined based upon third party appraisals and evaluations.  Loan to value ratios at origination are governed by established policy and regulatory guidelines. Repayment sources consist of: primarily, cash flow from operating leases and rents, and secondarily, liquidation of assets.
Commercial Construction: Loans in this category consist of short-term construction loans, revolving and nonrevolving credit lines and construction/permanent loans to finance the acquisition, development and construction or rehabilitation of real property.  Project types include: residential 1-4 family condominium and multi-family homes, commercial/retail, office, industrial, hotels, educational and healthcare facilities and other specific use properties.  Loans may be written with nonamortizing or hybrid payment structures depending upon the type of project.  Collateral values are determined based upon third party appraisals and evaluations.  Loan to value ratios at origination are governed by established policy and regulatory guidelines.  Repayment sources vary depending upon the type of project and may consist of: sale or lease of units, operating cash flows or liquidation of other assets.
Small Business: Loans in this category consist of revolving, term loan and mortgage obligations extended to sole proprietors and small businesses for purposes of financing working capital and/or capital investment.  Collateral generally consists of pledges of business assets including, but not limited to: accounts receivable, inventory, plant & equipment, or real estate if applicable.  Repayment sources consist of: primarily, operating cash flows, and secondarily, liquidation of assets.
For the commercial portfolio it is the Bank’s policy to obtain personal guarantees for payment from individuals holding material ownership interests of the borrowing entities.
Consumer Portfolio
Residential Real Estate: Residential mortgage loans held in the Bank’s portfolio are made to borrowers who demonstrate the ability to make scheduled payments with full consideration to underwriting factors such as current and expected income, employment status, current assets, other financial resources, credit history and the value of the collateral.  Collateral consists of mortgage liens on 1-4 family residential properties.  The Company does not originate or purchase sub-prime loans.
Home Equity: Home equity loans and lines are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied 1-4 family homes, condominiums or vacation homes or on nonowner occupied 1-4 family homes with more restrictive loan to value requirements. The home equity loan has a fixed rate and is billed in equal payments comprised of principal and interest. The home equity line of credit has a variable rate and is billed in interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Additionally, the Bank has the option of renewing the line of credit for additional draw periods.  Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan to value ratios within established policy guidelines.
Other Consumer: Other consumer loan products including personal lines of credit and amortizing loans made to qualified individuals for various purposes such as education, auto loans, debt consolidation, personal expenses or overdraft protection.  Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines.  These loans may be secured or unsecured.
Credit Quality
The Company continually monitors the asset quality of the loan portfolio using all available information. Based on this information, loans demonstrating certain payment issues or other weaknesses may be categorized as delinquent, impaired, nonperforming and/or put on nonaccrual status. Additionally, in the course of resolving such loans, the Company may choose to restructure the contractual terms of certain loans to match the borrower’s ability to repay the loan based on their current financial condition. If a restructured loan meets certain criteria, it may be categorized as a troubled debt restructuring (“TDR”).
The Company reviews numerous credit quality indicators when assessing the risk in its loan portfolio. For the commercial portfolio, the Company utilizes a 10-point commercial risk-rating system, which assigns a risk-grade to each borrower based on a number of quantitative and qualitative factors associated with a commercial loan transaction. Factors considered include industry and market conditions, position within the industry, earnings trends, operating cash flow, asset/liability values, debt capacity,

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guarantor strength, management and controls, financial reporting, collateral, and other considerations. The risk-ratings categories are defined as follows:
1- 6 Rating — Pass: Risk-rating grades “1” through “6” comprise those loans ranging from ‘Substantially Risk Free’ which indicates borrowers are of unquestioned credit standing and the pinnacle of credit quality, well established companies with a very strong financial condition, and loans fully secured by cash collateral, through ‘Acceptable Risk’, which indicates borrowers may exhibit declining earnings, strained cash flow, increasing leverage and/or weakening market fundamentals that indicate above average or below average asset quality, margins and market share. Collateral coverage is protective.
7 Rating — Potential Weakness: Borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s asset and position. While potentially weak, currently these borrowers are marginally acceptable; no loss of principal or interest is envisioned.
8 Rating — Definite Weakness Loss Unlikely: Borrowers exhibit well defined weaknesses that jeopardize the orderly liquidation of debt. Loan may be inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. However, there is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Collateral coverage may be inadequate to cover the principal obligation.
9 Rating — Partial Loss Probable: Borrowers exhibit well defined weaknesses that jeopardize the orderly liquidation of debt with the added provision that the weaknesses make collection of the debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely.
10 Rating — Definite Loss: Borrowers deemed incapable of repayment. Loans to such borrowers are considered uncollectible and of such little value that continuation as active assets of the Bank is not warranted.
The credit quality of the commercial loan portfolio is actively monitored and any changes in credit quality are reflected in risk-rating changes. Risk-ratings are assigned or reviewed for all new loans, when advancing significant additions to existing relationships (over $50,000), at least quarterly for all actively managed loans, and any time a significant event occurs, including at renewal of the loan.
The Company utilizes a comprehensive strategy for monitoring commercial credit quality. Borrowers are required to provide updated financial information at least annually which is carefully evaluated for any changes in credit quality. Larger loan relationships are subject to a full annual credit review by an experienced credit analysis group. Additionally, the Company retains an independent loan review firm to evaluate the credit quality of the commercial loan portfolio. The independent loan review process achieves significant penetration into the commercial loan portfolio and reports the results of these reviews to the Audit Committee of the Board of Directors on a quarterly basis.
The following table details the amount of outstanding principal balances relative to each of the risk-rating categories for the Company’s commercial portfolio:
 
 
 
September 30, 2014
Category
Risk
Rating
 
Commercial  and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small Business
 
Total
 
 
 
(Dollars in thousands)
Pass
1 - 6
 
$
781,106

 
$
2,172,537

 
$
260,854

 
$
77,108

 
$
3,291,605

Potential weakness
7
 
41,260

 
94,977

 
12,235

 
3,213

 
151,685

Definite weakness-loss unlikely
8
 
20,112

 
68,166

 
3,504

 
1,086

 
92,868

Partial loss probable
9
 
355

 
2,961

 

 
28

 
3,344

Definite loss
10
 

 

 

 

 

Total
 
 
$
842,833

 
$
2,338,641

 
$
276,593

 
$
81,435

 
$
3,539,502



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December 31, 2013
Category
Risk
Rating
 
Commercial  and
Industrial
 
Commercial
Real Estate
 
Commercial
Construction
 
Small Business
 
Total
 
 
 
(Dollars in thousands)
Pass
1 - 6
 
$
736,996

 
$
2,068,995

 
$
210,372

 
$
71,514

 
$
3,087,877

Potential weakness
7
 
21,841

 
91,984

 
8,608

 
3,031

 
125,464

Definite weakness-loss unlikely
8
 
24,409

 
85,767

 
4,779

 
2,552

 
117,507

Partial loss probable
9
 
956

 
2,514

 
100

 
143

 
3,713

Definite loss
10
 

 

 

 

 

Total
 
 
$
784,202

 
$
2,249,260

 
$
223,859

 
$
77,240

 
$
3,334,561

For the Company’s consumer portfolio, the quality of the loan is best indicated by the repayment performance of an individual borrower. However, the Company does supplement performance data with current Fair Isaac Corporation (“FICO”) and Loan to Value (“LTV”) estimates. Current FICO data is purchased and appended to all consumer loans on a quarterly basis. In addition, automated valuation services and broker opinions of value are used to supplement original value data for the residential and home equity portfolios, periodically. The following table shows the weighted average FICO scores and the weighted average combined LTV ratios as of the periods indicated below:
 
September 30,
2014
 
December 31,
2013
Residential portfolio
 
 
 
FICO score (re-scored) (1)
738

 
738

LTV (re-valued) (2)
67.4
%
 
67.0
%
Home equity portfolio
 
 
 
FICO score (re-scored) (1)
764

 
763

LTV (re-valued) (2)
53.4
%
 
53.0
%
 
(1)
The average FICO scores for September 30, 2014 are based upon rescores available from August 30, 2014 and origination score data for loans booked between September 1 and September 30, 2014. The average FICO scores for December 31, 2013 are based upon rescores available from November 30, 2013 and origination score data for loans booked between December 1, 2013 and December 31, 2013.
(2)
The combined LTV ratios for September 30, 2014 are based upon updated automated valuations as of February 28, 2013 and origination value data for loans booked between March 1, 2013 and September 30, 2014. The combined LTV ratios for December 31, 2013 are based upon updated automated valuations as of February 28, 2013 and origination value data for loans booked from March 1, 2013 through December 31, 2013. For home equity loans and lines in a subordinate lien, the LTV data represents a combined LTV, taking into account the senior lien data for loans and lines.
The Bank’s philosophy toward managing its loan portfolios is predicated upon careful monitoring, which stresses early detection and response to delinquent and default situations. Delinquent loans are managed by a team of seasoned collection specialists and the Bank seeks to make arrangements to resolve any delinquent or default situation over the shortest possible time frame. As a general rule, loans more than 90 days past due with respect to principal or interest are classified as nonaccrual loans. As permitted by banking regulations, certain consumer loans 90 days or more past due may continue to accrue interest. The Company also may use discretion regarding other loans over 90 days delinquent if the loan is well secured and in process of collection. Set forth is information regarding the Company’s nonaccrual, delinquent, TDRs, and impaired loans at the period shown.

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The following table shows nonaccrual loans at the dates indicated:

 
September 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
Commercial and industrial
$
2,321

 
$
4,178

Commercial real estate
6,201

 
11,734

Commercial construction
311

 
100

Small business
278

 
633

Residential real estate
9,088

 
10,329

Home equity
7,672

 
7,068

Other consumer
9

 
92

Total nonaccrual loans (1)
$
25,880

 
$
34,134


(1)
Included in these amounts were $5.7 million and $7.5 million of nonaccruing TDRs at September 30, 2014 and December 31, 2013, respectively.
The following table shows the age analysis of past due financing receivables as of the dates indicated:
 
September 30, 2014
 
30-59 days
 
60-89 days
 
90 days or more
 
Total Past Due
 
 
 
Total
Financing
Receivables
 
Recorded
Investment
>90 Days
and Accruing
 
Number
of Loans
 
Principal
Balance
 
Number
of Loans
 
Principal
Balance
 
Number
of Loans
 
Principal
Balance
 
Number
of Loans
 
Principal
Balance
 
Current
 
 
(Dollars in thousands)
Loan Portfolio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
12

 
$
2,871

 
2

 
$
560

 
16

 
$
2,069

 
30

 
$
5,500

 
$
837,333

 
$
842,833

 
$

Commercial real estate
9

 
7,001

 
9

 
4,088

 
16

 
4,221

 
34

 
15,310

 
2,323,331

 
2,338,641

 

Commercial construction

 

 

 

 
1

 
311

 
1

 
311

 
276,282

 
276,593

 

Small business
8

 
168

 
4

 
23

 
4

 
158

 
16

 
349

 
81,086

 
81,435

 

Residential real estate
15

 
3,547

 
12

 
1,480

 
35

 
5,184

 
62

 
10,211

 
526,611

 
536,822

 
217

Home equity
12

 
1,068

 
7

 
431

 
28

 
2,491

 
47

 
3,990

 
850,656

 
854,646

 

Other consumer
37

 
174

 
17

 
48

 
10

 
31

 
64

 
253

 
16,632

 
16,885

 
22

Total
93

 
$
14,829

 
51

 
$
6,630

 
110

 
$
14,465

 
254

 
$
35,924

 
$
4,911,931

 
$
4,947,855

 
$
239

 
December 31, 2013
 
30-59 days
 
60-89 days
 
90 days or more
 
Total Past Due
 
 
 
Total
Financing
Receivables
 
Recorded
Investment
>90 Days
and Accruing
 
Number
of Loans
 
Principal
Balance
 
Number
of Loans
 
Principal
Balance
 
Number
of Loans
 
Principal
Balance
 
Number
of Loans
 
Principal
Balance
 
Current
 
 
(Dollars in thousands)
Loan Portfolio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
9

 
$
743

 
6

 
$
327

 
20

 
$
3,763

 
35

 
$
4,833

 
$
779,369

 
$
784,202

 
$

Commercial real estate
21

 
8,643

 
2

 
356

 
30

 
8,155

 
53

 
17,154

 
2,232,106

 
2,249,260

 

Commercial construction
1

 
847

 

 

 
1

 
100

 
2

 
947

 
222,912

 
223,859

 

Small business
18

 
353

 
6

 
227

 
14

 
247

 
38

 
827

 
76,413

 
77,240

 

Residential real estate
23

 
2,903

 
8

 
1,630

 
39

 
6,648

 
70

 
11,181

 
530,262

 
541,443

 
462

Home equity
27

 
1,922

 
8

 
852

 
23

 
2,055

 
58

 
4,829

 
817,312

 
822,141

 

Other consumer
110

 
514

 
30

 
106

 
34

 
148

 
174

 
768

 
19,394

 
20,162

 
63

Total
209

 
$
15,925

 
60

 
$
3,498

 
161

 
$
21,116

 
430

 
$
40,539

 
$
4,677,768

 
$
4,718,307

 
$
525

In the course of resolving nonperforming loans, the Bank may choose to restructure the contractual terms of certain loans. The Bank attempts to work out an alternative payment schedule with the borrower in order to avoid foreclosure actions. Any

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loans that are modified are reviewed by the Bank to identify if a TDR has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two.
The following table shows the Company’s total TDRs and other pertinent information as of the dates indicated:
 
September 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
TDRs on accrual status
$
40,140

 
$
38,410

TDRs on nonaccrual
5,709

 
7,454

Total TDRs
$
45,849

 
$
45,864

Amount of specific reserves included in the allowance for loan losses associated with TDRs:
$
2,097

 
$
2,474

Additional commitments to lend to a borrower who has been a party to a TDR:
$
1,064

 
$
1,877

The Bank’s policy is to have any restructured loan which is on nonaccrual status prior to being modified remain on nonaccrual status for six months, subsequent to being modified, before management considers its return to accrual status. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. Additionally, loans classified as TDRs are adjusted to reflect the changes in value of the recorded investment in the loan, if any, resulting from the granting of a concession. For all residential loan modifications, the borrower must perform during a 90 day trial period before the modification is finalized.
The following table shows the modifications which occurred during the periods indicated and the change in the recorded investment subsequent to the modifications occurring:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2014
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment (1)
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment (1)
 
(Dollars in thousands)
Troubled debt restructurings
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
3

 
$
193

 
$
193

 
12

 
$
744

 
$
744

Commercial real estate
5

 
2,095

 
2,095

 
13

 
4,225

 
4,225

Small business

 

 

 
1

 
58

 
58

Residential real estate
1

 
156

 
158

 
8

 
1,388

 
1,419

Home equity
2

 
55

 
55

 
9

 
781

 
781

Other consumer

 

 

 
1

 
8

 
8

Total
11

 
$
2,499

 
$
2,501

 
44

 
$
7,204

 
$
7,235

 

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Table of Contents

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2013
 
September 30, 2013
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment (1)
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment (1)
 
(Dollars in thousands)
Troubled debt restructurings
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
1

 
$
37

 
$
37

 
3

 
$
319

 
$
319

Commercial real estate
2

 
463

 
463

 
4

 
1,526

 
1,526

Small business
4

 
261

 
261

 
9

 
543

 
543

Residential real estate
1

 
228

 
228

 
7

 
2,128

 
2,154

Home equity
1

 
184

 
184

 
4

 
378

 
378

Other consumer

 

 

 
2

 
11

 
11

Total
9

 
$
1,173

 
$
1,173

 
29

 
$
4,905

 
$
4,931

 
(1)
The post-modification balances represent the balance of the loan on the date of modifications. These amounts may show an increase when modifications include a capitalization of interest.
The following table shows the Company’s post-modification balance of TDRs listed by type of modification during the period indicated:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
 
(Dollars in thousands)
Extended maturity
$
1,902

 
$
438

 
$
3,403

 
$
1,429

Adjusted interest rate

 

 
726

 

Combination rate & maturity
599

 
735

 
2,269

 
3,491

Court ordered concession

 

 
837

 
11

Total
$
2,501

 
$
1,173

 
$
7,235

 
$
4,931

The Company considers a loan to have defaulted when it reaches 90 days past due. The following table shows the loans that have been modified during the past twelve months which have subsequently defaulted during the periods indicated.
 
Three Months Ended September 30
 
2014
 
2013
 
Number
of Contracts
 
Recorded
Investment
 
Number
of Contracts
 
Recorded
Investment
 
(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted
 
 
 
 
 
 
 
Commercial and industrial
1

 
$
46

 

 
$

Residential real estate
1

 
87

 

 

 
2

 
$
133

 

 
$




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Table of Contents

 
Nine Months Ended September 30
 
2014
 
2013
 
Number
of Contracts
 
Recorded
Investment
 
Number
of Contracts
 
Recorded
Investment
 
(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted
 
 
 
 
 
 
 
Commercial and industrial
1

 
$
46

 
1

 
$
1,614

Small business

 

 
1

 
231

Residential real estate
3

 
214

 

 

Total
4

 
$
260

 
2

 
$
1,845

All TDR loans are considered impaired and therefore are subject to a specific review for impairment. The impairment analysis appropriately discounts the present value of the anticipated cash flows by the loan’s contractual rate of interest in effect prior to the loan’s modification. The amount of impairment, if any, is recorded as a specific loss allocation to each individual loan in the allowance for loan losses. Commercial loans (commercial and industrial, commercial construction, commercial real estate and small business loans), residential loans, and home equity loans that have been classified as TDRs and which subsequently default are reviewed to determine if the loan should be deemed collateral dependent. In such an instance, any shortfall between the value of the collateral and the carrying value of the loan is determined by measuring the recorded investment in the loan against the fair value of the collateral less estimated costs to sell. The Bank charges off the amount of any confirmed loan loss in the period when the loans, or portion of loans, are deemed uncollectible. Smaller balance consumer TDR loans are reviewed for performance to determine when a charge-off is appropriate.
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. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.




25

Table of Contents

The tables below set forth information regarding the Company’s impaired loans by loan portfolio at the dates indicated:
 
September 30, 2014
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
(Dollars in thousands)
With no related allowance recorded
 
 
 
 
 
Commercial and industrial
$
3,827

 
$
4,085

 
$

Commercial real estate
16,297

 
17,979

 

Commercial construction
311

 
311

 

Small business
824

 
860

 

Residential real estate
2,794

 
2,852

 

Home equity
4,387

 
4,434

 

Other consumer
360

 
363

 

Subtotal
28,800

 
30,884

 

With an allowance recorded
 
 
 
 
 
Commercial and industrial
$
3,765

 
$
4,341

 
$
541

Commercial real estate
17,468

 
17,781

 
315

Small business
420

 
455

 
10

Residential real estate
12,709

 
13,909

 
1,521

Home equity
1,105

 
1,201

 
269

Other consumer
614

 
616

 
43

Subtotal
36,081

 
38,303

 
2,699

Total
$
64,881

 
$
69,187

 
$
2,699

 
December 31, 2013
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
(Dollars in thousands)
With no related allowance recorded
 
 
 
 
 
Commercial and industrial
$
7,147

 
$
7,288

 
$

Commercial real estate
14,283

 
15,891

 

Commercial construction
100

 
408

 

Small business
1,474

 
1,805

 

Residential real estate
1,972

 
2,026

 

Home equity
4,263

 
4,322

 

Other consumer
446

 
446

 

Subtotal
29,685

 
32,186

 

With an allowance recorded
 
 
 
 
 
Commercial and industrial
$
2,001

 
$
2,045

 
$
1,150

Commercial real estate
25,233

 
25,377

 
765

Small business
429

 
462

 
109

Residential real estate
13,228

 
14,197

 
1,564

Home equity
627

 
694

 
116

Other consumer
852

 
856

 
70

Subtotal
42,370

 
43,631

 
3,774

Total
$
72,055

 
$
75,817

 
$
3,774

The following tables set forth information regarding interest income recognized on impaired loans, by portfolio, for the periods indicated:

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Table of Contents

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2014
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(Dollars in thousands)
With no related allowance recorded
 
 
 
 
 
 
 
Commercial and industrial
$
4,411

 
$
63

 
$
4,743

 
$
194

Commercial real estate
16,517

 
263

 
17,098

 
787

Commercial construction
311

 
3

 
311

 
10

Small business
840

 
13

 
889

 
40

Residential real estate
2,806

 
48

 
2,836

 
90

Home equity
4,405

 
51

 
4,456

 
154

Other consumer
365

 
5

 
382

 
18

Subtotal
29,655

 
446

 
30,715

 
1,293

With an allowance recorded
 
 
 
 
 
 
 
Commercial and industrial
$
3,889

 
$
52

 
$
4,285

 
$
160

Commercial real estate
17,509

 
246

 
17,674

 
734

Small business
427

 
7

 
452

 
23

Residential real estate
12,841

 
132

 
12,959

 
395

Home equity
1,111

 
12

 
1,124

 
30

Other consumer
625

 
5

 
656

 
17

Subtotal
36,402

 
454

 
37,150

 
1,359

Total
$
66,057

 
$
900

 
$
67,865

 
$
2,652

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2013
 
September 30, 2013
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(Dollars in thousands)
With no related allowance recorded
 
 
 
 
 
 
 
Commercial and industrial
$
7,553

 
$
91

 
$
7,762

 
$
275

Commercial real estate
15,175

 
262

 
15,638

 
788

Commercial construction
1,105

 
13

 
1,441

 
39

Small business
1,479

 
26

 
1,631

 
79

Residential real estate
2,159

 
24

 
2,221

 
68

Home equity
3,570

 
41

 
3,604

 
126

Other consumer
500

 
9

 
543

 
32

Subtotal
31,541

 
466

 
32,840

 
1,407

With an allowance recorded
 
 
 
 
 
 
 
Commercial and industrial
$
2,360

 
$
30

 
$
2,684

 
$
96

Commercial real estate
24,984

 
330

 
25,128

 
1,013

Small business
624

 
10

 
652

 
30

Residential real estate
13,773

 
135

 
13,884

 
391

Home equity
575

 
6

 
585

 
18

Other consumer
973

 
9

 
1,041

 
27

Subtotal
43,289

 
520

 
43,974

 
1,575

Total
$
74,830

 
$
986

 
$
76,814

 
$
2,982



27

Table of Contents

Certain loans acquired by the Company may have shown evidence of deterioration of credit quality since origination and it was therefore deemed unlikely that the Bank would be able to collect all contractually required payments. As such, these loans were deemed to be Purchase Credit Impaired (“PCI”) loans and the carrying value and prospective income recognition are predicated upon future cash flows expected to be collected. The following table displays certain information pertaining to purchased credit impaired loans at the dates indicated:
 
September 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
Outstanding balance
$
28,578

 
$
33,555

Carrying amount
$
25,285

 
$
29,544


The following table summarizes activity in the accretable yield for the PCI loan portfolio:
 
(Dollars in thousands)
Balance at January 1, 2013
$
2,464

Acquisition
386

Accretion
(1,812
)
Other change in expected cash flows (2)
1,142

Reclassification from nonaccretable difference for loans with improved cash flows (1)
334

Balance at December 31, 2013
$
2,514

Accretion
(1,722
)
Other change in expected cash flows (2)
2,572

Reclassification from nonaccretable difference for loans with improved cash flows (1)
194

Balance at September 30, 2014
$
3,558

(1) Results in increased interest income during the period in which the loan paid off.
(2) Represents changes in cash flows expected to be collected and resulting in increased interest income as a prospective yield adjustment over the remaining life of the loan(s).

