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RCKB > SEC Filings for RCKB > Form 10-Q on 9-May-2013All Recent SEC Filings

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Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand Rockville Financial, Inc., our operations and our present business environment. We believe accuracy, transparency and clarity are the primary goals of successful financial reporting. We remain committed to transparency in our financial reporting, providing our stockholders with informative financial disclosures and presenting an accurate view of our financial disclosures, financial position and operating results.

MD&A is provided as a supplement to - and should be read in conjunction with - our Unaudited Consolidated Financial Statements and the accompanying notes thereto contained in Part I, Item 1, of this report as well as our Annual Report on Form 10-K for the year ended December 31, 2012. The following sections are included in MD&A:

Our Business - a general description of our business, our objectives and regulatory considerations.

Critical Accounting Estimates - a discussion of accounting estimates that require critical judgments and estimates.

Operating Results - an analysis of our Company's consolidated results of operations for the periods presented in our Unaudited Consolidated Financial Statements.

Comparison of Financial, Liquidity and Capital Resources - an overview of financial condition and market and interest rate risk.

Our Business


By assets, Rockville Financial, Inc. is the third largest publicly traded banking institution headquartered in Connecticut with consolidated assets of $2.06 billion and stockholders' equity of $321.0 million at March 31, 2013. The Company delivers financial services to individuals, families and businesses throughout Connecticut and the region through its 24 banking offices, its commercial loan production office, its mortgage loan production office, 38 ATMs and internet website ( The Company's common stock is traded on the NASDAQ Global Select Stock Exchange under the symbol "RCKB."

The Company strives to remain a leader in meeting the financial service needs of the community and to provide superior customer service to the individuals and businesses in the market areas that it has served since 1858. Rockville Bank is a community-oriented provider of traditional banking products and services to business organizations and individuals, offering products such as residential and commercial real estate loans, commercial business loans, consumer loans and a variety of deposit products. Our business philosophy is to remain a community-oriented franchise and continue to focus on providing superior customer service to meet the financial needs of the communities in which we operate. Current strategies include expanding our banking network by pursuing new branch locations and branch acquisition opportunities in our market area, continuing our residential mortgage lending activities which comprise a majority of our loan portfolio and continuing to expand our commercial real estate and commercial business lending activities and growing our deposit base.

The Company's results of operations depend primarily on net interest income, which is the difference between the income earned on its loan and securities portfolios and its cost of funds, consisting of the interest paid on

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deposits and borrowings. Results of operations are also affected by the Company's provision for loan losses, income and expenses pertaining to other real estate owned, gains and losses from sales of loans and securities and non-interest income and expenses. Non-interest income primarily consists of fee income from depositors, mortgage servicing income, mortgage origination and loan sale income and increases in cash surrender value of bank-owned life insurance ("BOLI"). Non-interest expenses consist principally of salaries and employee benefits, occupancy, service bureau fees, marketing, professional fees, FDIC insurance assessments, other real estate owned and other operating expenses.

Results of operations are also significantly affected by general economic and competitive conditions and changes in interest rates as well as government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect the Company. Uncertainty and challenges surrounding future economic growth, consumer confidence, credit availability, competition and corporate earnings remains. Management believes that overall credit quality continues to be somewhat affected by weaknesses in national and regional economic conditions, including high unemployment levels, particularly in Connecticut.

Our Objectives

The Company seeks to continually deliver superior value to its customers, stockholders, employees and communities through achievement of its core operating objectives which are to:

Grow and retain primary households to increase core deposit relationships with a focus on checking, savings and money market accounts for personal, business and municipal depositors;

Build high quality, profitable loan portfolios using primarily organic growth and also purchase strategies, while also continuing to build efficiencies in its robust secondary mortgage banking business;

Build and diversify revenue streams through development of banking-related fee income, in particular, through the expansion of its financial advisory services and introduction of private banking professionals;

Maintain expense discipline and improve operating efficiencies;

Invest in technology to enhance superior customer service and products; and

Maintain a rigorous risk identification and management process.

Significant factors management reviews to evaluate achievement of the Company's operating objectives and its operating results and financial condition include, but are not limited to: net income and earnings per share, return on equity and assets, net interest margin, non-interest income, operating expenses related to total assets and efficiency ratio, asset quality, loan and deposit growth, capital management, liquidity and interest rate sensitivity levels, customer service standards, market share and peer comparisons.

