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, 2013

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 S No £

 

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 S No £

 

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

 

Large accelerated filer £ Accelerated filer £ Non-accelerated filer £ Smaller reporting company S

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes£ No S

 

The number of shares of Common Stock outstanding as of May 13, 2013 is 1,709,291.

 

 

1
 

 

TABLE OF CONTENTS

 

  PART I FINANCIAL INFORMATION Page
     
Item 1. Financial Statements (unaudited):  
  Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012 3
  Consolidated Statements of Income for the three month period  
  ended March 31, 2013 and 2012 4
  Consolidated Statements of Comprehensive Income for the three month period  
  ended March 31, 2013 and 2012 5
  Consolidated Statements of Changes in Shareholders' Equity for the three month  
  period ended March 31, 2013 and 2012 5
  Consolidated Statements of Cash Flows for the three month period ended  
  March 31, 2013 and 2012 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 About Market Risk 36
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

2
 

PART I - FINANCIAL INFORMATION

 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share data)  March 31, 2013  December 31, 2012
ASSETS          
Cash and due from banks  $4,982   $9,545 
Interest bearing demand deposits with other banks   26,459    34,029 
Total cash and cash equivalents   31,441    43,574 
Securities          
Available-for-sale at fair value   118,664    126,287 
Federal Home Loan Bank of Boston stock at cost   5,340    5,747 
Loans held-for-sale   710    1,879 
Loans receivable, net (allowance for loan losses: $4,686 and $4,360)   406,258    388,758 
Other real estate owned   712    244 
Bank premises and equipment, net   11,340    11,520 
Goodwill   9,829    9,829 
Intangible assets (net of accumulated amortization: $1,801 and $1,745)   742    798 
Accrued interest receivable   2,021    1,818 
Cash surrender value of life insurance policies   7,356    7,295 
Other assets   2,930    3,064 
Total Assets  $597,343   $600,813 
LIABILITIES and SHAREHOLDERS' EQUITY          
Deposits          
Demand (non-interest bearing)  $88,464   $98,850 
Demand (interest bearing)   67,714    65,991 
Money market   129,832    128,501 
Savings and other   109,657    103,985 
Certificates of deposit   92,106    93,888 
Total deposits   487,773    491,215 
Repurchase agreements   2,329    1,784 
Federal Home Loan Bank of Boston advances   31,574    31,980 
Deferred taxes   456    590 
Accrued interest and other liabilities   3,005    3,247 
Total Liabilities   525,137    528,816 
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: 1,709,291 and 1,689,691   171    169 
Paid-in capital   13,646    13,158 
Retained earnings   40,653    40,233 
Unearned Compensation - restricted stock awards   (466)   —   
Accumulated other comprehensive income, net   2,202    2,437 
Total Shareholders' Equity   72,206    71,997 
Total Liabilities and Shareholders' Equity  $597,343   $600,813 

3
 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

   Three months ended
Periods ended March 31, (in thousands except per share amounts) unaudited  2013  2012
Interest and dividend income          
Interest and fees on loans  $4,429   $4,595 
Interest on debt securities          
Taxable   467    716 
Tax exempt   488    534 
Other interest and dividends   22    13 
Total interest and dividend income   5,406    5,858 
Interest expense          
Deposits   490    667 
Repurchase agreements   1    13 
Federal Home Loan Bank of Boston advances   312    495 
Total interest expense   803    1,175 
Net interest and dividend income   4,603    4,683 
Provision for loan losses   396    180 
Net interest and dividend income after provision for loan losses   4,207    4,503 
Non-interest income          
Trust and wealth advisory   725    755 
Service charges and fees   516    521 
Gains on sales of mortgage loans, net   279    372 
Mortgage servicing, net   26    (84)
Gains on securities, net       12 
Other   79    83 
Total non-interest income   1,625    1,659 
Non-interest expense          
Salaries   1,750    1,710 
Employee benefits   685    690 
Premises and equipment   583    605 
Data processing   419    402 
Professional fees   380    313 
Collections and OREO   157    111 
FDIC insurance   125    128 
Marketing and community support   122    87 
Amortization of intangibles   56    56 
Other   428    398 
Total non-interest expense   4,705    4,500 
Income before income taxes   1,127    1,662 
Income tax provision   187    412 
Net income  $940   $1,250 
Net income available to common shareholders  $900   $1,167 
           
Basic and diluted earnings per common share  $0.53   $0.69 
Common dividends per share   0.28    0.28 

 

4
 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

   Three months ended
Periods ended March 31, (in thousands)  2013  2012
Net income  $940   $1,250 
Other comprehensive (loss) income          
Net unrealized (losses) gains on securities available-for-sale   (356)   725 
Reclassification of net realized gains in net income       12 
Unrealized (losses) gains on securities available-for-sale   (356)   737 
Income tax benefit (expense)   121    (250)
Unrealized (losses) gains on securities available-for-sale, net of tax   (235)   487 
Pension plan income       36 
Income tax expense       (12)
Pension plan income, net of tax       24 
Other comprehensive (loss) income, net of tax   (235)   511 
Comprehensive income  $705   $1,761 

 

 

 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)

(dollars in thousands) unaudited 

Common Stock

   Shares      Amount

  Preferred Stock  Paid-in
capital
  Retained earnings  Unrecognized
Compensation –
Restricted Stock
Awards
  Accumulated
other comprehensive loss
  Total
shareholders' equity
Balances at December 31, 2011   1,688,731   $169   $16,000   $13,134   $38,264   $   $(705)  $66,862 
Net income for period                   1,250            1,250 
Other comprehensive income, net of tax                           511    511 
Common stock dividends declared                   (473)           (473)
Preferred stock dividends declared                   (83)           (83)
Balances March 31, 2012    1,688,731   $169   $16,000   $13,134   $38,958   $   $(194)  $68,067 
Balances at December 31, 2012   1,689,691   $169   $16,000   $13,158   $40,233   $   $2,437   $71,997 
Net income for year                   940            940 
Other comprehensive income, net of tax                           (235)   (235)
Common stock dividends declared                   (479)           (479)
Preferred stock dividends declared                   (41)           (41)
Issuance of restricted common stock   19,600    2        488        (490)        
Stock based compensation-restricted
stock awards
                       24         24 
Balances at March 31, 2013    1,709,291   $171   $16,000   $13,646   $40,653    $ (466)  $2,202   $72,206 
                                    

5
 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

Three months ended March 31, (in thousands) unaudited  2013  2012
Operating Activities          
Net income  $940   $1,250 
Adjustments to reconcile net income to net cash provided by operating activities:          
Amortization and depreciation          
Securities   155    181 
Bank premises and equipment   215    225 
Core deposit intangible   56    56 
Mortgage servicing rights   104    77 
Fair value adjustment on loans   8    8 
Gains on calls of securities available-for-sale       (12)
Gains on sale/disposals of premises and equipment       (1)
Gain recognized on other real estate owned   (1)   (1)
Provision for loan losses   396    180 
Decrease (increase) in loans held-for-sale   1,169    (360)
(Increase) decrease in deferred loan origination fees and costs, net   (37)   6 
Mortgage servicing rights originated   (152)   (180)
(Decrease) increase in mortgage servicing rights impairment reserve   (33)   92 
Increase in interest receivable   (204)   (663)
Deferred tax benefit   (13)   (13)
Decrease (Increase) in prepaid expenses   15    (1)
Increase in cash surrender value of life insurance policies   (61)   (67)
Decrease in income tax receivable   169    389 
Decrease in other assets   32    6 
Decrease in accrued expenses   174    300 
Decrease in interest payable   (33)   (30)
(Decrease) increase in other liabilities   (383)   16 
Issuance of shares of restricted stock   24     
Net cash provided by operating activities   2,540    1,458 
Investing Activities          
Redemption of Federal Home Loan Bank stock   408    285 
Proceeds from calls of securities available-for-sale   1,200    3,820 
Proceeds from maturities of securities available-for-sale   5,911    6,623 
Proceeds from maturities of securities held-to-maturity       50 
Loan originations and principle collections, net   (19,423)   (147)
Recoveries of loans previously charged-off   3    10 
Proceeds from sale of other real estate owned   1,086    1,744 
Capital expenditures   (35)   (54)
         Net cash (utilized) provided by investing activities   (10,850)   12,331 
Financing Activities          
(Decrease) increase in deposit transaction accounts, net   (1,661)   3,725 
Decrease in time deposits, net   (1,782)   (2,345)
Increase (decrease) in securities sold under agreements to repurchase, net   545    (1,789)
Principal payments on Federal Home Loan Bank of Boston advances   (406)   (11,408)
Common stock dividends paid   (479)   (473)
Preferred stock dividends paid   (40)   (62)
Net cash utilized by financing activities   (3,823)   (12,352)
Net (decrease) increase in cash and cash equivalents   (12,133)   1,437 
Cash and cash equivalents, beginning of period   43,574    36,886 
Cash and cash equivalents, end of period  $31,441   $38,323 
Cash paid during period          
Interest  $948   $1,205 
Income taxes   1,285    788 
Non-cash transfers          
Transfer from loans to other real estate owned   1,553     
From other real estate owned to loans       1,000 

