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SALISBURY BANCORP, INC. - Quarter Report: 2012 March (Form 10-Q)

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended March 31, 2012

OR

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

 

FOR THE TRANSITION PERIOD FROM ________ TO ________

 

Commission file number 0-24751

SALISBURY BANCORP, INC.

(Exact name of registrant as specified in its charter)

Connecticut 06-1514263
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) 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 ý 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 (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ý No o

 

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

 

The number of shares of Common Stock outstanding as of May 10, 2012 is 1,688,731.

 

1
 

TABLE OF CONTENTS

 

    Page
     
  PART I FINANCIAL INFORMATION  
     
Item 1. Financial Statements (unaudited):  
     
  Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011 3
     
  Consolidated Statements of Income for the three month period ended March 31, 2012 and 2011 4
     
  Consolidated Statements of Comprehensive Income for the three month period ended March 31, 2012 and 2011 5
     
  Consolidated Statements of Changes in Shareholders' Equity for the three month period ended March 31, 2012 and 2011 5
     
  Consolidated Statements of Cash Flows for the three month period ended March 31, 2012 and 2011 6
     
  Notes to Consolidated Financial Statements 7
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 22
     
Item 3. Quantitative and Qualitative Disclosures of Market Risk 35
     
Item 4. Controls and Procedures 37
     
  PART II OTHER INFORMATION  
     
Item 1. Legal Proceedings 37
Item 1A. Risk Factors 38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 38
Item 3. Defaults upon Senior Securities 38
Item 4. Mine Safety Disclosures 38
Item 5. Other Information 38
Item 6. Exhibits 38

 

 

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PART I - FINANCIAL INFORMATION

 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share data)  March 31, 2012   December 31, 2011 
ASSETS          
Cash and due from banks  $4,783   $4,829 
Interest bearing demand deposits with other banks   33,540    32,057 
Total cash and cash equivalents   38,323    36,886 
Securities          
  Available-for-sale at fair value   145,919    155,794 
  Held-to-maturity at amortized cost (fair value: $ - and $52)       50 
  Federal Home Loan Bank of Boston stock at cost   5,747    6,032 
Loans held-for-sale   1,308    948 
Loans receivable, net (allowance for loan losses: $4,166 and $4,076)   371,709    370,766 
Other real estate owned       2,744 
Bank premises and equipment, net   11,861    12,023 
Goodwill   9,829    9,829 
Intangible assets (net of accumulated amortization: $1,579 and $1,523)   964    1,020 
Accrued interest receivable   2,789    2,126 
Cash surrender value of life insurance policies   7,104    7,037 
Deferred taxes   579    829 
Other assets   2,818    3,200 
       Total Assets  $598,950   $609,284 
LIABILITIES and SHAREHOLDERS' EQUITY          
Deposits          
  Demand (non-interest bearing)  $88,588   $82,202 
  Demand (interest bearing)   64,563    66,332 
  Money market   119,944    124,566 
  Savings and other   98,232    94,503 
  Certificates of deposit   101,359    103,703 
       Total deposits   472,686    471,306 
Repurchase agreements   10,359    12,148 
Federal Home Loan Bank of Boston advances   43,207    54,615 
Accrued interest and other liabilities   4,631    4,353 
       Total Liabilities   530,883    542,422 
Commitments and contingencies        
Shareholders' Equity          
  Preferred stock - $.01 per share par value          
       Authorized: 25,000; Issued: 16,000 (Series B);          
       Liquidation preference: $1,000 per share   16,000    16,000 
  Common stock - $.10 per share par value          
       Authorized: 3,000,000;          
       Issued: 1,688,731 and 1,688,731   169    169 
  Paid-in capital   13,134    13,134 
  Retained earnings   38,958    38,264 
  Accumulated other comprehensive loss, net   (194)   (705)
       Total Shareholders' Equity   68,067    66,862 
       Total Liabilities and Shareholders' Equity  $598,950   $609,284 
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Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

   Three months ended 
Periods ended March 31, (in thousands except per share amounts) unaudited  2012   2011 
Interest and dividend income          
Interest and fees on loans  $4,595   $4,664 
Interest on debt securities          
   Taxable   716    783 
   Tax exempt   534    554 
Other interest and dividends   13    38 
   Total interest and dividend income   5,858    6,039 
Interest expense          
Deposits   667    871 
Repurchase agreements   13    15 
Federal Home Loan Bank of Boston advances   495    646 
   Total interest expense   1,175    1,532 
Net interest and dividend income   4,683    4,507 
Provision for loan losses   180    330 
   Net interest and dividend income after provision for loan losses   4,503    4,177 
Non-interest income          
Trust and wealth advisory   755    667 
Service charges and fees   521    499 
Gains on sales of mortgage loans, net   372    133 
Mortgage servicing, net   (84)   32 
Gains on securities, net   12    11 
Other   83    59 
   Total non-interest income   1,659    1,401 
Non-interest expense          
Salaries   1,710    1,729 
Employee benefits   690    634 
Premises and equipment   605    583 
Data processing   402    377 
Professional fees   313    280 
Collections and OREO   111    126 
FDIC insurance   128    223 
Marketing and community support   87    68 
Amortization of intangibles   56    56 
Other   398    348 
   Total non-interest expense   4,500    4,424 
Income before income taxes   1,662    1,154 
Income tax provision   412    211 
Net income  $1,250   $943 
Net income available to common shareholders  $1,167   $828 
           
Basic and diluted earnings per common share  $0.69   $0.49 
Common dividends per share   0.28    0.28 

 

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Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

   Three months ended 
Periods ended March 31, (in thousands)  2012   2011 
Net income  $1,250   $943 
Other comprehensive income          
  Net unrealized gains on securities available-for-sale   725    837 
  Reclassification of net realized gains in net income   12    11 
  Unrealized gains on securities available-for-sale   737    848 
  Income tax expense   (250)   (288)
       Unrealized gains on securities available-for-sale, net of tax   487    560 
  Pension plan income   36    17 
  Income tax expense   (12)   (6)
       Pension plan income, net of tax   24    11 
Other comprehensive income, net of tax   511    571 
Comprehensive income  $1,761   $1,514 

 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)

   Common Stock   Preferred       Paid-in   Retained   Accumulated
other comp-
   Total
share-holders'
 
(dollars in thousands) unaudited  Shares   Amount   Stock   Warrants   capital   earnings   rehensive loss   equity 
Balances at December 31, 2010   1,687,661   $168   $8,738   $112   $13,200   $36,567   $(3,769)  $55,016 
Net income for period                       943        943 
Other comprehensive income, net of tax                           571    571 
   Total comprehensive income                                      1,514 
Amortization (accretion) of preferred stock           5            (5)        
Common stock dividends paid                       (472)       (472)
Preferred stock dividends paid                       (110)       (110)
Balances March 31, 2011   1,687,661   $168   $8,743   $112   $13,200   $36,923   $(3,198)  $55,948 
Balances at December 31, 2011   1,688,731   $169   $16,000   $   $13,134   $38,264   $(705)  $66,862 
Net income for year                       1,250        1,250 
Other comprehensive income, net of tax                           511    511 
   Total comprehensive income                                      1,761 
Common stock dividends declared                       (473)       (473)
Preferred stock dividends declared                       (83)       (83)
Balances at March 31, 2012   1,688,731   $169   $16,000   $   $13,134   $38,958   $(194)  $68,067 

 

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Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

Three months ended March 31, (in thousands) unaudited  2012   2011 
Operating Activities        
Net income  $1,250   $943 
Adjustments to reconcile net income to net cash provided by operating activities:          
   (Accretion), amortization and depreciation          
       Securities   181    62 
       Bank premises and equipment   225    206 
       Core deposit intangible   56    56 
       Mortgage servicing rights   77    58 
       Fair value adjustment on loans   8    11 
Gains on calls of securities available-for-sale   (12)   (11)
Write down of other real estate owned       57 
Losses on sale/disposals of premises and equipment   (1)    
Loss recognized on other real estate owned   (1)    
   Provision for loan losses   180    330 
   (Increase) decrease in loans held-for-sale   (360)   998 
   Decrease (increase) in deferred loan origination fees and costs, net   6    (57)
   Mortgage servicing rights originated   (180)   (77)
   Increase (decrease) in mortgage servicing rights impairment reserve   92    (2)
   (Increase) decrease in interest receivable   (663)   130 
   Deferred tax benefit   (13)   (14)
   (Increase) decrease in prepaid expenses   (1)   73 
   Increase in cash surrender value of life insurance policies   (67)   (39)
   Decrease in income tax receivable   389    224 
   Decrease in other assets   6    25 
   Decrease in accrued expenses   300    537 
   Decrease in interest payable   (30)   (101)
   Increase (decrease) in other liabilities   16    (143)
       Net cash provided by operating activities   1,458    3,266 
Investing Activities          
Redemption of Federal Home Loan Bank stock   285     
Proceeds from calls of securities available-for-sale   3,820    22,997 
Proceeds from maturities of securities available-for-sale   6,623     
Proceeds from maturities of securities held-to-maturity   50    1 
Loan originations and principle collections, net   (147)   (9,394)
Recoveries of loans previously charged-off   10    7 
Proceeds from sale of other real estate owned   1,744     
Capital expenditures   (54)   (327)
        Net cash provided by investing activities   12,331    13,284 
Financing Activities          
Increase in deposit transaction accounts, net   3,725    32,640 
Decrease in time deposits, net   (2,345)   (10,550)
Decrease in securities sold under agreements to repurchase, net   (1,789)   (4,949)
Principal payments on Federal Home Loan Bank of Boston advances   (11,408)   (16,925)
Common stock dividends paid   (473)   (473)
Preferred stock dividends paid   (62)   (110)
       Net cash provided by financing activities   (12,352)   (367)
Net increase in cash and cash equivalents   1,437    16,183 
Cash and cash equivalents, beginning of period   36,886    26,908 
Cash and cash equivalents, end of period  $38,323   $43,091 
Cash paid during period          
   Interest  $1,205   $633 
   Income taxes   788    449 
Non-cash transfers          
Transfer from loans to other real estate owned       314 
From other real estate owned to loans   1,000     
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Salisbury Bancorp, Inc. and Subsidiary

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

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, shareholders’ 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 interim period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in Salisbury's 2011 Annual Report on Form 10-K for the period ended December 31, 2011.

