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CBNK > SEC Filings for CBNK > Form 10-K on 15-Mar-2013All Recent SEC Filings

Show all filings for CHICOPEE BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for CHICOPEE BANCORP, INC.


15-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the "Selected Financial Data" and the Company's Consolidated Financial Statements and notes thereto, each appearing elsewhere in this Annual Report on Form 10-K.

Forward-Looking Statements

This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain.

By identifying these forward-looking statements for you in this manner, we are alerting you to the possibility that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ from those indicated in the forward-looking statements include, among others, those discussed under "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K. In addition to these risk factors, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These additional factors include, but are not limited to: (1) changes in consumer spending, borrowing and savings habits; (2) the financial health of certain entities, including government sponsored enterprises, the securities of which are owned or acquired by the Company; (3) adverse changes in the securities market; and (4) the costs, effects and outcomes of existing of future litigation. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

Overview

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and securities, and interest expense, which is the interest that we pay on our deposits and borrowings. Other significant sources of pre-tax income are service charges fees and commissions, which include service charges on deposit accounts, brokerage fee income and other loan fees (including loan brokerage fees and late charges), income from bank-owned life insurance and income from loan sales and servicing. In addition, we recognize income or losses from the sale of securities available-for-sale in years that we have such sales.

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance to cover the inherent probable losses in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, information about specific borrower situations, estimated collateral values, economic conditions, and other factors. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off.

Expenses. The non-interest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy expenses, furniture and equipment expenses, data processing expenses and various other miscellaneous expenses.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the following to be our critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

Management believes the allowance for loan losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on management's evaluation of the level of the allowance required in relation to the probable loss exposure in the loan portfolio. The allowance for loan losses is evaluated on a regular basis by management. Qualitative factors, or risks considered in evaluating the adequacy of the allowance


for loan losses for all loan classes include historical loss experience; levels and trends in delinquencies, nonaccrual loans, impaired loans and net charge-offs; the character and size of the loan portfolio; effects of any changes in underwriting policies; experience of management and staff; current economic conditions and their effect on borrowers; effects of changes in credit concentrations, and management's estimation of probable losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Loans considered for impairment include all loan classes of commercial and residential, as well as home equity loans. The classes are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment evaluation, except for home equity loans.

Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes as prescribed in "Accounting for Income Taxes". Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. A valuation allowance would result in additional income tax expense in the period, which would negatively affect earnings.

Mortgage Servicing Rights. Mortgage servicing rights associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet. Mortgage servicing rights are amortized into non-interest income in proportion to, and over the period of, estimated future net servicing income of the underlying financial assets. Mortgage servicing rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for mortgage servicing rights relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of mortgage servicing rights requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the mortgage servicing rights is periodically reviewed for impairment


based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as a component of non-interest expense.

Other-Than-Temporary Impairment. "Accounting for Certain Investments in Debt and Equity Securities," "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Benefits," and "Noncurrent Marketable Equity Securities," require companies to perform periodic reviews of individual securities in their investment portfolios to determine whether decline in the value of a security is other than temporary. A review of other-than-temporary impairment requires companies to make certain judgments regarding the materiality of the decline, its effect on the financial statements and the probability, extent and timing of a valuation recovery and the company's intent and ability to hold the security. Pursuant to these requirements, we assess valuation declines to determine the extent to which such changes are attributable to (1) fundamental factors specific to the issuer, such as financial condition, business prospects or other factors or (2) market-related factors, such as interest rates or equity market declines. Declines in the fair value of securities below their costs that are deemed to be other than temporary are recorded in earnings as realized losses. For declines in the fair value of individual debt securities available-for-sale below their cost that are deemed to be other-than-temporary, where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis, the other-than-temporary decline in the fair value of the debt security related to 1) credit loss is recognized in earnings and 2) other factors is recognized in other comprehensive income or loss. Credit loss is determined to exist if the present value of expected future cash flows using the effective rate at acquisition is less than the amortized cost basis of the debt security. For individual debt securities where the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost, the other-than-temporary impairment is recognized in earnings equal to the difference between the security's cost basis and its fair value at the balance sheet date. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Operating Strategy

