SIFI 09.30.2014 10-Q3

 
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, 2014
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _______ to ______

 Commission File Number:  0-54241
 
SI FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
__________________________________________________
Maryland
 
80-0643149
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
803 Main Street, Willimantic, Connecticut
 
06226
(Address of principal executive offices)
 
(Zip Code)
 
(860) 423-4581
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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. Yes x   No  o

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 (Section 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).  Yes  x No  o
 
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer o
Accelerated Filer x
 
 
Non-Accelerated Filer o
Smaller Reporting Company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o    No  x
 
As of November 3, 2014, there were 12,783,122 shares of the registrant’s common stock outstanding.
 




SI FINANCIAL GROUP, INC.
TABLE OF CONTENTS
 
 
 
 
Page No.
 
 
 
 
PART I. FINANCIAL INFORMATION
 
 
 
 
 
Item 1.
 
Financial Statements (Unaudited):
 
 
 
 
 
 
 
Consolidated Balance Sheets at September 30, 2014 and December 31, 2013
 
 
 
 
 
 
Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013
 
 
 
 
 
 
Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2014
 
 
 
 
 
 
Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
Item 5.
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 





PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements.
SI FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Amounts / Unaudited)
 
September 30,
2014
 
December 31,
2013
ASSETS:
 
 
 
Cash and due from banks:
 
 
 
Noninterest-bearing
$
16,942

 
$
20,554

Interest-bearing
16,676

 
6,767

Total cash and cash equivalents
33,618

 
27,321

 
 
 
 
Available for sale securities, at fair value
170,777

 
170,220

Loans held for sale
1,123

 
1,764

Loans receivable (net of allowance for loan losses of $7,619 at September 30, 2014 and $6,916 at December 31, 2013)
1,041,071

 
1,047,410

Federal Home Loan Bank stock, at cost
10,333

 
13,109

Bank-owned life insurance
21,159

 
20,726

Premises and equipment, net
21,303

 
21,090

Goodwill and other intangibles
18,847

 
19,566

Accrued interest receivable
3,898

 
4,021

Deferred tax asset, net
9,633

 
9,705

Other real estate owned, net
1,361

 
2,429

Other assets
7,019

 
9,018

Total assets
$
1,340,142

 
$
1,346,379

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY:
 

 
 

Liabilities:
 

 
 

Deposits:
 

 
 

Noninterest-bearing
$
140,992

 
$
139,428

Interest-bearing
856,847

 
845,321

Total deposits
997,839

 
984,749

 
 
 
 
Mortgagors' and investors' escrow accounts
1,794

 
3,214

Federal Home Loan Bank advances
154,148

 
176,272

Junior subordinated debt owed to unconsolidated trust
8,248

 
8,248

Accrued expenses and other liabilities
22,007

 
21,054

Total liabilities
1,184,036

 
1,193,537

 
 
 
 
Shareholders' Equity:
 

 
 

Preferred stock ($.01 par value; 1,000,000 shares authorized; none issued)

 

Common stock ($.01 par value; 35,000,000 shares authorized; 12,783,122 and 12,798,461 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively)
128

 
128

Additional paid-in-capital
125,369

 
125,277

Unallocated common shares held by ESOP
(4,248
)
 
(4,608
)
Unearned restricted shares
(1,422
)
 
(1,751
)
Retained earnings
36,546

 
34,644

Accumulated other comprehensive loss
(267
)
 
(848
)
Total shareholders' equity
156,106

 
152,842

Total liabilities and shareholders' equity
$
1,340,142

 
$
1,346,379

 

See accompanying notes to unaudited interim consolidated financial statements.

1



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts / Unaudited)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Interest and dividend income:
 
 
 
 
 
 
 
Loans, including fees
$
10,735

 
$
8,105

 
$
32,489

 
$
22,822

Securities:
 

 
 

 
 
 
 
Taxable interest
877

 
986

 
2,651

 
3,078

Tax-exempt interest
59

 
42

 
160

 
62

Dividends
46

 
8

 
143

 
15

Other
11

 
10

 
39

 
31

Total interest and dividend income
11,728

 
9,151

 
35,482

 
26,008

 
 
 
 
 
 
 
 
Interest expense:
 

 
 

 
 
 
 
Deposits
1,355

 
1,241

 
4,033

 
3,877

Federal Home Loan Bank advances
602

 
736

 
1,921

 
2,227

Subordinated debt and other borrowings
84

 
87

 
251

 
253

Total interest expense
2,041

 
2,064

 
6,205

 
6,357

 
 
 
 
 
 
 
 
Net interest income
9,687

 
7,087

 
29,277

 
19,651

 
 
 
 
 
 
 
 
Provision for loan losses
350

 
443

 
1,195

 
633

 
 
 
 
 
 
 
 
Net interest income after provision for loan losses
9,337

 
6,644

 
28,082

 
19,018

 
 
 
 
 
 
 
 
Noninterest income:
 

 
 

 
 
 
 
Total other-than-temporary impairment losses

 

 

 
(8
)
Portion of losses recognized in other comprehensive income/loss

 

 

 

Net impairment losses

 

 

 
(8
)
Service fees
1,762

 
1,515

 
5,265

 
3,964

Wealth management fees
293

 
302

 
926

 
846

Increase in cash surrender value of bank-owned life insurance
147

 
90

 
433

 
226

Net gain (loss) on sales of securities

 
(922
)
 
64

 
(919
)
Mortgage banking
81

 
69

 
396

 
919

Net gain on fair value of derivatives
78

 
18

 
69

 
191

Other
85

 
161

 
527

 
526

Total noninterest income
2,446

 
1,233

 
7,680

 
5,745

 
 
 
 
 
 
 
 
Noninterest expenses:
 

 
 

 
 
 
 
Salaries and employee benefits
4,897

 
4,394

 
15,128

 
12,923

Occupancy and equipment
1,883

 
1,417

 
5,852

 
4,104

Computer and electronic banking services
1,417

 
1,057

 
4,082

 
2,896

Outside professional services
420

 
298

 
1,422

 
948

Marketing and advertising
216

 
170

 
754

 
471

Supplies
146

 
110

 
465

 
316

FDIC deposit insurance and regulatory assessments
303

 
251

 
953

 
714

Merger expenses

 
1,305

 

 
2,198

Core deposit intangible amortization
150

 
55

 
463

 
55

Other real estate operations
72

 
83

 
303

 
402

Other
500

 
1,234

 
1,873

 
2,137

Total noninterest expenses
10,004

 
10,374

 
31,295

 
27,164

 
 
 
 
 
 
 
 
Income (loss) before income tax provision (benefit)
1,779

 
(2,497
)
 
4,467

 
(2,401
)
Income tax provision (benefit)
579

 
(755
)
 
1,447

 
(522
)
Net income (loss)
$
1,200

 
$
(1,742
)
 
$
3,020

 
$
(1,879
)
 
 
 
 
 
 
 
 
Earnings (loss) per share:
 

 
 

 
 
 
 
Basic
$
0.10

 
$
(0.17
)
 
$
0.25

 
$
(0.19
)
Diluted
$
0.10

 
$
(0.17
)
 
$
0.24

 
$
(0.19
)
 

See accompanying notes to unaudited interim consolidated financial statements.

2



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In Thousands / Unaudited)

 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2014
 
2013
 
2014
 
2013
Net income (loss)
 
$
1,200

 
$
(1,742
)
 
$
3,020

 
$
(1,879
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Available for sale securities:
 
 
 
 
 
 
 
 
Net unrealized holding gains (losses)
 
(382
)
 
(631
)
 
546

 
(2,211
)
Reclassification adjustment for losses (gains) recognized in net income (loss) (1)
 

 
609

 
(42
)
 
607

Plus: credit portion of OTTI losses recognized in net loss (2)
 

 

 

 
5

Plus: noncredit portion of OTTI loss
 

 
163

 

 
124

Net unrealized gains (losses) on available for sale securities
 
(382
)
 
141

 
504

 
(1,475
)
 Net unrealized gain on interest-rate swap derivative
 
31

 
10

 
77

 
82

Other comprehensive income (loss)
 
(351
)
 
151

 
581

 
(1,393
)
Comprehensive income (loss)
 
$
849

 
$
(1,591
)
 
$
3,601

 
$
(3,272
)
 
 
 
 
 
 
 
 
 
 
(1) Amounts are included in net gain (loss) on the sales of securities in noninterest income on the consolidated statements of operations. Income tax expense (benefit) associated with the reclassification adjustment for the three and nine months ended September 30, 2014 was $0 and $22,000, respectively, and $(313,000) and $(312,000) for the three and nine months ended September 30, 2013, respectively.
(2) Amounts are included in net impairment losses recognized in noninterest income on the consolidated statements of operations. Income tax expense associated with the reclassification adjustment for both the three and nine months ended September 30, 2014 totaled $0, respectively, and amounted to $0 and $3,000, for the three and nine months ended September 30, 2013, respectively.


See accompanying notes to unaudited interim consolidated financial statements.

    
 



3



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014
(In Thousands, Except Share Data / Unaudited)

 
Common Stock
 
Additional
Paid-in
Capital
 
Unallocated
Common
Shares Held
by ESOP
 
Unearned
Restricted
Shares
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Shareholders'
Equity
 
Shares
 
Dollars
 
 
 
 
 
 
Balance at December 31, 2013
12,798,461

 
$
128

 
$
125,277

 
$
(4,608
)
 
$
(1,751
)
 
$
34,644

 
$
(848
)
 
$
152,842

Comprehensive income

 

 

 

 

 
3,020

 
581

 
3,601

Cash dividends declared ($0.09 per share)

 

 

 

 

 
(1,107
)
 

 
(1,107
)
Equity incentive plan compensation

 

 
230

 

 
329

 

 

 
559

Allocation of 36,477 ESOP shares

 

 
56

 
360

 

 

 

 
416

Tax benefit from share-based compensation

 

 
4

 

 

 

 

 
4

Stock options exercised
51,806

 

 
552

 

 

 

 

 
552

Common shares repurchased
(67,145
)
 

 
(750
)
 

 

 
(11
)
 

 
(761
)
Balance at September 30, 2014
12,783,122

 
$
128

 
$
125,369

 
$
(4,248
)
 
$
(1,422
)
 
$
36,546

 
$
(267
)
 
$
156,106

 
See accompanying notes to unaudited interim consolidated financial statements.