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 December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The amendments in this update defer those changes in ASU 2011-05 that relate to the presentation of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. All other requirements in ASU 2011-05 are not affected by this update. The amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-12 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities.” This ASU is to enhance current disclosures. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The amendments in this ASU are effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of ASU 2011-11 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other”, an update to ASC 350, “Intangibles – Goodwill and Other.” ASU 2011-08 simplifies how entities, both public and nonpublic, test goodwill for impairment. The amendments in this update permit an entity to first assess qualitative factors to determine whether it is more likely than not the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. For public and nonpublic entities, the amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of ASU 2011-08 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. Under this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. An entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. An entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. The amendments in this ASU should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

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In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards.” The amendments in this ASU explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

In April 2011, the FASB issued ASU 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” The objective of this ASU is to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. This ASU prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011. Early adoption is not permitted. The adoption of ASU 2011-03 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This ASU provides additional guidance or clarification to help creditors determine whether a restructuring constitutes a troubled debt restructuring. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and were applied retrospectively to the beginning of the 2011 annual period. The adoption of ASU 2011-02 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

NOTE 2 - SECURITIES

The composition of securities is as follows:

(in thousands)  Amortized
cost (1)
   Gross un-
realized gains
   Gross un-
realized losses
   Fair value 
March 31, 2012                    
Available-for-sale                    
U.S. Treasury notes  $5,000   $450   $   $5,450 
U.S. Government Agency notes   14,530    300        14,830 
Municipal bonds   47,103    1,421    (826)   47,698 
Mortgage backed securities                    
   U.S. Government Agencies   52,954    1,076    (1)   54,029 
Collateralized mortgage obligations                    
   U.S. Government Agencies   6,590    50        6,640 
   Non-agency   13,526    370    (236)   13,660 
SBA bonds   3,409    85        3,494 
Preferred Stock   20    98        118 
   Total securities available-for-sale  $143,132   $3,850   $(1,063)  $145,919 
Non-marketable securities                    
Federal Home Loan Bank of Boston stock  $5,747   $   $   $5,747 
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(in thousands)  Amortized
cost (1)
   Gross un-
realized gains
   Gross un-
realized losses
   Fair value 
December 31, 2011                    
Available-for-sale                    
U.S. Treasury notes  $5,000   $528   $   $5,528 
U.S. Government Agency notes   14,544    380        14,924 
Municipal bonds   50,881    1,067    (1,152)   50,796 
Mortgage backed securities                    
   U.S. Government Agencies   57,193    1,126    (19)   58,300 
Collateralized mortgage obligations                    
   U.S. Government Agencies   7,077    76        7,153 
   Non-agency   14,300    355    (488)   14,167 
SBA bonds   3,629    77        3,706 
Corporate bonds   1,100    4        1,104 
Preferred Stock   20    96        116 
   Total securities available-for-sale  $153,744   $3,709   $(1,659)  $155,794 
Held-to-maturity                    
Mortgage backed security  $50   $2   $   $52 
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.

Salisbury did not sell any securities available-for-sale during the three month periods ended March 31, 2012 and 2011.

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 
(in thousands)  Fair
Value
   Unrealized 
losses
   Fair
value
   Unrealized 
losses
   Fair
value
   Unrealized
losses
 
March 31, 2012                              
Available-for-sale                              
Municipal Bonds  $3,785   $38   $5,382   $788   $9,167   $826 
Mortgage backed securities   4,289        55    1    4,344    1 
Collateralized mortgage obligations                              
   Non-agency   1,598    21    1,080    53    2,678    74 
Total temporarily impaired securities   9,672    59    6,517    842    16,189    901 
Other-than-temporarily impaired securities                              
   Collateralized mortgage obligations                              
       Non-agency   2,131    87    1,526    75    3,657    162 
   Total temporarily and other-than-temporarily impaired securities  $11,803   $146   $8,043   $917   $19,846   $1,063 

Salisbury evaluates securities for Other Than Temporary Impairment (“OTTI”) where the fair value of a security is less than its amortized cost basis at the balance sheet date. 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.

The following summarizes, by security type, the basis for evaluating if the applicable securities were OTTI at March 31, 2012.

U.S Government Agency notes, U.S. Government Agency mortgage-backed securities and U.S. Government Agency CMOs: The contractual cash flows are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Changes in fair values are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider these securities to be OTTI at March 31, 2012.

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Municipal bonds: Contractual cash flows are performing as expected. Salisbury purchased substantially all of these securities during 2006-to-2008 as bank qualified, insured, AAA rated general obligation or revenue bonds. Salisbury’s portfolio is mostly comprised of tax-exempt general obligation bonds or public-purpose revenue bonds for schools, municipal offices, sewer infrastructure and fire houses, for small towns and municipalities across the United States. In the wake of the financial crisis, most monoline bond insurers had their ratings downgraded or withdrawn because of excessive exposure to insurance for collateralized debt obligations. Where appropriate, Salisbury performs credit underwriting reviews of issuers, including some that have had their ratings withdrawn and are insured by insurers that have had their ratings withdrawn, to assess default risk. For all completed reviews pass credit risk ratings have been assigned. Management expects to recover the entire amortized cost basis of these securities. Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity. Management does not consider these securities to be OTTI at March 31, 2012.

Non-agency CMOs: Salisbury performed a detailed cash flow analysis of its non-agency CMOs at March 31, 2012 to assess whether any of the securities were OTTI. Salisbury uses first party provided 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. In 2009 Salisbury determined that five non-agency CMO securities reflected OTTI and recognized losses for deterioration in credit quality of $1,128,000. Salisbury judged the four remaining securities not to have additional OTTI and all other CMO securities not to be OTTI as of March 31, 2012. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis.

The following table presents activity related to credit losses recognized into earnings on the non-agency CMOs held by Salisbury for which a portion of an OTTI charge was recognized in accumulated other comprehensive income:

Three months ended March 31 (in thousands)  2012   2011 
Balance, beginning of period  $1,128   $1,128 
Credit component on debt securities in which OTTI was not previously recognized        
Balance, end of period  $1,128   $1,128 

Federal Home Loan Bank of Boston (“FHLBB”): The Bank is a member of the FHLBB. The FHLBB is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. In 2008, the FHLBB announced to its members that it is focusing on preserving capital in response to ongoing market volatility including the extension of a moratorium on excess stock repurchases and in 2009 announced the suspension of its quarterly dividends. In 2011, the FHLBB resumed modest quarterly cash dividends to its members and in early 2012 the FHLBB repurchase its excess stock pool. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank’s FHLBB stock as of March 31, 2012. Further deterioration of the FHLBB’s capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock.

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NOTE 3 - LOANS

The composition of loans receivable and loans held-for-sale is as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Residential 1-4 family  $187,985   $187,676 
   Residential 5+ multifamily   3,155    3,187 
   Construction of residential 1-4 family   5,235    5,305 
   Home equity credit   34,523    34,621 
Residential real estate   230,898    230,789 
   Commercial   81,604    81,958 
   Construction of commercial   7,517    7,069 
Commercial real estate   89,121    89,027 
Farm land   3,860    4,925 
Vacant land   12,737    12,828 
Real estate secured   336,616    337,569 
Commercial and industrial   31,081    29,358 
Municipal   2,729    2,415 
Consumer   4,451    4,496 
Loans receivable, gross   374,877    373,838 
Deferred loan origination fees and costs, net   998    1,004 
Allowance for loan losses   (4,166)   (4,076)
Loans receivable, net  $371,709   $370,766 
Loans held-for-sale          
   Residential 1-4 family  $1,308   $948 

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.

Credit Quality

The composition of loans receivable by credit risk rating is as follows:

(in thousands)  Pass   Special mention   Substandard   Doubtful   Loss   Total 
March 31, 2012                              
   Residential 1-4 family  $170,462   $13,646   $3,877   $   $   $187,985 
   Residential 5+ multifamily   2,724    431                3,155 
   Construction of residential 1-4 family   4,034    415    786            5,235 
   Home equity credit   31,332    1,524    1,667            34,523 
Residential real estate   208,552    16,016    6,330            230,898 
   Commercial   62,620    8,156    10,828            81,604 
   Construction of commercial   6,744    302    471            7,517 
Commercial real estate   69,364    8,458    11,299            89,121 
Farm land   2,300    347    1,213            3,860 
Vacant land   8,001    878    3,858            12,737 
Real estate secured   288,217    25,699    22,700            336,616 
Commercial and industrial   22,331    6,539    2,211            31,081 
Municipal   2,729                    2,729 
Consumer   4,243    153    55            4,451 
Loans receivable, gross  $317,520   $32,391   $24,966   $   $   $374,877 
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(in thousands)  Pass   Special mention   Substandard   Doubtful   Loss   Total 
December 31, 2011                              
   Residential 1-4 family  $168,326   $15,517   $3,833   $   $   $187,676 
   Residential 5+ multifamily   2,752    435                3,187 
   Construction of residential 1-4 family   4,116    415    774            5,305 
   Home equity credit   31,843    1,451    1,327            34,621 
Residential real estate   207,037    17,818    5,934            230,789 
   Commercial   64,458    6,187    11,313            81,958 
   Construction of commercial   6,296    302    471            7,069 
Commercial real estate   70,754    6,489    11,784            89,027 
Farm land   2,327    1,768    830            4,925 
Vacant land   8,039    883    3,906            12,828 
Real estate secured   288,157    26,958    22,454            337,569 
Commercial and industrial   21,104    6,847    1,407            29,358 
Municipal   2,415                    2,415 
Consumer   4,254    178    64            4,496 
Loans receivable, gross  $315,930   $33,983   $23,925   $   $   $373,838 

Credit quality segments of loans receivable by credit risk rating are as follows:

(in thousands)  Pass   Special mention   Substandard   Doubtful   Loss   Total 
March 31, 2012                              
Performing loans  $316,514   $30,624   $   $   $   $347,138 
Potential problem loans           14,836            14,836 
Troubled debt restructurings: accruing   1,006    1,767    2,523            5,296 
Troubled debt restructurings: non-accrual           1,680            1,680 
Other non-accrual loans           5,927            5,927 
Impaired loans   1,006    1,767    10,130            12,903 
Loans receivable, gross  $317,520   $32,391   $24,966   $   $   $374,877 
December 31, 2011                              
Performing loans  $314,551   $32,570   $   $   $   $347,121 
Potential problem loans           14,039            14,039 
Troubled debt restructurings: accruing   1,379    1,413    1,810            4,602 
Troubled debt restructurings: non-accrual           1,753            1,753 
Other non-accrual loans           6,323            6,323 
Impaired loans   1,379    1,413    9,886            12,678 
Loans receivable, gross  $315,930   $33,983   $23,925   $   $   $373,838 

Potential problem loans are performing loans risk rated substandard that are not classified as impaired. Impaired loans are loans for which it is probable that Salisbury will not be able to collect all principal and interest amounts due according to the contractual terms of the loan agreements.