6
 

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, comprehensive 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, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in Salisbury's 2012 Annual Report on Form 10-K for the period ended December 31, 2012.

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 February 2013, the FASB issued ASU 2013-04, “Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date.” The objective of the amendments in this ASU is to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing guidance in U.S. generally accepted accounting principles (GAAP). Examples of obligations within the scope of this ASU include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013; and should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within the ASU scope that exist at the beginning of an entity’s fiscal year of adoption. Salisbury anticipates that the adoption of this guidance will not have a material impact on its consolidated financial statements.

In April 2013, the FASB issued ASU 2013-07, “Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting.” The amendments in this ASU are being issued to clarify when an entity should apply the liquidation basis of accounting. The guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. Additionally, the amendments require disclosures about an entity’s plan for liquidation, the methods and significant assumptions used to measure assets and liabilities, the type and amount of costs and income accrued, and the expected duration of the liquidation process. The amendments are effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted. Salisbury anticipates that the adoption of this guidance will not have an impact on its consolidated financial statements.

In October 2012, the FASB issued ASU 2012-06, “Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution.” The amendments in this update clarify the applicable guidance for subsequently measuring an indemnification asset recognized as a result of a government-assisted acquisition of a financial institution. For public entities, the amendments in this update are effective for fiscal years, and interim periods within those years beginning on or after December 15, 2012. The adoption of ASU 2012-06 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.

7
 

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 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, 2013                    
Available-for-sale                    
U.S. Treasury notes  $2,496   $223   $   $2,719 
U.S. Government Agency notes   7,514    183        7,697 
Municipal bonds   44,235    1,883    (262)   45,856 
Mortgage backed securities                    
U.S. Government Agencies   42,782    1,204    (28)   43,958 
Collateralized mortgage obligations                    
U.S. Government Agencies   4,689    63        4,752 
Non-agency   10,292    462    (64)   10,690 
SBA bonds   2,589    92        2,681 
Preferred Stock   20    291        311 
Total securities available-for-sale  $114,617   $4,401   $(354)  $118,664 
Non-marketable securities                    
Federal Home Loan Bank of Boston stock  $5,340   $   $   $5,340 

 

(in thousands)  Amortized
cost (1)
  Gross un-
realized gains
  Gross un-realized losses  Fair value
December 31, 2012                    
Available-for-sale                    
U.S. Treasury notes  $2,496   $237   $   $2,733 
U.S. Government Agency notes   7,515    211        7,726 
Municipal bonds   45,395    2,138    (168)   47,365 
Mortgage backed securities                    
U.S. Government Agencies   47,465    1,284    (20)   48,729 
Collateralized mortgage obligations                    
U.S. Government Agencies   5,131    66        5,197 
Non-agency   11,081    494    (68)   11,507 
SBA bonds   2,781    82        2,863 
Preferred Stock   20    147        167 
Total securities available-for-sale  $121,884   $4,659   $(256)  $126,287 
Non-marketable securities                    
Federal Home Loan Bank of Boston stock  $5,747   $   $   $5,747 
(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, 2013 and 2012.

8
 

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, 2013                  
Available-for-sale                              
Municipal Bonds  $1,325   $56   $2,316   $206   $3,641   $262 
Mortgage backed securities   2,735    27    43    1    2,778    28 
Collateralized mortgage obligations                              
Non-agency   597    2    847    17    1,444    19 
Total temporarily impaired securities   4,657    85    3,206    224    7,863    309 
Other-than-temporarily impaired securities                              
Collateralized mortgage obligations                              
Non-agency   459    6    1,817    39    2,276    45 
Total temporarily and other-than-temporarily impaired securities  $5,116   $91   $5,023   $263   $10,139   $354 

 

 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, 2013.

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, 2013.

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, 2013.

Non-agency CMOs: Salisbury performed a detailed cash flow analysis of its non-agency CMOs at March 31, 2013 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, 2013. 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.

9
 

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)   2013    2012 
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 was 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 repurchased 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, 2013. 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.

10
 

NOTE 3 - LOANS

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

(in thousands)  March 31, 2013  December 31, 2012
Residential 1-4 family  $209,159   $198,552 
Residential 5+ multifamily   4,714    3,889 
Construction of residential 1-4 family   1,395    2,379 
Home equity credit   33,925    34,162 
Residential real estate   249,193    238,982 
Commercial   96,835    87,382 
Construction of commercial   9,755    5,823 
Commercial real estate   106,590    93,205 
Farm land   4,282    4,320 
Vacant land   7,898    9,926 
Real estate secured   367,963    346,433 
Commercial and industrial   33,943    38,094 
Municipal   3,995    3,378 
Consumer   3,975    4,181 
Loans receivable, gross   409,876    392,086 
Deferred loan origination fees and costs, net   1,068    1,032 
Allowance for loan losses   (4,686)   (4,360)
Loans receivable, net  $406,258   $388,758 
Loans held-for-sale          
Residential 1-4 family  $710   $1,879 

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.

Loan Credit Quality

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

(in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
March 31, 2013                              
Residential 1-4 family  $189,694   $13,344   $6,023   $98   $   $209,159 
Residential 5+ multifamily   2,354    1,142    1,218            4,714 
Construction of residential 1-4 family   1,395                    1,395 
Home equity credit   30,881    1,368    1,676            33,925 
Residential real estate   224,324    15,854    8,917    98        249,193 
Commercial   68,196    19,679    8,960            96,835 
Construction of commercial   8,989    153    613            9,755 
Commercial real estate   77,185    19,832    9,573            106,590 
Farm land   1,644    1,466    1,172            4,282 
Vacant land   4,425    189    3,284            7,898 
Real estate secured   307,578    37,341    22,946    98        367,963 
Commercial and industrial   24,049    8,532    1,362            33,943 
Municipal   3,995                    3,995 
Consumer   3,851    101    23            3,975 
Loans receivable, gross  $339,473   $45,974   $24,331   $98   $   $409,876 

11
 

(in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
December 31, 2012                              
Residential 1-4 family  $180,442   $12,473   $5,538   $99   $   $198,552 
Residential 5+ multifamily   2,872    773    244            3,889 
Construction of residential 1-4 family   1,570        809            2,379 
Home equity credit   30,981    1,848    1,333            34,162 
Residential real estate   215,865    15,094    7,924    99        238,982 
Commercial   64,817    13,299    9,266            87,382 
Construction of commercial   5,055    297    471            5,823 
Commercial real estate   69,872    13,596    9,737            93,205 
Farm land   2,799    341    1,180            4,320 
Vacant land   4,885    863    4,178            9,926 
Real estate secured   293,421    29,894    23,019    99        346,433 
Commercial and industrial   28,453    8,300    1,341            38,094 
Municipal   3,378                    3,378 
Consumer   3,994    159    28            4,181 
Loans receivable, gross  $329,246   $38,353   $24,388   $99   $   $392,086 

