WELLESLEY BANCORP, INC. OnDecember 5, 2019 , Cambridge Bancorp and the Company issued a joint press release announcing that Cambridge and the Company have entered into the Merger Agreement pursuant to which the Company will merge with and into Cambridge, withCambridge as the surviving entity. Under the terms of the Merger Agreement, which has been approved by the boards of directors and stockholders of both companies, stockholders of the Company will receive 0.580 shares of Cambridge common stock for each share of Company common stock. The transaction is subject to customary closing conditions and is expected to close during the second
quarter of 2020. Overview Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Other sources of income include fees from investment management services, earnings from customer service fees (mostly from service charges on deposit accounts), bank-owned life insurance, income from mortgage banking activities and fees from customer loan-related interest rate swaps.
Provision for Loan Losses.The allowance for loan losses is maintained at a level
representing management's best estimate of inherent losses in the loan
portfolio, based upon management's evaluation of the portfolio's collectibility.
The allowance is established through the provision for loan losses, which is
charged against income. Charge-offs, if any, are charged to the allowance.
Subsequent recoveries, if any, are credited to the allowance. Allocation of the
allowance may be made for specific loans or pools of loans, but the entire
allowance is available for the entire loan portfolio.
Expenses. The noninterest expenses we incur in operating our business consist of
salaries and employee benefits, occupancy and equipment, data processing,
federal deposit insurance, professional fees, advertising and marketing, and
other general and administrative expenses.
Salaries and employee benefits consist primarily of salaries and wages paid to
our employees, payroll taxes, and expenses for health insurance, retirement
plans and other employee benefits. We recognize annual employee compensation
expenses stemming from our Employee Stock Ownership Plan ("ESOP") and our equity
incentive plans. The actual amount of stock-related compensation and benefit
expenses related to the ESOP is based on the fair market value of the shares of
our common stock at specific points in time.
Occupancy and equipment expenses, which are the fixed and variable costs of
buildings and equipment, consist primarily of depreciation charges, rental
expenses, furniture and equipment expenses, maintenance, real estate taxes and
costs of utilities. Depreciation of premises and equipment is computed using a
straight-line method based on the estimated useful lives of the related assets,
which range from three to 40 years, or the expected lease terms, if shorter.
Data processing expense represents the fees associated with all business
applications we pay to third parties for the use of their software for recording
and managing deposit accounts, loan accounts, investment securities, general
ledger, payroll and administrative functions within the organization. Included
in this category are primary contracts with vendors, service providers and
maintenance agreements in support of these functions.
Federal deposit insurance premiums are payments we make to the
30
Professional fees include consulting fees and expenses associated with being a
public company which consist primarily of legal and accounting fees, expenses of
stockholder communications and meetings, and stock exchange listing fees.
Advertising and marketing expense includes costs associated with design and delivery of promotional material through a variety of media related to products and services we make available to our customers.
Other general and administrative expenses include office supplies, postage, insurance, board of directors and committee fees, and other miscellaneous operating expenses.
Business Strategy and Objectives
AtWellesley Bank , it is all about the people: our employees, our community and most importantly our clients. It's about hiring great people, developing them and treating them well, which, in turn, is a direct reflection on how we treat our clients. The foundation of our bank is built on integrity, community and exceptional client service, where everyone is treated fairly and with respect. We pride ourselves in having an entrepreneurial spirit, where we continue to evolve, stay open to ideas and make quick, sound decisions. This is our strategy and our source of distinction. Our primary objective is to operate and grow a profitable community-oriented financial institution serving customers in our primary market areas. We seek to achieve this by maintaining a strong capital position and high asset quality. Our operating objectives include the following: Emphasizing lower cost core deposits and accessing a wider network of funding sources to maintain low funding costs. We seek to increase net interest income by controlling our funding costs. Over the past several years, we have sought to reduce our dependence on traditional higher cost certificates of deposits in favor of stable lower cost demand deposits. We have utilized additional product offerings, technology and a focus on customer service in working toward this goal. In addition, we seek demand deposits by growing commercial banking relationships. Core deposits (demand, NOW, money market and savings accounts) comprised 71.2% of our total deposits atDecember 31, 2019 . While our focus and strategy will be to continue to emphasize core deposits and relationship banking, we have occasionally utilized our ability to grow certificates of deposit during times of greater loan demand as a means to support loan growth. We do this through our retail and brokered certificate offerings and we participate in a national market clearinghouse for placing competitively priced certificates of deposits with financial institutions, nonprofits and other corporate participants. National market certificates of deposit are sometimes less costly funds than local market retail certificates, and may provide access to a wider range of maturities than retail funds. In addition, we utilize borrowings from theFederal Home Loan Bank of Boston ("FHLB") to provide matched funding of commercial loans and short-term liquidity needs at relatively lower cost than retail deposits. Balances of FHLB advances increased$20.7 million from$73.5 million atDecember 31, 2018 to$94.2 million atDecember 31, 2019 . Increasing our deposit market share within our primary markets in easternMassachusetts . Since its inception in 1911,Wellesley Bank has primarily served the town ofWellesley, Massachusetts and the immediate surrounding communities. Despite considerable competition from larger financial institutions, we have made significant progress in recent years to increase our market presence in the town ofWellesley and in the greaterBoston metropolitan area. Our deposits increased$34.5 million , or 4.8%, from$717.9 million atDecember 31, 2018 to$752.5 million atDecember 31, 2019 . AtJune 30, 2019 (the latest data available), we had 13.7% of the deposits in the town ofWellesley , which represented the third largest market share out of 14 financial institutions with branches in the town ofWellesley . Our market position is fortified by three full-service offices inWellesley . We believeWellesley and the surrounding market area will continue to provide opportunities for growth. We expanded our market reach intoBoston through a full-service office that opened inNovember 2013 and opened a new full-service banking office inNewton Centre in the spring of 2016. 