Our mission is to operate and grow a profitable community-oriented financial institution serving primarily retail customers and businesses in our market areas. We plan to continue our strategy of:

? increasing our commercial relationships in our expanding market area;

? increasing our deposit market share in our expanding market area;

? increasing our sale of non-deposit investment products;

? improving operating efficiency and cost control; and

? applying disciplined underwriting practices to maintain the high quality of our loan portfolio.

Continuing to increase our commercial relationships in our expanding market area. We have diversified our loan portfolio beyond residential loans by increasing our commercial relationships. Our commercial real estate, commercial construction and commercial and industrial loan portfolio has increased $88.3 million, or 39.9%, from $221.5 million, or 52.9% of the total loan portfolio, at December 31, 2008 to $309.8 million, or 66.1% of the total loan portfolio, at December 31, 2012. Business deposit accounts have increased $33.3 million, or 128.6%, from $25.9 million at December 31, 2008 to $59.2 million at December 31, 2012. In order to support the growth in the commercial loan portfolio, we have also increased the number of commercial lenders and commercial lending administrative staff.

Increasing our deposit market share in our expanding market area. Retail deposits are our primary source of funds for investing and lending. By offering a variety of deposit products, special and tiered pricing, and superior customer service, we will seek to retain and expand existing customer relationships as well as attract new deposit customers. Personalized service and flexibility with regard to customer needs will continue to be augmented with a full array of delivery channels to maximize customer convenience. These include drive-up banking, ATMs, internet banking, automated bill payment, remote capture, and telephone banking. Through our continued focus on these deposit-gathering efforts in existing branch locations, couple with our plans for geographic expansion, we expect to increase the overall level of deposits and our market share in the markets we serve.

In addition, historically, one of our primary competitors for retail deposits in the Chicopee market area has been credit unions. Credit unions are formidable competitors since, as tax-exempt organizations, they are able to offer higher rates on retail deposits than banks. By expanding our market area beyond the immediate Chicopee market area, and beyond the market areas of our larger credit union competitors, we intend to increase our overall deposit market share of Hampden County.


Increasing our sale of non-deposit investment products. Our profits rely heavily on the spread between the interest earned on loans and securities and interest paid on deposits and borrowings. In order to decrease our reliance on interest rate spread income we have pursued initiatives to increase non-interest income. We offer non-deposit investment products, including mutual funds, annuities, pension plans, life insurance, long-term care and 529 college savings plans through a third party registered broker-dealer, Linsco/Private Ledger. This initiative generated $312,000, $232,000 and $183,000 of non-interest income during the years ended December 31, 2012, 2011, and 2010, respectively. In connection with our expanding branch network, we intend to continue to increase our sale of non-deposit investment products by engaging one additional retail investment employee to serve customers of our anticipated branch expansion.

Improving operating efficiency and cost control. Non-interest expense decreased $429,000, or 2.3%, from $18.7 million, or 3.21% of average total assets, at December 31, 2011 to $18.3 million, or 3.06% of average total assets, at December 31, 2012. The decrease in expenses was largely due to the decrease in salaries and benefits of $466,000, or 4.3%, and a decrease in FDIC insurance premium fees of $180,000, or 33.5%. We recognize that our growth strategies have required greater investments in personnel, marketing, premises and equipment which have had a negative impact on our expense ratio over the short term. Our non-interest expenses are also impacted as a result of the financial, accounting, legal and compliance and other additional expenses usually associated with operating as a public company. We will also recognize additional annual employee compensation and benefit expenses stemming from our employee stock ownership plan and options and restricted stock granted to employees and executives. These additional expenses adversely affect our profitability. We recognize expenses for our employee stock ownership plan when shares are committed to be released to participants' accounts and recognize expenses for restricted stock awards and stock options over the vesting period of awards made to recipients pursuant to our 2007 Equity Incentive Plan.