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Table of Contents


NOTE 5 - EARNINGS PER SHARE
Earnings per share consisted of the following components for the periods indicated:

 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands, except per share data)
Net income
$
15,738

 
$
14,655

 
$
43,867

 
$
39,665

 
 
 
 
 
 
 
 
Weighted Average Shares
 
 
 
Basic shares
23,911,678

 
22,946,308

 
23,876,391

 
22,886,521

Effect of diluted securities
90,685

 
100,806

 
95,320

 
72,799

Dilutive shares
24,002,363

 
23,047,114

 
23,971,711

 
22,959,320

 
 
 
 
 
 
 
 
Net income per share
 
 
 
 
 
 
 
Basic EPS
$
0.66

 
$
0.64

 
$
1.84

 
$
1.73

Effect of diluted securities

 

 
(0.01
)
 

Dilutive EPS
$
0.66

 
$
0.64

 
$
1.83

 
$
1.73

The following table illustrates the options to purchase common stock and the shares of performance-based restricted stock that were excluded from the calculation of diluted earnings per share because they were anti-dilutive:
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
Stock options

 

 

 
125,241

Performance-based restricted stock

 

 

 



29

Table of Contents




NOTE 6 - STOCK BASED COMPENSATION
Time Vested Restricted Stock Awards
During the nine months ended September 30, 2014, the Company made the following awards of restricted stock:
Date
 
Shares Granted
 
Plan
 
Grant Date Fair Value
 
Vesting Period
3/20/2014
 
65,950

 
2005 Employee Stock Plan
 
$
39.82

 
Ratably over 5 years from grant date
3/31/2014
 
3,000

 
2005 Employee Stock Plan
 
$
39.00

 
Ratably over 3 years from grant date
5/20/2014
 
10,920

 
2010 Non-Employee Director Stock Plan
 
$
35.08

 
At the end of 5 years from grant date
The fair value of the restricted stock awards is based upon the average of the high and low price at which the Company’s common stock traded on the date of grant. The holders of restricted stock awards participate fully in the rewards of stock ownership of the Company, including voting and dividend rights.
Performance-Based Restricted Stock Awards
On March 20, 2014, the Company granted 20,700 performance-based restricted stock awards to certain executive level employees. These performance-based restricted stock awards were issued from the 2005 Employee Stock Plan and were determined to have a grant date fair value per share of $39.82. The number of shares to be vested will be contingent upon the Company's attainment of certain performance measures outlined in the award agreement and will be measured as of the end of the three year performance period, or December 31, 2016. These awards will be accounted for as equity awards due to the nature of these awards and the fact that these shares will not be settled in cash.
The fair value of the performance-based restricted stock awards, assuming achievement at target, is based upon the average of the high and low price at which the Company’s common stock traded on the date of grant. The holders of these awards are not entitled to receive dividends on or vote shares of performance-based restricted shares until vested.
Stock Options
The Company has not issued any awards of options to purchase shares of common stock during nine months ended September 30, 2014.

NOTE 7 - DERIVATIVE AND HEDGING ACTIVITIES
The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally to manage the Company’s interest rate risk. Additionally, the Company enters into interest rate derivatives and foreign exchange contracts to accommodate the business requirements of its customers (“customer related positions”). The Company minimizes the market and liquidity risks of customer related positions by entering into similar offsetting positions with broker-dealers. Derivative instruments are carried at fair value in the Company’s financial statements. The accounting for changes in the fair value of a derivative instrument is dependent upon whether or not it qualifies as a hedge for accounting purposes, and further, by the type of hedging relationship.
The Company does not enter into proprietary trading positions for any derivatives.
Interest Rate Positions
The Company currently utilizes interest rate swap agreements as hedging instruments against interest rate risk associated with the Company’s borrowings. An interest rate swap is an agreement whereby one party agrees to pay a floating rate of interest on a notional principal amount in exchange for receiving a fixed rate of interest on the same notional amount, for a predetermined period of time, from a second party. The amounts relating to the notional principal amount are not actually exchanged. The maximum length of time over which the Company is currently hedging its exposure to the variability in future cash flows for forecasted transactions related to the payment of variable interest on existing financial instruments is four years.

30

Table of Contents

The following table reflects the Company’s derivative positions for the periods indicated below for interest rate swaps which qualify as cash flow hedges for accounting purposes:

September 30, 2014
Notional Amount
 
Trade Date
 
Effective Date
 
Maturity Date
 
Receive (Variable) Index
 
Current  Rate Received
 
Pay Fixed Swap Rate
 
Fair Value
(Dollars in thousands)
$
25,000

 
16-Feb-06
 
28-Dec-06
 
28-Dec-16
 
3 Month LIBOR
 
0.23
%
 
5.04
%
 
$
(2,318
)
25,000

 
16-Feb-06
 
28-Dec-06
 
28-Dec-16
 
3 Month LIBOR
 
0.23
%
 
5.04
%
 
(2,319
)
25,000

 
9-Dec-08
 
10-Dec-08
 
10-Dec-18
 
3 Month LIBOR
 
0.23
%
 
2.94
%
 
(1,286
)
$
75,000

 
 
 
 
 
 
 
 
 
 
 
 
 
$
(5,923
)
December 31, 2013
Notional Amount
 
Trade Date
 
Effective Date
 
Maturity Date
 
Receive (Variable) Index
 
Current  Rate Received
 
Pay Fixed Swap Rate
 
Fair Value
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
$
25,000

 
16-Feb-06
 
28-Dec-06
 
28-Dec-16
 
3 Month LIBOR
 
0.24
%
 
5.04
%
 
$
(3,151
)
25,000

 
16-Feb-06
 
28-Dec-06
 
28-Dec-16
 
3 Month LIBOR
 
0.24
%
 
5.04
%
 
(3,152
)
25,000

 
9-Dec-08
 
10-Dec-08
 
10-Dec-18
 
3 Month LIBOR
 
0.24
%
 
2.94
%
 
(1,493
)
50,000

 
17-Nov-09
 
20-Dec-10
 
20-Dec-14
 
3 Month LIBOR
 
0.25
%
 
3.04
%
 
(1,341
)
25,000

 
5-May-11
 
10-Jun-11
 
10-Jun-15
 
3 Month LIBOR
 
0.24
%
 
1.71
%
 
(493
)
$
150,000

 
 
 
 
 
 
 
 
 
 
 
 
 
$
(9,630
)
For derivative instruments that are designated and qualify as cash flow hedging instruments, the effective portion of the gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  The Company expects approximately $2.8 million (pre-tax) to be reclassified to interest expense from OCI related to the Company’s cash flow hedges in the next twelve months.  This reclassification is due to anticipated payments that will be made and/or received on the swaps based upon the forward curve as of September 30, 2014.
The Company recognized $61,000 and $183,000 of net amortization income that was an offset to interest expense related to previously terminated swaps for both the three and nine month periods ended September 30, 2014 and 2013, respectively.
In June 2014, the Company repaid certain borrowings and consequently terminated the corresponding cash flow hedges. As a result of the termination of the cash flow hedges, the Company reclassified a pre-tax loss of approximately $1.1 million out of OCI and into noninterest expense.
The Company had no fair value hedges as of September 30, 2014 or December 31, 2013.
Customer Related Positions
Loan level derivatives, primarily interest rate swaps, offered to commercial borrowers through the Bank’s loan level derivative program do not qualify as hedges for accounting purposes. The Bank believes that its exposure to commercial customer derivatives is limited because these contracts are simultaneously matched at inception with an offsetting dealer transaction. The commercial customer derivative program allows the Bank to retain variable-rate commercial loans while allowing the customer to synthetically fix the loan rate by entering into a variable-to-fixed interest rate swap.
Foreign exchange contracts offered to commercial borrowers through the Bank’s derivative program do not qualify as hedges for accounting purposes. The Bank acts as a seller and buyer of foreign exchange contracts to accommodate its customers. To mitigate the market and liquidity risk associated with these derivatives, the Bank enters into similar offsetting positions.

31

Table of Contents

The following table reflects the Company’s customer related derivative positions for the periods indicated below for those derivatives not designated as hedging:

 
 
 
Notional Amount Maturing
 
 
 
Number of  Positions (1)
 
Less than 1 year
 
Less than 2 years
 
Less than 3 years
 
Less than 4 years
 
Thereafter
 
Total
 
Fair Value
 
September 30, 2014
 
(Dollars in thousands)
Loan level derivatives
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Receive fixed, pay variable
172

 
$
47,702

 
85,305

 
27,960

 
44,931

 
382,700

 
$
588,598

 
$
12,300

Pay fixed, receive variable
166

 
$
47,702

 
85,305

 
27,960

 
44,931

 
382,700

 
$
588,598

 
$
(12,309
)
Foreign exchange contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Buys foreign currency, sells US currency
27

 
$
64,914

 

 

 

 

 
$
64,914

 
$
4,040

Buys US currency, sells foreign currency
27

 
$
64,914

 

 

 

 

 
$
64,914

 
$
(4,012
)
 
December 31, 2013
 
(Dollars in thousands)
Loan level derivatives
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Receive fixed, pay variable
168

 
$
48,882

 
97,975

 
42,957

 
42,116

 
329,554

 
$
561,484

 
$
9,484

Pay fixed, receive variable
162

 
$
48,882

 
97,975

 
42,957

 
42,116

 
329,554

 
$
561,484

 
$
(9,523
)
Foreign exchange contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Buys foreign currency, sells US currency
6

 
$
11,367

 

 

 

 

 
$
11,367

 
$
396

Buys US currency, sells foreign currency
6

 
$
11,367

 

 

 

 

 
$
11,367

 
$
(390
)
 
(1)
The Company may enter into one dealer swap agreement which offsets multiple commercial borrower swap agreements.
Mortgage Derivatives
Prior to closing and funding certain one-to-four family residential mortgage loans, an interest rate lock commitment is generally extended to the borrower. During the period from commitment date to closing date, the Company is subject to the risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments are executed, under which the Company agrees to deliver whole mortgage loans to various investors. In addition, the Company may also enter into additional Forward To Be Announced ("TBA") mortgage contracts, also considered derivative instruments, which are purchased by the Company from a diversified list of counterparties in order to hedge customer rate locks. These forward contracts carry a market price that has a strong inverse relationship to that of mortgage prices. When the Company locks a rate to the customer, the rate can be held for the benefit of the customer for a certain period of time until the mortgage is sold. During that time, the Company may not have agreed on a price with a mortgage investor and fluctuations in market conditions may cause the mortgage to lose market value. Within a short period after the rate is locked with the customer, the Company may, depending upon the effectiveness of existing hedges, execute a Forward TBA trade with a counterparty to hedge that market risk. Certain assumptions, including pull through rates and rate lock periods, are used in managing the existing and future hedges. The effectiveness of the hedges rely on the accuracy of these assumptions.
    
The change in fair value on the interest rate lock commitments, forward delivery sale commitments, and forward TBA mortgage contracts are recorded in current period earnings as a component of mortgage banking income. In addition, the Company has elected the fair value option to carry loans held for sale at fair value. The change in fair value of loans held for sale is recorded in current period earnings as a component of mortgage banking income in accordance with the Company's fair value election. The change in fair value associated with loans held for sale was a decrease of $223,000 and an increase of $1.6 million for the

32

Table of Contents

three months ended September 30, 2014 and 2013, respectively, and an increase of $1,000 and $274,000 for the nine months ended September 30, 2014 and 2013, respectively. These amounts were offset in earnings by the change in the fair value of mortgage derivatives.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheet at the periods indicated:
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet
Location
 
Fair Value at September 30, 2014
 
Fair Value at December 31, 2013
 
Balance Sheet
Location
 
Fair Value at September 30, 2014
 
Fair Value at December 31, 2013
 
(Dollars in thousands)
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
Interest rate derivatives
Other assets
 
$

 
$

 
Other liabilities
 
$
5,923

 
$
9,630

Derivatives not designated as hedges
 
 
 
 
 
 
 
 
 
 
 
Customer Related Positions:
 
 
 
 
 
 
 
 
 
 
 
Loan level derivatives
Other assets
 
$
14,820

 
$
16,301

 
Other liabilities
 
$
14,829

 
$
16,340

Foreign exchange contracts
Other assets
 
4,040

 
396

 
Other liabilities
 
4,012

 
390

Mortgage Derivatives:
 
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments
Other assets
 
280

 
204

 
Other liabilities
 

 

Forward TBA mortgage contracts
Other assets
 

 
64

 
Other liabilities
 
14

 

Forward sales agreements
Other assets
 
10

 

 
Other liabilities
 

 
35

Total
 
 
$
19,150

 
$
16,965

 
 
 
$
18,855

 
$
16,765

The table below presents the effect of the Company’s derivative financial instruments included in OCI and current earnings for the periods indicated:
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
 
(Dollars in thousands)
Derivatives designated as hedges
 
 
 
 
 
 
 
Gain in OCI on derivatives (effective portion), net of tax
$
578

 
$
455

 
$
2,085

 
$
2,907

Loss reclassified from OCI into interest expense (effective portion)
$
726

 
$
1,464

 
$
2,937

 
$
4,322

Loss reclassified from OCI into noninterest expense (loss on termination)
$

 
$

 
$
1,121

 
$

Loss recognized in income on derivatives (ineffective portion & amount excluded from effectiveness testing)
 
 
 
 
 
 
 
Interest expense
$

 
$

 
$

 
$

Other expense

 

 

 

Total
$

 
$

 
$

 
$

Derivatives not designated as hedges
 
 
 
 
 
 
 
Changes in fair value of customer related positions
 
 
 
 
 
 
 
Other income
$
10

 
$
1

 
$
54

 
$
27

Other expense
(1
)
 
(27
)
 
(3
)
 
(108
)
Changes in fair value of mortgage derivatives
 
 
 
 
 
 
 
Mortgage banking income
42

 
(1,101
)
 
43

 
247

Total
$
51

 
$
(1,127
)
 
$
94

 
$
166



33

Table of Contents

By using derivatives, the Company is exposed to credit risk to the extent that counterparties to the derivative contracts do not perform as required. Should a counterparty fail to perform under the terms of a derivative contract, the Company's credit exposure on interest rate swaps is limited to the net positive fair value and accrued interest of all swaps with each counterparty. The Company seeks to minimize counterparty credit risk through credit approvals, limits, monitoring procedures, and obtaining collateral, where appropriate. Institutional counterparties must have an investment grade credit rating and be approved by the Company's Board of Directors. As such, management believes the risk of incurring credit losses on derivative contracts with those counterparties is remote and losses, if any, would be immaterial. The Company had $1.3 million and $3.4 million in exposure (inclusive of accrued interest) relating to institutional counterparties at September 30, 2014 and December 31, 2013, respectively. The Company’s exposure (inclusive of accrued interest) relating to customer counterparties was approximately $14.3 million and $13.6 million at September 30, 2014 and December 31, 2013, respectively. Additionally, credit exposure may be reduced by the amount of collateral pledged by the counterparty.

NOTE 8 - BALANCE SHEET OFFSETTING
The Company does not offset fair value amounts recognized for derivative instruments or repurchase agreements. The Company does net the amount recognized for the right to reclaim cash collateral against the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement. Collateral legally required to be maintained at dealer banks by the Company is monitored and adjusted as necessary. At September 30, 2014, it was determined that no additional collateral would have to be posted to immediately settle these instruments.
The following tables present the Company's asset and liability derivative positions and the potential effect of netting arrangements on its financial position, as of the periods indicated:
 
 
 
 
Gross Amounts Not Offset in the Statement of Financial Position
 
 
Gross Amounts Recognized in the Statement of Financial Position
Gross Amounts Offset in the Statement of Financial Position
Net Amounts Presented in the Statement of Financial Position
Financial Instruments (1)
Collateral Pledged (Received)
Net Amount
 
September 30, 2014
 
(Dollars in thousands)
Derivative Assets
 
Interest rate swaps
$

$

$

$

$

$

Loan level derivatives
14,820


14,820

1,260


13,560

Customer foreign exchange contracts
4,040


4,040



4,040

 
$
18,860

$

$
18,860

$
1,260

$

$
17,599

 
 
 
 
 
 
 
Derivative Liabilities
 
Interest rate swaps
$
5,923

$

$
5,923

$

$
5,923

$

Loan level derivatives
14,829


14,829

1,260

12,308

1,260

Customer foreign exchange contracts
4,012


4,012



4,012

Repurchase agreements
 
 

 
 

Customer repurchase agreements
153,192


153,192


151,953

1,239

Wholesale repurchase agreements
50,000


50,000


50,000


 
$
227,956

$

$
227,956

$
1,260

$
220,184

$
6,511

(1)
Includes loan level swaps which are not subject to a master netting arrangement and thus are not offset in the statement of financial position.


34

Table of Contents

 
 
 
 
Gross Amounts Not Offset in the Statement of Financial Position
 
 
Gross Amounts Recognized in the Statement of Financial Position
Gross Amounts Offset in the Statement of Financial Position
Net Amounts Presented in the Statement of Financial Position
Financial Instruments
Collateral Pledged (Received)
Net Amount
 
December 31, 2013
 
(Dollars in thousands)
Derivative Assets
 
Interest rate swaps
$

$

$

$

$

$

Loan level swaps
16,301


16,301

2,823


13,478

Customer foreign exchange contracts
396


396



396

 
$
16,697

$

$
16,697

$
2,823

$

$
13,874

 
 
 
 
 
 
 
Derivative Liabilities
 
Interest rate swaps
$
9,630

$

$
9,630

$

$
9,630

$

Loan level swaps
16,340


16,340

2,823

10,108

3,409

Customer foreign exchange contracts
390


390



390

Repurchase agreements
 
 
 
 
 
 
Customer repurchase agreements
149,288


149,288


149,288


Wholesale repurchase agreements
50,000


50,000


50,000


 
$
225,648

$

$
225,648

$
2,823

$
219,026

$
3,799


The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well capitalized institution, then the Company could be required to terminate any outstanding derivatives with the counterparty. All liability position interest rate swap and customer loan level swap counterparties have credit-risk contingent features as of the dates indicated in the table above. In addition, derivative instruments that contain credit-risk related contingent features that are in a net liability position require the Company to assign collateral as noted in the table above.