The components of impaired loans are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
Troubled debt restructurings: accruing  $5,296   $4,602 
Troubled debt restructurings: non-accrual   1,680    1,753 
All other non-accrual loans   5,927    6,323 
Impaired loans  $12,903   $12,678 
Commitments to lend additional amounts to impaired borrowers  $   $ 
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The composition of loans receivable delinquency status by credit risk rating is as follows:

(in thousands)  Pass   Special mention   Substandard   Doubtful   Loss   Total 
March 31, 2012                              
Current  $311,798   $30,106   $11,412   $   $   $353,316 
Past due 001-029   4,899    1,168    4,408            10,475 
Past due 030-059   765    500    2,253            3,518 
Past due 060-089   58    617    266            941 
Past due 090-179           174            174 
Past due 180+           6,453            6,453 
Loans receivable, gross  $317,520   $32,391   $24,966   $   $   $374,877 
December 31, 2011                              
Current  $311,741   $31,407   $12,618   $   $   $355,766 
Past due 001-029   3,696    1,195    3,517            8,408 
Past due 030-059   435    1,024    674            2,133 
Past due 060-089   58    357    46            461 
Past due 090-179           1,095            1,095 
Past due 180+           5,975            5,975 
Loans receivable, gross  $315,930   $33,983   $23,925   $   $   $373,838 

The composition of loans receivable by delinquency status is as follows:

       Past due     
(in thousands)  Current   1-29
days
   30-59
days
   60-89
days
   90-179
days
   180 days
and over
   30 days
and over
   Accruing
90 days
and over
   Non-
accrual
 
March 31, 2012                                             
   Residential 1-4 family  $181,806   $4,108   $969   $312   $152   $638   $2,071   $   $1,300 
   Residential 5+ multifamily   2,999            156            156         
   Residential 1-4 family construction   5,090    145                             
   Home equity credit   32,806    1,038    345    217        117    679        140 
Residential real estate   222,701    5,291    1,314    685    152    755    2,906        1,440 
   Commercial   73,969    4,333    1,632    58        1,612    3,302        1,755 
   Construction of commercial   7,351            145        21    166        21 
Commercial real estate   81,320    4,333    1,632    203        1,633    3,468        1,776 
Farm land   3,438    44    378                378         
Vacant land   9,002    72        50        3,613    3,663        3,613 
Real estate secured   316,461    9,740    3,324    938    152    6,001    10,415        6,829 
Commercial and industrial   29,776    672    159        22    452    633        778 
Municipal   2,729                                 
Consumer   4,350    63    35    3            38         
Loans receivable, gross  $353,316   $10,475   $3,518   $941   $174   $6,453   $11,086   $   $7,607 
December 31, 2011                                             
   Residential 1-4 family  $182,263   $3,772   $811   $121   $   $709   $1,641   $   $1,240 
   Residential 5+ multifamily   2,918        112    157            269         
   Residential 1-4 family construction   5,305                                 
   Home equity credit   34,124    298    50        83    66    199         173 
Residential real estate   224,610    4,070    973    278    83    775    2,109        1,413 
   Commercial   75,486    3,887    483    180    930    992    2,585        2,317 
   Construction of commercial   6,796    108    145        20        165        20 
Commercial real estate   82,282    3,995    628    180    950    992    2,750        2,337 
Farm land   4,499    46    380                380         
Vacant land   9,047    73    50            3,658    3,708        3,658 
Real estate secured   320,438    8,184    2,031    458    1,033    5,425    8,947        7,408 
Commercial and industrial   28,542    152    51    1    62    550    664        668 
Municipal   2,415                                 
Consumer   4,371    72    51    2            53         
Loans receivable, gross  $355,766   $8,408   $2,133   $461   $1,095   $5,975   $9,664   $   $8,076 

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Troubled Debt Restructurings

Troubled debt restructurings occurring during the periods are as follows:

   March 31, 2012   March 31, 2011 
Three months ended
(in thousands)
  Quantity   Pre-modification
balance
   Post-modification
balance
   Quantity   Pre-modification
balance
   Post-modification
balance
 
   Residential real estate   1   $326   $326       $   $ 
   Commercial and industrial   5    779    779             
Troubled debt restructurings   6   $1,105   $1,105       $   $ 
   Rate reduction and term extension   2   $373   $373       $   $ 
   Debt consolidation and term extension   3    706    706             
   Seasonal interest only concession   1    26    26             
Troubled debt restructurings   6   $1,105   $1,105       $   $ 

Six loans were restructured during the quarter ended March 31, 2012 and all were current at March 31, 2012.

Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:

   March 31, 2012   March 31, 2011 
Three months ended
(in thousands)
  Beginning
balance
   Provision   Charge-
offs
   Reco-
veries
   Ending
balance
   Beginning
balance
   Provision   Charge-
offs
   Reco-
veries
   Ending
balance
 
   Residential  $1,479   $39   $(18)  $   $1,500   $1,504   $60   $(101)  $   $1,463 
   Commercial   1,139    (79)       1    1,061    1,132    291    (80)       1,343 
   Land   410    (29)   (42)       339    392    (18)   (79)       295 
Real estate   3,028    (69)   (60)   1    2,900    3,028    333    (260)       3,101 
Commercial & industrial   704    100    (29)   3    778    541    (9)           532 
Municipal   24    4            28    51    4            55 
Consumer   79    59    (10)   5    133    164    16    (19)   7    168 
Unallocated   241    86            327    136    (14)           122 
Totals  $4,076   $180   $(99)  $9   $4,166   $3,920   $330   $(279)  $7   $3,978 

The composition of loans receivable and the allowance for loan losses is as follows:

   Collectively evaluated   Individually evaluated   Total portfolio 
(in thousands)  Loans   Allowance   Loans   Allowance   Loans   Allowance 
March 31, 2012                              
   Residential 1-4 family  $183,741   $738   $4,244   $295   $187,985   $1,033 
   Residential 5+ multifamily   2,410    17    745        3,155    17 
   Construction of residential 1-4 family   5,235    21            5,235    21 
   Home equity credit   34,383    429    140        34,523    429 
Residential real estate   225,769    1,205    5,129    295    230,898    1,500 
   Commercial   75,146    858    6,458    102    81,604    960 
   Construction of commercial   7,496    81    21    21    7,517    102 
Commercial real estate   82,642    939    6,479    123    89,121    1,062 
Farm land   3,040    25    820    150    3,860    175 
Vacant land   8,977    104    3,760    60    12,737    164 
Real estate secured   320,428    2,273    16,188    628    336,616    2,901 
Commercial and industrial   29,083    384    1,998    394    31,081    778 
Municipal   2,729    28            2,729    28 
Consumer   4,241    42    210    91    4,451    133 
Unallocated allowance                       326 
Totals  $356,481   $2,727   $18,396   $1,113   $374,877   $4,166 

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   Collectively evaluated   Individually evaluated   Total portfolio 
(in thousands)  Loans   Allowance   Loans   Allowance   Loans   Allowance 
December 31, 2011                              
   Residential 1-4 family  $182,695   $762   $4,981   $297   $187,676   $1,059 
   Residential 5+ multifamily   2,437    17    750    4    3,187    21 
   Construction of residential 1-4 family   4,606    17    699        5,305    17 
   Home equity credit   34,333    382    288        34,621    382 
Residential real estate   224,071    1,178    6,718    301    230,789    1,479 
   Commercial   74,419    840    7,539    202    81,958    1,042 
   Construction of commercial   7,049    77    20    20    7,069    97 
Commercial real estate   81,468    917    7,559    222    89,027    1,139 
Farm land   4,095    35    830    150    4,925    185 
Vacant land   9,021    104    3,807    120    12,828    224 
Real estate secured   318,655    2,234    18,914    793    337,569    3,027 
Commercial and industrial   28,091    368    1,267    336    29,358    704 
Municipal   2,415    24            2,415    24 
Consumer   4,431    44    65    35    4,496    79 
Unallocated allowance                       242 
Totals  $353,592   $2,670   $20,246   $1,164   $373,838   $4,076 

The credit quality segments of loans receivable and the allowance for loan losses are as follows:

   Collectively evaluated   Individually evaluated   Total portfolio 
(in thousands)  Loans   Allowance   Loans   Allowance   Loans   Allowance 
March 31, 2012                              
Performing loans  $346,929   $2,419   $210   $91   $347,139   $2,510 
Potential problem loans   9,552    308    5,284    242    14,836    550 
Impaired loans           12,902    780    12,902    780 
Unallocated allowance                       326 
Totals  $356,481   $2,727   $18,396   $1,113   $374,877   $4,166 
December 31, 2011                              
Performing loans  $346,303   $2,436   $819   $35   $347,122   $2,471 
Potential problem loans   7,289    234    6,750    255    14,039    489 
Impaired loans           12,677    874    12,677    874 
Unallocated allowance                       242 
Totals  $353,592   $2,670   $20,246   $1,164   $373,838   $4,076 

Certain data with respect to impaired loans individually evaluated is as follows:

   Impaired loans with specific allowance   Impaired loans with no specific allowance 
   Loan balance   Specific   Income   Loan balance   Income 
(in thousands)  Book   Note   Average   allowance   recognized   Book   Note   Average   recognized 
March 31, 2012                                             
   Residential 1-4 family  $1,950   $2,086   $2,369   $253   $45   $1,502   $1,524   $1,152   $7 
   Home equity credit                       140    162    164    3 
Residential real estate   1,950    2,086    2,369    253    45    1,642    1,686    1,316    10 
Commercial   1,750    1,891    1,918    123    14    1,979    2,404    2,047    31 
Vacant land   134    154    479    10    2    3,479    4,245    3,167     
Real estate secured   3,834    4,131    4,766    386    61    7,100    8,335    6,530    41 
Commercial and industrial   747    828    724    394        1,222    1,894    687    28 
Consumer                           143         
Totals  $4,581   $4,959   $5,490   $780   $61   $8,322   $10,372   $7,217   $69 

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   Impaired loans with specific allowance   Impaired loans with no specific allowance 
   Loan balance   Specific   Income   Loan balance   Income 
(in thousands)  Book   Note   Average   allowance   recognized   Book   Note   Average   recognized 
December 31, 2011                                             
   Residential 1-4 family  $3,012   $3,160   $1,822   $266   $38   $390   $426   $3,875   $ 
   Home equity credit                       173    177    227     
Residential real estate   3,012    3,160    1,822    266    38    563    603    4,102     
Commercial   2,151    2,405    2,550    203    77    2,157    2,612    2,175    37 
Vacant land   594    774    639    70        3,063    3,627    3,243     
Real estate secured   5,757    6,339    5,011    539    115    5,783    6,842    9,520    37 
Commercial and industrial   560    639    364    335        577    1,221    876    16 
Consumer                           142    14     
Totals  $6,317   $6,978   $5,375   $874   $115   $6,360   $8,205   $10,410   $53 

NOTE 4 - 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:

March 31, (in thousands)  2012   2011 
Residential mortgage loans serviced for others  $125,086   $101,636 
Fair value of mortgage servicing rights   754    948 

Changes in mortgage servicing rights are as follows:

   Three months 
Periods ended March 31, (in thousands)  2012   2011 
Loan Servicing Rights          
Balance, beginning of period  $772   $683 
Originated   177    77 
Amortization (1)   (77)   (59)
Balance, end of period   872    701 
Valuation Allowance          
Balance, beginning of period   (22)   (10)
(Increase) decrease in impairment reserve (1)   (92)   2 
Balance, end of period   (114)   (8)
Loan servicing rights, net  $758   $693 
(1)Amortization expense and changes in the impairment reserve are recorded in loan servicing fee income.