31 Continuing to develop our commercial real estate lending, commercial business lending, and construction lending, as well as increasing our commercial business depository relationships in our market area. We have worked to increase our commercial relationships by developing our premier bankers and diversifying our loan portfolio beyond residential mortgage loans along with offering business deposit and checking products. FromDecember 31, 2018 toDecember 31, 2019 , our commercial real estate, construction and commercial business loan portfolio increased$95.6 million , or 29.7%, and atDecember 31, 2019 was 49.5% of our total loan portfolio. The reason for the increase in the portfolio is due to the development of a successful commercial pipeline over the past few years. In connection with our commercial business loan portfolio, we also have focused on providing a full banking relationship and, as a result, experienced an increase in our business deposit and checking accounts. Our business checking accounts increased$2.8 million , or 2.7% during 2019 and represented 13.7% of our total deposits as ofDecember 31, 2019 . In addition, we continue to expand and develop our cash management products, along with on-line and mobile banking solutions to better serve our commercial customers. Increasing our residential mortgage lending in our market area. We believe there are opportunities to increase residential mortgage lending in our market areas. The town ofWellesley and its surrounding communities have a sound economy. As a result, the demand for residential mortgage loans in our market area, in particular larger "jumbo" loans, has been steady. FromDecember 31, 2018 toDecember 31, 2019 , our residential loans increased$5.8 million , or 1.5%, and atDecember 31, 2019 were 46.1% of our total loan portfolio. In addition to our traditional markets in the town ofWellesley and surrounding communities, our lending territory currently includes sections ofBoston inSuffolk County andCambridge inMiddlesex County , which we believe provide additional lending opportunities and further diversifies our residential loan portfolio. Continuing conservative underwriting practices while maintaining a high quality loan portfolio. We believe that strong asset quality is a key to long-term financial success. We have sought to maintain a high level of asset quality and manageable credit risk by using conservative underwriting standards and applying diligent monitoring and collection efforts. Nonperforming loans increased from$1.1 million atDecember 31, 2018 to$2.5 million atDecember 31, 2019 . AtDecember 31, 2019 , nonperforming loans were 0.30% of the total loan portfolio and 0.26% of total assets. The increase in nonperforming loans was the result of slowing payments on a home equity line of credit and a commercial and industrial loan with a deteriorating cash flow situation. We believe both situations will be favorably resolved in the short-term. We intend to increase our commercial real estate, construction and commercial business lending, while continuing our philosophy of managing large loan exposures through conservative loan underwriting and sound credit administration standards. Seeking to enhance fee income by growing investment advisory services. Our profits rely heavily on the spread between the interest earned on loans and securities and interest paid on deposits and borrowings. In order to decrease our reliance on net interest income, we have pursued initiatives to increase noninterest income. In particular, we offer a full array of investment advisory services for individuals, nonprofits, institutions, and endowments through our wholly-owned subsidiary,Wellesley Investment Partners, LLC , a registered investment advisor. We appointed a new president ofWellesley Investment Partners in the fourth quarter of 2014 and have augmented our business development efforts and research and support functions with a number of key individuals as we intend to grow and develop this aspect of our business. Investment management fees relating to our investment advisory services totaled$1.7 million ,$1.6 million and$1.3 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively. Critical Accounting Policies We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are the following factors: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the current evaluation. In addition, theFDIC andMassachusetts Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See notes 1 and 6 of the notes to consolidated financial statements included in this document. 32 Deferred Tax Assets. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Management reviews deferred tax assets on a quarterly basis to identify any uncertainties pertaining to realization of such assets. In determining whether a valuation allowance is required against deferred tax assets, management assesses historical and forecasted operating results, including a review of eligible carryforward periods, tax planning opportunities and other relevant considerations. We believe the accounting estimate related to the valuation allowance is a critical estimate because the underlying assumptions can change from period to period. For example, the 2017 enactment of TCJA, the law that reduced our federal tax rate from 34.0% to 21.0%, caused us to re-value our
deferred tax asset. Balance Sheet Analysis
General. Total assets increased$73.8 million , or 8.5%, from$871.4 million atDecember 31, 2018 to$945.2 million atDecember 31, 2019 . Total assets increased primarily due to an increase in net loans of$97.4 million , or 13.2%, along with the addition of an operating lease right-of-use asset of$6.5 million and an increase in loans held for sale of$3.3 million , partially offset by a reduction in investments of$37.0 million . Total liabilities increased$65.5 million due to deposit growth of$34.5 million , additional FHLB borrowings of$20.7 million , and the addition of an operating lease liability of$6.5 million . Loans. Net loans increased$97.4 million , or 13.2%, from$737.0 million atDecember 31, 2018 to$834.5 million atDecember 31, 2019 . The bank has been successful in emphasizing commercial loans: commercial real estate loans increased$33.9 million to$181.9 million ; construction loans increased$31.3 million to$138.0 million ; and commercial and industrial loans increased$30.4 million to$97.3 million . The increase in commercial and industrial loans reflects our continued emphasis on originating these types of loans and increased loan demand. Permanent construction loans, or those loans financing construction of owner-occupied residential properties, totaled$20.5 million atDecember 31, 2019 , while speculative construction loans on residential properties, representing loans to builders, totaled$83.3 million atDecember 31, 2019 . The increase in construction loan balances generally was due to the continued strong demand for new home construction within our primary markets. Residential real estate loans increased$5.8 million , or 1.5%, to$388.3 million . Fixed-rate residential loans increased$13.5 million to$77.7 million . Adjustable-rate residential mortgage loans decreased$7.6 million , or 2.4%, to$310.6 million . We continue to sell some conforming longer-term fixed-rate residential loans that we have originated. For the years endedDecember 31, 2019 and 2018, residential mortgage loans originated and sold to investors totaled$25.1 million and$8.5 million , respectively.
The following table sets forth the composition of our loan portfolio, excluding loans held for sale, at the dates indicated.
At December 31,
2019 2018 2017
(Dollars in thousands) Amount Percent Amount Percent Amount Percent
Real estate loans:
Residential mortgage $ 388,325 46.10 % $ 382,510 51.43 % $ 329,026 47.52 %
Commercial real estate 181,928 21.60 148,006 19.90 138,784 20.05
Construction 138,007 16.38 106,723 14.35 120,004 17.33
Total real estate loans 708,260 84.08 637,239 85.68 587,814 84.90
Commercial loans 97,281 11.54 66,890 8.99 67,971 9.82
Consumer loans:
Home equity lines of
credit 36,693 4.36 39,486 5.31 36,378 5.25
Other 171 0.02 163 0.02 214 0.03
Total loans 842,405 100.00 % 743,778 100.00 % 692,377 100.00 %
Less:
Net deferred loan
origination (fees) costs (292 ) (8 ) 78
Allowance for loan losses (7,653 ) (6,738 ) (6,153 )
Net loans $ 834,460 $ 737,032 $ 686,302
33
At December 31,
2016 2015
(Dollars in thousands) Amount Percent Amount Percent
Real estate loans:
Residential mortgage $ 268,059 46.09 % $ 256,470 50.05 %
Commercial real estate 121,134 20.83 103,106 20.11
Construction 110,390 18.98 94,886 18.52
Total real estate loans 499,583 85.90 454,462 88.68
Commercial loans 49,347 8.48 23,681 4.62
Consumer loans:
Home equity lines of credit 32,437 5.58 34,083 6.65
Other 216 0.04 256 0.05
Total loans 581,583 100.00 % 512,482 100.00 %
Less:Net deferred loan origination (fees) costs (20 )
(63 )
Allowance for loan losses (5,432 ) (5,112 )
Net loans $ 576,131 $ 507,307
Loan Maturity. The following table sets forth certain information at December
31, 2019 regarding scheduled contractual maturities. The table does not include
any estimate of prepayments which could significantly shorten the average life
of all loans and may cause our actual repayment experience to differ from that
shown below. Demand loans having no stated schedule of repayments and no stated
maturity are reported as due in one year or less. The amounts shown below
exclude net deferred loan costs and fees.