NOTE 9 - FAIR VALUE MEASUREMENTS
Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. If there has been a significant decrease in the volume and level of activity for the asset or liability, regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. The Company uses prices and inputs that are current as of the measurement date. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from one level to another.
The Fair Value Measurements and Disclosures Topic of the FASB ASC defines fair value and establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under the Fair Value Measurements and Disclosures Topic of the FASB ASC are described below:
Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

35

Table of Contents

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Valuation Techniques
There have been no changes in the valuation techniques used during the current period.
Securities:
U.S. Government Agency Securities
Fair value is estimated using either multi-dimensional spread tables or benchmarks. The inputs used include benchmark yields, reported trades, and broker/dealer quotes. These securities are classified as Level 2.
Agency Mortgage-Backed Securities
Fair value is estimated using either a matrix or benchmarks. The inputs used include benchmark yields, reported trades, broker/dealer quotes, and issuer spreads. These securities are categorized as Level 2.
Agency Collateralized Mortgage Obligations
The valuation model for these securities is volatility-driven and ratings based, and uses multi-dimensional spread tables. The inputs used include benchmark yields, recent reported trades, new issue data, broker and dealer quotes, and collateral performance. If there is at least one significant model assumption or input that is not observable, these securities are categorized as Level 3 within the fair value hierarchy; otherwise, they are classified as Level 2.
State, County, and Municipal Securities
The fair value is estimated using a valuation matrix with inputs including bond interest rate tables, recent transaction, and yield relationships. These securities are categorized as Level 2.
Single and Pooled Issuer Trust Preferred Securities
The fair value of trust preferred securities, including pooled and single issuer preferred securities, is estimated using external pricing models, discounted cash flow methodologies or similar techniques. The inputs used in these valuations include benchmark yields, recent reported trades, new issue data, broker and dealer quotes and collateral performance. If there is at least one significant model assumption or input that is not observable, these securities are categorized as Level 3 within the fair value hierarchy; otherwise, they are classified as Level 2.
Equity Securities
These equity securities and mutual funds are valued based on market quoted prices. These securities are categorized in Level 1 as they are actively traded and no valuation adjustments have been applied.
Loans Held for Sale
The Company elects to account for new originations of mortgage loans held for sale at fair value, which is measured using quoted market prices when available. If quoted market prices are not available, comparable market values or discounted cash flow analysis may be utilized. These assets are typically categorized as Level 2.
Derivative Instruments
Derivatives
The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Company incorporates credit valuation adjustments to appropriately reflect nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings. Additionally, in conjunction with fair value measurement guidance, the Company has made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. Although the Company has determined that the majority of the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of September 30, 2014 and December 31,

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2013, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2.
Mortgage Derivatives
The fair value of the commitments and agreements are estimated using the anticipated market price based on pricing indications provided from syndicate banks. These commitments and agreements are categorized as Level 2.
Impaired Loans
Collateral dependent loans that are deemed to be impaired are valued based upon the lower of cost or fair value of the underlying collateral less costs to sell.  The inputs used in the appraisals of the collateral are not always observable, and therefore the loans may be categorized as Level 3 within the fair value hierarchy; otherwise, they are classified as Level 2.
Other Real Estate Owned and Other Foreclosed Assets
The fair values are estimated based upon recent appraisal values of the property less costs to sell the property, as Other Real Estate Owned ("OREO") and Other Foreclosed Assets are valued at the lower of cost or fair value of the property, less estimated costs to sell. Certain inputs used in appraisals are not always observable, and therefore OREO and Other Foreclosed Assets may be categorized as Level 3 within the fair value hierarchy. When inputs in appraisals are observable, they are classified as Level 2.
Goodwill and Other Intangible Assets
Goodwill and identified intangible assets are subject to impairment testing. The Company conducts an annual impairment test of goodwill in the third quarter of each year, or more frequently if necessary, and other intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. To estimate the fair value of goodwill and, if necessary, other intangible assets the Company utilizes both a comparable analysis of relevant price multiples in recent market transactions and discounted cash flow analysis. Both valuation models require a significant degree of management judgment. In the event the fair value as determined by the valuation model is less than the carrying value, the intangibles may be impaired. If the impairment testing resulted in impairment, the Company would classify the impaired goodwill and other intangible assets subjected to nonrecurring fair value adjustments as Level 3.

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Table of Contents

Assets and liabilities measured at fair value at the periods indicated were as follows:

 
 
 
Fair Value Measurements at Reporting Date Using
 
Balance
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
September 30, 2014
 
(Dollars in thousands)
Recurring fair value measurements
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
U.S. Government agency securities
$
41,287

 
$

 
$
41,287

 
$

Agency mortgage-backed securities
229,204

 

 
229,204

 

Agency collateralized mortgage obligations
65,586

 

 
65,586

 

State, county, and municipal securities
5,253

 

 
5,253

 

Single issuer trust preferred securities issued by banks
2,923

 

 
2,923

 

Pooled trust preferred securities issued by banks and insurers
5,386

 

 

 
5,386

Equity securities
11,816

 
11,816

 

 

Loans held for sale
12,580

 

 
12,580

 

Derivative instruments
19,150

 

 
19,150

 

Liabilities
 
 
 
 
 
 
 
Derivative instruments
24,778

 

 
24,778

 

Total recurring fair value measurements
$
368,407

 
$
11,816

 
$
351,205

 
$
5,386

 
 
 
 
 
 
 
 
Nonrecurring fair value measurements
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Collateral dependent impaired loans
$
9,614

 
$

 
$

 
$
9,614

Other real estate owned and other foreclosed assets
9,632

 

 

 
9,632

Total nonrecurring fair value measurements
$
19,246

 
$

 
$

 
$
19,246



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Table of Contents

 
December 31, 2013
 
(Dollars in thousands)
Recurring fair value measurements
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
U.S. government agency securities
$
40,449

 
$

 
$
40,449

 
$

Agency mortgage-backed securities
234,591

 

 
234,591

 

Agency collateralized mortgage obligations
58,153

 

 
58,153

 

State, county, and municipal securities
5,412

 

 
5,412

 

Single issuer trust preferred securities issued by banks
2,952

 

 
2,952

 

Pooled trust preferred securities issued by banks and insurers
3,841

 

 

 
3,841

Equity securities
11,464

 
11,464

 

 

Loans held for sale
8,882

 

 
8,882

 

Derivative instruments
16,965

 

 
16,965

 

Liabilities
 
 
 
 
 
 
 
Derivative instruments
26,395

 

 
26,395

 

Total recurring fair value measurements
$
356,314

 
$
11,464

 
$
341,009

 
$
3,841

 
 
 
 
 
 
 
 
Nonrecurring fair value measurements
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Collateral dependent impaired loans
$
10,328

 
$

 
$

 
$
10,328

Other real estate owned and other foreclosed assets
7,633

 

 

 
7,633

Total nonrecurring fair value measurements
$
17,961

 
$

 
$

 
$
17,961

The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3). These instruments were valued using pricing models and discounted cash flow methodologies.
 
Securities Available for Sale:
 
(Dollars in thousands)
 
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
 
Pooled Trust
Preferred
Securities
 
Private
Mortgage-
Backed
Securities
 
Total
 
Pooled Trust
Preferred
Securities
 
Private
Mortgage-
Backed
Securities
 
Total
Beginning balance
$
5,091

 
$

 
$
5,091

 
$
3,617

 
$
3,036

 
$
6,653

Gains and (losses) (realized/unrealized)
 
 
 
 
 
 
 
 
 
 
 
Included in other comprehensive income
318

 

 
318

 
399

 
46

 
445

Settlements
(23
)
 

 
(23
)
 
(45
)
 
(219
)
 
(264
)
Ending balance
$
5,386

 
$

 
$
5,386

 
$
3,971

 
$
2,863

 
$
6,834

 
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
 
Pooled Trust
Preferred
Securities
 
Private
Mortgage-
Backed
Securities
 
Total
 
Pooled Trust
Preferred
Securities
 
Private
Mortgage-
Backed
Securities
 
Total
Beginning balance
$
3,841

 
$

 
$
3,841

 
$
2,981

 
$
3,532

 
$
6,513

Gains and (losses) (realized/unrealized)
 
 
 
 
 
 
 
 
 
 
 
Included in other comprehensive income
1,666

 

 
1,666

 
1,230

 
(43
)
 
1,187

Settlements
(121
)
 

 
(121
)
 
(240
)
 
(626
)
 
(866
)
Ending balance
$
5,386

 
$

 
$
5,386

 
$
3,971

 
$
2,863

 
$
6,834



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It is the Company’s policy to recognize the transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers between the levels of the fair value hierarchy for any assets or liabilities measured at fair value on a recurring basis during the three or nine month periods ended September 30, 2014 or 2013.
The following table sets forth certain unobservable inputs regarding the Company’s investment in securities that are classified as Level 3 for the periods indicated:

 
 
September 30
 
December 31
 
 
 
September 30
 
December 31
 
September 30
 
December 31
 
 
2014
 
2013
 
 
 
2014
 
2013
 
2014
 
2013
Valuation Technique
 
Fair Value
 
Unobservable Inputs
 
Range
 
Weighted Average
 
 
(Dollars in Thousands)
 
 
Discounted cash flow methodology
 
 
 
 
 
 
 
 
 
 
Pooled trust preferred securities
 
$
5,386

 
$
3,841

 
Cumulative prepayment
 
0% - 75%
 
0% - 76%
 
7.0%
 
7.2%
 
 
 
 
 
 
Cumulative default
 
2.8% - 100%
 
3% - 100%
 
15.9%
 
18.1%
 
 
 
 
 
 
Loss given default
 
85% - 100%
 
85% - 100%
 
95.9%
 
95.7%
 
 
 
 
 
 
Cure given default
 
0% - 75%
 
0% - 75%
 
43.7%
 
39.9%
Appraisals of collateral (1)
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
9,614

 
$
10,328

 
 
 
 
 
 
 
 
 
 
Other real estate owned and foreclosed assets
 
$
9,632

 
$
7,633

 
 
 
 
 
 
 
 
 
 
 
(1)
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable. Appraisals may be adjusted by management for qualitative factors such as economic factors and estimated liquidation expenses. The range of these possible adjustments may vary.
For the fair value measurements in the table above, which are classified as Level 3 within the fair value hierarchy, the Company’s Treasury and Finance groups determine the valuation policies and procedures. For the pricing of the securities, the Company uses third-party pricing information, without adjustment. Depending on the type of the security, management employs various techniques to analyze the pricing it receives from third parties, such as analyzing changes in market yields and in certain instances reviewing the underlying collateral of the security. Management reviews changes in fair value from period to period and performs testing to ensure that prices received from the third parties are consistent with their expectation of the market. For the securities whose market is deemed to be inactive and which are categorized as Level 3, the fair value models are calibrated and significant inputs are back tested on a quarterly basis, to the extent possible. This testing is done by the third party service provider, who performs this testing by comparing anticipated inputs to actual results. Significant changes in fair value from period to period are closely scrutinized to ensure fair value models are not flawed. The driver(s) of the respective change in fair value and the method for forecasting the driver(s) is closely considered by management.
The significant unobservable inputs used in the fair value measurement of the Company’s pooled trust preferred securities are cumulative prepayment rates, cumulative defaults, loss given defaults and cure given defaults. Significant increases (decreases) in deferrals or defaults, in isolation, would result in a significantly lower (higher) fair value measurement. Alternatively, significant increases (decreases) in cure rates, in isolation, would result in a significantly higher (lower) fair value measurement.
Additionally, the Company has financial instruments which are marked to fair value on a nonrecurring basis which are categorized within Level 3. These instruments include collateral dependent impaired loans and OREO. The determination of the fair value amount is derived from the use of independent third party appraisals and evaluations, prepared by firms from a predetermined list of qualified and approved appraisers or evaluators. Upon receipt of an appraisal or evaluation, the internal Commercial Real Estate Appraisal Department will review the report for compliance with regulatory and Bank standards, as well as reasonableness and acceptance of the value conclusions. Any issues or concerns regarding compliance or value conclusions will be addressed with the engaged firm and the report may be adjusted or revised. If a disagreement cannot be resolved, the Commercial Real Estate Appraisal Department will either address the key issues and modify the report for acceptance or reject the report and re-order a new report. Ultimately the Company’s Commercial Real Estate Appraisal Department will confirm the collateral value as part of its review process.

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Table of Contents

The estimated fair values and related carrying amounts for assets and liabilities for which fair value is only disclosed are shown below as of the periods indicated:

 
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
Carrying
Value
 
Fair
Value
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
  
September 30, 2014
 
(Dollars in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Securities held to maturity (a)
 
U.S. Treasury securities
$
1,010

 
$
1,060

 
$

 
$
1,060

 
$

Agency mortgage-backed securities
164,531

 
168,000

 

 
168,000

 

Agency collateralized mortgage obligations
199,950

 
197,277

 

 
197,277

 

State, county, and municipal securities
424

 
433

 

 
433

 

Single issuer trust preferred securities issued by banks
1,500

 
1,530

 

 
1,530

 

Corporate debt securities
5,003

 
5,165

 

 
5,165

 

Loans, net of allowance for loan losses (b)
4,892,850

 
4,855,967

 

 

 
4,855,967

Financial liabilities
 
 
 
 
 
 
 
 
 
Time certificates of deposits (c)
$
672,464

 
$
674,280

 
$

 
$
674,280

 
$

Federal Home Loan Bank borrowings (c)
60,127

 
60,087

 

 
60,087

 

Customer repurchase agreements and other short-term borrowings (c)
153,192

 
153,192

 

 

 
153,192

Wholesale repurchase agreements (c)
50,000

 
50,678

 

 

 
50,678

Junior subordinated debentures (d)
73,741

 
73,289

 

 
73,289

 

Subordinated debentures (c)
30,000

 
28,588

 

 

 
28,588

 


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Table of Contents

 
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
Carrying
Value
 
Fair
Value
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
  
December 31, 2013
 
(Dollars in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Securities held to maturity (a)
 
U.S. Treasury securities
$
1,011

 
$
1,042

 
$

 
$
1,042

 
$

Agency mortgage-backed securities
155,067

 
155,951

 

 
155,951

 

Agency collateralized mortgage obligations
187,388

 
182,036

 

 
182,036

 

State, county, and municipal securities
678

 
685

 

 
685

 

Single issuer trust preferred securities issued by banks
1,503

 
1,526

 

 
1,526

 

Corporate debt securities
5,005

 
5,215

 

 
5,215

 

Loans, net of allowance for loan losses (b)
4,665,068

 
4,655,920

 

 

 
4,655,920

Financial liabilities
 
 
 
 
 
 
 
 
 
Time certificates of deposits (c)
$
743,628

 
$
746,908

 
$

 
$
746,908

 
$

Federal Home Loan Bank borrowings (c)
140,294

 
140,321

 

 
140,321

 

Customer repurchase agreements and other short-term borrowings (c)
154,288

 
154,349

 

 

 
154,349

Wholesale repurchase agreements (c)
50,000

 
51,298

 

 

 
51,298

Junior subordinated debentures (d)
73,906

 
67,481

 

 
67,481

 

Subordinated debentures (c)
30,000

 
28,396

 

 

 
28,396


(a)
The fair values presented are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments and/or discounted cash flow analyses.
(b)
Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities or cash flows.
(c)
Fair value was determined by discounting anticipated future cash payments using rates currently available for instruments with similar remaining maturities.
(d)
Fair value was determined based upon market prices of securities with similar terms and maturities.
This summary excludes financial assets and liabilities for which the carrying value approximates fair value. For financial assets, these include cash and due from banks, federal funds sold, short-term investments, Federal Home Loan Bank stock, and cash surrender value of life insurance policies. For financial liabilities, these include demand, savings, money market deposits, and federal funds purchased. The estimated fair value of demand, savings and money market deposits is the amount payable at the reporting date. These instruments would all be considered to be classified within Level 1 of the fair value hierarchy. Also excluded from the summary are financial instruments measured at fair value on a recurring and nonrecurring basis, as previously described.



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Table of Contents


NOTE 10 - COMPREHENSIVE INCOME/(LOSS)
Information on the Company’s comprehensive income (loss), presented net of taxes, is set forth below for the periods indicated:

 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
 
Pre Tax
Amount
 
Tax (Expense)
Benefit
 
After Tax
Amount
 
Pre Tax
Amount
 
Tax (Expense)
Benefit
 
After Tax
Amount
 
(Dollars in thousands)
 
(Dollars in thousands)
Change in fair value of securities available for sale
$
(1,322
)
 
$
512

 
$
(810
)
 
$
5,869

 
$
(2,325
)
 
$
3,544

Less: net security gains (losses) reclassified into other noninterest income
67

 
(27
)
 
40

 
138

 
(56
)
 
82

Net change in fair value of securities available for sale
(1,389
)
 
539

 
(850
)
 
5,731

 
(2,269
)
 
3,462

 
 
 
 
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedges
252

 
(103
)
 
149

 
(535
)
 
220

 
(315
)
Less: net cash flow hedge losses reclassified into interest on borrowings expense (1)
(726
)
 
297

 
(429
)
 
(2,937
)
 
1,200

 
(1,737
)
Less: Loss on termination of hedge reclassified into noninterest expense

 

 

 
(1,121
)
 
458

 
(663
)
Net change in fair value of cash flow hedges
978

 
(400
)
 
578

 
3,523

 
(1,438
)
 
2,085

 
 
 
 
 
 
 
 
 
 
 
 
Net loss during the period and amortization of certain costs included in net periodic retirement costs (2)
(66
)
 
27

 
(39
)
 
(198
)
 
81

 
(117
)
Total other comprehensive income (loss)
$
(477
)
 
$
166

 
$
(311
)
 
$
9,056

 
$
(3,626
)
 
$
5,430


 
Three Months Ended September 30, 2013
 
Nine Months Ended September 30, 2013
 
Pre Tax
Amount
 
Tax (Expense)
Benefit
 
After Tax
Amount
 
Pre Tax
Amount
 
Tax (Expense)
Benefit
 
After Tax
Amount
 
(Dollars in thousands)
 
(Dollars in thousands)
Change in fair value of securities available for sale
$
(190
)
 
$
42

 
$
(148
)
 
$
(8,924
)
 
$
3,407

 
$
(5,517
)
Less: net security losses reclassified into other noninterest income

 

 

 
(4
)
 
1

 
(3
)
Change in fair value of securities available for sale
(190
)
 
42

 
(148
)
 
(8,920
)
 
3,406

 
(5,514
)
 
 
 
 
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedges
(696
)
 
285

 
(411
)
 
592

 
(242
)
 
350

Less: net cash flow hedge losses reclassified into interest on borrowings expense (1)
(1,464
)
 
598

 
(866
)
 
(4,322
)
 
1,765

 
(2,557
)
Net change in fair value of cash flow hedges
768

 
(313
)
 
455

 
4,914

 
(2,007
)
 
2,907

 
 
 
 
 
 
 
 
 
 
 
 
Net gain during the period and amortization of certain costs included in net periodic retirement costs (2)
51

 
(21
)
 
30

 
124

 
(51
)
 
73

Total other comprehensive income
$
629

 
$
(292
)
 
$
337

 
$
(3,882
)
 
$
1,348

 
$
(2,534
)
 
(1)
Includes the amortization of the remaining balance of a realized but unrecognized gain, net of tax, from the termination of interest rate swaps in June 2009. The original gain of $1.4 million, net of tax, is being recognized in earnings through December 2018, the original maturity date of the swap. The balance of this gain has amortized to $606,000 and $751,000 at September 30, 2014 and 2013, respectively.
(2)
The amortization of prior service costs is included in the computation of net periodic pension cost as disclosed in the Employee Benefit Plans footnote in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission.


