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Enterprise Bancorp 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x

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

 

For the quarterly period ended   September 30, 2009

 

or

 

o

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                 to               

 

Commission File Number:   001-33912

 

Enterprise Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Massachusetts

 

04-3308902

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

222 Merrimack Street, Lowell, Massachusetts

 

01852

(Address of principal executive offices)

 

(Zip code)

 

(978) 459-9000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   x Yes o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)   o Yes o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition for “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerate filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes x No

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

November 4, 2009 Common Stock - Par Value $0.01:  8,242,291 shares outstanding

 

 

 



Table of Contents

 

ENTERPRISE BANCORP, INC.

 

INDEX

 

 

 

Page Number

 

 

 

 

Cover Page

1

 

 

 

 

Index

2

 

 

 

PART I FINANCIAL INFORMATION

 

 

 

Item 1

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets – September 30, 2009 and December 31, 2008

3

 

 

 

 

Consolidated Statements of Income - Three and nine months ended September 30, 2009 and 2008

4

 

 

 

 

Consolidated Statement of Changes in Stockholders’ Equity - Nine months ended September 30, 2009

5

 

 

 

 

Consolidated Statements of Cash Flows - Nine months ended September 30, 2009 and 2008

6

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

7

 

 

 

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

41

 

 

 

Item 4

Controls and Procedures

42

 

 

 

PART II OTHER INFORMATION

 

 

 

Item 1

Legal Proceedings

42

 

 

 

Item 1A

Risk Factors

42

 

 

 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

Item 3

Defaults Upon Senior Securities

42

 

 

 

Item 4

Submission of Matters to a Vote of Security Holders

42

 

 

 

Item 5

Other Information

42

 

 

 

Item 6

Exhibits

42

 

 

 

 

Signature page

43

 

2



Table of Contents

 

ENTERPRISE BANCORP, INC.

Consolidated Balance Sheets

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2009

 

2008

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Cash and due from banks

 

$

30,737

 

$

21,479

 

Short-term investments

 

11,102

 

3,797

 

Total cash and cash equivalents

 

41,839

 

25,276

 

 

 

 

 

 

 

Investment securities

 

142,904

 

159,373

 

Loans, less allowance for loan losses of $17,488 at Sept. 30, 2009 and $15,269 at December 31, 2008

 

1,041,410

 

933,372

 

Premises and equipment

 

22,281

 

21,651

 

Accrued interest receivable

 

5,504

 

5,357

 

Deferred income taxes, net

 

9,646

 

9,349

 

Bank-owned life insurance

 

13,697

 

13,290

 

Prepaid income taxes

 

359

 

1,034

 

Prepaid expenses and other assets

 

4,021

 

5,910

 

Core deposit intangible, net of amortization

 

110

 

209

 

Goodwill

 

5,656

 

5,656

 

 

 

 

 

 

 

Total assets

 

$

1,287,427

 

$

1,180,477

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

$

1,127,701

 

$

947,903

 

Borrowed funds

 

31,170

 

121,250

 

Junior subordinated debentures

 

10,825

 

10,825

 

Accrued expenses and other liabilities

 

19,003

 

7,546

 

Accrued interest payable

 

1,270

 

1,849

 

 

 

 

 

 

 

Total liabilities

 

1,189,969

 

1,089,373

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Preferred stock, $0.01 par value per share; 1,000,000 shares authorized; no shares issued

 

 

 

Common stock $0.01 par value per share; 20,000,000 shares authorized; 8,242,291 and, 8,025,239 shares issued and outstanding at Sept 30, 2009 and December 31, 2008, respectively

 

82

 

80

 

Additional paid-in capital

 

31,302

 

29,698

 

Retained earnings

 

63,040

 

60,200

 

Accumulated other comprehensive income

 

3,034

 

1,126

 

 

 

 

 

 

 

Total stockholders’ equity

 

97,458

 

91,104

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,287,427

 

$

1,180,477

 

 

See the accompanying notes to the unaudited consolidated financial statements.

 

3



Table of Contents

 

ENTERPRISE BANCORP, INC.

Consolidated Statements of Income

Three and nine months ended September 30, 2009 and 2008

(unaudited)

 

 

 

Three Months Ended Sept 30,

 

Nine Months Ended Sept 30,

 

(Dollars in thousands, except per share data)

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Interest and dividend income:

 

 

 

 

 

 

 

 

 

Loans

 

$

14,721

 

$

14,501

 

$

42,436

 

$

43,154

 

Investment securities

 

1,055

 

1,415

 

3,759

 

4,427

 

Short-term investments

 

15

 

60

 

88

 

165

 

Total interest and dividend income

 

15,791

 

15,976

 

46,283

 

47,746

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

2,941

 

4,210

 

9,874

 

14,156

 

Borrowed funds

 

49

 

557

 

211

 

1,721

 

Junior subordinated debentures

 

294

 

294

 

883

 

883

 

Total interest expense

 

3,284

 

5,061

 

10,968

 

16,760

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

12,507

 

10,915

 

35,315

 

30,986

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

1,140

 

1,173

 

3,106

 

2,040

 

Net Interest income after provision for loan losses

 

11,367

 

9,742

 

32,209

 

28,946

 

 

 

 

 

 

 

 

 

 

 

Non-interest income:

 

 

 

 

 

 

 

 

 

Investment advisory fees

 

688

 

778

 

2,034

 

2,439

 

Deposit service fees

 

1,037

 

988

 

2,815

 

2,826

 

Income on bank-owned life insurance

 

155

 

157

 

466

 

464

 

Other than temporary impairment on investment securities

 

(8

)

 

(782

)

 

Net gains on sales of investment securities

 

 

220

 

971

 

267

 

Gains on sales of loans

 

148

 

40

 

526

 

100

 

Other income

 

337

 

442

 

1,055

 

1,314

 

Total non-interest income

 

2,357

 

2,625

 

7,085

 

7,410

 

 

 

 

 

 

 

 

 

 

 

Non-interest expense:

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

6,158

 

5,791

 

18,203

 

16,948

 

Occupancy expenses

 

1,892

 

1,685

 

5,672

 

4,937

 

Audit, legal and other professional fees

 

350

 

331

 

1,110

 

1,096

 

Advertising and public relations expenses

 

514

 

434

 

1,506

 

1,272

 

Deposit insurance premiums

 

393

 

194

 

1,720

 

537

 

Supplies and postage expenses

 

209

 

222

 

626

 

685

 

Investment advisory and custodial expenses

 

85

 

72

 

304

 

274

 

Other operating expenses

 

919

 

910

 

2,934

 

2,525

 

Total non-interest expense

 

10,520

 

9,639

 

32,075

 

28,274

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

3,204

 

2,728

 

7,219

 

8,082

 

Provision for income taxes

 

935

 

1,009

 

2,058

 

2,563

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

2,269

 

$

1,719

 

$

5,161

 

$

5,519

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.28

 

$

0.22

 

$

0.63

 

$

0.69

 

Diluted earnings per share

 

$

0.28

 

$

0.21

 

$

0.63

 

$

0.69

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

8,228,897

 

7,984,628

 

8,157,273

 

7,961,943

 

Diluted weighted average common shares outstanding

 

8,239,729

 

8,012,595

 

8,171,171

 

7,997,111

 

 

See the accompanying notes to the unaudited consolidated financial statements.

 

4



Table of Contents

 

ENTERPRISE BANCORP, INC.

 

Consolidated Statement of Changes in Stockholders’ Equity

(unaudited)

 

Nine months ended September 30, 2009

 

(Dollars in thousands)

 

Common
Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Comprehensive
Income

 

Accumulated
Other
Comprehensive
Income

 

Total
Stockholders’
Equity

 

Balance at December 31, 2008

 

$

80

 

$

29,698

 

$

60,200

 

 

 

$

1,126

 

$

91,104

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

5,161

 

5,161

 

 

 

5,161

 

Other comprehensive income, net

 

 

 

 

 

 

 

1,908

 

1,908

 

1,908

 

Total comprehensive income

 

 

 

 

 

 

 

$

7,069

 

 

 

 

 

Tax benefit from exercise of stock options

 

 

 

13

 

 

 

 

 

 

 

13

 

Common stock dividend paid ($0.285 per share)

 

 

 

 

 

(2,321

)

 

 

 

 

(2,321

)

Common stock issued under dividend reinvestment plan

 

1

 

808

 

 

 

 

 

 

 

809

 

Stock-based compensation

 

1

 

561

 

 

 

 

 

 

 

562

 

Stock options exercised

 

 

 

222

 

 

 

 

 

 

 

222

 

Balance at September 30, 2009

 

$

82

 

$

31,302

 

$

63,040

 

 

 

$

3,034

 

$

97,458

 

 

See the accompanying notes to the unaudited consolidated financial statements.

 

5



Table of Contents

 

ENTERPRISE BANCORP, INC.

Consolidated Statements of Cash Flows

(unaudited)

 

 

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

5,161

 

$

5,519

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for loan losses

 

3,106

 

2,040

 

Depreciation and amortization

 

2,375

 

1,839

 

Amortization of intangible assets

 

99

 

99

 

Stock-based compensation expense

 

542

 

387

 

Mortgage loans originated for sale

 

(49,600

)

(11,746

)

Proceeds from mortgage loans sold

 

50,776

 

11,251

 

Gains on sales of loans

 

(526

)

(100

)

Net gains on sales of investment securities

 

(971

)

(267

)

Other-than-temporary-impairment on investment securities

 

782

 

 

Income on bank-owned life insurance, net of costs

 

(407

)

(420

)

(Increase)/Decrease in:

 

 

 

 

 

Accrued interest receivable

 

(147

)

302

 

Prepaid expenses and other assets

 

2,967

 

3,273

 

Deferred income tax

 

(1,349

)

(842

)

Increase (decrease) in:

 

 

 

 

 

Accrued expenses and other liabilities

 

11,477

 

536

 

Accrued interest payable

 

(579

)

(1,762

)

Net cash provided by operating activities

 

23,706

 

10,109

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sales of investment securities available for sale

 

39,505

 

4,913

 

Proceeds from maturities, calls and pay-downs of investment securities

 

40,471

 

27,520

 

Purchase of investment securities

 

(60,364

)

(27,094

)

Net increase in loans

 

(112,489

)

(75,119

)

Additions to premises and equipment, net

 

(2,999

)

(3,131

)

Proceeds from OREO sales and payments

 

632

 

 

Purchase of OREO

 

(340

)

 

Net cash used in investing activities

 

(95,584

)

(72,911

)

Cash flows from financing activities:

 

 

 

 

 

Net increase in deposits

 

179,798

 

75,467

 

Net (decrease)/increase in borrowed funds

 

(90,080

)

2,047

 

Cash dividends paid

 

(2,321

)

(2,146

)

Proceeds from issuance of common stock

 

809

 

758

 

Proceeds from exercise of stock options

 

222

 

110

 

Excess tax benefit from exercise of stock options

 

13

 

2

 

Net cash provided by financing activities

 

88,441

 

76,238

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

16,563

 

13,436

 

Cash and cash equivalents at beginning of period

 

25,276

 

32,718

 

Cash and cash equivalents at end of period

 

$

41,839

 

$

46,154

 

 

 

 

 

 

 

Supplemental financial data:

 

 

 

 

 

Cash Paid For:

Interest

 

$

11,547

 

$

18,522

 

 

Income taxes

 

3,123

 

3,764

 

Supplemental schedule of non-cash investing activity:

 

 

 

 

 

Transfer from loans to real estate owned

 

695

 

375

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

6



Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

(1)                     Organization of Holding Company

 

The consolidated financial statements of Enterprise Bancorp, Inc. (the “Company”) include the accounts of the Company and its wholly owned subsidiary Enterprise Bank and Trust Company (the “Bank”). The Bank is a Massachusetts trust company organized in 1989. Substantially all of the Company’s operations are conducted through the Bank.

