SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended September 30, 2014

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  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  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 ☑

 

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

Yes ☐  No ☑

 

The number of shares of Common Stock outstanding as of November 14, 2014 is 1,713,281.

 

 
 

TABLE OF CONTENTS

 

    Page
  PART I FINANCIAL INFORMATION  
     
Item 1. Financial Statements (unaudited):  
  Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013 3
  Consolidated Statements of Income for the three and nine month periods ended September 30, 2014 and 2013 (unaudited) 4
  Consolidated Statements of Comprehensive Income for the three and nine month periods ended September 30, 2014 and 2013 (unaudited) 5
  Consolidated Statements of Changes in Shareholders' Equity for the nine month periods ended September 30, 2014 and 2013 (unaudited) 5
  Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2014 and 2013 (unaudited) 6
  Notes to Consolidated Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 45
Item 4. Controls and Procedures 46
     
  PART II OTHER INFORMATION  
     
Item 1. Legal Proceedings 47
Item 1A. Risk Factors 48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 48
Item 3. Defaults upon Senior Securities 48
Item 4. Mine Safety Disclosures 48
Item 5. Other Information 48
Item 6. Exhibits 48
Signatures 49

2
 

PART I - FINANCIAL INFORMATION

 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED BALANCE SHEETS

  (in thousands, except share data)  September 30, 2014  December 31, 2013
  ASSETS  (unaudited)   
Cash and due from banks  $5,759   $5,926 
Interest bearing demand deposits with other banks   43,066    6,785 
Total cash and cash equivalents   48,825    12,711 
Interest-bearing time deposits with other banks       738 
Securities          
Available-for-sale at fair value   85,445    94,491 
Federal Home Loan Bank of Boston stock at cost   3,515    5,340 
Loans held-for-sale       173 
Loans receivable, net (allowance for loan losses: $5,384 and $4,683)   461,913    438,178 
Other real estate owned   333    377 
Bank premises and equipment, net   12,899    11,611 
Goodwill   9,829    9,829 
Intangible assets (net of accumulated amortization: $2,160 and $1,967)   872    576 
Accrued interest receivable   1,834    1,760 
Cash surrender value of life insurance policies   8,802    7,529 
Deferred taxes       260 
Other assets   3,822    3,536 
Total Assets  $638,089   $587,109 
LIABILITIES and SHAREHOLDERS' EQUITY          
Deposits          
Demand (non-interest bearing)  $99,843   $84,677 
Demand (interest bearing)   81,877    81,932 
Money market   132,471    120,550 
Savings and other   122,836    107,171 
Certificates of deposit   85,267    83,039 
Total deposits   522,294    477,369 
Repurchase agreements   6,500    2,554 
Federal Home Loan Bank of Boston advances   29,218    30,411 
Capital lease liability   424    425 
Deferred taxes   643     
Accrued interest and other liabilities   3,494    3,560 
Total Liabilities   562,573    514,319 
Commitments and contingencies         
Shareholders' Equity          
Preferred stock - $.01 per share par value   16,000    16,000 
Authorized: 25,000; Issued: 16,000 (Series B);          
Liquidation preference: $1,000 per share          
Common stock - $.10 per share par value   171    171 
Authorized: 3,000,000;          
Issued: 1,713,281 and 1,710,121          
Unearned compensation - restricted stock awards   (254)   (335)
Paid-in capital   13,764    13,668 
Retained earnings   42,960    42,240 
Accumulated other comprehensive income, net   2,875    1,046 
Total Shareholders' Equity   75,516    72,790 
Total Liabilities and Shareholders' Equity  $638,089   $587,109 

3
 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

  Periods ended September 30,   Three months ended    Nine months ended  
  (in thousands, except per share amounts)    2014      2013      2014      2013  
Interest and dividend income                    
Interest and fees on loans  $4,656   $4,516   $13,983   $13,415 
Interest on debt securities                    
Taxable   330    418    1,075    1,359 
Tax exempt   416    475    1,294    1,441 
Other interest and dividends   42    22    87    58 
Total interest and dividend income   5,444    5,431    16,439    16,273 
Interest expense                    
Deposits   379    459    1,079    1,437 
Repurchase agreements   3    2    5    4 
Capital lease   12        29     
Federal Home Loan Bank of Boston advances   296    311    892    935 
Total interest expense   690    772    2,005    2,376 
Net interest income   4,754    4,659    14,434    13,897 
Provision for loan losses   318    240    969    876 
Net interest and dividend income after provision for loan losses   4,436    4,419    13,465   $13,021 
Non-interest income                    
Trust and wealth advisory   791    750    2,509    2,299 
Service charges and fees   639    595    1,807    1,687 
Gains on sales of mortgage loans, net       69    43    501 
Mortgage servicing, net   41    (37)   80    (3)
Other   82    82    234    251 
Total non-interest income   1,553    1,459    4,673    4,735 
Non-interest expense                    
Salaries   1,980    1,922    5,776    5,508 
Employee benefits   697    693    2,176    2,140 
Premises and equipment   728    622    2,102    1,789 
Data processing   420    358    1,254    1,145 
Professional fees (1)   441    306    1,485    996 
Collections and OREO   77    74    298    305 
FDIC insurance   119    111    340    350 
Marketing and community support   115    99    355    326 
Amortization of intangibles   75    56    193    167 
Other   456    402    1,307    1,232 
Total non-interest expense   5,108    4,643    15,286    13,958 
Income before income taxes   881    1,235    2,852    3,798 
Income tax provision   113    219    567    695 
Net income  $768   $1,016   $2,285   $3,103 
Net income available to common shareholders  $728   $976   $2,159   $2,982 
                     
Basic earnings per common share  $0.43   $0.57   $1.26   $1.75 
Diluted earnings per common share   0.43    0.57    1.26    1.75 
Common dividends per share   0.28    0.28    0.84    0.84 

 

(1) Includes one-time professional fees of $126,000 and $464,000 incurred in conjunction with the following strategic initiatives for the three and nine month periods ended September 30, 2014: (i) the acquisition of the Sharon, CT branch office of another institution and related branch deposits and the consolidation of an existing Salisbury branch office in Sharon, CT with such branch, which was consummated in June of 2014, and (ii) the execution of an agreement to merge Riverside Bank of Poughkeepsie, NY with and into Salisbury Bank, which agreement was announced March 19, 2014,approved by the shareholders of both Salisbury and Riverside Bank on October 29, 2014 and approved by the FDIC and Connecticut Department of Banking on November 3, 2014 and November 5, 2014, respectively.

4
 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

   Three months ended    Nine months ended  
  Three and nine months ended September 30, (in thousands)    2014      2013      2014      2013  
Net income  $768   $1,016   $2,285   $3,103 
Other comprehensive income (loss)                    
Net unrealized gains (losses) on securities available-for-sale   342    (1,240)   2,771    (3,741)
Reclassification of net realized gains in net income                
Unrealized gains (losses) on securities available-for-sale   342    (1,240)   2,771    (3,741)
Income tax (expense) benefit   (116)   422    (942)   1,272 
Unrealized gains (losses) on securities available-for-sale, net of tax   226    (818)   1,829    (2,469)
Change in unrecognized pension plan costs                
Income tax (benefit) expense                
Pension plan income (loss), net of tax                
  Other comprehensive income (loss), net of tax   226    (818)   1,829    (2,469)
Comprehensive income  $994   $198   $4,114   $634 

 

 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)