43

Table of Contents

Information on the Company’s accumulated other comprehensive income (loss), net of tax is comprised of the following components as of the periods indicated:

 
Unrealized Gain (Loss) on Securities
 
Unrealized Loss on Cash Flow Hedge
 
Deferred Gain on Hedge Transactions
 
Defined Benefit Pension Plans
 
Accumulated Other Comprehensive Loss
 
2014
 
(Dollars in thousands)
Beginning balance January 1, 2014
$
(2,023
)
 
$
(5,698
)
 
$
715

 
$
(428
)
 
$
(7,434
)
Net change in other comprehensive income
$
3,462

 
$
2,194

 
$
(109
)
 
$
(117
)
 
$
5,430

Ending balance September 30, 2014
1,439

 
(3,504
)
 
606

 
(545
)
 
(2,004
)
 
2013
Beginning balance January 1, 2013
$
5,478

 
$
(9,577
)
 
$
859

 
$
(1,286
)
 
$
(4,526
)
Net change in other comprehensive income
$
(5,514
)
 
$
3,015

 
$
(108
)
 
$
73

 
$
(2,534
)
Ending balance September 30, 2013
(36
)
 
(6,562
)
 
751

 
(1,213
)
 
(7,060
)

NOTE 11 - COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, the Company enters into various transactions to meet the financing needs of its customers, which, in accordance with GAAP are not included in its consolidated balance sheets. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Company minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of these commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Standby letters of credit are written conditional commitments issued to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment were funded, the Company would be entitled to seek recovery from the customer. The Company’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.
The fees collected in connection with the issuance of standby letters of credit are representative of the fair value of its obligation undertaken in issuing the guarantee. In accordance with applicable accounting standards related to guarantees, fees collected in connection with the issuance of standby letters of credit are deferred. The fees are then recognized in income proportionately over the life of the standby letter of credit agreement. The deferred standby letter of credit fees represent the fair value of the Company's potential obligations under the standby letter of credit guarantees.
Financial instruments with off-balance-sheet risk were as follows at the dates indicated:
 
September 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
Commitments to extend credit
$
1,680,254

 
$
1,621,873

Standby letters of credit
16,903

 
18,923

Deferred standby letter of credit fees
108

 
87


44

Table of Contents

Lease Commitments
The Company leases office space, space for ATM locations, and certain branch locations under noncancelable operating leases.
Rent expense incurred under operating leases was approximately $1.9 million for both the three months ended September 30, 2014 and 2013, respectively, and $5.8 million and $5.7 million for the nine months ended September 30, 2014 and 2013, respectively. Renewal options ranging from 1-10 years exist for several of these leases. The Company has entered into lease agreements with related third parties on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties. Rent expense incurred under related third party leases was approximately $780,000 and $759,000 for the three months ended September 30, 2014 and 2013 respectively, and $1.5 million for both the nine month periods ended September 30, 2014 and 2013. There has been no significant change in the future minimum lease payments payable by the Company since December 31, 2013. See the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for information regarding commitments.
Other Contingencies
At September 30, 2014, Rockland Trust was involved in pending lawsuits that arose in the ordinary course of business. Management has reviewed these pending lawsuits with legal counsel and has taken into consideration the view of counsel as to their outcome. In the opinion of management, the final disposition of pending lawsuits is not expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows.
The Bank is required to maintain certain reserve requirements of vault cash and/or deposits with the Federal Reserve Bank of Boston. The amount of this reserve requirement was $37.7 million and $21.0 million at September 30, 2014 and December 31, 2013, respectively.


NOTE 12 - LOW INCOME HOUSING PROJECT INVESTMENTS
The Company’s investment in Low Income Housing Projects that generate Low Income Housing Tax Credits (“LIHTC”) at September 30, 2014 was $26.3 million with a recorded liability of $22.3 million in funding obligations. The Company has invested in four separate LIHTC projects which provide the Company with tax credits and operating loss tax benefits over a period of approximately 15 years. None of the original investment is expected to be repaid. The investment in LIHTC projects is being accounted for using the proportional amortization method, under which the Company amortizes the initial cost of the investment in proportion to the amount of the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit).
The following table presents the Company's investments in low income housing projects as of the date indicated:
 
September 30, 2014
 
(Dollars in thousands)
Original investment value
$
29,543

Current recorded investment
26,305

Unfunded liability obligation
22,273

Tax credits and benefits (1)
1,557

Amortization of investments (2)
1,098

Net income tax benefit (3)
459

(1)
This amount reflects anticipated tax credits and tax benefits for the year ended December 31, 2014.
(2)
The amortization amount reduces the tax credits and benefits anticipated for the year ended December 31, 2014.
(3)
This amount represents the net tax benefit expected to be realized for the year ended December 31, 2014 in determining the Company's effective tax rate as of September 30, 2014.


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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial statements, notes and tables included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the Securities and Exchange Commission.

Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q, both in the MD&A and elsewhere, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations. These statements may be identified by forward-looking terminology such as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties and our actual results may differ materially from such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements in addition to those risk factors listed under the “Risk Factors” section of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013 include, but are not limited to:

a weakening in the United States economy in general and the regional and local economies within the New England region and the Company’s market area;
adverse changes in the local real estate market;
a deterioration of the credit rating for U.S. long-term sovereign debt;
acquisitions may not produce results at levels or within time frames originally anticipated and may result in unforeseen integration issues or impairment of goodwill and/or other intangibles;
changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
higher than expected tax expense, resulting from failure to comply with general tax laws, changes in tax laws or failure to comply with requirements of the federal New Markets Tax Credit program;
unexpected changes in market interest rates for interest earning assets and/or interest bearing liabilities;
adverse changes in asset quality including an unanticipated credit deterioration in our loan portfolio;
unexpected increased competition in the Company’s market area;
unanticipated loan delinquencies, loss of collateral, decreased service revenues, and other potential negative effects on our business caused by severe weather or other external events;
a deterioration in the conditions of the securities markets;
our inability to adapt to changes in information technology;
electronic fraudulent activity within the financial services industry, especially in the commercial banking sector;
adverse changes in consumer spending and savings habits;
the effect of new laws and regulations regarding the financial services industry including, but not limited to, the Dodd-Frank Wall Street Reform and Consumer Protection Act;
changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) generally applicable to the Company’s business;
risks associated with the pending merger with Peoples Federal, including failure to obtain shareholder or regulatory approval of the merger or to satisfy other conditions to the merger on the proposed terms and within the proposed time frame; reaction to the merger of, or the inability to retain, Peoples Federal customers and employees; the diversion of management’s time on issues relating to the merger; the inability to realize expected cost savings and synergies from the merger in the amounts or the time frame anticipated; changes in the estimate of non-recurring charges; unanticipated costs or difficulties relating to integration matters; changes in the Company’s stock price from the date of the merger announcement to the closing date; or material adverse changes in operations or earnings of the Company or Peoples Federal;
changes in accounting policies, practices and standards, as may be adopted by the regulatory agencies as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standard setters; and
other unexpected material adverse changes in our operations or earnings.

Except as required by law, the Company disclaims any intent or obligation to update publicly any such forward-looking statements, whether in response to new information, future events or otherwise. Any public statements or disclosures by the Company following

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this Quarterly Report on Form 10-Q which modify or impact any of the forward-looking statements contained in this Quarterly Report on Form 10-Q will be deemed to modify or supersede such statements in this Quarterly Report on Form 10-Q.


Selected Quarterly Financial Data
The selected consolidated financial and other data of the Company 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, appearing elsewhere herein.
 
 
 
Three Months Ended
 
 
 
September 30,
2014
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
(Dollars in thousands, except per share data)
Financial condition data
 
 
 
 
 
 
 
 
 
Securities available for sale
$
361,455

 
$
340,081

 
$
348,258

 
$
356,862

 
$
284,398

Securities held to maturity
372,418

 
373,888

 
375,556

 
350,652

 
317,373

Loans
4,947,855

 
4,885,500

 
4,807,269

 
4,718,307

 
4,556,029

Allowance for loan losses
(55,005
)
 
(54,538
)
 
(53,629
)
 
(53,239
)
 
(53,562
)
Goodwill and core deposit intangibles
180,871

 
181,460

 
182,051

 
182,642

 
160,562

Total assets
6,384,428

 
6,348,318

 
6,225,920

 
6,099,234

 
5,895,464

Total deposits
5,302,434

 
5,298,161

 
5,114,259

 
4,986,418

 
4,757,309

Total borrowings
367,060

 
345,737

 
422,565

 
448,488

 
507,681

Stockholders’ equity
627,182

 
616,489

 
602,556

 
591,540

 
555,744

Income statement
 
 
 
 
 
 
 
 
 
Interest income
$
54,368

 
$
54,285

 
$
52,980

 
$
52,571

 
$
51,027

Interest expense
4,805

 
5,232

 
5,374

 
5,666

 
5,831

Net interest income
49,563

 
49,053

 
47,606

 
46,905

 
45,196

Provision for loan losses
1,901

 
2,250

 
4,502

 
3,150

 
2,650

Noninterest income
17,098

 
16,857

 
17,516

 
17,464

 
18,130

Noninterest expenses
42,607

 
42,980

 
41,887

 
47,845

 
40,722

Net income
15,738

 
14,746

 
13,383

 
10,588

 
14,655

Per share date
 
 
 
 
 
 
 
 
 
Net income—basic
$
0.66

 
$
0.62

 
$
0.56

 
$
0.45

 
$
0.64

Net income—diluted
0.66

 
0.61

 
0.56

 
0.45

 
0.64

Cash dividends declared
0.24

 
0.24

 
0.24

 
0.22

 
0.22

Book value
26.23

 
25.79

 
25.23

 
24.85

 
24.21

Performance ratios
 
 
 
 
 
 
 
 
 
Return on average assets
0.99
%
 
0.94
%
 
0.88
%
 
0.70
%
 
1.00
%
Return on average common equity
9.97
%
 
9.65
%
 
9.02
%
 
7.29
%
 
10.53
%
Net interest margin (on a fully tax equivalent basis)
3.42
%
 
3.48
%
 
3.49
%
 
3.45
%
 
3.43
%
Equity to assets
9.82
%
 
9.71
%
 
9.68
%
 
9.70
%
 
9.43
%
Dividend payout ratio
36.47
%
 
38.91
%
 
39.13
%
 
47.70
%
 
34.38
%
Asset quality
 
 
 
 
 
 
 
 
 
Nonperforming loans
26,119

 
27,416

 
36,171

 
34,659

 
37,887

Nonperforming assets
38,557

 
39,661

 
46,521

 
43,833

 
48,879

Nonperforming loans as a percent of gross loans
0.53
%
 
0.56
%
 
0.75
%
 
0.73
%
 
0.83
%
Nonperforming assets as a percent of total assets
0.60
%
 
0.62
%
 
0.75
%
 
0.72
%
 
0.83
%

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Allowance for loan losses as a percent of total loans
1.11
%
 
1.12
%
 
1.12
%
 
1.13
%
 
1.18
%
Allowance for loan losses as a percent of nonperforming loans
210.59
%
 
198.93
%
 
148.27
%
 
153.61
%
 
141.37
%
Capital ratios
 
 
 
 
 
 
 
 
 
Tier 1 leverage capital ratio
8.75
%
 
8.62
%
 
8.60
%
 
8.64
%
 
8.64
%
Tier 1 risk-based capital ratio
10.75
%
 
10.65
%
 
10.76
%
 
10.78
%
 
10.82
%
Total risk-based capital ratio
12.47
%
 
12.38
%
 
12.52
%
 
12.58
%
 
12.69
%


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Executive Level Overview

Management evaluates the Company's operating results and financial condition using measures that include net income, earnings per share, return on assets and equity, return on tangible common equity, net interest margin, tangible book value per share, asset quality indicators, and many others. These metrics help management make key decisions regarding the Bank's balance sheet, liquidity, interest rate sensitivity, and capital resources and assist with identifying areas to improve. The Company is focused on organic growth, but will consider acquisition opportunities that provide a satisfactory financial return.

During the third quarter the Company announced the signing of a definitive merger agreement for the acquisition of Peoples Federal Bancshares, Inc. The Company anticipates that the legal closing for that acquisition will occur in the first quarter of 2015.
    
Loans and Asset Quality

Management’s balance sheet strategy emphasizes commercial and home equity lending, with continued strong growth in both categories. The results depicted in the following table reflect the focus on those asset classes:


Management strives to be disciplined about loan pricing and generates loan assets with interest rate sensitivity in mind. The Company has gradually and intentionally shifted its balance sheet composition so that its interest-rate risk position is fundamentally asset-sensitive.

Management takes a disciplined approach to credit underwriting, seeking to avoid undue credit risk and loan losses as evidenced by consistently strong overall asset quality metrics.
 

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Funding and the Net Interest Margin

Management emphasizes core deposit growth to fund loans, as depicted by the following chart:

As of September 30, 2014 core deposits comprise 87.1% of total deposits compared to 86.6% in the prior quarter. Our core deposit focus resulted in our total cost of deposits decreasing one basis point to 0.21% compared to the prior quarter.

The Company's net interest margin was 3.42% for the quarter ended September 30, 2014, a decrease of six basis point from the linked quarter. The Company's net interest margin decreased due to higher average liquid balances and a decline in loan yield that was only partially offset by reduced funding costs. In addition, our second quarter loan yield was enhanced by the payoff of impaired loans. The Company anticipates some additional loan yield contraction in the current low rate environment.

Noninterest Income

Management continues to focus on noninterest income growth. Noninterest income is primarily comprised of deposit account fees, interchange and ATM fees, and investment management fees. Strong performance from these categories was partially offset by a decrease in loan level derivative income. The following chart depicts noninterest income, excluding certain noncore items, as a percentage of total revenue (the sum of net noninterest income, excluding certain noncore items, and net interest income):
*See "Non-GAAP Measures" below for a reconciliation to GAAP financial measures.


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Expense Control

Management takes a balanced approach to noninterest expense control by paying close attention to the management of ongoing operating expenses while making needed capital expenditures and prudently investing in growth initiatives. The Company’s primary expenses arise from Rockland Trust’s employee salaries and benefits and expenses associated with buildings and equipment. During the third quarter of 2014, noninterest expense was well contained, resulting in a further decrease to the Company's efficiency ratio, with the following chart showing the trend in the Company's efficiency ratio, on an operating basis (calculated by dividing noninterest expense excluding certain noncore items by the sum of net noninterest income, excluding certain noncore items, and net interest income), over the past five quarters:
*See "Non-GAAP Measures" below for a reconciliation to GAAP financial measures.

Tax Effectiveness

The Company participates in federal and state tax credit programs designed to promote economic development, affordable housing, and job creation. During 2014 the Company continues to participate in the federal New Markets Tax Credit program and has also made low-income housing tax credit investments. The Company has also established security corporation subsidiaries and, through its subsidiaries, purchased tax-exempt bonds. Federal and state tax credit program participation and other tax strategies permit the Company to operate in a tax effective manner and sometimes also creates a competitive advantage for Rockland Trust and its community development subsidiaries. During the third quarter of 2014, the Company’s effective tax rate was 28.96%, remaining relatively consistent with the prior quarter.


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Capital

The Company's disciplined approach with respect to revenue, expense, and tax effectiveness is designed to promote long-term shareholder value, and is reflected in the strong capital growth experienced during 2014. As a result, tangible book value per share increased $0.46 during the third quarter, and tangible common equity as a percentage of tangible assets increased from 7.05% in the prior quarter to 7.19%. The following chart shows the trend of the Company's tangible book value per share over the past five quarters:

This strong growth in capital has led to a consistent cash dividend which increased from $0.22 per share in each quarter of 2013 to $0.24 per share in the three quarters of 2014, respectively, representing a 9.1% increase.

2014 Results

Net income for the third quarter of 2014 computed in accordance with Generally Accepted Accounting Principles ("GAAP") was $15.7 million, or $0.66 on a diluted earnings per share basis, as compared to $14.7 million, or $0.64 per diluted shares for the prior year third quarter. Third quarter 2014 net operating earnings were $16.2 million, or $0.67 on a diluted earnings per share basis, an increase of 12.0% and 6.4%, respectively, when compared to net operating earnings of $14.4 million, or $0.63 per diluted share, for the third quarter of 2013. The third quarters in both 2014 and 2013 included merger and acquisition expenses which are excluded from operating earnings.

2014 Earnings Outlook

The Company anticipates 2014 diluted operating earnings per share performance to be in the middle to upper end range between $2.42 and $2.52. Key assumptions in the 2014 outlook include:

Total loan growth slightly above the 5% range;

Total deposit growth of 5-7%;

A net interest margin percentage in the mid 3.40s;

Stable asset quality, with a provision for loan loss in the range of $11-$14 million and net charge-offs in the range of $9-$12 million;

Noninterest income growing by 1-2%;

Noninterest expense increasing by 3-4%;

An effective tax rate of 28-29%; and

Tangible Common Equity ratio increasing to a range of 7.25% to 7.50% by the end of 2014.


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Non-GAAP Measures
When management assesses the Company’s financial performance for purposes of making day-to-day and strategic decisions, it does so based upon the performance of its core banking business, which is primarily derived from the combination of net interest income and noninterest or fee income, reduced by operating expenses, the provision for loan losses, and the impact of income taxes and other noncore items shown in the table that follows. The Company’s financial performance is determined in accordance with GAAP which sometimes includes gains or losses due to items that management believes are unrelated to its core banking business and will not have a material financial impact on operating results in future periods, such as gains or losses on the sales of securities, merger and acquisition expenses, and other items. Management, therefore, also computes the Company’s non-GAAP operating earnings, which excludes these items, to measure the strength of the Company’s core banking business and to identify trends that may to some extent be obscured by such gains or losses.
Management’s computation of the Company’s non-GAAP operating earnings information is set forth because management believes it may be useful for investors to have access to the same analytical tool used by management to evaluate the Company’s core operational performance so that investors may assess the Company’s overall financial health and identify business and performance trends that may be more difficult to identify and evaluate when noncore items are included. Management also believes that the computation of non-GAAP operating earnings may facilitate the comparison of the Company to other companies in the financial services industry.
Non-GAAP operating earnings should not be considered a substitute for GAAP results. An item which management deems to be noncore and excludes when computing non-GAAP operating earnings can be of substantial importance to the Company’s results for any particular quarter or year. The Company’s non-GAAP operating earning information set forth is not necessarily comparable to non-GAAP information which may be presented by other companies.
The following tables summarizes the impact of noncore items recorded for the time periods indicated below and reconciles them in accordance with GAAP:

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Three Months Ended September 30
 
Net Income
 
Diluted
Earnings Per Share
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
As reported (GAAP)
 
 
 
 
 
 
 
Net income available to common shareholders (GAAP)
$
15,738

 
$
14,655

 
$
0.66

 
$
0.64

Non-GAAP adjustments
 
 
 
 
 
 
 
Noninterest income components
 
 
 
 
 
 
 
Gain on extinguishment of debt, net of tax

 
(451
)
 

 
(0.02
)
Noninterest expense components
 
 
 
 
 
 
 
Merger and acquisition expenses, net of tax
400

 
216

 
0.01

 
0.01

Impairment on acquired facilities, net of tax
12

 

 

 

Total impact of noncore items
412

 
(235
)
 
0.01

 
(0.01
)
As adjusted (Non-GAAP)
$
16,150

 
$
14,420

 
$
0.67

 
$
0.63

 
 
 
 
 
 
 
 
 
Nine Months Ended September 30
 
Net Income
 
Diluted
Earnings Per Share
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
As reported (GAAP)
 
 
 
 
 
 
 
Net income available to common shareholders (GAAP)
$
43,867

 
$
39,665

 
1.83

 
$
1.73

Non-GAAP measures
 
 
 
 
 
 
 
Noninterest income components
 
 
 
 
 
 
 
Gain on life insurance benefits, tax exempt
(1,964
)
 

 
(0.08
)
 

Gain on extinguishment of debt, net of tax
 
 
$
(451
)
 
 
 
(0.02
)
Noninterest expense components
 
 
 
 
 
 
 
Severance, net of tax

 
192

 

 
0.01

Merger and acquisition expenses, net of tax
466

 
1,531

 
0.02

 
0.06

Impairment on acquired facilities, net of tax
310

 

 
0.01

 

Loss on termination of derivatives, net of tax
663

 

 
0.03

 

Total impact of noncore items
(525
)
 
1,272

 
(0.02
)
 
0.05

As adjusted (Non-GAAP)
$
43,342

 
$
40,937

 
1.81

 
$
1.78


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The following table summarizes the impact of noncore items on the calculation of the Company's efficiency ratio for the periods indicated:

 
Quarter-to-Date
 
 
September 30, 2014
 
June 30, 2014
 
March 31, 2014
 
December 31, 2013
 
September 30, 2013
 
 
(Dollars in thousands)
 
Net interest income
$
49,563

 
$
49,053

 
$
47,606

 
$
46,905

 
$
45,196

(a)
 
 
 
 
 
 
 
 
 
 
 
Noninterest income (GAAP)
$
17,098

 
$
16,857

 
$
17,516

 
$
17,464

 
$
18,130

(b)
Net gain on sale of nonequity securities

 

 

 
(258
)
 

 
Gain on life insurance benefits

 
(337
)
 
(1,627
)
 
(227
)
 

 
Gain on extinguishment of debt

 

 

 

 
(763
)
 
Noninterest income on an operating basis (Non-GAAP)
$
17,098

 
$
16,520

 
$
15,889

 
$
16,979

 
$
17,367

(c)
 
 
 
 
 
 
 
 
 
 
 
Noninterest expense (GAAP)
$
42,607

 
$
42,980

 
$
41,887

 
$
47,845

 
$
40,722

(d)
Merger & acquisition
(677
)
 

 
(77
)
 
(6,219
)
 
(366
)
 
Loss on termination of derivatives

 
(1,122
)
 

 

 

 
Impairment on acquired facilities
(21
)
 

 
(503
)
 

 

 
Noninterest expense on an operating basis (Non-GAAP)
$
41,909

 
$
41,858

 
$
41,307

 
$
41,626

 
$
40,356

(e)
 
 
 
 
 
 
 
 
 
 
 
Total revenue (GAAP)
$
66,661

 
$
65,910

 
$
65,122

 
$
64,369

 
$
63,326

(a+b)
Total operating revenue (Non-GAAP)
$
66,661

 
$
65,573

 
$
63,495

 
$
63,884

 
$
62,563

(a+c)
 
 
 
 
 
 
 
 
 
 
 
Ratios
 
 
 
 
 
 
 
 
 
 
  Efficiency ratio (GAAP)
63.92
%
 
65.21
%
 
64.32
%
 
74.33
%
 
64.31
%
(d/(a+b))
Efficiency ratio on an operating basis (Non-GAAP)
62.87
%
 
63.83
%
 
65.06
%
 
65.16
%
 
64.50
%
(e/(a+c))
 
 
 
 
 
 
 
 
 
 
 
Noninterest income as a % of revenue
25.65
%
 
25.58
%
 
26.90
%
 
27.13
%
 
28.63
%
(b/(a+b))
Noninterest income as a % of revenue on an operating basis (Non-GAAP)
25.65
%
 
25.19
%
 
25.02
%
 
26.58
%
 
27.76
%
(c/(a+c))

Critical Accounting Policies
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. The Company believes that the most critical accounting policies are those which the Company’s financial condition depends upon, and which involve the most complex or subjective decisions or assessments.
There have been no material changes in critical accounting policies during the first nine months of 2014. Please refer to the Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for a complete listing of critical accounting policies.


