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WEBK > SEC Filings for WEBK > Form 10-K on 24-Mar-2014All Recent SEC Filings

Show all filings for WELLESLEY BANCORP, INC.



Annual Report

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


Income. Our primary source of 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 investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Other sources of income include earnings from customer service fees (mostly from service charges on deposit accounts), bank-owned life insurance, fees from investment management services, income from mortgage banking activities and gains on the sale of securities.

Provision for Loan Losses. The allowance for loan losses is maintained at a level representing management's best estimate of inherent losses in the loan portfolio, based upon management's evaluation of the portfolio's collectibility. The allowance is established through the provision for loan losses, which is charged against income. Charge-offs, if any, are charged to the allowance. Subsequent recoveries, if any, are credited to the allowance. Allocation of the allowance may be made for specific loans or pools of loans, but the entire allowance is available for the entire loan portfolio.

Expenses. The noninterest expenses we incur in operating our business consist of salaries and employee benefits, occupancy and equipment, data processing, federal deposit insurance and other general and administrative expenses. Our noninterest expenses have increased as a result of operating as a public company. These additional expenses consist primarily of stock-related compensation, legal and accounting fees, expenses of stockholder communications and meetings and stock exchange listing fees.

Salaries and employee benefits consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We recognize annual employee compensation expenses stemming from our Employee Stock Ownership Plan ("ESOP") and our equity incentive plan. The actual amount of stock-related compensation and benefit expenses related to the ESOP is based on the fair market value of the shares of common stock at specific points in the future.

Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, rental expenses, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using a straight-line method based on the estimated useful lives of the related assets, which range from 3 to 40 years, or the expected lease terms, if shorter.

Data processing expense represents the fees associated with all business applications we pay to third parties for the use of their software for recording and managing deposit accounts, loan accounts, investment securities, general ledger, payroll and administrative functions within the organization. Included in this category are primary contracts with vendors, service and maintenance agreements in support of these functions.

Federal deposit insurance premiums are payments we make to the Federal Deposit Insurance Corporation for insurance of our deposit accounts.

Advertising and marketing expense includes costs associated with design and delivery of promotional material through a variety of media related to products and services we make available to our customers.

Our contribution to the charitable foundation in connection with the Bank's stock conversion was an additional operating expense that reduced net income during the first quarter of 2012. The contribution to the foundation resulted in a $1.8 million pre-tax, or $1.1 million after tax, expense in the first quarter of 2012. This expense will not be a recurring expense.

Other expenses include expenses for professional services, office supplies, postage, telephone, insurance and other miscellaneous operating expenses.

Business Strategy

Our primary objective is to operate and grow a profitable community-oriented financial institution serving customers in our primary market areas. We have sought to achieve this through the adoption of a business strategy designed to maintain a strong capital position and high asset quality. Our operating strategy includes the following:

Increasing our deposit market share within our primary markets in eastern Massachusetts. Since its inception in 1911, Wellesley Bank has primarily served the town of Wellesley, Massachusetts and the immediate surrounding communities. Despite considerable competition from larger financial institutions with greater resources than Wellesley Bank, we have made significant progress in recent years to increase our market presence in the town of Wellesley and in the greater Boston metropolitan area. Our deposits have increased $59.5 million, or 19.9%, from $298.1 million at December 31, 2012 to $357.5 million at December 31, 2013. At June 30, 2013 (latest available), we had 13.59% of the deposits in the town of Wellesley, which represented the third largest market share out of 16 financial institutions with branches in the town of Wellesley. We believe the Wellesley market area will continue to provide us opportunities for growth. We have recently expanded our market presence into Boston through our new Boston office that opened in November 2013.

Continuing to emphasize our commercial real estate lending, commercial business lending, and construction lending, as well as increasing our commercial business depository relationships in our market area. We have worked to increase our commercial relationships by diversifying our loan portfolio beyond residential mortgage loans and offering business deposit and checking products. Since December 31, 2012, our commercial real estate, construction and commercial business loan portfolio has increased $34.8 million, or 24.2%, and at December 31, 2013 was 46.1% of our total loan portfolio. In connection with the increase in our commercial business loan portfolio, we also have focused on providing a full banking relationship and, as a result, experienced an increase in our business deposit and checking accounts. Since December 31, 2012, our business deposit and checking accounts increased $9.9 million, or 19.5%, of which, $1.7 million was attributable to a revised sweep account program. At December 31, 2013, business deposit and checking accounts represented 16.7% of our total deposits. In addition, we will continue to expand and develop our cash management products, and on-line and mobile banking solutions to better serve our commercial customers.