                        Unearned    Accumulated      
                        compensation-    other comp    Total 
                        restricted    rehensive    share- 
    Common Stock    Preferred    Paid-in    Retained     stock    income    holders’ 
(dollars in thousands)   Shares    Amount    stock    capital    earnings    awards   (loss)    equity 
Balances at December 31, 2012   1,689,691   $169   $16,000   $13,158   $40,233   $   $2,437   $71,997 
Net income                   3,103            3,103 
Other comprehensive loss, net of tax                           (2,469)   (2,469)
Common stock dividends declared                   (1,436)           (1,436)
Preferred stock dividends declared                   (121)           (121)
Issuance of restricted common stock   19,600    2        488        (490)        
Forfeiture of restricted common stock   (500)            (12)        12         
Stock based compensation-restricted                                        
  stock awards                       103        103 
Issuance of common stock for director fees   1,330            34                34 
Balances at September 30, 2013    1,710,121   $171   $16,000   $13,668   $41,779   $(375)  $(32)  $71,211 
Balances at December 31, 2013   1,710,121   $171   $16,000   $13,668   $42,240   $(335)  $1,046   $72,790 
Net income                   2,285            2,285 
Other comprehensive income, net of tax                           1,829    1,829 
Common stock dividends declared                   (1,439)           (1,439)
Preferred stock dividends declared                   (126)           (126)
Issuance of restricted common stock   3,000            81        (81)        
Forfeiture of restricted common stock   (2,000)           (50)       50         
Stock based compensation-restricted                                        
  stock awards                       112        112 
Issuance of common stock for director fees   2,160            65                65 
Balances at September 30, 2014    1,713,281   $171   $16,000   $13,764   $42,960   $(254)  $2,875   $75,516 

5
 

Salisbury Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

  Nine months ended September 30, (in thousands) unaudited    2014      2013  
Operating Activities          
Net income  $2,285   $3,103 
Adjustments to reconcile net income to net cash provided by operating activities:          
Amortization (accretion) and depreciation          
Securities   163    366 
Bank premises and equipment   737    642 
Core deposit intangible   193    167 
Mortgage servicing rights   220    298 
Fair value adjustment on loans   24    24 
Fair value adjustment on deposits   53     
(Gains) and losses          
Gain on sale of loans   (39)   (239)
Loss on sale of other real estate owned   4    9 
Loss on sale/disposals of premises and equipment   5    34 
Provision for loan losses   969    876 
Proceeds from loans sold   3,536    15,670 
Loans originated for sale   (3,324)   (14,260)
Increase in deferred loan origination fees and costs, net   (21)   (117)
Mortgage servicing rights originated   (6)   (261)
(Increase) decrease in mortgage servicing rights impairment reserve   (14)   4 
Increase in interest receivable   (74)   (5)
Deferred tax benefit   (39)   (37)
(Increase) decrease in prepaid expenses   (81)   542 
Increase in cash surrender value of life insurance policies   (173)   (185)
(Increase) decrease in income tax receivable   (329)   352 
(Increase) decrease in other assets   (76)   63 
(Decrease) increase in accrued expenses   (144)   436 
Decrease in interest payable   (5)   (29)
Increase in other liabilities   82    76 
Issuance of shares for director fees   65    34 
Compensation expense - restricted stock   112    103 
Net cash provided by operating activities   4,123    7,666 
Investing Activities          
Redemption of Federal Home Loan Bank stock   1,825    407 
Maturities (purchases) of interest-bearing time deposits with other banks   738    (5,220)
Proceeds from calls of securities available-for-sale   4,115    1,650 
Proceeds from maturities of securities available-for-sale   7,539    20,714 
Loan originations and principal collections, net   (24,694)   (34,040)
Recoveries of loans previously charged-off   50    20 
Proceeds from sales of other real estate owned   40    1,353 
Capital expenditures   (1,872)   (409)
Premiums paid on bank-owned life insurance   (1,100)    
Cash and cash equivalents acquired from Sharon, CT branch office of another institution   17,462     
         Net cash provided (utilized) by investing activities   4,103    (15,525)
Financing Activities          
Increase (decrease) in deposit transaction accounts, net   24,527    (1,753)
Increase (decrease) in time deposits, net   2,174    (9,593)
Decrease in capital lease liability   (1)    
Increase in securities sold under agreements to repurchase, net   3,946    2,086 
Principal payments on Federal Home Loan Bank of Boston advances   (1,193)   (1,179)
Common stock dividends paid   (1,439)   (1,436)
Preferred stock dividends paid   (126)   (121)
Net cash provided (utilized) by financing activities   27,888    (11,996)
Net increase (decrease) in cash and cash equivalents   36,114    (19,855)
Cash and cash equivalents, beginning of period   12,711    43,574 
Cash and cash equivalents, end of period  $48,825   $23,719 

 

6
 

  Salisbury Bancorp, Inc. and Subsidiary              
  CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)              
  Nine months ended September 30, (in thousands) unaudited    2014      2013  
Cash paid during period          
Interest  $2,010   $2,405 
Income taxes   935    380 
Non-cash transfers          
Transfer from loans to other real estate owned       1,689 
Sharon branch acquisition          
Cash and cash equivalents acquired   17,462     
Net loans acquired   63     
Fixed assets acquired   158     
 Core deposit intangible   489     
Deposits assumed   18,171     
Accrued interest payable assumed   1     

7
 

Salisbury Bancorp, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

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

The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). 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 September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in Salisbury's 2013 Annual Report on Form 10-K for the period ended December 31, 2013.

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 provides 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 January 2014, the FASB issued ASU 2014-01, “Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects.” The amendments in this ASU apply to all reporting entities that invest in qualified affordable housing projects through limited liability entities that are flow-through entities for tax purposes as follows:

1.For reporting entities that meet the conditions for and that elect to use the proportional amortization method to account for investments in qualified affordable housing projects, all amendments in this ASU apply.
2.For reporting entities that do not meet the conditions for or that do not elect the proportional amortization method, only the amendments in this ASU that are related to disclosures apply.

The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). For those investments in qualified affordable housing projects not accounted for using the proportional amortization method, the investment should be accounted for as an equity method investment or a cost method investment in accordance with Subtopic 970-323. The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company does not expect that the adoption of this ASU will have an impact on the Company’s consolidated financial statements.

8
 

In January 2014, the FASB issued ASU 2014-04, “Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The objective of the amendments in this ASU is to reduce diversity by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The amendments in this ASU clarify that an insubstance repossession or foreclosure occurs; and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This ASU changes the criteria for reporting discontinued operations and modifies related disclosure requirements. The new guidance is effective on a prospective basis for fiscal years beginning on or after December 15, 2014, and interim periods within those years. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).”  The objective of this ASU is to clarify principles for recognizing revenue and to develop a common revenue standard for GAAP and International Financial Reporting Standards.  The guidance in this ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards.  The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.   For public entities, the amendments in this update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  Early application is not permitted.  The Company anticipates that the adoption of this ASU will not have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing (Topic 860):  Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.”  The amendments in this ASU require two accounting changes.  First, the amendments in this ASU change the accounting for repurchase-to-maturity transactions to secured borrowing accounting.  Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement.  This ASU also includes new disclosure requirements.  The accounting changes in this Update are effective for public business entities for the first interim or annual period beginning after December 15, 2014.  An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption.  Earlier application for a public business entity is prohibited; however, all other entities may elect to apply the requirements for interim periods beginning after December 15, 2014.  The Company anticipates that the adoption of this ASU will not have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-12, “Compensation - Stock Compensation (Topic 718):  Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period.”  The amendments in this ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  A reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards.  This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  Earlier adoption is permitted.  ASU 2014-12 may be adopted either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements, and to all new or modified awards thereafter.  If retrospective transition is adopted, the cumulative effect of applying this update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date.  The Company is currently reviewing this ASU to determine if it will have an impact on its consolidated financial statements.

9
 

The Company anticipates that the adoption of this ASU will not have a material impact on its oncsolidated financial statements. In August 2014, the FASB issued ASU 2014-13, “Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity.” This ASU applies to entities that meet the following criteria:

 

1.they are required to consolidate a collateralized entity under the Variable Interest Entities guidance;
2.they measure all of the financial assets and the financial liabilities of that consolidated collateralized financing entity at fair value in the consolidated financial statements based on other FASB rules; and
3.those changes in fair value are reflected in earnings.

 

Under ASU 2014-13, entities that meet these criteria are provided an alternative under which they can choose to eliminate the difference between the fair value of financial assets and financial liabilities of a consolidated collateralized financing entity. If that alternative is not elected, then ASU 2014-13 indicates that the fair value of the financial assets and the fair value of the financial liabilities of the consolidated collateralized financing entity should be measured in accordance with ASC 820, “Fair Value Measurement” and differences between the fair value of the financial assets and the financial liabilities of that consolidated collateralized financing entity should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income or loss. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The Company anticipates that the adoption of this ASU will not have a material impact on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-14, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government - Guaranteed Mortgage Loans upon Foreclosure.” The amendments in this ASU require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met:

 

1.the loan has a government guarantee that is not separable from the loan before foreclosure;
2.at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and
3.at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed.