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FINANCIAL POSITION
Securities Portfolio The Company’s securities portfolio consists of securities available for sale and securities which management intends to hold until maturity. Securities increased by $26.4 million, or 3.7%, at September 30, 2014 as compared to December 31, 2013. The ratio of securities to total assets was 11.5% and 11.6% as of September 30, 2014 and December 31, 2013, respectively.
The Company continually reviews investment securities for the presence of other-than-temporary impairment (“OTTI”). Further analysis of the Company’s OTTI can be found in Note 3Securities within Notes to Consolidated Financial Statements included in Item 1 hereof.

    Residential Mortgage Loan Sales The Company’s primary loan sale activity arises from the sale of government sponsored enterprise eligible residential mortgage loans to government sponsored agencies and other financial institutions. During the three and nine months ended September 30, 2014 and 2013, the Bank originated residential loans with the intention of selling them in the secondary market, and to a lesser extent, to hold in the Company's residential portfolio. The following table shows the total residential loans that were closed and whether the amounts were held in the portfolio or sold/held for sale in the secondary market during the period indicated:
Table 1 - Closed Residential Real Estate Loans
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Held in portfolio
$
21,368

 
$
11,173

 
$
53,318

 
$
23,140

Sold/held for sale in secondary market
46,155

 
55,835

 
106,008

 
227,479

Total closed loans
$
67,523

 
$
67,008

 
159,326

 
250,619


The table below reflects the loans which were sold during the periods indicated:

Table 2 - Residential Mortgage Loan Sales
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Sold with servicing rights released
$
8,221

 
$
53,807

 
$
17,251

 
$
201,338

Sold with servicing rights retained
42,812

 
18,121

 
85,366

 
58,059

Total loans sold
$
51,033

 
$
71,928

 
$
102,617

 
$
259,397



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As noted in the table above, loans may be sold with servicing rights released or with servicing rights retained. Upon sale with servicing rights retained, the mortgage servicing asset is established, which represents the then current estimated fair value based on market prices for comparable mortgage servicing contracts, when available, or alternatively is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing rights are recorded in other assets in the consolidated balance sheets, are amortized in proportion to and over the period of estimated net servicing income, and are assessed for impairment based on fair value at each reporting date. Impairment is determined by stratifying the rights based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance, to the extent that fair value is less than the capitalized amount. If the Company later determines that all or a portion of the impairment no longer exists, a reduction of the allowance may be recorded as an increase to income. The principal balance of loans serviced by the Bank on behalf of investors amounted to $384.7 million, $331.4 million, and $197.8 million at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. The following table shows the adjusted cost of the servicing rights associated with these loans and the changes for the periods indicated:
Table 3 - Mortgage Servicing Asset
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Balance at beginning of period
$
2,440

 
$
1,264

 
$
2,368

 
$
899

Additions
416

 
160

 
785

 
508

Amortization
(154
)
 
(101
)
 
(445
)
 
(331
)
Change in valuation allowance
32

 
49

 
26

 
296

Balance at end of period
$
2,734

 
$
1,372

 
$
2,734

 
$
1,372

When a loan is sold, the Company enters into agreements that contain representations and warranties about the characteristics of the loans sold and their origination. The Company may be required to either repurchase mortgage loans or to indemnify the purchaser from losses if representations and warranties are breached. The Company incurred no material losses during the three and nine months ended September 30, 2014 or 2013, and therefore at this time, has not established a reserve for loan repurchases because it believes the amount of probable losses is not reasonably estimable.
Forward sale contracts of mortgage loans and forward to-be-announced ("TBA") mortgage contracts, considered derivative instruments for accounting purposes, are utilized by the Company in its efforts to manage risk of loss associated with its mortgage loan commitments and mortgage loans held for sale. Prior to closing and funding certain one-to-four family residential mortgage loans, an interest rate lock commitment is generally extended to the borrower. During the period from commitment date to closing date, the Company is subject to the risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans, resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments are executed, under which the Company agrees to deliver whole mortgage loans to various investors, or forward TBA mortgage contracts are entered into with a counterparty, which economically hedges this market risk. See Note 7, “Derivative and Hedging Activitieswithin Notes to Consolidated Financial statements included in Item 1 hereof for more information on mortgage activity and mortgage related derivatives.

Loan Portfolio Management continues to focus on growth in the commercial and home equity lending categories. Management believes this emphasis is prudent, given the prevailing interest rate and economic environment, as well as strategic priorities. The Bank’s loan portfolio increased $229.5 million during the first nine months of 2014 to $4.9 billion. The commercial loan portfolio continues to be the major driver, increasing by $204.9 million during the first nine months of 2014, accompanied by solid growth in the home equity categories.

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The Bank’s commercial and industrial portfolio grew 7.5% in the nine months ended September 30, 2014. This portfolio is well-diversified with loans to various types of industries. The following pie chart shows the diversification of the commercial and industrial portfolio as of September 30, 2014:
 
(Dollars in thousands)
Average loan size
$
234

Largest individual commercial and industrial loan
$
19,000

Commercial and industrial nonperforming loans/commercial and industrial loans
0.28
%
The Bank’s commercial real estate portfolio, inclusive of commercial construction, is the Bank’s largest loan type concentration and has grown by 5.7% for the nine months ended September 30, 2014. This portfolio is also well-diversified with loans secured by a variety of property types, such as owner-occupied and nonowner-occupied commercial, retail, office, industrial, warehouse, industrial development bonds, and other special purpose properties, such as hotels, motels, nursing homes, restaurants, churches, recreational facilities, marinas, and golf courses. Commercial real estate also includes loans secured by certain residential-related property types including multi-family apartment buildings, residential development tracts and condominiums. The following pie chart shows the diversification of the commercial real estate portfolio as of September 30, 2014:

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Table of Contents

 
 
(Dollars in thousands)
Average loan size
$
772

Largest individual commercial real estate mortgage outstanding
$
24,735

Commercial real estate nonperforming loans/commercial real estate loans
0.25
%
Owner occupied commercial real estate loans/commercial real estate loans
17.7
%

In addition to the commercial portfolios, the Bank also originates both fixed-rate and adjustable-rate residential real estate loans as well as residential construction lending related to single-home residential development within the Bank's market area. The Bank also provides home equity loans and lines that may be made as a fixed rate term loan or under a variable rate revolving line of credit secured by a first or second mortgage on the borrower's residence or second home. Additionally, the Bank makes loans for a wide variety of other personal needs. Consumer loans primarily consist of installment loans and overdraft protections. The residential, home equity and other consumer portfolios have increased in total by $24.6 million for the nine months ended September 30, 2014 to $1.4 billion.

Asset Quality    The Company continually monitors the asset quality of the loan portfolio using all available information. Based on this assessment, loans demonstrating certain payment issues or other weaknesses may be categorized as delinquent, impaired, nonperforming and/or put on nonaccrual status. Additionally, in the course of resolving such loans, the Company may choose to restructure the contractual terms of certain loans to match the borrower’s ability to repay the loan based on their current financial condition. If a restructured loan meets certain criteria, it may be categorized as a troubled debt restructuring (TDR).

Delinquency    The Bank’s philosophy toward managing its loan portfolios is predicated upon careful monitoring, which stresses early detection and response to delinquent and default situations.  The Bank seeks to make arrangements to resolve any delinquent or default situation over the shortest possible time frame.  Generally, the Bank requires that a delinquency notice be mailed to a borrower upon expiration of a grace period (typically no longer than 15 days beyond the due date).  Reminder notices may be sent and telephone calls may be made prior to the expiration of the grace period. If the delinquent status is not resolved within a reasonable time frame following the mailing of a delinquency notice, the Bank’s personnel charged with managing its loan portfolios contact the borrower to ascertain the reasons for delinquency and the prospects for payment.  Any subsequent actions taken to resolve the delinquency will depend upon the nature of the loan and the length of time that the loan has been delinquent. The borrower’s needs are considered as much as reasonably possible without jeopardizing the Bank’s position. A late charge is usually assessed on loans upon expiration of the grace period.

59


Nonaccrual Loans    As a general rule, within commercial real estate or home equity categories, loans more than 90 days past due with respect to principal or interest are classified as nonaccrual loans. As permitted by banking regulations, certain consumer loans past due 90 days or more continue to accrue interest. In addition, certain commercial and real estate loans that are more than 90 days past due may be kept on an accruing status if the loans are well secured and in the process of collection. The Company may also put a junior lien mortgage on nonaccrual status as a result of delinquency with respect to the first position, which is held by another financial institution, while the junior lien is currently performing. Income accruals are suspended on all nonaccrual loans and all previously accrued and uncollected interest is reversed against current income. A loan remains on nonaccrual status until it becomes current with respect to principal and interest (and in certain instances remains current for up to six months), when the loan is liquidated, or when the loan is determined to be uncollectible and is charged-off against the allowance for loan losses.
Troubled Debt Restructurings    In the course of resolving problem loans, the Bank may choose to restructure the contractual terms of certain loans. The Bank attempts to work out an alternative payment schedule with the borrower in order to avoid or cure a default. Any loans that are modified are reviewed by the Bank to identify if a TDR has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status and the restructuring of the loan may include adjustments to interest rates, extensions of maturity, consumer loans where the borrower's obligations have been effectively discharged through Chapter 7 Bankruptcy and the borrower has not reaffirmed the debt to the Bank, and other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral. If such efforts by the Bank do not result in satisfactory performance, the loan is referred to legal counsel, at which time foreclosure proceedings are initiated. At any time prior to a sale of the property at foreclosure, the Bank may terminate foreclosure proceedings if the borrower is able to work-out a satisfactory payment plan.
It is the Bank’s policy to have any restructured loans which are on nonaccrual status prior to being modified remain on nonaccrual status for six months, subsequent to being modified, before management considers its return to accrual status. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. Loans that are considered TDRs are classified as performing, unless they are on nonaccrual status or greater than 90 days delinquent. Loans classified as TDRs remain classified as such for the life of the loan, except in limited circumstances, when it may be determined that the borrower is performing under modified terms and the restructuring agreement specified an interest rate greater than or equal to an acceptable market rate for a comparable new loan at the time of the restructuring.
Purchased Credit Impaired Loans    Purchased Credit Impaired (“PCI”) loans are acquired loans which had evidence of deterioration in credit quality at the purchase date and for which it is probable that all contractually required payments will not be collected. The PCI loans are recorded at fair value without any carryover of the allowance for loan losses. The excess cash flows expected to be collected over the carrying amount of the loans, referred to as the "accretable yield," is accreted into interest income over the life of the loans using the effective yield method. Accordingly, PCI loans are not subject to classification as nonaccrual in the same manner as originated loans, rather they are generally considered to be accruing loans because their interest income recognized relates to the accretable yield and not to contractual interest payments. The carrying amount of these purchased credit impaired loans was $25.3 million as of September 30, 2014, as compared to $29.5 million as of December 31, 2013. See Note 4, "Loans, Allowance for Loan Losses, and Credit Quality" within Notes to Consolidated Financial Statements included in Item 1 hereof for more information.
Nonperforming Assets    Nonperforming assets are comprised of nonperforming loans, nonperforming securities, other real estate owned (“OREO”), and other assets in possession. Nonperforming loans consist of nonaccrual loans and loans that are more than 90 days past due but still accruing interest.
Nonperforming securities consist of securities that are on nonaccrual status. The Company holds five collateralized debt obligation securities (“CDOs”) comprised of pools of trust preferred securities issued by banks and insurance companies, which are currently deferring interest payments on certain tranches within the bonds’ structures including the tranches held by the Company. The bonds are anticipated to continue to defer interest until cash flows are sufficient to satisfy certain collateralization levels designed to protect more senior tranches. As a result, the Company has placed the five securities on nonaccrual status and has reversed any previously accrued but unpaid income related to these securities.
OREO consists of real estate properties, which have served as collateral to secure loans, that are controlled or owned by the Bank. These properties are recorded at fair value less estimated costs to sell at the date control is established, resulting in a new cost basis. The amount by which the recorded investment in the loan exceeds the fair value (net of estimated costs to sell) of the foreclosed asset is charged to the allowance for loan losses. Subsequent declines in the fair value of the foreclosed asset below the new cost basis are recorded through the use of a valuation allowance. Subsequent increases in the fair value are recorded as reductions in the valuation allowance, but not below zero. All costs incurred thereafter in maintaining the property are generally

60


charged to noninterest expense. In the event the real estate is utilized as a rental property, rental income and expenses are recorded as incurred.
Other assets in possession typically consist of foreclosed non-real estate assets deemed to be in control of the Company.

The following table sets forth information regarding nonperforming assets held by the Bank at the dates indicated:
Table 4 - Nonperforming Assets

 
September 30,
2014
 
December 31,
2013
 
September 30,
2013
 
(Dollars in thousands)
Loans Accounted for on a nonaccrual basis
 
 
 
 
 
Commercial and industrial
$
2,321

 
$
4,178

 
$
4,557

Commercial real estate
6,512

 
11,834

 
12,900

Small business
278

 
633

 
615

Residential real estate
9,088

 
10,329

 
11,817

Home equity
7,672

 
7,068

 
7,320

Other consumer
9

 
92

 
134

Total (1)
$
25,880

 
$
34,134

 
$
37,343

Loans past due 90 days or more but still accruing
 
 
 
 
 
Residential real estate (2)
217

 
462

 
433

Other consumer
22

 
63

 
111

Total
$
239

 
$
525

 
$
544

Total nonperforming loans
$
26,119

 
$
34,659

 
$
37,887

Nonaccrual securities (3)
2,806

 
1,541

 
1,628

Other real estate owned
9,602

 
7,466

 
9,188

Other assets in possession
30

 
167

 
176

Total nonperforming assets
$
38,557

 
$
43,833

 
$
48,879

Nonperforming loans as a percent of gross loans
0.53
%
 
0.73
%
 
0.83
%
Nonperforming assets as a percent of total assets
0.60
%
 
0.72
%
 
0.83
%
 

(1)
Inclusive of TDRs on nonaccrual of $5.7 million, $7.5 million, and $8.6 million at September 30, 2014December 31, 2013, and September 30, 2013, respectively.
(2)
Represents purchased credit impaired loans that are accruing interest due to expectations of future cash collections.
(3)
Amounts represent the fair value of five nonaccrual securities at September 30, 2014, December 31, 2013, and September 30, 2013.

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The following table summarizes the changes in nonperforming assets for the periods indicated:
Table 5 - Activity in Nonperforming Assets

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
(Dollars in thousands)
Nonperforming assets beginning balance
 
 
$
39,661

 
 
 
$
43,833

New to nonperforming
 
 
4,972

 
 
 
20,450

Loans charged-off
 
 
(1,906
)
 
 
 
(8,622
)
Loans paid-off
 
 
(1,833
)
 
 
 
(10,815
)
Loans transferred to other real estate owned and foreclosed assets
 
 
(783
)
 
 
 
(5,039
)
Loans restored to performing status
 
 
(1,705
)
 
 
 
(4,258
)
Change to other real estate owned
 
 
 
 
 
 
 
New to other real estate owned
$
783

 
 
 
$
5,039

 
 
Valuation write down
(109
)
 
 
 
(391
)
 
 
Sale of Other Real Estate Owned
(1,480
)
 
 
 
(4,239
)
 
 
Capital improvements to other real estate owned
896

 
 
 
1,772

 
 
Total change to other real estate owned
90

 
90

 
2,181

 
2,181

Change in nonaccrual securities
 
 
235

 
 
 
1,264

Other
 
 
(175
)
 
 
 
(437
)
Nonperforming assets ending balance
 
 
$
38,557

 
 
 
$
38,557


The following table sets forth information regarding troubled debt restructured loans as of the dates indicated:
Table 6 - Troubled Debt Restructurings

 
September 30,
2014
 
December 31,
2013
 
(Dollars in thousands)
Performing troubled debt restructurings
$
40,140

 
$
38,410

Nonaccrual troubled debt restructurings
5,709

 
7,454

Total
$
45,849

 
$
45,864

Performing troubled debt restructurings as a % of total loans
0.81
%
 
0.81
%
Nonaccrual troubled debt restructurings as a % of total loans
0.12
%
 
0.16
%
Total troubled debt restructurings as a % of total loans
0.93
%
 
0.97
%

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The following table summarizes changes in TDRs for the periods indicated:
Table 7 - Activity in Troubled Debt Restructurings

 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
 
(Dollars in thousands)
TDRs beginning balance
$
46,424

 
$
45,864

New to TDR status
1,869

 
5,571

Paydowns
(2,201
)
 
(4,372
)
Charge-offs
(243
)
 
(1,214
)
TDRs ending balance
$
45,849

 
$
45,849

 
Income accruals are suspended on all nonaccrual loans and all previously accrued and uncollected interest is reversed against current income. The table below shows interest income that was recognized or collected on all nonaccrual loans and TDRs as of the dates indicated:
Table 8 - Interest Income Recognized/Collected on Nonaccrual Loans and Troubled Debt Restructurings
 
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
The amount of incremental gross interest income that would have been recorded if nonaccrual loans had been current in accordance with their original terms
$
355

 
$
406

 
$
1,141

 
$
1,262

The amount of interest income on nonaccrual loans and performing TDRs that was included in net income
771

 
916

 
$
1,949

 
$
2,373

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. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and industrial, commercial real estate, commercial construction, and small business categories and for all loans identified as a TDR by comparing the loan’s value to either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. For impaired loans deemed collateral dependent, where impairment is measured using the fair value of the collateral, the Bank will either order a new appraisal or use another available source of collateral assessment such as a broker’s opinion of value to determine a reasonable estimate of the fair value of the collateral.
At September 30, 2014, impaired loans included all commercial and industrial loans, commercial real estate loans, commercial construction, and small business loans that are on nonaccrual status, TDRs, and other loans that have been categorized as impaired. Total impaired loans at September 30, 2014 and December 31, 2013 were $64.9 million and $72.1 million, respectively. For additional information regarding the Bank’s asset quality, including delinquent loans, nonaccruals, TDRs, and impaired loans, see Note 4, “Loans, Allowance for Loan Losses, and Credit Quality within Notes to Consolidated Financial Statements included in Item 1 hereof.

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Table of Contents


Potential problem loans are any loans which are not included in nonaccrual or nonperforming loans, where known information about possible credit problems of the borrowers causes management to have concerns as to the ability of such borrowers to comply with present loan repayment terms. At September 30, 2014, there were 75 relationships, with an aggregate balance of $72.6 million, deemed to be potential problem loans. These potential problem loans continued to perform with respect to payments. Management actively monitors these loans and strives to minimize any possible adverse impact to the Bank.
Allowance for Loan Losses The allowance for loan losses is maintained at a level that management considers appropriate to provide for probable loan losses based upon evaluation of known and inherent risks in the loan portfolio. The allowance is increased by providing for loan losses through a charge to expense and by recoveries of loans previously charged-off and is reduced by loans being charged-off.
While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on increases in nonperforming loans, changes in economic conditions, or for other reasons. Additionally, various regulatory agencies, as an integral part of the Bank's examination process, periodically assess the appropriate of the allowance for loan losses and may require it to increase its provision for loan losses or recognize further loan charge-offs, in accordance with U.S. GAAP.

