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SALISBURY BANCORP, INC. - Quarter Report: 2010 March (Form 10-Q)

form10q-108642_sal.htm


SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-24751
SALISBURY BANCORP, INC.
(Exact name of registrant as specified in its charter)
Connecticut
06-1514263
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
5 Bissell Street, Lakeville, CT
06039
(Address of principal executive offices)
(Zip code)
(860) 435-9801
(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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec.232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes_________ No_________

Indicate by check mark 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).  (Check one):
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
The number of shares of Common Stock outstanding as of May 17, 2010, is 1,687,661.
 


 
1

 

TABLE OF CONTENTS

   
Page
     
PART I  FINANCIAL INFORMATION
     
Item 1.
 
     
 
3
     
   
 
4
     
   
 
5
     
   
 
6
     
 
8
     
Item 2.
 
 
18
     
Item 3.
28
     
Item 4T.
30
     
PART II Other Information
     
Item 1.
30
Item 1A.
31
Item 2.
31
Item 3.
31
Item 4.
31
Item 5.
31
Item 6.
31


PART I - FINANCIAL INFORMATION
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
             
(in thousands, except par value) unaudited
 
March 31,
2010
   
December 31,
2009
 
ASSETS
           
Cash and due from banks
  $ 5,878     $ 6,248  
Interest bearing demand deposits with other banks
    13,851       37,050  
Total cash and cash equivalents
    19,729       43,298  
Interest bearing time deposits with other banks
    5,000       5,000  
Securities
               
Available-for-sale at fair value
    166,179       145,031  
Held-to-maturity at amortized cost (fair value: $62 and $62)
    60       62  
Federal Home Loan Bank of Boston stock at cost
    6,032       6,032  
Loans held-for-sale
    1,178       665  
Loans receivable, net (allowance for loan losses: $3,649 and $3,473)
    329,600       327,257  
Investment in real estate
    75       75  
Other real estate owned
    275       275  
Bank premises and equipment, net
    11,398       10,434  
Goodwill
    9,829       9,829  
Intangible assets (net of accumulated amortization: $1,135 and $1,079)
    1,409       1,464  
Accrued interest receivable
    2,093       2,177  
Cash surrender value of life insurance policies
    3,727       3,685  
Deferred taxes
    2,957       3,285  
Other assets
    3,577       3,778  
Total Assets
  $ 563,118     $ 562,347  
LIABILITIES and SHAREHOLDERS' EQUITY
               
Deposits
               
Demand (non-interest bearing)
  $ 68,852     $ 70,026  
Demand (interest bearing)
    50,148       43,845  
Money market
    68,317       64,477  
Savings and other
    88,699       86,316  
Certificates of deposit
    146,473       153,539  
Total deposits
    422,489       418,203  
Repurchase agreements
    7,973       11,415  
Federal Home Loan Bank of Boston advances
    75,356       76,364  
Accrued interest and other liabilities
    4,277       4,010  
Total Liabilities
    510,095       509,992  
Commitments and contingencies
    -       -  
Shareholders' Equity
               
Preferred stock - $.01 per share par value
               
Authorized: 25,000; Shares issued: 8,816;
               
Liquidation preference: $1,000 per share
    -       -  
Common stock - $.10 per share par value
               
Authorized: 3,000,000 and 3,000,000;
               
Issued: 1,686,701 and 1,685,861
    168       168  
Common stock warrants outstanding
    112       112  
Paid-in capital
    21,899       21,894  
Retained earnings
    35,266       35,259  
Accumulated other comprehensive loss, net
    (4,422 )     (5,078 )
Total Shareholders' Equity
    53,023       52,355  
Total Liabilities and Shareholders' Equity
  $ 563,118     $ 562,347  


Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
             
Three months ended March 31, (in thousands except per share amounts) unaudited
 
2010
   
2009
 
Interest income
           
Interest and fees on loans
  $ 4,487     $ 4,483  
Interest on debt securities
               
Taxable
    926       1,331  
Tax exempt
    560       644  
Other interest
    46       2  
Total interest income
    6,019       6,460  
Interest expense
               
Deposits
    1,198       1,483  
Repurchase agreements
    27       39  
Federal Home Loan Bank of Boston advances
    758       762  
Total interest expense
    1,983       2,284  
Net interest income
    4,036       4,176  
Provision for loan losses
    180       430  
Net interest income after provision for loan losses
    3,856       3,746  
Non-interest income
               
Trust and wealth advisory
    545       540  
Service charges and fees
    469       398  
Gains on securities, net
    -       427  
Gains on sales of mortgage loans, net
    60       82  
Mortgage servicing, net
    15       42  
Other
    57       137  
Total non-interest income
    1,146       1,626  
Non-interest expense
               
Salaries
    1,746       1,753  
Employee benefits
    471       438  
Premises and equipment
    515       484  
Data processing
    408       383  
Professional fees
    402       356  
FDIC insurance
    171       114  
Marketing and community support
    88       76  
Amortization of intangibles
    56       41  
Other
    472       383  
Total non-interest expense
    4,329       4,028  
Income before income taxes
    673       1,344  
Income tax provision
    79       263  
Net income
  $ 594     $ 1,081  
Net income available to common shareholders
  $ 479     $ 1,081  
                 
Basic and diluted earnings per share
  $ 0.28     $ 0.64  
Common dividends per share
    0.28       0.28  

See accompanying notes to consolidated financial statements.


Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                                           
   
Common Stock
                Paid-in     Retained    
Accumulated
other comp-
   
Total
share-
holders'
 
(dollars in thousands)
 
Shares
   
Amount
   
Preferred Stock
   
Warrants
   
capital
   
earnings
   
rehensive loss
   
equity
 
Balances at December 31, 2009
    1,686,701     $ 168      -      112     21,894       35,259      (5,078   52,355   
Net income for period
    -       -       -       -       -       594       -       594  
Other comprehensive income, net of tax
    -       -       -       -       -       -       656       656  
Total comprehensive income
                                                            1,250  
Amortization (accretion) of preferred stock
    -       -       -       -       5       (5 )     -       -  
Common stock dividends paid
    -       -       -       -       -       (472 )     -       (472 )
Preferred stock dividends paid
    -       -       -       -       -       (110 )     -       (110 )
Balances at March 31, 2010
    1,686,701       168       -       112       21,899       35,266       (4,422 )     53,023  
Balances at December 31,  2008
    1,685,861       168       -       -       13,158       34,518       (8,905 )     38,939  
Net income for period
    -       -       -       -       -       1,081       -       1,081  
Other comprehensive loss, net of tax
    -       -       -       -       -       -       (2,107 )     (2,107 )
Total comprehensive loss
                                                            (1,026 )
Issuance of preferred stock and warrants
    -       -       -       112       8,704       -       -       8,816  
Common stock dividends declared
    -       -       -       -       -       (472 )     -       (472 )
Balances March 31, 2009
    1,685,861     $ 168     $ -     $ 112     $ 21,862     $ 35,127     $ (11,012 )   $ 46,257  

See accompanying notes to consolidated financial statements.


Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS

Three months ended March 31, (in thousands)
 
2010
   
2009
 
Operating Activities
           
Net income
  $ 594     $ 1,081  
Adjustments to reconcile net income to net cash provided by operating activities:
               
(Accretion), amortization and depreciation
               
Securities
    174       101  
Bank premises and equipment
    193       174  
Core deposit intangible
    56       41  
Mortgage servicing rights
    31       33  
Fair value adjustment on loans
    11       12  
Fair value adjustment on deposits and borrowings
    -       (33 )
(Gains) and losses
               
Sales and calls of securities available-for-sale, net
    -       (427 )
Provision for loan losses
    180       430  
(Increase) decrease in loans held-for-sale
    (513 )     1,507  
Increase in deferred loan origination fees and costs, net
    (41 )     (7 )
Mortgage servicing rights originated
    (28 )     (61 )
Decrease in mortgage servicing rights impairment reserve
    (2 )     (41 )
Increase in unearned income on loans
    -       6  
Decrease in interest receivable
    85       229  
Deferred tax (benefit)
    (8 )     (1 )
Decrease (increase) in prepaid expenses
    68       (63 )
Increase in cash surrender value of life insurance policies
    (42 )     (125 )
Increase in income tax receivable
    69       155  
Increase in other assets
    (25 )     (81 )
Increase in accrued expenses
    431       377  
(Decrease) increase in interest payable
    (40 )     21  
Decrease in other liabilities
    (111 )     (67 )
Net cash provided by operating activities
    1,082       3,261  
Investing Activities
               
Purchases of securities available-for-sale
    (33,985 )     (53,864 )
Proceeds from sales of securities available-for-sale
    -       24,956  
Proceeds from calls of securities available-for-sale
    1,550       18,000  
Proceeds from maturities of securities available-for-sale
    12,089       -  
Proceeds from maturities of securities held-to-maturity
    1       1  
Loan originations and principle collections, net
    (2,499 )     (1,554 )
Purchases of loans
    -       (76 )
Recoveries of loans previously charged-off
    6       10  
Capital expenditures
    (1,068 )     (1,303 )
Net cash utilized by investing activities
  $ (23,906 )   $ (13,830 )


Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

Three months ended March 31, (in thousands)
 
2010
   
2009
 
Financing Activities
           
Increase in deposit transaction accounts, net
  $ 11,352     $ 7,986  
(Decrease) increase in time deposits, net
    (7,065 )     13,852  
Decrease in securities sold under agreements to repurchase, net
    (3,442 )     (2,122 )
Federal Home Loan Bank of Boston advances
    -       12,000  
Principle payments on Federal Home Loan Bank of Boston advances
    (1,008 )     (405 )
Decrease in short term Federal Home Loan Bank of Boston advances, net
    -       (20,878 )
Proceeds from issuance of preferred stock
    -       8,816  
Common stock dividends paid
    (472 )     (472 )
Preferred stock dividends paid
    (110 )     -  
Net cash (utilized) provided by financing activities
    (745 )     18,777  
Net (decrease) increase in cash and cash equivalents
    (23,569 )     8,208  
Cash and cash equivalents, beginning of period
    43,298       9,660  
Cash and cash equivalents, end of period
  $ 19,729     $ 17,868  
Cash paid during period
               
Interest
  $ 2,023     $ 2,295  
Income taxes
    139       110  
See accompanying notes to consolidated financial statements.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1 - BASIS OF PRESENTATION

The interim (unaudited) consolidated financial statements of Salisbury Bancorp, Inc. ("Salisbury") include those of Salisbury and its wholly owned subsidiary, Salisbury Bank and Trust Company (the "Bank"). In the opinion of management, the interim unaudited consolidated financial statements include all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of Salisbury and the statements of income,  shareholder's equity and cash flows for the interim periods presented.