Regulatory Considerations

Rockville Financial and its subsidiaries are subject to numerous examinations by federal and state banking regulators, as well as the Securities and Exchange Commission. Please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for additional disclosures with respect to laws and regulations affecting the Company's businesses.

It is difficult to predict at this time what specific impact certain provisions the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on the Company, including any regulations promulgated by the Consumer Financial Protection Bureau. The financial reform legislation and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and our ability to conduct business. Management will have to apply additional resources to ensure compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

In June 2012, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation approved three proposals that would amend the existing capital adequacy requirements of banks and bank holding companies. The three proposals would, among other things, implement the Basel III capital standards, as well as the standardized approach for almost all banking organizations in the United States. The proposal would increase the minimum levels of required capital, narrow the definition of capital, and place greater emphasis on common equity. The Basel III standardized proposal would modify the risk weights for various asset classes.

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While the Basel Committee initially called for the implementation of the Basel III final framework to commence January 1, 2013, final rules have not yet been implemented in the United States. The federal banking agencies extended the deadline for the proposed capital rules to go into effect and indicated that final rules would be issued in 2013. The final capital rules may differ significantly in substance or in scope from the proposed capital rules. Accordingly, the Company is still in the process of assessing the impacts of these complex proposals. We believe, however, that we will continue to exceed all expected well-capitalized regulatory requirements over the course of the proposed phase-in period, and on a fully phased-in basis.

Critical Accounting Estimates

The accounting policies followed by the Company and its subsidiaries conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our Consolidated Financial Statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP.

We believe that our most critical accounting policies, which involve the most complex subjective decisions or assessments, relate to allowance for loan losses, other-than-temporary impairment of investment securities, derivatives, income taxes, pension and other post-retirement benefits and share-based compensation. None of the Company's critical accounting estimates have changed during the quarter. Additional accounting policies are more fully described in Note 1 in the "Notes to Consolidated Financial Statements" presented in our 2012 Annual Report on Form 10-K. A brief description of our current policies involving significant judgment follows:

Allowance for Loan Losses: The allowance for loan losses is established as embedded losses are estimated to have occurred through the provisions for losses charged against operations and is maintained at a level that management considers adequate to absorb losses in the loan portfolio. Management's judgment in determining the adequacy of the allowance is inherently subjective and is based on past loan loss experience, known and inherent losses and size of the loan portfolios, an assessment of current economic and real estate market conditions, estimates of the current value of underlying collateral, review of regulatory authority examination reports and other relevant factors.

Although management believes it uses appropriate available information to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the evaluation.

Other-than-Temporary Impairment of Securities: The Company maintains a securities portfolio that is classified into two major categories: available for sale and held to maturity. Securities available for sale are recorded at estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Held to maturity securities are recorded at amortized cost. Management determines the classifications of a security at the time of its purchase.

Quarterly, securities with unrealized losses are reviewed as deemed appropriate to assess whether the decline in fair value is temporary or other-than-temporary. The assessment is to determine whether the decline in value is from company-specific events, industry developments, general economic conditions, credit losses on debt or other reasons. Declines in the fair value of available for sale securities below their cost or amortized cost that are deemed to be other-than-temporary are reflected in earnings for equity securities and for debt securities that have an identified credit loss. Unrealized losses on debt securities with no identified credit loss component are reflected in other comprehensive income. In the first quarter of 2013, the Company did not experience any losses which were deemed to be other-than-temporarily impaired.

Derivative Instruments and Hedging Activities: The Company uses derivatives to manage a variety of risks, including risks related to interest rates. Accounting for derivatives as hedges requires that, at inception and over the term of the arrangement, the hedged item and related derivative meet the requirements for hedge accounting. The rules and interpretations related to derivatives accounting are complex. Failure to apply this complex guidance correctly will result in the changes in the fair value of the derivative being reported in earnings.

The Company uses interest rate swaps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. The fair values of interest rate swaps are determined using the standard methodology of netting the discounted future fixed cash receipts (or payment) and the expected variable cash payments (or receipts.) The variable cash payment (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rates curves.