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, 2012   December 31, 2011 
Securities available-for-sale (at fair value)  $66,986   $68,839 
Loans receivable   112,589    132,720 
Total pledged assets  $179,575   $201,559 

At March 31, 2012, securities were pledged as follows: $46.3 million to secure public deposits, $18.3 million to secure repurchase agreements and $2.4 million to secure FHLBB advances. Loans receivable were pledged to secure FHLBB advances and credit facilities.

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NOTE 6 – EARNINGS PER SHARE

The calculation of earnings per share is as follows:

Periods ended March 31, (in thousands, except per share amounts)  2012   2011 
Net income  $1,250   $943 
Preferred stock net accretion      (5)
Preferred stock dividends declared   (83)   (110)
Net income available to common shareholders  $1,167   $828 
Weighted average common stock outstanding - basic   1,689    1,688 
Weighted average common and common equivalent stock outstanding - diluted   1,689    1,688 
Earnings per common and common equivalent share          
   Basic  $0.69   $0.49 
   Diluted   0.69    0.49 

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, 2012, 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, 2012                              
Total Capital (to risk-weighted assets)                              
   Salisbury  $61,730    16.34%  $30,223    8.0%   n/a     
   Bank   51,661    13.49    30,652    8.0   $38,303    10.0%
Tier 1 Capital (to risk-weighted assets)                              
   Salisbury   57,468    15.21    15,111    4.0    n/a     
   Bank   47,420    12.38    15,321    4.0    22,982    6.0 
Tier 1 Capital (to average assets)                              
   Salisbury   57,468    9.72    23,661    4.0    n/a     
   Bank   47,420    8.02    23,636    4.0    29,546    5.0 
December 31, 2011                              
Total Capital (to risk-weighted assets)                              
   Salisbury  $60,869    15.97%  $30,490    8.0%   n/a     
   Bank   50,729    13.16    30,840    8.0   $38,550    10.0%
Tier 1 Capital (to risk-weighted assets)                              
   Salisbury   56,718    14.88    15,245    4.0    n/a     
   Bank   46,578    12.08    15,420    4.0    23,130    6.0 
Tier 1 Capital (to average assets)                              
   Salisbury   56,718    9.45    24,014    4.0    n/a     
   Bank   46,578    7.77    23,969    4.0    29,961    5.0 
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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.

Preferred Stock

In August 2011, Salisbury issued to the U.S. Secretary of the Treasury (the “Treasury”) $16,000,000 of its Series B Preferred Stock under the Small Business Lending Fund (the “SBLF”) program. The SBLF program is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. The Preferred Stock qualifies as Tier 1 capital for regulatory purposes and ranks senior to the Common Stock.

The Series B Preferred Stock pays noncumulative dividends. The dividend rate on the Series B Preferred Stock for the initial quarterly dividend period ending September 30, 2011 and each of the next nine quarterly dividend periods the Series B Preferred Stock is outstanding is determined each quarter based on the increase in the Bank’s Qualified Small Business Lending. The dividend rate for the quarterly dividend period ended March 31, 2012 and December 31, 2011, were 2.10375% and 1.55925%, respectively. For the tenth quarterly dividend period through four and one-half years after its issuance, the dividend rate on the Series B Preferred Stock will be fixed at the rate in effect at the end of the ninth quarterly dividend period and after four and one-half years from its issuance the dividend rate will be fixed at 9 percent per annum. March 30, 2012, Salisbury declared a Series B Preferred Stock dividend of $83,000, payable on April 2, 2012. The Series B Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Series B Preferred Stock. The Series B Preferred Stock is redeemable at any time at one hundred percent of the issue price plus any accrued and unpaid dividends.

Simultaneously with the receipt of the SBLF capital, Salisbury repurchased for $8,816,000 all of its Series A Preferred Stock sold to the Treasury in 2009 under the Capital Purchase Program (“CPP”), a part of the Troubled Asset Relief Program of the Emergency Economic Stabilization Act of 2008, and made a payment for accrued dividends. The transaction resulted in net capital proceeds to Salisbury of $7,184,000, of which Salisbury invested $6,465,600, or 90%, in the Bank as Tier 1 Capital.

As part of the CPP, Salisbury had 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. The Warrant was repurchased for $205,000 on November 2, 2011 and simultaneously cancelled.

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 
Periods ended March 31, (in thousands)  2012   2011 
Service cost  $115   $95 
Interest cost on benefit obligation   93    93 
Expected return on plan assets   (115)   (106)
Amortization of prior service cost        
Amortization of net loss   36    17 
Net periodic benefit cost  $129   $99 

Salisbury’s 401(k) Plan contribution expense was $70,000 and $43,000, respectively, for the three month periods ended March 31, 2012 and 2011. Other post-retirement benefit obligation expense for endorsement split-dollar life insurance arrangements was $11,000 and $12,000, respectively, for the three month periods ended March 31, 2012 and 2011.

NOTE 9 –COMPREHENSIVE INCOME

The components of accumulated other comprehensive losses are as follows:

March 31, (in thousands)  2012   2011 
Unrealized losses on securities available-for-sale, net of tax  $1,839   $(2,022)
Unrecognized pension plan expense, net of tax   (2,033)   (1,176)
Accumulated other comprehensive loss, net  $(194)  $(3,198)

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, other assets are recorded at fair value 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.

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Salisbury adopted ASC 820-10, “Fair Value Measurements and Disclosures,” which provides a framework for measuring fair value under generally accepted accounting principles, in 2008. This guidance permitted Salisbury the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. Salisbury did not elect fair value treatment for any financial assets or liabilities upon adoption.

In accordance with ASC 820-10, 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.

GAAP specifies a hierarchy of valuation techniques based on whether the types of valuation information (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Salisbury’s market assumptions. These two types of inputs have created the following fair value hierarchy

Level 1. Quoted prices in active markets for identical assets. 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. Significant other observable inputs. Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from first party pricing services for identical or comparable assets or liabilities.
Level 3. Significant unobservable inputs. 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.

The following is a description of valuation methodologies for assets recorded at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.

Securities available-for-sale. Securities available-for-sale are recorded at fair value on a recurring basis. Level 1 securities include exchange-traded equity securities. Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes obligations of the U.S. Treasury and U.S. government-sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, municipal bonds, SBA bonds, corporate bonds and certain preferred equities. 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 first-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.
Collateral dependent loans that are deemed to be impaired are valued based upon the fair value of the underlying collateral less costs to sell. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. Management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral dependent impaired loans are categorized as Level 3.
Other real estate owned acquired through foreclosure or repossession is adjusted to fair value less costs to sell upon transfer out of loans. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral. Management adjusts appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property, and such property is categorized as Level 3.
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 Assets measured at fair value are as follows:

   Fair Value Measurements Using   Assets at 
(in thousands)  Level 1   Level 2   Level 3   fair value 
March 31, 2012                    
Assets at fair value on a recurring basis                    
   U.S. Treasury notes  $   $5,450   $   $5,450 
   U.S. Government agency notes       14,830        14,830 
   Municipal bonds       47,698        47,698 
   Mortgage-backed securities:                    
       U.S. Government agencies       54,029        54,029 
   Collateralized mortgage obligations:                    
       U.S. Government agencies       6,640        6,640 
       Non-agency       13,660        13,660 
   SBA bonds       3,494        3,494 
   Corporate bonds                
   Preferred stocks   118            118 
Securities available-for-sale  $118   $145,801   $   $145,919 
Assets at fair value on a non-recurring basis                    
   Collateral dependent impaired loans  $   $   $3,801   $3,801 
December 31, 2011                    
Assets at fair value on a recurring basis                    
   U.S. Treasury notes  $   $5,528   $   $5,528 
   U.S. Government agency notes       14,924        14,924 
   Municipal bonds       50,796        50,796 
   Mortgage-backed securities:                    
       U.S. Government agencies       58,300        58,300 
   Collateralized mortgage obligations:                    
       U.S. Government agencies       7,153        7,153 
       Non-agency       14,167        14,167 
   SBA bonds       3,706        3,706 
   Corporate bonds       1,104        1,104 
   Preferred stocks   116            116 
Securities available-for-sale  $116   $155,678   $   $155,794 
Assets at fair value on a non-recurring basis                    
   Collateral dependent impaired loans  $   $   $5,443   $5,443 
   Other real estate owned           2,744    2,744 

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 Carrying values and estimated fair values of financial instruments are as follows:

   Carrying   Estimated   Fair value measurements using 
(in thousands)  value   fair value   Level 1   Level 2   Level 3 
March 31, 2012                         
Financial Assets                         
Cash and due from banks  $38,323   $38,323   $38,323   $   $ 
Securities available-for-sale   145,919    145,919    118    145,801     
Federal Home Loan Bank stock   5,747    5,747        5,747     
Loans held-for-sale   1,308    1,308            1,308 
Loans receivable net   371,709    376,975            376,975 
Accrued interest receivable   2,789    2,789            2,789 
Financial Liabilities                         
   Demand (non-interest-bearing)  $88,588   $88,588   $   $   $88,588 
   Demand (interest-bearing)   64,563    64,563            64,563 
   Money market   119,944    119,944            119,944 
   Savings and other   98,232    98,232            98,232 
   Certificates of deposit   101,359    102,758            102,758 
Deposits   472,686    474,085            474,085 
FHLBB advances   43,208    46,980            46,980 
Repurchase agreements   10,359    10,359            10,359 
Accrued interest payable   284    284            284 
December 31, 2011                         
Financial Assets                         
Cash and due from banks  $36,886   $36,886   $36,886   $   $ 
Securities available-for-sale   155,794    155,794    116    155,678     
Security held-to-maturity   50    52        52     
Federal Home Loan Bank stock   6,032    6,032            6,032 
Loans held-for-sale   948    955            955 
Loans receivable net   370,766    373,071            373,071 
Accrued interest receivable   2,126    2,126            2,126 
Financial Liabilities                         
   Demand (non-interest-bearing)  $82,202   $82,202   $   $   $82,202 
   Demand (interest-bearing)   66,332    66,332            66,332 
   Money market   124,566    124,566            124,566 
   Savings and other   94,503    94,503            94,503 
   Certificates of deposit   103,703    104,466            104,466 
Deposits   471,306    472,069            472,069 
FHLBB advances   54,615    58,808            58,808 
Repurchase agreements   12,148    12,148            12,148 
Accrued interest payable   271    271            271 

 

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

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Item 2. 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, 2011.