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Table of Contents

The following table summarizes changes in the allowance for loan losses and other selected statistics for the periods presented:

Table 9 - Summary of Changes in the Allowance for Loan Losses

 
Three Months Ended
 
September 30,
2014
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
 
(Dollars in thousands)
Average total loans
$
4,893,674

 
$
4,844,917

 
$
4,788,064

 
$
4,651,524

 
$
4,535,596

Allowance for loan losses, beginning of period
$
54,538

 
$
53,629

 
$
53,239

 
$
53,562

 
$
52,976

Charged-off loans
 
 
 
 
 
 
 
 
 
Commercial and industrial
504

 
470

 
783

 
92

 
866

Commercial real estate
691

 
660

 
2,922

 
2,776

 
209

Commercial construction

 

 

 

 
308

Small business
73

 
128

 
268

 
268

 
84

Residential real estate
199

 
326

 
128

 
165

 
210

Home equity
160

 
308

 
94

 
416

 
420

Other consumer
279

 
258

 
371

 
381

 
273

Total charged-off loans
1,906

 
2,150

 
4,566

 
4,098

 
2,370

Recoveries on loans previously charged-off
 
 
 
 
 
 
 
 
 
Commercial and industrial
6

 
128

 
79

 
9

 
24

Commercial real estate
57

 
197

 
68

 
109

 
89

Commercial construction

 

 

 
100

 

Small business
29

 
92

 
47

 
156

 
47

Residential real estate
178

 
190

 

 
52

 
5

Home equity
67

 
55

 
93

 
62

 
22

Other consumer
135

 
147

 
167

 
137

 
119

Total recoveries
472

 
809

 
454

 
625

 
306

Net loans Charged-off (Recovered)
 
 
 
 
 
 
 
 
 
Commercial and industrial
498

 
342

 
704

 
83

 
842

Commercial real estate
634

 
463

 
2,854

 
2,667

 
120

Commercial construction

 

 

 
(100
)
 
308

Small business
44

 
36

 
221

 
112

 
37

Residential real estate
21

 
136

 
128

 
113

 
205

Home equity
93

 
253

 
1

 
354

 
398

Other consumer
144

 
111

 
204

 
244

 
154

Total net loans charged-off
1,434

 
1,341

 
4,112

 
3,473

 
2,064

Provision for loan losses
1,901

 
2,250

 
4,502

 
3,150

 
2,650

Total allowances for loan losses, end of period
$
55,005

 
$
54,538

 
$
53,629

 
$
53,239

 
$
53,562

Net loans charged-off as a percent of average total loans (annualized)
0.12
%
 
0.11
%
 
0.35
%
 
0.30
%
 
0.18
%
Allowance for loan losses as a percent of total loans
1.11
%
 
1.12
%
 
1.12
%
 
1.13
%
 
1.18
%
Allowance for loan losses as a percent of nonperforming loans
210.59
%
 
198.93
%
 
148.27
%
 
153.61
%
 
141.37
%
Net loans charged-off as a percent of allowance for loan losses (annualized)
10.34
%
 
9.86
%
 
31.10
%
 
25.88
%
 
15.29
%
Recoveries as a percent of charge-offs
24.76
%
 
37.63
%
 
9.94
%
 
15.25
%
 
12.91
%

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Table of Contents

For purposes of the allowance for loan losses, management segregates the loan portfolio into the portfolio segments detailed in the table below. The allocation of the allowance for loan losses is made to each loan category using the analytical techniques and estimation methods described herein. While these amounts represent management’s best estimate of the distribution of probable losses at the evaluation dates, they are not necessarily indicative of either the categories in which actual losses may occur or the extent of such actual losses that may be recognized within each category. Each of these loan categories possess unique risk characteristics that are considered when determining the appropriate level of allowance for each segment. The total allowance is available to absorb losses from any segment of the loan portfolio.

The following table sets forth the allocation of the allowance for loan losses by loan category at the dates indicated:
Table 10 - Summary of Allocation of Allowance for Loan Losses
 
 
September 30,
2014
 
December 31,
2013
 
Allowance
Amount
 
Percent of
Loans
In  Category
To Total Loans
 
Allowance
Amount
 
Percent of
Loans
In  Category
To Total Loans
 
(Dollars in thousands)
Commercial and industrial
$
15,522

 
17.1
%
 
$
15,622

 
16.6
%
Commercial real estate
25,709

 
47.3
%
 
24,541

 
47.7
%
Commercial construction
4,113

 
5.6
%
 
3,371

 
4.7
%
Small business
1,155

 
1.6
%
 
1,215

 
1.6
%
Residential real estate
2,822

 
10.8
%
 
2,760

 
11.5
%
Home equity
4,947

 
17.3
%
 
5,036

 
17.5
%
Other consumer
737

 
0.3
%
 
694

 
0.4
%
Total allowance for loan losses
$
55,005

 
100.0
%
 
$
53,239

 
100.0
%
To determine if a loan should be charged-off, all possible sources of repayment are analyzed. Possible sources of repayment include the potential for future cash flows, the value of the Bank’s collateral, and the strength of co-makers or guarantors. When available information confirms that specific loans or portions thereof are uncollectible, these amounts are promptly charged-off against the allowance for loan losses and any recoveries of such previously charged-off amounts are credited to the allowance.
Regardless of whether a loan is unsecured or collateralized, the Company charges off the amount of any confirmed loan loss in the period when the loans, or portions of loans, are deemed uncollectible. For troubled, collateral-dependent loans, loss-confirming events may include an appraisal or other valuation that reflects a shortfall between the value of the collateral and the carrying value of the loan or receivable, or a deficiency balance following the sale of the collateral.
For additional information regarding the Bank’s allowance for loan losses, see Note 4, “Loans, Allowance for Loan Losses, and Credit Quality within Notes to Consolidated Financial Statements included in Item 1hereof.
Federal Home Loan Bank Stock The Bank held an investment in Federal Home Loan Bank (“FHLB”) of Boston of $33.2 million and $39.9 million at September 30, 2014 and December 31, 2013, respectively. The decline is a result of the FHLB's repurchase of excess stock from its shareholders. The FHLB is a cooperative that provides services to its member banking institutions. The primary reason for the FHLB of Boston membership is to gain access to a reliable source of wholesale funding, particularly term funding, as a tool to manage interest rate risk. The purchase of stock in the FHLB is a requirement for a member to gain access to funding. The Company purchases FHLB stock proportional to the volume of funding received and views the purchases as a necessary long-term investment for the purposes of balance sheet liquidity and not for investment return.
Goodwill and Identifiable Intangible Assets Goodwill and identifiable intangible assets were $180.9 million and $182.6 million at September 30, 2014 and December 31, 2013, respectively.
The Company typically performs its annual goodwill impairment testing during the third quarter of the year, unless certain indicators suggest earlier testing to be warranted. The Company performed its annual goodwill impairment testing during the third quarter of 2014 and determined that the Company's goodwill was not impaired. Identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. There were no events or changes that indicated impairment of identifiable intangible assets.

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Cash Surrender Value of Life Insurance Policies The Bank holds life insurance policies for the purpose of offsetting its future obligations to its employees under its retirement and benefits plans. The cash surrender value of life insurance policies was $108.9 million and $100.4 million at September 30, 2014 and December 31, 2013, respectively. During the third quarter of 2014 the Company purchased an additional $10.0 million in life insurance policies. The Bank recorded tax exempt income from the life insurance policies of $774,000 and $2.2 million for the three and nine months ended September 30, 2014, respectively, a decrease of 2.4% and 4.6%, respectively, compared to the year ago period. In addition, the Company recognized tax exempt gains on life insurance benefits in the amount $2.0 million for the nine months ended September 30, 2014, respectively. There were no such gains for the three months ended September 30, 2014.
Deposits As of September 30, 2014, deposits increased by 6.3% to $5.3 billion when compared to $5.0 billion at December 31, 2013. Strong deposit growth was heavily led by the core deposit categories, which increased by $387.2 million from December 31, 2013 and now represent 87.1% of total deposits. Total cost of deposits was 0.21% for the third quarter.
The Bank also participates in the Certificate of Deposit Registry Service (“CDARS”) program, allowing the Bank to provide easy access to multi-million dollar FDIC deposit insurance protection on certificate of deposits investments for consumers, businesses and public entities. In addition, the Bank may occasionally raise funds through brokered certificates of deposit. This channel allows the Bank to seek additional funding in potentially large quantities by attracting deposits from outside the Bank’s core market. At September 30, 2014 and December 31, 2013, the Company had $72.7 million and $77.5 million, respectively, of brokered deposits of which $51.7 million and $53.7 million, respectively, were part of the CDARS program.
Borrowings The Company’s borrowings consist of both short-term and long-term borrowings and provide the Bank with one of its primary sources of funding. Maintaining available borrowing capacity provides the Bank with a contingent source of liquidity.

In June of 2014, the Company used excess liquidity to pay off $75.0 million of FHLB borrowings and exited the associated hedge which fixed the rate on those borrowings. As represented in the financial statements, this resulted in a loss on termination of derivatives for the second quarter of approximately $1.1 million.

The Company’s borrowings consisted of the following as of the periods indicated:
Table 11 - Borrowings
 
September 30,
2014
 
December 31,
2013
 
(Dollars in thousands)
Federal Home Loan Bank borrowings
$
60,127

 
$
140,294

Short-term borrowings - one year and under (1)
 
 
 
Customer repurchase agreements and other short-term borrowings
153,192

 
154,288

Long-term borrowings - over one year (1)
 
 
 
Wholesale repurchase agreements
50,000

 
50,000

Junior subordinated debentures:
 
 
 
Capital Trust V
51,547

 
51,547

Slades Ferry Trust I
10,310

 
10,310

Central Trust I
5,258

 
5,258

Central Trust II
6,626

 
6,791

Subordinated debentures
30,000

 
30,000

Total long-term borrowings
$
153,741

 
$
153,906

Total borrowings
$
367,060

 
$
448,488

(1) Classification is based upon duration at origination and not predicated upon remaining time to maturity.
At both September 30, 2014 and December 31, 2013, the Bank had $2.9 billion of assets pledged as collateral against borrowings. These assets are primarily pledged to the FHLB of Boston, the Federal Reserve Bank of Boston, and serve as collateral for repurchase agreements.

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Capital Resources On September 18, 2014, the Company’s Board of Directors declared a cash dividend of $0.24 per share to stockholders of record as of the close of business on September 29, 2014. This dividend was paid on October 10, 2014.
The Federal Reserve Board (Federal Reserve), the FDIC, and other regulatory agencies have established capital guidelines for banks and bank holding companies. Risk-based capital guidelines issued by the federal regulatory agencies require banks to meet a minimum Tier 1 risk-based capital ratio of 4.0% and a total risk-based capital ratio of 8.0%. A minimum requirement of 4.0% Tier 1 leverage capital is also mandated. At September 30, 2014 and December 31, 2013, the Company and the Bank exceeded the minimum requirements for Tier 1 risk-based, total risk-based capital, and Tier 1 leverage capital.

The Company’s and the Bank’s actual capital amounts and ratios are also presented in the following table:
Table 12 - Company and Bank's Capital Amounts and Ratios
 
 
Actual
 
For Capital Adequacy Purposes
 
To Be Well Capitalized Under Prompt
Corrective Action Provisions
 
Amount
 
Ratio
 
Amount
 
 
 
Ratio
 
Amount
 
 
 
Ratio
 
September 30, 2014
 
(Dollars in thousands)
Company (consolidated)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk weighted assets)
$
623,793

 
12.47
%
 
$
400,277

 
 
8.00
%
 
N/A

 
 
 
N/A

Tier 1 capital (to risk weighted assets)
537,815

 
10.75
%
 
200,138

 
 
4.00
%
 
N/A

 
 
 
N/A

Tier 1 capital (to average assets)
537,815

 
8.75
%
 
245,945

 
 
4.00
%
 
N/A

 
 
 
N/A

Bank
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk weighted assets)
$
606,610

 
12.13
%
 
$
400,126

 
 
8.00
%
 
$
500,157

 
 
10.00
%
Tier 1 capital (to risk weighted assets)
520,632

 
10.41
%
 
200,063

 
 
4.00
%
 
300,094

 
 
6.00
%
Tier 1 capital (to average assets)
520,632

 
8.47
%
 
245,922

 
 
4.00
%
 
307,402

 
 
5.00
%
 
December 31, 2013
 
(Dollars in thousands)
Company (consolidated)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk weighted assets)
$
589,811

 
12.58
%
 
$
375,117

 
 
8.00
%
 
N/A

 
 
 
N/A

Tier 1 capital (to risk weighted assets)
505,646

 
10.78
%
 
187,558

 
 
4.00
%
 
N/A

 
 
 
N/A

Tier 1 capital (to average assets)
505,646

 
8.64
%
 
234,153

 
 
4.00
%
 
N/A

 
 
 
N/A

Bank
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk weighted assets)
$
582,599

 
12.42
%
 
$
375,205

 
 
8.00
%
 
$
496,006

 
 
10.00
%
Tier 1 capital (to risk weighted assets)
498,434

 
10.63
%
 
187,603

 
 
4.00
%
 
281,404

 
 
6.00
%
Tier 1 capital (to average assets)
498,434

 
8.51
%
 
234,154

 
 
4.00
%
 
292,692

 
 
5.00
%
In July 2013, the Federal Reserve published final rules establishing a new comprehensive capital framework for U.S. banking organizations, referred to herein as the Rules. The FDIC has adopted substantially identical rules (as interim final rules). The Rules implement the Basel Committee’s December 2010 framework, commonly referred to as Basel III, for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Rules, among other things: (i) introduce a new capital measure called “Common Equity Tier 1,” or CET1; (ii) specify that Tier 1 capital consist of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements; (iii) apply most deductions/adjustments to regulatory capital measures to CET1 and not to the other components of capital, thus potentially requiring higher levels of CET1 in order to meet minimum ratios; and (iv) expand the scope of the reductions/adjustments from capital as compared to existing regulations. Based upon preliminary assessments of the proposed framework, management believes that the Company will continue to exceed all estimated well-capitalized regulatory requirements over the course of the proposed phase-in period.
Dividend Restrictions In the ordinary course of business, the Company is dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared

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exceed the net profits for that year combined with the retained net profits for the preceding two years. Under the foregoing dividend restrictions and while maintaining regulatory capital in excess of "well capitalized" minimum levels, dividends paid by the Bank to the Company totaled $11.8 million and $8.1 million for the three months ended September 30, 2014 and 2013, respectively, and totaled $28.3 million and $23.4 million for the nine months ended September 30, 2014 and 2013, respectively.
Trust Preferred Securities In accordance with the applicable accounting standard related to variable interest entities, the common stock of trusts which have issued trust preferred securities have not been included in the consolidated financial statements. At both September 30, 2014 and 2013, $71.0 million in trust preferred securities have been included in the Tier 1 capital of the Company for regulatory reporting purposes pursuant to the Federal Reserve's capital adequacy guidelines. Certain provisions of the Basel III capital standards proposal will require trust preferred securities to be excluded from Tier 1 capital, however, the Company qualifies under certain grandfathering provisions which allows the trust preferred securities to continue to be treated as Tier 1 capital under the Basel III capital standards.
Investment Management As of September 30, 2014, the Rockland Trust Investment Management Group had assets under administration of $2.4 billion, representing approximately 4,756 trust, fiduciary, and agency accounts. At December 31, 2013, assets under administration were $2.3 billion, representing approximately 4,401 trust, fiduciary, and agency accounts. Included in these amounts as of September 30, 2014 and December 31, 2013 are assets under administration of $208.2 million and $195.9 million, respectively, relating to the Company’s registered investment advisor, Bright Rock Capital Management, LLC, which provides institutional quality investment management services to institutional and high net worth clients. Revenue from the Investment Management Group amounted to $4.4 million and $13.1 million for the three and nine months ended September 30, 2014, respectively, compared to $3.8 million and $11.3 million for the three and nine months ended September 30, 2013.
Additionally, for the three and nine months ended September 30, 2014, retail investments and insurance revenue was $581,000 and $1.6 million, respectively, compared to $353,000 and $1.1 million for the three and nine months ended September 30, 2013. Retail investments and insurance includes commission revenue from LPL Financial and its affiliates, LPL Insurance Associates, Inc., Savings Bank Life Insurance of Massachusetts, and Smith Companies LTD, a division of Capitas Financial, LLC.

RESULTS OF OPERATIONS
The following table provides a summary of results of operations:
Table 13 - Summary of Results of Operations
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Net Income
$
15,738

 
$
14,655

 
$
43,867

 
$
39,665

Diluted earnings per share
$
0.66

 
$
0.64

 
$
1.83

 
$
1.73

Return on average assets
0.99
%
 
1.00
%
 
0.94
%
 
0.93
%
Return on average equity
9.97
%
 
10.53
%
 
9.56
%
 
9.74
%
Net interest margin
3.42
%
 
3.43
%
 
3.46
%
 
3.53
%
Net Interest Income The amount of net interest income is affected by changes in interest rates and by the volume and mix of interest earning assets and interest bearing liabilities.
On a fully tax equivalent basis, net interest income for the third quarter of 2014 increased $4.4 million, or 9.7%, to $49.8 million, when compared to the third quarter of 2013. The decline in the net interest margin is primarily the result of excess liquidity and assets re-pricing in a lower rate environment without the ability to fully offset this impact through further reductions in funding costs.

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The following tables present the Company’s average balances, net interest income, interest rate spread, and net interest margin for the three and nine months ending September 30, 2014 and 2013. Nontaxable income from loans and securities is presented on a fully tax-equivalent basis by adjusting tax-exempt income upward by an amount equivalent to the prevailing income taxes that would have been paid if the income had been fully taxable.
Table 14 - Average Balance, Interest Earned/Paid & Average Yields
 
Three Months Ended September 30
 
2014
 
2013
 
Average
Balance
 
Interest
Earned/
Paid
 
Average Yield
 
Average
Balance
 
Interest
Earned/
Paid
 
Average Yield
 
(Dollars in thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning deposits with banks, federal funds sold, and short term investments
$
153,314

 
$
96

 
0.25
%
 
$
128,027

 
$
79

 
0.24
%
Securities
 
 
 
 
 
 
 
 
 
 
 
Taxable investment securities
704,021

 
4,563

 
2.57
%
 
561,678

 
3,763

 
2.66
%
Nontaxable investment securities (1)
5,861

 
55

 
3.72
%
 
844

 
15

 
7.05
%
Total securities
709,882

 
4,618

 
2.58
%
 
562,522

 
3,778

 
2.66
%
Loans held for sale
16,812

 
159

 
3.75
%
 
20,784

 
156

 
2.98
%
Loans (2)
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
842,672

 
8,150

 
3.84
%
 
746,767

 
7,358

 
3.91
%
Commercial real estate (1)
2,302,181

 
24,252

 
4.18
%
 
2,159,869

 
23,812

 
4.37
%
Commercial construction
266,534

 
2,824

 
4.20
%
 
230,446

 
2,409

 
4.15
%
Small business
80,114

 
1,133

 
5.61
%
 
75,791

 
1,048

 
5.49
%
Total commercial
3,491,501

 
36,359

 
4.13
%
 
3,212,873

 
34,627

 
4.28
%
Residential real estate
537,669

 
5,511

 
4.07
%
 
503,313

 
4,899

 
3.86
%
Home equity
847,365

 
7,459

 
3.49
%
 
798,381

 
7,228

 
3.59
%
Total consumer real estate
1,385,034

 
12,970

 
3.72
%
 
1,301,694

 
12,127

 
3.70
%
Other consumer
17,139

 
412

 
9.54
%
 
21,029

 
488

 
9.21
%
Total loans
4,893,674

 
49,741

 
4.03
%
 
4,535,596

 
47,242

 
4.13
%
Total interest-earning assets
$
5,773,682

 
$
54,614

 
3.75
%
 
$
5,246,929

 
$
51,255

 
3.88
%
Cash and due from banks
78,375

 
 
 
 
 
141,922

 
 
 
 
Federal Home Loan Bank stock
34,576

 
 
 
 
 
38,674

 
 
 
 
Other assets
426,661

 
 
 
 
 
384,145

 
 
 
 
Total assets
$
6,313,294

 
 
 
 
 
$
5,811,670

 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking accounts
$
2,067,132

 
$
895

 
0.17
%
 
$
1,760,508

 
$
811

 
0.18
%
Money market
1,027,830

 
608

 
0.23
%
 
891,601

 
561

 
0.25
%
Time deposits
686,195

 
1,232

 
0.71
%
 
699,865

 
1,277

 
0.72
%
Total interest-bearing deposits
$
3,781,157

 
$
2,735

 
0.29
%
 
$
3,351,974

 
$
2,649

 
0.31
%
Borrowings
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank
$
60,151

 
$
462

 
3.05
%
 
225,749

 
1,377

 
2.42
%
Customer repurchase agreements and other short-term borrowings
146,804

 
49

 
0.13
%
 
149,365

 
49

 
0.13
%
Wholesale repurchase agreements
50,000

 
292

 
2.32
%
 
50,000

 
292

 
2.32
%
Junior subordinated debentures
73,771

 
1,010

 
5.43
%
 
73,990

 
1,021

 
5.47
%
Subordinated debentures
30,000

 
257

 
3.40
%
 
30,000

 
443

 
5.86
%

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Table of Contents

Total borrowings
$
360,726

 
$
2,070

 
2.28
%
 
$
529,104

 
$
3,182

 
2.39
%
Total interest-bearing liabilities
$
4,141,883

 
$
4,805

 
0.46
%
 
$
3,881,078

 
$
5,831

 
0.60
%
Demand deposits
1,459,105

 
 
 
 
 
1,303,181

 
 
 
 
Other liabilities
86,052

 
 
 
 
 
75,133

 
 
 
 
Total liabilities
$
5,687,040

 
 
 
 
 
$
5,259,392

 
 
 
 
Stockholders' equity
626,254

 
 
 
 
 
552,278

 
 
 
 
Total liabilities and stockholders' equity
$
6,313,294

 
 
 
 
 
$
5,811,670

 
 
 
 
Net interest income (1)
 
 
$
49,809

 
 
 
 
 
$
45,424

 
 
Interest rate spread (3)
 
 
 
 
3.29
%
 
 
 
 
 
3.28
%
Net interest margin (4)
 
 
 
 
3.42
%
 
 
 
 
 
3.43
%
Supplemental information
 
 
 
 
 
 
 
 
 
 
 
Total deposits, including demand deposits
$
5,240,262

 
$
2,735

 
 
 
$
4,655,155

 
$
2,649

 
 
Cost of total deposits
 
 
 
 
0.21
%
 
 
 
 
 
0.23
%
Total funding liabilities, including demand deposits
$
5,600,988

 
$
4,805

 
 
 
$
5,184,259

 
$
5,831

 
 
Cost of total funding liabilities
 
 
 
 
0.34
%
 
 
 
 
 
0.45
%
 
(1)
The total amount of adjustment to present interest income and yield on a FTE basis is $246,000 and $228,000 for the three months ended September 30, 2014 and 2013, respectively. The FTE adjustment relates to nontaxable investment securities with average balances of $5.9 million and $844,000 and nontaxable industrial development bonds recorded within commercial real estate with average balances of $44.3 million and $42.1 million, for the three months ended September 30, 2014 and 2013, respectively.
(2)
Average nonaccruing loans are included in loans.
(3)
Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(4)
Net interest margin represents annualized net interest income as a percentage of average interest-earning assets.