 

Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company anticipates that the adoption of this ASU will not have a material impact on its consolidated financial statements.

10
 

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
September 30, 2014                    
Available-for-sale                    
U.S. Treasury notes  $2,498   $122   $   $2,620 
U.S. Government Agency notes   2,501    16        2,517 
Municipal bonds   37,770    1,310    (190)   38,890 
Mortgage-backed securities                    
U.S. Government Agencies   28,412    610    (21)   29,001 
Collateralized mortgage obligations                    
U.S. Government Agencies   2,849    25        2,874 
Non-agency   6,398    537    (8)   6,927 
SBA bonds   1,566    113        1,679 
Preferred stock   20    917        937 
Total securities available-for-sale  $82,014   $3,650   $(219)  $85,445 
Non-marketable securities                    
Federal Home Loan Bank of Boston stock  $3,515   $   $   $3,515 

 

  (in thousands)  Amortized
cost (1)
  Gross un-
realized gains
  Gross un-realized losses  Fair value
December 31, 2013                    
Available-for-sale                    
U.S. Treasury notes  $2,497   $160   $   $2,657 
U.S. Government Agency notes   2,507    83        2,590 
Municipal bonds   41,775    782    (2,120)   40,437 
Mortgage-backed securities                    
U.S. Government Agencies   33,522    442    (72)   33,892 
Collateralized mortgage obligations                    
U.S. Government Agencies   3,545    35        3,580 
Non-agency   7,923    401    (16)   8,308 
SBA bonds   2,042    188        2,230 
Preferred stock   20    777        797 
Total securities available-for-sale  $93,831   $2,868   $(2,208)  $94,491 
Non-marketable securities                    
Federal Home Loan Bank of Boston stock  $5,340   $   $   $5,340 
(1)Net of other-than-temporary impairment write-downs recognized in earnings.

Salisbury did not sell any securities available-for-sale during the nine month periods ended September 30, 2014 and 2013.

11
 

The following table summarizes, for all securities in an unrealized loss position, including debt securities for which a portion of other-than-temporary impairment (“OTTI”) has been recognized in other comprehensive income, the aggregate fair value and gross unrealized loss of securities that have been in a continuous unrealized loss position as of the date presented:

    Less than 12 Months    12 Months or Longer    Total 
    Fair    Unrealized    Fair    Unrealized    Fair    Unrealized 
(in thousands)   Value    losses    value    losses    value    losses 
September 30, 2014                              
Available-for-sale                              
Municipal bonds  $1,040   $1   $4,044   $189   $5,084   $190 
Mortgage-backed securities   557    2    1,948    19    2,505    21 
Collateralized mortgage obligations                              
Non-agency   391    4    169    4    560    8 
Total temporarily impaired securities   1,988    7    6,161    212    8,149    219 
Other-than-temporarily impaired securities                              
Collateralized mortgage obligations                              
Non-agency                        
Total temporarily and other-than-temporarily impaired securities  $1,988   $7   $6,161   $212   $8,149   $219 
    Less than 12 Months    12 Months or Longer    Total 
    Fair    Unrealized    Fair    Unrealized    Fair    Unrealized 
(in thousands)   Value    losses    value    losses    value    losses 
December 31, 2013                              
Available-for-sale                              
Municipal bonds  $19,714   $1,428   $2,323   $692   $22,037   $2,120 
Mortgage-backed securities   15,096    20    2,132    52    17,228    72 
Collateralized mortgage obligations                              
Non-agency   398    2    294    10    692    12 
Total temporarily impaired securities   35,208    1,450    4,749    754    39,957    2,204 
Other-than-temporarily impaired securities                              
Collateralized mortgage obligations                              
Non-agency   320    4            320    4 
Total temporarily and other-than-temporarily impaired securities  $35,528   $1,454   $4,749   $754   $40,277   $2,208 

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 whether it has the 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 September 30, 2014.

U.S Government Agency notes, U.S. Government Agency mortgage-backed securities and U.S. Government Agency CMOs: The contractual cash flows are derived from 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 evaluates these securities for strategic fit and may reduce its position in these securities, although 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 September 30, 2014.

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 to assess default risk of issuers, including some that have had their ratings withdrawn and are insured by insurers that have had their ratings withdrawn. For all completed reviews, pass credit risk ratings have been assigned. Management expects to recover the entire amortized cost basis of these securities. 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 September 30, 2014.

12
 

Non-agency CMOs: Salisbury performed a detailed cash flow analysis of its non-agency CMOs at September 30, 2014, to assess whether any of the securities were OTTI. Salisbury uses first party provided cash flow forecasts for 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 September 30, 2014. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury evaluates these securities for strategic fit and depending upon such factor could reduce its position in these securities, although it has no present intention to do so, and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis.

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

  Nine months ended September 30 (in thousands)    2014      2013  
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 FHLBB is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. In 2008, the FHLBB announced to its members that it is focusing on preserving capital in response to ongoing market volatility including the extension of a moratorium on excess stock repurchases and in 2009 announced the suspension of its quarterly dividends. On February 22, 2011, the FHLBB declared a modest cash dividend payable to its members on March 2, 2011. The FHLBB has continued to declare modest cash dividends through 2014. 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 September 30, 2014. 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.

13
 

NOTE 3 - LOANS

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

  (in thousands)  September 30, 2014  December 31, 2013
Residential 1-4 family  $242,222   $231,113 
Residential 5+ multifamily   5,397    4,848 
Construction of residential 1-4 family   2,042    1,876 
Home equity credit   34,826    34,139 
Residential real estate   284,487    271,976 
Commercial   96,096    91,853 
Construction of commercial   17,865    10,948 
Commercial real estate   113,961    102,801 
Farm land   3,301    3,402 
Vacant land   9,037    9,067 
Real estate secured   410,786    387,246 
Commercial and industrial   45,100    46,292 
Municipal   6,181    4,252 
Consumer   4,027    3,889 
Loans receivable, gross   466,094    441,679 
Deferred loan origination fees and costs, net   1,203    1,182 
Allowance for loan losses   (5,384)   (4,683)
Loans receivable, net  $461,913   $438,178 
Loans held-for-sale          
Residential 1-4 family  $   $173 

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.

14
 

Loan Credit Quality

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

  (in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
September 30, 2014                              
Residential 1-4 family  $221,221   $13,755   $7,152   $94   $   $242,222 
Residential 5+ multifamily   3,253    1,079    1,065            5,397 
Construction of residential 1-4 family   2,042                    2,042 
Home equity credit   32,183    1,179    1,464            34,826 
Residential real estate   258,699    16,013    9,681    94        284,487 
Commercial   76,287    11,756    8,053            96,096 
Construction of commercial   16,721    563    581            17,865 
Commercial real estate   93,008    12,319    8,634            113,961 
Farm land   817    1,378    1,106            3,301 
Vacant land   5,745    143    3,149            9,037 
Real estate secured   358,269    29,853    22,570    94        410,786 
Commercial and industrial   39,648    4,641    811            45,100 
Municipal   6,181                    6,181 
Consumer   3,918    81    28            4,027 
Loans receivable, gross  $408,016   $34,575   $23,409   $94   $   $466,094 
  (in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
  December 31, 2013                              
Residential 1-4 family  $212,683   $12,338   $5,997   $95   $   $231,113 
Residential 5+ multifamily   2,674    1,199    975            4,848 
Construction of residential 1-4 family   1,876                    1,876 
Home equity credit   31,444    1,355    1,340            34,139 
Residential real estate   248,677    14,892    8,312    95        271,976 
Commercial   67,554    16,044    8,255            91,853 
Construction of commercial   10,257    102    589            10,948 
Commercial real estate   77,811    16,146    8,844            102,801 
Farm land   847    1,421    1,134            3,402 
Vacant land   5,640    288    3,139            9,067 
Real estate secured   332,975    32,747    21,429    95        387,246 
Commercial and industrial   37,860    7,452    980            46,292 
Municipal   4,252                    4,252 
Consumer   3,739    113    37            3,889 
Loans receivable, gross  $378,826   $40,312   $22,446   $95   $   $441,679 