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, 2013                                             
Residential 1-4 family  $199,921   $5,445   $549   $2,771   $356   $117   $3,793   $165   $2,880 
Residential 5+ multifamily   4,610            104            104         
Construction of residential
1-4 family
   1,395                                 
Home equity credit   33,241    153    495    36            531        113 
Residential real estate   239,167    5,598    1,044    2,911    356    117    4,428    165    2,993 
Commercial   91,560    2,817    76    1,024    424    934    2,458    198    2,043 
Construction of commercial   9,592        21    142            163        21 
Commercial real estate   101,152    2,817    97    1,166    424    934    2,621    198    2,064 
Farm land   3,110    785    14    373            387         
Vacant land   4,772            47        3,079    3,126        3,126 
Real estate secured   348,201    9,200    1,155    4,497    780    4,130    10,561    363    8,182 
Commercial and industrial   33,592    267    58    26            84        42 
Municipal   3,995                                 
Consumer   3,886    66    15    8            23         
Loans receivable, gross  $389,674   $9,533   $1,228   $4,531   $780   $4,130   $10,668   $165   $8,224 
December 31, 2012                                             
Residential 1-4 family  $190,488   $2,545   $3,578   $639   $1,185   $117   $5,519   $   $3,024 
Residential 5+ multifamily   3,889                                 
Construction of residential
1-4 family
   2,379                                 
Home equity credit   32,540    890    113    396        223    732        442 
Residential real estate   229,296    3,435    3,691    1,035    1,185    340    6,251        3,466 
Commercial   83,477    864    1,104    566    58    1,313    3,041        2,214 
Construction of commercial   5,659        164                164        21 
Commercial real estate   89,136    864    1,268    566    58    1,313    3,205        2,235 
Farm land   3,898    422                             
Vacant land   5,932            48    740    3,206    3,994        3,994 
Real estate secured   328,262    4,721    4,959    1,649    1,983    4,859    13,450        9,695 
Commercial and industrial   37,618    351    26    99            125        164 
Municipal   3,378                                 
Consumer   4,034    108    25    14            39         
Loans receivable, gross  $373,292   $5,180   $5,010   $1,762   $1,983   $4,859   $13,614   $   $9,859 

12
 

Troubled Debt Restructurings

Troubled debt restructurings occurring during the periods are as follows:

   Three months ended March 31, 2013  Three months ended March 31, 2012
(in thousands)  Quantity  Pre-modification balance  Post-modification balance  Quantity  Pre-modification balance  Post-modification balance
Residential real estate      $   $    1   $326   $326 
Commercial real estate   2    1,022    1,022    5    559    559 
Commercial and industrial                        
Troubled debt restructurings   2   $1,022   $1,022    6   $1,105   $1,105 
Rate reduction and term extension   2   $1,022   $1,022    2   $373   $373 
Debt consolidation and term extension               3    706    706 
Seasonal interest only concession               1    26    26 
Troubled debt restructurings   2   $1,022   $1,022    6   $1,105   $1,105 

Two loans were restructured during the quarter ended March 31, 2013 and both were current at March 31, 2013.

Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:

   March 31, 2013   March 31, 2012 
Three months ended
(in thousands)
   Beginning balance    Provision    Charge-offs    Recoveries    Ending balance    Beginning balance    Provision    Charge-offs    Recoveries    Ending balance 
Residential  $1,934   $23   $(18)  $   $1,939   $1,479   $39   $(18)  $   $1,500 
Commercial   1,059    178            1,237    1,139    (79)       1    1,061 
Land   301    265    (38)       528    410    (29)   (42)       339 
Real estate   3,294    466    (56)       3,704    3,028    (69)   (60)   1    2,900 
Commercial & industrial   499    (40)   (4)       455    704    100    (29)   3    778 
Municipal   36    4            40    24    4            28 
Consumer   91    (15)   (13)   3    66    79    59    (10)  5    133 
Unallocated   440    (19)           421    241    86            327 
Totals  $4,360   $396   $(73)  $3   $4,686   $4,076   $180   $(99)  $9   $4,166 

13
 

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, 2013                              
Residential 1-4 family  $202,490   $794   $6,669   $643   $209,159   $1,437 
Residential 5+ multifamily   3,743    21    971    50    4,714    71 
Construction of residential 1-4 family   1,395    6            1,395    6 
Home equity credit   33,741    424    184    1    33,925    425 
Residential real estate   241,369    1,245    7,824    694    249,193    1,939 
Commercial   91,276    1,045    5,559    88    96,835    1,133 
Construction of commercial   9,734    104    21        9,755    104 
Commercial real estate   101,010    1,149    5,580    88    106,590    1,237 
Farm land   4,282    68            4,282    68 
Vacant land   4,773    58    3,125    402    7,897    460 
Real estate secured   351,434    2,520    16,529    1,184    367,962    3,704 
Commercial and industrial   32,952    426    991    29    33,943    455 
Municipal   3,995    40            3,995    40 
Consumer   3,898    36    77    30    3,975    66 
Unallocated allowance                       421 
Totals  $392,279   $3,022   $17,597   $1,243   $409,876   $4,686 
  Collectively evaluated  Individually evaluated  Total portfolio
(in thousands)   Loans    Allowance    Loans    Allowance    Loans    Allowance 
December 31, 2012                              
Residential 1-4 family  $191,886   $743   $6,666   $652   $198,552   $1,395 
Residential 5+ multifamily   2,913    22    976    50    3,889    72 
Construction of residential 1-4 family   2,379    10            2,379    10 
Home equity credit   33,697    365    465    92    34,162    457 
Residential real estate   230,875    1,140    8,107    794    238,982    1,934 
Commercial   81,635    931    5,747    64    87,382    995 
Construction of commercial   5,802    64    21        5,823    64 
Commercial real estate   87,437    995    5,768    64    93,205    1,059 
Farm land   4,320    66            4,320    66 
Vacant land   5,795    70    4,131    164    9,926    234 
Real estate secured   328,427    2,271    18,006    1,022    346,433    3,293 
Commercial and industrial   37,073    467    1,021    32    38,094    499 
Municipal   3,378    36            3,378    36 
Consumer   4,061    39    120    53    4,181    92 
Unallocated allowance                       440 
Totals  $372,939   $2,813   $19,147   $1,107   $392,086   $4,360 

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

(in thousands)  Collectively evaluated  Individually evaluated  Total portfolio
   Loans    Allowance    Loans    Allowance    Loans    Allowance 
March 31, 2013                              
Performing loans  $382,423   $2,687   $77   $30   $382,500   $2,717 
Potential problem loans   9,856    335    2,558    86    12,414    421 
Impaired loans           14,962    1,127    14,962    1,127 
Unallocated allowance                       421 
Totals  $392,279   $3,022   $17,597   $1,243   $409,876   $4,686 
December 31, 2012                              
Performing loans  $364,594   $2,567   $121   $52   $364,713   $2,619 
Potential problem loans   8,345    246    2,465    131    10,810    377 
Impaired loans           16,562    924    16,563    924 
Unallocated allowance                       440 
Totals  $372,939   $2,813   $19,148   $1,107   $392,086   $4,360 