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Table 15—Average Balance, Interest Earned/Paid & Average Yields

 
Nine Months Ended September 30
 
2014
 
2013
 
Average
Balance
 
Interest
Earned/
Paid
 
Yield/
Rate
 
Average
Balance
 
Interest
Earned/
Paid
 
Yield/
Rate
 
(Dollars in Thousands)
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning deposits with banks, federal funds sold, and short-term investments
$
108,771

 
$
203

 
0.25
%
 
$
72,126

 
$
134

 
0.25
%
Securities
 
 
 
 
 
 
 
 
 
 
 
Taxable investment securities
709,774

 
13,903

 
2.62
%
 
539,823

 
10,798

 
2.67
%
Nontaxable investment securities (1)
6,036

 
181

 
4.01
%
 
892

 
52

 
7.79
%
Total securities
715,810

 
14,084

 
2.63
%
 
540,715

 
10,850

 
2.68
%
Loans held for sale
10,840

 
306

 
3.77
%
 
32,796

 
661

 
2.69
%
Loans (2)
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
835,092

 
24,234

 
3.88
%
 
725,385

 
21,534

 
3.97
%
Commercial real estate (1)
2,289,601

 
73,177

 
4.27
%
 
2,143,925

 
71,780

 
4.48
%
Commercial construction
246,077

 
7,787

 
4.23
%
 
218,181

 
6,732

 
4.13
%
Small business
78,832

 
3,289

 
5.58
%
 
77,068

 
3,200

 
5.55
%
Total commercial
3,449,602

 
108,487

 
4.20
%
 
3,164,559

 
103,246

 
4.36
%
Residential real estate
539,400

 
15,997

 
3.97
%
 
540,073

 
16,206

 
4.01
%
Home equity
835,549

 
22,061

 
3.53
%
 
796,326

 
21,391

 
3.59
%

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Table of Contents

Total consumer real estate
1,374,949

 
38,058

 
3.70
%
 
1,336,399

 
37,597

 
3.76
%
Other consumer
18,054

 
1,345

 
9.96
%
 
23,320

 
1,568

 
8.99
%
Total loans
4,842,605

 
147,890

 
4.08
%
 
4,524,278

 
142,411

 
4.21
%
Total interest-earning assets
$
5,678,026

 
$
162,483

 
3.83
%
 
$
5,169,915

 
$
154,056

 
3.98
%
Cash and due from banks
111,091

 
 
 
 
 
114,199

 
 
 
 
Federal home loan bank stock
37,557

 
 
 
 
 
39,455

 
 
 
 
Other assets
418,333

 
 
 
 
 
403,311

 
 
 
 
Total assets
$
6,245,007

 
 
 
 
 
$
5,726,880

 
 
 
 
Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking accounts
$
2,024,157

 
$
2,703

 
0.18
%
 
$
1,685,398

 
$
2,192

 
0.17
%
Money market
1,009,821

 
1,834

 
0.24
%
 
877,891

 
1,689

 
0.26
%
Time deposits
711,393

 
3,777

 
0.71
%
 
726,737

 
3,976

 
0.73
%
Total interest-bearing deposits
$
3,745,371

 
$
8,314

 
0.30
%
 
$
3,290,026

 
$
7,857

 
0.32
%
Borrowings
 
 
 
 
 
 
 
 
 
 
 
Federal home loan bank
$
113,995

 
$
2,327

 
2.73
%
 
$
267,515

 
$
4,188

 
2.09
%
Customer repurchase agreements and other short-term borrowings
140,421

 
148

 
0.14
%
 
146,872

 
205

 
0.19
%
Wholesale repurchase agreements
50,000

 
866

 
2.32
%
 
50,000

 
866

 
2.32
%
Junior subordinated debentures
73,826

 
2,996

 
5.43
%
 
74,046

 
3,029

 
5.47
%
Subordinated debentures
30,000

 
758

 
3.38
%
 
30,000

 
1,524

 
6.79
%
Total borrowings
$
408,242

 
$
7,095

 
2.32
%
 
$
568,433

 
$
9,812

 
2.31
%
Total interest-bearing liabilities
$
4,153,613

 
$
15,409

 
0.50
%
 
$
3,858,459

 
$
17,669

 
0.61
%
Demand Deposits
1,398,599

 
 
 
 
 
1,244,138

 
 
 
 
Other liabilities
79,139

 
 
 
 
 
79,650

 
 
 
 
Total liabilities
$
5,631,351

 
 
 
 
 
$
5,182,247

 
 
 
 
Stockholders' equity
613,656

 
 
 
 
 
544,633

 
 
 
 
Total liabilities and stockholders' equity
$
6,245,007

 
 
 
 
 
$
5,726,880

 
 
 
 
Net interest income (1)
 
 
$
147,074

 
 
 
 
 
$
136,387

 
 
Interest rate spread (3)
 
 
 
 
3.33
%
 
 
 
 
 
3.37
%
Net interest margin (4)
 
 
 
 
3.46
%
 
 
 
 
 
3.53
%
Supplemental information
 
 
 
 
 
 
 
 
 
 
 
Total deposit, including demand deposits
$
5,143,970

 
$
8,314

 
 
 
$
4,534,164

 
$
7,857

 
 
Cost of total deposits
 
 
 
 
0.22
%
 
 
 
 
 
0.23
%
Total funding liabilities, including demand deposits
$
5,552,212

 
$
15,409

 
 
 
$
5,102,597

 
$
17,669

 
 
Cost of total funding liabilities
 
 
 
 
0.37
%
 
 
 
 
 
0.46
%
 
(1)
The total amount of adjustment to present interest income and yield on a FTE basis is $851,000 and $714,000 for the nine months ended September 30, 2014 and 2013, respectively. The FTE adjustment relates to nontaxable investment securities with average balances of $6.0 million and $892,000 and nontaxable industrial development bonds recorded within commercial real estate with average balances of $44.6 million and $37.4 million for the nine months ended September 30, 2014 and 2013, respectively.
(2)
Average nonaccruing loans are included in loans.
(3)
Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(4)
Net interest margin represents annualized net interest income as a percentage of average interest-earning assets.


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The following table presents certain information on a fully tax-equivalent basis regarding changes in the Company’s interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to: (1) changes in rate (change in rate multiplied by old volume), (2) changes in volume (change in volume multiplied by old rate), and (3) changes in volume/rate (change in volume multiplied by change in rate) which is allocated to the change due to rate column:

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Table 16 - Volume Rate Analysis
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2014 Compared To 2013
 
2014 Compared To 2013
 
Change
Due to
Rate
 
Change
Due to
Volume
 
Total Change
 
Change
Due to
Rate
 
Change
Due to
Volume
 
Total Change
 
(Dollars in thousands)
Income on interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest earning deposit, federal funds sold and short term investments
$
1

 
$
16

 
$
17

 
$
1

 
$
68

 
$
69

Securities
 
 
 
 
 
 
 
 
 
 
 
Taxable investment securities
(154
)
 
954

 
800

 
(295
)
 
3,400

 
3,105

Nontaxable investment securities (1)
(49
)
 
89

 
40

 
(171
)
 
300

 
129

Total securities
 
 
 
 
840

 
 
 
 
 
3,234

Loans held for sale
33

 
(30
)
 
3

 
88

 
(443
)
 
(355
)
Loans
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
(153
)
 
945

 
792

 
(557
)
 
3,257

 
2,700

Commercial real estate (1)
(1,129
)
 
1,569

 
440

 
(3,479
)
 
4,877

 
1,398

Commercial construction
38

 
377

 
415

 
194

 
861

 
1,055

Small business
25

 
60

 
85

 
16

 
73

 
89

Total commercial
 
 
 
 
1,732

 
 
 
 
 
5,242

Residential real estate
278

 
334

 
612

 
(189
)
 
(20
)
 
(209
)
Home equity
(212
)
 
443

 
231

 
(384
)
 
1,054

 
670

Total consumer real estate
 
 
 
 
843

 
 
 
 
 
461

Other consumer
14

 
(90
)
 
(76
)
 
131

 
(354
)
 
(223
)
Total loans (1)(2)
 
 
 
 
2,499

 
 
 
 
 
5,480

Total income of interest-earning assets
 
 
 
 
$
3,359

 
 
 
 
 
$
8,428

Expense of interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking accounts
$
(57
)
 
$
141

 
$
84

 
$
70

 
$
441

 
$
511

Money market
(39
)
 
86

 
47

 
(109
)
 
254

 
145

Time certificates of deposits
(20
)
 
(25
)
 
(45
)
 
(115
)
 
(84
)
 
(199
)
Total interest bearing deposits
 
 
 
 
86

 
 
 
 
 
457

Borrowings
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank borrowings
95

 
(1,010
)
 
(915
)
 
542

 
(2,403
)
 
(1,861
)
Customer repurchase agreements and other short-term borrowings
1

 
(1
)
 

 
(48
)
 
(9
)
 
(57
)
Wholesale repurchase agreements

 

 

 

 

 

Junior subordinated debentures
(8
)
 
(3
)
 
(11
)
 
(24
)
 
(9
)
 
(33
)
Subordinated debt
(186
)
 

 
(186
)
 
(766
)
 

 
(766
)
Total borrowings
 
 
 
 
(1,112
)
 
 
 
 
 
(2,717
)
Total expense of interest-bearing liabilities
 
 
 
 
(1,026
)
 
 
 
 
 
(2,260
)
Change in net interest income
 
 
 
 
$
4,385

 
 
 
 
 
$
10,688

 
(1)
The table above reflects income determined on a fully tax equivalent basis. See footnote (1) to tables 14 and 15 above for the related adjustments.
(2)
Loans include portfolio loans and nonaccrual loans; however, unpaid interest on nonaccrual loans has not been included for purposes of determining interest income.
The increase in net interest income is driven primarily by loan growth, fueled mainly by acquisitions, exceeding the impact of a continued decreasing interest rate environment.


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Provision For Loan Losses The provision for loan losses represents the charge to expense that is required to maintain an appropriate level of allowance for loan losses. The provision for loan losses totaled $1.9 million and $8.7 million for the three and nine months ended September 30, 2014, respectively, compared with $2.7 million and $7.1 million for the comparable year-ago periods. The Company’s allowance for loan losses, as a percentage of total loans, was 1.11% at September 30, 2014, as compared to 1.13% at December 31, 2013 and 1.18% at September 30, 2013. For the three and nine months ended September 30, 2014, net loan charge-offs totaled $1.4 million and $6.9 million, respectively, a decrease of $630,000 and an increase of $1.6 million from the three and nine months ended September 30, 2013.
Regional and local general economic conditions continued to improve during the first nine months of 2014, as measured by employment levels, economic activity, and other regional economic indicators. Local residential real estate market fundamentals were mixed during the third quarter of 2014, characterized by a lower level of home sales but increased sales prices compared to the same period in 2013. Consumer spending in Massachusetts continued to grow in 2014 through the third quarter. Regional commercial real estate market conditions were mixed, with most markets experiencing positive trends, but some exhibiting higher vacancy rates and flat to negative absorption. Leading economic indicators suggest continued economic improvement through the end of 2014.
Management’s periodic evaluation of the adequacy of the allowance for loan losses considers past loan loss experience, known and inherent risks in the loan portfolio, adverse situations which may affect the borrowers’ ability to repay, the estimated value of the underlying collateral, if any, and current economic conditions. Substantial portions of the Bank’s loans are secured by real estate in Massachusetts and Rhode Island. Accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio is susceptible to changes in property values within those states.

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Noninterest Income The following table sets forth information regarding noninterest income for the periods shown:
Table 17 - Noninterest Income
 
Three Months Ended
 
September 30
 
Change
 
2014
 
2013
 
Amount
 
%
 
(Dollars in thousands)
 
 
Deposit account fees
$
4,656

 
$
4,604

 
$
52

 
1.13
 %
Interchange and ATM fees
3,375

 
2,845

 
530

 
18.63
 %
Investment management
5,016

 
4,175

 
841

 
20.14
 %
Mortgage banking income
1,015

 
1,843

 
(828
)
 
(44.93
)%
Loan level derivative income
381

 
1,331

 
(950
)
 
(71.37
)%
Increase in cash surrender value of life insurance policies
774

 
793

 
(19
)
 
(2.40
)%
Gain on extinguishment of debt

 
763

 
(763
)
 
(100.00
)%
Gain on sale of equity securities, net
67

 

 
67

 
100.00
 %
Other noninterest income
1,814

 
1,776

 
38

 
2.14
 %
Total
$
17,098

 
$
18,130

 
$
(1,032
)
 
(5.69
)%
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
September 30
 
Change
 
2014
 
2013
 
Amount
 
%
 
(Dollars in thousands)
 
 
Deposit account fees
$
13,478

 
$
13,164

 
$
314

 
2.39
 %
Interchange and ATM fees
9,672

 
7,934

 
1,738

 
21.91
 %
Investment management
14,755

 
12,417

 
2,338

 
18.83
 %
Mortgage banking income
2,379

 
5,794

 
(3,415
)
 
(58.94
)%
Loan level derivative income
1,452

 
2,679

 
(1,227
)
 
(45.80
)%
Increase in cash surrender value of life insurance policies
2,217

 
2,325

 
(108
)
 
(4.65
)%
Gain on extinguishment of debt

 
763

 
(763
)
 
(100.00
)%
Gain on life insurance benefits
1,964

 

 
1,964

 
100.00
 %
Gain (loss) on sale of equity securities, net
138

 
(4
)
 
142

 
3,550.00
 %
Other noninterest income
5,414

 
5,473

 
(59
)
 
(1.08
)%
Total
$
51,469

 
$
50,545

 
$
924

 
1.83
 %
Noninterest income amounted to $17.1 million and $51.5 million during the three and nine months ended September 30, 2014, a $1.0 million, or 5.7%, decrease and a $924,000, or 1.8%, increase, respectively, from the same periods in the prior year. The primary reasons for the significant variances in the noninterest income category shown in the preceding tables are noted below:
Deposit account fees and interchange and ATM fees increased as compared to the prior year comparative periods due to the Bank's increased customer base, as a result of acquisitions and successful growth of core checking accounts.
Investment management income growth is driven primarily from growth in overall assets under administration, which were $2.4 billion at September 30, 2014, an increase of 284.7 million, or 13.2%, as compared to September 30, 2013. In addition, the Company has experienced successful growth in the retail channel during the year.
Mortgage banking income decreased driven by a lower volume of loan production during the three and nine months ended September 30, 2014.
Loan level derivative income decreased due to the mix of commercial loan closings during the three and nine months ended September 30, 2014.

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Certain nonrecurring items such as gains on life insurance benefits and extinguishment of debt also impact comparisons to the prior year comparative periods.

Noninterest Expense The following table sets forth information regarding non-interest expense for the periods shown:
Table 18 - Noninterest Expense
 
Three Months Ended
 
September 30
 
Change
 
2014
 
2013
 
Amount
 
%
 
(Dollars in thousands)
 
 
Salaries and employee benefits
$
23,651

 
$
22,654

 
$
997

 
4.40
 %
Occupancy and equipment expenses
5,027

 
4,573

 
454

 
9.93
 %
Data processing & facilities management
1,178

 
1,179

 
(1
)
 
(0.08
)%
FDIC assessment
957

 
898

 
59

 
6.57
 %
Advertising expense
1,179

 
759

 
420

 
55.34
 %
Consulting expense
737

 
914

 
(177
)
 
(19.37
)%
Debit card expense
552

 
766

 
(214
)
 
(27.94
)%
Merger and acquisition expenses
677

 
366

 
311

 
84.97
 %
Software maintenance
579

 
599

 
(20
)
 
(3.34
)%
Other noninterest expenses
8,070

 
8,014

 
56

 
0.70
 %
Total
$
42,607

 
$
40,722

 
$
1,885

 
4.63
 %
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
September 30
 
Change
 
2014
 
2013
 
Amount
 
%
 
(Dollars in thousands)
 
 
Salaries and employee benefits
$
69,574

 
$
66,963

 
$
2,611

 
3.90
 %
Occupancy and equipment expenses
16,474

 
14,742

 
1,732

 
11.75
 %
Data processing & facilities management
3,609

 
3,564

 
45

 
1.26
 %
FDIC assessment
2,828

 
2,653

 
175

 
6.60
 %
Advertising expense
3,252

 
3,410

 
(158
)
 
(4.63
)%
Consulting expense
2,105

 
2,291

 
(186
)
 
(8.12
)%
Debit card expense
1,694

 
2,209

 
(515
)
 
(23.31
)%
Loss on termination of derivatives
1,122

 

 
1,122

 
100.00
 %
Merger and acquisition expenses
754

 
2,465

 
(1,711
)
 
(69.41
)%
Software maintenance
1,850

 
1,878

 
(28
)
 
(1.49
)%
Other noninterest expenses
24,212

 
25,630

 
(1,418
)
 
(5.53
)%
Total
$
127,474

 
$
125,805

 
$
1,669

 
1.33
 %
Noninterest expense increased by $1.9 million, or 4.63%, and increased by $1.7 million, or 1.33%, during the three and nine months ended September 30, 2014, as compared to the same periods in the prior year. The primary reasons for the significant variances in the noninterest expense category shown in the preceding tables are noted below:
The increase in salaries and employee benefits reflects overall increases in the employee base (including the November 2013 Mayflower acquisition) along with increases in commissions and payroll taxes.
Occupancy and equipment expense increases were attributable to costs associated with the Mayflower acquired facilities, 2014 first quarter impairment on certain acquired facilities, increased equipment maintenance and repairs, increased snow removal costs, and utilities.

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Advertising expense fluctuates due to the timing of marketing campaigns.
Consulting expense has decreased slightly due to timing of certain initiatives.
During the second quarter of 2014, the Company repaid $75.0 million of Federal Home Loan Bank borrowings and terminated associated derivative positions which resulted in the recognition of a loss on termination of $1.1 million.
Merger and acquisition expense in 2014 is primarily related to the Peoples Federal Bancorp acquisition which is expected to close in the first quarter of 2015 subject to shareholder and regulatory approval and satisfaction of other conditions to closing. The majority of the expense in 2013 relates to various contract terminations and benefit expenses associated with the Central Bancorp, Inc. acquisition which closed in November of 2012.
Other noninterest expense decreased for the nine months ended September 30, 2014 due primarily to reduced contract labor costs, mortgage operations expense, and loan workout costs.