4



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands / Unaudited)
 
Nine Months Ended
September 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income (loss)
$
3,020

 
$
(1,879
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 

Provision for loan losses
1,195

 
633

Employee stock ownership plan expense
416

 
417

Equity incentive plan expense
559

 
576

Excess tax benefit from share-based compensation
(4
)
 
(4
)
Amortization of investment premiums and discounts, net
724

 
921

Amortization of loan premiums and discounts, net
1,051

 
1,071

Depreciation and amortization of premises and equipment
1,921

 
1,355

Amortization of core deposit intangible
463

 
55

Amortization of deferred debt issue costs
79

 
227

Net loss (gain) on sales of securities
(64
)
 
919

Net gain on fair value of derivatives
(69
)
 
(191
)
Deferred income tax benefit
28

 
67

Loans originated for sale
(12,633
)
 
(36,927
)
Proceeds from sale of loans held for sale
13,353

 
40,464

Net gain on sales of loans held for sale
(201
)
 
(735
)
Net gain on sales of loans held for investment

 
(201
)
Net loss on sales or write-downs of other real estate owned
67

 
25

Increase in cash surrender value of bank-owned life insurance
(433
)
 
(226
)
Impairment charge on long-lived assets
175

 

Other-than-temporary impairment losses on securities

 
8

Change in operating assets and liabilities:
 

 
 

Accrued interest receivable
123

 
42

Other assets
1,947

 
(2,008
)
Accrued expenses and other liabilities
1,143

 
1,974

Net cash provided by operating activities
12,860

 
6,583

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of available for sale securities
(24,626
)
 
(40,863
)
Proceeds from sales of available for sale securities
1,109

 
13,108

Proceeds from maturities of and principal repayments on available for sale securities
23,063

 
31,786

Redemption of Federal Home Loan Bank stock
2,776

 
325

Loan principal collections, net of originations
42,628

 
28,811

Purchases of loans
(38,643
)
 
(20,115
)
Net cash paid from acquisition of Newport Bancorp, Inc.

 
(8,935
)
Proceeds from sales of loans held for investment

 
3,189

Proceeds from sales of other real estate owned
1,109

 
1,255

Purchases of premises and equipment
(2,134
)
 
(1,868
)
Net cash provided by investing activities
5,282

 
6,693

 
 
 
 

5



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
(In Thousands / Unaudited)
 
Nine Months Ended
September 30,
 
2014
 
2013
Cash flows from financing activities:
 

 
 

Net increase in deposits
13,090

 
7,971

Net decrease in mortgagors' and investors' escrow accounts
(1,420
)
 
(1,738
)
Proceeds from Federal Home Loan Bank advances
10,000

 
40,000

Repayments of Federal Home Loan Bank advances
(32,203
)
 
(44,000
)
Excess tax benefit from share-based compensation
4

 
4

Cash dividends on common stock
(1,107
)
 
(860
)
Stock options exercised
552

 
15

Common shares repurchased
(761
)
 
(9
)
Net cash provided by (used in) financing activities
(11,845
)
 
1,383

 
 
 
 
 
 
 
 
Net change in cash and cash equivalents
6,297

 
14,659

Cash and cash equivalents at beginning of period
27,321

 
37,689

Cash and cash equivalents at end of period
$
33,618

 
$
52,348

 
 
 
 
Supplemental cash flow information:
 

 
 

Interest paid
$
6,234

 
$
6,146

Income taxes paid, net
(555
)
 
1,312

Transfer of loans to other real estate owned
108

 
1,407


 See accompanying notes to unaudited interim consolidated financial statements.

6

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 


NOTE 1.  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business
SI Financial Group, Inc. (the “Company”) is the holding company for Savings Institute Bank and Trust Company (the “Bank”). Established in 1842, the Bank is a community-oriented financial institution headquartered in Willimantic, Connecticut. The Bank provides a variety of financial services to individuals, businesses and municipalities through its twenty-six offices in eastern Connecticut and Rhode Island. Its primary products include savings, checking and certificate of deposit accounts, residential and commercial mortgage loans, commercial business loans and consumer loans.  In addition, wealth management services, which include trust, financial planning, life insurance and investment services, are offered to individuals and businesses through the Bank’s offices. The Company does not conduct any material business other than owning all of the stock of the Bank and making payments on the subordinated debentures held by the Company.

On September 6, 2013, the Company acquired Newport Bancorp, Inc. ("Newport"), and its wholly-owned subsidiary, Newport Federal Savings Bank. The acquisition added six full-service banking offices in eastern Connecticut and Rhode Island.

Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary, the Bank, and the Bank’s wholly-owned subsidiaries, SI Mortgage Company and SI Realty Company, Inc. All significant intercompany accounts and transactions have been eliminated.

Basis of Financial Statement Presentation
The interim consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, with the instructions to Form 10-Q and Rule 10.01 of Regulation S-X of the Securities and Exchange Commission (“SEC”) and general practices within the banking industry. Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been omitted.  Information in the accompanying interim consolidated financial statements and notes to the financial statements of the Company as of September 30, 2014 and for the three and nine months ended September 30, 2014 and 2013 is unaudited. These unaudited interim consolidated financial statements and related notes should be read in conjunction with the audited financial statements of the Company and the accompanying notes for the year ended December 31, 2013 contained in the Company’s Form 10-K.

In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all of the adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the financial condition, results of operations and cash flows as of and for the periods covered herein. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the operating results for the year ending December 31, 2014 or for any other period.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, as of the date of the balance sheets and reported amounts of revenues and expenses for the periods presented. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, other-than-temporary impairment (“OTTI”) of securities, deferred income taxes and the impairment of long-lived assets.
     

7

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Reclassifications
Amounts in the Company’s prior year consolidated financial statements are reclassified to conform to the current year presentation.  Such reclassifications have no effect on net income.

Loans Receivable
Loans receivable are stated at current unpaid principal balances, net of the allowance for loan losses and deferred loan origination fees and costs. Management has the ability and intent to hold its loans receivable for the foreseeable future or until maturity or pay-off.

A loan is impaired when, based on current information and events, it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis for residential and commercial mortgage loans and commercial business loans by either the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not typically identify individual consumer loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring ("TDR") agreement.

The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and concessions have been made to the original contractual terms, such as reductions of interest rates or deferral of interest or principal payments due to the borrower’s financial condition, the modification is considered a TDR.

Management considers all nonaccrual loans, with the exception of certain consumer loans, to be impaired. Also, all TDRs are initially classified as impaired.  In most cases, loan payments less than 90 days past due are considered minor collection delays and the related loans are generally not considered impaired.

Allowance for Loan Losses
The allowance for loan losses, a material estimate which could change significantly in the near-term, is established through a provision for loan losses charged to earnings to account for losses that are inherent in the loan portfolio and estimated to occur, and is maintained at a level that management considers adequate to absorb losses in the loan portfolio. Loan losses are charged against the allowance for loan losses when management believes that the uncollectibility of the principal loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for loan losses when received. In the determination of the allowance for loan losses, management may obtain independent appraisals for significant properties, if necessary.

Management's judgment in determining the adequacy of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses is evaluated on a monthly basis by management and is based on the evaluation of the known and inherent risk characteristics and size and composition of the loan portfolio, the assessment of current economic and real estate market conditions, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, historical loan loss experience, the level and trends of nonperforming loans, delinquencies, classified assets and loan charge-offs and evaluations of loans and other relevant factors.

The allowance for loan losses consists of the following key elements:

Specific allowance for identified impaired loans. For loans that are identified as impaired, an allowance is established when the present value of expected cash flows (or observable market price of the loan or fair

8

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

value of the collateral if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan.

General valuation allowance. The general component represents a valuation allowance on the remainder of the loan portfolio, after excluding impaired loans. For this portion of the allowance, loans are segregated by category and assigned an allowance percentage based on historical loan loss experience adjusted for qualitative factors stratified by the following loan segments:  residential one- to four-family, multi-family and commercial real estate, construction, commercial business and consumer. Management uses a rolling average of historical losses based on the time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies, classified loans, nonaccrual loans, troubled debt restructurings and other loan modifications; trends in nature, volume and terms of loans; existence and effect of/or changes in the level of credit concentrations; effects of changes in lending policies, procedures and practices, including underwriting standards and collection, charge-off and recovery practices; changes in the quality of loan review and degree of oversight; experience, ability and depth of lending management and staff; national, regional and local economic trends and conditions and impact on the value of underlying collateral for collateral dependent loans; effect of external factors, including legal and regulatory requirements.

The qualitative factors are determined based on the following various risk characteristics for each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

Residential – One- to Four-Family – The Bank primarily originates conventional loans with loan-to-value ratios less than 95% and generally originates loans with loan-to-value ratios in excess of 80% only when secured by first liens on owner-occupied one- to four-family residences. Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance or additional collateral. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality of this segment.

Multi-family and Commercial – Loans in this segment are originated for the purpose of acquiring, developing, improving or refinancing multi-family and commercial real estate where the property is the primary collateral securing the loan, and the income generated from the property is the primary repayment source. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Payments on loans secured by income-producing properties often depend on the successful operation and management of the properties. Management continually monitors the cash flows of these loans.

Construction – This segment includes loans to individuals, and to a lesser extent builders, to finance the construction of residential dwellings. The Bank also originates construction loans for commercial development projects. Upon the completion of construction, the loan generally converts to a permanent mortgage loan. Credit risk is affected by cost overruns, correct estimates of the sale price of the property, time to sell at an adequate price and market conditions.

Commercial Business – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy and reduced viability of the industry in which the customer operates will have a negative impact on the credit quality in this segment. The Bank also provides loans to investors in the time share industry, which are secured by consumer receivables, and provides loans for capital improvements to condominium associations, which are secured by the assigned rights to levy special assessments to condominium owners.

9

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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 


Consumer – Loans in this segment primarily include home equity lines of credit (representing both first and second liens), indirect automobile loans and, to a lesser extent, loans secured by marketable securities, passbook or certificate accounts, motorcycles, automobiles and recreational vehicles, as well as unsecured loans. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

In computing the allowance for loan losses, we do not assign a general valuation allowance to the Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”) loans that we purchase as such loans are fully guaranteed. These loans are included in commercial business loans. See Note 4 for details.
 
The majority of the Company's loans are collateralized by real estate located in eastern Connecticut and Rhode Island. To a lesser extent, certain commercial real estate loans are secured by collateral located outside of our primary market area. Accordingly, the collateral value of a substantial portion of the Company's loan portfolio and real estate acquired through foreclosure is susceptible to changes in local market conditions.
 
Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and the Company’s results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with GAAP, our regulators, in reviewing the loan portfolio, may request us to increase our allowance for loan losses based on judgments different from ours. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate or increases may be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses would adversely affect the Company’s financial condition and results of operations.