14
 

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             Loan balance      
(in thousands)   Book    Note    Average    Specific allowance    Income recognized    Book    Note    Average    Income recognized 
March 31, 2013                                             
Residential 1-4 family  $3,917   $3,998   $3,868   $631   $17   $2,073   $2,279   $2,161   $10 
Home equity credit   48    48    223    1        113    118    109     
Residential real estate   3,965    4,046    4,091    632    17    2,186    2,396    2,270    10 
Commercial   1,695    1,860    1,665    88    14    3,122    3,320    3,096    26 
Vacant land   3,187    3,387    3,187    403        (61)   601    527     
Real estate secured   8,847    9,293    8,943    1,123    31    5,247    6,317    5,893    36 
Commercial and industrial   227    257    257    4    3    641    1,043    669    9 
Consumer                                    
Totals  $9,074   $9,550   $9,200   $1,127   $34   $5,888   $7,360   $6,562   $45 

 

   Impaired loans with specific allowance   Impaired loans with no specific allowance 
   Loan balance             Loan balance      
(in thousands)   Book    Note    Average    Specific allowance    Income recognized    Book    Note    Average    Income recognized 
December 31, 2012                                             
Residential 1-4 family  $3,857   $3,925   $2,404   $578   $77   $2,263   $2,460   $1,601   $34 
Home equity credit   351    351    146    92        91    93    203     
Residential real estate   4,208    4,276    2,550    670    77    2,354    2,553    1,804    34 
Commercial   1,629    1,784    1,925    64    60    3,381    3,576    3,122    82 
Vacant land   3,186    3,387    1,455    158    —      808    1,467    2,358    4 
Real estate secured   9,023    9,447    5,930    892    137    6,543    7,596    7,284    120 
Commercial and industrial   335    368    833    32    13    661    1,063    854    31 
Consumer                                    
Totals  $9,358   $9,815   $6,763   $924   $150   $7,204   $8,659   $8,138   $151 

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)   2013    2012 
Residential mortgage loans serviced for others  $148,705   $125,086 
Fair value of mortgage servicing rights   1,739    754 

Changes in mortgage servicing rights are as follows:

     Three months
Periods ended March 31, (in thousands)  2013    2012  
Loan Servicing Rights          
Balance, beginning of period  $1,075   $772 
Originated   152    177 
Amortization (1)   (104)   (77)
Balance, end of period   1,123    872 
Valuation Allowance          
Balance, beginning of period   (38)   (22)
Decrease (increase) in impairment reserve (1)   33    (92)
Balance, end of period   (5)   (114)
Loan servicing rights, net  $1,119   $758 
(1)Amortization expense and changes in the impairment reserve are recorded in loan servicing fee income.

15
 

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, 2013  December 31, 2012
Securities available-for-sale (at fair value)  $53,484   $68,839 
Loans receivable   115,496    132,720 
Total pledged assets  $168,980   $201,559 

At March 31, 2013, securities were pledged as follows: $43.6 million to secure public deposits, $9.7 million to secure repurchase agreements and $0.2 million to secure FHLBB advances. Loans receivable were pledged to secure FHLBB advances and credit facilities.

NOTE 6 – EARNINGS PER SHARE

The Company defines unvested share-based payment awards that contain nonforfeitable rights to dividends as participating securities that are included in computing Earnings Per Share (“EPS”) using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each share of common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. Earnings per common share are calculated by dividing earnings allocated to common stockholders by the weighted-average number of common shares outstanding during the period. Basic EPS excludes dilution and is computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

The following table sets forth the computation of earnings per share (basic and diluted) for the periods indicated:

Periods ended March 31, (in thousands, except per share amounts)  2013  2012
Net income  $940   $1,250 
  Less: Preferred stock dividends declared   (40)   (83)
  Less: Undistributed earnings allocated to participating securities   (10)    
Net income allocated to common stock  $890   $1,167 
Common shares issued   1,709    1,689 
  Less: Unvested restricted stock awards   (20)    
Common shares outstanding used to calculate basic earnings per common share   1,689    1,689 
  Add: Diluted effect of unvested restricted stock awards        
Common shares outstanding used to calculate diluted earnings per common share   1,689     
Earnings per common share (basic and diluted)   0.53    0.69 

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, 2013, that Salisbury and the Bank meet all of their capital adequacy requirements.

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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, 2013                  
Total Capital (to risk-weighted assets)                              
Salisbury  $64,281    16.47%  $31,228    8.0%   n/a    —   
Bank   54,097    13.71    31,559    8.0   $39,449    10.0%
Tier 1 Capital (to risk-weighted assets)                              
Salisbury   59,433    15.23    15,614    4.0    n/a    —   
Bank   49,248    12.48    15,780    4.0    23,669    6.0 
Tier 1 Capital (to average assets)                              
Salisbury   59,433    10.17    23,372    4.0    n/a    —   
Bank   49,248    8.43    23,372    4.0    29,215    5.0 
December 31, 2012                              
Total Capital (to risk-weighted assets)                              
Salisbury  $63,391    16.63%  $30,494    8.0%   n/a    —   
Bank   53,132    13.77    30,866    8.0   $38,582    10.0%
Tier 1 Capital (to risk-weighted assets)                              
Salisbury   58,933    15.46    15,247    4.0    n/a    —   
Bank   48,674    12.62    15,432    4.0    23,149    6.0 
Tier 1 Capital (to average assets)                              
Salisbury   58,933    9.87    23,876    4.0    n/a    —   
Bank   48,674    8.15    23,876    4.0    29,845    5.0 

DIVIDENDS

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 periods ended March 31, 2013 and December 31, 2012, was 1.0000%. 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 29, 2013, Salisbury declared a Series B Preferred Stock dividend of $41,000, payable on April 1, 2013. 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.

On February 8, 2013, Salisbury granted a total of 19,600 shares of restricted stock pursuant to its 2011 Long Term Incentive Plan, which was approved by shareholders at the 2011 Annual Meeting, to 22 employees, including 5,000 shares to one Named Executive Officer, Richard J. Cantele, Jr., President and Chief Executive Officer.

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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)  2013  2012
Service cost  $—     $115 
Interest cost on benefit obligation   66    93 
Expected return on plan assets   (67)   (115)
Amortization of prior service cost   —      —   
Amortization of net loss   —      36 
Net periodic benefit cost  $(1)  $129 

Salisbury’s 401(k) Plan expense was $83,000 and $70,000, respectively, for the three month periods ended March 31, 2013 and 2012. Other post-retirement benefit obligation expense for endorsement split-dollar life insurance arrangements was $11,000 for the three month periods ended March 31, 2013 and 2012.

NOTE 9 –COMPREHENSIVE INCOME

The components of accumulated other comprehensive losses are as follows:

March 31, (in thousands)  2013  2012
Unrealized losses on securities available-for-sale, net of tax  $2,671   $1,839 
Unrecognized pension plan expense, net of tax   (469)   (2,033)
Accumulated other comprehensive loss, net  $2,202   $(194)

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.

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 provided 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. However, Salisbury did not elect fair value treatment for any financial assets or liabilities upon adoption of such ASC.

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.