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 operates its trust and wealth advisory services from offices in Lakeville, Connecticut.

Critical Accounting Policies and Estimates

Salisbury’s consolidated financial statements follow GAAP as applied to 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 in Salisbury's 2011 Annual Report on Form 10-K for the year ended December 31, 2011 and, along with this Management’s Discussion and Analysis, provide information on how significant assets are valued in the financial statements and how those values are determined. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating Salisbury’s reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.

The allowance for loan losses represents management’s estimate of credit losses inherent 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. Note 1 of Notes to Consolidated Financial Statements in Salisbury's 2011 Annual Report on Form 10-K for the period ended December 31, 2011 describes the methodology used to determine the allowance for loan losses. In addition, a discussion of the factors driving changes in the amount of the allowance for loan losses are included in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis of this Quarterly Report.

Management evaluates goodwill and identifiable intangible assets for impairment annually using valuation techniques that involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates, which are used to determine the carrying value of goodwill and identifiable intangible assets or which otherwise adversely affects their value or estimated lives, could have a material adverse impact on the results of operations.

Management evaluates securities for other-than-temporary impairment giving consideration to the extent to which the fair value has been less than cost, estimates of future cash flows, delinquencies and default severity, and the intent and ability of Salisbury to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The consideration of the above factors is subjective and involves estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.

The determination of the obligation and expense for pension and other postretirement benefits is dependent on certain assumptions used in calculating such amounts. Key assumptions used in the actuarial valuations include the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs.

Actual results could differ from the assumptions and market driven rates may fluctuate. Significant differences in actual experience or significant changes in the assumptions may materially affect the future pension and other postretirement obligations and expense.

 

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RESULTS OF OPERATIONS

For the three month periods ended March 31, 2012 and 2011

Overview

Net income available to common shareholders was $1,167,000, or $0.69 per common share, for the first quarter ended March 31, 2012 (first quarter 2012), compared with $1,184,000, or $0.70 per common share, for the fourth quarter ended December 31, 2011 (fourth quarter 2011), and $828,000, or $0.49 per common share, for the first quarter ended March 31, 2011 (first quarter 2011).

Net income available to common shareholders for the first quarters of 2012 and 2011 and the fourth quarter of 2011 is net of preferred stock dividends. First quarter 2011 is also net of preferred stock accretion of $5,000.

·Earnings per common share decreased $0.01, or 1.5%, to $0.69 versus fourth quarter 2011, increased $0.20, or 40.6%, versus first quarter 2011.
·Tax equivalent net interest income decreased $59,000, or 1.2%, versus fourth quarter 2011, and increased $169,000, or 3.6%, versus first quarter 2011.
·Provision for loan losses was $180,000, versus $580,000 for fourth quarter 2011 and $330,000 for first quarter 2011. Net loan charge-offs were $90,000, versus $531,000 for fourth quarter 2011 and $272,000 for first quarter 2011.
·Non-interest income decreased $32,000, or 1.9%, versus fourth quarter 2011 and increased $258,000, or 18.4%, versus first quarter 2011.
·Non-interest expense increased $251,000, or 5.9%, versus fourth quarter 2011 and $76,000, or 1.7%, versus first quarter 2011.
·Non-performing assets decreased $3.2 million, or 29.7%, to $7.6 million, or 1.3% of total assets, versus fourth quarter 2011 and decreased $4.1 million versus first quarter 2011. Accruing loans receivable 30-to-89 days past due increased $1.7 million to $4.2 million, or 1.12% of gross loans receivable, versus fourth quarter 2011 and remained substantially unchanged versus first quarter 2011.

Net Interest Income

Tax equivalent net interest income for first quarter 2012 decreased $59,000, or 1.2%, versus fourth quarter 2011, and increased $169,000, or 3.6%, versus first quarter 2011. The net interest margin decreased 4 basis points to 3.52% from 3.56%, for the year-over-year period.

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The following table sets forth the components of Salisbury's fully tax-equivalent (“FTE”) 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)  2012   2011   2012   2011   2012   2011 
Loans (a)  $377,704   $362,436   $4,595   $4,664    4.87%   5.15%
Securities (c)(d)   149,699    145,216    1,490    1,594    3.98    4.39 
FHLBB stock   5,962    6,032    10    6    0.68    0.42 
Short term funds (b)   27,113    23,753    13    33    0.19    0.56 
Total earning assets   560,478    537,437    6,108    6,297    4.36    4.69 
Other assets   41,829    33,436                     
Total assets  $602,307   $570,873                     
Interest-bearing demand deposits  $68,510   $63,094    109    116    0.64    0.74 
Money market accounts   121,869    84,306    114    110    0.37    0.52 
Savings and other   95,919    95,454    77    97    0.32    0.41 
Certificates of deposit   102,418    120,688    367    548    1.43    1.82 
Total interest-bearing deposits   388,716    363,542    667    871    0.69    0.96 
Repurchase agreements   11,119    12,077    13    15    0.47    0.50 
FHLBB advances   46,963    63,080    495    646    4.22    4.10 
Total interest-bearing liabilities   446,798    438,699    1,175    1,532    1.05    1.40 
Demand deposits   83,354    72,989                     
Other liabilities   4,387    3,995                     
Shareholders’ equity   67,768    55,190                     
Total liabilities & shareholders’ equity  $602,307   $570,873                     
Net interest income            $4,933   $4,765           
Spread on interest-bearing funds                       3.31    3.29 
Net interest margin (e)                       3.52    3.56 
(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 benefit of $250,000 and $258,000, respectively for 2012 and 2011 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)  2012 versus 2011 
Change in interest due to  Volume   Rate   Net 
Interest-earning assets               
Loans  $191   $(260)  $(69)
Securities   47    (151)   (104)
FHLBB stock       4    4 
Short term funds   3    (23)   (20)
Total   241    (430)   (189)
Interest-bearing liabilities               
Deposits   (23)   (181)   (204)
Repurchase agreements   (1)   (1)   (2)
FHLBB advances   (167)   16    (151)
Total   (191)   (166)   (357)
Net change in net interest income  $432   $(264)  $168 

Interest Income

Tax equivalent interest income decreased $189,000, or 3.0%, to $6.1 million for first quarter 2012 as compared with first quarter 2011.

Loan income decreased $69,000, or 1.5%, primarily due to a 28 basis points decline in the average loan yield offset in part by a $15.3 million, or 4.2%, increase in average loans.

Tax equivalent securities income decreased $100,000, or 6.2%, for first quarter 2012 as compared with first quarter 2011, primarily due to a 41 basis points decline in the average yield offset in part by a $4.4 million, or 2.9%, increase in average volume. Changes in securities yields resulted from the effect of changes in market interest rates on securities purchases, calls of agency bonds and prepayments of mortgage backed securities.

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Income from short term funds decreased $20,000 for first quarter 2012 as compared with first quarter 2011 as a result of a 37 basis points decline in the average yield offset in part by a $3.4 million increase in the average balance.

Interest Expense

Interest expense decreased $357,000, or 23.3%, to $1.2 million for first quarter 2012 as compared with first quarter 2011.

Interest on deposit accounts and retail repurchase agreements decreased $206,000, or 23.25%, as a result of lower average rates, down 26 basis points to 0.68%. Decreased rates were offset in part by a $24.2 million, or 6.4%, increase in the average balance of deposits and repurchase agreements. 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 $151,000 as a result of lower average borrowings, down $16.1 million, offset in part by the average borrowing rate increase of 12bp as compared with first quarter 2011. The decline in advances resulted from scheduled maturities that were not replaced with new advances.

Provision and Allowance for Loan Losses

The provision for loan losses was $180,000 for first quarter 2012 and $330,000 for first quarter 2011. Net loan charge-offs were $90,000 and $272,000, for the respective quarters. The following table sets forth changes in the allowance for loan losses and other selected statistics:

   Three months 
Periods ended March 31, (dollars in thousands)  2012   2011 
Balance, beginning of period  $4,076   $3,920 
Provision for loan losses   180    330 
Charge-offs          
   Real estate mortgages   (60)   (259)
   Commercial & industrial   (29)    
   Consumer   (10)   (19)
Total charge-offs   (99)   (278)
Recoveries          
   Real estate mortgages   1     
   Commercial & industrial   3     
   Consumer   5    6 
Total recoveries   9    6 
Net charge-offs   (90)   (272)
Balance, end of period  $4,166   $3,978 
Loans receivable, gross  $374,877   $364,337 
Non-performing loans   7,606    10,875 
Accruing loans past due 30-89 days   4,181    4,191 
Ratio of allowance for loan losses:          
   to loans receivable, gross   1.11%   1.09%
   to non-performing loans   54.77    36.58 
Ratio of non-performing loans to loans receivable, gross   2.03    2.98 
Ratio of accruing loans past due 30-89 days to loans receivable, gross   1.12    1.15 

Reserve coverage at March 31, 2012, as measured by the ratio of allowance for loan losses to gross loans, remained substantially unchanged at 1.11%, as compared with 1.09% at December 31, 2011 and 1.09% a year ago at March 31, 2011. During the first three months of 2012, non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) decreased $0.5 million to $7.6 million, or 2.03% of gross loans receivable, from 2.16% at December 31, 2011 and 2.98% at March 31, 2011 while accruing loans past due 30-89 days increased $1.7 million to $4.2 million, or 1.12% of gross loans receivable from 0.66% at December 31, 2011 and 1.15% at March 31, 2011. See “Financial Condition – Loan Credit Quality” for further discussion and analysis.