Interest and Fees on Loans
Interest on loans is accrued and included in net interest income based on contractual rates applied to principal amounts outstanding. Accrual of interest is discontinued when loan payments are 90 days or more past due, based on contractual terms, or when, in the judgment of management, collectibility of the loan or loan interest becomes uncertain. Subsequent recognition of income occurs only to the extent payment is received subject to management's assessment of the collectibility of the remaining interest and principal. A nonaccrual loan is restored to accrual status when it is no longer delinquent and collectibility of interest and principal is no longer in doubt and the borrower has made regular payments in accordance with the terms of the loan over a period of at least six months. Interest collected on nonaccrual loans is recognized only to the extent cash payments are received, and may be recorded as a reduction to principal if the collectibility of the principal balance of the loan is unlikely.

Loan origination fees, direct loan origination costs and loan purchase premiums are deferred, and the net amount is recognized as an adjustment of the related loan's yield utilizing the interest method over the contractual life of the loan. In addition, discounts related to fair value adjustments for loans receivable acquired in a business combination or asset purchase are accreted into earnings over the contractual term as an adjustment of the loan's yield. The Company periodically evaluates the cash flows expected to be collected for loans acquired with deteriorated credit quality. Changes in the expected cash flows compared to the expected cash flows as of the date of acquisition may impact the accretable yield or result in a charge to the provision for loan losses to the extent of a shortfall.


10

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Common Share Repurchases
The Company is chartered in the state of Maryland. Maryland law does not provide for treasury shares, rather shares repurchased by the Company constitute authorized but unissued shares. GAAP states that accounting for treasury stock shall conform to state law. Therefore, the cost of shares repurchased by the Company has been allocated to common stock, additional paid-in capital and retained earnings balances.

Recent Accounting Pronouncements
Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. In January 2014, the Financial Accounting Standards Board ("FASB") issued amended guidance that clarifies when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The amended guidance clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. In addition, the amended guidance requires interim and annual disclosures of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amended guidance may be applied prospectively or through a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. The adoption of the amended guidance is not expected to have a material impact on the Company’s consolidated financial statements.

Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure - In August 2014, the FASB issued amended guidance that addresses the diversity in practice regarding the classification and measurement of foreclosed loans which were part of a government-sponsored loan guarantee program (e.g. HUD, FHA, VA). The amended guidance outlines certain criteria that, if met, the loan (residential or commercial) should be derecognized and a separate other receivable should be recorded upon foreclosure at the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This amended guidance will be effective for annual reporting periods beginning after December 15, 2014, including interim periods within that reporting period. Early adoption is permitted, provided the entity has adopted Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40):  Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amended guidance should be adopted either prospectively or on a modified retrospective basis. The Company is assessing the impact that these amendments will have on its consolidated financial statements, but does not currently anticipate that it will have a material impact.

NOTE 2.  EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is calculated by dividing the net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Unvested restricted shares are considered outstanding in the computation of basic earnings (loss) per share since the shares participate in dividends and the rights to the dividends are non-forfeitable. Diluted earnings (loss) per share is computed in a manner similar to basic earnings (loss) per share except that the weighted average number of common shares outstanding is increased to include the incremental common shares (as computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period. The Company’s common stock equivalents relate solely to stock options. Repurchased common shares

11

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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

and unallocated common shares held by the Bank’s ESOP are not deemed outstanding for earnings (loss) per share calculations.
 
Anti-dilutive shares are common stock equivalents with weighted average exercise prices in excess of the weighted average market value for the periods presented, and are not considered in diluted earnings (loss) per share calculations. The Company had anti-dilutive common shares outstanding of 677,590 and 485,459 for the three and nine months ended September 30, 2014, respectively, and 534,492 and 595,761 for the three and nine months ended September 30, 2013, respectively.

The computation of earnings (loss) per share is as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
 
(Dollars in Thousands, Except Per Share Data)
Net income (loss)
$
1,200

 
$
(1,742
)
 
$
3,020

 
$
(1,879
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 
 
 
Basic
12,310,368

 
10,310,210

 
12,315,829

 
9,814,017

Effect of dilutive stock options
23,065

 

 
38,382

 

Diluted
12,333,433

 
10,310,210

 
12,354,211

 
9,814,017

 
 
 
 
 
 
 
 
Earnings (loss) per share:
 

 
 

 
 
 
 
Basic
$
0.10

 
$
(0.17
)
 
$
0.25

 
$
(0.19
)
Diluted
$
0.10

 
$
(0.17
)
 
$
0.24

 
$
(0.19
)

NOTE 3.  SECURITIES

Available for sale securities:
The amortized cost, gross unrealized gains and losses and fair values of available for sale securities at September 30, 2014 and December 31, 2013 are as follows:
 
 
September 30, 2014
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(In Thousands)
Debt securities:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
63,021

 
$
338

 
$
(236
)
 
$
63,123

Government-sponsored enterprises
24,492

 
78

 
(136
)
 
24,434

Mortgage-backed securities:(1)
 
 
 

 
 

 
 

Agency - residential
70,260

 
887

 
(1,383
)
 
69,764

Non-agency - residential
375

 
15

 
(3
)
 
387

Corporate debt securities
1,000

 
8

 

 
1,008

Collateralized debt obligation
1,187

 
1

 

 
1,188

Obligations of state and political subdivisions
4,041

 
172

 
(27
)
 
4,186

Tax-exempt securities
6,610

 
82

 
(5
)
 
6,687

Total available for sale securities
$
170,986

 
$
1,581

 
$
(1,790
)
 
$
170,777

 
 
 
 
 
 
 
 
 
(1) Agency securities refer to debt obligations issued or guaranteed by government corporations or government-sponsored enterprises (“GSEs”).  Non-agency securities, or private-label securities, are the sole obligation of their issuer and are not guaranteed by any of the GSEs or the U.S. Government.

12

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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

 
 
December 31, 2013
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(In Thousands)
Debt securities:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
54,228

 
$
485

 
$
(168
)
 
$
54,545

Government-sponsored enterprises
26,551

 
134

 
(393
)
 
26,292

Mortgage-backed securities:(1)
 
 
 
 
 
 
 

Agency - residential
77,037

 
889

 
(1,809
)
 
76,117

Non-agency - residential
530

 
26

 
(2
)
 
554

Corporate debt securities
3,708

 
90

 

 
3,798

Collateralized debt obligation
1,210

 

 
(19
)
 
1,191

Obligations of state and political subdivisions
4,063

 
141

 
(81
)
 
4,123

Tax-exempt securities
3,841

 

 
(266
)
 
3,575

Foreign government securities
25

 

 

 
25

Total available for sale securities
$
171,193

 
$
1,765

 
$
(2,738
)
 
$
170,220

 
 
 
 
 
 
 
 
 
(1) Agency securities refer to debt obligations issued or guaranteed by government corporations or GSEs.  Non-agency securities, or private-label securities, are the sole obligation of their issuer and are not guaranteed by any of the GSEs or the U.S. Government.

The amortized cost and fair value of debt securities by contractual maturities at September 30, 2014 are presented below. Maturities are based on the final contractual payment dates, and do not reflect the impact of potential prepayments or early redemptions. Because mortgage-backed securities ("MBS") are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.
 
 
Amortized
Cost
 
Fair
Value
 
(In Thousands)
Within 1 year
$
6,268

 
$
6,292

After 1 but within 5 years
39,057

 
39,040

After 5 but within 10 years
17,169

 
17,222

After 10 years
37,857

 
38,072

 
100,351

 
100,626

Mortgage-backed securities
70,635

 
70,151

Total debt securities
$
170,986

 
$
170,777


The following is a summary of realized gains and losses on the sales of securities for the three and nine months ended September 30, 2014 and 2013:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
 
(In Thousands)
Gross gains on sales
$

 
$
37

 
$
64

 
$
40

Gross losses on sales

 
(959
)
 

 
(959
)
Net gain (loss) on sales of securities
$

 
$
(922
)
 
$
64

 
$
(919
)


13

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Proceeds from the sale of available for sale securities were $1.1 million for the nine months ended September 30, 2014 and $12.1 million and $13.1 million for the three and nine months ended September 30, 2013, respectively. There were no security sales for the three months ended September 30, 2014.

The following tables present information pertaining to securities with gross unrealized losses at September 30, 2014 and December 31, 2013, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.
 
 
Less Than 12 Months
 
12 Months Or More
 
Total
September 30, 2014
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In Thousands)
U.S. Government and agency obligations
$
22,003

 
$
59

 
$
12,910

 
$
177

 
$
34,913

 
$
236

Government sponsored enterprises
5,630

 
9

 
5,852

 
127

 
11,482

 
136

Mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Agency - residential
8,558

 
115

 
32,777

 
1,268

 
41,335

 
1,383

Non-agency - residential

 

 
135

 
3

 
135

 
3

Obligations of state and political subdivisions

 

 
1,219

 
27

 
1,219

 
27

Tax-exempt securities

 

 
1,148

 
5

 
1,148


5

Total
$
36,191

 
$
183

 
$
54,041

 
$
1,607

 
$
90,232

 
$
1,790


 
Less Than 12 Months
 
12 Months Or More
 
Total
December 31, 2013
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In Thousands)
U.S. Government and agency obligations
$
21,921

 
$
142

 
$
883

 
$
26

 
$
22,804

 
$
168

Government-sponsored enterprises
12,376

 
393

 

 

 
12,376

 
393

Mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Agency - residential
38,119

 
1,772

 
2,686

 
37

 
40,805

 
1,809

Non-agency - residential
169

 
2

 

 

 
169

 
2

Collateralized debt obligation

 

 
1,191

 
19

 
1,191

 
19

Obligations of state and political subdivisions
1,187

 
81

 

 

 
1,187

 
81

Tax-exempt securities
3,575

 
266

 

 

 
3,575

 
266

Total
$
77,347

 
$
2,656

 
$
4,760

 
$
82

 
$
82,107

 
$
2,738


At September 30, 2014, forty-three debt securities with gross unrealized losses had aggregate depreciation of approximately 1.95% of the Company’s amortized cost basis. The majority of the unrealized losses are related to the Company’s agency MBS. There were no investments deemed other-than-temporarily impaired for the three and nine months ended September 30, 2014. Impairment charges recognized on investments deemed other-than-temporarily impaired were $0 and $8,000 for the three and nine months ended September 30, 2013. The following summarizes, by security type, the basis for management’s determination during the preparation of the financial statements that the applicable investments within the Company’s securities portfolio were not other-than-temporarily impaired at September 30, 2014.