 

The Bank has five wholly owned subsidiaries.  The Bank’s subsidiaries include Enterprise Insurance Services, LLC and Enterprise Investment Services, LLC, organized for the purposes of engaging in insurance sales activities and offering non-deposit investment products and services, respectively.  In addition, the Bank has three subsidiary security corporations (Enterprise Security Corporation, Enterprise Security Corporation II, and Enterprise Security Corporation III), which hold various types of qualifying securities. The security corporations are limited to conducting securities investment activities that the Bank itself would be allowed to conduct under applicable laws.

 

Through the Bank and its subsidiaries, the Company offers a range of commercial and consumer loan products, deposit and cash management products, investment advisory, trust and insurance services.  The services offered through the Bank and subsidiaries are managed as one strategic unit and represent the Company’s only reportable operating segment.

 

The FDIC and the Massachusetts Commissioner of Banks (the “Commissioner”) have regulatory authority over the Bank.  The business and operations of the Company are subject to the regulatory oversight of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).  The Commissioner also retains supervisory jurisdiction over the Company.

 

(2)                     Basis of Presentation

 

The accompanying unaudited consolidated financial statements and these notes should be read in conjunction with the Company’s December 31, 2008 audited consolidated financial statements and notes thereto contained in the Company’s 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 16, 2009.  Interim results are not necessarily indicative of results to be expected for the entire year.

 

The Company has not changed its significant accounting and reporting policies from those disclosed in its 2008 Annual Report on Form 10-K.

 

In the opinion of management, the accompanying consolidated financial statements reflect all necessary adjustments consisting of normal recurring accruals for a fair presentation.  All significant intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements.

 

Based on management’s evaluation through November 6, 2009, the date the financials statements were originally issued to shareholders, there were no events or material transactions subsequent to the financial statements date that required recognition or disclosure in the financial statements presented in this Form 10-Q.

 

Certain fiscal 2008 information has been reclassified to conform to the 2009 presentation.

 

In June 2009, the Financial Accounting Standards Board (FASB) issued new guidance establishing the FASB “Accounting Standards Codification” as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles. This guidance was effective for the Company beginning in the third quarter of 2009. The adoption of this guidance did not have any impact on the Company’s consolidated financial position and results of operations, or the selection and application of accounting principles.

 

(3)                     Critical Accounting Estimates

 

In preparing the consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to exercise judgment in determining many of the methodologies, assumptions and estimates to be utilized.  These estimates and assumptions affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period.  Actual results could differ should the assumptions and estimates used change over time due to changes in circumstances.

 

7



Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

As discussed in the Company’s 2008 Annual Report on Form 10-K, the three most significant areas in which management applies critical assumptions and estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses, impairment review of investment securities and the impairment review of goodwill and other intangible assets.  Refer to note 1 to the Company’s consolidated financial statements included in the Company’s 2008 Annual Report on Form 10-K for significant accounting policies.

 

(4)                     Reporting Comprehensive Income

 

Comprehensive income is defined as all changes to equity except investments by and distributions to stockholders.  Net income is one component of comprehensive income, with other components referred to in the aggregate as other comprehensive income.  The Company’s only other comprehensive income component is the net unrealized holding gains or losses on investments available for sale, net of deferred income taxes.

 

The following table summarized the components of other comprehensive income (loss) for the nine month periods ended September 30, 2009 and 2008.

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Disclosure of other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross unrealized holding gains (losses) on investments arising during the period

 

$

3,161

 

$

(2,756

)

Income tax benefit (expense)

 

(1,137

)

932

 

Net unrealized holding gains (losses), net of tax

 

2,024

 

(1,824

)

 

 

 

 

 

 

Less: Reclassification adjustment for impairment included in net income:

 

 

 

 

 

Other than temporary impairment loss arising during the period

 

(782

)

 

Income tax benefit

 

266

 

 

Reclassification adjustment for impairment realized, net of tax

 

(516

)

 

 

 

 

 

 

 

Less: Reclassification adjustment for net gains included in net income

 

 

 

 

 

Net realized gains on sales of securities during the period

 

971

 

267

 

Income tax expense

 

(339

)

(95

)

Reclassification adjustment for gains realized, net of tax

 

632

 

172

 

 

 

 

 

 

 

Other comprehensive income (loss), net of reclassifications

 

$

1,908

 

(1,996

)

 

(5)                     FDIC Deposit Insurance Assessment

 

The Company’s deposit accounts are insured by the Deposit Insurance Fund (the “DIF”) of the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum amount provided by law.  The Company’s FDIC deposit insurance premiums (excluding the special assessment discussed below) amounted to $1.1 million for the nine months ended September 30, 2009 compared to $537 thousand for the same period in 2008.

 

As a result of nationwide bank failures in 2008, the DIF reserve ratio (DIF reserves as a percent of estimated insured deposits) declined substantially, and the FDIC took several steps to restore the ratio, as required by law.  The FDIC increased its assessment rate uniformly by 7 basis points for all insured institutions for the first quarter of 2009 only.  In addition, the FDIC subsequently modified the risk-based assessment system beginning April 1, 2009.  The modified system increased the base assessment rates from a range of 5 to 43 basis points to an adjusted total assessment range of 7 to 77.5 basis points, depending on risk category and several possible adjustments that could increase or decrease the institution’s base rate.

 

As an additional measure, the FDIC also adopted a final rule in May 2009 to impose special assessments on all insured depository institutions as of June 30, 2009, which was collected on September 30, 2009.   The Company’s FDIC special June assessment, which was charged to earnings in the second quarter, amounted to $576 thousand.

 

8



Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

In addition to general increases in the FDIC’s assessment rates, the Company’s deposit insurance costs have increased in 2009 due to its participation in the FDIC’s Transaction Account Guarantee Program (the “TAGP”) which began in November 2008.  Under the TAGP, the FDIC provides participating depository institutions with full insurance coverage for non-interest bearing deposit transaction accounts, regardless of the dollar amount. (The FDIC has made exceptions for certain interest bearing transaction accounts and funds swept into non-interest bearing savings accounts to also be covered under the TAGP.)  Participating institutions are currently charged a 10-basis point surcharge on those non-interest bearing account balances over the existing insurance limit of $250,000.  The Company’s participation in the TAGP has added approximately $35 thousand to its FDIC insurance cost through September 30, 2009.

 

In August 2009, the FDIC voted to extend the TAGP through June 30, 2010 with a risked-based fee structure, which ranges from 15 to 25 basis points, depending upon each institutions Risk Category rating.  The Company has opted to continue participating in the TAGP through June 30, 2010 and does not expect the increase in fee to have a material impact on its financial results.

 

In September 2009, the FDIC proposed a rule that would not include any additional special assessments but instead will require insured institutions to prepay their estimated risked-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.  The FDIC Board also proposed a uniform three-basis point increase in assessment rates effective January 1, 2011.  The FDIC has proposed a formula for estimating the assessment base and will collect the prepaid assessment for these periods on December 30, 2009.   Upon remittance of the assessment, institutions would record a prepaid asset which will be charged to earnings over subsequent quarters in amounts equal to the actual quarterly assessments for each period, until the asset is exhausted.  If approved as proposed, management estimates that the Company’s prepayment will be approximately $6 million.

 

Any future increases in annual assessment rates will further increase the Company’s deposit insurance expense and may have a material effect on the Company’s results of operations.

 

(6)                     Accounting for Income Taxes

 

The Company uses the asset and liability method of accounting for income taxes.  Under this method 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.  As changes in tax laws or rates are enacted, deferred tax assets and liabilities will be adjusted accordingly through the provision for income taxes.

 

On July 3, 2008, the Commonwealth of Massachusetts enacted a law that included reducing future tax rates on net income applicable to financial institutions. For tax years beginning on or after January 1, 2010, the tax rate drops from the current rate of 10.5% to 10%, for tax years beginning on or after January 1, 2011 the rate drops to 9.5%, and to 9% for tax years beginning on or after January 1, 2012 and thereafter.  Therefore, the Company recorded additional income tax expense of approximately $130 thousand in the third quarter of 2008 to adjust the Company’s net deferred tax assets down to the future realizable tax rates.

 

The Company’s policy is to classify interest resulting from underpayment of income taxes as income tax expense in the first period the interest would begin accruing according to the provisions of the relevant tax law.  The Company classifies penalties resulting from underpayment of income taxes as income tax expense in the period for which the Company claims or expects to claim an uncertain tax position or in the period in which the Company’s judgment changes regarding an uncertain tax position.

 

The Company did not have any unrecognized tax benefits accrued as income tax liabilities or receivables or as deferred tax items at September 30, 2009.  The Company’s tax years beginning after December 31, 2005 and later are open to federal and state income tax examinations.

 

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Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

(7)                     Stock-Based Compensation

 

On May 5, 2009, the Company adopted a 2009 Stock Incentive Plan (the “2009 plan”).  The 2009 plan permits the board of directors to grant both incentive and non-qualified stock options (as well as restricted stock, restricted stock units and stock appreciation rights) to officers and other employees, directors and consultants for the purchase of up to 400,000 shares of common stock.