15
 

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

         Past due      
                             180    30    Accruing 90      
                             days    days    days      
         1-29    30-59    60-89    90-179    and    and    and    Non- 
(in thousands)   Current    days    days    days    days   over    over    over    accrual 
September 30, 2014                                             
Residential 1-4 family  $231,727   $6,752   $71   $1,583   $1,793   $296   $3,743   $453   $2,589 
Residential 5+ multifamily   5,306        1    90            91        90 
Construction of residential 1-4 family   2,042                                 
Home equity credit   34,222    77    96    15    317    99    527        630 
Residential real estate   273,297    6,829    168    1,688    2,110    395    4,361    453    3,309 
Commercial   93,383    1,153    132    193        1,235    1,560        1,427 
Construction of commercial   17,865                                131 
Commercial real estate   111,248    1,153    132    193        1,235    1,560        1,558 
Farm land   2,180    722    15            384    399        384 
Vacant land   5,957    190    25            2,865    2,890        2,865 
Real estate secured   392,682    8,894    340    1,881    2,110    4,879    9,210    453    8,116 
Commercial and industrial   44,341    696    20    28    15        63        20 
Municipal   6,181                                 
Consumer   3,959    55    6    7            13        22 
Loans receivable, gross  $447,163   $9,645   $366   $1,916   $2,125   $4,879   $9,286   $453   $8,158 
December 31, 2013                                             
Residential 1-4 family  $222,356   $3,853   $1,795   $2,622   $353   $134   $4,904   $   $1,525 
Residential 5+ multifamily   4,749            99            99         
Construction of residential 1-4 family   1,876                                 
Home equity credit   33,391    129    361    125        133    619        402 
Residential real estate   262,372    3,982    2,156    2,846    353    267    5,622        1,927 
Commercial   89,434    566    371    108    235    1,139    1,853        1,857 
Construction of commercial   9,784    1,025        139            139         
Commercial real estate   99,218    1,591    371    247    235    1,139    1,992        1,857 
Farm land   2,995    23                384    384        384 
Vacant land   6,058    139                2,870    2,870        2,870 
Real estate secured   370,643    5,735    2,527    3,093    588    4,660    10,868        7,038 
Commercial and industrial   45,897    262    112            21    133        134 
Municipal   4,252                                 
Consumer   3,746    113    29    1            30         
Loans receivable, gross  $424,538   $6,110   $2,668   $3,094   $588   $4,681   $11,031   $   $7,172 

Troubled Debt Restructurings

Troubled debt restructurings occurring during the periods are as follows:

   Three months ended September 30, 2014  Nine months ended September 30, 2014
  (in thousands)  Quantity  Pre-modification balance  Post-modification balance  Quantity  Pre-modification balance  Post-modification balance
Residential real estate   1   $207   $207    2   $237   $237 
Commercial real estate   1    399    399    3    846    846 
Construction of commercial   1    131    131    1    131    131 
Home equity credit               2    72    72 
Troubled debt restructurings   3   $737   $737    8   $1,286   $1,286 
Interest only and term extension      $   $    1   $48   $48 
Term extension and amortization   2    338    338    2    338    338 
Debt consolidation and term extension               2    447    447 
Debt consolidation, rate reduction, term extension   1    399    399    1    399    399 
Interest only               2    54    54 
Troubled debt restructurings   3   $737   $737    8   $1,286   $1,286 

Three loans were restructured during the quarter ended September 30, 2014 and all were current at September 30, 2014.

16
 

Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:

   Three months ended September 30, 2014   Nine months ended September 30, 2014 
    Beginning    Provision    Charge-    Reco-    Ending    Beginning    Provision    Charge-    Reco-    Ending 
(in thousands)   balance    (benefit)    offs    veries    balance    balance    (benefit)    offs    veries    balance 
Residential  $1,974   $357   $(46)  $16   $2,301   $1,938   $494   $(149)  $18   $2,301 
Commercial   1,622    89            1,711    1,385    378    (52)       1,711 
Land   184    (17)   (6)       161    226    33    (98)       161 
Real estate   3,780    429    (52)   16    4,173    3,549    905    (299)   18    4,173 
Commercial and industrial   584    (68)       1    517    561    (57)   (1)   14    517 
Municipal   44    18            62    43    19            62 
Consumer   49    11    (3)   2    59    105    (46)   (18)   18    59 
Unallocated   645    (72)           573    425    148            573 
Totals  $5,102   $318   $(55)  $19   $5,384   $4,683   $969   $(318)  $50   $5,384 

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  
  September 30, 2014                              
Residential 1-4 family  $235,995   $1,302   $6,227   $499   $242,222   $1,801 
Residential 5+ multifamily   4,370    66    1,027    3    5,397    69 
Construction of residential 1-4 family   2,042    17            2,042    17 
Home equity credit   34,148    353    678    61    34,826    414 
Residential real estate   276,555    1,738    7,932    563    284,487    2,301 
Commercial   91,393    994    4,703    527    96,096    1,521 
Construction of commercial   17,734    190    131        17,865    190 
Commercial real estate   109,127    1,184    4,834    527    113,961    1,711 
Farm land   2,917    59    384        3,301    59 
Vacant land   5,955    64    3,082    38    9,037    102 
Real estate secured   394,554    3,045    16,232    1,128    410,786    4,173 
Commercial and industrial   44,503    490    597    27    45,100    517 
Municipal   6,181    62            6,181    62 
Consumer   3,945    37    82    22    4,027    59 
Unallocated allowance       573                573 
Totals  $449,183   $4,207   $16,911   $1,177   $466,094   $5,384 
    Collectively evaluated    Individually evaluated    Total portfolio 
  (in thousands)   Loans    Allowance    Loans     Allowance    Loans     Allowance  
December 31, 2013                              
Residential 1-4 family  $225,419   $897   $5,694   $617   $231,113   $1,514 
Residential 5+ multifamily   3,894    20    954        4,848    20 
Construction of residential 1-4 family   1,876    11            1,876    11 
Home equity credit   33,689    363    450    30    34,139    393 
Residential real estate   264,878    1,291    7,098    647    271,976    1,938 
Commercial   87,059    977    4,794    282    91,853    1,259 
Construction of commercial   10,948    126            10,948    126 
Commercial real estate   98,007    1,103    4,794    282    102,801    1,385 
Farm land   3,018    61    384        3,402    61 
Vacant land   5,972    64    3,095    101    9,067    165 
Real estate secured   371,875    2,519    15,371    1,030    387,246    3,549 
Commercial and industrial   45,584    519    708    42    46,292    561 
Municipal   4,252    43            4,252    43 
Consumer   3,710    36    179    69    3,889    105 
Unallocated allowance       425                425 
Totals  $425,421   $3,542   $16,258   $1,141   $441,679   $4,683 

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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 
  (in thousands)   Loans    Allowance    Loans     Allowance    Loans     Allowance  
  September 30, 2014                              
  Performing loans  $439,458   $3,112   $61   $21   $439,519   $3,133 
  Potential problem loans   9,725    522    12        9,737    522 
  Impaired loans           16,838    1,156    16,838    1,156 
  Unallocated allowance       573                573 
  Totals  $449,183   $4,207   $16,911   $1,177   $466,094   $5,384 
  December 31, 2013                              
  Performing loans  $416,734   $2,835   $157   $69   $416,891   $2,904 
  Potential problem loans   8,687    282    429    19    9,116    301 
  Impaired loans           15,672    1,053    15,672    1,053 
  Unallocated allowance       425                425 
  Totals  $425,421   $3,542   $16,258   $1,141   $441,679   $4,683 

 