14

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

U.S. Government and Agency Obligations. The unrealized losses on the Company’s U.S. Government and agency obligations related primarily to a widening of the rate spread to comparable treasury securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell the securities before their anticipated recovery, which may be at maturity, the Company did not consider these securities to be other-than-temporarily impaired at September 30, 2014.

Government Sponsored Enterprises. The unrealized losses on the Company's government sponsored enterprises were also caused by interest rate movement. The contractual cash flows of these investments are guaranteed by a government sponsored agency. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of our investment. As a result of (1) the decline in market value being attributable to changes in interest rates and not credit quality, (2) the Company's position that it does not intend to sell these securities and (3) it is not more likely than not that the Company will be required to sell the securities before their anticipated recovery, which may be at maturity, the Company did not consider these securities to be other-than-temporarily impaired at September 30, 2014.

Mortgage-backed Securities - Agency - Residential. The unrealized losses on the Company’s agency–residential mortgage-backed securities were caused by increases in the rate spread to comparable treasury securities. The Company does not expect these securities to settle at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before the recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than-temporarily impaired at September 30, 2014.

Mortgage-backed Securities - Non-agency - Residential. The unrealized losses on the Company's non-agency - residential mortgage-backed securities relate to one investment which has been evaluated by management and no potential credit losses were identified. The Company does not intend to sell this security and it is not more likely than not that the Company will be required to sell this security before the recovery of its amortized cost basis, which may be maturity, the Company did not consider this investment to be other-than-temporarily impaired at September 30, 2014.
 
Obligations of State and Political Subdivisions. The unrealized losses on the Company's obligations of state and political subdivisions relate to two investments in municipal general obligation bonds purchased during the second quarter of 2013. The unrealized loss was mainly attributable to the widening of interest rate spreads for these securities since their purchase date. Management monitors the financial data of the individual municipalities to ensure that they meet minimum credit standards. Since the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost basis, which may be at maturity, the Company did not record impairment losses at September 30, 2014.

Tax-exempt Securities. The unrealized losses on the Company's tax-exempt securities relate to one municipal general obligation bond purchased during the second quarter of 2013. The unrealized loss was mainly attributable to the widening of interest rate spread for this security since its purchase date. Management monitors the financial data of the individual municipality to ensure that it meets minimum credit standards. Since the Company does not intend to sell this security and it is not more likely than not that the Company will be required to sell this security before recovery of its amortized cost basis, which may be at maturity, the Company did not record an impairment loss at September 30, 2014.





15

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

The following table presents a roll-forward of the balance of credit losses on the Company’s debt securities for which a portion of OTTI was recognized in other comprehensive income (loss) for the three and nine months ended September 30, 2014 and 2013.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
 
(In Thousands)
Balance at beginning of period
$

 
$
267

 
$

 
$
259

Amounts related to credit for which OTTI losses were not previously recognized

 

 

 
8

Reduction for securities sold during the period (realized)

 
(205
)
 

 
(205
)
Balance at end of period
$

 
$
62

 
$

 
$
62



16

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

NOTE 4.  LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loan Portfolio
The composition of the Company’s loan portfolio at September 30, 2014 and December 31, 2013 is as follows:
 
 
 
September 30, 2014
 
December 31, 2013
 
 
(In Thousands)
Real estate loans:
 
 
 
Residential - 1 to 4 family
$
434,766

 
$
449,812

Multi-family and commercial
294,177

 
285,660

Construction
13,416

 
10,162

Total real estate loans
742,359

 
745,634

 
 
 
 
 
Commercial business loans:
 

 
 

SBA and USDA guaranteed
118,524

 
137,578

Time share
42,090

 
28,615

Condominium association
20,517

 
18,442

Other
68,592

 
69,705

Total commercial business loans
249,723

 
254,340

 
 
 
 
 
Consumer loans:
 

 
 

Home equity
48,677

 
44,284

Indirect automobile
4,329

 
6,354

Other
2,003

 
2,116

Total consumer loans
55,009

 
52,754

 
 
 
 
 
Total loans
1,047,091

 
1,052,728

 
 
 
 
 
Deferred loan origination costs, net of fees
1,599

 
1,598

Allowance for loan losses
(7,619
)
 
(6,916
)
Loans receivable, net
$
1,041,071

 
$
1,047,410


The Company purchased commercial loans totaling $38.6 million during the nine months ended September 30, 2014. For the twelve months ended December 31, 2013, the Company purchased commercial business loans totaling $23.0 million.

17

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Allowance for Loan Losses
Changes in the allowance for loan losses for the three and nine months ended September 30, 2014 and 2013 are as follows:
Three Months Ended
September 30, 2014
Residential -
1 to 4 Family
 
Multi-family
and Commercial
 
Construction
 
Commercial
Business
 
Consumer
 
Total
 
(In Thousands)
Balance at beginning of period
$
984

 
$
3,465

 
$
221

 
$
2,208

 
$
567

 
$
7,445

Provision for loan losses
123

 
135

 
26

 
21

 
45

 
350

Loans charged-off
(137
)
 
(1
)
 

 

 
(42
)
 
(180
)
Recoveries of loans previously charged-off

 

 

 
1

 
3

 
4

Balance at end of period
$
970

 
$
3,599

 
$
247

 
$
2,230

 
$
573

 
$
7,619

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30, 2014
Residential -
1 to 4 Family
 
Multi-family
and Commercial
 
Construction
 
Commercial
Business
 
Consumer
 
Total
 
(In Thousands)
Balance at beginning of period
$
975

 
$
3,395

 
$
169

 
$
1,875

 
$
502

 
$
6,916

Provision for loan losses
281

 
347

 
78

 
364

 
125

 
1,195

Loans charged-off
(317
)
 
(144
)
 

 
(13
)
 
(75
)
 
(549
)
Recoveries of loans previously charged-off
31

 
1

 

 
4

 
21

 
57

Balance at end of period
$
970

 
$
3,599

 
$
247

 
$
2,230

 
$
573

 
$
7,619


Three Months Ended
September 30, 2013
Residential -
1 to 4 Family
 
Multi-family
and Commercial
 
Construction
 
Commercial
Business
 
Consumer
 
Total
 
(In Thousands)
Balance at beginning of period
$
999

 
$
2,947

 
$
30

 
$
1,531

 
$
500

 
$
6,007

Provision for loan losses
99

 
11

 
83

 
231

 
19

 
443

Loans charged-off
(128
)
 

 

 

 
(10
)
 
(138
)
Recoveries of loans previously charged-off
1

 
1

 

 
2

 
6

 
10

Balance at end of period
$
971

 
$
2,959

 
$
113

 
$
1,764

 
$
515

 
$
6,322

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30, 2013
Residential -
1 to 4 Family
 
Multi-family
and Commercial
 
Construction
 
Commercial
Business
 
Consumer
 
Total
 
(In Thousands)
Balance at beginning of period
$
1,125

 
$
3,028

 
$
22

 
$
1,735

 
$
477

 
$
6,387

Provision for loan losses
401

 
56

 
91

 
27

 
58

 
633

Loans charged-off
(586
)
 
(197
)
 

 

 
(71
)
 
(854
)
Recoveries of loans previously charged-off
31

 
72

 

 
2

 
51

 
156

Balance at end of period
$
971

 
$
2,959

 
$
113

 
$
1,764

 
$
515

 
$
6,322




18

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Further information pertaining to the allowance for loan losses at September 30, 2014 and December 31, 2013 is as follows:
September 30, 2014
Residential -
1 to 4 Family
 
Multi-family
and Commercial
 
Construction
 
Commercial
Business
 
Consumer
 
Total
 
(In Thousands)
Allowance for loans individually evaluated and deemed to be impaired
$
314

 
$
131

 
$

 
$
75

 
$

 
$
520

Allowance for loans individually or collectively evaluated and not deemed to be impaired
656

 
3,468

 
247

 
2,155

 
573

 
7,099

Allowance for loans acquired with deteriorated credit quality

 

 

 

 

 

Total allowance for loan losses
$
970

 
$
3,599

 
$
247

 
$
2,230

 
$
573

 
$
7,619

 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated and deemed to be impaired
$
5,222

 
$
1,971

 
$

 
$
765

 
$

 
$
7,958

Loans individually or collectively evaluated and not deemed to be impaired
429,169

 
287,943

 
13,416

 
248,597

 
55,009

 
1,034,134

Amount of loans acquired with deteriorated credit quality
375

 
4,263

 

 
361

 

 
4,999

Total loans
$
434,766

 
$
294,177

 
$
13,416

 
$
249,723

 
$
55,009

 
$
1,047,091

 
December 31, 2013
Residential -
1 to 4 Family
 
Multi-family
and Commercial
 
Construction
 
Commercial
Business
 
Consumer
 
Total
 
(In Thousands)
Allowance for loans individually evaluated and deemed to be impaired
$
341

 
$
185

 
$

 
$
4

 
$

 
$
530

Allowance for loans individually or collectively evaluated and not deemed to be impaired
634

 
3,210

 
169

 
1,871

 
502

 
6,386

Allowance for loans acquired with deteriorated credit quality

 

 

 

 

 

Total allowance for loan losses
$
975

 
$
3,395

 
$
169

 
$
1,875

 
$
502

 
$
6,916

 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated and deemed to be impaired
$
5,695

 
$
3,036

 
$

 
$
385

 
$

 
$
9,116

Loans individually or collectively evaluated and not deemed to be impaired
443,734

 
277,483

 
10,162

 
252,930

 
52,754

 
1,037,063

Amount of loans acquired with deteriorated credit quality
383

 
5,141

 

 
1,025

 

 
6,549

Total loans
$
449,812

 
$
285,660

 
$
10,162

 
$
254,340

 
$
52,754

 
$
1,052,728




19

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Past Due Loans
The following represents an aging of loans at September 30, 2014 and December 31, 2013:
 
September 30, 2014
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days or More
Past Due
 
Total 30
Days or More
Past Due
 
Current
 
Total
Loans
 
 
(In Thousands)
 
Real Estate:
 

 
 

 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$
36

 
$
430

 
$
1,271

 
$
1,737

 
$
433,029

 
$
434,766

 
Multi-family and commercial
642

 
426

 
619

 
1,687

 
292,490

 
294,177

 
Construction

 

 

 

 
13,416

 
13,416

 
Commercial Business:
 

 
 

 
 

 
 

 
 

 
 

 
SBA and USDA guaranteed
2,104

 
818

 

 
2,922

 
115,602

 
118,524

 
Time share

 

 

 

 
42,090

 
42,090

 
Condominium association
61

 

 

 
61

 
20,456

 
20,517

 
Other
288

 

 
432

 
720

 
67,872

 
68,592

 
Consumer:
 