 

Prior to May 5, 2009, the Company had two stock incentive plans.  The Company has not significantly changed the general terms and conditions of these plans from those disclosed in the Company’s 2008 Annual Report on Form 10-K.

 

The Company’s stock-based compensation expense includes restricted stock awards and stock option awards to officers and other employees, and stock compensation in lieu of cash fees to directors. Total stock-based compensation expense was $173 thousand and $128 thousand for the three months ended September 30, 2009 and 2008, respectively and was $542 thousand and $387 thousand for the nine months ended September 30, 2009 and 2008, respectively.

 

Restricted Stock Awards

 

Stock-based compensation expense recognized in association with restricted stock awards amounted to $79 thousand and $12 thousand for the three months ended September 30, 2009 and 2008 respectively and $183 thousand and $37 thousand for the nine months ended September 30, 2009 and 2008, respectively.

 

There were no restricted stock awards granted in 2008 or during the three month period ended September 30, 2009. During the first quarter of 2009, the Company granted 83,200 shares of common stock to employees as restricted stock awards.  The grant date fair value of the restricted stock awarded was $8.75 per share, which reflects the market value of the common stock on the grant date. Of the 2009 award, 43,200 shares vest twenty-five percent per year and 40,000 shares vest fifty percent per year, in each case starting on the first anniversary date of the award. There have been 150 awards forfeited to date.

 

Prior to the 2009 restricted stock grant, the Company had granted one restricted stock award, comprised of 17,500 shares, issued in September 2005.  The grant date fair value of the restricted stock awarded was $14.25 per share, which reflects the market value of the common stock on the grant date.  The shares granted vest twenty percent per year starting on the first anniversary date of the award and there have been no forfeitures to date.

 

The restricted stock awards allow for the receipt of dividends, and the voting of all shares, whether or not vested, throughout the vesting periods.

 

Stock Option Awards

 

The Company recognized stock-based compensation expense related to stock option awards of $53 thousand and $212 thousand for the three and nine months ended September 30, 2009, compared to $77 thousand and $225 thousand for the same period in 2008.

 

There were no stock option awards granted to employees during the three month period ended September 30, 2009 or 2008.  There were 51,050 and 132,000 stock option awards granted to employees during the nine month period ended September 30, 2009 and September 30, 2008, respectively. All of the options granted in 2009 and 2008 become exercisable at the rate of twenty-five percent per year on the anniversary date of the original grant, and provide for accelerated vesting of the entire grant for those who are age 62 on the grant date or upon attaining age 62 during the normal vesting period.  Vested options are only exercisable while the employee remains employed with the Bank and for a limited period thereafter, and the options expire seven years from the date of grant.

 

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Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

The Company utilizes the Black-Scholes option valuation model in order to determine the per share grant date fair value of option grants.  The table below provides a summary of the options granted, fair value, the fair value as a percentage of the market value of the stock at the date of grant and the average assumptions used in the model for the nine months ended September 30, 2009 and 2008.

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Options granted

 

51,050

 

132,000

 

Per share weighted average fair value

 

$

2.51

 

$

2.47

 

Percentage of market value at grant date

 

29

%

19

%

Average assumptions used in the model:

 

 

 

 

 

Expected volatility

 

40

%

25

%

Expected dividend yield

 

4.54

%

2.82

%

Expected life in years

 

5.5

 

5.5

 

Risk-free interest rate

 

2.32

%

2.61

%

 

Refer to note 9 “Stock Based Compensation Plans” in the Company’s 2008 Annual Report on Form 10-K for a further description of the assumptions used in the valuation model.

 

Director Stock-based Compensation

 

Stock-based compensation expense related to Directors’ election to receive shares of common stock in lieu of cash fees for attendance at Board and Board Committee meetings amounted to $41 thousand and $147 thousand for the three and nine months ended September 30, 2009 compared to $39 thousand and $125 thousand for the same periods in 2008.  In January 2009, 13,013 shares of common stock were issued to directors in lieu of cash fees related to 2008 annual directors’ stock-based compensation expense of $168 thousand.

 

(8)                     Supplemental Retirement Plan and Other Postretirement Benefit Obligations

 

Supplemental Retirement Plan

 

The Company has salary continuation agreements with three of its executive officers.  These salary continuation agreements (SERPs) provide for a predetermined fixed-cash supplemental retirement benefit, the amount subject to vesting requirements, to be provided for a period of 20 years after the individual reaches a defined “retirement age”.

 

The following table illustrates the net periodic benefit cost for the SERPs for the periods indicated:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

2009

 

2008

 

Service Cost

 

$

41

 

$

40

 

$

123

 

$

300

 

Interest Cost

 

44

 

42

 

133

 

122

 

Net periodic benefit cost

 

$

85

 

$

82

 

$

256

 

$

422

 

 

Benefits paid amounted to $60 thousand for the three months and $135 thousand for the nine months ended September 30, 2009, and $45 thousand and $65 thousand for the three and nine months ended September 30, 2008, respectively.  The Company anticipates accruing an additional $85 thousand to the plan during the remainder of 2009.

 

Bank Owned Life Insurance

 

The Company has purchased bank owned life insurance (“BOLI”) on certain senior and executive officers.  The cash surrender value carried on the balance sheet at September 30, 2009 and December 31, 2008 amounted to $13.7 million and $13.3 million, respectively. There are no associated surrender charges under the outstanding policies.

 

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Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

Supplemental Life Insurance

 

For certain senior and executive officers on whom the Bank owns BOLI, the Bank has provided supplemental life insurance which provides a death benefit to the officer’s designated beneficiaries.

 

On January 1, 2008, the FASB issued new accounting guidance for deferred compensation and postretirement benefit aspects of endorsement split dollar life insurance arrangements, which required that an employer recognize a liability for future benefits associated with an endorsement split-dollar life insurance arrangement that provides a benefit to an employee that extends to postretirement periods.  Upon adoption of the accounting guidance, the Company recorded a cumulative-effect adjustment to retained earnings of $1.0 million.

 

The following table illustrates the net periodic post retirement benefit cost for the supplemental life insurance plans for the periods indicated:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

(Dollars in thousands)

 

2009

 

2008

 

2009

 

2008

 

Service Cost

 

$

5

 

$

5

 

$

15

 

$

15

 

Interest Cost

 

20

 

15

 

61

 

46

 

Net periodic post retirement benefit cost

 

$

25

 

$

20

 

$

76

 

$

61

 

 

(9)                     Earnings per share

 

Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted earnings per share reflects the effect on weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.

 

The table below presents the increase in average shares outstanding, using the treasury stock method, for the diluted earnings per share calculation and the effect of those shares on earnings, for the periods indicated:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Basic weighted average common shares outstanding

 

8,228,897

 

7,984,628

 

8,157,273

 

7,961,943

 

Dilutive shares

 

10,832

 

27,967

 

13,898

 

35,168

 

Diluted weighted average common shares outstanding

 

8,239,729

 

8,012,595

 

8,171,171

 

7,997,111

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.28

 

$

0.22

 

$

0.63

 

$

0.69

 

Effect of dilutive shares

 

 

(0.01

)

 

 

Diluted earnings per share

 

$

0.28

 

$

0.21

 

$

0.63

 

$

0.69

 

 

At September 30, 2009, there were additional options outstanding to purchase up to 637,105 shares which were excluded from the year-to-date calculation of diluted earnings per share due to the exercise price of these options exceeding the average market price of the Company’s common stock.  These options, which were not dilutive at that date, may potentially dilute earnings per share in the future.

 

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Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

(10)              Investment Securities

 

The amortized cost and carrying values of investment securities at September 30, 2009 are summarized as follows:

 

 

 

September 30, 2009

 

(Dollars in thousands)

 

Amortized
cost

 

Unrealized
gains

 

Unrealized
losses

 

Carrying Value

 

Federal Agency obligations (1)

 

$

27,219

 

$

39

 

$

4

 

$

27,254

 

Federal Agency mortgage backed securities (MBS) (1)

 

41,738

 

721

 

26

 

42,433

 

Non-agency MBS

 

3,730

 

 

117

 

3,613

 

Municipal securities

 

56,373

 

2,257

 

5

 

58,625

 

Total fixed income securities

 

129,060

 

3,017

 

152

 

131,925

 

Equity investments

 

4,441

 

1,798

 

 

6,239

 

Total available for sale securities, at fair value

 

133,501

 

4,815

 

152

 

138,164

 

FHLB Boston stock, at cost (2)

 

4,740

 

 

 

4,740

 

Total investment securities

 

$

138,241

 

$

4,815

 

$

152

 

$

142,904

 

 


(1)

 

Investments issued or guaranteed by government sponsored enterprises such as Fannie Mae (FNMA), Freddie Mac (FHLMC), Ginnie Mae (GNMA) or one of several Federal Home Loan Banks. All agency MBS investments owned by the Company are backed by residential mortgages.

(2)

 

The Bank is required to purchase Federal Home Loan Bank of Boston (FHLB) stock in association with outstanding advances from the FHLB; this stock is classified as a restricted investment and carried at cost which management believes approximates fair value.

 

See Note 11, “Fair Value Measurements” below for further information regarding the Company’s fair value measurements for available-for-sale securities.

 

The net unrealized gain or loss in the Company’s fixed income portfolio fluctuates as market interest rates rise and fall.  Due to the fixed rate nature of this portfolio, as market rates fall the value of the portfolio rises, and as market rates rise, the value of the portfolio declines.  The unrealized gains or losses on fixed income investments will also decline as the securities approach maturity. Unrealized gains or losses will be recognized in the statements of income if the securities are sold. However, if an unrealized loss on the fixed income portfolio is deemed to be other than temporary the credit loss portion is charged to earnings and the noncredit portion is recognized in accumulated other comprehensive income.

 

As of September 30, 2009, the $30 thousand of unrealized losses on the federal agency obligations and federal agency MBS investments were limited to four individual securities and were attributed to market volatility. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government, and the agencies that issued these securities are sponsored by the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the par value of the Company’s investment. The Company does not consider these investments to be other-than-temporarily impaired at September 30, 2009, because the decline in market value is attributable to interest rate volatility and not credit quality, and because the Company does not intend to, and it is more likely than not that it will not be required to, sell these investments prior to a market price recovery or maturity.

 

As of September 30, 2009, Company’s non-agency MBS portfolio consisted of one residential mortgage backed security.  The $117 thousand unrealized losses on this MBS was due to market conditions which have resulted generally in lower prices for most non-agency MBS in relation to government issued and agency securities. The Company does not consider this investment to be other-than-temporarily impaired at September 30, 2009 due to the AAA rating of the security and the high credit quality of the underlying loans. In addition, the Company does not intend to, and it is more likely than not that it will not be required to, sell this investment prior to a market price recovery or maturity.