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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 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, 2013                    
Assets at fair value on a recurring basis                    
U.S. Treasury notes  $   $2,719   $   $2,719 
U.S. Government agency notes       7,697        7,697 
Municipal bonds       45,856        45,856 
Mortgage-backed securities:                    
U.S. Government agencies       43,958        43,958 
Collateralized mortgage obligations:                    
U.S. Government agencies       4,752        4,752 
Non-agency       10,690        10,690 
SBA bonds       2,681        2,681 
Corporate bonds                
Preferred stocks   311            311 
Securities available-for-sale  $311   $118,353   $   $118,664 
Assets at fair value on a non-recurring basis                    
Collateral dependent impaired loans  $   $   $7,947   $7,947 
Other real estate owned           712    712 
December 31, 2012                    
Assets at fair value on a recurring basis                    
U.S. Treasury notes  $   $2,733   $   $2,733 
U.S. Government agency notes       7,726        7,726 
Municipal bonds       47,365        47,365 
Mortgage-backed securities:                   
U.S. Government agencies       48,729        48,729 
Collateralized mortgage obligations:                    
U.S. Government agencies       5,197        5,197 
Non-agency       11,507        11,507 
SBA bonds       2,863        2,863 
Preferred stocks  $167   $126,120   $   $126,287 
Securities available-for-sale                    
Assets at fair value on a non-recurring basis                    
Collateral dependent impaired loans           8,434    8,434 
Other real estate owned           244    244 

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

      Fair value measurements using
(in thousands)   Carrying value    Estimated
fair value
    Level 1    Level 2     Level 3 
March 31, 2013                       
Financial Assets                         
Cash and due from banks  $31,441   $31,441   $31,441   $   $ 
Securities available-for-sale   118,664    118,664    311    118,353     
Federal Home Loan Bank stock   5,340    5,340        5,340     
Loans held-for-sale   710    710            710 
Loans receivable net   406,258    406,258            406,258 
Accrued interest receivable   2,021    2,021            2,021 
Financial Liabilities                         
Demand (non-interest-bearing)  $88,464   $88,464   $   $   $88,464 
Demand (interest-bearing)   67,714    67,714            67,714 
Money market   129,832    129,832            129,832 
Savings and other   109,657    109,657            109,657 
Certificates of deposit   92,106    92,886            92,886 
Deposits   487,773    488,553            488,553 
FHLBB advances   31,574    35,203            35,203 
Repurchase agreements   2,329    2,329            2,329 
Accrued interest payable    163    163            163 
December 31, 2012                         
Financial Assets                         
Cash and due from banks  $43,574   $43,574   $43,574   $   $ 
Securities available-for-sale   126,287    126,287    167    126,120     
Federal Home Loan Bank stock   5,747    5,747        5,747     
Loans held-for-sale   1,879    1,893            1,893 
Loans receivable net   388,758    389,292            389,292 
Accrued interest receivable   1,818    1,818            1,818 
Financial Liabilities                         
Demand (non-interest-bearing)  $98,850   $98,850   $   $   $98,850 
Demand (interest-bearing)   65,991    65,991            65,991 
Money market   128,501    128,501            128,501 
Savings and other   103,985    103,985            103,985 
Certificates of deposit   93,888    94,894            94,894 
Deposits   491,215    492,221            492,221 
FHLBB advances   31,980    35,363            35,363 
Repurchase agreements   1,784    1,784            1,784 
Accrued interest payable    196    196            196 

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, 2012.

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 2012 Annual Report on Form 10-K for the year ended December 31, 2012 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 2012 Annual Report on Form 10-K for the period ended December 31, 2012 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 affect 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, 2013 and 2012

Overview

Net income available to common shareholders was $900,000, or $0.53 per common share, for the first quarter ended March 31, 2013 (first quarter 2013), compared with $531,000, or $0.31 per common share, for the fourth quarter ended December 31, 2012 (fourth quarter 2012), and $1,167,000, or $0.69 per common share, for the first quarter ended March 31, 2012 (first quarter 2012).

Earnings per common share of $0.53 increased $0.22 versus fourth quarter 2012, and decreased $0.16, versus first quarter 2012.
The net interest margin increased 22 basis points versus fourth quarter 2012 and remained the same as first quarter 2012 at 3.54%.
Tax equivalent net interest income increased $194,000, or 4%, versus fourth quarter 2012, and decreased $59,000, or 1%, versus first quarter 2012.
Provision for loan losses was $396,000, versus $380,000 for fourth quarter 2012 and $180,000 for first quarter 2012. Net loan charge-offs were $70,000, versus $199,000 for fourth quarter 2012 and $90,000 for first quarter 2012.
Non-interest income decreased $252,000, or 13%, versus fourth quarter 2012 and decreased $34,000, or 2%, versus first quarter 2012.
Non-interest expense decreased $629,000, or 12%, versus fourth quarter 2012 and increased $205,000, or 5%, versus first quarter 2012.
Net loans receivable increased $17.5 million or 4.5% during the first calendar quarter of 2013 to $406 million, which reflected an increase of $34.5 million or 9% from the end of the first quarter of 2012.
Non-performing assets decreased $807,000, or 8%, to $9.3 million, or 1.6% of total assets, versus fourth quarter 2012 and increased $1.7 million versus first quarter 2012. Accruing loans receivable 30-to-89 days past due decreased $911,000 to $4.7 million, or 1.15% of gross loans receivable, versus fourth quarter 2012 and increased $538,000 versus first quarter 2012.

Net Interest Income

Tax equivalent net interest income for first quarter 2013 increased $194,000, or 4%, versus fourth quarter 2012, and decreased $59,000, or 1%, versus first quarter 2012. Average total interest bearing deposits increased $0.7 million versus fourth quarter 2012 and increased $5.3 million versus first quarter 2012. Average earning assets decreased $12.4 million versus fourth quarter 2012 due to the early prepayment of a $10 million FHLBB advance in fourth quarter 2012, and decreased $5.9 million versus first quarter 2012. The net interest margin increased 22 basis points versus fourth quarter 2012 and remained the same as first quarter 2012 at 3.54%.

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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)  2013  2012  2013  2012  2013  2012
Loans (a)  $403,033   $377,704   $4,485   $4,595    4.46%   4.87%
Securities (c)(d)   118,410    149,699    1,199    1,519    4.05    4.06 
FHLBB stock   5,652    5,962    5    10    0.38    0.68 
Short term funds (b)   27,447    27,113    17    13    0.25    0.19 
Total earning assets   554,542    560,478    5,706    6,137    4.12    4.38 
Other assets   40,320    41,829                     
Total assets  $594,862   $602,307                     
Interest-bearing demand deposits  $66,689   $68,510    69    109    0.42    0.64 
Money market accounts   128,691    121,869    87    114    0.27    0.37 
Savings and other   105,934    95,919    52    77    0.20    0.32 
Certificates of deposit   92,696    102,418    282    367    1.23    1.43 
Total interest-bearing deposits   394,010    388,716    490    667    0.50    0.69 
Repurchase agreements   1,856    11,119    1    13    0.23    0.47 
FHLBB advances   31,709    46,963    312    495    3.93    4.22 
Total interest-bearing liabilities   427,575    446,798    803    1,175    0.76    1.05 
Demand deposits   87,923    83,354                     
Other liabilities   6,876    4,387                     
Shareholders’ equity   72,488    67,768                     
Total liabilities & shareholders’ equity  $594,862   $602,307                     
Net interest income            $4,903   $4,962           
Spread on interest-bearing funds                       3.36    3.33 
Net interest margin (e)                       3.54    3.54 
(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 $300,000 and $279,000, respectively for 2013 and 2012 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)  2013 versus 2012
Change in interest due to   Volume    Rate    Net 
Interest-earning assets               
Loans  $295   $(405)  $(110)
Securities   (317)   (3)   (320)
FHLBB stock       (5)   (5)
Short term funds       4    4 
Total   (22)   (409)   (431)
Interest-bearing liabilities               
Deposits   (23)   (154)   (177)
Repurchase agreements   (8)   (4)   (12)
FHLBB advances   (155)   (28)   (183)
Total   (186)   (186)   (372)
Net change in net interest income  $164   $(223)  $(59)

Interest Income

Tax equivalent interest income decreased $431,000, or 7.0%, to $5.7 million for first quarter 2013 as compared with first quarter 2012.

Loan income decreased $110,000, or 2.4%, primarily due to a 41 basis points decline in the average loan yield offset in part by a $25.3 million, or 6.7%, increase in average loans.

Tax equivalent securities income decreased $320,000, or 21.7%, for first quarter 2013 as compared with first quarter 2012, primarily due to a $31.3 million, or 20.9%, decrease in average volume calls and sales of agency bonds and prepayments of mortgage backed securities.