   Impaired loans with specific allowance  Impaired loans with no specific allowance
   Loan balance  Specific  Income  Loan balance  Income
  (in thousands)  Book  Note  Average  allowance  recognized  Book  Note  Average  recognized
  September 30, 2014                           
Residential  $5,107   $5,252   $4,392   $503   $100   $2,146   $2,252   $2,779   $38 
Home equity credit   179    184    110    61        499    513    454    4 
Residential real estate   5,286    5,436    4,502    564    100    2,645    2,765    3,233    42 
Commercial   3,572    3,746    3,183    527    74    1,131    1,325    1,529    34 
Construction of commercial                       131    136    121    3 
Farm land                       384    384    384     
Vacant land   3,082    3,997    3,090    38    10                 
Real estate secured   11,940    13,179    10,775    1,129    184    4,291    4,610    5,267    79 
Commercial and industrial   95    140    107    27        490    492    528    23 
Consumer                       22    22    22     
Totals  $12,035   $13,319   $10,882   $1,156   $184   $4,803   $5,124   $5,817   $102 
December 31, 2013                                             
Residential  $4,409   $4,516   $3,995   $598   $99   $2,073   $2,522   $2,285   $54 
Home equity credit   72    72    101    30    2    378    428    251    4 
Residential real estate   4,481    4,588    4,096    628    101    2,451    2,950    2,536    58 
Commercial   2,777    2,835    2,349    282    127    1,771    2,299    2,411    47 
Construction of commercial           3                20    8     
Farm land                       384    384    118     
Vacant land   3,095    3,889    1,853    101            100    1,430     
Real estate secured   10,353    11,312    8,301    1,011    228    4,606    5,753    6,503    105 
Commercial and industrial   119    154    233    42    1    573    975    595    36 
Consumer                       22    22         
Totals  $10,472   $11,466   $8,534   $1,053   $229   $5,201   $6,750   $7,098   $141 

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NOTE 4 - MORTGAGE SERVICING RIGHTS

   September 30, (in thousands)    2014      2013  
Residential mortgage loans serviced for others  $140,893   $146,726 
Fair value of mortgage servicing rights   1,624    1,550 

Changes in mortgage servicing rights are as follows:

   Three months  Nine months
   Periods ended September 30, (in thousands)    2014      2013      2014      2013  
Mortgage Servicing Rights                    
Balance, beginning of period  $838   $1,109   $980   $1,076 
Originated   (17)   31    5    261 
Amortization (1)   (56)   (101)   (220)   (298)
Balance, end of period   765    1,039    765    1,039 
Valuation Allowance                    
Balance, beginning of period   (1)   (4)   (15)   (38)
Decrease in impairment reserve (1)   1    (38)   14    (4)
Balance, end of period       (42)   (1)   (42)
Loan servicing rights, net  $765   $997   $765   $997 
(1)Amortization expense and changes in the impairment reserve are recorded in loan servicing fee income.

NOTE 5 - PLEDGED ASSETS

  (in thousands)  September 30, 2014  December 31, 2013
Securities available-for-sale (at fair value)  $63,767   $57,623 
Loans receivable   141,681    130,574 
Total pledged assets  $205,448   $188,197 

At September 30, 2014, securities were pledged as follows: $54.7 million to secure public deposits, $9.0 million to secure repurchase agreements and $0.1 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.

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

   Three months    Nine months  
  Periods ended September 30, (in thousands)    2014      2013      2014      2013  
  Net income  $768   $1,016   $2,285   $3,103 
Less: Preferred stock dividends declared   (40)   (40)   (126)   (121)
  Net income available to common shareholders   728    976    2,159    2,982 
Less: Undistributed earnings allocated to participating securities   (8)   (11)   (26)   (31)
  Net income allocated to common stock  $720   $965   $2,133   $2,951 
  Common shares issued   1,713    1,710    1,713    1,707 
Less: Unvested restricted stock awards   (20)   (19)   (21)   (17)
Common shares outstanding used to calculate basic earnings per common share   1,693    1,691    1,692    1,690 
Add: Dilutive effect of unvested restricted stock awards                
Common shares outstanding used to calculate diluted earnings per common share   1,693    1,691    1,692    1,690 
  Earnings per common share (basic and diluted)  $0.43   $0.57   $1.26   $1.75 

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 September 30, 2014, that Salisbury and the Bank meet all of their capital adequacy requirements.

In December 2010, the Basel Committee, a group of bank regulatory supervisors from around the world, released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III.” Basel III, when fully implemented by the U.S. bank regulatory agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.

In July 2013, the Federal Reserve Board, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation approved final rules to implement the Basel III capital framework. The rules will be effective on January 1, 2015 and phased-in over a multiple year period through 2019. The new capital rules call for higher quality capital with higher minimum capital level requirements. Salisbury and the Bank are in the process of assessing the impact from these new regulatory requirements, and while management cannot be certain of the impact, management believes that Salisbury and the Bank will exceed the new requirements of adequately capitalized plus the capital conservation buffer, once they become effective.

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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
  September 30, 2014                  
Total Capital (to risk-weighted assets)                              
Salisbury  $67,769    16.27%  $33,331    8.0%   n/a     
Bank   57,765    13.77    33,555    8.0   $41,944    10.0%
Tier 1 Capital (to risk-weighted assets)                              
Salisbury   61,941    14.87    16,666    4.0    n/a     
Bank   51,937    12.38    16,777    4.0    25,167    6.0 
Tier 1 Capital (to average assets)                              
Salisbury   61,941    9.85    25,158    4.0    n/a     
Bank   51,937    8.26    25,159    4.0    31,450    5.0 
December 31, 2013                              
Total Capital (to risk-weighted assets)                              
Salisbury  $66,404    16.46%  $32,280    8.0%   n/a     
Bank   56,425    13.87    32,539    8.0   $40,674    10.0%
Tier 1 Capital (to risk-weighted assets)                              
Salisbury   61,340    15.20    16,140    4.0    n/a     
Bank   51,361    12.63    16,270    4.0    24,405    6.0 
Tier 1 Capital (to average assets)                              
Salisbury   61,340    10.65    23,035    4.0    n/a     
Bank   51,361    8.96    22,938    4.0    28,673    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.

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

21
 

The Series B Preferred Stock pays noncumulative dividends. The dividend rate on the Series B Preferred Stock for the initial ten quarterly dividend periods, commencing with the period ended September 30, 2011 and ending with the period ended December 31, 2013, is determined each quarter based on the increase in the Bank’s Qualified Small Business Lending over a baseline amount. The dividend rate for the quarterly period ended September 30, 2014 was 1.00%. For the eleventh quarterly dividend payment 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. 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.

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  Nine months
  Periods ended September 30, (in thousands)    2014      2013      2014      2013  
Service cost  $   $   $   $ 
Interest cost on benefit obligation   69    66    207    197 
Expected return on plan assets   (74)   (67)   (222)   (202)
Amortization of net loss       1        5 
Settlements and curtailments                
Net periodic benefit cost  $(5)  $   $(15)  $ 

Salisbury’s 401(k) Plan expense was $159,000 and $183,000, respectively for the three month periods ended September 30, 2014 and 2013, and $495,000 and $514,000, respectively for the nine month periods ended September 30, 2014 and 2013. Other post-retirement benefit obligation expense for endorsement split-dollar life insurance arrangements was $13,000 and $12,000, respectively for the three month periods ended September 30, 2014 and 2013, and $40,000 and $37,000, respectively for the nine month periods ended September 30, 2014 and 2013.

Employee Stock Ownership Plan (ESOP)

Salisbury offers an Employee Stock Ownership Plan (ESOP) to eligible employees.  Under the Plan, Salisbury may make discretionary contributions to the Plan. Discretionary contributions vest in full upon six years and reflect the following schedule of qualified service:

20% after the second year, 20% per year thereafter, vesting at 100% after six full years of service.

Salisbury’s ESOP expense was $47,000 and $40,000, respectively, for the three month periods ended September 30, 2014 and 2013, and $141,000 and $120,000, respectively, for the nine month periods ended September 30, 2014 and 2013.

Other Retirement Plans

A Non-Qualified Deferred Compensation Plan (the "Plan") was effective January 1, 2013. This Plan was adopted by the Bank for the benefit of certain key employees, ("Executive" or "Executives"), who have been selected and approved by the Bank to participate in this Plan and who have evidenced their participation by execution of a Non-Qualified Deferred Compensation Plan Participation Agreement ("Participation Agreement") in a form provided by the Bank. This Plan is intended to comply with Internal Revenue Code ("Code") Section 409A and any regulatory or other guidance issued under such Section.