 

As of September 30, 2009, the $5 thousand of unrealized losses on the Company’s municipal securities were related to three obligations and attributed to market volatility and not a fundamental deterioration in the issuers. The Company does not consider these investments to be other-than-temporarily impaired at September 30, 2009 due to the portfolio being “investment grade” quality indicating the lower risk nature of municipal investments. In addition, the Company does not intend to, and it is more likely than not that it will not be required to, sell these investments prior to a market price recovery or maturity.

 

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Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

The net unrealized gain or loss on equity securities will fluctuate based on changes in the market value of the funds and individual securities held in the portfolio.  Unrealized gains or losses will be recognized in the statements of income if the securities are sold. However, if an unrealized loss is deemed to be other than temporary prior to a sale, the loss is charged to earnings.  Management regularly reviews the equity portfolio for securities with unrealized losses that are other than temporarily impaired.  Management’s assessment includes evaluating if any equity security or fund exhibits fundamental deterioration and whether it is unlikely that the security or fund will completely recover its unrealized loss within a reasonable time period.  In determining the amount of the other than temporary impairment charge, management considers the severity of the declines in the stock market and the general economy and the uncertainty in determining the likelihood of recovery in the short-term for these equities.

 

At September 30, 2009, the Company’s equity portfolio consisted primarily of investments in a diversified group of mutual funds, with a small portion of the portfolio (approximately 8%) invested in funds or individual common stock of entities in the financial services industry.

 

During the first nine months of 2009, the Company recorded fair market value impairment charges on certain investments contained in its equity portfolio, to reflect the impact of declines in the equity markets during the period.  The pretax impairment charge of $782 thousand represented a $516 thousand after tax charge against earnings.  In March 2009, the Company sold $991 thousand of previously impaired equity funds and recognized additional losses of $299 thousand.

 

As a member of the Federal Home Loan Bank of Boston (FHLB), the Company is required to purchase FHLB capital stock in association with the Bank’s outstanding advances from the FHLB; this stock is classified as a restricted investment and carried at cost.  The FHLB is currently operating with retained earnings below its target level.  The FHLB has instituted a plan to increase retained earnings which includes suspending its quarterly dividend and a moratorium on the repurchase of excess capital stock from member banks, among other programs. If further deterioration in the FHLB financial condition or capital levels occurs, the FHLB capital stock may become other than temporarily impaired to some degree and its carrying value correspondingly reduced.  Management reviews its investment in FHLB stock for other than temporary impairment based on an assessment of the ultimate recoverability of the par value. Management’s most recent evaluation considered the long term nature of the investments, the liquidity position of the FHLB, actions taken by FHLB to address the issue, and the Company’s intent and ability to hold the investment for sufficient time to recover the par value.  Based on this review, management concluded that no other than temporary impairment charge on FHLB stock was necessary as of September 30, 2009.

 

(11)              Fair Value Measurements

 

On January 1, 2008, the Company adopted new FASB accounting guidance regarding fair value measurements which provides a single definition of fair value and establishes a framework for measuring fair value in generally accepted accounting principles, with the intention of increasing consistency and comparability in fair value measurements. The primary impact of the application of this guidance was expanded disclosure requirements about fair value measurements.   The adoption did not require any new fair value measurements, as the FASB rule applies under other existing accounting pronouncements that require or permit fair value measurements.

 

FASB defines the fair value to be the price which a seller would receive in an orderly transaction between market participants (an exit price) and also establishes a fair value hierarchy segregating fair value measurements using three levels of inputs: (Level 1) quoted market prices in active markets for identical assets or liabilities; (Level 2) significant other observable inputs, including quoted prices for similar items in active markets, quoted prices for identical or similar items in market that are not active, inputs such as interest rates and yield curves, volatilities, prepayment speeds, credit risks and default rates which provide a reasonable basis for fair value determination or inputs derived principally from observed market data; (Level 3) significant unobservable inputs for situations in which there is little, if any, market activity for the asset or liability. Unobservable inputs must reflect reasonable assumptions that market participants would use in pricing the asset or liability, which are developed on the basis of the best information available under the circumstances.

 

14



Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

The following table summarizes significant assets and liabilities carried at fair value at September 30, 2009:

 

 

 

 

 

Fair Value Measurements using:

 

(Dollars in thousands)

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Assets measured on a recurring basis:

 

 

 

 

 

 

 

 

 

Available for sale securities

 

$

138,164

 

$

6,239

 

$

131,925

 

 

 

 

 

 

 

 

 

 

 

 

Assets measured on a non-recurring basis:

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

4,485

 

$

 

$

 

$

4,485

 

 

Available for sale securities

 

Investment securities that are considered “available for sale” are carried at fair value.  The Company utilizes third-party pricing vendors to provide valuations on its fixed income securities.  These vendors generally determine fair value prices based upon pricing matrices utilizing observable market data inputs for similar or benchmark securities.  The Company’s equity portfolio fair value is measured based on quoted market prices for the shares.  Net unrealized appreciation and depreciation on investments available for sale, net of applicable income taxes, are reflected as a component of accumulated other comprehensive income.

 

Impaired loans

 

Impaired loan balances in the table above represent those collateral dependent impaired loans where management has estimated the credit loss by comparing the loan’s carrying value against the expected realizable fair value of the collateral, in accordance with FASB Accounting Standards.  A specific allowance is assigned to the collateral dependent impaired loan for the amount of estimated credit loss utilizing Level 3 measurement inputs (appraised value less estimated cost to sell) adjusted as necessary to changes in relevant valuation factors subsequent to the measurement date.  Specific allowances assigned to the collateral dependent impaired loans at September 30, 2009 amounted to $1.4 million, an increase of $1.1 million since December 31, 2008.

 

Guarantees and Commitments

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  If the letter of credit is drawn upon, the Company creates a loan for the customer with the same criteria associated with similar loans.  The fair value of these commitments was estimated to be the fees charged to enter into similar agreements, and accordingly these fair value measures are deemed to be FASB Level 2 measurements.  In accordance with the FASB, the estimated fair values of these commitments are carried on the balance sheet as a liability and amortized to income over the life of the letters of credit, which are typically one year.  At September 30, 2009 and December 31, 2008, the estimated fair values of these commitments were immaterial.

 

Interest rate lock commitments related to the origination of mortgage loans that will be sold are considered derivative instruments.  The Company estimates the fair value of these derivatives using the difference between the guaranteed interest rate in the commitment and the current market interest rate. To reduce the net interest rate exposure arising from its loan sale activity, the Company enters into the commitment to sell these loans at essentially the same time that the interest rate lock commitment on the loan is quoted.   The commitments to sell loans are also considered derivative instruments, with estimated fair values based on changes in current market rates.   These commitments represent the Company’s only derivative instruments and are accounted for in accordance with FASB guidance. The fair values of the Company’s derivative instruments are deemed to be FASB Level 2 measurements.   At September 30, 2009 and December 31, 2008, the estimated fair value of the Company’s derivative instruments was considered to be immaterial.

 

15



Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

Interim Disclosures about Fair Value of Financial Instruments

 

In April 2009, the FASB issued additional requirements for publicly traded companies to provide disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements.  This requirement is effective for interim reporting periods ending after June 15, 2009.  The implementation did not have a material impact on the Company’s financial position or results of operations.

 

In accordance with these FASB requirements, the Company is required to disclose fair value information about financial instruments whether or not recognized on the balance sheet. In cases where quoted fair values are not available, fair values are based upon estimates using various valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  The following methods and assumptions were used by the Company in estimating fair values of its financial instruments:

 

The respective carrying values of certain financial instruments approximated their fair value, as they were short-term in nature or payable on demand.  These include cash and due from banks, total short-term investments, accrued interest receivable, repurchase agreements, accrued interest payable and non-certificate deposit accounts.

 

Investments:  Fair values for investments were based on quoted market prices, where available, as provided by third-party investment portfolio pricing vendors.  If quoted market prices were not available, fair values provided by the vendors were based on quoted market prices of comparable instruments in active markets and/or based on a matrix pricing methodology which employs The Bond Market Association’s standard calculations for cash flow and price/yield analysis, live benchmark bond pricing and terms/condition data available from major pricing sources. Management regards the inputs and methods used by third party pricing vendors to be “Level 2 inputs and methods” as defined in the “fair value hierarchy” provided by FASB.

 

The carrying amount of FHLB stock reported approximates fair value.  If the FHLB stock is redeemed, the Company will receive an amount equal to the par value of the stock.  The FHLB is currently operating with retained earnings below its target level.  The FHLB has instituted a plan to increase retained earnings which includes suspending its quarterly dividend and a moratorium on the repurchase of excess capital stock from member banks, among other programs.  If further deterioration in the FHLB financial condition or capital levels occurs, the FHLB capital stock may become other-than-temporarily impaired to some degree.

 

Loans: The fair value of loans was determined using discounted cash flow analysis, using interest rates currently being offered by the Company.  The incremental credit risk for non-accrual loans was considered in the determination of the fair value of the loans.

 

Commitments: The fair values of the unused portion of lines of credit and letters of credit were estimated to be the fees currently charged to enter into similar agreements. Commitments to originate non-mortgage loans were short-term and were at current market rates and estimated to be immaterial and have no significant change in fair value.

 

Financial liabilities: The fair values of certificates of deposit and FHLB borrowings were estimated using discounted cash flow analysis using rates offered by the Bank, or advance rates offered by the FHLB on September 30, 2009 and December 31, 2008 for similar instruments.   The fair value of junior subordinated debentures was estimated using discounted cash flow analysis using a market rate of interest at September 30, 2009 and December 31, 2008.

 

Limitations:  The estimates of fair value of financial instruments were based on information available at September 30, 2009 and December 31, 2008 and are not indicative of the fair market value of those instruments as of the date of this report.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.

 

Because no active market exists for a portion of the Company’s financial instruments, fair value estimates were based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

 

16



Table of Contents

 

ENTERPRISE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

Fair value estimates were based on existing on- and off-balance sheet financial instruments without an attempt to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments, including premises and equipment and foreclosed real estate.