Applying disciplined underwriting practices to maintain the high quality of our loan portfolio. We believe that high asset quality is a key to long-term financial success. We have sought to grow and diversify the loan portfolio, while maintaining a high level of asset quality and moderate credit risk, using underwriting standards that we believe are conservative and diligent monitoring and collection efforts. At December 31, 2012, our ratio of nonperforming loans (loans which are 90 or more days delinquent) to total loans was 0.85% of our total loan portfolio. Although we intend to continue our efforts to originate commercial real estate, commercial business and construction loans, we intend to continue our philosophy of managing large loan exposures through our conservative approach to lending.

Balance Sheet Analysis

Comparison of Financial Condition at December 31, 2012 and December 31, 2011

Total Assets. Total assets decreased $16.3 million, or 2.6%, from $616.3 million at December 31, 2011 to $600.0 million at December 31, 2012. The decrease was primarily due to a $21.5 million, or 35.2%, decrease in cash and cash equivalents, and a decrease in investments of $14.3 million or 19.2%. These decreases were partially offset by the increase in net loans of $21.7 million, or 4.9%, from $443.5 million, or 72.0% of total assets, at December 31, 2011 to $465.2 million, or 77.5% of total assets, at December 31, 2012.

Cash and Cash Equivalents. Cash, including correspondent bank balances and federal funds sold, decreased $21.5 million, or 35.2%, from $61.1 million at December 31, 2011 to $39.6 million at December 31, 2012.

Investments. The investment securities portfolio, including held-to-maturity and available-for-sale securities, decreased $14.3 million, or 19.2%, from $74.5 million at December 31, 2011 to $60.2 million at December 31, 2012. The decrease in investments was primarily due to a $13.3 million, or 49.2%, decrease in the U.S. Treasury portfolio, a $4.2 million, or 31.5%, decrease in certificates of deposit, and a decrease of $892,000, or 43.1%, in collateralized mortgage obligations, partially offset by the increase in tax-exempt industrial revenue bonds of $4.1 million, or 12.9%.

Net Loans. Net loans increased $21.7 million, or 4.9%, from $443.5 million at December 31, 2011 to $465.2 million at December 31, 2012. Commercial real estate loans increased $14.7 million, or 8.4%, commercial and industrial loans increased $5.2 million, or 6.5%, commercial construction loans increased $4.1 million, or 12.9%, and home equity loans increased $1.9 million, or 6.5%. These increases were partially offset by a decrease in one-to four-family residential loans of $3.0 million, or 2.5%, a decrease in residential construction loans of $1.3 million, or 22.6%, and a decrease of $74,000, or 2.9%, in consumer loans. The decrease in residential real estate loans was primarily due to prepayments and refinancing activity attributed to the decline in interest rates to historically low levels. The residential construction portfolio decreased as borrowers completed construction projects and the demand for construction loans decreased due to the economy. In accordance with the Company's asset/liability management strategy and in an effort to reduce interest rate risk, the Company sold $24.4 million fixed rate, low coupon residential real estate loans originated in 2012 to the secondary market. The Company currently services $87.1 million in loans sold to the secondary market. Servicing rights will continue to be retained on all loans originated and sold in the secondary market.


Deposits and Borrowed Funds. Total deposits increased $12.8 million, or 2.8%, from $453.4 million at December 31, 2011 to $466.2 million at December 31, 2012. NOW accounts increased $10.0 million, or 37.3%, to $36.7 million, money market deposit accounts increased $30.1 million, or 30.9%, to $127.7 million, demand accounts increased $6.6 million, or 9.6%, to $75.4 million and regular savings accounts increased $1.8 million, or 3.7%, to $48.9 million. These increases were offset by a decrease in certificates of deposit of $35.7 million, or 16.7%, to $177.4 million. The decrease in certificates of deposit was mainly attributed to the strategic run-off of high cost accounts as a result of management's focus to lower the cost of deposits and allow higher cost, short-term time deposits to mature without renewals. The $35.7 million, or 16.7%, decrease in certificates of deposit was offset by the $48.5 million, or 20.2%, increase in low cost relationship focused transaction and savings accounts.