The financial statements have been prepared in accordance with generally accepted accounting principles.  In preparing the financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period.  Actual results could differ significantly from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.  In connection with the determination of the allowance for loan losses and valuation of real estate, management obtains independent appraisals for significant properties.

Certain financial information, which is normally included in financial statements prepared in accordance with generally accepted accounting principles, but which is not required for interim reporting purposes, has been condensed or omitted. Operating results for the three month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.  The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in Salisbury's 2009 Annual Report on Form 10-K for the period ended December 31, 2009.

The allowance for loan losses is a significant accounting policy and is presented in the Notes to Consolidated Financial Statements and in Management’s Discussion and Analysis, which provide information on how significant assets are valued in the financial statements and how those values are determined.  Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan losses to be the accounting area that requires the most subjective judgments, and as such could be most subject to revision as new information becomes available.

Impact of New Accounting Pronouncements Issued

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets,” and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).”  These standards are effective for the first interim reporting period of 2010.  SFAS No. 166 amends the guidance in ASC 860 to eliminate the concept of a qualifying special-purpose entity (“QSPE”) and changes some of the requirements for derecognizing financial assets. SFAS No. 167 amends the consolidation guidance in ASC 810-10.  Specifically, the amendments will (a) eliminate the exemption for QSPEs from the new guidance, (b) shift the determination of which enterprise should consolidate a variable interest entity (“VIE”) to a current control approach, such that an entity that has both the power to make decisions and right to receive benefits or absorb losses that could potentially be significant, will consolidate a VIE, and (c) change when it is necessary to reassess who should consolidate a VIE. These standards did not have a significant impact on the Company’s financial statements.

In March 2010, the FASB issued ASU 2010-11, “Scope Exception Related to Embedded Credit Derivatives.”  The ASU clarifies that certain embedded derivatives, such as those contained in certain securitizations, CDOs and structured notes, should be considered embedded credit derivatives subject to potential bifurcation and separate fair value accounting.  The ASU allows any beneficial interest issued by a securitization vehicle to be accounted for under the fair value option at transition.  At transition, the Company may elect to reclassify various debt securities (on an instrument-by-instrument basis) from held-to-maturity (HTM) or available-for-sale (AFS) to trading.  The new rules are effective July 1, 2010.  The Company is currently analyzing the impact of the changes to determine the population of instruments that may be reclassified to trading upon adoption.

In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements.”  The ASU requires disclosing the amounts of significant transfers in and out of Level 1 and 2 of the fair value hierarchy and describing the reasons for the transfers.  The disclosures are effective for reporting periods beginning after December 15, 2009.  The Company adopted ASU 2010-06 as of January 1, 2010.  The required disclosures are included in Note 16.  Additionally, disclosures of the gross purchases, sales, issuances and settlements activity in the Level 3 of the fair value


measurement hierarchy will be required for fiscal years beginning after December 15, 2010.

Acquisition

Salisbury assumed approximately $11 million in deposits and acquired approximately $2.5 million in loans and the branch office located at 10 Granite Ave., Canaan, Connecticut from Webster Bank, National Association, as of the close of business on December 4, 2009. Salisbury recorded a core deposit intangible of $463,000 for deposits assumed.

NOTE 2 - SECURITIES

The composition of securities is as follows:
                         
   
Amortized
   
Gross un-
   
Gross un-
   
Fair
 
(in thousands)
 
cost (1)
   
realized gains
   
realized losses
   
value
 
March 31, 2010
                       
Available-for-sale
                       
U.S. Treasury notes
  $ 4,999     $ -     $ (17 )   $ 4,982  
U.S. Government Agency notes
    50,253       197       (18 )     50,432  
Municipal bonds
    51,803       125       (4,374 )     47,553  
Mortgage backed securities
                               
U.S. Government Agencies
    27,641       593       (125 )     28,109  
Collateralized mortgage obligations
                               
U.S. Government Agencies
    5,324       3       (31 )     5,296  
Non-agency
    23,690       717       (2,066 )     22,341  
SBA bonds
    6,196       57       -       6,253  
Corporate bonds
    1,082       48       -       1,130  
Preferred Stock
    20       62       -       82  
Total securities available-for-sale
  $ 171,008     $ 1,802     $ (6,631 )   $ 166,179  
Held-to-maturity
                               
Mortgage backed security
  $ 60     $ 2     $ -     $ 62  
Non-marketable securities
                               
Federal Home Loan Bank of Boston stock
  $ 6,032     $ -     $ -     $ 6,032  
December 31, 2009
                               
Available-for-sale
                               
U.S. Treasury bills
  $ 1,999     $ 1     $ -     $ 2,000  
U.S. Government Agency notes
    24,833       125       (126 )     24,832  
Municipal bonds
    51,775       113       (4,735 )     47,153  
Mortgage backed securities
                               
U.S. Government Agencies
    33,535       535       (143 )     33,927  
Collateralized mortgage obligations
                               
U.S. Government Agencies
    5,696       -       (58 )     5,638  
Non-agency
    25,317       433       (2,121 )     23,629  
SBA bonds
    6,581       59       -       6,640  
Corporate bonds
    1,079       49       -       1,128  
Preferred Stock
    20       64       -       84  
Total securities available-for-sale
  $ 150,835     $ 1,379     $ (7,183 )   $ 145,031  
Held-to-maturity
                               
Mortgage backed security
  $ 62     $ -     $ -     $ 62  
Non-marketable securities
                               
Federal Home Loan Bank of Boston stock
  $ 6,032     $ -     $ -     $ 6,032  

(1)
Net of other-than-temporary impairment write-down recognized in earnings.

Sales of securities available-for-sale and gains realized are as follows:
             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Proceeds
  $ -     $ 21,347  
Gains realized
    -       435  
Losses realized
    -       8  
Net gains realized
    -       427  
Income tax provision
    -       145  


Included in non-agency Collateralized Mortgage Obligations (“CMOs”) are seven securities issued by Wells Fargo with an aggregate amortized cost basis and fair value of $6,827,000 and $5,943,000, respectively, that exceeded 10% of shareholders’ equity as of March 31, 2010.

The following table summarizes, for all securities in an unrealized loss position, including debt securities for which a portion of other-than-temporary impairment has been recognized in other comprehensive income, , the aggregate fair value and gross unrealized loss of securities that have been in a continuous unrealized loss position as of the date presented:
                   
   
Less than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
(in thousands)
 
Value
   
losses
   
value
   
losses
   
value
   
losses
 
March 31, 2010
                                   
Available-for-sale
                                   
U.S. Government Agency notes
  $ 4,472     $ 35     $ -     $ -     $ 4,472     $ 35  
Municipal Bonds
    11,100       377       30,579       3,997       41,679       4,374  
Mortgage backed securities
    2,937       14       1,652       111       4,589       125  
Collateralized mortgage obligations
                                               
U.S. Government Agencies
    2,621       31       -       -       2,621       31  
Non-agency
    3,180       60       7,464       591       10,644       651  
Total temporarily impaired securities
    24,310       517       39,695       4,699       64,005       5,216  
Other-than-temporarily impaired securities
                                               
Collateralized mortgage obligations
                                               
Non-agency
    584       57       3,229       1,358       3,813       1,415  
Total temporarily impaired and other-than-
                                               
temporarily impaired securities
  $ 24,894     $ 574     $ 42,924     $ 6,057     $ 67,818     $ 6,631  

Salisbury evaluates its individual available-for-sale investment securities for OTTI on at least a quarterly basis. As part of this process, Salisbury considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI.

Salisbury believes that principal and interest on U.S Treasury securities, mortgage-backed securities or securities backed by a U.S. government sponsored entity and the Small Business Administration and bank qualified insured municipal securities are deemed recoverable.

Salisbury adopted ASC 320-10-65, “Investments-Debt and Equity Securities/Transition and Open Effective Date Information”, (previously FSP FAS No. 115-2 and FAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments), effective April 1, 2009. ASC 320-10-65 requires an assessment of OTTI whenever the fair value of a security is less than its amortized cost basis at the balance sheet date. Amortized cost basis includes adjustments made to the cost of a security for accretion, amortization, collection of cash and previous OTTI recognized into earnings.

Salisbury performed a detailed cash flow analysis of its non-agency CMOs at March 31, 2010 to assess whether any of the securities were OTTI. Salisbury uses a third party provider to generate cash flow forecasts of each security based on a variety of market driven assumptions and securitization terms, including prepayment speed, default or delinquency rate, and default severity for losses including interest, legal fees, property repairs, expenses and realtor fees, that, together with the loan amount are subtracted from collateral sales proceeds to determine severity.