 

In addition, the tax ramifications related to the realization of the unrealized appreciation and depreciation can have a significant effect on fair value estimates and have not been considered in any of the estimates.  Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The carrying value and estimated fair values of the Company’s financial instruments as of September 30, 2009, and December 31, 2008 are summarized as follows:

 

 

 

September 30, 2009

 

December 31, 2008

 

(Dollars in thousands)

 

Carrying
Amount

 

Fair Value

 

Carrying
Amount

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

41,839

 

$

41,839

 

$

25,276

 

$

25,276

 

Investment securities

 

142,904

 

142,904

 

159,373

 

159,373

 

Loans, net

 

1,041,410

 

1,038,774

 

933,372

 

955,010

 

Accrued interest receivable

 

5,504

 

5,504

 

5,357

 

5,357

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Non-interest demand deposits

 

180,029

 

180,029

 

166,430

 

166,430

 

Interest bearing checking, savings, money market accounts

 

599,995

 

599,995

 

452,023

 

452,023

 

Certificates of deposit (including brokered)

 

347,677

 

348,467

 

329,450

 

330,184

 

Borrowed funds

 

31,170

 

31,227

 

121,250

 

121,274

 

Junior subordinated debentures

 

10,825

 

10,825

 

10,825

 

10,825

 

Accrued interest payable

 

1,270

 

1,270

 

1,849

 

1,849

 

 

(12)              Recent Accounting Pronouncements

 

In June 2009, the FASB amended the consolidation guidance applicable to variable interest entities (VIEs) by eliminating exceptions to consolidating qualifying special-purpose entities, changing the approach to determining a VIE’s primary beneficiary, and requiring a company to more frequently reassess whether VIEs must be consolidated. This amended guidance is effective for the Company beginning in fiscal year 2010. The Company is currently assessing the impact of this guidance on its consolidated financial position and results of operations.

 

In June 2009, the FASB amended its guidance related to transfers and servicing of financial assets and extinguishments of liabilities to address certain practices that have developed that the FASB determined are not consistent with the original intent and key requirement of the prior guidance, and to address concerns that financial assets that have been derecognized should continue to be reported in the financial statements of the transferors.  The new guidance is intended to improve the information that a reporting entity provides in its financial reports about the transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows.   The appropriateness of derecognition is evaluated based on whether or not the transferor has surrendered control of the transferred assets.  The evaluation must consider any continuing involvement by the transferor in the financial assets.  New disclosure requirements must be applied to transfers that occurred both before and after the effective date of this new guidance, which is effective for the first interim and annual periods that begin after November 15, 2009 and for interim and annual periods thereafter.  Earlier application is prohibited.  The implementation of this guidance is not expected to have a material impact on the Company’s financial position or results of operations.

 

In May 2009, the FASB issued new guidance on management’s assessment of subsequent events, clarifying that management must evaluate, as of each reporting period, events or transactions that occur after the balance sheet date through the date that the financial statements are issued or are available to be issued. This guidance was effective for the Company beginning in the second quarter of 2009 and is disclosed in Note 2, “Basis of Presentation”, above. The adoption of this guidance did not have any impact on the Company’s consolidated financial statements.

 

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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in this report and the Company’s 2008 Annual Report on Form 10-K.

 

Special Note Regarding Forward-Looking Statements

 

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements concerning plans, objectives, future events or performance and assumptions and other statements that are other than statements of historical fact.  Forward-looking statements may be identified by reference to a future period or periods or by use of forward-looking terminology such as “anticipates”, “believes”, “expects”, “intends”, “may”, “plans”, “pursue”, “views” and similar terms or expressions. Various statements contained in Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 3 — “Quantitative and Qualitative Disclosures About Market Risk,” including, but not limited to, statements related to management’s views on the banking environment and the economy, competition and market expansion opportunities, the interest rate environment, credit risk and the level of future non-performing assets and charge-offs, potential asset and deposit growth, future non-interest expenditures and non-interest income growth, and borrowing capacity are forward-looking statements.  The Company wishes to caution readers that such forward-looking statements reflect numerous assumptions and involve a number of risks and uncertainties that may adversely affect the Company’s future results. The following important factors, among others, could cause the Company’s results for subsequent periods to differ materially from those expressed in any forward-looking statement made herein: (i) changes in interest rates could negatively impact net interest income;  (ii) changes in the business cycle and downturns in the local, regional or national economies, including deterioration in the local real estate market, could negatively impact credit and/or asset quality and result in credit losses and increases in the Company’s allowance for loan losses; (iii) changes in consumer spending could negatively impact the Company’s credit quality and financial results; (iv) increasing competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services could adversely affect the Company’s competitive position within its market area and reduce demand for the Company’s products and services; (v) deterioration of securities markets could adversely affect the value or credit quality of the Company’s assets and the availability of funding sources necessary to meet the Company’s liquidity needs; (vi) changes in technology could adversely impact the Company’s operations and increase technology-related expenditures;  (vii) increases in employee compensation and benefit expenses could adversely affect the Company’s financial results;  (viii) changes in laws and regulations that apply to the Company’s business and operations could increase the Company’s regulatory compliance costs and adversely affect the Company’s business environment, operations and financial results; (ix) changes in accounting standards, policies and practices, as may be adopted or established by the regulatory agencies, the Financial Accounting Standards Board (the “FASB”) or the Public Company Accounting Oversight Board could negatively impact the Company’s financial results; and (x) some or all of the risks and uncertainties described in Item 1A of the Company’s 2008 Annual Report on From 10-K could be realized, which could have a material adverse effect on the Company’s business, financial condition and results of operation.  Therefore, the Company cautions readers not to place undue reliance on any such forward-looking information and statements.

 

Overview

 

Management believes that the current banking environment provides many opportunities for community banks like Enterprise Bank, as customers migrate from larger, national banks to local community banks, choosing to do business with banking professionals they know and trust.  At a time when many large regional and national financial institutions have retrenched, Enterprise Bank has successfully grown loans and deposits.

 

Loans outstanding totaled $1.06 billion at September 30, 2009, an increase of $110.3 million, or 12%, since December 31, 2008, and an increase of $39.5 million since June 30, 2009.   Deposits, excluding brokered deposits, totaled $1.04 billion at September 30, 2009, an increase of $167 million, or 19%, since December 31, 2008, and an increase of $14.7 million since June 30, 2009.   The year-to-date growth in loans and deposits, excluding brokered CD, equates to annualized growth rates of 16% and 26%, respectively.

 

The Company continues to expand its branch network.  In January we opened our sixteenth branch location in Acton, Massachusetts and during the current quarter, our temporary Derry, NH loan production office began operating as our seventeenth full-service branch. We also recently began construction on our permanent Derry location, which we expect to be open in late spring 2010.  The Company continues to make significant strategic investments in employee professional development, facilities, technology, and marketing and public relations.  While management recognizes that such investments will increase non-interest expenses in the short-term, the Company believes that the opportunities for long-term benefits, including growth and expansion and increased market share, have never been stronger than they are at the present time.

 

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· Results of Operations

 

Net income increased 32% for the third quarter, when compared to the same period in 2008 and amounted to $2.3 million, or $0.28 per diluted share, for the quarter ended September 30, 2009, compared to $1.7 million, or $0.21 per diluted share, for the quarter ended September 30, 2008.  The increase was primarily due to an increase in net interest income, partially offset by a decrease in gains on sales of investments and increases in FDIC insurance premiums and other non-interest expenses.

 

Net income for the nine months ended September 30, 2009 amounted to $5.2 million, or $0.63 diluted earnings per share, compared to $5.5 million, or $0.69 diluted earnings per share, for the comparable 2008 period.  The year to date net income decrease of 6% when compared to the same period in 2008, was primarily impacted by an increase in net interest income, which was more than offset by increases in the provision for loan losses, a decrease in non-interest income, and increases in FDIC insurance premiums and other non-interest expenses.

 

· Net interest income and margin

 

The Company’s earnings are largely dependent on its net interest income, which is the difference between interest earned on loans and investments and the cost of funding (primarily deposits and borrowings).  Net interest income expressed as a percentage of average interest earning assets is referred to as net interest margin.  The re-pricing frequency of the Company’s assets and liabilities are not identical, and therefore subject the Company to the risk of adverse changes in interest rates. This is often referred to as “interest rate risk” and is reviewed in more detail in Item 3, “Quantitative and Qualitative Disclosures About Market Risk,” of this Form 10-Q.

 

Net interest income for the quarter ended September 30, 2009 amounted to $12.5 million, an increase of $1.6 million, or 15%, compared to the September 2008 quarter.  Net interest income for the nine months ended September 30, 2009 amounted to $35.3 million, an increase of $4.3 million, or 14%, compared to the nine months ended September 30, 2008.  The increase in net interest income over the comparable quarter and year-to-date 2008 periods was due primarily to strong loan growth. Average loan balances increased $150.6 million and $133.6 million for the quarter-over-quarter and year-over-year periods, respectively.

 

Net interest margin was 4.32% for the quarter ended September 30, 2009 compared to 4.27% for the September 2008 quarter and 4.19% for the quarter ended June 30, 2009.  Year-to-date net interest margin was 4.23% for the nine months ended September 30, 2009, compared to 4.22 % for the same period ended September 30, 2008, and 4.23% for the year ended December 31, 2008.  Due to the lower market interest rates compared to the prior year, earning assets and funding sources continued to reprice downward during the current year, reducing both the yield on earning assets and the Company’s cost of funding.  However, in recent months, the pace of asset repricing (primarily loans) has slowed, while funding costs have declined at a faster rate, contributing to the recent increase in margin.

 

· Provision for loan losses and Credit Quality

 

The provision for loan losses amounted to $1.1 million for the three months ended September 30, 2009, compared to $1.2 million for the same period in 2008, and amounted to $3.1 million and $2.0 million for the nine months ended September 30, 2009 and 2008, respectively. The increase in the year-to-date provision was due to several factors: the level of loan growth during the period; level of net charge-offs compared to the prior year; and an increase in specific reserves.  Total loans increased $110.3 million during the nine months ended September 30, 2009, compared to loan growth of $75 million in the 2008 nine-month period.  Year-to-date net charge offs amounted to $887 thousand compared to $387 thousand in the same period last year.  Annualized year-to-date net charge-offs amounted to 0.12% of average total loans in 2009 compared to 0.06% for the same period in 2008.  Specific reserves for impaired loans increased by $833 thousand at September 30, 2009, compared to September 30, 2008.