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Interest Expense

Interest expense decreased $372,000, or 31.7%, to $0.8 million for first quarter 2013 as compared with first quarter 2012.

Interest on deposit accounts and retail repurchase agreements decreased $189,000, or 27.8%, as a result of lower average rates, down 19 basis points on deposits and 24 basis points on repurchase agreements. Decreased rates were offset in part by a $5.3 million, or 1.4%, increase in the average balance of deposits. 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 $183,000 as a result of lower average borrowings, down $15.3 million, and by the average borrowing rate decrease of 29 basis points as compared with first quarter 2012. The decline in advances resulted from scheduled maturities that were not replaced with new advances and the prepayment of a $10 million advance in December 2012.

Provision and Allowance for Loan Losses

The provision for loan losses was $396,000 for first quarter 2013 and $180,000 for first quarter 2012. Net loan charge-offs were $70,000 and $90,000, 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)  2013  2012
Balance, beginning of period  $4,360   $4,076 
Provision for loan losses   396    180 
Charge-offs          
Real estate mortgages   (56)   (60)
Commercial & industrial   (4)   (29)
Consumer   (13)   (10)
Total charge-offs   (73)   (99)
Recoveries          
Real estate mortgages       1 
Commercial & industrial       3 
Consumer   3    5 
Total recoveries   3    9 
Net charge-offs   (70)   (90)
Balance, end of period  $4,686   $4,166 
Loans receivable, gross  $409,876   $374,877 
Non-performing loans   8,587    7,606 
Accruing loans past due 30-89 days   4,718    4,181 
Ratio of allowance for loan losses:          
to loans receivable, gross   1.14%   1.11%
to non-performing loans   54.59    54.77 
Ratio of non-performing loans to loans receivable, gross   2.09    2.03 
Ratio of accruing loans past due 30-89 days to loans receivable, gross   1.15    1.12 

Reserve coverage at March 31, 2013, as measured by the ratio of allowance for loan losses to gross loans, improved to 1.14%, as compared with 1.11% at December 31, 2012 and 1.11% a year ago at March 31, 2012.

During the first three months of 2013, non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) decreased $1.3 million to $8.6 million, or 2.09% of gross loans receivable, from 2.51% at December 31, 2012 and 2.03% at March 31, 2012 while accruing loans past due 30-89 days decreased $0.9 million to $4.7 million, or 1.15% of gross loans receivable from 1.44% at December 31, 2012 and 1.12% at March 31, 2012. 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:

   Collectively evaluated  Individually evaluated  Total portfolio
March 31, 2013  (in thousands)   Loans    Allowance    Loans    Allowance    Loans    Allowance 
Performing loans  $382,422   $2,687   $78   $30   $382,500   $2,717 
Potential problem loans   9,856    335    2,558    86    12,414    421 
Impaired loans           14,962    1,127    14,962    1,127 
Unallocated allowance               421        421 
Totals  $392,278   $3,022   $17,598   $1,664   $409,876   $4,686 
   Collectively evaluated  Individually evaluated  Total portfolio
December 31, 2012  (in thousands)   Loans    Allowance    Loans    Allowance    Loans    Allowance 
Performing loans  $364,592   $2,567   $121   $52   $364,713   $2,619 
Potential problem loans   8,345    246    2,465    131    10,810    377 
Impaired loans           16,563    924    16,563    924 
Unallocated allowance               440        440 
Totals  $372,937   $2,813   $19,149   $1,547   $392,086   $4,360 

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, 2013.

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, 2013.

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 July 2012 and by the FDIC in July 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)  2013    2012    2013 vs. 2012
Trust and wealth advisory fees  $725   $755   $(30)   (3.97)%
Service charges and fees   516    521    (5)   (0.96)
Gains on sales of mortgage loans, net   279    372    (93)   (25.00)
Mortgage servicing, net   26    (84)   110    130.95 
Gains on securities, net       12    (12)   (100.00)
Other   79    83    (4)   (4.82)
Total non-interest income  $1,625   $1,659   $(34)   (2.05)%

Non-interest income for first quarter 2013 decreased $252,000 versus fourth quarter 2012 and decreased $34,000 versus first quarter 2012. Trust and Wealth Advisory revenues decreased $47,000 versus fourth quarter 2012 and decreased $30,000 versus first quarter 2012. The year-over-year revenue decrease is the result of higher estate fees collected in first quarter 2012, offset by growth in managed assets. Service charges and fees decreased $45,000 versus fourth quarter 2012 and decreased $5,000 versus first quarter 2012. Income from sales and servicing of mortgage loans decreased $165,000 versus fourth quarter 2012 and increased $17,000 versus first quarter 2012 due to residential mortgage loan sales and mortgage servicing valuations. Mortgage loans sales totaled $8.7 million for first quarter 2013, $13.4 million for fourth quarter 2012 and $16.3 million for first quarter 2012. First quarter 2013, fourth quarter 2012, and first quarter 2012 included mortgage servicing valuation impairment (benefits)/charges of $(33,000), $(73,000), and $92,000, respectively. Other income includes 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)  2013    2012    2013 vs. 2012
Salaries  $1,750   $1,710   $40    2.34%
Employee benefits   685    690    (5)   (0.72)
Premises and equipment   583    605    (22)   (3.64)
Data processing   419    402    17    4.23 
Professional fees   380    313    67    21.41 
Collections and OREO   157    111    46    40.54 
FDIC insurance   125    128    (3)   (2.34)
Marketing and community contributions   122    87    35    40.23 
Amortization of intangible assets   56    56         
Other   428    398    30    7.79 
Non-interest expense  $4,705   $4,500   $205    4.56%

Non-interest expense for first quarter 2013 decreased $629,000 versus fourth quarter 2012 and increased $205,000 versus first quarter 2012. Salaries decreased $130,000 versus fourth quarter 2012 due to changes in staffing levels and mix. Employee benefits increased $17,000 versus fourth quarter 2012 due to new deferred compensation plans and an increase in the 401K Safe Harbor Plan in response to the freeze placed on the defined benefit pension plan as of December 31, 2012. Employee benefit expense for the period also reflects the current expense related to the award of 19,600 shares of restricted stock. The total expense of $490,000 will be recognized on a straight line basis over the thirty six month vesting period under which the shares were awarded on February 8, 2013. Premises and equipment decreased $26,000 versus fourth quarter 2012 and decreased $22,000 versus first quarter 2012. The current quarter’s decrease in expense was a result of seasonal maintenance, and repairs to the Lakeville branch during the fourth quarter of 2012. The year-over-year decrease was due primarily to the prior year’s one-time expense related to ADA compliance for ATMs. This favorable first quarter 2013 non-interest expense decrease was offset slightly by higher building maintenance and repairs, and weather related expenses this quarter as compared to the mild winter experienced in the Northeast during the prior quarter and year ago quarter.

Data processing increased $40,000 versus fourth quarter 2012 and $17,000 versus first quarter 2012. Professional fees increased $83,000 versus fourth quarter 2012, and $67,000 versus first quarter 2012. The increases in the current quarter were due to legal expenses and an executive search. Collections and OREO related expenses decreased $184,000 versus fourth quarter 2012 and increased $46,000 versus first quarter 2012. The decrease versus fourth quarter was mainly due to lower current quarter real estate taxes and legal collections, while the fourth quarter 2012 included a one-time loss associated with the sale of an OREO property. Other operating expenses decreased $466,000 versus fourth quarter 2012 and increased $30,000 versus first quarter 2012. The expense in the prior quarter includes a one-time prepayment expense of $450,000 as the result of the early prepayment of a $10 million FHLBB advance maturing 12/16/2013 with a 4.88% coupon. Year-over-year increases were due to rises in other administrative and operational expenses.