Increasing our residential mortgage lending in our market area. We believe there are opportunities to increase our residential mortgage lending in our market areas. The town of Wellesley and its surrounding communities has a sound economy and was not as negatively affected by the recent recession as other regions of the United States. As a result, the demand for residential mortgage loans in our market area, in particular larger "jumbo" loans, has not been significantly impacted by the downturn in the economy. Since early in 2012, we have hired two additional residential mortgage lenders to complement our existing residential mortgage lending operations, and have expanded our lending territory to include sections of Boston in Suffolk County and Cambridge in Middlesex County. We believe this provides additional lending opportunities and further diversifies our residential loan portfolio.

Continuing conservative underwriting practices while maintaining a high quality loan portfolio. We believe that strong asset quality is a key to long-term financial success. We have sought to maintain a high level of asset quality and manageable credit risk by using conservative underwriting standards and by diligent monitoring and collection efforts. Nonperforming loans increased from $3.5 million at December 31, 2012 to $3.7 million at December 31, 2013. At December 31, 2013, nonperforming loans were 0.98% of the total loan portfolio and 0.82% of total assets. The increase in nonperforming loans is the result of the addition of two residential properties and one home equity line of credit partially offset by the payoff of certain troubled residential and commercial relationships. We intend to increase our commercial real estate, construction and commercial business lending, we intend to continue our philosophy of managing large loan exposures through conservative loan underwriting and sound credit administration standards.

Seeking to enhance fee income by growing investment advisory services. 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 net interest income, we have pursued initiatives to increase noninterest income. In particular, we offer a full array of investment advisory services for individuals, nonprofits, institutions, endowments, and other registered investment advisors through our wholly-owned subsidiary, Wellesley Investment Partners, LLC, a registered investment advisor. Investment management fees relating to our investment advisory services totaled $391 thousand, $231 thousand and $109 thousand for the years ended December 31, 2013, 2012 and 2011, respectively. We have recently hired a director and wealth adviser to attract and support client relationships in our subsidiary, Wellesley Investment Partners, as we intend to grow and develop this aspect of our business.

Emphasizing lower cost core deposits and accessing a wider network of funding sources to maintain low funding costs. We seek to increase net interest income by controlling costs of funding. Over the past several years, we have sought to reduce our dependence on traditional higher cost certificates of deposits in favor of stable lower cost demand deposits. We have utilized additional product offerings, technology and a focus on customer service in working toward this goal. In addition, we intend to seek demand deposits by growing commercial banking relationships. Core deposits (demand, NOW, money market and savings accounts) comprised 55.4% of our total deposits at December 31, 2013, as compared to 54.3% at December 31, 2012. In 2013, we began participating in a national market clearinghouse for placing competitively priced certificates of deposits with financial institutions, nonprofits and other corporate participants. National market certificates of deposit are often less costly funds than local market retail certificates, and may provide access to a wider range of maturities than retail funds. In addition, we have expanded our use of borrowings from the Federal Home Loan Bank of Boston ("FHLB") to provide funds in support of commercial loans and short-term liquidity needs at relatively lower cost than retail deposits. Balances of FHLB advances have grown $21.0 million to $52.5 million at December 31, 2013.

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.

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectibility of the loan portfolio. 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 or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the Federal Deposit Insurance Corporation and Massachusetts Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See notes 2 and 7 of the notes to consolidated financial statements included in this document.

Deferred Tax Assets. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Management reviews deferred tax assets on a quarterly basis to identify any uncertainties pertaining to realization of such assets. In determining whether a valuation allowance is required against deferred tax assets, management assesses historical and forecasted operating results, including a review of eligible carryforward periods, tax planning opportunities and other relevant considerations. We believe the accounting estimate related to the valuation allowance is a critical 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. An increase in statutory tax rates, if enacted, could cause a material increase in the amount of taxes we might owe and would be reflected as a reduction in our deferred tax asset and an immediate charge against earnings in the period enacted. Should actual factors and conditions differ materially from those used by management, the actual realization of net deferred tax assets could differ materially from the amounts recorded in the financial statements. If we were not able to realize all or part of our deferred tax assets in the future, an adjustment to the related valuation allowance would be charged to income tax expense in the period such determination was made and could have a negative impact on earnings. In addition, if actual factors and conditions differ materially from those used by management, we could incur penalties and interest imposed by taxing authorities.