During 2009, Salisbury determined that five non-agency CMO securities reflected OTTI and recognized credit losses of $1,128,000. Salisbury judged all other CMO securities not to be OTTI as of March 31, 2010. It is possible that future loss assumptions could change and cause future OTTI credit losses in these securities.

Salisbury does not intend to sell the securities which it has judged to be OTTI and it is not more likely than not that it will be required to sell these securities before its anticipated recovery of each security’s remaining amortized cost basis. For the remainder of Salisbury’s securities portfolio that have experienced decreases in the fair value, the decline is considered to be temporary as Salisbury expects to recover the entire amortized cost basis on the securities and neither intends to sell these securities nor is it more likely than not that it will be required to sell these securities.


NOTE 3 - LOANS

The composition of the loan portfolio is as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Loans receivable, net
           
Real estate mortgages:
           
Residential
  $ 164,119     $ 163,863  
Commercial
    77,210       70,066  
Construction, land & land development
    23,801       31,011  
Home equity credit
    32,830       33,099  
Total mortgage loans
    297,960       298,039  
Commercial and industrial
    29,162       26,400  
Consumer
    5,224       5,436  
Other
    276       269  
Total loans, gross
    332,622       330,144  
Deferred loan origination fees and costs, net
    627       586  
Allowance for loan losses
    (3,649 )     (3,473 )
Total loans, net
  $ 329,600     $ 327,257  
Loans held-for-sale
               
Residential mortgages
  $ 1,178     $ 665  

Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:
             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Balance, beginning of period
  $ 3,473     $ 2,724  
Provision for losses
    180       430  
Charge-offs
    (10 )     (160 )
Recoveries
    6       11  
Balance, end of period
  $ 3,649     $ 3,005  

Concentrations of Credit Risk

Salisbury's loans consist primarily of residential and commercial real estate loans located principally in northwestern Connecticut and nearby New York and Massachusetts towns, which constitute Salisbury's service area. Salisbury offers a broad range of loan and credit facilities to borrowers in its service area, including residential mortgage loans, commercial real estate loans, construction loans, working capital loans, equipment loans, and a variety of consumer loans, including home equity lines of credit, and installment and collateral loans.  All residential and commercial mortgage loans are collateralized by first or second mortgages on real estate.  The ability of single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the market area and real estate values. The ability of commercial borrowers to honor their repayment commitments is dependent on the general economy as well as the health of the real estate economic sector in Salisbury’s market area.

Mortgage Servicing Rights

Loans serviced for others are not included in the Consolidated Balance Sheets. The balance of loans serviced for others and the fair value of mortgage servicing rights are as follows:
             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Residential mortgage loans serviced for others
  $ 75,414     $ 55,652  
Fair value of mortgage servicing rights
    493       227  


Changes in mortgage servicing rights are as follows:
             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Loan Servicing Rights
           
Balance, beginning of period
  $ 427     $ 227  
Originated
    28       61  
Amortization (1)
    (31 )     (33 )
Balance, end of period
    424       255  
Valuation Allowance
               
Balance, beginning of period
    (30 )     (118 )
Decrease (increase) in impairment reserve (1)
    2       41  
Balance, end of period
    (28 )     (77 )
Loan servicing rights, net
  $ 396     $ 178  

(1)
Amortization expense and changes in the impairment reserve are recorded in loan servicing fee income.

NOTE 4 - IMPAIRED LOANS

Impaired loans are loans for which it is probable that Salisbury will not be able to collect all amounts due according to the contractual terms of the loan agreements and loans restructured in a troubled debt restructuring. Impaired loans do not include large groups of smaller-balance homogenous loans that are collectively evaluated for impairment, which consist of most residential mortgage loans and consumer loans. The components of impaired loans are as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Non-accrual loans, excluding troubled debt restructured loans
  $ 5,798     $ 5,098  
Non-accrual troubled debt restructured loans
    6,263       2,341  
Accruing troubled debt restructured loans
    5,046       4,566  
Total impaired loans
  $ 17,107     $ 12,004  
Requiring valuation allowance
  $ 4,551     $ 3,388  
Not requiring valuation allowance
    12,556       9,379  
Total impaired loans
  $ 17,107     $ 12,004  
Valuation allowance
  $ 517     $ 388  
Average impaired loans
    13,791       9,443  
Commitments to lend additional amounts to impaired borrowers
    -       -  

NOTE 5 - PLEDGED ASSETS

The following securities and loans were pledged to secure public and trust deposits, securities sold under agreements to repurchase, FHLBB advances and credit facilities available.

             
 (in thousands)
 
March 31, 2010
   
December 31, 2009
 
Securities available-for-sale (at fair value)
  $ 60,081     $ 63,097  
Loans receivable
    108,246       104,960  
Total pledged assets
  $ 168,327     $ 168,057  

At March 31, 2010, securities were pledged as follows: $42 million to secure public deposits and Treasury Tax and Loan deposits, $10.2 million to secure repurchase agreements and $7.9 million to secure FHLBB advances. Loans receivable were pledged to secure FHLBB advances and credit facilities.


NOTE 6 – EARNINGS PER SHARE

The calculation of earnings per share is as follows:
             
Three months ended March 31, (in thousands, except per share amounts)
 
2010
   
2009
 
Net income
  $ 594     $ 1,081  
Preferred stock net accretion
    5       -  
Preferred stock dividends paid
    110       -  
Net income available to common shareholders
  $ 479     $ 1,081  
Weighted average common stock outstanding - basic
    1,687       1,686  
Weighted average common and common equivalent stock outstanding- diluted
    1,687       1,686  
Earnings per common and common equivalent share
               
Basic
  $ 0.28     $ 0.64  
Diluted
    0.28       0.64  

NOTE 7 – SHAREHOLDERS’ EQUITY

Capital Requirements

Salisbury and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional and discretionary actions by the regulators that, if undertaken, could have a direct material effect on Salisbury and the Bank's financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Salisbury and the Bank must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  Salisbury and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require Salisbury and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined) to average assets (as defined) and total and Tier 1 capital (as defined) to risk-weighted assets (as defined).  Management believes, as of March 31, 2010, that Salisbury and the Bank meet all of their capital adequacy requirements.

The Bank was classified, as of its most recent notification, as "well capitalized".  The Bank's actual regulatory capital position and minimum capital requirements as defined "To Be Well Capitalized Under Prompt Corrective Action Provisions" and "For Capital Adequacy Purposes" are as follows:
                   
   
Actual
   
For Capital Adequacy Purposes
   
To be Well Capitalized Under Prompt Corrective Action Provisions
 
(dollars in thousands)
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
March  31, 2010
                                   
Total Capital (to risk-weighted assets)
                                   
Salisbury
  $ 49,916       12.75 %   $ 31,311       8.0 %     n/a       -  
Bank
    40,420       10.36       31,227       8.0     $ 38,034       10.0 %
Tier 1 Capital (to risk-weighted assets)
                                               
Salisbury
    46,207       11.81       15,656       4.0       n/a       -  
Bank
    36,712       9.41       15,613       4.0       23,420       6.0  
Tier 1 Capital (to average assets)
                                               
Salisbury
    46,207       8.40       22,387       4.0       n/a       -  
Bank
    36,712       6.68       21,996       4.0       27,494       5.0  
March 31, 2009
                                               
Total Capital (to risk-weighted assets)
                                               
Salisbury
    49,354       14.55       27,130       8.0       n/a       -  
Bank
    39,556       11.74       26,965       8.0       33,707       10.0  
Tier 1 Capital (to risk-weighted assets)
                                               
Salisbury
    46,317       13.66       13,565       4.0       n/a       -  
Bank
    36,516       10.83       13,483       4.0       20,224       6.0  
Tier 1 Capital (to average assets)
                                               
Salisbury
    46,317       9.48       19,535       4.0       n/a       -  
Bank
    36,519       7.52       19,426       4.0       24,282       5.0  


Restrictions on Cash Dividends to Common Shareholders

Salisbury's ability to pay cash dividends is substantially dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law, the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations.  The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.

Federal Reserve Board (“FRB”) Supervisory Letter SR 09-4, February 24, 2009, revised March 27, 2009, notes that, as a general matter, the Board of Directors of a Bank Holding Company (“BHC”) should inform the FRB and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the FRB reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital structure.

Further restrictions on cash dividends are imposed on Salisbury because of Salisbury’s issuance of Preferred Stock on March 13, 2009 in the United States Treasury’s Troubled Asset Relief Program’s Capital Purchase Program (the “CPP”). These preclude the payment of any common stock cash dividends if Salisbury is not paying the preferred stock dividend.  Additionally, the common stock dividend may not be increased without prior approval from the Treasury for the first three years Salisbury is a CPP participant unless all CPP preferred shares are redeemed or transferred to third parties.

Preferred Stock

In March 2009, Salisbury issued to the U.S. Treasury Department (“Treasury”) $8,816,000 of Preferred Stock under the CPP of the Emergency Economic Stabilization Act of 2008.

The Preferred Stock qualifies as Tier 1 capital for regulatory purposes and ranks senior to the Common Stock. The Preferred Stock pays a cumulative dividend of 5 percent per annum for the first five years it is outstanding and thereafter at a rate of 9 percent per annum. The Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Preferred Stock. The Preferred Stock is redeemable at one hundred percent of the issue price plus any accrued and unpaid dividends.

As part of the CPP, Salisbury issued to the Treasury a 10-year Warrant to purchase 57,671 shares of Common Stock at an exercise price of $22.93 per share. If the Warrant were fully exercised, Salisbury estimates that the ownership percentage of the current shareholders would be diluted by approximately 3.3% percent.