 
 

 
 

 
 

 
 

 
 

 
Home equity
152

 

 

 
152

 
48,525

 
48,677

 
Indirect automobile
80

 
28

 

 
108

 
4,221

 
4,329

 
Other

 

 

 

 
2,003

 
2,003

 
Total
$
3,363

 
$
1,702

 
$
2,322

 
$
7,387

 
$
1,039,704

 
$
1,047,091

 


December 31, 2013
30-59
Days
Past Due
 
60-89
Days
Past Due
 
90 Days or More
Past Due
 
Total 30
Days or More
Past Due
 
Current
 
Total
Loans
 
 
(In Thousands)
 
Real Estate:
 

 
 

 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$
5,402

 
$
783

 
$
1,473

 
$
7,658

 
$
442,154

 
$
449,812

 
Multi-family and commercial
1,057

 

 
1,388

 
2,445

 
283,215

 
285,660

 
Construction

 

 

 

 
10,162

 
10,162

 
Commercial Business:
 

 
 

 
 

 
 

 
 

 
 

 
SBA and USDA guaranteed
7,266

 
1,161

 
66

 
8,493

 
129,085

 
137,578

 
Time share

 

 

 

 
28,615

 
28,615

 
Condominium association

 

 

 

 
18,442

 
18,442

 
Other

 
171

 
338

 
509

 
69,196

 
69,705

 
Consumer:
 

 
 

 
 

 
 

 
 

 
 

 
Home equity
258

 
36

 
49

 
343

 
43,941

 
44,284

 
Indirect automobile
80

 
47

 
16

 
143

 
6,211

 
6,354

 
Other
1

 
1

 

 
2

 
2,114

 
2,116

 
Total
$
14,064

 
$
2,199

 
$
3,330

 
$
19,593

 
$
1,033,135

 
$
1,052,728

 
     
The Company did not have any loans that were past due 90 days or more and still accruing interest at September 30, 2014 or December 31, 2013.


20

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Impaired and Nonaccrual Loans
The following is a summary of impaired loans and nonaccrual loans at September 30, 2014 and December 31, 2013:
 
Impaired Loans(1)
 
 
September 30, 2014
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Nonaccrual
Loans
 
(In Thousands)
Impaired loans without valuation allowance:(2)
 
 
 
 
 
 
 
Real Estate:
 
 
 
 
 
 
 
Residential - 1 to 4 family
$
3,188

 
$
3,312

 
$

 
$
2,800

Multi-family and commercial
4,701

 
4,898

 

 
636

Commercial business - Other
975

 
975

 

 
589

Total impaired loans without valuation allowance
8,864

 
9,185

 

 
4,025

 
 
 
 
 
 
 
 
Impaired loans with valuation allowance:
 

 
 

 
 

 
 

Real Estate:
 
 
 
 
 
 
 
Residential - 1 to 4 family
2,409

 
2,420

 
314

 
366

Multi-family and commercial
1,533

 
1,623

 
131

 
370

Commercial business - Other
151

 
151

 
75

 
151

Total impaired loans with valuation allowance
4,093

 
4,194

 
520

 
887

Total impaired loans
$
12,957

 
$
13,379

 
$
520

 
$
4,912

 
 
 
 
 
 
 
 
 
(1) Includes loans acquired with deteriorated credit quality and performing TDRs.
(2) Includes loans acquired with deteriorated credit quality from the Newport merger.
 
Impaired Loans(1)
 
 
December 31, 2013
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Nonaccrual
Loans
 
(In Thousands)
Impaired loans without valuation allowance:(2)
 
 
 
 
 
 
 
Real Estate:
 
 
 
 
 
 
 
Residential - 1 to 4 family
$
3,641

 
$
3,822

 
$

 
$
3,241

Multi-family and commercial
6,853

 
7,050

 

 
1,655

Commercial business - Other
1,402

 
1,402

 

 
377

Consumer - Home equity

 

 

 
53

Consumer - Indirect automobile

 

 

 
16

Total impaired loans without valuation allowance
11,896

 
12,274

 

 
5,342

 
 
 
 
 
 
 
 
 
Impaired loans with valuation allowance:
 

 
 

 
 

 
 

Real Estate:
 
 
 
 
 
 
 
Residential - 1 to 4 family
2,437

 
2,448

 
341

 
319

Multi-family and commercial
1,324

 
1,414

 
185

 
1,324

Commercial business - Other
8

 
8

 
4

 
8

Total impaired loans with valuation allowance
3,769

 
3,870

 
530

 
1,651

Total impaired loans
$
15,665

 
$
16,144

 
$
530

 
$
6,993

 
 
 
 
 
 
 
 
 
(1) Includes loans acquired with deteriorated credit quality and performing TDRs.
(2) Includes loans acquired with deteriorated credit quality from the Newport merger.


21

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

The Company reviews and establishes, if necessary, an allowance for certain impaired loans for the amount by which the present value of expected cash flows (or observable market price of loan or fair value of the collateral if the loan is collateral dependent) are lower than the carrying value of the loan. At September 30, 2014 and December 31, 2013, the Company concluded that certain impaired loans required no valuation allowance as a result of management’s measurement of impairment. No additional funds are committed to be advanced to those borrowers whose loans are deemed impaired.

Additional information related to impaired loans is as follows:
 
Three Months Ended
September 30, 2014
 
Nine Months Ended
September 30, 2014
 
Average Recorded
Investment
 
Interest Income
Recognized
 
 Interest
Income Recognized
on Cash Basis
 
Average Recorded
Investment
 
Interest Income
Recognized
 
 Interest
Income Recognized
on Cash Basis
 
(In Thousands)
Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$
5,829

 
$
27

 
$
4

 
$
5,987

 
$
117

 
$
47

Multi-family and commercial
6,262

 
70

 

 
6,989

 
312

 
72

Commercial business - Other
1,145

 
6

 

 
1,123

 
34

 
15

Consumer - Home equity
22

 
2

 
2

 
40

 
3

 
3

Consumer - Other
20

 

 

 
10

 

 

Total
$
13,278

 
$
105

 
$
6

 
$
14,149

 
$
466

 
$
137


 
Three Months Ended
September 30, 2013
 
Nine Months Ended
September 30, 2013
 
Average Recorded
Investment
 
Interest Income
Recognized
 
 Interest
Income Recognized
on Cash Basis
 
Average Recorded
Investment
 
Interest Income
Recognized
 
 Interest
Income Recognized
on Cash Basis
 
(In Thousands)
Real Estate:
 
 
 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$
6,984

 
$
43

 
$
24

 
$
7,168

 
$
201

 
$
149

Multi-family and commercial
5,589

 
29

 

 
5,093

 
75

 

Commercial business - Other
965

 
5

 

 
710

 
12

 
5

Consumer - Home equity
203

 

 

 
297

 
27

 
27

Total
$
13,741

 
$
77

 
$
24

 
$
13,268

 
$
315

 
$
181


22

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Credit Quality Information
The Company utilizes an eight-grade internal loan rating system for all loans in the portfolio, with the exception of its purchased SBA and USDA commercial business loans that are fully guaranteed by the U.S. government, as follows:
o
Pass (Ratings 1-4): Loans in these categories are considered low to average risk.
o
Special Mention (Rating 5): Loans in this category are starting to show signs of potential weakness and are being closely monitored by management.
o
Substandard (Rating 6): Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.  There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.
o
Doubtful (Rating 7): Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.
o
Loss (Rating 8): Loans in this category are considered uncollectible and of such little value that their continuance as assets is not warranted.

Management periodically reviews the ratings described above and the Company’s internal audit function reviews components of the credit files, including the assigned risk ratings, of certain commercial loans as part of its loan review.  

The following tables present the Company’s loans by risk rating at September 30, 2014 and December 31, 2013:
September 30, 2014
Not Rated
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
 
(In Thousands)
Real Estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$

 
$
427,270

 
$
1,333

 
$
6,163

 
$

 
$

 
$
434,766

Multi-family and commercial

 
265,266

 
16,967

 
11,944

 

 

 
294,177

Construction

 
13,416

 

 

 

 

 
13,416

Total real estate loans

 
705,952

 
18,300

 
18,107

 

 

 
742,359

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Business:
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA guaranteed
118,524

 

 

 

 

 

 
118,524

Time share

 
42,090

 

 

 

 

 
42,090

Condominium association

 
20,517

 

 

 

 

 
20,517

Other

 
63,589

 
2,768

 
2,235

 

 

 
68,592

Total commercial business loans
118,524

 
126,196

 
2,768

 
2,235

 

 

 
249,723

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity

 
48,570

 
59

 
48

 

 

 
48,677

Indirect automobile

 
4,316

 

 
13

 

 

 
4,329

Other

 
2,003

 

 

 

 

 
2,003

Total consumer loans

 
54,889

 
59

 
61

 

 

 
55,009

Total loans
$
118,524

 
$
887,037

 
$
21,127

 
$
20,403

 
$

 
$

 
$
1,047,091


23

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

December 31, 2013
Not Rated
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
 
(In Thousands)
Real Estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$

 
$
441,646

 
$
1,296

 
$
6,870

 
$

 
$

 
$
449,812

Multi-family and commercial

 
250,667

 
18,363

 
16,630

 

 

 
285,660

Construction

 
10,162

 

 

 

 

 
10,162

Total real estate loans

 
702,475

 
19,659

 
23,500

 

 

 
745,634

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Business:
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA guaranteed
137,578

 

 

 

 

 

 
137,578

Time share

 
28,615

 

 

 

 

 
28,615

Condominium association

 
18,442

 

 

 

 

 
18,442

Other

 
63,959

 
2,230

 
3,516

 

 

 
69,705

Total commercial business loans
137,578

 
111,016

 
2,230

 
3,516

 

 

 
254,340

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity

 
44,117

 
66

 
101

 

 

 
44,284

Indirect automobile

 
6,338

 

 
16

 

 

 
6,354

Other

 
2,116

 

 

 

 

 
2,116

Total consumer loans

 
52,571

 
66

 
117

 

 

 
52,754

Total loans
$
137,578

 
$
866,062

 
$
21,955

 
$
27,133

 
$

 
$

 
$
1,052,728


Troubled Debt Restructurings
A modified loan is considered a TDR when two conditions are met:  1) the borrower is experiencing documented financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower with similar risk characteristics. The most common types of modifications include below market interest rate reductions, deferrals of principal and maturity extensions. Modified terms are dependent upon the financial position and needs of the individual borrower. If the modification agreement is violated, the loan is handled by the Company’s Collections Department for resolution, which may result in foreclosure. The Company’s determination of whether a loan modification is a TDR considers the individual facts and circumstances surrounding each modification.