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 The credit quality segments of loans receivable and the allowance for loan losses are as follows:

   March 31, 2012   December 31, 2011 
(in thousands)  Loans   Allowance   Loans   Allowance 
Performing loans  $346,929   $2,419   $346,303   $2,436 
Potential problem loans   9,552    308    7,289    234 
Collectively evaluated   356,481    2,727    353,592    2,670 
Performing loans   210    91    819    35 
Potential problem loans   5,284    242    6,750    255 
Impaired loans   12,902    780    12,677    874 
Individually evaluated   18,396    1,113    20,246    1,164 
Unallocated allowance       326        242 
Totals  $374,877   $4,166   $373,838   $4,076 

The allowance for loan losses represents management’s estimate of the probable credit losses inherent in the loan portfolio as of the reporting date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. Loan charge-offs are recognized when management determines a loan or portion of a loan to be uncollectible. The allowance for loan losses is computed by segregating the portfolio into three components: (1) loans collectively evaluated for impairment: general loss allocation factors for non-impaired loans are segmented into pools of loans based on similar risk characteristics such as loan product, collateral type and loan-to-value, loan risk rating, historical loss experience, delinquency factors and other similar economic indicators, (2) loans individually evaluated for impairment: individual loss allocations for loans deemed to be impaired based on discounted cash flows or collateral value, and (3) unallocated: general loss allocations for other environmental factors.

Impaired loans and certain potential problem loans, where warranted, are individually evaluated for impairment. Impairment is measured for each individual loan, or for a borrower’s aggregate loan exposure, using either the fair value of the collateral if the loan is collateral dependent or the present value of expected future cash flows discounted at the loan’s effective interest rate. An allowance is established when the collateral value or discounted cash flows of the loan is lower than the carrying value of that loan.

The component of the allowance for loan losses for loans collectively evaluated for impairment is estimated by stratifying loans into segments and credit risk ratings and applying management’s general loss allocation factors. The general loss allocation factors are based on expected loss experience adjusted for historical loss experience and other qualitative factors, including levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. The qualitative factors are determined based on the various risk characteristics of each loan segment. There were no significant changes in Salisbury’s policies or methodology pertaining to the general component of the allowance for loan losses during the quarter ended March 31, 2012.

The unallocated component of the allowance is maintained to cover uncertainties that could affect management’s estimate of probable losses. It reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.

Determining the adequacy of the allowance at any given period is difficult, particularly during deteriorating or uncertain economic periods, and 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, 2012.

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, the bank is examined annually on a rotational process by one of its two primary regulatory agencies, the FDIC and State of Connecticut Department of Banking (“CTDOB”). As an integral part of their examination process, the FDIC and CTDOB review the Bank's credit risk ratings and allowance for loan losses. The Bank was examined by the CTDOB April 2010 and by the FDIC in May 2011.

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Non-interest income

The following table details the principal categories of non-interest income.

Three months ended March 31, (dollars in thousands)  2012   2011   2012 vs. 2011 
Trust and wealth advisory fees  $755   $667   $88    13.19%
Service charges and fees   521    499    22    4.41 
Gains on sales of mortgage loans, net   372    133    239    179.70 
Mortgage servicing, net   (84)   32    (116)   (362.50)
Gains on securities, net   12    11    1    9.09 
Other   83    59    24    40.68 
Total non-interest income  $1,659   $1,401   $258    18.42%

Non-interest income for first quarter 2012 decreased $32,000 versus fourth quarter 2011 and increased $258,000 versus first quarter 2011. Trust and Wealth Advisory revenues increased $69,000 versus fourth quarter 2011 and increased $88,000 versus first quarter 2011. The year-over-year revenue increase results from growth in managed assets and higher estate fees collected in first quarter 2012. Service charges and fees decreased $13,000 versus fourth quarter 2011 and increased $22,000 versus first quarter 2011. Income from sales and servicing of mortgage loans increased $54,000 versus fourth quarter 2011 and increased $239,000 versus first quarter 2011 due to interest rate driven fluctuations in fixed rate residential mortgage loan sales and mortgage servicing valuations. Mortgage loans sales totaled $16.3 million for first quarter 2012, $14.8 million for fourth quarter 2011 and $6.1 million for first quarter 2011. First quarter 2012, fourth quarter 2011, and first quarter 2011, included mortgage servicing valuation impairment charges (benefits) of $92,000, $(69,000) and $2,000, respectively. Gains on securities represent the accretion of discounts on called securities. Other income consisted of bank owned life insurance income and rental income.

Non-interest expense

The following table details the principal categories of non-interest expense.

Three months ended March 31, (dollars in thousands)  2012   2011   2012 vs. 2011 
Salaries  $1,710   $1,729   $(19)   (1.10)%
Employee benefits   690    634    56    8.83 
Premises and equipment   605    583    22    3.77 
Data processing   402    377    25    6.63 
Professional fees   313    280    33    11.79 
Collections and OREO   111    126    (15)   (11.90)
FDIC insurance   128    223    (95)   (42.60)
Marketing and community contributions   87    68    19    27.94 
Amortization of intangible assets   56    56         
Other   398    348    50    14.37 
Non-interest expense  $4,500   $4,424   $76    1.72%

Non-interest expense for first quarter 2012 increased $251,000 versus fourth quarter 2011 and $76,000 versus first quarter 2011. Salaries decreased $19,000 versus first quarter 2011 due to changes in staffing levels and mix. Employee benefits increased $56,000 versus first quarter 2011 due to higher health benefits expense, caused by year-over-year premium increases, higher staff utilization, and higher 401K Plan expense due to an under accrual in first quarter 2011 following the implementation of a 401K Safe Harbor Plan. Premises and equipment increased $8,000 versus fourth quarter 2011 and increased $22,000 versus first quarter 2011. The year-over-year increase was due primarily to higher depreciation and increased machine and software maintenance due to replaced and upgraded equipment and software. The increase was offset slightly by lower building maintenance and repairs, snow removal and utilities due to the mild winter experienced in the Northeast.

Data processing increased $20,000 versus fourth quarter 2011 and $25,000 versus first quarter 2011. Professional fees increased $101,000 versus fourth quarter 2011, and $33,000 versus first quarter 2011. The increase over fourth quarter 2011 was due to accrual reversals in fourth quarter 2011. Collections and OREO increased $42,000 versus fourth quarter 2011 and decreased $15,000 versus first quarter 2011. The increase versus fourth quarter was due to real estate taxes, radon mediation and utilities associated with the sale of an OREO property in first quarter 2012. FDIC insurance increased $73,000 versus fourth quarter 2011 and decreased $95,000 versus first quarter 2011. The year-over-year decrease was due to a favorable change in the assessment method effective June 30, 2011. Other operating expenses increased $68,000 versus fourth quarter 2011 and decreased $50,000 versus first quarter 2011. Year-over-year decreases were due to reductions in other administrative and operational expenses.

Income taxes

The effective income tax rates for first quarter 2012, fourth quarter 2011 and first quarter 2011 were 24.82%, 21.99% and 18.27%, respectively. Fluctuations in the effective tax rate result from changes in the mix of taxable and tax exempt income. Salisbury’s effective tax rate is generally less than the 34% federal statutory rate due to holdings of tax-exempt municipal bonds, some tax-exempt loans and bank owned life insurance.

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Salisbury did not incur Connecticut income tax in 2012 or 2011, 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 the Bank 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 $599 million at March 31, 2012, down $10 million from December 31, 2011. Loans receivable, net, were $372 million at March 31, 2012, up $1 million, or 0.3%, from December 31, 2011. Non-performing assets were $7.6 million at March 31, 2012, down $3.2 million from $10.8 million at December 31, 2011. Reserve coverage, as measured by the ratio of the allowance for loan losses to gross loans, was 1.11%, 1.09% and 1.09%, at March 31, 2012, December 31, 2011 and March 31, 2011, respectively. Deposits were $472 million, up $1 million from $471 million at December 31, 2011.

At March 31, 2012, book value and tangible book value per common share were $30.83 and $24.44, respectively. Salisbury’s Tier 1 leverage and total risk-based capital ratios were 9.72% and 16.34%, respectively, and above the “well capitalized” limits as defined by the FRB.

Securities and Short Term Funds

During first quarter 2012, securities decreased $10.2 million to $152 million, and FHLBB advances decreased $11.0 million, while cash and cash-equivalents (interest-bearing deposits with other banks, money market funds and federal funds sold) increased $1 million to $38 million as Salisbury slightly increased its liquidity position in light of historically low interest rates and growth in volatile deposits.

Salisbury evaluates securities for OTTI where the fair value of a security is less than its amortized cost basis at the balance sheet date. 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 does not intend to sell any of its securities and it is not more likely than not that Salisbury will be required to sell any of its securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider any of its securities, other than four non-agency CMO securities reflecting OTTI, to be OTTI at March 31, 2012.

In 2009 Salisbury determined that five non-agency CMO securities reflected OTTI and recognized losses for deterioration in credit quality of $1.1 million. Salisbury judged the four remaining securities not to have additional OTTI and all other CMO securities not to be OTTI as of March 31, 2012. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis.

Accumulated other comprehensive loss at March 31, 2012 included net unrealized holding gains, net of tax, of $1.8 million, and gain of $1.4 million over December 2011, more than offset by unrecognized pension plan expense, net of tax, of $2.0 million and $2.1 million respectively.

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Loans

Net loans receivable increased $1.0 million during first quarter 2012 to $371.7 million at March 31, 2012, compared with $370.8 million at December 31, 2011.

The composition of loans receivable and loans held-for-sale is as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Residential 1-4 family  $187,985   $187,676 
   Residential 5+ multifamily   3,155    3,187 
   Construction of residential 1-4 family   5,235    5,305 
   Home equity credit   34,523    34,621 
Residential real estate   230,898    230,789 
   Commercial   81,604    81,958 
   Construction of commercial   7,517    7,069 
Commercial real estate   89,121    89,027 
Farm land   3,860    4,925 
Vacant land   12,737    12,828 
Real estate secured   336,616    337,569 
Commercial and industrial   31,081    29,358 
Municipal   2,729    2,415 
Consumer   4,451    4,496 
Loans receivable, gross   374,877    373,838 
Deferred loan origination fees and costs, net   998    1,004 
Allowance for loan losses   (4,166)   (4,076)
Loans receivable, net  $371,709   $370,766 
Loans held-for-sale          
   Residential 1-4 family  $1,308   $948 

Loan Credit Quality

The persistent weakness in the local and regional economies continues to impact the credit quality of Salisbury’s loans receivable. During first quarter 2012 total impaired and potential problem loans increased $1.0 million to $27.7 million, or 7.40% of gross loans receivable at March 31, 2012, from $26.7 million, or 7.15% of gross loans receivable at December 31, 2011.