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At March 31, 2013, derivative assets and liabilities were $1.6 million and $35,000 respectively. Further information about our use of derivatives is provided in Note 6, "Derivatives and Hedging Activities" in the Notes to the Unaudited Consolidated Financial Statements contained elsewhere in this report.

Income Taxes: The Company recognizes income taxes under the asset and liability method. 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.

Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. Some judgments are subjective and involve estimates and assumptions about matters that are inherently uncertain. In determining the valuation allowance, we use forecasted future operating results, based upon approved business plans, including a review of the eligible carryforward periods, tax planning opportunities and other relevant considerations. Management believes that the accounting estimate related to the valuation allowance is a critical accounting estimate because the underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance.

The reserve for tax contingencies contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various tax positions. The effective income tax rate is also affected by changes in tax law, entry into new tax jurisdictions, the level of earnings and the results of tax audits.

Pension and Other Post-retirement Benefits: Management uses key assumptions that include discount rates, expected return on plan assets, benefits earned, interest costs, mortality rates, increases in compensation, and other factors. The two most critical assumptions - estimated return on plan assets and the discount rate - are important elements of plan expense and asset/liability measurements. These critical assumptions are evaluated at least annually on a plan basis.

Share-based Compensation: The Company accounts for stock options and restricted stock based on the grant date fair value of the award. These costs are recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period). The Company expenses the grant date fair value of the Company's stock options and restricted stock with a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria.

The Company uses the Black-Scholes option valuation model to value stock options. Determining the appropriate fair-value model and calculating the estimated fair value of share-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life, expected dividend rate, risk-free interest rate and expected forfeiture rate. The Company develops estimates based on historical data and market information which can change significantly over time.

Operating Results

Executive Overview

Earnings for the first quarter of 2013 were $4.6 million, or $0.17 per diluted share, compared to $3.9 million, or $0.13 per diluted share, for the first quarter in 2012. The Company's results can be attributed to its continued business momentum characterized by strong revenues, balance sheet growth, in tandem with solid asset quality. The quarterly results include the impact of the net interest margin decline which is attributable to decreased yields on loans and securities in the continued low interest rate environment.

The increase in the Company's revenues over the prior year period reflects the expansion of the mortgage banking business. The Company sold residential mortgage loans totaling $63.0 million in the first quarter of 2013 and reported net gains of $2.1 million, compared to $18.0 million sold in the first quarter of 2012 with net gains of $525,000. Catalysts for this increase include the introduction of mortgage loan officers during 2012 into the mortgage banking business model to foster relationships with local realtors to target purchase mortgage production and decrease reliance on the refinance business and launching an online mortgage loan application solution to enhance the efficiency of the mortgage loan process.

The Company's tax-equivalent net interest margin for the three months ended March 31, 2013 was 3.48%, a decrease of 35 basis points over the same quarter of 2012. The general year over year trends impacting the

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margin includes a 47 basis point reduction in the yield on earning assets coupled with a 21 basis point reduction in the cost of interest-bearing liabilities. The margin decline was partially offset by the 13.7% increase in average earning assets for the quarter. A sustained period of low interest rates is anticipated to continue, therefore, as interest-earning assets continue to originate or reprice downward, the net interest margin could be adversely affected.

The Company's strategy with interest rate risk management is to incrementally shorten asset duration and lengthen liability duration. Execution of this strategy contributed to the reduction of net interest margin in the first quarter of 2013 relative to the comparable period. During the quarter, the Company added adjustable rate securities to the investment portfolio that will react positively when market interest rates rise. Furthermore, the secondary market strategy of selling the majority of long duration fixed rate residential originations without adding to the legacy higher yielding residential portfolio has had a significant impact on the residential portfolio's contribution to net interest margin. With interest bearing funding, the Company has exhibited price discipline with maturity deposits and other perceived rate-sensitive deposit products and is emphasizing low cost demand deposit generation. The success of this strategy will be dependent on the ability for the Company to reduce its cost of funds further. However, given the duration of the low interest rate environment and the actions taken previously to reduce rates on our deposit products will make it difficult to reduce the cost of funds in a meaningful way. The Company will continually reassess this strategy in light of new economic data releases and market expectations for changes to interest rates.

