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

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Form 10-K for WESTFIELD FINANCIAL INC


15-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview. We strive to remain a leader in meeting the financial service needs of the local community and to provide quality service to the individuals and businesses in the market areas that we have served since 1853. Historically, we have been a community-oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. We meet the needs of our local community through a community-based and service-oriented approach to banking.

We have adopted a growth-oriented strategy that has focused on increasing commercial lending. Our strategy also calls for increasing deposit relationships and broadening our product lines and services. We believe that this business strategy is best for our long-term success and viability, and complements our existing commitment to high quality customer service. In connection with our overall growth strategy, we seek to:

• grow our commercial and industrial and commercial real estate loan portfolio by targeting businesses in our primary market area and in northern Connecticut as a means to increase the yield on and diversify our loan portfolio and build transactional deposit account relationships;

• focus on expanding our retail banking franchise and increase the number of households served within our market area; and

• to supplement the commercial focus, grow the residential loan portfolio to diversify risk and deepen customer relationships. We will maintain our arrangement with a third-party mortgage company which assists in originating and servicing residential real estate loans. By doing this, we reduce the overhead costs associated with these loans.

You should read the following financial results for the year ended December 31, 2012 in the context of this strategy.

• Net income was $6.3 million, or $0.26 per diluted share, for the year ended December 31, 2012, compared to $5.9 million, or $0.22 per diluted share for the same period in 2011. The results for the year ended December 31, 2012 showed a decrease in the provision for loan losses as well as an increase in noninterest income compared to the same period in 2011; however, these were partially offset by an increase in noninterest expense.

• We provided $698,000 for loan losses for the year ended December 31, 2012, compared to $1.2 million for the same period in 2011. While there was net loan growth during 2012, the decrease in the provision for loan losses occurred because there was an overall positive change in the risk profile of the loan portfolio during the fourth quarter of 2012, which offset the need for additional provision expense. In 2012, total loans increased $40.7 million, with the increase primarily in residential real estate loans which contain less credit risk and market risk than both commercial real estate and commercial and industrial loans. The allowance was $7.8 million for both December 31, 2012 and December 31, 2011, or 1.31% and 1.40% of total loans, respectively.

• Noninterest income increased $2.2 million to $6.0 million for the year ended December 31, 2012, compared to $3.8 million for the same period in 2011. The increase was primarily the result of an increase in net gains on the sale of securities of $2.5 million for the year ended December 31, 2012, partially offset by $1.0 million in prepayment expense incurred on the prepayment of $28.0 million in repurchase agreements.

• Noninterest expense increased $1.2 million to $27.2 million at December 31, 2012, compared to $26.0 million at December 31, 2011. The increase in noninterest expense for the year ended December 31, 2012 was due to an increase in salaries and benefits of $973,000 related to regular annual adjustments as well as salaries and benefits related to the hiring of additional personnel, particularly in the commercial lending and compliance divisions.


General. Our consolidated results of operations depend primarily on net interest and dividend income. Net interest and dividend income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Interest-earning assets consist primarily of securities, commercial real estate loans, commercial and industrial loans and residential real estate loans. Interest-bearing liabilities consist primarily of certificates of deposit and money market account, NOW account and savings account deposits, borrowings from the FHLBB and securities sold under repurchase agreements. The consolidated results of operations also depend on the provision for loan losses, noninterest income, and noninterest expense. Noninterest expense includes salaries and employee benefits, occupancy expenses and other general and administrative expenses. Noninterest income includes service fees and charges, income on bank-owned life insurance, and gains (losses) on securities.

Critical Accounting Policies. Our accounting policies are disclosed in Note 1 to our consolidated financial statements. Given our current business strategy and asset/liability structure, the more critical policies are accounting for nonperforming loans, the allowance for loan losses and provision for loan losses, other than temporary impairment of securities, and the valuation of deferred taxes. In addition to the informational disclosure in the notes to the consolidated financial statements, our policy on each of these accounting policies is described in detail in the applicable sections of "Management's Discussion and Analysis of Financial Condition and Results of Operations." Senior management has discussed the development and selection of these accounting policies and the related disclosures with the Audit Committee of our Board of Directors.

Our general policy regarding recognition of interest on loans is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of the principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and when subsequent performance reduces the concern as to the collectability of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans.