The Company’s nonaccrual policy is followed for TDRs. If the loan was current prior to modification, nonaccrual status would not be required. If the loan was on nonaccrual prior to modification or if the payment amount significantly increases, the loan will remain on nonaccrual for a period of at least six months. Loans qualify for return to accrual status once the borrower has demonstrated the willingness and the ability to perform in accordance with the restructured terms of the loan agreement for a period of not less than six consecutive months.

All TDRs are initially reported as impaired. Impaired classification may be removed after a year following the restructure if the borrower demonstrates compliance with the modified terms and the restructuring agreement specifies an interest rate equal to that which would be provided to a borrower with similar risk characteristics at the time of restructuring.
 

24

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

The following table provides information on loans modified as TDRs during the nine months ended September 30, 2014 and 2013. There were no loans modified as TDRs during the three months ended September 30, 2014 and 2013.  
 
Nine Months Ended September 30,
 
2014
 
2013
 
 
 
 
 
Allowance for Loan Losses (End of Period)
 
 
 
 
 
Allowance for Loan Losses (End of Period)
 
 
 
 
 
 
 
 
 
 
 
Number of Loans
 
Recorded Investment
 
 
Number of Loans
 
Recorded Investment
 
 
(Dollars in Thousands)
Residential - 1 to 4 family
1
 
$
100

 
$

 
1
 
$
408

 
$

Multi-family and commercial
2
 
1,416

 
50

 
 

 

Commercial business - other
2
 
314

 

 
 

 

Total
5
 
$
1,830

 
$
50

 
1
 
$
408

 
$


During the modification process, there were no loan charge-offs or principal reductions for the loans included in the above tables.

The following table provides the recorded investment, by type of modification, during the three and nine months ended September 30, 2014 and 2013 for modified loans identified as TDRs.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(In Thousands)
Interest rate adjustments
$

 
$

 
$
379

 
$

Combination of rate and payment (1)

 

 
288

 

Combination of rate and maturity (2)

 

 
1,163

 
408

Total
$

 
$

 
$
1,830

 
$
408

 
 
 
 
 
 
 
 
 
(1) Terms include combination of interest rate adjustments and interest-only payments with deferral of principal.        
(2) Terms include combination of interest rate adjustments and extensions of maturity.

There were no TDRs in payment default (defined as 90 days or more past due) within twelve months of restructure for the three and nine months ended September 30, 2014 and 2013.

Loans Acquired with Deteriorated Credit Quality
The following is a summary of loans acquired with evidence of credit deterioration from Newport as of
September 30, 2014 and December 31, 2013.
 
Contractual Required Payments Receivable
 
Cash Expected To Be Collected
 
Non-Accretable Discount
 
Accretable Yield
 
Loans Receivable
 
(In Thousands)
Balance at December 31, 2013
$
7,776

 
$
6,549

 
$
1,227

 
$

 
$
6,549

Collections
(216
)
 
(183
)
 
(33
)
 

 
(183
)
Dispositions
(1,722
)
 
(1,367
)
 
(355
)
 

 
(1,367
)
Balance at September 30, 2014
$
5,838

 
$
4,999

 
$
839

 
$

 
$
4,999




25

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

NOTE 5.  PREMISES AND EQUIPMENT
 
Premises and equipment at September 30, 2014 and December 31, 2013 are summarized as follows:
 
September 30, 2014
 
December 31, 2013
 
(In Thousands)
Land
$
4,746

 
$
4,311

Buildings
11,813

 
11,497

Leasehold improvements
10,780

 
10,762

Furniture and equipment
12,435

 
12,549

Construction in process
545

 
45

 
40,319

 
39,164

Accumulated depreciation and amortization
(19,016
)
 
(18,074
)
Premises and equipment, net
$
21,303

 
$
21,090


At September 30, 2014 and December 31, 2013, construction in process related to design and site costs associated with a new branch location. At September 30, 2014, the Company had outstanding commitments related to the construction of a new branch location and the renovation of an existing branch totaling $2.1 million.

NOTE 6.  OTHER COMPREHENSIVE INCOME (LOSS)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss). Although certain changes in assets and liabilities are reported as a separate component of shareholders’ equity on the balance sheet, such items, along with net income (loss) are components of comprehensive income (loss).

The components of other comprehensive income and related tax effects are as follows:
 
Nine Months Ended September 30, 2014
 
Before Tax
Amount
 
Tax
Effects
 
Net of Tax
Amount
Securities:
(In Thousands)
Unrealized holding gains on available for sale securities
$
828

 
$
(282
)
 
$
546

Reclassification adjustment for gains recognized in net income
(64
)
 
22

 
(42
)
Unrealized holding gains on available for sale securities, net of taxes
764

 
(260
)
 
504

Derivative instrument:
 

 
 

 
 

Change in fair value of effective cash flow hedging derivative
117

 
(40
)
 
77

Other comprehensive income
$
881

 
$
(300
)
 
$
581



26

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

The components of accumulated other comprehensive loss included in shareholders’ equity are as follows:
 
 
September 30, 2014
 
Before Tax
Amount
 
Tax
Effects
 
Net of Tax
Amount
 
(In Thousands)
Net unrealized losses on available for sale securities
$
(209
)
 
$
71

 
$
(138
)
Net unrealized loss on effective cash flow hedging derivative
(195
)
 
66

 
(129
)
Accumulated other comprehensive loss
$
(404
)
 
$
137

 
$
(267
)

 
December 31, 2013
 
Before Tax
Amount
 
Tax
Effects
 
Net of Tax
Amount
 
(In Thousands)
Net unrealized losses on available for sale securities
$
(973
)
 
$
331

 
$
(642
)
Net unrealized loss on effective cash flow hedging derivative
(312
)
 
106

 
(206
)
Accumulated other comprehensive loss
$
(1,285
)
 
$
437

 
$
(848
)

NOTE 7.  REGULATORY CAPITAL

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to total assets (as defined). As of September 30, 2014 and December 31, 2013, the Bank met the conditions to be classified as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since then that management believes have changed the Bank’s regulatory category. As a savings and loan holding company regulated by the Federal Reserve Board (the “FRB”), the Company is not currently subject to any separate regulatory capital requirements. The Dodd-Frank Act, however, requires the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, quantitatively in terms of components of capital, than those applicable to institutions themselves. There is a five-year transition period before the capital requirements will apply to savings and loan holding companies.

In July 2013, the FRB released its final rules which will implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act. These rules become effective January 1, 2015 for community banks and will increase both the quality and quantity of capital held by banks. The final rule implements strict eligibility criteria for regulatory capital instruments and improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. Consistent with the international Basel framework, the final rule includes a new minimum capital requirement of common equity Tier I capital to risk-weighted assets of 4.5 percent and a common equity Tier I capital conservation buffer of 2.5 percent of risk-weighted assets. The capital conservation buffer will be phased in beginning January 1, 2016, at 0.625 percent of

27

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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

risk-weighted assets, increasing each year until fully implemented at 2.5 percent on January 1, 2019. In addition, the final rule raises the minimum ratio of Tier I capital to risk-weighted assets requirement from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banking organizations.

The Bank’s actual capital amounts and ratios as of September 30, 2014 and December 31, 2013 were as follows:
 
 
Actual
 
For Capital
Adequacy
Purposes
 
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
September 30, 2014
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
(Dollars in Thousands)
Tier I Capital Ratio
$
122,307

 
9.32
%
 
$
52,474

 
4.00
%
 
$
65,593

 
5.00
%
Tier I Risk-based Capital Ratio
122,307

 
14.90

 
32,837

 
4.00

 
49,256

 
6.00

Total Risk-based Capital Ratio
130,514

 
15.90

 
65,674

 
8.00

 
82,093

 
10.00

Tangible Equity Ratio
122,307

 
9.32

 
19,678

 
1.50

 
N/A

 
      N/A


 
Actual
 
For Capital
Adequacy
Purposes
 
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
December 31, 2013
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
(Dollars in Thousands)
Tier I Capital Ratio
$
117,477

 
8.94
%
 
$
52,550

 
4.00
%
 
$
65,688

 
5.00
%
Tier I Risk-based Capital Ratio
117,477

 
14.71

 
31,936

 
4.00

 
47,905

 
6.00

Total Risk-based Capital Ratio
124,964

 
15.65

 
63,873

 
8.00

 
79,841

 
10.00

Tangible Equity Ratio
117,477

 
8.94

 
19,706

 
1.50

 
N/A

 
N/A

 
NOTE 8.  FAIR VALUE OF ASSETS AND LIABILITIES

Fair Value Hierarchy
The Company groups its assets and liabilities in three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. Transfers between levels are recognized at the end of a reporting period, if applicable.

Level 1:
Valuation is based on quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2: 
Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3:
Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using unobservable inputs to pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.    

28

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Determination of Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The following methods and assumptions were used by the Company in estimating fair value measurement and disclosures of its financial instruments:
 
Cash and cash equivalents. The carrying amounts of cash and cash equivalents approximate the fair values based on the short-term nature of the assets.

Securities available for sale. Included in the available for sale category are both debt and equity securities. The securities measured at fair value in Level 1 are based on quoted market prices in an active exchange market. Securities measured at fair value in Level 2 are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data. The Company utilizes a nationally-recognized, third-party pricing service to estimate fair value measurements for the majority of its portfolio. The pricing service evaluates each asset class based on relevant market information considering observable data, but these prices do not represent binding quotes. The fair value prices on all investments are reviewed for reasonableness by management. Securities measured at fair value in Level 3 include a collateralized debt obligation that is backed by trust preferred securities issued by banks, thrifts and insurance companies. Management determined that an orderly and active market for these securities and similar securities did not exist based on a significant reduction in trading volume and widening spreads relative to historical levels. The Company estimates future cash flows discounted using a rate management believes is representative of current market conditions. Factors in determining the discount rate include the current level of deferrals and/or defaults, changes in credit rating and the financial condition of the debtors within the underlying securities, broker quotes for securities with similar structure and credit risk, interest rate movements and pricing for new issuances.

Federal Home Loan Bank stock. The carrying value of Federal Home Loan Bank (“FHLB”) stock approximates fair value based on the redemption provisions of the FHLB.

Loans held for sale. The fair value of loans held for sale is estimated using quoted market prices.

Loans receivable. For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of fixed-rate loans are estimated by discounting the future cash flows using the rates at the end of the period in which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Accrued interest receivable. The carrying amount of accrued interest approximates fair value.