December 31, 2019
Residential Commercial
Mortgage Real Estate Construction Commercial Consumer Total
(In thousands) Loans Loans Loans Loans Loans Loans
Amounts due in:
One year or less $ 3,051 $ 10,571 $
84,369
3,098 18,724 32,600 9,029 5,865 69,316
More than five years 382,176 152,633 21,038 69,299 29,020 654,166
Total $ 388,325 $ 181,928 $ 138,007 $ 97,281 $ 36,864 $ 842,405
Fixed vs. Adjustable Rate Loans.The following table sets forth the dollar amount
of all scheduled maturities of loans at December 31, 2019 that are due after
December 31, 2020 and have either fixed interest rates or adjustable interest
rates. The amounts shown below exclude net deferred loan costs and fees.
34
Floating or
Fixed Adjustable
(In thousands) Rates Rates Total
Real estate loans:
Residential mortgage $ 70,039 $ 315,235 $ 385,274
Commercial real estate 22,628 148,729 171,357
Construction 39,002 14,636 53,638
Commercial loans 21,274 57,054 78,328
Consumer loans 2,910 31,975 34,885
Total $ 155,853 $ 567,629 $ 723,482
Securities. Our securities portfolio consists primarily of residential
mortgage-backed securities issued by U.S. government agencies and government
sponsored enterprises, corporate bonds, SBA and other asset-backed securities
and municipal bonds. Securities available for sale decreased by $37.0 million ,
or 55.4%, to $29.8 million for the year ended December 31, 2019 , primarily due
to the sale of lower yielding securities which were used to pay down higher cost
borrowings.
The following table sets forth the amortized cost and fair values of our securities portfolio at the dates indicated.
At December 31,
2019 2018 2017
Amortized Fair Amortized Fair Amortized Fair(In thousands) Cost Value Cost Value Cost Value Residential mortgage-backed securities: Government National Mortgage Association$ 2,770 $ 2,815 $ 3,846 $ 3,847 $ 3,358 $ 3,351 Government-sponsored enterprises 2,224 2,266 11,382 11,223 11,690 11,649 SBA and other asset-backed securities 4,082 4,192 11,720 11,627 11,961 11,963 State and municipal bonds 7,446 7,821 12,908 12,908 13,026 13,287 Government-sponsored enterprise obligations 4,000 3,994 8,000 7,813 8,000 7,834 Corporate bonds 8,597 8,727 18,151 17,857 17,166 17,161 U.S.Treasury bonds -- -- 1,495 1,495 1,241 1,241 Total securities available for sale$ 29,119 $ 29,815 $ 67,502 $ 66,770 $ 66,442 $ 66,486
At
The following table sets forth the stated maturities and weighted average yields of debt securities atDecember 31, 2019 . Weighted average yields on tax-exempt securities are not presented on a tax equivalent basis. Certain mortgage related securities have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules, as well as monthly principal payments on mortgage- and asset-backed securities, are not reflected in the
table below.
More than Five
More than One Year Years
One Year or Less to Five Years to Ten Years More than Ten Years Total
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield State and municipal bonds -- -- 2,063 3.17 3,029 2.79 2,354 3.09 7,446 2.99
Government-sponsored
enterprise obligations -- -- 3,000
1.77 1,000 2.00 -- -- 4,000 1.83
Corporate bonds 1,850 2.09 2,747 2.87 4,000 5.66 -- -- 8,597 4.00Total debt securities$ 1,850 2.09 %$ 7,810
2.53 %$ 8,029 4.12 %$ 2,354 3.09 %$ 20,043 3.19 % 35 Deposits. Our primary sources of funds are retail deposit accounts held primarily by individuals and businesses within our market area. Deposits increased$34.5 million , or 4.8%, during the year endedDecember 31, 2019 due primarily to increases in money market accounts of$75.4 million , or 37.0%; noninterest-bearing demand deposits of$23.0 million , or 18.6%; and, NOW accounts of$1.9 million , or 5.2%; partially offset by decreases in certificate of deposit accounts of$61.6 million , or 28.8%; and, in regular and other savings accounts of$4.2 million , or 10.4%. Brokered certificate of deposit accounts decreased$35.5 million to$47.0 million atDecember 31, 2019 accounting for most of the decline in certificates of deposits. During 2019, we continued our evolution of the premier service relationship-based delivery model. Leveraging our expansion of offices and investments in our premier bankers, we have been able to grow our core, relationship-based deposits significantly. We have continued to upgrade our business and consumer online banking capabilities and focused our business development activities on client relationships across product lines. The following table sets forth the average balances of our deposit products at the dates indicated. For the Year Ended December 31, 2019 2018 2017 (Dollars in thousands) Total Percent Total Percent Total Percent Noninterest-bearing demand deposits$ 129,477 17.35 %$ 115,854 17.78 %$ 96,011 17.41 % Interest-bearing deposits: NOW 38,629 5.18 36,627 5.62 35,399 6.42 Money market 257,559 34.52 155,439 23.85 119,862 21.74 Regular and other savings 74,870 10.04 91,780 14.09 96,454 17.50 Term certificates of deposit 245,569 32.91 251,912 38.66 203,645 36.93 Total$ 746,104 100.00 %$ 651,612 100.00 %$ 551,371 100.00 % The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity atDecember 31, 2019 . Jumbo certificates of deposit require minimum deposits of$250 thousand . Between theFDIC's and Co-operative Central Bank's deposit insurance coverage, these funds are fully insured. Jumbo Certificates of (In thousands) Deposits Maturity Period at December 31, 2019: Three months or less $ 17,081 Over three through six months 18,927 Over six through twelve months 37,541 Over twelve months 17,232 Total $ 90,781
Borrowings. We primarily use advances from the
Long-term debt, consisting entirely of FHLB advances, increased$15.7 million , or 26.8%, for the year endedDecember 31, 2019 . AtDecember 31, 2019 and 2018, short-term borrowings consisted entirely of advances from the FHLB with original maturities less than one year. Balances outstanding atDecember 31, 2019 were$20.0 million , an increase of$5.0 million over balances atDecember 31, 2018 . Long-term and short-term borrowings were typically used to fund loan growth and support short-term liquidity needs resulting from the timing of loan originations and irregular deposit flows. AtDecember 31, 2019 , subordinated debt, net of issuance costs, totaled$9.9 million as a result of the sale by the Company of$10.0 million of subordinated debentures maturing in 2025 to qualified institutional investors inDecember 2015 . The funds received from the sale have been used for general corporate purposes including the down-streaming of substantially all of the funds to the Bank in the form of additional paid-in capital, to support the growth objectives of the Bank. 36 The following table sets forth selected information regarding borrowings for the periods indicated. At or For the Year Ended December 31, (Dollars in thousands) 2019 2018 2017 Short-term Borrowings: Balance at end of the year$ 20,000 $ 15,000 $ 38,000
Average balance during the year 32,855 27,943 23,533 Maximum outstanding at any month end during the year 54,000 51,000 38,000 Weighted average interest rate at end of the year 2.10 % 2.44 % 1.53 % Weighted average interest rate during the year 2.63 %
2.08 % 1.25 %
Long-term Debt:
Balance at end of the year $ 74,196 $ 58,528 $ 77,174 Average balance during the year 68,269 75,565 89,319 Maximum outstanding at any month end during the year 77,643 95,399 100,848 Weighted average interest rate at end of the year 2.61 % 1.65 % 1.32 % Weighted average interest rate during the year 2.40 %
1.66 % 1.32 %
Subordinated Debt:
Balance at end of the year $ 9,861 $ 9,832 $ 9,802 Average balance during the year 9,846 9,816 9,784 Maximum outstanding at any month end during the year 9,861 9,832 9,802 Weighted average interest rate at end of the year 6.12 % 6.12 % 6.12 % Weighted average interest rate during the year 6.39 %
6.43 % 6.47 %
Results of Operations for the Years Ended
Overview. Net income was$6.0 million for the year endedDecember 31, 2019 , an increase of$9 thousand , or 0.2% as compared to December, 2018. Earnings were lessened by merger-related expenses. For the year endedDecember 31, 2019 , compared to 2018, net interest income plus non-interest income increased$2.9 million , offset by an increase in non-interest expenses of$2.6 million and an increase in the provision for loan losses of$330 thousand . The tax provision decreased$74 thousand . Net Interest Income. Net interest income for the year endedDecember 31, 2019 totaled$27.1 million compared to$24.7 million for the year endedDecember 31, 2018 , an increase of$2.4 million , or 9.5%. The increase in net interest income was primarily due to greater interest and dividend income, which increased by$6.7 million , or 19.8%, to$40.3 million for 2019 from$33.6 million for 2018. The average balance of interest-earning assets increased 12.4%, with an average rate earned on these assets of 4.41% for 2019. Interest income from loans and loans held for sale increased$6.6 million , or 21.4%, due to a 14.6% increase in the average balance of loans and loans held for sale and an increase of 26 basis points in the average rate earned on loans and loans held for sale. Most of the remaining increase was from higher balances in short-term investments combined with the rise in short-term interest rates. Interest expense increased$4.3 million , or 48.2%, during this period due to an increase in deposit balances and rates paid on interest-bearing deposits and short- and long-term borrowings. The average rates paid on deposits increased by 43 basis points in 2019 primarily due to a shift in the mix of deposits to higher cost term certificates and money market accounts. Rates paid on money market accounts increased 62 basis points during the period while rates paid on term certificates increased 49 basis points. Average balances of interest-bearing deposits increased$80.9 million or 15.1% in 2019. We experienced an increase in the average balance of money market accounts of 65.7% for the year endedDecember 31, 2019 , as compared to the prior year, while the average balance of savings accounts decreased 18.4% during that period. Balances in lower cost NOW checking accounts and interest free checking accounts increased 8.9% during 2019 and helped to mitigate the interest expense increase. 37 During 2019, we reduced our average combined use of FHLB short- and long-term borrowings due to their relatively higher interest rate cost as compared to core deposits. FHLB short-term borrowings increased$4.9 million and carried an average rate of 2.63% in 2019, compared to 2.08% in 2018. As a result, interest expense on short-term borrowings increased$285 thousand . Overall interest cost on long-term FHLB advances increased$386 thousand , or 30.7% as compared to the prior year. Average balances of long-term FHLB advances decreased$7.3 million to$68.3 million atDecember 31, 2019 , while the rate paid on FHLB advances increased 74 basis points to 2.40% in 2019. Average Balances and Yields.The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Loan fees are included in interest income on loans and are insignificant. Yields are not presented on a tax-equivalent basis. Any adjustments necessary to present yields on a tax-equivalent basis are insignificant. For the Years Ended December 31, 2019 2018 2017 Average Interest Average Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ (Dollars in thousands) Balance Paid Rate Balance Paid Rate Balance Paid Rate Interest-earning Assets: Short-term investments$ 38,334 $ 757 1.97 %$ 29,092 $ 509 1.75 %$ 21,602 $ 220 1.02 % Debt securities: Taxable 43,484 1,270 2.92 54,106 1,441 2.66 53,706 1,338 2.49 Tax-exempt 11,514 291 2.53 12,917 327 2.53 12,293 305 2.48 Total loans and loans held for sale 815,692 37,670 4.62 711,528 31,028 4.36 624,784 26,251 4.20 FHLB stock 5,095 302 5.93 5,767 333 5.77 6,153 252 4.09 Total interest-earning assets 914,119 40,290 4.41 813,410 33,638 4.14 718,539 28,366 3.95 Allowance for loan losses (7,093 ) (6,394 ) (5,611 ) Total interest-earning assets less allowance for loan losses 907,026 807,016 712,928 Noninterest-earning assets 34,198 23,541 22,664 Total assets$ 941,224 $ 830,557 $ 735,592 Interest-bearing Liabilities: Regular savings accounts$ 74,870 429 0.57$ 91,780 524 0.57$ 96,454 432 0.45 NOW checking accounts 38,629 141 0.37 36,627 112 0.31 35,399 93 0.26 Money market accounts 257,559 4,134 1.61 155,439 1,537 0.99 119,862 640 0.53 Certificates of deposit 245,569 5,365 2.18 251,912 4,269 1.69 203,645 2,416 1.19 Total interest-bearing deposits 616,627 10,069 1.63 535,758 6,442 1.20 455,360 3,581 0.79 Short-term borrowings 32,855 865 2.63 27,943 580 2.08 23,533 293 1.24 Long-term debt 68,269 1,642 2.40 75,565 1,256 1.66 89,319 1,182 1.32 Subordinated debt 9,846 628 6.39 9,816 631 6.43 9,784 632 6.47 Total interest-bearing liabilities 727,597 13,204 1.81 649,082 8,909 1.37 577,996 5,688 0.98 Noninterest-bearing demand deposits 129,477 115,854 96,011 Other noninterest-bearing liabilities 14,087 3,494 3,336 Total liabilities 871,161 768,430 677,343 Equity 70,063 62,127 58,249 Total liabilities and equity$ 941,224 $ 830,557 $ 735,592 Net interest income$ 27,086 $ 24,729 $ 22,678 Net interest rate spread (1) 2.59 % 2.76 % 2.97 % Net interest-earning assets (2)$ 186,522 $ 164,328 $ 140,543 Net interest margin (3) 2.96 % 3.04 % 3.16 % Average total interest-earning assets to average total interest-bearing liabilities 125.64 % 125.32 % 124.32 %
(1) Represents the difference between the weighted average yield on average
interest-earning assets and the weighted average cost of average
interest-bearing liabilities.
(2) Represents total average interest-earning assets less total average
interest-bearing liabilities.
(3) Represents net interest income as a percent of average interest-earning
assets.
38
Rate/Volume Analysis. The following table sets forth the effects of changing
rates and volumes on our net interest income. The rate column shows the effects
attributable to changes in rate (changes in rate multiplied by prior volume).
The volume column shows the effects attributable to changes in volume (changes
in volume multiplied by prior rate). The total increase (decrease) column
represents the sum of the prior columns. For purposes of this table, changes
attributable to changes in both rate and volume that cannot be segregated have
been allocated proportionally based on the changes due to rate and the changes
due to volume.