 

At September 30, 2009, non-performing assets amounted to 1.30% of total assets compared to 1.09% and 0.73% at June 30, 2009, and December 31, 2008, respectively.  The ratio of loans 60-89 days past due to total loans declined to 0.12% at September 30, 2009 compared to 0.32% at June 30, 2009 and 0.28% at December 31, 2008.  The allowance for loan losses to total loans ratio was 1.65% at September 30, 2009, compared to 1.64% at June 30, 2009, and 1.61% at December 31, 2008.  In general, the trend in non-performing statistics is consistent with the economic environment at the local level, and was considered reasonable, especially in light of the historic low level of these statistics in recent years.  Our credit quality and allowance ratios continue to compare favorably to both national and state peer groups.   Management believes the overall credit quality of the general portfolio is sound, and that the level of the allowance for loan losses was appropriate given management’s assessment of the risk inherent in the portfolio as of September 30, 2009.

 

See “Credit Risk/Asset Quality and the Allowance for Loan Losses” below in this Item 2, for further discussion of management’s assessment of the allowance for loan losses.

 

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· Non-interest income and expense

 

Non-interest income for the three months ended September 30, 2009 amounted to $2.4 million as compared to $2.6 million at September 30, 2008.  Non-interest income for the nine months ended September 30, 2009 and September 30, 2008 amounted to $7.1 million and $7.4 million, respectively.  Year-to-date investment advisory income decreased $405 thousand over the same period in the prior year due to the decline in the value of assets under management resulting primarily from investment market conditions.  During the nine months ended September 30, 2009, net gains on security sales were offset in part by the other than temporary impairment on certain equity securities and resulted in net gains of $189 thousand, compared to net gains of $267 thousand for the nine months ended September 30, 2008.  Gains realized on the sales of loans increased $426 thousand over the comparable year-to-date period due to the increase in volume of residential loan production as a result of the favorable market interest rates in 2009.

 

Non-interest expense for the three months ended September 30, 2009, amounted to $10.5 million, an increase of 9%, compared to the same quarter last year.  Non-interest expense for the nine months ended September 30, 2009, amounted to $32.1 million, an increase of 13%, compared to the same period in the prior year. The increase in non-interest expense was related primarily to strategic growth, new branches opened and increases in FDIC deposit insurance assessments. Strategic growth initiatives resulted in increases in the areas of compensation-related costs, occupancy, and advertising and public relations expenses.  Year-to-date deposit insurance premiums increased $1.2 million compared to the same nine month period in 2008, due to changes in the FDIC insurance assessment rates and a special June 30, 2009 assessment, which applied to all insured banks, intended to replenish the FDIC’s deposit insurance reserves.

 

· Effective tax rates

 

The effective tax rate for the nine months ended September 30, 2009 was 28.5% compared to 31.7% in the 2008 period.  The decrease in the effective tax rate was primarily due to the impact of the level of non-taxable income on lower earnings.

 

· Sources and Uses of Funds

 

The Company’s primary sources of funds are customer deposits, brokered certificates of deposit (“brokered CDs”), borrowings from the Federal Home Loan Bank of Boston (the “FHLB”), repurchase agreements, current earnings and proceeds from the sales, maturities and paydowns on loans and investment securities.  The Company uses these funds to originate loans, purchase investment securities, conduct operations, expand the branch network, and pay dividends to shareholders.

 

Total assets amounted to $1.29 billion at September 30, 2009, an increase of 9% since December 31, 2008. The Company’s core asset strategy is to grow loans, primarily high quality commercial loans. Total loans increased 12%, or $110.3 million, since December 31, 2008 and amounted to $1.06 billion, or 82% of total assets. Commercial loans amounted to $901.2 million, or 85% of gross loans, which was consistent with the December 31, 2008 composition.

 

The investment portfolio is the other key component of the Company’s earning assets and is primarily used to invest excess funds, provide liquidity and to manage the Company’s asset-liability position. The fair value of total investments amounted to $142.9 million at September 30, 2009. The $16.5 million decline since December 31, 2008 was due to principal paydowns, calls, maturities, and sales partially offset by purchase activity.  The cash flow that has not yet been fully redeployed is carried temporarily in short-term money market mutual funds.

 

Management’s preferred strategy for funding asset growth is to grow low cost deposits (comprised of demand deposit, interest checking and business checking accounts and traditional savings accounts). Asset growth in excess of low cost deposits is typically funded through higher cost deposits (comprised of money market accounts, commercial tiered rate or “investment savings” accounts and certificates of deposit, or “CDs”), customer repurchase agreements, wholesale funding (brokered CDs and FHLB borrowings), and investment portfolio cash flow.

 

Deposits, excluding brokered CDs, amounted to $1.04 billion, an increase of $167 million, or 19%, since December 31, 2008, representing an annualized growth rate of 26%.  Deposit growth was noted in all categories; with low cost deposit balances increasing 8% and higher cost transactional deposit balances increasing 60%, while CDs increased 2% since December 31, 2008.  The deposit growth, which primarily occurred in the first six months of 2009, is attributed to the Company’s expansion and sales efforts to attract relationship customers seeking a competitive, but secure, alternative to the larger regional and national banks and mutual funds, as well as the migration of off-balance sheet sweep accounts to on-balance sheet accounts.

 

At September 30, 2009, total deposits, which include brokered CDs, amounted to $1.13 billion, representing 19% growth over December 31, 2008.

 

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Table of Contents

 

Wholesale funding amounted to $118 million at September 30, 2009, compared to $195.2 million at December 31, 2008.  At September 30, 2009, wholesale funding included $88.2 million in brokered CDs, an increase of $12.8 million, or 17%, since December 31, 2008, and FHLB borrowings amounting to $29.8 million, a decrease of $90.1 million, or 75%, since December 31, 2008.  The declines in wholesale funding were achieved due to the strong deposit growth during the period.

 

· Opportunities and Risks

 

The Company has concentrated on community lending with commercial loans and traditional mortgages to growing and established local businesses, professionals, non-profit organizations and individuals.  While the current economic environment presents significant challenges for all companies, management also believes that it creates opportunities for growth and expansion.  In management’s view, the actions of the larger regional and national banks, and other non-bank financial service companies, to restrict their lending practices and service levels in broad strokes, has alienated many strong credit customers.  This has resulted in a level of market activity that has not been seen for many years, where strong customers are seeking local, stable community banks with which to do their banking business.  Management believes that Enterprise Bank is well positioned to capitalize on this market opportunity by utilizing the disciplined and consistent lending, conservative credit review practices, and strong customer service standards that have served to provide quality asset growth over varying economic cycles during the Company’s twenty year history.  The Company continues to seek to position itself to increase market share, with carefully planned expansion into neighboring markets through focused marketing strategies and new branch development.   Over the past eighteen months we have opened two new full service branch facilities in Massachusetts, in addition to the temporary Derry, New Hampshire office, with construction of the permanent Derry facility underway.

 

In addition to branch expansion, management continues to undertake many significant strategic initiatives, including investments in employee training and professional development, marketing and public relations, technology and facilities improvement.  While management recognizes that such investments will increase expenses in the short-term, it believes that such initiatives are an investment in the long-term growth and value of the Company and are reflective of the opportunities in the marketplace for community banks such as Enterprise.

 

Notwithstanding the market opportunities that management believes the current economic environment has created, any long-term continuation of the nationwide recession or possible lagging effects could further weaken the local New England economy, and have long-term adverse consequences on local industries leading to increased unemployment, further deterioration of local commercial real estate values, or other complications, which could have a severe negative impact on the Company’s financial condition, capital position, liquidity, and performance.  In addition, the Company’s loan portfolio consists primarily of commercial real estate, commercial and industrial and construction loans.  These types of loans are typically larger and are generally viewed as having more risk of default than owner occupied residential real estate loans or consumer loans. The underlying commercial real estate values, customer cash flow and payment expectations and, in the case of commercial construction loans, the actual costs necessary to complete a construction project, can be more easily influenced by adverse conditions in the local or national economy, the real estate market, or the related industries. Any significant deterioration in the Company’s commercial loan portfolio or underlying collateral values could have a material adverse effect on the Company’s financial condition and results of operations.

 

The Company’s primary market area will continue to be marked by substantial competition from multiple sources, including the expanded commercial lending capabilities of credit unions, the shift to commercial lending by traditional savings banks, the continuing presence of large regional and national commercial banks, the products offered by non-bank financial services competitors and increased competition for investment advisory assets and deposit resources within the Company’s market area.

 

The Company will continue to face significant risks in seeking to achieve its long-term growth and market share objectives, which will continue to depend upon the Company’s success in differentiating itself from competitors, developing strong relationships with business and community leaders, and providing a superior customer experience through a full range of diversified financial products and services, delivered through consistent, responsive and personal service based on an understanding of the financial needs of customers.   Management believes the Company’s business model, strong service and technology cultures, experienced banking professionals, in-depth knowledge of our markets and trusted reputation within the community create opportunities for the Company to be the leading provider of banking and investment management services in its growing market area and that the Company is well positioned, both financially and strategically, to capitalize on opportunities created by the current challenging banking landscape.

 

The value of the Company’s investment portfolio as a whole, or individual securities held, including bonds issued by government agencies or municipalities and restricted FHLB capital stock could be negatively impacted by any continued volatility in the financial markets, tightening of credit markets, and any possible subsequent effects of the current economic recession, which could possibly result in the recognition of additional other-than-temporary-impairment (“OTTI”) charges in the future.

 

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Any further changes in government regulation or oversight, including responses to the recent financial crisis, could affect the Company in substantial and unpredictable ways, including, but not limited to, subjecting the Company to additional operating and compliance costs.  As discussed above, changes in the FDIC’s deposit insurance rates applicable to all insured banks and the Company’s participation in the FDIC’s TAGP have already increased the Company’s ongoing FDIC-related costs, and the FDIC’s ability to impose additional future special assessments to restore the DIF could further increase these costs.

 

Additional significant challenges facing the Company continue to be the effective management of interest rate and credit risk, liquidity management and capital adequacy, and operational risk.

 

The re-pricing frequency of interest earning assets and liabilities are not identical, and therefore subjects the Company to the risk of adverse changes in interest rates. This is often referred to as “interest rate risk” and is reviewed in more detail under Item 3, “Quantitative and Qualitative Disclosures About Market Risk.”

 

The risk of loss due to customers’ non-payment of loans or lines of credit is called “credit risk.”  Credit risk management is reviewed below in this Item 2 under the heading “Credit Risk/Asset Quality and the Allowance for Loan Losses.”

 

Liquidity management is the coordination of activities so that cash needs are anticipated and met readily and efficiently.  Liquidity management is reviewed under this Item 2 under the heading “Liquidity” below.