NOTE 8 – PENSION AND OTHER BENEFITS

The components of net periodic cost for Salisbury’s insured noncontributory defined benefit retirement plan were as follows:

             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Service cost
  $ 100     $ 107  
Interest cost on benefit obligation
    91       101  
Expected return on plan assets
    (100 )     (90 )
Amortization of prior service cost
    -       -  
Amortization of net loss
    18       33  
Net periodic benefit cost
  $ 109     $ 151  

Salisbury’s 401(k) Plan contribution expense was $41,000 and $30,000, respectively, for the three month periods ended March 31, 2010 and 2009. Other post-retirement benefit obligation expense for endorsement split-dollar life insurance arrangements was $12,000 and $11,000, respectively, for the three month periods ended March 31, 2010 and 2009.

NOTE 9 - COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) includes net income (loss) and any changes in equity from non-owner sources that are not recorded in the income statement (such as changes in net unrealized gains (losses) on securities).  The purpose of


reporting comprehensive income (loss) is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners.

The components of comprehensive income (loss) are as follows:
             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Net income
  $ 594     $ 1,081  
Other comprehensive income (loss)
               
Net unrealized gains (losses) on securities available-for-sale
    975       (3,225 )
Reclassification of net realized gains in net income
    -       427  
Unrealized gains (losses) on securities available-for-sale
    975       (2,798 )
Income tax (expense) benefit
    (331 )     670  
Unrealized gains (losses) on securities available-for-sale, net of tax
    644       (2,128 )
Pension plan income
    18       32  
Income tax expense
    (6 )     (11 )
Pension plan income, net of tax
    12       21  
Other comprehensive income (loss), net of tax
    656       (2,107 )
Comprehensive income (loss)
  $ 1,250     $ (1,026 )

The components of accumulated other comprehensive loss are as follows:
             
Three months ended March 31, (in thousands)
 
2010
   
2009
 
Unrealized losses on securities available-for-sale, net of tax
  $ (3,186 )   $ (9,096 )
Unrecognized pension plan expense, net of tax
    (1,236 )     (1,916 )
Accumulated other comprehensive loss, net
  $ (4,422 )   $ (11,012 )

NOTE 10 – FAIR VALUE OF ASSETS AND LIABILITIES

Salisbury uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, Salisbury may be required to record at fair value other assets on a nonrecurring basis, such as loans held-for-sale, collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or-market accounting or write-downs of individual assets.

Salisbury groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 - Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Level 1 also includes U.S. Treasury, other U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 - Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.

Level 3 - Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, are not based on market exchange, dealer, or broker traded transactions.  Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.  These valuation methodologies were applied to all of Salisbury’s financial assets and financial liabilities carried at fair value for December 31, 2009 and March 31, 2010.

Salisbury’s cash instruments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of


price transparency.

Salisbury’s investments in debt securities and mortgage-backed securities available-for-sale are generally classified within level 2 of the fair value hierarchy.  For these securities, Salisbury obtains fair value measurements from independent pricing services.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, trading levels, market consensus prepayment speeds, credit information and the instrument’s terms and conditions.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions. Valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence.  In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.

Salisbury’s impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using level 2 inputs based upon appraisals of similar properties obtained from a third party. For level 3 inputs, fair values are based upon management’s estimates.
             
         
Fair Value Measurements at Reporting Date Using
 
(in thousands)
  March 31,    
Quoted prices in Active markets for Identical assets
   
Significant other observable inputs
   
Significant unobservable inputs
 
   
2010
   
Level 1
   
Level 2
   
Level 3
 
Items Measured at Fair Value
                       
Recurring basis
                       
Securities available-for-sale
  $ 166,179     $ 82     $ 166,097     $ -  
Non-recurring basis
                               
Impaired loans
    12,064       9,014       2,999       51  

       
   
Fair Value Measurements using significant
unobservable inputs
 
   
Level 3
 
Three months ended March 31, 2010 (in thousands)
 
Securities available-for-sale
   
Impaired Loans
   
Total
 
Balance, beginning of period
  $ -     $ 116     $ 116  
Total gains or losses (realized/unrealized)
                       
Included in earnings
    -       -       -  
Included in other comprehensive income
    -       -       -  
Principal paydowns of securities, net of accretion
    -       -       -  
Transfers in and/or out of Level 3
    -       (65 )     (65 )
Balance, end of period
  $ -     $ 51     $ 51  
Amount of total gains or losses for the period
                       
included in earnings attributable to the change
                       
in unrealized gains or losses relating to assets
                       
still held at the reporting date
  $ -     $ -     $ -  


Carrying values and estimated fair values of financial instruments are as follows:
             
   
March 31, 2010
   
December 31, 2009
 
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
(in thousands)
 
value
   
fair value
   
value
   
fair value
 
Financial Assets
                       
Cash and due from banks
  $ 19,729     $ 19,729     $ 43,298     $ 43,298  
Interest bearing time deposits with other banks
    5,000       5,000       5,000       5,000  
Securities available-for-sale
    166,179       166,179       145,031       145,031  
Security held-to-maturity
    60       62       62       62  
Federal Home Loan Bank stock
    6,032       6,032       6,032       6,032  
Loans held-for-sale
    1,178       1,187       665       670  
Loans receivable net
    329,600       323,567       327,257       321,882  
Accrued interest receivable
    2,093       2,093       2,177       2,177  
Financial Liabilities
                               
Demand (non-interest-bearing)
  $ 68,852     $ 68,852     $ 70,026     $ 70,026  
Demand (interest-bearing)
    50,148       50,148       43,845       43,845  
Money market
    68,317       68,317       64,477       64,477  
Savings and other
    88,699       88,699       86,316       86,316  
Certificates of deposit
    146,473       146,956       153,539       155,441  
Total deposits
    422,489       422,972       418,203       420,105  
FHLBB advances
    75,356       79,092       76,364       80,830  
Repurchase agreements
    7,973       7,973       11,415       11,415  
Accrued interest payable
    484       484       523       523  

The carrying amounts of financial instruments shown in the above table are included in the consolidated balance sheets under the indicated captions.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's discussion and analysis of financial condition and results of operations of Salisbury and its subsidiary should be read in conjunction with Salisbury's Annual Report on Form 10-K for the year ended December 31, 2009.

BUSINESS

Salisbury Bancorp, Inc. ("Salisbury"), a Connecticut corporation, formed in 1998, is a bank holding company for Salisbury Bank and Trust Company ("Bank"), a Connecticut-chartered and Federal Deposit Insurance Corporation (the "FDIC") insured commercial bank headquartered in Lakeville, Connecticut.  Salisbury's principal business consists of the business of the Bank.  The Bank, formed in 1848, is engaged in customary banking activities, including general deposit taking and lending activities to both retail and commercial markets, and trust and wealth advisory services. The Bank conducts its banking business from eight full-service offices in the towns of Canaan, Lakeville, Salisbury and Sharon, Connecticut, South Egremont and Sheffield, Massachusetts, Millerton and Dover Plains, New York, and its trust and wealth advisory services from offices in Lakeville, Connecticut.

Acquisition

Salisbury assumed approximately $11 million in deposits and acquired approximately $2.5 million in loans and the branch office located at 10 Granite Ave., Canaan, Connecticut from Webster Bank, National Association, as of the close of business on December 4, 2009. Salisbury recorded a core deposit intangible of $463,000 for deposits assumed.

Application of Critical Accounting Policies

Salisbury’s consolidated financial statements are prepared in accordance with US GAAP and follow general practices within the banking industry in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event.

Salisbury’s significant accounting policies are presented in Note 1 of Notes to Consolidated Financial Statements. These policies, along with the disclosures presented in Notes to Consolidated Financial Statements and in Management’s Discussion and Analysis, provide information on how significant assets are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan losses to be the accounting area that requires the most subjective judgments, and as such could be most subject to revision as new information becomes available.

The allowance for loan losses represents management’s estimate of credit losses in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet. A discussion of the factors driving changes in the amount of the allowance for loan losses is included in the “Provision and Allowance For Loan Losses” section of Management’s Discussion and Analysis.

RESULTS OF OPERATIONS

For the three month periods ended March 31, 2010 and 2009

Overview

Net income available to common shareholders was $479,000, or $0.28 per common share, for the first quarter ended March 31, 2010 compared with $1,081,000, or $0.64 per common share, for the first quarter of 2009.

Net income available to common shareholders for the first quarter of 2010 is net of preferred stock dividends of $115,000.


Net interest income for the first quarter of 2010 decreased by $140,000, or 3%, from the first quarter of 2009. Average earning assets grew $55.3 million, or 12%, over the period, as a result of significant deposit growth, of which $34.0 million was invested in short term funds. The net interest margin (tax equivalent) declined 55 basis points to 3.25% compared with 3.80% a year ago due to several factors. The average yield on securities declined 103 basis points, due to the re-pricing of callable Agency bonds, increased prepayments on mortgage backed securities and lower volume. The increase in holdings of short-term funds also had a dilutive effect on the net interest margin of approximately 15 basis points.

The provision for loan losses for the first quarter of 2010 was $180,000, compared with $430,000 for the first quarter of 2009, which included a provision for emerging risks or unallocated reserves. Net loan charge-offs were $4,000 and $149,000 for the respective periods.