Year Ended December 31, 2019 Year Ended December 31, 2018
Compared to Compared to
December 31, 2018 December 31, 2017
Increase (Decrease) Total Increase (Decrease) Total
Due to Increase Due to Increase(Dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease) Interest-earning Assets: Short-term investments$ 176 71$ 247 $ 94 195$ 289 Debt securities: Taxable (335 ) 166 (169 ) 10 93 103 Tax-exempt (36 ) (1 ) (37 ) 15 7 22 Total loans and loans held for sale 4,734 1,908 6,642 3,753 1,024 4,777 FHLB stock (40 ) 9 (31 ) (15 ) 96 81 Total interest-earning assets 4,499 2,153 6,652 3,857 1,415 5,272 Interest-bearing Liabilities: Regular savings (97 ) 3 (94 ) (20 ) 111 91 NOW checking 7 22 29 3 17 20 Money market 1,333 1,264 2,597 232 665 897
Certificates of deposit (105 ) 1,200 1,095 660 1,193 1,853 Total interest-bearing deposits 1,138 2,489 3,627 875 1,986 2,861 Short-term borrowings 113 172 285 63 224 287 Long-term debt (106 ) 492 386 (112 ) 186 74 Subordinated debt 1 (4 ) (3 ) (1 ) -- (1 ) Total interest-bearing liabilities 1,146 3,149 4,295 825 2,396 3,221 Increase in net interest )
)
income $ 3,353 $ (996 $ 2,357 $ 3,033 $ (982 $ 2,051
Provision for Loan Losses.During the year ended December 31, 2019 , we recorded a
$915 thousand provision to the allowance for loan losses as compared to a
provision of $585 thousand for the year ended December 31, 2018 . The 2019
provision reflects a change in our mix of loans and favorable loan portfolio
performance, along with the establishment of a specific reserve of $350 thousand
for a commercial and industrial loan that was downgraded late in 2019.
From December 31, 2018 to December 31, 2019 , nonperforming loans increased from
$1.1 million to $2.5 million . The increase was due to one home equity line of
credit and one commercial and industrial loan relationship moving to non-accrual
status. Criticized and classified assets were $5.4 million at December 31, 2019
and 2018, respectively. Commercial real estate, construction and commercial
business loans, which bear higher risk and generally larger loss reserves than
our residential mortgage loans, increased as an overall portion of our loan
portfolio from 43.2% of loans at December 31, 2018 to 49.5% at December 31 ,
2019.
39
An analysis of the changes in the allowance for loan losses is presented under "-Risk Management-Analysis and Determination of the Allowance for Loan Losses."
Noninterest Income. Noninterest income increased$523 thousand , or 20.2%, to$3.1 million during the year endedDecember 31, 2019 , from$2.6 million for the year endedDecember 31, 2018 . Income from customer interest rate swaps increased$526 thousand from 2018 to 2019 associated with our increase in commercial lending activity. For 2019, wealth management fees totaled$1.7 million , an increase of$59 thousand , or 3.6%, from 2018, resulting from the increase in assets under management within our wealth management subsidiary. Total assets under management, including the bank's portfolio, were$419.5 million . In 2019, we recorded income from mortgage banking activities of$211 thousand compared to 2018 when income from mortgage banking activities totaled$99 thousand . The volume of loans originated for sale in 2019 totaled$28.4 million as compared to$8.5 million for 2018. A discontinued website development project resulted in a loss$121 thousand with the write-down of the associated fixed asset. Noninterest Expense. Noninterest expense increased$2.6 million , or 14.1%, to$21.2 million during the year endedDecember 31, 2019 , from$18.6 million for the year endedDecember 31, 2018 . Salaries and employee benefits increased$1.4 million , or 13.1%, and totaled$12.3 million , compared to$10.8 million for the year endedDecember 31, 2018 . The compensation increase is attributable to annual merit increases and promotions along with the expansion of staff. Occupancy and equipment expense increased$284 thousand primarily related to annual increases in rent expense and the full year impact of the relocation of business operations to a new home office. Professional fees increased$583 thousand due mainly to higher corporate legal expenses and professional fees associated with the proposed merger withCambridge trust. Data processing expense was higher by$282 thousand and other general administrative costs and advertising costs increased$97 thousand associated with increased business volumes.FDIC insurance costs decreased$50 thousand , primarily due to a one-time small bank credit. Income Taxes. Income tax provision decreased by$74 thousand for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . The effective tax rate for 2019 was 25.9% compared with 26.6% for 2018. Risk Management Overview. Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk, market risk and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or security when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are recorded at fair value. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers when due. Other risks that we face are operational risks and reputation risk. Operational risks include risks related to fraud, cyber security, regulatory compliance, processing errors, and technology and disaster recovery. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base and revenue.
Credit Risk Management. Our strategy for credit risk management focuses on
having well-defined credit policies and uniform underwriting criteria and
providing prompt attention to potential problem loans. This strategy also
emphasizes conservative loan-to-value ratios and guarantees of construction and
commercial real estate loans by parties with substantial net worth. In addition,
annually, we engage an outside loan review firm to perform a thorough review of
our commercial portfolio. This review involves analyzing all large borrowing
relationships, delinquency trends and loan collateral valuation in order to
identify impaired loans. We do not originate "interest only" mortgage loans on
one-to-four family residential properties nor do we offer loans that provide for
negative amortization of principal such as "option ARM" loans where the borrower
can pay less than the interest owed on their loan. Additionally, we generally do
not offer "subprime loans" (loans that are made with low down payments to
borrowers with weakened credit histories typically characterized by payment
delinquencies, previous charge-offs, judgments or bankruptcies, or borrowers
with questionable repayment capacity) or "Alt-A" loans (loans to borrowers
having less than full documentation).
When a borrower fails to make a required loan payment, management takes a number
of steps to have the borrower cure the delinquency and restore the loan to
current status. Management makes initial contact with the borrower when the loan
becomes 15 days past due. If payment is not received by the 30th day of
delinquency, efforts to contact the borrower are increased, and a plan of
collection is pursued for each individual loan. A particular plan of collection
may lead to foreclosure, the timing of which depends on the prospects for the
borrower bringing the loan current, the financial strength and commitment of any
guarantors, and the type and value of the collateral securing the loan and other
factors. If a foreclosure action is instituted and the loan is not brought
current, paid in full, or refinanced before the foreclosure sale, the real
property securing the loan generally is sold at foreclosure. We may consider
loan workout arrangements with certain borrowers under certain circumstances, as
well as the sale of the nonperforming loans.
40
Management informs the board of directors on a monthly basis of the amount of
loans delinquent more than 30 days. Management also provides detailed reporting
of loans greater than 90 days delinquent, all loans in foreclosure and all
foreclosed and repossessed property that we own.
Analysis of Nonperforming and Classified Assets. We consider foreclosed assets,
loans that are maintained on a nonaccrual basis and loans that are past due 90
days or more and still accruing to be nonperforming assets. Loans are generally
placed on nonaccrual status when they are classified as impaired or when they
become 90 days or more past due. Loans are classified as impaired when, based on
current information and events, it is probable that we will be unable to collect
the scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. At the time a loan is placed on
nonaccrual status, the accrual of interest ceases and interest income previously
accrued on such loans is reversed against current period interest income.