 

Federal banking agencies require the Company and the Bank to meet minimum capital requirements. At September 30, 2009, the Company and the Bank were categorized as “well capitalized”; however future unanticipated charges against capital could impact these regulatory capital designations. In addition, although the Company believes its current capital is adequate to support ongoing operations, on September 10, 2009, the Company filed a shelf registration of rights and common stock with the Securities and Exchange Commission for the flexibility to raise, over a three year period, up to $25 million in capital, in order to increase capital to ensure the Company is positioned to take advantage of growth and market share opportunities.  On October 22, 2009, the Company commenced a subscription rights offering to the Company’s stockholders, together with a supplemental community-based offering to be undertaken concurrently with the rights offering, with the intention of raising between $7.5 million and $8.9 million, under the shelf registration, at a per share price of $10.85.  Subject to extension at the sole discretion of the Company, the rights offering is scheduled to close on November 19, 2009 and the supplemental community offering is scheduled to close on December 1, 2009.

 

For information regarding the capital requirements applicable to the Company and the Bank and their respective capital levels at September 30, 2009, see the section entitled “Capital Resources” contained in this Item 2 below.

 

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people or systems, or from external events. Operational risk management is also a key component of the Company’s risk management process, particularly as it relates to technology administration, information security, and business continuity.

 

Management utilizes a combination of third party security assessments, key technologies and ongoing internal evaluations in order to protect non-public customer information and continually monitor and safeguard information on its operating systems and those of third party service providers.  The Company contracts with outside parties to perform a broad scope of both internal and external security assessments on the Company’s systems on a regular basis. These third parties test the Company’s network configuration and security controls, and assess internal practices aimed at protecting the Company’s operating systems.

 

In addition, the Company contracts with an outside service provider to monitor usage patterns and identify unusual activity on debit/ATM cards issued by the Bank.  The Company also utilizes firewall technology and a combination of software and third-party monitoring to detect intrusion, protect against unauthorized access and continuously scan for computer viruses on the Company’s information systems.

 

The Company has a Business Continuity Plan that consists of the information and procedures required to enable rapid recovery from an occurrence, such as natural disaster or business disruption, which would disable the Company for an extended period.  The Company also has a detailed Pandemic Plan that outlines steps for recovering from any significant disruption or loss or personnel from such an occurrence.  The plans establishes responsibility for assessing a disruption of business, contains alternative strategies for the continuance of critical business functions, assigns responsibility for restoring services, and sets priorities by which critical services will be restored.

 

In addition to the risks discussed above numerous other factors that could adversely affect the Company’s future results of operations and financial condition are addressed in Item 1A, “Risk Factors” included in the Company’s 2008 Annual Report on Form 10-K.

 

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Table of Contents

 

Financial Condition

 

Total assets increased $107 million, or 9%, since December 31, 2008, to $1.29 billion at September 30, 2009.  The increase was primarily attributable to increases in total loans, funded primarily through deposit growth.

 

Short-term investments

 

As of September 30, 2009, short-term investments amounted to $11.1 million, an increase of $7.3 million compared to December 31, 2008. Short-term investments carried as cash equivalents consist of overnight and term federal funds sold and money market mutual funds.  The balance of these investments will fluctuate depending on the short-term deposit inflows, investment sales proceeds and the immediate liquidity needs of the Company.

 

Investments

 

At September 30, 2009, the investment portfolio declined $16.5 million compared to December 31, 2008 as discussed below.  The carrying value of the investment portfolio represented 11% of total assets at September 30, 2009 and 14% at December 31, 2008.

 

The following table summarizes investments at the dates indicated:

 

(Dollars in thousands)

 

September 30,
2009

 

December 31,
2008

 

September 30,
2008

 

 

 

 

 

 

 

 

 

Federal agency obligations (1)

 

$

27,254

 

$

 

$

 

Federal agency mortgage backed securities (MBS) (1)

 

42,433

 

82,936

 

67,061

 

Non-agency MBS

 

3,613

 

4,316

 

4,406

 

Municipal securities

 

58,625

 

61,386

 

53,821

 

Total fixed income securities

 

131,925

 

148,638

 

125,288

 

 

 

 

 

 

 

 

 

Equity investments

 

6,239

 

4,740

 

7,717

 

Total available for sale securities, at fair value

 

138,164

 

153,378

 

133,005

 

 

 

 

 

 

 

 

 

Federal Home Loan Bank stock (2)

 

4,740

 

5,995

 

4,530

 

Total investment securities

 

$

142,904

 

$

159,373

 

$

137,535

 

 


(1)            Investments issued or guaranteed by government enterprises such as Fannie Mae, Freddie Mac, Ginnie Mae and the FHLB. All agency MBS investments owned by the Company are backed by residential mortgages.

(2)            This stock is classified as a restricted investment and carried at cost which management believes approximates fair value.

 

During the nine months ended September 30, 2009, the Company sold $38.5 million in federal agency and MBS obligations and equity mutual funds, and recognized net gains of $971 thousand.  During the same period, the total principal paydowns, calls and maturities amounted to $40.5 million.  These portfolio cash flows were partially utilized to purchase $60.4 million in securities and fund cash management operations, with the remainder placed temporarily in short-term investments.

 

Net unrealized gains amounted to $4.7 million at September 30, 2009 compared to $1.7 million at December 31, 2008 and net unrealized losses of $2.6 million at September 30, 2008. See Note 10, “Investment Securities” and Note 11, “Fair Value Measurements” to the Company’s unaudited consolidated financial statements contained in this Form 10-Q for further information regarding the Company’s unrealized gain and losses on debt and equity securities,  including information about investments in an unrealized loss position for which an other-than-temporary impairment has or has not been recognized and the Company’s fair value measurements for available-for-sale securities.

 

The Company has not purchased sub-prime mortgage-backed securities and has never invested in the stock of Fannie Mae or Freddie Mac and does not have any direct investments in corporate debt.

 

From time to time the Company may pledge investments from the portfolio as collateral for various municipal deposit accounts, repurchase agreements and treasury, tax and loan deposits.  The fair value of securities pledged as collateral was $29.9 million at September 30, 2009.  Securities designated as qualified collateral for FHLB borrowing capacity amounted to $36.0 million at September 30, 2009.  Securities designated as qualified collateral for borrowing from the Federal Reserve Bank of Boston (the “FRB”) through its discount window amounted to $56.6 million at September 30, 2009.

 

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Loans

 

The Company specializes in lending to business entities, non-profit organizations, professionals and individuals. The Company’s primary lending focus is on the development of high quality commercial relationships achieved through active business development efforts, strong community involvement and focused marketing strategies.  Loans made by the Company to businesses include commercial mortgage loans, construction and land development loans, secured and unsecured commercial loans and lines of credit, and standby letters of credit.  The Company also originates equipment lease financing for businesses. Loans made to individuals include conventional residential mortgage loans, home equity loans, residential construction loans on primary residences, secured and unsecured personal loans and lines of credit.  The Company does not have a “sub-prime” mortgage program.

 

Total loans increased $110.3 million, or 12%, compared to December 31, 2008, and 17% since September 30, 2008.  Total loans represented 82% and 80% of total assets at September 30, 2009 and at December 31, 2008.  The majority of the growth since December has been focused in the commercial portfolio, as total commercial loans have increased $98.8 million, or 12%, over the period.

 

The following table sets forth the loan balances by certain loan categories at the dates indicated and the percentage of each category to gross loans.

 

 

 

September 30, 2009

 

December 31, 2008

 

September 30, 2008

 

(Dollars in thousands)

 

Amount

 

Percent

 

Amount

 

Percent

 

Amount

 

Percent

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

$

538,723

 

50.8

%

$

472,279

 

49.7

%

$

456,662

 

50.2

%

Commercial and industrial

 

255,693

 

24.1

%

231,815

 

24.4

%

208,940

 

23.0

%

Commercial construction

 

106,793

 

10.1

%

98,365

 

10.4

%

109,127

 

12.0

%

Total commercial loans

 

901,209

 

85.0

%

802,459

 

84.5

%

774,729

 

85.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

91,296

 

8.6

%

84,609

 

8.9

%

80,362

 

8.8

%

Residential construction

 

5,857

 

0.5

%

6,375

 

0.7

%

4,920

 

0.5

%

Home equity

 

55,879

 

5.3

%

49,773

 

5.2

%

44,471

 

4.9

%

Consumer

 

4,936

 

0.5

%

4,857

 

0.5

%

4,390

 

0.5

%

Loans held for sale

 

946

 

0.1

%

1,596

 

0.2

%

863

 

0.1

%

Gross loans

 

1,060,123

 

100.0

%

949,669

 

100.0

%

909,735

 

100.0

%

Deferred fees, net

 

(1,225

)

 

 

(1,028

)

 

 

(964

)

 

 

Total loans

 

1,058,898

 

 

 

948,641

 

 

 

908,771

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

(17,488

)

 

 

(15,269

)

 

 

(15,198

)

 

 

Net loans

 

$

1,041,410

 

 

 

$

933,372

 

 

 

$

893,573

 

 

 

 

Commercial real estate loans represent an area of significant growth and increased $66.4 million, or 14%, as of September 30, 2009, compared to December 31, 2008, and 18% compared to September 30, 2008.  Commercial real estate loans include loans secured by both owner-use and non-owner occupied real estate.  These loans are typically secured by a variety of commercial and industrial property types including apartment buildings, office or mixed-use facilities, strip shopping malls or other commercial property.

 

Commercial and industrial loans increased by $23.9 million, or 10%, since December 31, 2008, and 22% as compared to September 30, 2008.  These loans include seasonal revolving lines of credit, working capital loans, equipment financing (including equipment leases), and term loans.  Also included in commercial and industrial loans are loans under various U.S. Small Business Administration programs. These commercial and industrial loans include unsecured loans or lines to financially strong borrowers, loans secured in whole or in part by real estate unrelated to the principal purpose of the loan, or secured by inventories, equipment and/or receivables.  Commercial and industrial loans are generally guaranteed by the principals of the borrower.

 

Commercial construction loans increased $8.4 million, or 9%, since December 31, 2008, but decreased 2% compared to September 30, 2008. The decrease since September 2008 reflects the limited new construction projects by qualified builders due to the environment in the construction industry over that time frame.   The increase in 2009 has occurred during the third quarter as a result of select opportunities in the market place to lend to strong developers.  Commercial construction loans include the development of residential housing and condominium projects, the development of commercial and industrial use property and

 

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loans for the purchase and improvement of raw land.  The Company limits the amount of financing provided to any single developer for the construction of properties built on a speculative basis.  Funds for construction projects are disbursed as pre-specified stages of construction are completed.  Regular site inspections are performed, either by experienced construction lenders on staff or by independent outside inspection companies, at each construction phase, prior to advancing additional funds.