In 2013, the Bank awarded six (6) Executives with a discretionary contribution to this account for a total of $59,590. This was the first year for this benefit. Based on the Executive’s date of retirement, the vesting schedule ranges from 10% per year to 50% per year.

Grants of Restricted Stock and Options

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.

On January 3, 2014, Salisbury granted a total of 3,000 shares of restricted stock, pursuant to its 2011 Long Term Incentive Plan, to two (2) additional employees, including 2,000 shares to one Named Executive Officer, Donald E. White, Chief Financial Officer.

22
 

NOTE 9 –ACCUMULATED OTHER COMPREHENSIVE INCOME

The components of accumulated other comprehensive income are as follows:

  (in thousands)  September 30, 2014  December 31, 2013
Unrealized gains on securities available-for-sale, net of tax  $2,265   $436 
Unrecognized pension plan benefit (expense), net of tax   610    610 
Accumulated other comprehensive income, net  $2,875   $1,046 

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.

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

In accordance with ASC 820-10, Salisbury groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

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

Level 1. Quoted prices in active markets for identical assets. Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury, other U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2. Significant other observable inputs. Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third 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. Salisbury did not have any significant transfers of assets between levels 1 and 2 of the fair value hierarchy during the quarter or nine months ended September 30, 2014.

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

Securities available-for-sale. Securities available-for-sale are recorded at fair value on a recurring basis. Level 1 securities include exchange-traded equity securities. Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes obligations of the U.S. Treasury and U.S. government-sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, municipal bonds, SBA bonds, corporate bonds and certain preferred equities. Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
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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.

 

Assets measured at fair value are as follows:

    Fair Value Measurements Using    Assets at 
(in thousands)   Level 1    Level 2    Level 3    fair value 
September 30, 2014                    
Assets measured at fair value on a recurring basis                    
U.S. Treasury notes  $   $2,620   $   $2,620 
U.S. Government agency notes       2,517        2,517 
Municipal bonds       38,890        38,890 
Mortgage-backed securities:                    
U.S. Government agencies       29,001        29,001 
Collateralized mortgage obligations:                    
U.S. Government agencies       2,874        2,874 
Non-agency       6,927        6,927 
SBA bonds       1,679        1,679 
Preferred stock   937            937 
Securities available-for-sale  $937   $84,508   $   $85,445 
Assets measured at fair value on a non-recurring basis                    
Collateral dependent impaired loans  $   $   $10,879   $10,879 
Other real estate owned           333    333 
December 31, 2013                    
Assets measured at fair value on a recurring basis                    
U.S. Treasury notes  $   $2,657   $   $2,657 
U.S. Government agency notes       2,590        2,590 
Municipal bonds       40,437        40,437 
Mortgage-backed securities:                    
U.S. Government agencies       33,892        33,892 
Collateralized mortgage obligations:                    
U.S. Government agencies       3,580        3,580 
Non-agency       8,308        8,308 
SBA bonds       2,230        2,230 
Preferred stock   797            797 
Securities available-for-sale  $797   $93,694   $   $94,491 
Assets measured at fair value on a non-recurring basis                    
Collateral dependent impaired loans  $   $   $9,782   $9,782 
Other real estate owned           377    377 

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

    Carrying    Estimated    Fair value measurements using 
(in thousands)   value    fair value    Level 1    Level 2    Level 3 
September 30, 2014                         
Financial Assets                         
Cash and due from banks  $48,825   $48,825   $48,825   $   $ 
Securities available-for-sale   85,445    85,445    937    84,508     
Federal Home Loan Bank stock   3,515    3,515        3,515     
Loans receivable, net   461,913    459,425            459,425 
Accrued interest receivable   1,834    1,834            1,834 
Financial Liabilities                         
Demand (non-interest-bearing)  $99,843   $99,843   $   $   $99,843 
Demand (interest-bearing)   81,877    81,877            81,877 
Money market   132,471    132,471            132,471 
Savings and other   122,836    122,836            122,836 
Certificates of deposit   85,267    85,972            85,972 
Deposits   522,294    522,999            522,999 
FHLBB advances   29,218    31,191            31,191 
Repurchase agreements   6,500    6,500            6,500 
Capital lease liability   424    925    925         
Accrued interest payable    136    136            136 
December 31, 2013                         
Financial Assets                         
Cash and due from banks  $12,711   $12,711   $12,711   $   $ 
Interest-bearing time deposits with other banks   738    738            738 
Securities available-for-sale   94,491    94,491    797    93,694     
Federal Home Loan Bank stock   5,340    5,340        5,340     
Loans held-for-sale   173    175            175 
Loans receivable, net   438,178    430,645            430,645 
Accrued interest receivable   1,760    1,760            1,760 
Financial Liabilities                         
Demand (non-interest-bearing)  $84,677   $84,677   $   $   $84,677 
Demand (interest-bearing)   81,932    81,932            81,932 
Money market   120,550    120,550            120,550 
Savings and other   107,171    107,171            107,171 
Certificates of deposit   83,039    83,520            83,520 
Deposits   477,369    477,850            477,850 
FHLBB advances   30,411    33,034            33,034 
Repurchase agreements   2,554    2,554            2,554 
Capital lease liability   425    425    425         
Accrued interest payable    140    140            140 

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, 2013, which Salisbury filed with the Securities and Exchange Commission (the “SEC”) on March 29, 2014. Readers should also review other disclosures Salisbury files from time to time with the SEC.

BUSINESS

Salisbury, a Connecticut corporation, formed in 1998, is the bank holding company for the Bank, a Connecticut-chartered and 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 full-service offices in the towns of: Canaan, Lakeville, Salisbury and Sharon, Connecticut; South Egremont, Sheffield, and Great Barrington, Massachusetts; and, Dover Plains and Millerton, New York. The Bank conducts its trust and wealth advisory services from offices in Lakeville, Connecticut.

The Bank opened a new branch in Great Barrington, Massachusetts on May 5, 2014. In addition, on June 6, 2014, the Bank acquired a branch office and related deposits from another institution in Sharon, Connecticut and consolidated its existing Sharon office with such new branch. On March 19, 2014, Salisbury announced the execution of a definitive merger agreement with Riverside Bank of Poughkeepsie, NY through which, following the satisfaction of normal closing conditions, Riverside Bank will merge with and into the Bank. On November 5, 2014 and November 3, 2014, respectively, the Bank received state and federal regulatory approval in connection with such transaction, which is expected to be completed by year-end 2014. In addition, shareholders of both institutions approved the merger on October 29, 2014.

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 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.

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.

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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.

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.

FINANCIAL CONDITION

Overview

As discussed above, during the first nine months of 2014, Salisbury took strategic initiatives to provide for future growth in each of the three states in which it operates. The new branch in Great Barrington, MA opened May 5, 2014. The agreement to acquire a branch office from another institution in Sharon, CT and consolidate the Bank’s existing Salisbury branch in Sharon, CT into this facility was consummated June 6, 2014. The merger of Riverside Bank of Poughkeepsie, NY with Salisbury Bank, which was announced on March 19, 2014, will add four (4) new offices to Salisbury’s New York footprint upon consummation, which is expected to be completed by year-end 2014. Total assets were $638.1 million at September 30, 2014, up $16.6 million from June 30, 2014. Loans receivable, net, were $461.9 million at September 30, 2014, up $5.3 million, or 1.2%, from June 30, 2014. Non-performing assets were $8.9 million at September 30, 2014, up $0.1 million from $8.8 million at June 30, 2014. Reserve coverage, as measured by the ratio of the allowance for loan losses to gross loans, was 1.15%, 1.11% and 1.10%, at September 30, 2014, June 30, 2014 and September 30, 2013, respectively. Deposits were $522.3 million, up $14.9 million from $507.4 million at June 30, 2014.

At September 30, 2014, book value and tangible book value per common share were $34.74 and $28.50, respectively. Salisbury’s Tier 1 leverage and total risk-based capital ratios were 9.85% and 16.27%, respectively, and above the “well capitalized” limits as defined by the FRB.

Securities and Short Term Funds

During third quarter 2014, securities decreased $3.9 million to $89.0 million. FHLBB stock decreased $0.4 million, while cash and cash equivalents (non-time interest-bearing deposits with other banks, money market funds and federal funds sold) increased $13.9 million to $48.8 million.