The process of evaluating the loan portfolio, classifying loans and determining the allowance and provision is described in detail in Part I under "Business - Lending Activities - Allowance for Loan Losses." Our methodology for assessing the allocation of the allowance consists of two key components, which are a specific allowance for impaired loans and an allowance for the remainder of the portfolio. Measurement of impairment can be based on present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The allocation of the allowance is also reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio. Although management believes it has established and maintained the allowance for loan losses at adequate levels, if management's assumptions and judgments prove to be incorrect due to continued deterioration in economic, real estate and other conditions, and the allowance for loan losses is not adequate to absorb inherent losses, our earnings and capital could be significantly and adversely affected.

On a quarterly basis, we review securities with a decline in fair value below the amortized cost of the investment to determine whether the decline in fair value is temporary or other than temporary. Declines in the fair value of marketable equity securities below their cost that are deemed to be other than temporary based on the severity and duration of the impairment are reflected in earnings as realized losses. In estimating other than temporary impairment losses for securities, impairment is required to be recognized if (1) we intend to sell the security; (2) it is "more likely than not" that we will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired available for sale securities that we intend to sell, or more likely than not will be required to sell, the full amount of the other than temporary impairment is recognized through earnings. For other impaired debt securities, credit-related other than temporary impairment is recognized through earnings, while non-credit related other than temporary impairment is recognized in other comprehensive income, net of applicable taxes.


We must make certain estimates in determining income tax expense for financial statement purposes. These estimates occur in the calculation of the deferred tax assets and liabilities, which arise from the temporary differences between the tax basis and financial statement basis of our assets and liabilities. The carrying value of our net deferred tax asset is based on our historic taxable income for the two prior years as well as our belief that it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets. Judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws or other factors which could result in a change in the assessment of the realization of the net deferred tax asset.

Average Balance Sheet and Analysis of Net Interest and Dividend Income

The following table sets forth information relating to our financial condition and net interest and dividend income for the years ended December 31, 2012, 2011 and 2010 and reflects the average yield on assets and average cost of liabilities for the years indicated. The yields and costs were derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the years shown. Average balances were derived from actual daily balances over the years indicated. Interest income includes fees earned from making changes in loan rates or terms, and fees earned when commercial real estate loans were prepaid or refinanced.

The interest earned on tax-exempt assets is adjusted to a tax-equivalent basis to recognize the income tax savings which facilitates comparison between taxable and tax-exempt assets.


                                                                         For the Years Ended December 31,
                                          2012                                         2011                                         2010
                          Average                    Avg Yield/        Average                    Avg Yield/        Average                    Avg Yield/
                          Balance       Interest        Cost           Balance       Interest        Cost           Balance       Interest        Cost
                                                                             (Dollars in thousands)
ASSETS:
Interest-earning
assets
Loans(1)(2)            $   573,642     $ 25,762            4.49 %   $   536,084     $ 25,485            4.75 %   $   482,215     $ 24,887            5.16 %
Securities(2)              638,467       18,110            2.84         619,704       20,376            3.29         634,531       22,055            3.48
Other investments -
at cost                     15,287           94            0.61          14,034           61            0.43          12,900           24            0.19
Short-term
investments(3)              11,074            8            0.07           7,503            1            0.01          13,948            8            0.06
Total
interest-earning
assets                   1,238,470       43,974            3.55       1,177,325       45,923            3.90       1,143,594       46,974            4.11
Total
noninterest-earning
assets                      64,629                                       70,133                                       78,842

Total assets           $ 1,303,099                                  $ 1,247,458                                  $ 1,222,436

LIABILITIES AND
EQUITY:
Interest-bearing
liabilities
NOW accounts           $    61,277          266            0.43     $    85,094          762            0.90     $    76,954          933            1.21
Savings accounts            95,129          186            0.20         104,112          515            0.49         112,546          824            0.73
Money market
accounts                   170,171          807            0.47          99,319          619            0.62          56,082          358            0.64
Time certificates of
deposit                    318,000        4,883            1.54         332,327        5,693            1.71         347,590        7,735            2.23
Total
interest-bearing
deposits                   644,577        6,142                         620,852        7,589                         593,172        9,850
Short-term
borrowings and
long-term debt             332,129        6,521            1.96         303,909        6,878            2.26         296,752        6,915            2.33
Interest-bearing
liabilities                976,706       12,663            1.30         924,761       14,467            1.56         889,924       16,765            1.88
Noninterest-bearing
deposits                   104,454                                       91,024                                       83,077
Other
noninterest-bearing
liabilities                 11,179                                        9,754                                        9,513
Total
noninterest-bearing
liabilities                115,633                                      100,778                                       92,590

Total liabilities        1,092,339                                    1,025,539                                      982,514
Total equity               210,760                                      221,919                                      239,922
Total liabilities
and equity             $ 1,303,099                                  $ 1,247,458                                  $ 1,222,436
Less: Tax-equivalent
adjustment(2)                              (870 )                                       (918 )                                       (827 )
Net interest and
dividend income                        $ 30,441                                     $ 30,538                                     $ 29,382
Net interest rate
spread(4)                                                  2.24 %                                       2.34 %                                       2.22 %
Net interest
margin(5)                                                  2.53 %                                       2.67 %                                       2.64 %
Average
interest-earning
assets
   to average
interest-bearing
   liabilities                                           126.80 %                                     127.30 %                                     128.50 %


                   __________________________________________

(1) Loans, including non-accrual loans, are net of deferred loan origination costs, and unadvanced funds and allowance for loan losses.