The asset quality of our loan portfolio has remained strong even as the leading economic indicators have provided mixed results as evidenced in part by the continued high unemployment and foreclosure rates throughout the country. The allowance for loan losses to total loans ratio was 1.18% and 1.15%, the allowance for loan losses to non-performing loans ratio was 117.13% and 115.08%, and the ratio of non-performing loans to total loans was 1.01% and 1.00% at March 31, 2013 and December 31, 2012, respectively. A provision for loan losses of $391,000 was recorded for the current quarter compared to $704,000 for the quarter ended March 31, 2012.

The Company will be aggressive in pursuing its strategic goals while practicing prudent risk management to achieve continued positive business momentum and success.

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Selected Financial Data

                                                                       For the Three
                                                                        Months Ended
                                                                         March 31,
(Dollars in thousands, except share data)                           2013            2012
Share Data:
Basic and diluted net income per share common                     $   0.17        $   0.13
Dividends declared per share                                          0.10            0.08

Operating Data:
Total operating revenue                                           $ 21,391        $ 18,796
Total operating expense                                             14,670          12,343

Key Ratios:
Return on average assets                                              0.89 %          0.86 %
Return on average equity                                              5.68 %          4.62 %
Tax-equivalent net interest margin                                    3.48 %          3.83 %

Non-performing Assets:
Residential real estate                                           $  7,783        $  6,730
Commercial real estate                                               1,358           1,274
Construction                                                         1,760           1,006
Commercial business                                                  1,568           1,445
Installment and collateral                                              45              34

Total non-accrual loans, excluding troubled debt restructures       12,514          10,489
Troubled debt restructures - non-accruing                            3,312           3,166

Total non-performing loans                                          15,826          13,655
Other real estate owned                                              2,587           2,746

Total non-performing assets                                       $ 18,413        $ 16,401

Non-performing loans to total loans                                   1.01 %          0.90 %
Non-performing assets to total assets                                 0.89 %          0.88 %
Allowance for loan losses to non-performing loans                   117.13 %        121.03 %
Allowance for loan losses to total loans                              1.18 %          1.09 %

Non GAAP Ratios:
Non-interest expense to average assets                                2.87 %          2.77 %
Efficiency ratio                                                     68.58 %         65.67 %
Cost of interest-bearing deposits                                     0.61 %          0.79 %

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Average Balances, Interest, Average Yields\Cost and Rate\Volume Analysis

The table below sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. A tax-equivalent yield adjustment was made for the three months ended March 31, 2013 and 2012. All average balances are daily average balances. Loans held for sale and non-accrual loans are included in the computation of interest-earning average balances, with non-accrual loans carrying a zero yield. The yields set forth above include the effect of deferred costs, discounts and premiums that are amortized or accreted to interest income or expense.

Average Balance Sheets for the Three Months Ended March 31, 2013 and 2012

                                                                              Three Months Ended March 31,
                                                               2013                                                 2012
                                                                              Annualized                                           Annualized
                                            Average        Interest and         Yield/           Average        Interest and         Yield/
(Dollars in thousands)                      Balance         Dividends            Cost            Balance         Dividends            Cost
Interest-earning assets:
Loans receivable, net                     $ 1,577,725     $       17,155             4.35 %    $ 1,475,537     $       17,564             4.76 %
Investment securities                         290,844              2,095             2.88          176,039              1,358             3.09
Federal Home Loan Bank stock                   15,740                 15             0.38           16,719                 22             0.53
Other earning assets                           34,666                 21             0.24           19,469                 11             0.23

Total interest-earning assets               1,918,975             19,286             4.02        1,687,764             18,955             4.49

Non-interest-earning assets                   122,829                                               95,914

Total assets                              $ 2,041,804                                          $ 1,783,678

Interest-bearing liabilities:
NOW and money market accounts             $   546,934                374             0.27      $   428,214                277             0.26
Saving deposits(1)                            220,479                 34             0.06          195,174                 70             0.14
Time deposits                                 536,238              1,576             1.18          513,758              1,904             1.48

Total interest-bearing deposits             1,303,651              1,984             0.61        1,137,146              2,251             0.79
Advances from the Federal Home Loan
Bank                                          158,428                583             1.47           87,276                548             2.51
Other borrowings                                8,945                 11             0.49               -                  -              0.00

Total interest-bearing liabilities          1,471,024              2,578             0.70 %      1,224,422              2,799             0.91 %

Non-interest bearing liabilities              250,261                                              225,207
. . .
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