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Income Taxes The tax effect of all income and expense transactions is recognized by the Company in each year’s consolidated statements of income, regardless of the year in which the transactions are reported for income tax purposes. The following table sets forth information regarding the Company’s tax provision and applicable tax rates for the periods indicated:

Table 19 - Tax Provision and Applicable Tax Rates
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
 
(Dollars in thousands)
Combined federal and state income tax provisions
$
6,415

 
$
5,299

 
$
17,699

 
$
13,698

Effective income tax rates
28.96
%
 
26.56
%
 
28.75
%
 
25.67
%
The effective income tax rates are lower than the blended statutory tax rate of 40.74% for the three and nine months ended September 30, 2014 and 2013, due to certain tax preference assets such as life insurance policies and tax exempt bonds, as well as federal tax credits recognized primarily in connection with the New Markets Tax Credit program and investments in Low Income Housing Project Investments. The increase in the tax rate for 2014 is primarily due to a reduction in the benefits recognized from New Markets Tax Credits.

The Company's subsidiaries have received several awards of tax credit allocation authority under the federal New Markets Tax Credit Program which enable the Company to recognize federal tax credits over a seven year period totaling 39.0% of the total award. The Company recognizes federal tax credits as capital investments are made into its subsidiaries to fund below market interest rate loans to qualifying businesses in low income communities. The following table details the remaining tax credit recognition by year associated with this program:
Table 20 - New Markets Tax Credit Recognition Schedule
Investment
 
2014
 
2015
 
2016
 
2017
 
2018
 
2019
 
Total Remaining
Credits
 
 
 
(Dollars in thousands)
2008
$
6,800

 
408

 

 

 

 

 

 
408

2009
10,000

 
600

 
600

 

 

 

 

 
1,200

2010
40,000

 
2,400

 
2,400

 
2,400

 

 

 

 
7,200

2012
21,400

 
1,071

 
1,285

 
1,285

 
1,285

 
1,285

 

 
6,211

2013
44,600

 
2,229

 
2,229

 
2,675

 
2,675

 
2,675

 
2,675

 
15,158

Total
$
122,800

 
$
6,708

 
$
6,514

 
$
6,360

 
$
3,960

 
$
3,960

 
$
2,675

 
$
30,177

 
    
The Company invests in various Low Income Housing Projects which are real estate limited partnerships that acquire, develop, own and operate low and moderate-income housing. As a limited partner in these operating partnerships, the Company will receive tax credits and tax deductions for losses incurred by the underlying properties. The investments are accounted for using the proportional amortization method and will be amortized over various periods through 2030, which represents the period that the tax benefits will be utilized. The total committed investment in these partnerships is $29.5 million, of which $7.3 million has been funded. It is expected that the limited partnership investments will generate a net tax benefit of approximately $459,000 for the 2014 calendar year, and a total of $10.3 million over the remaining life of the investments, from the combination of the tax credits and operating losses.
Deferred tax assets generally represent items that can be used as a tax deduction or credit in future income tax returns, for which a financial statement tax benefit has already been recognized. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income to which “carry-back” refund claims could be made. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The effect of a change in enacted tax rates on the deferred tax assets is recognized in income in the period that includes the enactment date. The Company had no recorded tax valuation allowance as of September 30, 2014 and 2013.


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Risk Management
The Company’s Board of Directors and Executive Management have identified significant risk categories which affect the Company. The risk categories include: credit risk, operations risk, compliance risk, reputation risk, strategic risk, market risk and liquidity risk. The Board of Directors has approved a Risk Management Policy that addresses each category of risk. The Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Information Officer, Director of Residential Lending and Compliance Officer, Executive Vice President of Commercial Lending and other members of management provide regular reports to the Board of Directors, identifying key risk issues and plans to address these issues. The Board of Directors will ensure the level of risk is within limits established by both the Risk Management Policy and other previously approved policies.
Credit Risk Credit risk represents the possibility that the Company's borrowing customers or other counterparties may not repay loans or other contractual obligations according to their terms due to changes in the financial capacity and ability of such borrowing customers or counterparties to meet their obligations. In some cases, the collateral securing the payment of the loans may be sufficient to assure repayment, but in other cases the Company may experience significant credit losses which could have an adverse effect on its operating results. The Company makes various assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and counterparties and the value of the real estate and other assets serving as collateral for the repayment of loans. For further discussion regarding the credit risk and the credit quality of the Company’s loan portfolio, see Note 4, “Loans, Allowance for Loan Losses, and Credit Quality within Notes to Consolidated Financial Statements included in Item 1 hereof.
Operations Risk  Operations risk is the risk of loss due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, disasters and security risks. The Company continuously strives to strengthen its system of internal controls, operating processes and employee awareness. The Bank has an Operations Risk Management Committee that meets monthly and reports to the Board quarterly or more frequently if warranted. The Committee is chaired by the Director of Compliance and members of the Committee include representatives from Audit, Finance, Technology, Operations, Information Security and periodic attendance from business units throughout the organization. An operations risk management dashboard is updated quarterly and reviewed with the Board.
Compliance Risk Compliance risk represents the risk of regulatory sanctions or financial loss resulting from the Company’s failure to comply with rules and regulations issued by the various banking agencies, the U.S. Securities and Exchange Commission, the NASDAQ Stock Market, and standards of good banking practice. Activities which may expose the Company to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, adherence to all applicable laws and regulations, community reinvestment initiatives and employment and tax matters. Compliance risk is mitigated through the use of written policies and procedures, training of staff, and monitoring of activities for adherence to those procedures.
Strategic and Reputation Risk Strategic and reputation risk represent the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, and failure to assess current and new opportunities and threats in business, markets, and products. Management mitigates strategic and reputational risk through robust annual strategic planning, frequent executive strategic reviews, ongoing competitive and technological observation, rigorous assessment processes of new product, new branch, and new business initiatives, adherence to ethical standards, a philosophy of customer advocacy, a structured process of customer complaint resolution, and ongoing reputational monitoring and management tools.
Market Risk Market risk is the sensitivity of income to changes in interest rates, foreign exchange rates, commodity prices and other market-driven rates or prices. Interest rate sensitivity is the most significant market risk to which the Company is exposed.
Interest rate risk is the sensitivity of income to changes in interest rates. Changes in interest rates, as well as fluctuations in the level and duration of assets and liabilities, affect net interest income, the Company’s primary source of revenue. Interest rate risk arises directly from the Company’s core banking activities. In addition to directly impacting net interest income, changes in the level of interest rates can also affect the amount of loans originated, the timing of cash flows on loans and securities, and the fair value of securities and derivatives, as well as other effects.
The primary goal of interest rate risk management is to control this risk within limits approved by the Board of Directors. These limits reflect the Company’s tolerance for interest rate risk over both short-term and long-term horizons. The Company attempts to control interest rate risk by identifying, quantifying, and where appropriate, hedging its exposure. If assets and liabilities do not re-price simultaneously and in equal volume, the potential for interest rate exposure exists. It is management’s objective to maintain stability in the growth of net interest income through the maintenance of an appropriate mix of interest-earning assets and interest-bearing liabilities and, when necessary, within prudent limits, through the use of off-balance sheet hedging instruments such as interest rate swaps, floors and caps.

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The Company quantifies its interest rate exposures using net interest income simulation models, as well as simpler gap analysis, and Economic Value of Equity analysis. Key assumptions in these simulation analyses relate to behavior of interest rates and behavior of the Company’s deposit and loan customers. The most material assumptions relate to the prepayment of mortgage assets (including mortgage loans and mortgage-backed securities) and the life and sensitivity of nonmaturity deposits (e.g. DDA, NOW, savings and money market). In the case of prepayment of mortgage assets, assumptions are derived from published dealer median prepayment estimates for comparable mortgage loans. The risk of prepayment tends to increase when interest rates fall. Since future prepayment behavior of loan customers is uncertain, the resultant interest rate sensitivity of loans cannot be determined exactly.
The Company’s policy on interest-rate risk simulation specifies that for all "core" interest rate scenarios, estimated net interest income for the subsequent one-year period should not decline by more than 10%. The Company's core scenarios for September 30, 2014 included five instantaneous parallel shifts (“shocks”) to market interest rates and four gradual (12 to 24 months) shifts in interest. Additionally, the Company analyzed a separate alternative scenario, labeled "Yield Curve Twist". In this scenario the long-term end of the yield curve increases over the first 18 months of the simulation, followed by the short term rate rising over months 19-36. This causes the curve to flatten around a targeted fed fund rate of 4.00%.
The results of all scenarios are outlined in the table below:
Table 21 - Interest Rate Sensitivity
 
Impact on Net Interest Income
 
As of September 30,
 
2014
 
2013
 
Year 1
 
Year 2
 
Year 1
 
Year 2
Parallel rate shocks (basis points)
 
 
 
 
 
 
 
-100
(0.2
)%
 
(3.9
)%
 
%
 
(3.1
)%
+100
4.7
 %
 
7.1
 %
 
3.6
%
 
5.6
 %
+200
9.3
 %
 
14.2
 %
 
7.3
%
 
11.4
 %
+300
14.0
 %
 
21.4
 %
 
11.1
%
 
17.3
 %
+400
18.7
 %
 
28.5
 %
 
14.7
%
 
23.1
 %
 
 
 
 
 
 
 
 
Gradual rate shifts (basis points)
 
 
 
 
 
 
 
-100 over 12 months
0.2
 %
 
(2.6
)%
 
0.3
%
 
(2.1
)%
+200 over 12 months
4.2
 %
 
12.4
 %
 
3.2
%
 
9.8
 %
+400 over 24 months
4.3
 %
 
17.2
 %
 
3.2
%
 
13.5
 %
Flat +500 over 12 months
5.2
 %
 
19.9
 %
 
3.9
%
 
15.5
 %
 
 
 
 
 
 
 
 
Alternative scenarios
 
 
 
 
 
 
 
Yield curve twist
0.5
 %
 
4.1
 %
 
n/a

 
n/a

    
The Company's policy on interest rate risk simulation also specifies that estimated net interest income for the second year of all “core scenarios” should not decline by more than 15.0%. The Company was within policy limits at September 30, 2014 and 2013. It should be emphasized, however, that the results are dependent on material assumptions such as those discussed above. For instance, asymmetrical rate behavior can have a material impact on the simulation results. If competition for deposits forced the Company to raise rates on those liabilities more quickly than is assumed in the simulation analysis without a corresponding increase in asset yields, net interest income may be negatively impacted. Alternatively, if the Company is able to lag increases in deposit rates as loans re-price upward, net interest income would be positively impacted.
The most significant factors affecting market risk exposure of the Company’s net interest income during the nine months ended September 30, 2014 were the shape of the U.S. Government securities and interest rate swap yield curve, the level of U.S. prime interest rate and LIBOR rates, and the level of interest rates being offered on long-term fixed rate loans.
The Company manages the interest rate risk inherent in both its loan and borrowing portfolios by utilizing interest rate swap agreements and interest rate caps and floors. An interest rate swap is an agreement whereby one party agrees to pay a floating rate of interest on a notional principal amount in exchange for receiving a fixed rate of interest on the same notional amount for

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a predetermined period of time from a second party. Interest rate caps and floors are agreements whereby one party agrees to pay a floating rate of interest on a notional principal amount for a predetermined period of time to a second party if certain market interest rate thresholds are realized. The amounts relating to the notional principal amount are not actually exchanged. Additionally, the Company manages the interest rate risk inherent in its mortgage banking operations by entering into forward sales contracts and forward TBA mortgage contracts. An increase in market interest rates between the time the Company commits to terms on a loan and the time the Company ultimately sells the loan in the secondary market will have the effect of reducing the gain (or increasing the loss) the Company records on the sale. The Company attempts to mitigate this risk by entering into forward sales commitments and forward TBA mortgage contracts in amounts sufficient to cover loans anticipated to close and interest rate-locked loan commitments. See Note 7, “Derivative and Hedging Activities within Notes to Consolidated Financial Statements included in Item 1 hereof for additional information regarding the Company’s derivative financial instruments.
The Company’s earnings are not directly or materially impacted by movements in foreign currency rates or commodity prices. Movements in equity prices may have a modest impact on earnings by affecting the volume of activity or the amount of fees from investment-related business lines.
Liquidity Risk Liquidity risk is the risk that the Company will not have the ability to generate adequate amounts of cash in the most economical way for the institution to meet its ongoing obligations to pay deposit withdrawals, service borrowings, and to fund loan commitments. The Company’s primary sources of funds are deposits, borrowings, and the amortization, prepayment and maturities of loans and securities. The Bank utilizes its extensive branch network to access retail customers who provide a stable base of in-market core deposits. These funds are principally comprised of demand deposits, interest checking accounts, savings accounts, and money market accounts. Deposit levels are greatly influenced by interest rates, economic conditions, and competitive factors.
The Company actively manages its liquidity position under the direction of the Asset Liability Committee of the Bank (ALCO). The Company’s primary measure of short-term liquidity is the Total Basic Surplus/Deficit as a percentage of assets. This ratio, which is an analysis of the relationship between liquid assets, short-term liabilities, and available capacity at the FHLB relative to total assets, was within policy limits at September 30, 2014. The Total Basic Surplus/Deficit measure is affected primarily by changes in deposits, securities and short-term investments, loans and borrowings. An increase in deposits, without a corresponding increase in nonliquid assets, will improve the Total Basic Surplus/Deficit measure, whereas, an increase in loans, with no increase in deposits, will decrease the measure. Other factors affecting the Total Basic Surplus/Deficit measure include collateral requirements at the FHLB, changes in the securities portfolio, and the mix of deposits.
The Bank is careful to increase deposits without adversely impacting the weighted average cost of those funds. As part of a prudent liquidity risk management practice, the Company maintains various liquidity sources, some of which are only accessed on a contingency basis. Accordingly, management has implemented funding strategies that include FHLB advances, Federal Reserve Bank borrowing capacity and repurchase agreement lines. These nondeposit funds are also viewed as a contingent source of liquidity and, when profitable lending and investment opportunities exist, access to such funds provides a means to grow the balance sheet.
Borrowing capacity at the FHLB and the Federal Reserve is impacted by the amount and type of assets available to be pledged. For example, a prime, one-to-four family, residential loan, may provide 75 cents of borrowing capacity for every $1.00 pledged, whereas, a commercial loan may provide a lower amount. As a result, the Company’s strategic lending decisions can also affect its liquidity position.
The Company can raise additional liquidity through the issuance of equity or unsecured debt privately or publicly. Additionally, the Company is able to enter into additional repurchase agreements or acquire brokered deposits at its discretion. The availability and cost of equity or debt on an unsecured basis is dependent on many factors. Some factors that will impact this source of liquidity are the Company’s financial position, the market environment, and the Company’s credit rating. As such, the Company is careful to monitor the various factors that could impact its ability to raise liquidity through these channels.

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The table below shows current and unused liquidity capacity from various sources as of the dated indicated:
Table 22 - Sources of Liquidity
 
September 30, 2014
 
 
December 31, 2013
 
 
Outstanding
 
Additional
Borrowing
Capacity
 
 
Outstanding
 
Additional
Borrowing  Capacity
 
 
(Dollars in thousands)
 
Federal Home Loan Bank of Boston (1)
$
60,127

 
$
767,208

  
 
$
140,294

 
$
668,143

  
Federal Reserve Bank of Boston

 
801,435

  
 

 
856,013

  
Unpledged Securities

 
299,202

  
 

 
272,121

  
Customer repurchase agreements
153,192

 

(3
)
 
149,288

 

(3
)
Wholesale repurchase agreements
50,000

 

(3
)
 
50,000

 

(3
)
Junior subordinated debentures (1)
73,741

 

(3
)
 
73,906

 

(3
)
Subordinated debt
30,000

 

(3
)
 
30,000

 

(3
)
Parent Company line of credit

 
10,000

 
 
5,000

 
5,000

 
Brokered deposits (2)
72,723

 

(3
)
 
77,501

 

(3
)
 
$
439,783

 
1,877,845

  
 
$
525,989

 
$
1,801,277

  
 

(1)
Amounts shown are inclusive of fair value marks.
(2)
Inclusive of $51.7 million and $53.7 million of brokered deposits acquired through participation in the Certificate of Deposit Account Registry Service program as of September 30, 2014 and December 31, 2013, respectively.
(3)
The additional borrowing capacity has not been assessed for these categories.

In addition to policies used for managing operational liquidity, the Board of Directors and the ALCO recognize the need to establish reasonable guidelines for managing through an environment of heightened liquidity risk. Catalysts for elevated liquidity risk can be Bank-specific issues and/or systemic industry-wide events. It is therefore the responsibility of the Board and ALCO to institute systems and controls to provide advanced detection of potentially significant funding shortages, establish methods for assessing and monitoring risk levels, and institute prompt responses that may alleviate/circumvent a potential liquidity crisis. As such, the Board of Directors and the ALCO have put a Liquidity Contingency Plan in place. The overall goal of this plan is to provide a framework for the Bank to help detect liquidity problems promptly and appropriately address potential liquidity problems in a timely manner. In a period of perceived heightened liquidity risk, the Liquidity Contingency Plan provides for the establishment of a Liquidity Crisis Task Force. The Liquidity Crisis Task Force is responsible for monitoring the potential for a liquidity crisis and for establishing and executing an appropriate response.
Off-Balance Sheet Arrangements There have been no material changes in off-balance sheet financial instruments during the three months ended September 30, 2014. See Note 7, "Derivative and Hedging Activities" and Note 11, "Commitments and Contingencies" within Notes to Consolidated Financial Statements included in Item 1 hereof for more information relating to the Company's off-balance sheet financial instruments.
Contractual Obligations, Commitments, and Contingencies There have been no material changes in contractual obligations, commitments, or contingencies during the three months ended September 30, 2014. Please refer to the Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for a complete table of contractual obligations, commitments and contingencies.

Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information required by this Item 3 is included in the "Risk Management" section of Item 2 of Part I of this Form 10-Q, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Item 4. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures. The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act. Based upon that

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evaluation, the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this quarterly report.
Changes in Internal Controls over Financial Reporting. There were no changes in our internal control over financial reporting that occurred during the third quarter of 2014 that have materially affected or are reasonably likely to materially affect the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

Item  1. Legal Proceedings
The Company is not involved in any legal proceedings, other than routine legal proceedings occurring in the ordinary course of business, or other matters considered to be material. Management believes that those legal proceedings involve, in the aggregate, amounts that are immaterial to the Company’s financial condition and results of operations.

Item 1A. Risk Factors
As of the date of this report, there have been no material changes with regard to the Risk Factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, which are incorporated herein by reference.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable.
(b) Not applicable.
(c) The following table displays that there was no activity relating to the Company’s repurchases of its common stock during the three months ended September 30, 2014:
 
Issuer Purchases of Equity Securities
 
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced Plan or
Program (1)
 
Maximum Number of Shares That May Yet Be Purchased Under the Plan or Program
Period
 
 
 
 
 
 
 
July 1 to July 31, 2014

 
$

 

 

August 1 to August 31, 2014

 
$

 

 

September 1 to September 30, 2014

 
$

 

 

Total

 
 
 

 
 
 

(1)
The Company does not currently have a stock repurchase program or plan in place.

Item  3. Defaults Upon Senior Securities—None

Item 4. Mine Safety Disclosures - Not Applicable

Item 5. Other Information—None


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Item 6. Exhibits

Exhibit Index
 
No.
Exhibit
2.1
Agreement and Plan of Merger dated August 5, 2014 by and among Independent Bank Corp., Rockland Trust Company, Peoples Federal Banchares, Inc. and Peoples Federal Savings Bank is incorporated by reference to Exhibit 2.1 to Form 8-K filed on August 7, 2014.
4.1
Independent Bank Corp. 2014 Dividend Reinvestment and Stock Purchase Plan incorporated by reference to Form S-3 filed on October 31, 2014 (SEC File No. 333-169024).
31.1
Section 302 Certification of Sarbanes-Oxley Act of 2002 is attached hereto.*
31.2
Section 302 Certification of Sarbanes-Oxley Act of 2002 is attached hereto.*
32.1
Section 906 Certification of Sarbanes-Oxley Act of 2002 is attached hereto.+
32.2
Section 906 Certification of Sarbanes-Oxley Act of 2002 is attached hereto.+
101
Interactive Data File +

*
Filed herewith
+
Furnished herewith


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
INDEPENDENT BANK CORP.
(registrant)
 
November 6, 2014
 
/s/ Christopher Oddleifson
 
 
Christopher Oddleifson
President and
Chief Executive Officer
(Principal Executive Officer)
 
November 6, 2014
 
/s/ Robert Cozzone
 
 
Robert Cozzone
Chief Financial Officer and Treasurer
(Principal Financial Officer)
INDEPENDENT BANK CORP.
(registrant)

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