Balance Sheet Analysis

General. Total assets increased $82.4 million, or 21.9%, from $376.0 million at December 31, 2012 to $458.5 million at December 31, 2013. Total assets increased primarily due to an increase in net loans of $89.6 million, or 30.5%, while loans held for sale decreased $8.3 million. Securities available for sale decreased $2.6 million to $36.7 million, primarily due to funding loan growth.

Loans. Net loans increased $89.6 million, or 30.5%, from $294.1 million at December 31, 2012 to $383.7 million at December 31, 2013. The increase in loans was due primarily to an increase of $51.2 million, or 39.2%, in residential real estate loans. We have expanded our residential lending activity through the addition of commissioned loan originators, and the expansion of our CRA assessment area. Adjustable-rate residential mortgage loans increased $49.6 million, or 44.6%, to $160.6 million while fixed-rate residential loans increased $1.6 million, or 8.1%, and ended the year at $21.1 million. We continue to sell conforming longer-term fixed-rate residential loans that we have originated, while retaining adjustable-rate mortgages in portfolio. For the years ending December 31, 2013 and 2012, loans sold to investors totaled $29.7 million and $25.4 million, respectively. Commercial real estate loans increased $2.2 million, or 2.7%, to $82.4 million, and construction loans increased $31.9 million, or 66.3% to $80.1 million. The increase in commercial real estate loans and construction loans reflects our continued emphasis on originating these types of loans and increased loan demand, especially in the residential construction markets. Permanent construction loans, or those loans financing construction of owner-occupied residential properties, total $22.9 million at December 31, 2013, while speculative construction loans on residential properties, representing loans to builders, totaled $48.6 million at December 31, 2013.

The following table sets forth the composition of our loan portfolio at the dates indicated.

                                                                        At December 31,
                                               2013                          2012                          2011
(Dollars in thousands)                 Amount        Percent         Amount        Percent         Amount        Percent
Real estate loans:
mortgage                            $  181,719          46.82 %   $  130,565          43.78 %   $   80,226          35.56 %
Commercial real
estate                                  82,367          21.22         80,200          26.89         71,880          31.86
Construction                            80,103          20.64         48,158          16.15         39,267          17.40
Total real estate
loans                                  344,189          88.68        258,923          86.82        191,373          84.82

loans                                   16,430           4.23         15,725           5.28         13,262           5.88
Consumer loans:
Home equity lines of credit             27,092           6.98         23,111           7.75         20,463           9.07
Other                                      415           0.11            455           0.15            512           0.23
Total loans                            388,126         100.00 %      298,214         100.00 %      225,610         100.00 %
Deferred loan origination fees,
net                                       (195 )                        (279 )                        (381 )
Allowance for loan losses               (4,213 )                      (3,844 )                      (3,396 )
Net loans                           $  383,718                    $  294,091                    $  221,833

                                                                       At December 31,
                                                              2010                        2009
(Dollars in thousands)                                Amount        Percent       Amount        Percent
Real estate loans:
mortgage                                            $  72,890         35.18 %   $  73,443         39.32 %
Commercial real
estate                                                 53,907         26.02        49,911         26.72
Construction                                           40,770         19.68        31,223         16.71
Total real estate
loans                                                 167,567         80.88       154,577         82.75

loans                                                  14,905          7.20        13,880          7.43
Consumer loans:
Home equity lines of
credit                                                 24,198         11.68        17,805          9.53
Other                                                     503          0.24           539          0.29
Total loans                                           207,173        100.00 %     186,801        100.00 %
Deferred loan origination fees,
net                                                      (366 )                      (371 )
Allowance for loan
losses                                                 (2,690 )                    (2,060 )
Net loans                                           $ 204,117                   $ 184,370

Loan Maturity. The following table sets forth certain information at December 31, 2013 regarding scheduled contractual maturities. The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. The amounts shown below exclude net deferred loan fees.