Non-interest income for the first quarter of 2010 decreased $480,000, or 30%, due to several one-time benefits in the first quarter of 2009, including $427,000 of securities gains, a $72,000 market adjustment gain from the re-financing of Bank Owned Life Insurance, and a $39,000 mortgage servicing rights impairment benefit. Income from sales of mortgage loans decreased $22,000 in the first quarter of 2010 due to lower loan origination volume. Loan sales were $4.4 million and $6.9 million, respectively, for the 2010 and 2009 periods. Service fees and charges increased $71,000, or 18%, in the first quarter of 2010 due to higher interchange, overdraft and other fees. Trust and Wealth Advisory revenues were substantially unchanged.

Non-interest expense for the first quarter of 2010 increased $301,000, or 7%, due primarily to higher facilities expenses due to the opening of the Millerton branch in January 2010, increased FDIC insurance premiums, data processing and other operating expenses resulting from deposit and loan growth, and increased expenses for professional services, including audit.

The effective income tax rate for the first quarter of 2010 was 11.74%, compared with 19.58% for the first quarter of 2009. The decrease in the effective rate resulted from a higher proportion of tax-exempt income to total income in the 2010 period.

Net Interest Income

Net interest income, on a tax equivalent basis, decreased $206,000, or 4.6%, to $4.3 million for the first quarter of 2010 as compared with the first quarter of 2009, while the net interest margin (presented on a tax-equivalent basis) declined 55 basis points to 3.25% from 3.80%, for the respective periods.

The following table sets forth the components of Salisbury's tax-equivalent net interest income and yields on average interest-earning assets and interest-bearing funds.

Three months ended March 31,
 
Average Balance
   
Income / Expense
   
Average Yield / Rate
 
(dollars in thousands)
 
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Loans (a)
  $ 333,347     $ 301,202     $ 4,487     $ 4,509       5.40 %     5.99 %
Securities (c)(d)
    150,385       160,428       1,745       2,274       4.64       5.67  
FHLBB stock
    6,032       5,323       -       -       -       -  
Short term funds (b)
    40,746       8,272       46       2       0.45       0.09  
Total earning assets
    530,510       475,225       6,278       6,785       4.74       5.72  
Other assets
    32,884       24,106                                  
Total assets
  $ 563,394     $ 499,331                                  
Interest-bearing demand deposits
  $ 49,158     $ 24,442       147       13       1.20       0.21  
Money market accounts
    66,413       64,539       95       205       0.58       1.27  
Savings and other
    87,644       73,650       143       214       0.65       1.16  
Certificates of deposit
    148,941       132,038       813       1,051       0.55       0.80  
Total interest-bearing deposits
    352,156       294,669       1,198       1,483       1.36       2.01  
Repurchase agreements
    12,601       9,529       27       39       0.86       1.67  
FHLBB advances
    75,752       81,307       758       762       4.00       3.75  
Total interest-bearing liabilities
    440,509       385,505       1,983       2,284       1.80       2.37  
Demand deposits
    66,122       64,575                                  
Other liabilities
    3,809       7,145                                  
Shareholders’ equity
    52,954       42,106                                  
Total liabilities & shareholders’ equity
  $ 563,394     $ 499,331                                  
Net interest income
                  $ 4,295     $ 4,501                  
Spread on interest-bearing funds
                                    2.93       3.33  
Net interest margin (e)
                                    3.25       3.80  


(a)
Includes non-accrual loans.
(b)
Includes interest-bearing deposits in other banks and federal funds sold.
(c)
Average balances of securities are based on historical cost.
(d)
Includes tax exempt income of $259,000 and $325,000, respectively for 2010 and 2009 on tax-exempt securities whose income and yields are calculated on a tax-equivalent basis.
(e)
Net interest income divided by average interest-earning assets.

The following table sets forth the changes in FTE interest due to volume and rate.
       
Three months ended March 31, (in thousands)
 
2010 versus 2009
 
Change in interest due to
 
Volume
   
Rate
   
Net
 
Interest-earning assets
                 
Loans
  $ 457     $ (479 )   $ (22 )
Securities
    (129 )     (400 )     (529 )
Short term funds
    22       22       44  
Total
    350       (857 )     (507 )
Interest-bearing liabilities
                       
Deposits
    193       (478 )     (285 )
Repurchase agreements
    10       (23 )     (13 )
FHLBB advances
    (54 )     50       (4 )
Total
    149       (451 )     (302 )
Net change in net interest income
  $ 201     $ (406 )   $ (205 )
 
Interest Income

On a tax equivalent basis, interest income decreased $507,000, or 7.5%, to $6.3 million for the first quarter of 2010 as compared with the first quarter of 2009.  Loan income decreased $22,000, or 0.5%, primarily due to a lower average yield, down 61 basis points, the impact of which was substantially offset by a $32.1 million, or 10.7%, increase in average loans.  The decline in the average loan yield was caused by the effect of lower market interest rates on new loan origination, re-financing and adjustable rate re-pricing activity.

Income from securities, on a tax equivalent basis, decreased $529,000, or 23.3%, for the first quarter of 2010 as compared with the first quarter of 2009, as a result of a lower average yield, down 103 basis points, and a $10.0 million, or 6.3%, decrease in average volume. The lower yield resulted from the effect of lower market interest rates on securities purchases, calls of agency bonds and prepayments of mortgage backed securities. Income from government-guaranteed and government-sponsored mortgage backed securities owned at average prices above par were negatively impacted by increased prepayments that are believed to relate to the agencies announced intention to buy back delinquent loans during the quarter.

Income from short term funds increased $44,000 for the first quarter of 2010 as compared with the first quarter of 2009 as a result of a $32.5 million increase in average balance and higher yields.

Interest Expense

Interest expense decreased $301,000, or 13.2%, to $2.0 million for the first quarter of 2010 as compared with the first quarter of 2009.

Interest on deposit accounts and retail repurchase agreements, decreased $298,000, or 19.6%, as a result of a lower average rate, down 65 basis points to 1.38%, offset in part by a $60.6 million, or 19.9%, increase in the average balance. The lower average rate resulted from the effect of lower market interest rates on rates paid and changes in product mix. The higher average volume resulted from deposit growth.

Interest expense on FHLBB borrowings decreased $4,000 as a result of lower average borrowings, down $5.6 million, offset in part by a higher average borrowing rate, up 25 basis points as compared with 2009.

Provision and Allowance for Loan Losses

The provision for loan losses was $180,000 for the first quarter of 2010, compared with $430,000 for the first quarter of 2009, which included a provision for emerging risks or unallocated reserves. Net loan charge-offs were $4,000 and


$149,000, for the respective quarters. The following table sets forth changes in the allowance for loan losses and other selected statistics:

As of or for the three months ended (dollars in thousands)
 
March 31,
2010
   
December 31,
2009
   
March 31,
2009
 
Balance, beginning of period
  $ 3,473     $ 3,430     $ 2,724  
Provision (benefit) or loan losses
    180       60       430  
Charge-offs
                       
Real estate mortgages
    -       -       (50 )
Commercial & industrial
    -       (7 )     (76 )
Consumer
    (10 )     (15 )     (34 )
Total charge-offs
    (10 )     (22 )     (160 )
Recoveries
                       
Real estate mortgages
    -       -       -  
Commercial & industrial
    -       -       4  
Consumer
    6       5       7  
Total recoveries
    6       5       11  
Net (charge-offs) recoveries
    (4 )     (17 )     ( 149 )
Balance, end of period
  $ 3,649     $ 3,473     $ 3,005  
Loans receivable, gross
  $ 332,622     $ 330,144     $ 300,938  
Non-performing loans
    12,064       7,445       6,275  
Accruing loans past due 30-89 days
    5,385       4,098       6,458  
Ratio of allowance for loan losses:
                       
to loans receivable, gross
    1.10 %     1.05 %     1.00 %
to non-performing loans
    30.25       46.65       47.90  
Ratio of non-performing loans
                       
to loans receivable, gross
    3.62       2.25       2.09  
Ratio of accruing loans past due 30-89 days
                       
to loans receivable, gross
    1.62       1.24       2.15  

Reserve coverage at March 31, 2010, as measured by the ratio of allowance for loan losses to gross loans, increased slightly to 1.10%, as compared with 1.05% at December 31, 2009 and 1.00% a year ago at March 31, 2009. Non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) increased $4.6 million in the first quarter of 2010 to $12.1 million, or 3.62% of gross loans receivable, while accruing loans past due 30-89 days increased $1.3 million to $5.4 million, or 1.62% of gross loans receivable. See “Financial Condition – Loan Credit Quality” for further discussion and analysis.

Salisbury determines its allowance and provisions for loan losses based upon a detailed evaluation of the loan portfolio through a process which considers numerous factors, including estimated credit losses based upon internal and external portfolio reviews, delinquency levels and trends, estimates of the current value of underlying collateral, concentrations, portfolio volume and mix, changes in lending policy, current economic conditions and historical loan loss experience.  Determining the level of the allowance at any given period is difficult, particularly during deteriorating or uncertain economic periods, and therefore management takes a relatively long view of loan loss asset quality measures.  Management must make estimates using assumptions and information that are often subjective and changing rapidly.  The review of the loan portfolio is a continuing event in light of a changing economy and the dynamics of the banking and regulatory environment.  Should the economic climate deteriorate, borrowers could experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise and require increased provisions.  In management's judgment, Salisbury remains adequately reserved both against total loans and non-performing loans at March 31, 2010.

The allowance for loan losses is computed by segregating the portfolio into various risk rating and product categories.  Some loans have been further segregated and carry specific reserve amounts.  All other loans that do not have specific reserves assigned are reserved based on a loss percentage assigned to the outstanding balance.  The percentage applied to the outstanding balance varies depending on the loan’s risk rating and product category, as well as present economic conditions, which have or may adversely affect the financial capacity and/or collateral values supporting the loan.