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 evaluates securities for strategic fit and may reduce its position in securities, although it is not more likely than not that Salisbury will be required to sell 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 September 30, 2014.

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 deemed the four remaining securities not to have additional OTTI and all other CMO securities not to be OTTI as of September 30, 2014. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury evaluates securities for strategic fit and may reduce its position in securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis.

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Accumulated other comprehensive income at September 30, 2014 included net unrealized holding gains, net of tax, of $2.3 million, an increase of $1.9 million over December 31, 2013, and an unrecognized pension plan benefit, net of tax, of $0.6 million.

Loans

Net loans receivable increased $23.7 million to $461.9 million during the first nine months of 2014, compared with $438.2 million at December 31, 2013.

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

  (in thousands)  September 30, 2014  December 31, 2013
Residential 1-4 family  $242,222   $231,113 
Residential 5+ multifamily   5,397    4,848 
Construction of residential 1-4 family   2,042    1,876 
Home equity credit   34,826    34,139 
Residential real estate   284,487    271,976 
Commercial   96,096    91,853 
Construction of commercial   17,865    10,948 
Commercial real estate   113,961    102,801 
Farm land   3,301    3,402 
Vacant land   9,037    9,067 
Real estate secured   410,786    387,246 
Commercial and industrial   45,100    46,292 
Municipal   6,181    4,252 
Consumer   4,027    3,889 
Loans receivable, gross   466,094    441,679 
Deferred loan origination fees and costs, net   1,203    1,182 
Allowance for loan losses   (5,384)   (4,683)
Loans receivable, net  $461,913   $438,178 
Loans held-for-sale          
Residential 1-4 family  $   $173 

Loan Credit Quality

The persistent weakness in the local and regional economies continues to impact the credit quality of Salisbury’s loans receivable. During the first nine months of 2014, non-performing assets increased $1.4 million, and the amount of total impaired and potential problem loans increased $1.8 million.

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

  (in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
  September 30, 2014                              
Residential 1-4 family  $221,221   $13,755   $7,152   $94   $   $242,222 
Residential 5+ multifamily   3,253    1,079    1,065            5,397 
Construction of residential 1-4 family   2,042                    2,042 
Home equity credit   32,183    1,179    1,464            34,826 
Residential real estate   258,699    16,013    9,681    94        284,487 
Commercial   76,287    11,756    8,053            96,096 
Construction of commercial   16,721    563    581            17,865 
Commercial real estate   93,008    12,319    8,634            113,961 
Farm land   817    1,378    1,106            3,301 
Vacant land   5,745    143    3,149            9,037 
Real estate secured   358,269    29,853    22,570    94        410,786 
Commercial and industrial   39,648    4,641    811            45,100 
Municipal   6,181                    6,181 
Consumer   3,918    81    28            4,027 
Loans receivable, gross  $408,016   $34,575   $23,409   $94   $   $466,094 

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  (in thousands)  Pass  Special mention  Substandard  Doubtful  Loss  Total
  December 31, 2013                              
Residential 1-4 family  $212,683   $12,338   $5,997   $95   $   $231,113 
Residential 5+ multifamily   2,674    1,199    975            4,848 
Construction of residential 1-4 family   1,876                    1,876 
Home equity credit   31,444    1,355    1,340            34,139 
Residential real estate   248,677    14,892    8,312    95        271,976 
Commercial   67,554    16,044    8,255            91,853 
Construction of commercial   10,257    102    589            10,948 
Commercial real estate   77,811    16,146    8,844            102,801 
Farm land   847    1,421    1,134            3,402 
Vacant land   5,640    288    3,139            9,067 
Real estate secured   332,975    32,747    21,429    95        387,246 
Commercial and industrial   37,860    7,452    980            46,292 
Municipal   4,252                    4,252 
Consumer   3,739    113    37            3,889 
Loans receivable, gross  $378,826   $40,312   $22,446   $95   $   $441,679 

Changes in impaired and potential problem loans are as follows:

    September 30, 2014    September 30, 2013 
    Impaired loans    Potential         Impaired loans    Potential       
Three months ended    Non-         problem          Non-          problem      
(in thousands)   accrual    Accruing    loans    Total    accrual     Accruing      loans    Total  
Loans placed on non-accrual status  $409   $   $(311)  $98   $3,671   $(758)  $(1,517)  $1,396 
Loans restored to accrual status   (518)   401        (117)   (902)   385    143    (374)
Loan risk rating downgrades to substandard           2,261    2,261            3,586    3,586 
Loan risk rating upgrades from substandard                           (1,350)   (1,350)
Loan repayments   (66)   (422)   (557)   (1,045)   (2,246)   328    (2,540)   (4,458)
Loan charge-offs   (52)           (52)   (467)   19    (4)   (452)
Increase in TDR loans       400        400        884        884 
Real estate acquired in settlement of loans                   (971)   (736)       (1,707)
Inter-month tax advances   7            7    198            198 
(Decrease) increase in loans  $(220)  $379   $1,393   $1,552   $(717)  $122   $(1,682)  $(2,277)

For third quarter 2014, Salisbury placed $0.4 million of loans on non-accrual status as a result of deteriorated payment and financial performance and charged-off $52,000 of loans primarily as a result of collateral deficiencies.

Salisbury has cooperative relationships with the 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 Salisbury’s reasonable 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.

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Credit Quality Segments

Salisbury categorizes loans receivable into the following credit quality segments:

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

Credit Risk Ratings

Salisbury assigns credit risk ratings to loans receivable in order to manage credit risk and to determine the allowance for loan losses. Credit risk ratings categorize loans by common financial and structural characteristics that measure the credit strength of a borrower. Salisbury’s rating model has eight risk rating grades, with each grade corresponding to a progressively greater risk of default. Grades 1 through 4 are pass ratings and 5 through 8 are ratings (special mention, substandard, doubtful and loss) defined by the bank’s regulatory agencies, the FDIC and Connecticut Department of Banking (“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" contain 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 the 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 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.

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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)  September 30, 2014  December 31, 2013
Non-accrual loans, excluding troubled debt restructured loans  $6,229   $5,419 
Non-accrual troubled debt restructured loans   1,929    1,753 
Accruing troubled debt restructured loans   8,680    8,500 
Total impaired loans  $16,838   $15,672 
Commitments to lend additional amounts to impaired borrowers  $   $ 

Non-Performing Assets

Non-performing assets increased $1.4 million to $8.9 million, or 1.4% of assets at September 30, 2014, from $7.5 million, or 1.4% of assets at December 31, 2013, and decreased $0.8 million from $9.7 million, or 1.6% of assets at September 30, 2013.

The 2% increase in non-performing assets in third quarter 2014 resulted primarily from $0.4 million of loans placed on non-accrual status and a $0.4 million increase in 90+ past due status. This increase was offset in part by $0.1 million in payoffs and charge offs and $0.5 million in loans reinstated to accrual status.

The components of non-performing assets are as follows:

  (in thousands)  September 30, 2014  December 31, 2013
Residential 1-4 family  $2,589   $1,525 
Residential 5+ multifamily   90     
Home equity credit   630    402 
Commercial   1,558    1,857 
Farm land   384    384 
Vacant land   2,865    2,870 
Real estate secured   8,116    7,038 
Commercial and industrial   20    134 
Consumer   22     
Non-accruing loans   8,158    7,172 
Accruing loans past due 90 days and over   453     
Non-performing loans   8,611    7,172 
Real estate acquired in settlement of loans   333    377 
Non-performing assets  $8,944   $7,549 

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

  (in thousands)  September 30, 2014  December 31, 2013
Current  $597   $1,274 
Past due 001-029 days   23    241 
Past due 030-059 days   53    134 
Past due 060-089 days   934    254 
Past due 090-179 days   2,125    588 
Past due 180 days and over   4,879    4,681 
Total non-performing loans  $8,611   $7,172 

At September 30, 2014, 6.93% of non-performing loans were current with respect to loan payments, compared with 17.76% at December 31, 2013. Loans past due 180 days include a $2.8 million loan secured by vacant land (residential building lots) on which Salisbury has initiated a foreclosure action that is further discussed in Item 1 of Part II, Legal Proceedings. The balance of the allowance for loan losses at September 30, 2014 represented 62.5% of the balance of non-performing loans as compared with 65.3% at December 31, 2013. However, it should be noted that during this period, past due loans decreased $1.7 million to 2.0% of total loans as compared to 2.5% of total loans at December 31, 2013.