 

Residential mortgages, residential construction, home equity mortgages and consumer loans combined represented approximately 15% of the total loan portfolio at both September 30, 2009 and December 31, 2008.  These loans increased by $12.4 million, or 8%, since December 31, 2008 and by $23.8 million, or 18%, since September 30, 2008.  The increases were primarily within the residential mortgage and home equity portfolio due to favorable market rates over the period.

 

Depending on the current interest rate environment, management projections of future interest rates and the overall asset-liability management program of the Company, management may elect to sell those fixed and adjustable rate residential mortgage loans which are eligible for sale in the secondary market, or hold some or all of this residential loan production for the Company’s portfolio. The Company generally does not pool mortgage loans for sale, but instead sells the loans on an individual basis. The Company may retain or sell the servicing when selling the loans. All loans sold are currently sold without recourse, subject to an early payment default period covering the first four payments for certain loan sales. During the nine months ended September 30, 2009, the Company originated $49.6 million in residential loans designated for sale, compared to $11.7 million for the comparable period in the prior year.  The increase in volume of residential loan production was due to favorable market rates in 2009.  Loans sold generated gains on sales of $526 thousand and $100 thousand for the nine month periods ended September 30, 2009 and 2008, respectively.

 

At September 30, 2009, the Company had commercial loan balances participated out to various banks amounting to $30.9 million, compared to $19.2 million at December 31, 2008.  Balances participated out to other institutions are not carried as assets on the Company’s financial statements.  Loans originated by other banks in which the Company is the participating institution are carried in the loan portfolio at the Company’s pro rata share of ownership and amounted to $32.9 million and $24.9 million at September 30, 2009 and December 31, 2008, respectively.  The Company performs an independent credit analysis of each commitment prior to participation in any loan.

 

Loans designated as qualified collateral for FHLB borrowing capacity amounted to $224.5 million and $275.3 million at September 30, 2009 and December 31, 2008, respectively.

 

Credit Risk/Asset Quality and the Allowance for Loan Losses

 

There have been no material changes to the Company’s underwriting practices or to the allowance for loan loss methodology used to estimate loan loss exposure as reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The provision for loan losses is a significant factor in the Company’s operating results.

 

The Company manages its loan portfolio to avoid concentration by industry or loan size to minimize its credit risk exposure. In addition, the Company does not have a “sub-prime” mortgage program.  However, inherent in the lending process is the risk of loss due to customer non-payment, or “credit risk”.  The Company’s commercial lending focus may entail significant additional risks compared to long term financing on existing owner occupied residential real estate.  These types of loans are typically larger and are generally viewed as having more risk of default than owner occupied residential real estate loans or consumer loans. The underlying commercial real estate values, customer cash flow and payment expectations and, in the case of commercial construction loans, the actual costs necessary to complete a construction project, can be more easily influenced by adverse conditions in the local or national economy, the real estate market, or the related industries. As such, an extended downturn in the national or local economy or real estate markets, among other factors, could have a material impact on the borrowers’ ability to repay outstanding loans and on the value of the collateral securing these loans.  While the Company endeavors to minimize this risk through the risk management function, management recognizes that loan losses will occur and that the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio and economic conditions.

 

The Company’s credit risk management function focuses on a wide variety of factors, including, among others, current and expected economic conditions, the real estate market, the financial condition of borrowers, the ability of borrowers to adapt to changing conditions or circumstances affecting their business and the continuity of borrowers’ management teams.  Early detection of credit issues is critical to minimize credit losses.  Accordingly, management regularly monitors these factors, among others, through ongoing credit reviews by the Credit Department, an external loan review service, reviews by members of senior management and the Loan Committee of the Board of Directors.

 

The Company’s loan risk rating system classifies loans depending on risk of loss characteristics.  The classifications range from “substantially risk free” for the highest quality loans and loans that are secured by cash collateral, to the most severe adverse classifications of “substandard”, “doubtful” and “loss” based on criteria established under banking regulations.  Loans classified

 

25



Table of Contents

 

as substandard include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.  Loans classified as doubtful have all the weaknesses inherent in a substandard rated loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  Loans classified as loss are generally considered uncollectible at present, although long term recovery of part or all of loan proceeds may be possible.  These “loss” loans would require a specific loss reserve or charge-off.  Adversely classified loans may be accruing or in non-accrual status and may be additionally designated as impaired or restructured, or some combination thereof.

 

Impaired loans are individually significant loans for which management considers it probable that not all amounts due in accordance with original contractual terms will be collected.  The majority of impaired loans are included within the non-accrual balances; however, not every loan in non-accrual status has been designated as impaired. Management does not set any minimum delay of payments as a factor in reviewing for impaired classification.  Management considers the payment status, net worth and earnings potential of the borrower, and the value and cash flow of the collateral as factors to determine if a loan will be paid in accordance with its contractual terms.

 

When a loan is deemed to be impaired, management estimates the credit loss by comparing the loan’s carrying value against either 1) the present value of the expected future cash flows discounted at the loan’s effective interest rate; 2) the loan’s observable market price; or 3) the expected realizable fair value of the collateral, in the case of collateral dependent loans.  A specific allowance is assigned to the impaired loan for the amount of estimated credit loss. Impaired loans are charged off, in whole or in part, when management believes that the recorded investment in the loan is uncollectible.

 

Impaired loans exclude large groups of smaller-balance homogeneous loans, such as residential mortgage loans and consumer loans, which are collectively evaluated for impairment, loans that are measured at fair value and leases as defined by the FASB.

 

Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is generally discontinued when a loan becomes contractually past due, with respect to interest or principal, by ninety days, or when reasonable doubt exists as to the full and timely collection of interest or principal. When a loan is placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on such loans only when payments are brought current and have remained current for a period of ninety days or when, in the judgment of management, the collectability of both principal and interest is reasonably assured.  Interest payments received on loans in a non-accrual status are generally applied to principal.

 

Loans are designated as “restructured” when a concession is made on a credit as a result of financial difficulties of the borrower.  Typically, such concessions consist of a reduction in interest rate to a below market rate, taking into account the credit quality of the note, or a deferment of payments, principal or interest, which materially alters the Bank’s position or significantly extends the note’s maturity date, such that the present value of cash flows to be received is materially less than those contractually established at the loan’s origination.  Restructured loans are included in the impaired loan category.

 

Real estate acquired by the Company through foreclosure proceedings or the acceptance of a deed in lieu of foreclosure is classified as Other Real Estate Owned (“OREO”). When property is acquired, it is generally recorded at the lesser of the loan’s remaining principal balance or the estimated fair value of the property acquired, less estimated costs to sell. Any loan balance in excess of the estimated realizable fair value on the date of transfer is charged to the allowance for loan losses on that date. All costs incurred thereafter in maintaining the property, as well as subsequent declines in fair value are charged to non-interest expense.

 

Non-performing assets are comprised of non-accrual loans, deposit account overdrafts that are more than 90 days past due and OREO.  The designation of a loan or other asset as non-performing does not necessarily indicate that loan principal and interest will ultimately be uncollectible.  However, management recognizes the greater risk characteristics of these assets and therefore considers the potential risk of loss on assets included in this category in evaluating the adequacy of the allowance for loan losses.  Despite prudent loan underwriting, adverse changes within the Company’s market area, or deterioration in local, regional or national economic conditions, could negatively impact the Company’s level of non-performing assets in the future.

 

On a quarterly basis, management prepares an estimate of the reserves necessary to cover estimated credit losses.  The allowance for loan losses is an estimate of credit risk inherent in the loan portfolio as of the specified balance sheet dates.  The Company’s allowance is accounted for in accordance with FASB guidance.  The Company maintains the allowance at a level that it deems adequate to absorb all reasonably anticipated losses from specifically known and other credit risks associated with the portfolio.  There were no significant changes in the Company’s underwriting, credit risk management system, or the allowance assessment methodology used to estimate loan loss exposure as reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

 

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Table of Contents

 

In making its assessment on the adequacy of the allowance, management considers several quantitative and qualitative factors that could have an effect on the credit quality of the portfolio including individual assessment of larger and high risk credits, delinquency trends and the level of non-performing loans, net charge-offs, the growth and composition of the loan portfolio, expansion in geographic market area, the strength of the local and national economy, and comparison to industry peers, among other factors.  Except for loans specifically identified as impaired, as discussed above, the estimate is a two-tiered approach that allocates loan loss reserves to “adversely classified” loans by credit rating and to non-classified loans by credit type.  The general loss allocations take into account the historic loss experience as well as the quantitative and qualitative factors identified above.  The allowance for loan losses is established through a provision for loan losses, a direct charge to earnings.  Loan losses are charged against the allowance when management believes that the collectability of the loan principal is unlikely.  Recoveries on loans previously charged off are credited to the allowance.

 

The allowance for loan losses to total loans ratio was 1.65% and 1.64% at September 30, 2009 and June 30, 2009 respectively, compared to the December 31, 2008 ratio of 1.61%.  Based on the foregoing, as well as management’s judgment as to the risks inherent in the loan portfolio, the Company’s allowance for loan losses was deemed adequate to absorb reasonably anticipated losses from specifically known and other credit risks associated with the portfolio as of September 30, 2009.

 

Management closely monitors the credit quality of individual delinquent and non-performing relationships, industry concentrations, the local and regional real estate market and current economic conditions.  The level of delinquent and non-performing assets is largely a function of economic conditions and the overall banking environment.  Despite prudent loan underwriting, adverse changes within the Company’s market area or further deterioration in the local, regional or national economic conditions could negatively impact the Company’s level of non-performing assets in the future.

 

The following table sets forth information regarding non-performing assets and past due loans at the dates indicated:

 

(Dollars in thousands)

 

September 30,
2009

 

December 31,
2008

 

September 30,
2008

 

 

 

 

 

 

 

 

 

Commercial real estate

 

$

10,324

 

$

3,691

 

$

4,221

 

Commercial and industrial

 

2,923

 

1,713

 

1,733

 

Commercial construction

 

1,193

 

1,400

 

 

Residential

 

1,278

 

1,019

 

623

 

Home Equity

 

305

 

149

 

201

 

Consumer

 

15

 

39

 

15

 

Total non-accrual loans

 

16,038

 

8,011

 

6,793

 

Overdrafts > 90 days past due

 

7

 

256