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Income taxes

The effective income tax rates for first quarter 2013, fourth quarter 2012 and first quarter 2012 were 16.59%, 4.33% and 24.82%, 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.

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 $597 million at March 31, 2013, down $3 million from December 31, 2012. Loans receivable, net, were $406 million at March 31, 2013, up $17.5 million, or 4.5%, from December 31, 2012. Non-performing assets were $9.3 million at March 31, 2013, down $0.8 million from $10.1 million at December 31, 2012. Reserve coverage, as measured by the ratio of the allowance for loan losses to gross loans, was 1.14%, 1.11% and 1.11%, at March 31, 2013, December 31, 2012 and March 31, 2012, respectively. Deposits were $488 million, down $3 million from $491 million at December 31, 2012.

At March 31, 2013, book value and tangible book value per common share were $32.88 and $26.70, respectively. Salisbury’s Tier 1 leverage and total risk-based capital ratios were 10.17% and 16.47%, respectively, and above the “well capitalized” limits as defined by the FRB.

Securities and Short Term Funds

During first quarter 2013, securities decreased $7.6 million to $119 million, and FHLBB advances decreased $0.4 million, while cash and cash-equivalents (interest-bearing deposits with other banks, money market funds and federal funds sold) decreased $12.1 million to $31.4 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, 2013.

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, 2013. 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, 2013 included net unrealized holding gains, net of tax, of $2.2 million, and decrease of $0.2 million over December 2012, partially offset by unrecognized pension plan expense, net of tax, of $0.5 million and $0.5 million respectively.

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Loans

Net loans receivable increased $17.5 million during first quarter 2013 to $406.3 million at March 31, 2013, compared with $388.8 million at December 31, 2012.

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

(in thousands)  March 31, 2013  December 31, 2012
Residential 1-4 family  $209,159   $198,552 
Residential 5+ multifamily   4,714    3,889 
Construction of residential 1-4 family   1,395    2,379 
Home equity credit   33,925    34,162 
Residential real estate   249,193    238,982 
Commercial   96,835    87,382 
Construction of commercial   9,755    5,823 
Commercial real estate   106,590    93,205 
Farm land   4,282    4,320 
Vacant land   7,898    9,926 
Real estate secured   367,963    346,433 
Commercial and industrial   33,943    38,094 
Municipal   3,995    3,378 
Consumer   3,975    4,181 
Loans receivable, gross   409,876    392,086 
Deferred loan origination fees and costs, net   1,068    1,032 
Allowance for loan losses   (4,686)   (4,360)
Loans receivable, net  $406,258   $388,758 
Loans held-for-sale          
Residential 1-4 family  $710   $1,879 

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 2013, while non-performing assets decreased $0.8 million, the amount of total impaired and potential problem loans remained unchanged at $27.4 million (6.7% of gross loans receivable) during first quarter 2013, compared to $27.4 million, or 7.0% of gross loans receivable at December 31, 2012, and decreased $0.3 million from $27.7 million, or 7.4% of gross loans receivable at March 31, 2012.

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

(in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
March 31, 2013                              
Residential 1-4 family  $189,694   $13,344   $6,023   $98   $   $209,159 
Residential 5+ multifamily   2,354    1,142    1,218            4,714 
Construction of residential 1-4 family   1,395                    1,395 
Home equity credit   30,881    1,368    1,676            33,925 
Residential real estate   224,324    15,854    8,917    98        249,193 
Commercial   68,196    19,679    8,960            96,835 
Construction of commercial   8,989    153    613            9,755 
Commercial real estate   77,185    19,832    9,573            106,590 
Farm land   1,644    1,466    1,172            4,282 
Vacant land   4,425    189    3,284            7,898 
Real estate secured   307,578    37,341    22,946    98        367,963 
Commercial and industrial   24,049    8,532    1,362            33,943 
Municipal   3,995                    3,995 
Consumer   3,851    101    23            3,975 
Loans receivable, gross  $339,473   $45,974   $24,331   $98   $   $409,876 

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(in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
December 31, 2012                              
Residential 1-4 family  $180,442   $12,473   $5,538   $99   $   $198,552 
Residential 5+ multifamily   2,872    773    244            3,889 
Construction of residential 1-4 family   1,570        809            2,379 
Home equity credit   30,981    1,848    1,333            34,162 
Residential real estate   215,865    15,094    7,924    99        238,982 
Commercial   64,817    13,299    9,266            87,382 
Construction of commercial   5,055    297    471            5,823 
Commercial real estate   69,872    13,596    9,737            93,205 
Farm land   2,799    341    1,180            4,320 
Vacant land   4,885    863    4,178            9,926 
Real estate secured   293,421    29,894    23,019    99        346,433 
Commercial and industrial   28,453    8,300    1,341            38,094 
Municipal   3,378                    3,378 
Consumer   3,994    159    28            4,181 
Loans receivable, gross  $329,246   $38,353   $24,388   $99   $   $392,086 

Changes in impaired and potential problem loans are as follows:

   March 31, 2013  March 31, 2012
   Impaired loans            Impaired loans          
Three months ended (in thousands)   Non-accrual    Accruing    Potential problem loans    Total    Non-accrual    Accruing    Potential problem loans    Total 
Loans placed on non-accrual status  $1,016   $   $(281)  $735   $117   $   $   $117 
Loans restored to accrual status   (571)   54    143    (374)   (301)           (301)
Loan risk rating downgrades to substandard           2,678    2,678            1,386    1,386 
Loan risk rating upgrades from substandard           0    0            (320)   (320)
Loan repayments   (1,206)   652    (932)   1,486)   (237)   (37)   (133)   (407)
Loan charge-offs   (41)   19    (4)   (26)   (84)           (84)
Increase (decrease) in TDR loans   0    48    0    48    36    731    (136)   631 
Real estate acquired in settlement of loans   (835)   (736)       (1,571)                
Increase (decrease) in loans  $(1,637)  $37   $1,604   $4   $(469)  $694   $797   $1,022 

 

For year-to-date 2013 Salisbury has downgraded risk ratings on $2.7 million of loans, placed $1.0 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.

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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.
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

Loans individually evaluated for impairment (impaired loans) are loans for which Salisbury does not expect to collect all contractual principal and interest in accordance with the contractual terms of the loan. Impaired loans include all modified loans classified as troubled debt restructurings (TDRs) and loans on non-accrual status. The components of impaired loans are as follows:

(in thousands)  March 31, 2013  December 31, 2012
Non-accrual loans, excluding troubled debt restructured loans  $5,004   $7,579 
Non-accrual troubled debt restructured loans   3,220    2,280 
Accruing troubled debt restructured loans   6,738    6,704 
Total impaired loans  $14,962   $16,563 
Commitments to lend additional amounts to impaired borrowers  $   $ 
           

Non-Performing Assets

Non-performing assets decreased $807,000 during first quarter 2013 to $9.3 million, or 1.6% of assets at March 31, 2013, from $10.1 million, or 1.7% of assets at December 31, 2012, and increased $1.7 million from $7.6 million, or 1.3% of assets at March 31, 2012.

The 8% decrease in non-performing assets in first quarter 2013 resulted primarily from OREO sales of $1.1 million, in addition to $0.6 million of loans returning to accrual status, and $1.2 million from loan repayments. These declines were offset in part by a $0.4 million change in 90+ past due status and additions of $1.0 million in new non-accrual loans and $0.7 million of OREO additions.