The credit quality segments of loans receivable and their credit risk ratings are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Pass  $316,514   $314,551 
   Special mention   30,624    32,570 
Performing loans   347,138    347,121 
   Substandard   14,836    14,039 
Potential problem loans   14,836    14,039 
   Pass          
       Troubled debt restructured loans, accruing   1,006    1,379 
   Special mention          
Troubled debt restructured loans, accruing   1,766    1,413 
   Substandard          
       Troubled debt restructured loans, accruing   2,524    1,810 
       Troubled debt restructured loans, non-accrual   1,680    1,753 
       All other non-accrual loans   5,927    6,323 
Impaired loans   12,903    12,678 
Loans receivable, gross  $374,877   $373,838 
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Changes in impaired and potential problem loans are as follows:

   March 31, 2012   March 31, 2011 
   Impaired loans   Potential       Impaired loans   Potential     
Three months ended (in thousands)  Non-
accrual
   Accruing   problem
loans
   Total   Non-
accrual
   Accruing   Problem
 loans
   Total 
Loans placed on non-accrual status  $117   $   $   $117   $1,354   $   $(1,233)  $121 
Loans restored to accrual status   (301)           (301)                
Loan risk rating downgrades to substandard           1,386    1,386            7,131    7,131 
Loan risk rating upgrades from substandard           (320)   (320)           (85)   (85)
Loan repayments   (237)   (37)   (133)   (407)   (101)   (7)   (126)   (234)
Loan charge-offs   (84)           (84)   (259)           (259)
Increase (decrease) in TDR loans   36    731    (136)   631                 
Real estate acquired in settlement of loans                   (314)           (314)
Increase (decrease) in loans  $(469)  $694   $797   $1,022   $680   $(7)  $5,687   $6,360 

For year-to-date 2012 Salisbury has downgraded risk ratings on $1.4 million of loans, placed $0.1 million of loans on non-accrual status as a result of deteriorated payment and financial performance and charged-off $84,000 of losses primarily as a result of collateral deficiencies. Offsetting these deteriorations were loan risk rating upgrades resulting from improved performance and loan repayments.

Salisbury has cooperative relationships with the vast majority of its non-performing loan customers. Substantially all non-performing loans are collateralized with real estate and the repayment of such loans is largely dependent on the return of such loans to performing status or the liquidation of the underlying real estate collateral. Salisbury pursues the resolution of all non-performing loans through collections, restructures, voluntary liquidation of collateral by the borrower and, where necessary, legal action. When all attempts to work with a customer to return a loan to performing status, including restructuring the loan, are unsuccessful, Salisbury will initiate appropriate legal action seeking to acquire property by deed in lieu of foreclosure or through foreclosure, or to liquidate business assets.

Credit Quality Segments

Salisbury categorizes loans receivable into the following credit quality segments.

·Impaired loans consist of all non-accrual loans and troubled debt restructured loans, and represent loans for which it is probable that Salisbury will not be able to collect all principal and interest amounts due according to the contractual terms of the loan agreements.
·Non-accrual loans, a sub-set of impaired loans, are loans for which the accrual of interest has been discontinued because, in the opinion of management, full collection of principal or interest is unlikely.
·Non-performing loans consist of non-accrual loans, and accruing loans past due 90 days and over that are well collateralized, in the process of collection and where full collection of principal and interest is assured. Non-performing assets consist of non-performing loans plus real estate acquired in settlement of loans.
·Troubled debt restructured loans are loans for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower’s financial condition. Loan restructuring is employed when management believes the granting of a concession will increase the probability of the full or partial collection of principal and interest.
·Potential problem loans consist of performing loans that have been assigned a substandard credit risk rating and that are not classified as impaired.

Credit Risk Ratings

Salisbury assigns credit risk ratings to loans receivable in order to manage credit risk and to determine the allowance for loan losses. Credit risk ratings categorize loans by common financial and structural characteristics that measure the credit strength of a borrower. Salisbury’s rating model has eight risk rating grades, with each grade corresponding to a progressively greater risk of default. Grades 1 through 4 are pass ratings and 5 through 8 are ratings (special mention, substandard, doubtful and loss) defined by the bank’s regulatory agencies, the FDIC and CTDOB. Risk ratings are assigned to differentiate risk within the portfolio and are reviewed on an ongoing basis and revised, if needed, to reflect changes in the borrowers' current financial position and outlook, risk profiles and the related collateral and structural positions.

·Loans risk rated as "special mention" possesses credit deficiencies or potential weaknesses deserving management’s close attention that if left uncorrected may result in deterioration of the repayment prospects for the loans at some future date.
·Loans risk rated as "substandard" are loans where the Bank’s position is clearly not protected adequately by borrower current net worth or payment capacity. These loans have well defined weaknesses based on objective evidence and include loans where future losses to the Bank may result if deficiencies are not corrected, and loans where the primary source of repayment such as income is diminished and the Bank must rely on sale of collateral or other secondary sources of collection.
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·Loans risk rated as "doubtful" have the same weaknesses as substandard loans with the added characteristic that the weakness makes collection or liquidation in full, given current facts, conditions, and values, to be highly improbable. The possibility of loss is high, but due to certain important and reasonably specific pending factors, which may work to strengthen the loan, its reclassification as an estimated loss is deferred until its exact status can be determined.
·Loans risk rated as "loss" are considered uncollectible and of such little value, that continuance as Bank assets is unwarranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather, it is not practical or desirable to defer writing off this basically worthless loan even though partial recovery may be made in the future.

Management actively reviews and tests its credit risk ratings against actual experience and engages an independent third-party to annually validate its assignment of credit risk ratings. In addition, the Bank’s loan portfolio and risk ratings are examined annually on a rotating basis by its two primary regulatory agencies, the FDIC and CTDOB.

Impaired Loans

Impaired loans increased $0.2 million during first quarter 2012 to $12.9 million, or 3.44% of gross loans receivable at March 31, 2012, from $12.7 million, or 3.39% of gross loans receivable at December 31, 2011. The components of impaired loans are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
Troubled debt restructurings, accruing  $5,296   $4,602 
Troubled debt restructuring, non-accrual   1,680    1,753 
All other non-accrual loans   5,927    6,323 
Impaired loans  $12,903   $12,678 

Non-Performing Assets

Non-performing assets decreased $3.2 million during first quarter 2012 to $7.6 million, or 1.27% of assets at March 31, 2012, from $10.8 million, or 1.78% of assets at December 31, 2011. The components of non-performing assets are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Residential 1-4 family  $1,300   $1,240 
   Home equity credit   140    173 
   Commercial   1,775    2,337 
   Vacant land   3,613    3,658 
Real estate secured   6,828    7,408 
Commercial and industrial   778    668 
Consumer        
Non-accruing loans   7,606    8,076 
Accruing loans past due 90 days and over        
Non-performing loans   7,606    8,076 
Real estate acquired in settlement of loans       2,744 
Non-performing assets  $7,606   $10,820 

The past due status of non-performing loans is as follows:

(in thousands)  March 31, 2012   December 31, 2011 
Current  $700   $734 
Past due 001-029 days       138 
Past due 030-059 days   279    134 
Past due 060-089 days        
Past due 090-179 days   174    1,095 
Past due 180 days and over   6,453    5,975 
Total non-performing loans  $7,606   $8,076 

At March 31, 2012, 9.20% of non-accrual loans were current with respect to loan payments, compared with 9.09% at December 31, 2011. Loans past due 180 days include a $3.0 million loan secured by vacant land (residential building lots) where Salisbury has initiated a foreclosure action that is referred to in Item 1 of Part II, Legal Proceedings.

Troubled Debt Restructured Loans

Troubled debt restructured loans increased $0.6 million during first quarter 2012 to $7.0 million, or 1.86% of gross loans receivable at March 31, 2012, from $6.4 million, or 1.70% of gross loans receivable at December 31, 2011.

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 The components of troubled debt restructured loans are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Residential 1-4 family  $2,151   $2,163 
   Commercial   1,954    1,970 
Real estate secured   4,105    4,133 
Commercial and industrial   1,191    469 
Accruing troubled debt restructured loans   5,296    4,602 
   Residential 1-4 family   373    52 
   Commercial   572    1,132 
   Vacant land   419    461 
Real estate secured   1,364    1,645 
Commercial and industrial   316    108 
Non-accrual troubled debt restructured loans   1,680    1,753 
Troubled debt restructured loans  $6,976   $6,355 

The past due status of troubled debt restructured loans is as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Current  $4,078   $3,375 
   Past due 001-029 days   764    1,072 
   Past due 030-059 days   454    155 
Accruing troubled debt restructured loans   5,296    4,602 
   Current   668    251 
   Past due 001-029 days        
   Past due 030-059 days       98 
   Past due 060-089 days        
   Past due 090-179 days   22    493 
   Past due 180 days and over   990    911 
Non-accrual troubled debt restructured loans   1,680    1,753 
Total troubled debt restructured loans  $6,976   $6,355 

At March 31, 2012, 68.03% of troubled debt restructured loans were current with respect to loan payments, as compared with 57.06% at December 31, 2011.

Past Due Loans

Loans past due 30 days or more increased $1.4 million during first quarter 2012 to $11.1 million, or 2.96% of gross loans receivable at March 31, 2012, compared with $9.7 million, or 2.59% of gross loans receivable at December 31, 2011.

The components of loans past due 30 days or greater are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Past due 030-059 days  $3,239   $1,999 
   Past due 060-089 days   941    461 
   Past due 090-179 days        
Accruing loans   4,180    2,460 
   Past due 030-059 days   280    134 
   Past due 060-089 days        
   Past due 090-179 days   174    1,095 
   Past due 180 days and over   6,453    5,975 
Non-accrual loans   6,907    7,204 
Total loans past due 30 days or greater  $11,087   $9,664 

Potential Problem Loans

Potential problem loans increased $0.8 million during first quarter 2012 to $14.8 million, or 3.96% of gross loans receivable at March 31, 2012, compared with $14.0 million, or 3.76% of gross loans receivable at December 31, 2011.

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The components of potential problem loans are as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Residential 1-4 family  $3,363   $3,367 
   Home equity credit   1,527    1,154 
Residential real estate   4,890    4,521 
   Commercial   7,480    7,391 
   Construction of commercial   450    450 
Commercial real estate   7,930    7,841 
   Farm land   1,213    830 
   Vacant land   245    249 
Real estate secured   14,278    13,441 
Commercial and Industrial   503    534 
Consumer   55    64 
Potential problem loans  $14,836   $14,039 

The past due status of potential problem loans is as follows:

(in thousands)  March 31, 2012   December 31, 2011 
   Current  $8,881   $10,771 
   Past due 001-029 days   4,169    2,837 
   Past due 030-059 days   1,520    385 
   Past due 060-089 days   266    46 
   Past due 090-179 days        
Total potential problem loans  $14,836   $14,039 

At March 31, 2012, 59.86% of potential problem loans were current with respect to loan payments, as compared with 76.72% at December 31, 2011.