Payments received on a nonaccrual loan are first applied to the outstanding
principal balance when collectibility of principal is in doubt.
Real estate that we acquire as a result of foreclosure or by deed-in-lieu of
foreclosure is classified as other real estate owned until it is sold. When
property is acquired it is recorded at the lower of its cost or fair market
value at the date of foreclosure. Any holding costs and declines in fair value
after acquisition of the property result in charges against income.
Troubled debt restructurings ("TDRs") occur when we grant borrowers concessions
that we would not otherwise grant but for economic or legal reasons pertaining
to the borrower's financial difficulties. These concessions may include, but are
not limited to, modifications of the terms of the debt, the transfer of assets
or the issuance of an equity interest by the borrower to satisfy all or part of
the debt, or the substitution or addition of borrower(s). We will not return a
TDR to accrual status until the borrower has demonstrated the ability to make
principal and interest payments under the restructured terms for at least six
consecutive months.
The following table provides information with respect to our nonperforming assets, including TDRs, at the dates indicated. We did not have any accruing loans past due 90 days or more at the dates presented.
At December 31,
(Dollars in thousands) 2019 2018 2017 2016 2015
Nonaccrual loans:
Real estate loans:
Residential mortgage $ 562 $ 581 $ -- $ -- $ 773
Commercial real estate 548 556 576 591 645
Construction -- -- -- -- --
Commercial 883 -- -- -- 11
Consumer 500 -- -- -- 34
Total nonaccrual loans 2,493 1,137 576 591 1,463
Other real estate owned -- -- -- -- --
Total nonperforming assets 2,493 1,137 576 591 1,463
Accruing troubled debt
restructurings (1) 2,675 165 172 179 185
Total nonperforming assets and
accruing troubled debt
restructurings $ 5,168 $ 1,301 $ 748 $ 770 $ 1,648
Total nonperforming loans to total
loans 0.30 % 0.15 % 0.08 % 0.10 % 0.29 %
Total nonperforming assets to total
assets 0.26 % 0.13 % 0.07 % 0.09 % 0.24 %
Total nonperforming assets and
accruing troubled debt
restructurings to total assets 0.55 % 0.15 % 0.09 %
0.11 % 0.27 %
(1) Non-accruing TDRs totaled$548 thousand ,$556 thousand ,$576 thousand ,$214 thousand , and$220 thousand atDecember 31, 2019 , 2018, 2017, 2016, and 2015, respectively. There were no non-accruing TDRs atDecember 31, 2016 . Interest income that would have been recorded for the years endedDecember 31, 2019 and 2018 had non-accruing loans been current according to their original terms amounted to$61 thousand and$56 thousand , respectively. Income related to nonaccrual loans included in interest income for the years endedDecember 31, 2019 and 2018 amounted to$42 thousand and$65 thousand , respectively. 41 Federal regulations require us to review and classify assets on a regular basis. In addition, theFDIC and theMassachusetts Commissioner of Banks have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. "Substandard assets" must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. "Doubtful assets" have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high probability of loss. An asset classified as 'loss" is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. When management classifies an asset as substandard or doubtful, a specific allowance for loan losses may be established. If management classifies an asset as loss, an amount equal to 100% of the portion of the asset classified loss is charged to the allowance for loan losses. The regulations also provide for a "special mention" category, described as assets that do not currently expose the Bank to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving the Bank's close attention. The Bank also utilizes an eleven grade internal loan rating system for commercial real estate, construction and commercial loans to assist in evaluating individual loans and determining assets classifications. See note 6 in the notes to the consolidated financial statements.
The following table shows the aggregate amounts of our criticized and classified assets at the dates indicated.
At December 31,
(In thousands) 2019 2018 2017
Special mention assets $ 875 $ 2,562 $ 1,777
Substandard assets 4,011 2,290 3,114
Doubtful assets 548 556 576
Loss assets -- -- --
Total $ 5,434 $ 5,408 $ 5,467 AtDecember 31, 2019 , 2018 and 2017, none of the special mention loans were in nonaccrual status. The decrease in special mention assets in 2019 was primarily the result of several borrowers' loans being downgraded to substandard. Total substandard assets included one accruing commercial loan relationship totaling$2.0 million that subsequently paid off in January, 2020.
Other than as disclosed in the above tables, there are no other loans where management has serious doubts about the ability of the borrowers to comply with the present loan repayment terms.
Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated.
At December 31, 2019 At December 31, 2018
30 - 59 60 - 89 30 - 59 60 - 89
Days Days >90 Days Days Days >90 Days
(In thousands) Past Due Past Due Past Due Past Due Past Due Past Due
Real estate loans:
Residential mortgage $ -- $ -- $ -- $ 1,551 $ -- $ --
Commercial real estate -- -- 548 -- -- 556
Construction -- -- -- -- -- --
Commercial loans -- -- -- -- -- --
Consumer loans -- -- 500 -- -- --
Total $ -- $ -- $ 1,048 $ 1,551 $ -- $ 556 The balance of commercial loans more than 90 days past due atDecember 31, 2019 and 2018 consist of one commercial loan customer. The balance of consumer loans more than 90 days past due atDecember 31, 2019 consist of one home equity line of credit loan customer. The balance of loans 30-59 days past due in 2018 consisted of three loans, secured by one-to-four family residences, to three separate customers. 42
Analysis and Determination of the Allowance for Loan Losses. The allowance for
loan losses is a valuation allowance for probable losses inherent in the loan
portfolio. We evaluate the need to establish allowances against losses on loans
on a quarterly basis. When additional allowances are necessary, a provision for
loan losses is charged to earnings.
Our methodology for assessing the appropriateness of the allowance for loan
losses consists of the following: (1) an allocated component related to impaired
loans; (2) a general component related to the remainder of the loan portfolio;
and (3) an unallocated component related to overall uncertainties that could
affect management's estimate of probable losses. Although we determine the
amount of each element of the allowance separately, the entire allowance for
loan losses is available to absorb losses in the entire portfolio.
Allowance on Impaired Loans.The allocated component of the allowance for loan
losses relates to loans that are individually evaluated and determined to be
impaired. The allowance for each impaired loan is determined by either the
present value of expected future cash flows or, if the loan is collateral
dependent, by the fair value of the collateral less estimated costs to sell. We
identify a loan as impaired when, based upon current information and events, it
is probable that we will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Management evaluates loans other than smaller-balance homogeneous
loans for impairment. If a loan is determined to be impaired, an individual loss
assessment is performed to determine the likelihood of a loss and, if
applicable, the estimated measurement of the loss. Smaller-balance homogeneous
loans, such as performing residential real estate loans and consumer loans, are
generally excluded from an individual impairment analysis and are collectively
evaluated by management to estimate losses inherent in those loans. However,
certain smaller-balance homogeneous loans will be individually evaluated for
impairment when they reach nonperforming status or become subject to a
restructuring agreement.