Management’s loan risk rating assignments, loss percentages and specific reserves are subjected annually to an independent credit review by an external firm. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses.  Such agencies could require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.  The Bank was examined by the FDIC in February 2009, and by the State of Connecticut’s Department of


Banking in August 2007, and no additions to the allowance were requested as a result of these examinations.

Non-interest income

The following table details the principal categories of non-interest income.
                   
Three months ended March 31, (dollars in thousands)
 
2010
   
2009
   
2010 vs. 2009
 
Gains on securities, net
  $ -     $ 427     $ (427 )     (100.00 )%
Trust and wealth advisory fees
    545       540       5       0.93  
Service charges and fees
    469       398       71       17.84  
Gains on sales of mortgage loans, net
    60       82       (22 )     (26.83 )
Mortgage servicing, net
    15       42       (27 )     (64.28 )
Other
    57       137       (80 )     (58.39 )
Total non-interest income
  $ 1,146     $ 1,626     $ (480 )     (29.52 )

The $480,000 decrease in non-interest income for the first quarter of 2010 as compared to the 2009 quarter was due to several one-time benefits in the first quarter of 2009, including $427,000 of securities gains, a $72,000 market adjustment gain from the re-financing of Bank Owned Life Insurance, and a $39,000 mortgage servicing rights impairment benefit. Income from sales of mortgage loans decreased $22,000 in the first quarter of 2010 due to lower loan origination volume. Loan sales were $4.4 million and $6.9 million, respectively for the 2010 and 2009 periods. Service fees and charges increased $71,000, or 18%, in the first quarter of 2010 due to higher interchange, overdraft and other fees. Trust and Wealth Advisory revenues were substantially unchanged.

Non-interest expense

The following table details the principal categories of non-interest expense.
                   
Three months ended March 31, (dollars in thousands)
 
2010
   
2009
   
2010 vs. 2009
 
Salaries
  $ 1,746     $ 1,753     $ (7 )     (0.40 )%
Employee benefits
    471       438       33       7.53  
Premises and equipment
    515       484       31       6.40  
Data processing
    408       383       25       6.53  
Professional fees
    402       356       46       12.92  
FDIC insurance
    171       114       57       0.50  
Marketing and community contributions
    88       76       12       15.79  
Amortization of intangible assets
    56       41       15       36.59  
Other
    472       383       89       23.23  
Non-interest expense
  $ 4,329     $ 4,028     $ 301       7.47  

The increase in non-interest expense for the first quarter of 2010 was primarily due to higher operating costs. Benefits expense increased primarily due to higher health plan rates and employee participation levels.  Increased premises expense reflects the inclusion of the Millerton branch, opened in January 2010, and the future Sheffield branch, expected to open in mid 2010, and increases in real estate tax assessments.  Data processing expense reflects loan and deposit account growth and related transactional volumes. The increase in FDIC insurance premiums is due to deposit growth. The amortization of intangible assets for the 2010 period includes amortization related to last quarter’s assumption of Webster Bank’s Canaan branch deposits. Other operating expenses increased primarily as a result of deposit and loan account growth.

Income taxes

The effective income tax rate for the first quarter of 2010 was 11.74%, compared with 19.58% for the first quarter of 2009. The decrease in the effective rate resulted from a higher proportion of tax-exempt income to total income in the 2010 period. Salisbury’s effective tax rate is generally less than the 34% federal statutory rate due to holdings of tax-exempt municipal bonds and bank owned life insurance.

Salisbury did not incur Connecticut income tax in 2010 or 2009, other than minimum state income tax, as a result of its utilization of Connecticut tax legislation that permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a special purpose entity called a Passive Investment Company (“PIC”). In accordance with this legislation, in 2004 Salisbury formed a PIC, SBT Mortgage Service Corporation. Salisbury's income tax provision reflects the full impact of the Connecticut legislation. Salisbury does not expect to pay other than minimum state income tax in the foreseeable future unless there is a change in the State of Connecticut corporate tax law.


FINANCIAL CONDITION

Overview

Total assets were $563 million at March 31, 2010, up $771,000 from December 31, 2009.  Loans receivable, net, were $330 million at March 31, 2010, up $2.3 million, or 0.7%, from December 31, 2009.  Non-performing assets were $12.3 million at March 31, 2010, up $4.6 million from $7.7 million at December 31, 2009. Reserve coverage, as measured by the ratio of the allowance for loan losses to gross loans, was 1.10%, 1.05% and 1.00%, at March 31, 2010, December 31, 2009 and March 31, 2009, respectively. Deposits were $422 million, up $4 million from $418 million at December 31, 2009.

At March 31, 2010, book value and tangible book value per common share were $26.21 and $19.55, respectively. Salisbury’s Tier 1 leverage and total risk-based capital ratios were 8.40% and 12.75%, respectively, and above the “well capitalized” limits as defined by the FRB.

Securities and Short Term Funds

Salisbury's debt securities include U.S. Treasury bills and notes, U.S. Government sponsored agency bonds, agency mortgage-backed securities (“MBS”) and agency collateralized mortgage obligations (“CMO”), bank qualified municipal bonds, non-agency CMO’s and Small Business Administration (“SBA”) pools.

Securities available-for-sale were $166.2 million at March 31, 2010, up $21.1 million from December 31, 2009. During the first quarter of 2010 Salisbury purchased $34.0 million of debt securities, including U.S. Treasury notes and U.S. Government sponsored agency bonds. At March 31, 2010, the portfolio had a projected weighted average life of 5.34 years, based on median projected prepayment speeds for MBS and CMO, and likelihood of call for callable securities, at current interest rates.  At March 31, 2010, substantially all securities were classified as available-for-sale.

In 2009 Salisbury determined that five non-agency CMO securities reflected OTTI and it recognized credit losses of $1,128,000 by writing down the carrying value of such securities. Salisbury does not intend to sell the securities which it has judged to be OTTI and it is not more likely than not that it will be required to sell these securities before its anticipated recovery of each security’s remaining amortized cost basis. No additional OTTI was determined for the quarter ended March 31, 2010 and all other non-agency CMO securities were judged not to be OTTI as of March 31, 2010. It is possible that future loss assumptions could change and cause future OTTI credit losses in these securities.

Salisbury believes that principal and interest on all other debt securities are deemed recoverable. Accumulated other comprehensive income at March 31, 2010 included net unrealized holding losses, net of tax, of $3.2 million that management deems as temporary impairment.

Loans

During the first quarter of 2010, net loans receivable grew $2.3 million, or 0.7%, to $329.6 million at March 31, 2010, despite soft loan demand and aggressive competition for loans in Salisbury’s market area. First quarter 2010 loan growth compares with loan growth of $1.6 million, or 0.5%, in the first quarter of 2009.

The principal categories of loans receivable are as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Loans receivable
           
Real Estate Mortgages
           
Residential
  $ 164,119     $ 163,863  
Commercial
    77,210       70,066  
Construction, land & land development
    23,801       31,011  
Home equity credit
    32,830       33,099  
Total mortgage loans
    297,960       298,039  
Commercial and Industrial
    29,162       26,400  
Consumer
    5,224       5,436  
Other
    276       269  
Total loans, gross
    333,622       330,144  
Deferred loan origination costs, net
    627       586  
Allowance for loan losses
    (3,649 )     (3,473 )
Loans receivable, net
  $ 329,600     $ 327,257  
 Loans held-for-sale
               
Residential mortgages
  $ 1,178     $ 665  


Loan Credit Quality

Loan credit quality showed signs of deterioration during the first quarter ended March 31, 2010, reflecting the weakness in the regional economy. Non-performing assets increased $4.6 million to $12.3 million, or 2.19% of assets, compared with $7.7 million, or 1.37% of assets, at December 31, 2009. Of this increase, $3.9 million are classified as troubled debt restructurings. During the quarter Salisbury restructured loans of $4.4 million.

During the first quarter of 2010 loans past due 30 days or more increased $3.5 million to $11.9 million, or 3.6% of loans, at March 31, 2010. Of this increase $2.2 million, or 63%, are on non-accrual status and included in non-performing assets, and $1.3 million, or 37%, are accruing and none of which are classified as troubled debt restructurings.

Non-Performing Assets

The principal categories of non-performing assets are as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Real Estate Mortgages
           
Residential
  $ 3,332     $ 765  
Commercial
    4,196       2,226  
Construction, land & land development
    3,603       3,535  
Home equity credit
    366       367  
Total mortgage loans
    11,497       6,893  
Commercial and Industrial
    564       546  
Non-accruing loans
  $ 12,061     $ 7,439  
Accruing loans past due 90 days or more
    3       6  
Total non-performing loans
    12,064       7,445  
Real estate acquired in settlement of loans
    275       275  
Total non-performing assets
  $ 12,339     $ 7,720  

During the first quarter of 2010, loans totaling $4.7 million were placed on non-accrual status, $2.9 million, or 62%, of which are represented by two loans, a residential real estate mortgage and a commercial real estate mortgage, neither of which are past due and both of which were previously classified as troubled debt restructurings. Substantially all non-performing loans are collateralized with real estate and the repayment of such loans is largely dependent on the sale of the underlying real estate.

Salisbury pursues the resolution of all non-performing assets through restructurings, credit enhancements or collections. When all attempts to work with a customer to either restructure and bring the loan back to performing, or to simply bring the loan current are unsuccessful, Salisbury will initiate action to either foreclose the property, to acquire it by deed in lieu of foreclosure, or to liquidate business assets. At March 31, 2010 Salisbury held one property, acquired in 2009 as a result of collection activities, and that was subsequently sold in April 2010.