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Troubled Debt Restructured Loans

Troubled debt restructured loans increased $0.3 million during 2014 to $10.6 million, or 2.28% of gross loans receivable at September 30, 2014, from $10.3 million, or 2.32% of gross loans receivable at December 31, 2013.

The components of troubled debt restructured loans are as follows:

  (in thousands)  September 30, 2014  December 31, 2013
Residential 1-4 family  $4,573   $4,956 
Home equity credit   48    48 
Vacant land   217    225 
Commercial   3,276    2,691 
Real estate secured   8,114    7,920 
Personal/Consumer       22 
Commercial and industrial   566    558 
Accruing troubled debt restructured loans   8,680    8,500 
Residential 1-4 family   1,230    999 
Home equity credit   104    40 
Commercial   428    608 
Real estate secured   1,762    1,647 
Personal/Consumer   22     
Commercial and industrial   145    106 
Non-accrual troubled debt restructured loans   1,929    1,753 
Troubled debt restructured loans  $10,609   $10,253 

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

  (in thousands)  September 30, 2014  December 31, 2013
Current  $7,606   $6,559 
Past due 1-29 days   1,074    1,490 
Past due 30-59 days       95 
Past due 60-89 days       356 
Accruing troubled debt restructured loans   8,680    8,500 
Current   431    999 
Past due 1-29 days   23    241 
Past due 30-59 days   39    64 
Past due 60-89 days   457     
Past due 90-179 days   744    449 
Past due 180 days and over   235     
Non-accrual troubled debt restructured loans   1,929    1,753 
Total troubled debt restructured loans  $10,609   $10,253 

At September 30, 2014, 75.75% of troubled debt restructured loans were current with respect to loan payments, as compared with 73.72% at December 31, 2013.

Past Due Loans

Loans past due 30 days or more decreased $1.7 million during 2014 to $9.3 million, or 1.99% of gross loans receivable at September 30, 2014, compared with $11.0 million, or 2.50% of gross loans receivable at December 31, 2013.

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

  (in thousands)  September 30, 2014  December 31, 2013
Past due 030-059 days  $313   $2,535 
Past due 060-089 days   982    2,840 
Past due 090-179 days   453     
Accruing loans   1,748    5,375 
Past due 030-059 days    53    133 
Past due 060-089 days   934    254 
Past due 090-179 days   1,672    588 
Past due 180 days and over   4,879    4,681 
Non-accrual loans   7,538    5,656 
Total loans past due 30 days or greater  $9,286   $11,031 

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Potential Problem Loans

Potential problem loans increased $0.6 million during the first nine months of 2014 to $9.7 million, or 2.09% of gross loans receivable at September 30, 2014, compared with $9.1 million, or 2.06% of gross loans receivable at December 31, 2013.

The components of potential problem loans are as follows:

  (in thousands)  September 30, 2014  December 31, 2013
Residential 1-4 family  $2,839   $1,528 
Residential 5+ multifamily   975    975 
Construction of residential 1-4 family        
Home equity credit   786    890 
Residential real estate   4,600    3,393 
Commercial   3,665    4,036 
Construction of commercial   450    589 
Commercial real estate   4,115    4,625 
Farm land   723    751 
Vacant land   67    44 
Real estate secured   9,505    8,813 
Commercial and industrial   226    288 
Consumer   6    15 
Other classified loans receivable  $9,737   $9,116 

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

  (in thousands)  September 30, 2014  December 31, 2013
Current  $6,423   $7,646 
Past due 001-029 days   2,976    189 
Past due 030-059 days   122    298 
Past due 060-089 days   216    983 
Past due 090-179 days        
Total potential problem loans  $9,737   $9,116 

At September 30, 2014, 65.96% of potential problem loans were current with respect to loan payments, as compared with 83.87% at December 31, 2013.

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 provisions for loan losses.

Deposits and Borrowings

Including the acquisition of approximately $18.2 million in deposits in connection with the Sharon, Connecticut branch acquisition completed in June, 2014, deposits increased $44.9 million during 2014 to $522.3 million at September 30, 2014, from $477.4 million at December 31, 2013, and increased $42.4 million year-over-year from $479.9 million at September 30, 2013. Retail repurchase agreements increased $3.9 million during 2014 to $6.5 million at September 30, 2014, compared with $2.6 million at December 31, 2013, and increased $2.6 million year-over-year compared with $3.9 million at September 30, 2013.

Federal Home Loan Bank of Boston (FHLBB) advances decreased $1.2 million during 2014 to $29.2 million at September 30, 2014, from $30.4 million at December 31, 2013, and decreased $1.6 million year-over-year from $30.8 million at September 30, 2013. The decreases were due to amortizing payments of advances.

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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 provides for the prompt and comprehensive response to unexpected demands for liquidity. At September 30, 2014, 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 24.96%, up from 16.33% at December 31, 2013. Management believes Salisbury’s funding sources will meet anticipated funding needs.

Operating activities for the nine-month period ended September 30, 2014 provided net cash of $4.1 million. Investing activities provided net cash of $4.1 million, principally from cash and cash equivalents of $17.5 million related to the acquisition of the Sharon, CT branch and proceeds from calls and maturities of securities available-for-sale of $11.7 million, offset by $24.7 million of net loan originations and principal collections. Financing activities provided net cash of $27.9 million, principally due to a net increase of $30.6 million in deposits and repurchase agreements, offset by pay downs of FHLBB advances and common and preferred stock dividends paid.

At September 30, 2014, Salisbury had outstanding commitments to fund new loan originations of $15.3 million and unused lines of credit of $67.3 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. Additional liquidity is being carried on the balance sheet in anticipation of the closing of the previously announced merger with Riverside Bank.

RESULTS OF OPERATIONS

For the three month periods ended September 30, 2014 and 2013

OVERVIEW

During the third quarter of 2014, Salisbury made significant progress in implementing strategic initiatives to enhance its market presence in New York State:

·During the third quarter of 2014, the bank continued merger related planning.
·On October 29, 2014, shareholders of Riverside Bank and Salisbury voted to approve the merger.
·State and federal regulators approved the merger on November 5, 2014 and November 3, 2014, respectively. The merger is expected to close before end of year 2014.

Net income available to common shareholders was $728,000, or $0.43 per common share, for the quarter ended September 30, 2014 (third quarter 2014), versus $926,000, or $0.54 per common share, for the quarter ended June 30, 2014 (second quarter 2014), and $976,000, or $0.57 per common share, for the quarter ended September 30, 2013 (third quarter 2013).

·Earnings per common share of $0.43 decreased $0.11, or 20.4%, as compared to $0.54 for the second quarter 2014, and decreased $0.14, or 24.6%, as compared to third quarter 2013.

 

·Excluding non-recurring third quarter after tax expenses of $165,000 and similar second quarter non-recurring expenses of $83,000 (after taxes) substantially related to professional fees which were incurred in conjunction with strategic initiatives during the second and third quarter 2014 respectively (non-GAAP):
oThird quarter 2014 earnings per common share would have been $0.52, representing a decrease of $0.07 versus second quarter 2014, and a decrease of $0.05, versus third quarter 2013.
oThird quarter 2014 net income available to common shareholders would have decreased $115,000, or 11%, versus an adjusted second quarter 2014 and would have decreased $83,000, or 9%, versus third quarter 2013.
oThird quarter 2014 non-interest expense would have decreased $67,000, or 2%, versus an adjusted second quarter 2014 and would have increased $268,000, or 6%, versus third quarter 2013.
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·The net interest margin decreased 35 basis points versus second quarter 2014 and decreased 12 basis points versus third quarter 2013. The decline in net interest margin is attributable to a number of factors including:
oHigher balances, $34 million on average as compared with the prior quarter, of interest bearing demand deposits with other banks is a result of our branch acquisition and seasonal deposit flows. This additional liquidity is being carried on