(2) Securities income, loan income and net interest income are presented on a tax-equivalent basis using a tax rate of 34%. The tax-equivalent adjustment is deducted from tax-equivalent net interest and dividend income to agree to the amount reported in the statements of income.

(3) Short-term investments include federal funds sold.

(4) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.

(5) Net interest margin represents tax-equivalent net interest and dividend income as a percentage of average interest-earning assets.


Rate/Volume Analysis. The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest and dividend income and interest expense during the periods indicated. Information is provided in each category with respect to: (1) interest income changes attributable to changes in volume (changes in volume multiplied by prior rate); (2) interest income changes attributable to changes in rate (changes in rate multiplied by prior volume); and (3) the net change.

The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

                              Year Ended December 31, 2012 Compared to                 Year Ended December 31, 2011 Compared to
                                    Year Ended December 31, 2011                             Year Ended December 31, 2010
                                     Increase (Decrease) Due to                               Increase (Decrease) Due to
                           Volume              Rate                 Net             Volume              Rate                 Net
Interest-earning
assets                                                                 (In thousands)
Loans (1)               $      1,785       $      (1,508 )     $         277     $      2,780       $      (2,182 )     $         598
Securities (1)                   617              (2,883 )            (2,266 )           (515 )            (1,164 )            (1,679 )
Other investments -
at cost                            5                  28                  33                2                  35                  37
Short-term
investments                        -                   7                   7               (4 )                (3 )                (7 )
Total
interest-earning
assets                         2,407              (4,356 )            (1,949 )          2,263              (3,314 )            (1,051 )

Interest-bearing
liabilities
NOW accounts                    (213 )              (283 )              (496 )             99                (270 )              (171 )
Savings accounts                 (44 )              (285 )              (329 )            (62 )              (247 )              (309 )
Money market accounts            442                (254 )               188              276                 (15 )               261
Time deposits                   (245 )              (565 )              (810 )           (340 )            (1,702 )            (2,042 )
Short-term borrowing
and long-time debt               639                (996 )              (357 )            167                (204 )               (37 )
Total
interest-bearing
liabilities                      579              (2,383 )            (1,804 )            140              (2,438 )            (2,298 )
Change in net
interest and dividend
income                  $      1,828       $      (1,973 )     $        (145 )   $      2,123       $        (876 )     $       1,247


ญญ______________________


(1) Securities and loan income and net interest income are presented on a tax-equivalent basis using a tax rate of 34%. The tax-equivalent adjustment is deducted from tax-equivalent net interest income to agree to the amount reported in the statements of income.


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

Total assets increased $38.2 million to $1.3 billion at December 31, 2012. Net loans increased by $40.7 million to $587.1 million at December 31, 2012 from $546.4 million at December 31, 2011. Cash and cash equivalents decreased $9.3 million to $11.8 million at December 31, 2012 from $21.1 million at December 31, 2011, as funds were reinvested into the loan portfolio.

Securities increased $5.8 million to $635.8 million at December 31, 2012 from $630.0 million at December 31, 2011. The securities portfolio is primarily comprised of mortgage-backed securities, which totaled $458.8 million at December 31, 2012 and $540.7 million at December 31, 2011, the majority of which were issued by government-sponsored enterprises such as the Federal National Mortgage Association. Privately issued mortgage-backed securities comprised $1.6 million, or 0.29%, of the mortgage-backed securities portfolio at December 31, 2011. There were no privately issued mortgage-backed securities in the portfolio at December 31, 2012.

Debt securities issued by government-sponsored enterprises increased $37.3 million to $62.1 million at December 31, 2012 from $24.8 million at December 31, 2011. Securities issued by government-sponsored enterprises include bonds issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. At December 31, 2012, we had $52.3 million in corporate bonds. We began investing in investment grade corporate bonds during the second quarter of 2012 as a means of diversifying our securities portfolio while also increasing the average yield on the portfolio. We also invest in municipal bonds primarily issued by cities and towns in Massachusetts that are rated as investment grade by Moody's, Standard & Poor's or Fitch, and the majority of which are also independently insured. Municipal bonds were $40.8 million at December 31, 2012 and $45.9 million at December,31 2011. In addition, we have investments in FHLBB stock, common stock and mutual funds that invest only in securities allowed by the OCC.