Management cannot predict the extent to which economic or other factors may impact such borrowers’ future payment capacity, and there can be no assurance that such loans will not be placed on nonaccrual status, restructured, or require increased provision for loan losses.

Deposits and Borrowings

Deposits increased $1.4 million during first quarter 2012 to $472.7 million at March 31, 2012, from $471.3 million at December 31, 2011, and increased $20.3 million for year-over-year from $452.4 million at March 31, 2011. Retail repurchase agreements decreased $1.7 million during first quarter 2012 to $10.4 million at March 31, 2012, compared with $12.1 million at December 31, 2011, and increased $2.2 million for year-over-year compared with $8.2 million at March 31, 2011.

Federal Home Loan Bank of Boston (“FHLBB”) advances decreased $11.4 million during first quarter 2012 to $43.2 million at March 31, 2012, from $54.6 million at December 31, 2011, and decreased $12.7 million for year-over-year from $55.9 million at March 31, 2011. The decreases were due to amortizing payments of advances and maturities of advances that were not renewed.

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 FHLBB advances, net deposit growth and funds provided by operations. Liquidity can also be provided through sales of loans and available-for-sale securities.

Salisbury manages its liquidity in accordance with a liquidity funding policy, and also maintains a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. At March 31, 2012, 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 33.2%, down from 33.7% at December 31, 2011. Management believes Salisbury’s funding sources will meet anticipated funding needs.

Operating activities for the three-month period ended March 31, 2012 provided net cash of $1.4 million. Investing activities provided net cash of $12.3 million, principally from $10.4 million of proceeds from securities available-for-sale and $1.7 million proceeds from sales of other real estate owned. Financing activities utilized net cash of $12.4 million, principally for $11.4 million of scheduled FHLBB advance repayments, and a net decrease of $4.1 million in time deposits and repurchase agreements, offset in part by a $3.7 million increase in deposit transaction accounts.

At March 31, 2012, Salisbury had outstanding commitments to fund new loan originations of $13.7 million and unused lines of credit of $50.4 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.

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CAPITAL RESOURCES

Shareholders’ equity was $68.1 million at March 31, 2012, up $1.2 million from December 31, 2011. Book value and tangible book value per common share were $30.83 and $24.44, respectively, compared with $30.12 and $23.69, respectively, at December 31, 2011. Contributing to the increase in shareholders’ equity for year-to-date 2012 was net income of $1.3 million, other comprehensive gain of $511,000, less common and preferred stock dividends of $473,000 and $83,000, respectively. Other comprehensive income included unrealized gains on securities available-for-sale, net of tax, of $2,033 and unrealized loss on the pension plan income, net of tax, of $1,839.

In August 2011, Salisbury issued to the U.S. Secretary of the Treasury (the “Treasury”) $16.0 million of its Series B Preferred Stock under the Small Business Lending Fund (the “SBLF”) program. The SBLF program is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. The Preferred Stock qualifies as Tier 1 capital for regulatory purposes and ranks senior to the Common Stock.

The Series B Preferred Stock pays noncumulative dividends. The dividend rate on the Series B Preferred Stock for the initial quarterly dividend period ending March 31, 2012 and each of the next nine quarterly dividend periods the Series B Preferred Stock is outstanding is determined each quarter based on the increase in the Bank’s Qualified Small Business Lending. The dividend rates for the quarters ended March 31, 2012 and December 31, 2011 were 2.10375% and 1.55925%, respectively. For the tenth quarterly dividend period through four and one-half years after its issuance, the dividend rate on the Series B Preferred Stock will be fixed at the rate in effect at the end of the ninth quarterly dividend period and after four and one-half years from its issuance the dividend rate will be fixed at nine percent per annum. On March 30, 2012, Salisbury declared a Series B Preferred Stock dividend of $83,000, payable on April 2, 2012. The Series B Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Series B Preferred Stock. The Series B Preferred Stock is redeemable at any time at one hundred percent of the issue price plus any accrued and unpaid dividends.

Simultaneously with the receipt of the SBLF capital, Salisbury repurchased for $8,816,000 all of its Series A Preferred Stock sold to the Treasury in 2009 under the Capital Purchase Program (“CPP”), a part of the Troubled Asset Relief Program of the Emergency Economic Stabilization Act of 2008, and made a payment for accrued dividends. The transaction resulted in net capital proceeds to Salisbury of $7,184,000, of which Salisbury invested $6,465,600, or 90%, in the Bank as Tier 1 Capital.

As part of the CPP, Salisbury had 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. The Warrant was repurchased for $205,000 on November 2, 2011.

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, 2012  December 31, 2011
   capitalized  Salisbury  Bank  Salisbury  Bank
Total Capital (to risk-weighted assets)   10.00%   16.34%   13.49%   15.97%   13.16%
Tier 1 Capital (to risk-weighted assets)   6.00    15.21    12.38    14.88    12.08 
Tier 1 Capital (to average assets)   5.00    9.72    8.02    9.45    7.77 

A well-capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective Action 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’s 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, 2012 Salisbury paid $63,000 in Series B preferred stock dividends to the U.S. Treasury’s SBLF program, and $473,000 in common stock dividends.

The Board of Directors of Salisbury declared a common stock dividend of $0.28 per common share payable on May 25, 2012 to shareholders of record on May 10, 2012. Common stock dividends, when declared, will generally be paid the last Friday 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.

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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.

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 and the Bank’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 the 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 Reform 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 affect the operation, performance, development and results of Salisbury’s and the 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.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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. In management’s March 31, 2012 analysis, all of the simulations incorporate a static growth assumption over the simulation horizons. 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.

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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, 2012 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 250 basis points for the 10-year Treasury; (3) immediately falling interest rates – immediate non-parallel downward shift in market interest rates ranging from 25 basis points for short term rates to 75 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 310 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. Income simulations do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.

As of March 31, 2012 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, 2012:

As of March 31, 2012  Months 1-12  Months 13-24
Immediately rising interest rates (management’s growth assumptions)   (11.66)%   (8.02)%
Immediately falling interest rates (management’s growth assumptions)   (0.35)   (1.92)
Gradually rising interest rates (management’s growth assumptions)   (6.88)   (11.40)

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 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:

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As of March 31, 2012 (in thousands)  Rates up 100bp   Rates up 200bp 
U.S. Treasury notes  $(228)  $(445)
U.S. Government agency notes   (236)   (522)
Municipal bonds   (2,320)   (5,479)
Mortgage backed securities   (1,774)   (3,937)
Collateralized mortgage obligations   (662)   (1,297)
SBA pools   (11)   (21)
Total available-for-sale debt securities  $(5,231)  $(11,701)
Item 4. 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 Salisbury’s disclosure controls and procedures as of March 31, 2012. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective as of March 31, 2012.

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, as amended (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. 

Changes in Internal Controls

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, 2012 that has materially affected, or is reasonably likely to materially affect, Salisbury’s internal control over financial reporting.

PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS

The Bank is involved in various claims and legal proceedings arising out of the ordinary course of business.

The Bank, individually and in its capacity as a former Co-Trustee of the Erling C. Christophersen Revocable Trust (the “Trust”), has been named as a defendant in litigation currently pending in the Connecticut Complex Litigation Docket in Stamford, captioned John Christophersen v. Erling Christophersen, et al., X08-CV-08-5009597S (the “First Action”).  The Bank also is a counterclaim-defendant in a related mortgage foreclosure litigation also pending in the Connecticut Complex Litigation Docket in Stamford, captioned Salisbury Bank and Trust Company v. Erling C. Christophersen, et al., X08-CV-10-6005847-S (the “Foreclosure Action,” together with the First Action, the “Actions”).  The other parties to the Actions are John R. Christophersen; Erling C. Christophersen, individually and as Co-Trustee of the Trust; Bonnie Christophersen and Elena Dreiske, individually and as Co-Trustees of the Mildred B. Blount Testamentary Trust; People’s United Bank; Law Offices of Gary Oberst, P.C.; Rhoda Rudnick; and Hinckley Allen & Snyder LLP.

The Actions involve a dispute over title to certain real property located in Westport, Connecticut that was conveyed by Erling Christophersen, as grantor, to the Trust on or about August 8, 2007.  Subsequent to this conveyance, the Bank loaned $3,386,609 to the Trust, which was secured by an open-end commercial mortgage in favor of the Bank on the Westport property.  This mortgage is the subject of the Foreclosure Action brought by the Bank.

The gravamen of the plaintiff/counterclaim-plaintiff John Christophersen’s claims in the Actions is that he has an interest in the Westport real property transferred to the Trust of which he was allegedly wrongfully divested on account of the actions of the defendants.  In the Actions plaintiff seeks to quiet title to the property and to recover money damages from the defendants for the alleged wrongful divestiture of his claimed interest in the property.

In addition to the mortgage on the property, the Bank, at the time of the financing referenced above, acquired a lender’s title insurance policy from the Chicago Title & Insurance Company, which is providing a defense to the Bank in the First Action under a reservation of rights.  The Bank denies any wrongdoing, and is actively defending the case.  The First Action presently is stayed, by Court order, which was entered pending resolution of a parallel action pending in New York Surrogate’s Court to which the Bank is not a party.  That New York action was dismissed in November 2011, and as a result the Bank has moved to lift the stay of the First Action.  In the Foreclosure Action, the Bank has moved to strike each of the counterclaims asserted by John Christophersen.  Both of these motions await a Court hearing.  No discovery has been taken to date. 

There are no other material pending legal proceedings, other than ordinary routine litigation incident to the registrant’s business, to which Salisbury is a party or of which any of its property is subject.

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Table of Contents

Item 1A. RISK FACTORS

Not applicable

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

Item 4. MINE SAFETY DISCLOSURES
Not Applicable
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS
31.1Rule 13a-14(a)/15d-14(a) Certification.

 

31.2Rule 13a-14(a)/15d-14(a) Certification.

 

32Section 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 10, 2012 by    /s/ Richard J. Cantele, Jr.
  Richard J. Cantele, Jr.,
  Chief Executive Officer
   
May 10, 2012 by    /s/ B. Ian McMahon
  B. Ian McMahon,
  Chief Financial Officer

 

38