The past due status of non-performing loans is as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Current
  $ 5,248     $ 3,105  
Past due 001-029 days
    315       -  
Past due 030-059 days
    802       349  
Past due 060-089 days
    1,321       405  
Past due 090-179 days
    1,113       321  
Past due 180 days and over
    3,265       3,265  
Total non-performing loans
  $ 12,064     $ 7,445  

At March 31, 2010, 43.5% of non-accrual loans were current with respect to loan payments, compared with 41.7% at December 31, 2009. Loans past due 180 days and over consists primarily of a single $3.0 million residential construction loan relationship.

Troubled Debt Restructured Loans

Loans are considered restructured when Salisbury has granted concessions to a borrower due to the borrower’s financial condition that it otherwise would not have considered. These concessions include modifications of the terms of the debt


such as reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit Salisbury by increasing the ultimate probability of collection.

Restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans which are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status. Accruing restructured loans are generally placed into nonaccrual status if and when the borrower fails to comply with the restructured terms.

The principal categories of troubled debt restructured loans are as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Real Estate Mortgages
           
Residential
  $ 662     $ 2,708  
Commercial
    4,384       1,857  
Accruing troubled debt restructured loans
    5,046       4,565  
Real Estate Mortgages
               
Residential
    2,213       176  
Commercial
    3,866       2,008  
Construction, land & land development
    26       -  
Commercial and Industrial
    158       158  
Non-accrual troubled debt restructured loans
    6,263       2,342  
Total troubled debt restructured loans
  $ 11,309     $ 6,907  

During the first quarter of 2010, Salisbury restructured six loans totaling $4.4 million, of which $3.6 million are accruing and $0.8 million were placed on non-accrual status. Also during the quarter, Salisbury placed on non-accrual $3.1 million of loans previously classified as troubled debt restructured loans, $2.9 million of which are represented by the aforementioned two loans, a residential real estate mortgage and a commercial real estate mortgage.

The past due status of troubled debt restructured loans is as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Current
  $ 4,799     $ 4,566  
Past due 001-029 days
    247       -  
Accruing troubled debt restructured loans
    5,046       4,566  
Current
    4,001       1,991  
Past due 030-059 days
    729       -  
Past due 060-089 days
    1,183       350  
Past due 090-179 days
    350       -  
Non-accrual troubled debt restructured loans
    6,263       2,341  
Total troubled debt restructured loans
  $ 11,309     $ 6,907  

At March 31, 2010 77% of such loans were current with respect to loan payments, down from 95% at December 31, 2009.

Past Due Loans

Loans past due 30 days or greater are as follows:
             
(in thousands)
 
March 31, 2010
   
December 31, 2009
 
Past due 030-059 days
  $ 4,543     $ 2,821  
Past due 060-089 days
    840       1,272  
Past due 090-179 days
    3       5  
Accruing loans
    5,386       4,098  
Past due 030-059 days
    801       349  
Past due 060-089 days
    1,321       405  
Past due 090-179 days
    1,110       315  
Past due 180 days and over
    3,265       3,265  
Non-accrual loans
    6,497       4,334  
Total loans past due 30 days or greater
  $ 11,883     $ 8,432  


During the first quarter of 2010 loans past due 30 days or more increased $3.5 million to $11.9 million, or 3.6% of gross loans receivable, at March 31, 2010, up from 2.3% of gross loans receivable, at December 31, 2009. Of this increase $2.2 million, or 63%, are on non-accrual status and included in non-performing assets, and $1.3 million, or 37%, are accruing and none of which are classified as troubled debt restructurings.

Potential Problem Loans

Salisbury classifies certain loans as “substandard,” “doubtful,” or “loss” based on criteria consistent with guidelines prescribed by banking regulators. Potential problem loans consist of classified accruing commercial loans that were less than 90 days past due at March 31, 2010, but where known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonperforming at some time in the future. These loans are not included in the classification of non-accrual or troubled debt restructured loans above. Management cannot predict the extent to which economic conditions may worsen or other factors which may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, restructured, or require increased allowance coverage and provision for loan losses. Salisbury has identified approximately $10.0 million in potential problem commercial loans at March 31, 2010, 74% of which is represented by 6 commercial lending relationships.

Deposits and Borrowings

During the three-month period ended March 31, 2010 deposits grew $4.3 million, or 1.02%, to $422.5 million, while retail repurchase agreements decreased $3.4 million to $7.9 million. Salisbury opened its Millerton branch in January 2010.

During this period Salisbury’s Federal Home Loan Bank of Boston (FHLBB) advances decreased by $1 million from scheduled loan repayments.

LIQUIDITY

Salisbury manages its liquidity position to ensure that there is sufficient funding availability at all times to meet both anticipated and unanticipated deposit withdrawals, loan originations and advances, securities purchases and other operating cash outflows. Salisbury's primary sources of liquidity are principal payments and maturities of securities and loans, short-term borrowings through repurchase agreements and Federal Home Loan Bank advances, net deposit growth and funds provided by operations.  Liquidity can also be provided through sales of loans and available-for-sale securities.

Operating activities for the three-month period ended March 31, 2010 provided net cash of $1.1 million.  Investing activities utilized net cash of $23.9 million, principally to purchase $34.0 million of securities, and fund $2.5 million of net loan advances and $1.1 million in capital expenditures, offset in part by $13.6 million from security repayments, calls and maturities. Financing activities utilized net cash of $745,000, principally for $1.0 million of scheduled FHLB advance repayments and $582,000 of cash dividends, offset in part by $845,000 of net deposit and repurchase agreement inflows.

At March 31, 2010, Salisbury's liquidity ratio, as represented by cash, short term available-for-sale securities and marketable assets to net deposits and short term unsecured liabilities, was 33.4% and exceeded Salisbury's minimum guideline of 30%.

At March 31, 2010, Salisbury had outstanding commitments to fund new loan originations of $3.5 million, construction mortgage commitments of $3.6 million and unused lines of credit of $46.2 million. Salisbury believes that these commitments can be met in the normal course of business.  Salisbury believes that its liquidity sources will continue to provide funding sufficient to support operating activities, loan originations and commitments, and deposit withdrawals.

CAPITAL RESOURCES

Shareholders’ equity was $53.0 million at March 31, 2010, up $668,000 from December 31, 2009. Book value and tangible book value per share were $26.21 and $19.55, respectively, compared with $25.81 and $19.12, respectively, at December 31, 2009. Contributing to the increase in shareholders’ equity for the first quarter of 2010 was net income of $594,000, other comprehensive income of $656,000, less common and preferred stock dividends of $472,000 and $110,000, respectively. Other comprehensive income includes unrealized gains on securities available-for-sale, net of tax, of $644,000 and pension plan income, net of tax, of $656,000.


Capital Requirements

Salisbury and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Under current regulatory definitions, Salisbury and the Bank are considered to be “well capitalized” for capital adequacy purposes. As a result, the Bank pays lower federal deposit insurance premiums than banks that are not “well capitalized.” Salisbury and the Bank's regulatory capital ratios are as follows:
                   
   
Well
   
March 31, 2010
   
December 31, 2009
 
   
capitalized
   
Salisbury
   
Bank
   
Salisbury
   
Bank
 
Total Capital (to risk-weighted assets)
    10.00 %     12.75 %     10.36 %     12.86 %     10.40 %
Tier 1 Capital (to risk-weighted assets)
    6.00       11.81       9.41       11.95       9.48  
Tier 1 Capital (to average assets)
    5.00       8.40       6.68       8.39       6.70  

A well capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective Regulations issued by the FDIC and the FRB, is one which maintains a Total Risk-Based ratio of 10% or above, a Tier 1 Risk-Based ratio of 6% or above and a Leverage ratio of 5% or above, and is not subject to any written order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level. Maintaining strong capital is essential to Salisbury and the Bank’s safety and soundness.  However, the effective management of capital resources requires generating attractive returns on equity to build value for shareholders while maintaining appropriate levels of capital to fund growth, meet regulatory requirements and be consistent with prudent industry practices.

Dividends

During the three month period ended March 31, 2010 Salisbury paid $110,000 in preferred stock dividends to the U.S. Treasury’s TARP CPP, and $472,000 in common stock dividends.

The Board of Directors of Salisbury declared a common stock dividend of $0.28 per common share payable on May 26, 2010 to shareholders of record on May 12, 2010. Common stock dividends, when declared, will generally be paid the last business day of February, May, August and November, although Salisbury is not obligated to pay dividends on those dates or at any other time.

Salisbury's ability to pay cash dividends is substantially dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations.  The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Commissioner of Banking, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.

FRB Supervisory Letter SR 09-4, February 24, 2009 revised March 27, 2009 notes that, as a general matter, the board of directors of a bank holding company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2)  the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the FRB reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital structure.

Further restrictions on cash dividends are imposed on Salisbury because of Salisbury’s participation in the TARP, CPP. These preclude the payment of any common stock cash dividends if Salisbury is not paying the preferred stock dividend.  Additionally, the common stock dividend may not be increased without prior approval from the Treasury for the first three years Salisbury is a TARP participant unless all TARP preferred shares are redeemed or transferred to third parties.

Salisbury believes that the payment of common stock cash dividends is appropriate, provided that such payment considers Salisbury's capital needs, asset quality, and overall financial condition and does not adversely affect the financial stability of Salisbury or the Bank.  The continued payment of common stock cash dividends by Salisbury will be dependent on Salisbury's future core earnings, financial condition and capital needs, regulatory restrictions, and other factors deemed relevant by the Board of Directors of Salisbury.