Net loans increased by $40.7 million to $587.1 million at December 31, 2012 from $546.4 million at December 31, 2011. The increase in net loans was primarily the result of an increase in residential real estate loans and commercial real estate loans. Residential real estate loans increased $27.2 million to $219.7 million at December 31, 2012 from $192.5 million at December 31, 2011. Through our long standing relationship with a third-party mortgage company, we originated and purchased a total of $63.1 million in residential loans within and contiguous to our market area as a means of diversifying our loan portfolio and improving net interest income.

Commercial real estate loans increased $13.3 million to $245.8 million at December 31, 2012 from $232.5 million at December 31, 2011. Owner occupied commercial real estate loans totaled $113.0 million at December 31, 2012 and $109.7 million at December 31, 2011, while non-owner occupied commercial real estate loans totaled $132.8 million at December 31, 2012 and $122.8 million at December 31, 2011.

Commercial and industrial loans increased $306,000 to $126.1 million at December 31, 2012 from $125.7 million at December 31, 2011. While we continue to originate commercial and industrial loans, new originations were offset by customers decreasing their balances on lines of credit and normal loan payments and payoffs.

Total deposits increased $20.4 million to $753.4 million at December 31, 2012, compared to $733.0 million at December 31, 2011. Money market accounts increased $21.3 million to $168.2 million at December 31, 2012. Time deposits increased $10.2 million to $326.0 million at December 31, 2012. These increases were offset by decreases in both regular savings and NOW and checking accounts. Regular savings accounts decreased $6.4 million to $92.2 million at December 31, 2012. NOW and checking accounts decreased $4.6 million to $167.0 million at December 31, 2012.

Long-term debt consists of FHLBB advances, securities sold under repurchase agreements and customer repurchase agreements with an original maturity of one year or more. At December 31, 2012, we had $220.1 million in long-term debt with the FHLBB, $53.3 million in securities sold under repurchase agreements and $5.5 million in customer repurchase agreements. This compares to $160.6 million in FHLBB advances, $81.3 million in securities sold under repurchase agreements and $5.4 million in customer repurchase agreements at December 31, 2011. Long-term FHLBB advances increased for the year ended December 31, 2012 because current interest rates permit us to earn a more advantageous spread by borrowing low-cost long-term funds and reinvesting in loans and securities. The decrease in securities sold under repurchase agreements in 2012 was due to the prepayment of $28.0 million in December 2012, on which we incurred a prepayment expense of $1.0 million. The repurchase agreements had a weighted average cost of 3.06% and the prepayment will decrease the cost of funds which will help increase the net interest margin.


Short-term borrowings increased $16.9 million to $69.9 million at December 31, 2012 from $53.0 million at December 31, 2011. Short-term borrowings are made up of FHLBB advances with an original maturity of less than one year as well as customer repurchase agreements, which have an original maturity of one day. Short-term borrowings issued by the FHLBB were $41.7 million and $36.0 million at December 31, 2012 and 2011, respectively. Customer repurchase agreements increased $7.2 million to $24.2 million at December 31, 2012 from $17.0 million at December 31, 2011. A customer repurchase agreement is an agreement by us to sell to and repurchase from the customer an interest in specific securities issued by or guaranteed by the United States government or government-sponsored enterprises. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. At December 31, 2012 and 2011, all of our customer repurchase agreements were held by commercial customers. In addition, we had $4.0 million outstanding on our overnight line of credit with Bankers Bank Northeast ("BBN") at December 31, 2012. There were no outstanding BBN advances at December 31, 2011.

Shareholders' equity was $189.2 million and $219.0 million, which represented 14.5% and 17.3% of total assets at December 31, 2012 and December 31, 2011, respectively. The decrease in shareholders' equity reflects the repurchase of 4.3 million shares of our common stock at a cost of $31.7 million, pursuant to our stock repurchase program and the payment of regular and special dividends amounting to $10.7 million. This was partially offset by an increase in other comprehensive income of $3.0 million primarily due to the change in market value of securities, net income of $6.3 million for the year ended December 31, 2012, and an increase of $3.4 million related to the recognition of share-based compensation and the exercise of 237,313 stock options.

Comparison of Operating Results for Years Ended December 31, 2012 and 2011

General. Net income for the year ended December 31, 2012 was $6.3 million, or . . .

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