Allowance on the Remainder of the Loan Portfolio. The general component of the
allowance for loan losses relates to loans that are not impaired. Management
determines the appropriate loss factor for each group of loans with similar risk
characteristics within the portfolio based on loss experience and qualitative
and environmental factors for loans in each group. Loan categories may include
types of loans categorized by product, large credit exposures, concentrations,
loan grade, or any other characteristic that causes a loan's risk profile to be
similar to another. We consider qualitative or environmental factors that are
likely to cause estimated credit losses associated with our existing portfolio
to differ from historical loss experience including changes in lending policies
and procedures; changes in the nature and volume of the loan portfolio; changes
in experience, ability and depth of loan management; changes in the volume and
severity of past due loans, nonaccrual loans and adversely graded or classified
loans; changes in the quality of the loan review; changes in the value of
underlying collateral for collateral dependent loans; the existence of or
changes in concentrations of credit; changes in economic or business conditions;
and the effect of competition, and legal or regulatory requirements on estimated
credit losses. Our qualitative and environmental factors are reviewed on a
quarterly basis as is our historical loss experience to ensure they are
reflective of current conditions in our loan portfolio and economy.
Unallocated Allowance. Management maintains an unallocated component within the
allowance for loan losses to cover uncertainties that could affect our overall
estimate of probable losses. This component recognizes the imprecision inherent
in the assumptions used in the methodologies for estimating the allocated and
general components of the allowance, and is generally not a significant
component of the overall allowance.
We identify loans that may need to be charged-off as a loss by reviewing all
impaired loans and related loss analyses. Loan losses are charged against the
allowance when we believe the uncollectibility of the loan balance is confirmed.
A borrower's inability to make payments under the terms of the loan and a
shortfall in collateral value would generally result in our charging off the
loan to the extent of the loss deemed to be confirmed.
43
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.
At December 31,
2019 2018 2017
% of % of % of
% of Loans in % of Loans in % of Loans in
Allowance Category Allowance Category Allowance Category
(Dollars in to Total to Total to Total to Total to Total to Total
thousands) Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
Real estate loans:
Residential
mortgage $ 2,100 27.44 % 46.10 % $ 2,216 32.89 % 51.43 % $ 1,722 27.98 % 47.52 %
Commercial real
estate 1,626 21.25 21.60 1,602 23.78 19.90 1,520 24.71 20.05
Construction 1,823 23.82 16.38 1,462 21.69 14.35 1,661 27.00 17.33
Commercial loans 1,864 24.36 11.54 1,124 16.68 8.99 917 14.91 9.82
Consumer loans 239 3.12 4.38 260 3.86 5.33 239 3.88 5.28
Total allocated
allowance 7,652 99.99 100.00 6,664 98.90 100.00 6,059 98.48 100.00
Unallocated 1 0.01 -- 74 1.10 -- 94 1.52 --
Total $ 7,653 100.00 % 100.00 % $ 6,738 100.00 % 100.00 % $ 6,153 100.00 % 100.00 %
At December 31,
2016 2015
% of % of
% of Loans in % of Loans in
Allowance Category Allowance Category
to Total to Total to Total to Total
(Dollars in thousands) Amount Allowance Loans Amount Allowance Loans
Real estate loans:
Residential mortgage $ 1,422 26.18 % 46.09 % $ 1,490 29.15 % 50.05 %
Commercial real estate 1,145 21.08 20.83 1,025 20.05 20.11
Construction 1,827 33.63 18.98 1,684 32.94 18.52
Commercial loans 703 12.94 8.48 509 9.96 4.62
Consumer loans 214 3.93 5.62 240 4.70 6.70
Total allocated allowance 5,311 97.76 100.00 4,948 96.80 100.00 Unallocated 121 2.24 -- 164 3.20 -- Total$ 5,432 100.00 % 100.00 %$ 5,112 100.00 % 100.00 %
Although we believe that we use the best information available to establish the allowance for loan losses at a level that represents management's best estimate of losses in the loan portfolio at the balance sheet date, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with accounting principles generally accepted inthe United States of America , there can be no assurance that theFDIC or theMassachusetts Commissioner of Banks, in reviewing our loan portfolio, will not require us to increase our allowance for loan losses based on judgments different from ours. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. The spread of a highly infectious or contagious disease, such as COVID-19, could cause severe disruptions in theU.S. economy, which could in turn disrupt the business, activities, and operations of our customers, as well our business and operations. Moreover, since the beginning ofJanuary 2020 , the coronavirus outbreak has caused significant disruption in the financial markets both globally and inthe United States . The spread of COVID-19, or an outbreak of another highly infectious or contagious disease, may result in a significant decrease in business and/or cause our customers to be unable to meet existing payment or other obligations to us, particularly in the event of a spread of COVID-19 or an outbreak of an infectious disease in our market area. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operation.
Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated.
At or For the Years Ended
December 31,
(Dollars in thousands) 2019 2018 2017 2016 2015Allowance at beginning of year$ 6,738 $ 6,153 $ 5,432
$ 5,112 $ 4,738 Provision for loan losses 915 585 735 437 475 Charge-offs: Real estate loans: Residential -- -- -- 106 17 Commercial loans -- -- -- -- 83 Consumer loans -- -- 14 11 1 Total charge-offs -- -- 14 117 101 Recoveries -- -- -- -- -- Net charge-offs -- -- 14 117 101 Allowance at end of year$ 7,653 $ 6,738 $ 6,153 $ 5,432 $ 5,112 Allowance for loan losses to nonperforming loans at end of year 306.94 % 592.66 % 1,068.16 % 918.32 % 349.42 % Allowance for loan losses to total loans at end of year 0.91 % 0.91 % 0.89 % 0.93 % 1.00 % Net charge-offs to average loans outstanding during the year 0.00 % 0.00 % 0.00 % 0.02 % 0.02 % 44 Interest Rate Risk Management.We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Our strategy for managing interest rate risk emphasizes originating adjustable-rate loans for retention in our loan portfolio, selling in the secondary market substantially all newly originated conforming fixed-rate residential mortgage loans, promoting core deposit products and short-term time deposits, adjusting the maturities of borrowings and adjusting the investment portfolio mix and duration. We currently do not participate in balance sheet hedging programs, such as interest rate swaps or other activities involving the use of derivative financial instruments. We have an Asset/Liability Committee, which includes members of management, to communicate, coordinate and control all aspects of asset-liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals. Interest Rate Risk Analysis.We analyze our interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income and equity simulations. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest sensitive." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within
that time period.