29

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Deposits. The fair value of demand deposits, negotiable orders of withdrawal, regular savings, certain money market deposits and mortgagors’ and investors’ escrow accounts is the amount payable on demand at the reporting date. The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities to a schedule of aggregated expected maturities on such deposits.

Federal Home Loan Bank advances. The fair value of the advances is estimated using a discounted cash flow calculation that applies current FHLB interest rates for advances of similar maturity to a schedule of maturities of such advances.

Junior subordinated debt owed to unconsolidated trust. Rates currently available for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

Interest rate swap agreements. The fair values of the Company’s interest rate swaps are obtained from a third-party pricing service and are determined using a discounted cash flow analysis on the expected cash flows of the derivative. The pricing analysis is based on observable inputs for the contractual term of the derivative, including the period to maturity and interest rate curves.

Forward loan sale commitments and derivative loan commitments. Forward loan sale commitments and derivative loan commitments are based on the fair values of the underlying mortgage loans, including the servicing rights for derivative loan commitments, and the probability of such commitments being exercised. Significant management judgment and estimation is required in determining these fair value measurements.

Off-balance sheet instruments. Fair values for off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standings.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013.  The Company had no significant transfers into or out of Levels 1, 2 or 3 during the three and nine months ended September 30, 2014.
 
September 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
21,903

 
$
41,220

 
$

 
$
63,123

Government-sponsored enterprises

 
24,434

 

 
24,434

Mortgage-backed securities

 
70,151

 

 
70,151

Corporate debt securities

 
1,008

 

 
1,008

Collateralized debt obligation

 

 
1,188

 
1,188

Obligations of state and political subdivisions

 
4,186

 

 
4,186

Tax-exempt securities

 
6,687

 

 
6,687

Forward loan sale commitments and derivative loan commitments

 

 
34

 
34

Total assets
$
21,903

 
$
147,686

 
$
1,222

 
$
170,811

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Interest rate swap agreements
$

 
$
300

 
$

 
$
300

Total liabilities
$

 
$
300

 
$

 
$
300


30

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

 
 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
8,975

 
$
45,570

 
$

 
$
54,545

Government-sponsored enterprises

 
26,292

 

 
26,292

Mortgage-backed securities

 
76,671

 

 
76,671

Corporate debt securities

 
3,798

 

 
3,798

Collateralized debt obligation

 

 
1,191

 
1,191

Obligations of state and political subdivisions

 
4,123

 

 
4,123

Tax-exempt securities

 
3,575

 

 
3,575

Foreign government securities

 
25

 

 
25

Forward loan sale commitments and derivative loan commitments

 

 
22

 
22

Total assets
$
8,975

 
$
160,054

 
$
1,213

 
$
170,242

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Interest rate swap agreements
$

 
$
486

 
$

 
$
486

Total liabilities
$

 
$
486

 
$

 
$
486

 
The following table shows a reconciliation of the beginning and ending balances for Level 3 assets:
 
 
Collateralized
Debt
Obligations
 
Derivative Loan and Forward Loan Sale Commitments, Net
 
(In Thousands)
Balance at December 31, 2013
$
1,191

 
$
22

Total realized and unrealized gains included in net income

 
12

Total unrealized losses included in other comprehensive income
(3
)
 

Balance at September 30, 2014
$
1,188

 
$
34


Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company may also be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets at September 30, 2014 and December 31, 2013. There were no liabilities measured at fair value on a nonrecurring basis at September 30, 2014 and December 31, 2013.
 
 
At September 30, 2014
 
At December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
(In Thousands)
Impaired loans
$

 
$

 
$
639

 
$

 
$

 
$
1,384

Other real estate owned

 

 
1,361

 

 

 
2,429

Total assets
$

 
$

 
$
2,000

 
$

 
$

 
$
3,813





31

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

The following table summarizes losses resulting from fair value adjustments for assets measured at fair value on a nonrecurring basis.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
(In Thousands)
Impaired loans
$
22

 
$
33

 
$
126

 
$
318

Other real estate owned
10

 

 
25

 
32

Total losses
$
32

 
$
33

 
$
151

 
$
350


The Company measures the impairment of loans that are collateral dependent based on the fair value of the collateral (Level 3). The fair value of collateral used by the Company represents the amount expected to be received from the sale of the property, net of selling costs, as determined by an independent, licensed or certified appraiser using observable market data. This data includes information such as selling price of similar properties, expected future cash flows or earnings of the subject property based on current market expectations, and relevant legal, physical and economic factors. The appraised values of collateral are adjusted as necessary by management based on observable inputs for specific properties. Losses applicable to write-downs of impaired loans are based on the appraised market value of the underlying collateral, assuming foreclosure of these loans is imminent.

The amount of other real estate owned represents the carrying value of the collateral based on the appraised value of the underlying collateral less estimated selling costs. The loss on foreclosed assets represents adjustments in the valuation recorded during the time period indicated and not for losses incurred on sales.

Summary of Fair Values of Financial Instruments
The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are presented in the following table. Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction at September 30, 2014 and December 31, 2013. The estimated fair value amounts at September 30, 2014 and December 31, 2013 have been measured as of each respective date, and have not been re-evaluated or updated for purposes of the consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. The information presented should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only required for a limited portion of the Company's assets. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimate, comparisons between the Company's disclosures and those of other banks may not be meaningful.


32

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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

As of September 30, 2014 and December 31, 2013, the recorded carrying amounts and estimated fair values of the Company's financial instruments are as follows:
 
September 30, 2014
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
(In Thousands)
Cash and cash equivalents
$
33,618

 
$
33,618

 
$

 
$

 
$
33,618

Available for sale securities
170,777

 
21,903

 
147,686

 
1,188

 
170,777

Loans held for sale
1,123

 

 

 
1,236

 
1,236

Loans receivable, net
1,041,071

 

 

 
1,053,622

 
1,053,622

Federal Home Loan Bank stock
10,333

 

 

 
10,333

 
10,333

Accrued interest receivable
3,898

 

 

 
3,898

 
3,898

Financial Liabilities:
 

 
 

 
 

 
 

 
 
Deposits
997,839

 

 

 
1,000,885

 
1,000,885

Mortgagors' and investors' escrow accounts
1,794

 

 

 
1,794

 
1,794

Federal Home Loan Bank advances
154,148

 

 
155,537

 

 
155,537

Junior subordinated debt owed to unconsolidated trust
8,248

 

 
5,949

 

 
5,949

On-balance Sheet Derivative Financial Instruments:
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Derivative loan commitments
28

 

 

 
28

 
28

    Forward loan sale commitments
6

 

 

 
6

 
6

Liabilities:
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
300

 

 
300

 

 
300


 
 
December 31, 2013
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
(In Thousands)
  Cash and cash equivalents
$
27,321

 
$
27,321

 
$

 
$

 
$
27,321

  Available for sale securities
170,220

 
8,975

 
160,054

 
1,191

 
170,220

  Loans held for sale
1,764

 

 

 
1,766

 
1,766

  Loans receivable, net
1,047,410

 

 

 
1,050,834

 
1,050,834

  Federal Home Loan Bank stock
13,109

 

 

 
13,109

 
13,109

  Accrued interest receivable
4,021

 

 

 
4,021

 
4,021

Financial Liabilities:
 
 
 
 
 
 
 
 
 
  Deposits
984,749

 

 

 
987,705

 
987,705

  Mortgagors' and investors' escrow accounts
3,214

 

 

 
3,214

 
3,214

  Federal Home Loan Bank advances
176,272

 

 
178,448

 

 
178,448

  Junior subordinated debt owed to unconsolidated trust
8,248

 

 
6,337

 

 
6,337

On-balance Sheet Derivative Financial Instruments:
 
 
 
 
 
 
 
 
 
  Assets:
 
 
 
 
 
 
 
 
 
  Derivative loan commitments
14

 

 

 
14

 
14

  Forward loan sale commitments
8

 

 

 
8

 
8

  Liabilities:
 
 
 
 
 
 
 
 
 
  Interest rate swap agreements
486

 

 
486

 

 
486



33

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

NOTE 9.  DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Derivative Financial Instruments
The Company has stand-alone derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk.  The notional amounts are amounts on which calculations, payments and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instruments, is reflected on the Company’s balance sheets as other assets and other liabilities. The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures and does not expect any counterparties to fail their obligations.

Derivative instruments are generally either negotiated over-the-counter contracts or standardized contracts executed on a recognized exchange. Negotiated over-the-counter derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.

Derivative Instruments Designated As Hedging Instruments
The Company uses long-term variable rate debt as a source of funds for use in the Company’s lending and investment activities and other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, hedges its variable-rate interest payments on its junior subordinated debentures. To meet this objective, management entered into an interest rate swap agreement, characterized as a cash flow hedge, whereby the Company receives variable interest rate payments determined by three-month LIBOR in exchange for making payments at a fixed interest rate.

At September 30, 2014 and December 31, 2013, information pertaining to the outstanding interest rate swap agreement used to hedge variable rate debt is as follows:
 
 
 
September 30, 2014
 
December 31, 2013
 
 
 
(Dollars in Thousands)
 
Notional amount
$
8,000

 
$
8,000

 
Weighted average fixed pay rate
2.44
%
 
2.44
%
 
Weighted average variable receive rate
0.23
%
 
0.24
%
 
Weighted average maturity in years
1.2

 
2.0

 
Unrealized loss relating to interest rate swap
$
195

 
$
312


At September 30, 2014 and December 31, 2013, the unrealized loss related to the above mentioned interest rate swap was recorded as a derivative liability. Changes in the fair value of an interest rate swap designated as a hedging instrument of the variability of cash flows associated with long-term debt are reported in other comprehensive income. These amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the long-term debt affects earnings.

Risk management results for the periods ended September 30, 2014 and December 31, 2013 related to the balance sheet hedging of long-term debt indicate that the hedge was 100% effective and that there was no component of the derivative instrument’s loss which was excluded from the assessment of hedge effectiveness.


34

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

The Company’s derivative contract contains a provision establishing a collateral requirement (subject to minimum collateral posting thresholds) based on the Company’s external credit rating. If the Company’s junior subordinated debt rating was to fall below the level generally recognized as investment grade, the counterparty to such derivative contract could require additional collateral on the derivative transaction in a net liability position (after considering the effect of bilateral netting arrangements and posted collateral). The Company had previously posted collateral of $400,000 in the normal course of business for a derivative instrument, with a credit-related contingent feature, that was in a net liability position at September 30, 2014 and December 31, 2013.

Derivative Instruments Not Designated As Hedging Instruments
Certain derivative instruments do not meet the requirements to be accounted for as hedging instruments. These undesignated derivative instruments are recognized on the consolidated balance sheets at fair value, with changes in fair value recorded in noninterest income.