IMPACT OF INFLATION AND CHANGING PRICES

Salisbury’s consolidated financial statements are prepared in conformity with generally accepted accounting principles


that require the measurement of financial condition and operating results in terms of historical dollars without considering changes in the relative purchasing power of money, over time, due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of Salisbury are monetary and as a result, interest rates have a greater impact on Salisbury’s performance than do the effects of general levels of inflation, although interest rates do not necessarily move in the same direction or with the same magnitude as the prices of goods and services. Although not a material factor in recent years, inflation could impact earnings in future periods.

FORWARD-LOOKING STATEMENTS

This Form 10-Q and future filings made by Salisbury with the Securities and Exchange Commission, as well as other filings, reports and press releases made or issued by Salisbury and the Bank, and oral statements made by executive officers of Salisbury and the Bank, may include forward-looking statements relating to such matters as:

(a)
assumptions concerning future economic and business conditions and their effect on the economy in general and on the markets in which Salisbury and the Bank do business; and

(b)
expectations for revenues and earnings for Salisbury and Bank.

Such forward-looking statements are based on assumptions rather than historical or current facts and, therefore, are inherently uncertain and subject to risk.  For those statements, Salisbury claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Act of 1995.

Salisbury notes that a variety of factors could cause the actual results or experience to differ materially from the anticipated results or other expectations described or implied by such forward-looking statements.  The risks and uncertainties that may effect the operation, performance, development and results of Salisbury’s and Bank’s business include the following:

(a)
the risk of adverse changes in business conditions in the banking industry generally and in the specific markets in which the Bank operates;

(b)
changes in the legislative and regulatory environment that negatively impacts Salisbury and Bank through increased operating expenses;

(c)
increased competition from other financial and non-financial institutions;

(d)
the impact of technological advances; and

(e)
other risks detailed from time to time in Salisbury’s filings with the Securities and Exchange Commission.

Such developments could have an adverse impact on Salisbury’s and the Bank’s financial position and results of operations.

QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

Salisbury manages its exposure to interest rate risk through its Asset/Liability Management Committee (“ALCO”) using risk limits and policy guidelines to manage assets and funding liabilities to produce financial results that are consistent with Salisbury’s liquidity, capital adequacy, growth, risk and profitability targets. Interest rate risk is the risk of loss to future earnings due to changes in interest rates.

The ALCO manages interest rate risk using income simulation to measure interest rate risk inherent in Salisbury’s financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 24-month horizon. The simulations incorporate management’s growth assumptions over the simulation horizons, with allowances made for loan, deposit and security product mix shifts in selected interest rate scenarios, such as movements between lower rate savings and money market deposit accounts and higher rate time deposits, and changes in the reinvestment of loan and securities cash flows. Additionally, the simulations take into account the specific re-pricing, maturity and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios.

The ALCO reviews the simulation results to determine whether Salisbury’s exposure to change in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. Salisbury’s tolerance levels for changes in net interest income in its income simulations varies depending on the magnitude of interest rate changes and level of risk-based capital. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where interest rates remain stable over the forecast horizon. The ALCO also evaluates the directional trends of net interest income, net interest margin and other financial measures over the forecast horizon for consistency with its liquidity, capital adequacy, growth, risk and


profitability targets.

The ALCO uses four interest rate scenarios to evaluate interest risk exposure and may vary these interest rate scenarios to show the effect of steepening or flattening changes in yield curves as well as parallel changes in interest rates. At March 31, 2010 the ALCO used the following interest rate scenarios: (1) unchanged interest rates; (2) immediately rising interest rates – immediate non-parallel upward shift in market interest rates ranging from 300 basis points for short term rates to 150 basis points for the 10-year Treasury; (3) immediately falling interest rates – immediate non-parallel downward shift in market interest rates ranging from 0 basis points for short term rates to 100 basis points for the 10-year Treasury; and (4) gradually rising interest rates – gradual non-parallel upward shift in market interest rates ranging from 400 basis points for short term rates to 185 basis points for the 10-year Treasury. Deposit rates are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements. Further, deposits are assumed to have certain minimum rate levels below which they will not fall. Because income simulations assume that Salisbury’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.

As of March 31, 2009 net interest income simulations indicated that the Bank’s exposure to changing interest rates over the simulation horizons remained within its tolerance levels. The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for changes in market interest rates using the Bank’s financial instruments as of March 31, 2010.
             
As of March 31, 2010
 
Months 1-12
   
Months 13-24
 
Immediately rising interest rates
    (9.70 )%     (13.46 )%
Immediately falling interest rates
    0.17       (1.48 )
Gradually rising interest rates
    (0.81 )     (10.39 )

The negative exposure of net interest income to immediately and gradually rising rates as compared to the unchanged rate scenario results from a faster projected rise in the cost of funds versus income from earning assets, as relatively rate-sensitive money market and time deposits re-price faster than longer duration earning assets.  The negative exposure of net interest income to immediately falling rates as compared to an unchanged rate scenario results from a greater decline in earning asset yields compared to rates paid on funding liabilities, as a result of faster prepayments on existing assets and lower reinvestment rates on future loans originated and securities purchased.

While the ALCO reviews simulation assumptions and back-tests simulation results to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the re-pricing, maturity and prepayment characteristics of financial instruments and the composition of Salisbury’s balance sheet may change to a different degree than estimated. Simulation modeling assumes a relatively static balance sheet that does not necessarily reflect Salisbury’s expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The assumed relationship between short-term interest rate changes and core deposit rate and balance changes used in income simulation may differ from the ALCO’s estimates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.

Salisbury also monitors the potential change in market value of its available-for-sale debt securities in changing interest rate environments. The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to Salisbury’s capital and liquidity position. Results are calculated using industry-standard analytical techniques and securities data. Available-for-sale equity securities are excluded from this analysis because the market value of such securities cannot be directly correlated with changes in interest rates. The following table summarizes the potential change in market value of available-for-sale debt securities resulting from immediate parallel rate shifts:

 
             
As of March 31, 2010 (in thousands)
 
Rates up 100bp
   
Rates up 200bp
 
U.S. Treasury notes
  $ (143 )   $ (276 )
U.S. Government agency notes
    (2,118 )     (4,455 )
Municipal bonds
    (4,125 )     (7,883 )
Mortgage backed securities
    (744 )     (1,802 )
Collateralized mortgage obligations
    (1,789 )     (3,287 )
SBA pools
    (27 )     (46 )
Total available-for-sale debt securities
  $ (8,946 )   $ (17,749 )

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Salisbury’s management, including its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the disclosure controls and procedures as of March 31, 2010.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that the information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports filed under the Exchange Act is accumulated and communicated to management, including the principle executive officer and principle financial officer, as appropriate to allow timely decisions regarding required disclosure. 

In addition, based on an evaluation of its internal controls over financial reporting, no change in Salisbury’s internal control over financial reporting occurred during the quarter ended March 31, 2010 that has materially affected, or is reasonably likely to materially affect, Salisbury’s internal control over financial reporting.

OTHER INFORMATION

Item 1.
LEGAL PROCEEDINGS

The Bank is a party defendant, both in its capacity as Salisbury Bank and Trust Company and in its former capacity as the Trustee of the Erling C. Christophersen Revocable Trust, in litigation currently pending in the Connecticut Superior Court within the Judicial District of Bridgeport.  The other parties to the litigation are the Plaintiff, John R. Christophersen of Norwalk, Connecticut and Defendants, Erling C. Christophersen, of Westport, Connecticut; Bonnie Christophersen of  Westport, Connecticut; Elena Dreiske of Wanetka, Illinois; and People’s United Bank with its principal place of business in Bridgeport, Connecticut.

The litigation involves the ownership of certain real property located within Westport, Connecticut, which was conveyed by the Defendant, Erling Christophersen, to the Erling Christophersen Trust, of which the Bank was a co-Trustee.  Subsequent to this conveyance, the Bank loaned $3,386,609 to the Erling Christophersen Trust which was secured by an open-end commercial mortgage in favor of the Bank on the Westport real estate referenced above, which was appraised at a value significantly greater than the loan amount.

The claim of the Plaintiff John R. Christophersen is that he had an interest in the real property of which he was wrongfully divested.  He has brought this action seeking restoration of his allegedly divested interest as well as money damages.

In addition to his efforts to restore his alleged interest in the real property, the Plaintiff has made two additional claims directed at the Bank.  He has alleged that by financing the property, and holding it as a co-Trustee, the Bank participated in “stealing” the value of the Plaintiff’s interest in the property.  He has also alleged an implied trust against the Bank alleging that it acquired title to the property adverse to the Plaintiff’s interest and in contravention of the Plaintiffs entitlements, and therefore holds the property in trust for Plaintiff.  The Bank, at the time of the financing referenced above, acquired a lender’s title insurance policy from the Chicago Title & Insurance Company.  The Bank has resigned as a trustee and is actively defending the case.  The validity of the conveyance to Erling Christophersen is also the subject of a probate proceeding in New York State.  This Connecticut proceeding has been stayed until the New York Court litigation is resolved.  Prior to the resolution, the liquidity of the real estate collateral which secures the loan is diminished.


RISK FACTORS

 
Not applicable.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 
None

DEFAULTS UPON SENIOR SECURITIES

 
None

RESERVED

OTHER INFORMATION

 
None

EXHIBITS

Rule 13a-14(a)/15d-14(a) Certification.

Rule 13a-14(a)/15d-14(a) Certification.

Section 1350 Certifications

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.
 
SALISBURY BANCORP, INC.

May 17, 2010
by    /s/ Richard J. Cantele, Jr.
 
Richard J. Cantele, Jr.,
 
Chief Executive Officer
   
May 17, 2010
by    /s/ B. Ian McMahon
 
B. Ian McMahon,
 
Chief Financial Officer
 
 
31