Our goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income and the present value of our equity. Interest income and equity simulations are completed quarterly and presented to the Asset/Liability Committee and the board of directors. The simulations provide an estimate of the impact of changes in interest rates on net interest income and the present value of our equity under a range of assumptions. The numerous assumptions used in the simulation process are reviewed by the Asset/Liability Committee on a yearly basis. Changes to these assumptions can significantly affect the results of the simulation. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates. The simulation analysis incorporates management's current assessment of the risk that pricing margins will change adversely over time due to competition or other factors. Simulation analysis is only an estimate of our interest rate risk exposure at a particular point in time. We continually review the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities. The table below sets forth an approximation of our exposure as a percentage of estimated net interest income for the next 12 month period using interest income and equity simulations. The simulations use projected repricing of assets and liabilities atDecember 31, 2019 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on the simulations. Because of the large percentage of loans we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that, in turn, affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slow and would increase if prepayments accelerated. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity. The following table reflects changes in estimated net interest income for the Bank atDecember 31, 2019 throughDecember 31, 2020 , assuming a static balance sheet. These estimates are in compliance with our internal policy limits. 45 Net Interest Income Basis Point ("bp") Change in Rates Amount Change
% Change
(Dollars in thousands)
300 $ 29,181 $ 468 1.63 %
200 29,208 495 1.72
0 28,713 -- --
(100) 28,503 (210 ) (0.73 )
The following table reflects changes in the present value of equity for the Bank atDecember 31, 2019 . These estimates are also in compliance with our internal policy limits. Present Value of Equity Basis Point ("bp") Change in Rates Amount Change % Change (Dollars in thousands) 300$ 94,562 $ 249 0.26 % 200 98,012 3,699 3.92 0 94,313 -- -- (100) 89,401 (4,912 ) (5.21 ) Liquidity Management. Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, and borrowings from theFederal Home Loan Bank of Boston . While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, calls of investment securities and borrowed funds and prepayments on loans are greatly influenced by general interest rates, economic conditions and competition. Management regularly adjusts our investments in liquid assets based upon an assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our interest-rate risk and investment policies. Our most liquid assets are cash and cash equivalents, interest-bearing deposits in other banks, and securities available for sale. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. AtDecember 31, 2019 , cash and cash equivalents, which include short-term investments, totaled$42.1 million . Securities classified as available-for-sale, whose aggregate fair value exceeds cost, provide additional sources of liquidity and had a fair value of$29.8 million atDecember 31, 2019 . In addition, atDecember 31, 2019 , we had the ability to borrow approximately$104.0 million in additional funds from theFederal Home Loan Bank of Boston . OnDecember 31, 2019 , we had$74.2 million of long-term debt outstanding, and$20.0 million of short-term borrowings outstanding, all of which wereFederal Home Loan Bank of Boston advances. In addition, atDecember 31, 2019 , we had the ability to borrow$5.0 million from theCo-operative Central Bank on an unsecured basis, and$9.2 million from theFederal Reserve Bank under a collateralized borrowing program, none of which was outstanding at that date. The Company also has a$5.0 million unsecured line of credit with a correspondent bank. No additional advances were outstanding atDecember 31, 2019 . AtDecember 31, 2019 , we had$192.1 million in loan commitments outstanding, which included$150.0 in available line of credit for individuals and corporate customers and unadvanced funds on construction loans. Certificates of deposit due within one year ofDecember 31, 2019 total$169.6 million , or 78.3% of total certificates of deposit. The large percentage of certificates of deposit that mature within one year reflects customers' hesitancy to invest their funds for long periods. If these maturing deposits are not renewed, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit. Management believes, however, based on past experience that a significant portion of our certificates of deposit will be renewed. We have the ability to attract and retain deposits by adjusting the interest rates offered. 46 In addition, we believe that our branch network, which is presently comprised of three full-service retail banking offices located in ourWellesley market area, our banking office inBoston , an office in Newton, an office in Needham, and the general cash flows from our existing lending and investment activities, will afford us sufficient long-term liquidity. In the normal course of business, the Company contracts with numerous vendors to provide a wide range of services for the organization. Many of these contracts exceed one year in length. The cost of these contracts is generally recorded as period expenses and presented in appropriate line items in the accompanying consolidated financial statements. The following table presents certain of our contractual obligations as ofDecember 31, 2019 . December 31, 2019 - Payments Due by Period Over One Over Within to Three Three to Over (In thousands) Total One Year Years Five Years Five Years Contractual Obligations: Long-term debt obligations$ 74,196 $ 47,000 $ 8,961 $ 18,235 $ -- Subordinated debt obligations 10,000 -- -- -- 10,000 Operating lease obligations 7,311 1,633 2,665 1,994 1,019 Other contractual obligations 69 69 --
-- --
Total $ 91,576 $ 48,702 $ 11,626 $ 20,229 $ 11,019 Financing and Investing Activities
Our primary investing activities are the origination of loans and the purchase of securities. Primary financing activities consist of transactions in deposit accounts andFederal Home Loan Bank borrowings. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us, local competitors, and other factors. Management generally manages the pricing of deposits to be competitive and to increase core deposit and customer relationships. Occasionally, management offers promotional rates on certain deposit products to attract deposits. In addition, onDecember 17, 2015 , the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors (the "Purchasers") pursuant to which the Company sold and issued$10.0 million in aggregate principal amount of 6.00% fixed-to-floating rate subordinated notes due 2025 (the "Notes"). The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount. The net proceeds from the Notes offering will be used for general corporate purposes, including for the provision of additional liquidity and working capital. The Notes have a stated maturity ofDecember 30, 2025 , and bear interest at a fixed rate of 6.00% per year, from and includingDecember 17, 2015 to, but excluding,December 30, 2020 , computed on the basis of a 360-day year consisting of twelve 30-day months, payable semi-annually in arrears. From and includingDecember 30, 2020 to, but excluding the maturity date or early redemption date, the interest rate shall reset quarterly to an interest rate per year equal to the then current three-month LIBOR rate plus 435.5 basis points, computed on the basis of a 360-day year and the actual number of days elapsed, payable quarterly in arrears. The Notes are redeemable, in whole or in part, on or afterDecember 30, 2020 and at any time upon the occurrences of certain events. 47 The following table presents our primary investing and financing activities during the periods indicated. Years Ended December 31, (In thousands) 2019 2018 Investing activities:
Loan originations, net of principal payments$ (97,705 )
9,826 11,710
Proceeds from sales of securities available for sale 28,406
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Purchases of securities available for sale --
(12,914 ) Financing activities: Increase in deposits 34,536 101,189
Increase (decrease) in short-term borrowings 5,000 (23,000 ) Increase (decrease) in long-term debt 15,668
(18,646 ) Capital Management. We are subject to various regulatory capital requirements administered by theFDIC and theMassachusetts Commissioner of Banks, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. AtDecember 31, 2019 , we exceeded all of our regulatory capital requirements. We are considered "well capitalized" under regulatory guidelines. See "Regulation and Supervision-Federal Regulations-Capital Requirements" and note 15 of the notes to consolidated financial statements.
We may elect to use capital management tools such as cash dividends and common share repurchases to enhance stockholder value.
The Board of Directors declared cash dividends totaling
Off-Balance Sheet Arrangements.In the normal course of operations, we engage in a variety of financial transactions that, in accordance with accounting principles generally accepted inthe United States of America , are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments and unused lines of credit, see note 14 of the notes to consolidated financial statements.
For the years ended
Impact of Recent Accounting Pronouncements
For a discussion of the impact of recent accounting pronouncements, see note 1 of the notes to consolidated financial statements included in this Form 10-K.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented in this Form 10-K have been prepared according to accounting principles generally accepted inthe United States of America , which require the measurement of financial positions and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs and the effect that general inflation may have on both short-term and long-term interest rates. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Although inflation expectations do affect interest rates, interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
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