                                                                    December 31, 2013
                               Residential       Commercial
                                 Mortgage       Real Estate      Construction     Commercial       Consumer        Total
(In thousands)                    Loans            Loans            Loans            Loans          Loans          Loans
Amounts due in:
One year or
less                          $        858     $      7,486     $     58,174     $     8,192     $    2,772     $   77,482
More than one year to five
years                                   38              837           18,215           5,213          8,507         32,810
More than five
years                              180,823           74,044            3,714           3,025         16,228        277,834
Total                         $    181,719     $     82,367     $     80,103     $    16,430     $   27,507     $  388,126

Fixed vs. Adjustable Rate Loans. The following table sets forth the dollar amount of all scheduled maturities of loans at December 31, 2013 that are due after December 31, 2014 and have either fixed interest rates or adjustable interest rates. The amounts shown below exclude net deferred loan fees.

                                                                         Floating or
                                                            Fixed         Adjustable
(In thousands)                                              Rates           Rates            Total
Real estate loans:
mortgage                                                $    19,271     $    161,590     $   180,861
Commercial real
estate                                                        7,158           67,723          74,881
Construction                                                 18,215            3,714          21,929
loans                                                           836            7,402           8,238
loans                                                            21           24,714          24,735
Total                                                   $    45,501     $    265,143     $   310,644

Securities. Our securities portfolio consists primarily of residential mortgage-backed securities issued by U.S. government agencies and government sponsored enterprises, corporate debt securities and municipal bonds. Securities available for sale decreased by $2.6 million, or 6.6%, in the year ended December 31, 2013 reflective of the use of funds from maturing securities and prepayments of mortgage-backed securities to support loan growth. Securities available for sale increased by $3.2 million, or 8.8%, to $39.3 million in the year ended December 31, 2012 primarily due to the purchase of additional securities resulting from excess liquidity.

The following table sets forth the amortized cost and fair values of our securities portfolio at the dates indicated.

                                                      At December 31,
                                 2013                       2012                       2011
                        Amortized       Fair       Amortized       Fair       Amortized       Fair
(In thousands)            Cost         Value         Cost         Value         Cost         Value
Government National
Mortgage Association   $   7,673     $  7,831     $   9,235     $  9,546     $  10,861     $ 11,126
enterprises                9,622        9,682        10,841       11,213        10,627       10,866
SBA and other
securities                 5,089        5,014         3,988        4,127         2,402        2,507
State and municipal
bonds                      4,025        4,120         5,604        5,963         7,815        8,246
obligations                2,060        2,014         2,105        2,115         2,349        2,364
Corporate bonds            7,932        8,011         6,186        6,292           999          979
Total securities
available for sale     $  36,401     $ 36,672     $  37,959     $ 39,256     $  35,053     $ 36,088

At December 31, 2013, we had no investments in a single company or entity (other than the U.S. Government or an agency of the U.S. Government) that had an aggregate book value in excess of 10% of equity.

The following table sets forth the stated maturities and weighted average yields of debt securities at December 31, 2013. Weighted average yields on tax-exempt securities are not presented on a tax equivalent basis. Certain mortgage related securities have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules, as well as monthly principal payments on mortgage- and asset-backed securities, are not reflected in the table below.

                                                                                                   More than Five
                                                                   More than One Year                  Years
                                       One Year or Less               to Five Years                 to Ten Years              More than Ten Years                  Total
                                                  Weighted                      Weighted                     Weighted                       Weighted                    Weighted
                                   Amortized       Average       Amortized       Average      Amortized       Average       Amortized        Average      Amortized      Average
(Dollars in thousands)                Cost          Yield          Cost           Yield          Cost          Yield           Cost           Yield         Cost          Yield
Residential mortgage-
  backed securities:
Government National
  Mortgage Association            $       --            -- %   $       --             -- %   $       --            -- %   $     7,673           1.59 %   $   7,673          1.59 %
  enterprises                             --            --             --             --            654          0.66           8,968           2.21         9,622          2.10
SBA and other asset-backed
  securities                              --            --             --             --          1,150          1.40           3,939           2.67         5,089          2.39
State and municipal bonds                255          0.95          1,083           3.70          1,869          3.87             818           3.97         4,025          3.66
  enterprise obligations                  --            --          1,060           1.73             --            --           1,000           1.25         2,060          1.49
Corporate bonds                        3,491          1.48          4,441           1.98             --            --              --             --         7,932          1.76
Total debt securities             $    3,746          1.44 %   $    6,584           2.23 %   $    3,673          2.52 %   $    22,398           2.10 %   $  36,401          2.10 %
. . .
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