Total borrowings, including securities sold under agreement to repurchase of $9.8 million and Federal Home Loan Bank ("FHLB") advances of $33.3 million, decreased $28.5 million, or 39.8%, to $43.1 million at December 31, 2012. FHLB advances decreased $25.9 million, or 43.8%. On December 24, 2012, the Bank restructured $6.7 million of FHLB advances. From time to time, management may use borrowed money to engage in various leverage strategies to increase income as opportunities arise. Prior to this restructuring, these advances had a weighted average cost of 2.40% and a weighted average maturity term of 16.1 months. After this restructuring, the weighted average cost was reduced by 0.64% to 1.76% and the weighted average maturity term was extended 31.3 months to 47.4 months. In an effort to decrease the Bank's interest rate risk from rising interest rates, the Bank took advantage of the Federal Home Loan Bank of Boston's program to restructure outstanding advances. Repurchase agreements decreased $2.6 million, or 20.9%, from $12.3 million at December 31, 2011 to $9.8 million at December 31, 2012.

Total Stockholders' Equity. Total stockholders' equity at December 31, 2012 was $90.0 million compared to $90.8 million at December 31, 2011. The decrease was primarily attributed to the Company's stock repurchase plan of $4.4 million, partially offset by an increase in stock-based compensation of $1.1 million, and net income of $2.5 million. In 2012, the Company purchased 307,718 shares of the Company's common stock at a cost of $4.4 million and an average per share price of $14.22. Our capital management strategies allowed us to increase our book value per share by $0.74, or 4.7%, to $16.57 at December 31, 2012 compared to $15.83 at December 31, 2011.

Loans. Our primary lending activity is the origination of loans secured by real estate. We originate one-to-four-family residential loans, commercial real estate loans and commercial business loans. To a lesser extent, we originate residential investment, construction and consumer loans.

The size of our residential real estate loan portfolio has decreased from $123.3 million at December 31, 2011 to $120.3 million at December 31, 2012, primarily due to prepayments and refinancing activity attributed to the decline in interest rates to historically low levels. In accordance with the Company's asset/liability management strategy and in an effort to reduce interest rate risk, the Company sold $24.4 million of fixed rate, low coupon residential real estate loans originated in 2012 to the secondary market. Servicing rights will continue to be retained on all loans originated and sold in the secondary market.

The commercial real estate and residential investment portfolio increased $14.7 million, or 8.4%, from $174.8 million at December 31, 2011 to $189.5 million at December 31, 2012 as a result of new commercial loan relationships.

Commercial and industrial loans increased from $79.4 million at December 31, 2011 to $84.6 million at December 31, 2012 as a result of new commercial relationships due to increased marketing efforts and offering a wider variety of services for commercial borrowers, including cash management products.

The construction loan portfolio increased from $37.3 million at December 31, 2011 to $40.1 million at December 31, 2012. Commercial construction increased $4.1 million, or 12.9%, from $31.7 million at December 31, 2011 to $35.8 million at December 31, 2012 due to two commercial construction projects to existing borrowers. Residential construction decreased $1.3 million, or 22.6%, as borrowers completed existing projects and the demand for new construction loans decreased.

The consumer and home equity loan portfolio increased $1.9 million, or 5.8%, from $32.4 million at December 31, 2011 to $34.2 million at December 31, 2012, primarily due to refinancing activity attributed to the decline in interest rates to historically low levels.


Loan Portfolio Composition. The following table sets forth the composition of the Company's loan portfolio in dollar amounts and as a percentage of the respective portfolio at the dates indicated.

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