The components of non-performing assets are as follows:

(in thousands)  March 31, 2013  December 31, 2012
Residential 1-4 family  $2,880   $3,024 
Home equity credit   113    442 
Commercial   2,064    2,235 
Vacant land   3,125    3,994 
Real estate secured   8,182    9,695 
Commercial and industrial   42    164 
Consumer        
Non-accruing loans   8,224    9,859 
Accruing loans past due 90 days and over   363     
Non-performing loans   8,587    9,859 
Real estate acquired in settlement of loans   712    244 
Non-performing assets  $9,299   $10,103 

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

(in thousands)  March 31, 2013  December 31, 2012
Current  $2,622   $1,797 
Past due 001-029 days   15    75 
Past due 030-059 days   62    701 
Past due 060-089 days   978    445 
Past due 090-179 days   780    1,983 
Past due 180 days and over   4,129    4,858 
Total non-performing loans  $8,587   $9,859 

At March 31, 2013, 31.88% of non-accrual loans were current with respect to loan payments, compared with 18.23% at December 31, 2012. 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 $1.0 million during first quarter 2013 to $10.0 million, or 2.43% of gross loans receivable at March 31, 2013, from $9.0 million, or 2.29% of gross loans receivable at December 31, 2012.

The components of troubled debt restructured loans are as follows:

(in thousands)  March 31, 2013  December 31, 2012
Residential 1-4 family  $3,158   $3,098 
Commercial   2,754    2,774 
Real estate secured   5,912    5,872 
Commercial and industrial   826    832 
Accruing troubled debt restructured loans   6,738    6,704 
Residential 1-4 family   2,020    1,041 
Commercial   1,145    1,159 
Vacant land        
Real estate secured   3,165    2,200 
Commercial and industrial   55    80 
Non-accrual troubled debt restructured loans   3,220    2,280 
Troubled debt restructured loans  $9,958   $8,984 

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

(in thousands)  March 31, 2013  December 31, 2012
Current  $5,052   $5,354 
Past due 001-029 days   1,686    445 
Past due 030-059 days       905 
Accruing troubled debt restructured loans   6,738    6,704 
Current   2,522    1,333 
Past due 001-029 days        
Past due 030-059 days   55    301 
Past due 060-089 days   145    194 
Past due 090-179 days   46     
Past due 180 days and over   452    452 
Non-accrual troubled debt restructured loans   3,220    2,280 
Total troubled debt restructured loans  $9,958   $8,984 

At March 31, 2013, 76.07% of troubled debt restructured loans were current with respect to loan payments, as compared with 74.43% at December 31, 2012.

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Past Due Loans

Loans past due 30 days or more decreased $2.9 million during first quarter 2013 to $10.7 million, or 2.60% of gross loans receivable at March 31, 2013, compared with $13.6 million, or 3.47% of gross loans receivable at December 31, 2012.

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

(in thousands)  March 31, 2013  December 31, 2012
Past due 030-059 days  $1,166   $4,309 
Past due 060-089 days   3,553    1,317 
Past due 090-179 days   362     
Accruing loans   5,081    5,626 
Past due 030-059 days    62    701 
Past due 060-089 days   978    445 
Past due 090-179 days   418    1,983 
Past due 180 days and over   4,130    4,859 
Non-accrual loans   5,588    7,988 
Total loans past due 30 days or greater  $10,669   $13,614 

Potential Problem Loans

Potential problem loans increased $1.6 million during first quarter 2013 to $12.4 million, or 3.03% of gross loans receivable at March 31, 2013, compared with $10.8 million, or 2.76% of gross loans receivable at December 31, 2012.

The components of potential problem loans are as follows:

(in thousands)  March 31, 2013  December 31, 2012
Residential 1-4 family  $2,932   $3,108 
Residential 5+ multifamily   975     
Home equity credit   1,562    892 
Residential real estate   5,469    4,000 
Commercial   4,506    4,624 
Construction of commercial   592    450 
Commercial real estate   5,098    5,074 
Farm land   1,172    1,180 
Vacant land   158    183 
Real estate secured   11,897    10,437 
Commercial and Industrial   494    345 
Consumer   23    28 
Potential problem loans  $12,414    10,810 

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

(in thousands)  March 31, 2013  December 31, 2012
Current  $7,750   $7,992 
Past due 001-029 days   1,045    452 
Past due 030-059 days   846    2,065 
Past due 060-089 days   2,575    301 
Past due 090-179 days   198     
Total potential problem loans  $12,414   $10,810 

At March 31, 2013, 62.43% of potential problem loans were current with respect to loan payments, as compared with 73.93% at December 31, 2012.

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 decreased $3.4 million during first quarter 2013 to $487.8 million at March 31, 2013, from $491.2 million at December 31, 2012, and increased $15.1 million for year-over-year from $472.7 million at March 31, 2012. Retail repurchase agreements increased $0.5 million during first quarter 2013 to $2.3 million at March 31, 2013, compared with $1.8 million at December 31, 2012, and decreased $8.0 million for year-over-year compared with $10.4 million at March 31, 2012.

Federal Home Loan Bank of Boston (FHLBB) advances decreased $0.4 million during first quarter 2013 to $31.6 million at March 31, 2013, from $32.0 million at December 31, 2012, and decreased $11.6 million for year-over-year from $43.2 million at March 31, 2012. The decreases were due to amortizing payments of advances, maturities of advances that were not renewed, and the prepayment in fourth quarter 2012 of a $10.0 million advance maturing 12/16/2013 with a 4.88% coupon.

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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, 2013, 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 26.24%, down from 30.55% at December 31, 2012. Management believes Salisbury’s funding sources will meet anticipated funding needs.

Operating activities for the three-month period ended March 31, 2013 provided net cash of $2.5 million. Investing activities utilized net cash of $10.8 million, principally from $19.4 million of net loan originations and principle collections, offset by proceeds from calls and maturities of securities available-for-sale and $1.1 million proceeds from sales of other real estate owned. Financing activities utilized net cash of $3.8 million, principally due to a net decrease of $2.9 million in deposits and repurchase agreements and common and preferred stock dividends paid.

At March 31, 2013, Salisbury had outstanding commitments to fund new loan originations of $13.9 million and unused lines of credit of $52.1 million. Salisbury believes that these commitments can be met in the normal course of business. Salisbury believes that its liquidity sources will continue to provide funding sufficient to support operating activities, loan originations and commitments, and deposit withdrawals.

CAPITAL RESOURCES

Shareholders’ equity was $72.2 million at March 31, 2013, up $0.2 million from December 31, 2012. Book value and tangible book value per common share were $32.88 and $26.70, respectively, compared with $33.14 and $26.85, respectively, at December 31, 2012. Contributing to the increase in shareholders’ equity for year-to-date 2013 was net income of $940,000 and issuance of restricted stock of $490,000, less loss in other comprehensive income of $235,000, less common and preferred stock dividends of $479,000 and $41,000, respectively, and $466,000 in restricted stock unrecognized compensation. Other comprehensive income included unrealized gains on securities available-for-sale, net of tax, of $2.7 million and unrealized loss on the pension plan income, net of tax, of $0.5 million.

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 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 periods ended March 31, 2013 and December 31, 2012, was 1.0000%. 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. On March 29, 2013, Salisbury declared a Series B Preferred Stock dividend of $41,000, payable on April 1, 2013. 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.

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.

On February 8, 2013, Salisbury granted a total of 19,600 shares of restricted stock pursuant to its 2011 Long Term Incentive Plan, which was approved by shareholders at the 2011 Annual Meeting, to 22 employees, including 5,000 shares to one Named Executive Officer, Richard J. Cantele, Jr., Chief Executive Officer and President.

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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:

         March 31, 2013   December 31, 2012
    Well
capitalized
    Salisbury    Bank    Salisbury    Bank 
Total Capital (to risk-weighted assets)   10.00%   16.47%   13.71%   16.63%   13.77%
Tier 1 Capital (to risk-weighted assets)   6.00    15.23    12.48    15.46    12.62 
Tier 1 Capital (to average assets)   5.00    10.17    8.43    9.87    8.15 

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, 2013 Salisbury paid $40,000 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 31, 2013 to shareholders of record on May 10, 2013. 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.

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 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.

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 financi