Interest Rate Swap Agreement - In 2012, the Company entered into an interest rate swap agreement that does not meet the hedge accounting requirements of FASB's "Derivatives and Hedging" standard, to manage the Company's exposure to interest rate movements and other identified risks. At September 30, 2014 and December 31, 2013, information pertaining to the Company's interest rate swap agreement not designated as a hedge is as follows:
 
September 30, 2014
 
December 31, 2013
 
(Dollars in Thousands)
Notional amount
$
15,000

 
$
15,000

Weighted average fixed pay rate
1.26
%
 
1.26
%
Weighted average variable receive rate
0.23
%
 
0.25
%
Weighted average maturity in years
2.3

 
3.0

Unrealized loss relating to interest rate swap
$
105

 
$
174


The Company reported a gain in fair value on the interest rate swap not designated as a hedge of $78,000 and $69,000 in noninterest income for the three and nine months ended September 30, 2014, respectively.

Derivative Loan Commitments - Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding. The Company enters into commitments to fund residential mortgage loans at specified times in the future, with the intention that these loans will subsequently be sold in the secondary market. A mortgage loan commitment binds the Company to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock.

Outstanding derivative loan commitments expose the Company to the risk that the price of the loans arising from exercise of the loan commitment might decline from inception of the rate lock to funding of the loan due to increases in mortgage interest rates. If interest rates increase, the values of these loan commitments decrease. Conversely, if interest rates decrease, the value of these loan commitments increase. The notional amount of undesignated mortgage loan commitments was $5.6 million at September 30, 2014. At September 30, 2014, the fair value of such commitments was a net asset of $28,000.

Forward Loan Sale Commitments - To protect against the price risk inherent in derivative loan commitments, the Company utilizes “mandatory delivery” forward loan sale commitments to mitigate the risk of potential decreases in the value of loans that would result from the exercise of the derivative loan commitments.


35

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

With a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay a “pair-off” fee, based on then-current market prices, to the investor to compensate the investor for the shortfall.

The Company expects that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments. The notional amount of undesiginated forward loan sale commitments was $3.0 million at September 30, 2014. At September 30, 2014, the fair value of such commitments was a net asset of $6,000.

Interest Rate Risk Management - Derivative Instruments
The following table presents the fair values of derivative instruments as well as their classification on the consolidated balance sheets at September 30, 2014 and December 31, 2013.
 
 
 
September 30, 2014
 
December 31, 2013
 
Balance Sheet Location
 
Notional Amount
 
Estimated Fair Value
 
Notional Amount
 
Estimated Fair Value
 
 
 
(In Thousands)
Derivative designated as hedging instrument:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap
Other Liabilities
 
$
8,000

 
$
(195
)
 
$
8,000

 
$
(312
)
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap
Other Liabilities
 
15,000

 
(105
)
 
15,000

 
(174
)
Derivative loan commitments
Other Assets
 
5,595

 
28

 
3,129

 
14

Forward loan sale commitments
Other Assets
 
3,016

 
6

 
3,581

 
8



36




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

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding changes in the Company’s financial condition as of September 30, 2014 and December 31, 2013 and the results of operations for the three and nine months ended September 30, 2014 and 2013. The information contained in this section should be read in conjunction with the consolidated financial statements and notes thereto appearing in Part I, Item 1 of this document as well as with management’s discussion and analysis of financial condition and results of operations and consolidated financial statements included in the Company’s 2013 Annual Report on Form 10-K.

This report may contain certain “forward-looking statements” within the meaning of the federal securities laws, which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “projects” and similar expressions. These statements are not historical facts; rather, they are statements based on management’s current expectations regarding our business strategies, intended results and future performance.  

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the United States government, including policies of the United States Treasury and the Federal Reserve Board, the quality and composition of the loan and investment portfolios, demand for loan products, deposit flows, competition, failing to achieve the expected cost savings or revenue synergies related to the Newport acquisition, demand for financial services in the Company’s market area, changes in real estate market values in the Company’s market area and changes in relevant accounting principles and guidelines. Additional factors that may affect the Company’s results are discussed in the Company’s Annual Report on Form 10-K and in other reports filed with the Securities and Exchange Commission. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Critical Accounting Policies

The Company considers accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. The Company considers the determination of allowance for loan losses, other-than-temporary impairment of securities, deferred income taxes and the impairment of long-lived assets to be its critical accounting policies. Additional information about the Company’s accounting policies is included in the notes to the Company’s consolidated financial statements contained in Part I, Item 1 of this document and in the Company’s 2013 Annual Report on Form 10-K.

Impact of New Accounting Standards

Refer to Note 1 of the consolidated financial statements in this report for a discussion of recent accounting pronouncements.


37



Comparison of Financial Condition at September 30, 2014 and December 31, 2013

Assets:
Summary. Assets decreased $6.2 million, or 0.5%, to $1.34 billion at September 30, 2014 principally due to decreases of $6.3 million in net loans receivable, $2.8 million in FHLB stock and other real estate owned of $1.1 million, offset by an increase of $6.3 million in cash and cash equivalents.

Loans Receivable, Net. Contributing to the decrease of $6.3 million in net loans receivable were reductions in residential mortgage loan originations and principal repayments of SBA and USDA guaranteed loans, offset by increases in time share, condominium association and home equity loans. Changes in the loan portfolio consisted of the following:

Residential Real Estate. Residential mortgage loans comprised 41.5% of the total loan portfolio at September 30, 2014. The residential mortgage portfolio decreased $15.0 million, or 3.3%, partly due to the sale of $13.3 million of fixed-rate residential mortgage loans. Residential mortgage loan originations decreased $19.7 million during the first nine months of 2014 over the comparable period in 2013, as a result of rising interest rates and reduced activity in the housing market.

Multi-family and Commercial Real Estate. Multi-family and commercial real estate loans represented 28.1% of total loans at September 30, 2014 and increased $8.5 million, or 3.0%, during the first nine months of 2014. Loan originations for multi-family and commercial real estate loans were $36.0 million, representing an increase of $26.0 million during the first nine months of 2014 compared to the same period in 2013.

Construction. Construction loans, which include both residential and commercial construction loans, increased $3.3 million for the first nine months of 2014 as a result of commercial construction volume.
  
Commercial Business. Commercial business loans represented 23.9% of total loans at September 30, 2014. Commercial business loans decreased $4.6 million, or 1.8%, for the first nine months of 2014 primarily due to decreases of $19.1 million and $1.1 million in SBA and USDA guaranteed loans and other commercial business loans, respectively, offset by increases of $13.5 million and $2.1 million in time share and condominium association lending, respectively. Commercial business loan originations decreased $53.7 million as compared to the same period in 2013. At September 30, 2014, unfunded lines of credit related to time share lending totaled $38.1 million as a result of an experienced lender dedicated to identifying new opportunities for growth within the time share industry.

Consumer. Consumer loans represented 5.3% of the Company’s total loan portfolio at September 30, 2014. Consumer loans increased $2.3 million during the first nine months of 2014 as a result of an increase of $4.4 million in home equity loans, offset by a decrease of $2.0 million in indirect automobile loans. Loan originations for consumer loans totaled $21.1 million, representing an increase of $7.7 million, for the first nine months of 2014 over the comparable period in 2013 resulting from a home equity line of credit promotion.

The allowance for loan losses totaled $7.6 million at September 30, 2014 compared to $6.9 million at December 31, 2013. The ratio of the allowance for loan losses to total loans increased to 0.73% at September 30, 2014 from 0.66% at December 31, 2013, which was necessitated by an increase in commercial loans, which carry a higher degree of risk than other loans held in portfolio.  


38



The following table provides information with respect to nonperforming assets and TDRs as of the dates indicated.
 
 
September 30
2014
 
December 31, 2013
Nonaccrual loans:
(Dollars in Thousands)
Real estate loans:
 
 
 
Residential - 1 to 4 family
$
3,166

 
$
3,560

Multi-family and commercial
1,006

 
2,979

Total real estate loans
4,172

 
6,539

Commercial business loans - Other
740

 
385

Consumer loans:
 
 
 
     Home equity

 
53

Indirect automobile

 
16

Total nonaccrual loans
4,912

 
6,993

Accruing loans past due 90 days or more

 

Total nonperforming loans (1)
4,912

 
6,993

Other real estate owned, net (2)
1,361

 
2,429

Total nonperforming assets
6,273

 
9,422

Accruing troubled debt restructurings
3,300

 
2,192

Total nonperforming assets and troubled debt restructurings
$
9,573

 
$
11,614

 
 
 
 
 
Allowance for loan losses as a percent of nonperforming loans
155.11
%
 
98.90
%
Total nonperforming loans to total loans
0.47
%
 
0.66
%
Total nonperforming loans to total assets
0.37
%
 
0.52
%
Total nonperforming assets and troubled debt restructurings to total assets
0.71
%
 
0.86
%
 
 
 
 
 
(1) Includes nonperforming TDRs totaling $943,000 and $319,000 at September 30, 2014 and December 31, 2013, respectively.
(2) Other real estate owned balances are shown net of related write-downs.

The decrease in nonperforming assets was due to a decrease in nonaccrual loans and other real estate owned. Nonperforming multi-family and commercial real estate loans decreased $2.0 million and residential mortgage loans decreased $394,000 during the first nine months of 2014.

Other real estate owned decreased $1.1 million from December 31, 2013 to September 30, 2014, primarily as a result of the sale of nine residential properties with a carrying value of $1.0 million and net write-downs of $32,000. At September 30, 2014, other real estate owned included three commercial properties and one residential property.

Over the past few years, the Company has sought to restructure nonperforming loans rather than pursue foreclosure or liquidation, believing this approach achieves the best economic outcome for the Company in view of the current economic environment. Modified payment terms for TDRs generally involve deferred principal payments, interest rate concessions, a combination of deferred principal payments and interest rate concessions or a combination of maturity extensions and interest rate concessions. TDRs increased to $4.2 million at September 30, 2014, compared to $2.5 million at December 31, 2013, resulting from the addition of four commercial loans with a recorded investment of $1.7 million and one residential loan with a recorded investment of $100,000. Of the TDRs, $3.3 million and $2.2 million were performing in accordance with their restructured terms at September 30, 2014 and December 31, 2013, respectively. The Company anticipates that these borrowers will repay all contractual principal and interest in accordance with the terms of their restructured loan agreements.


39



Liabilities:
Summary. Liabilities decreased $9.5 million, or 0.8%, to $1.18 billion at September 30, 2014 compared to $1.19 billion at December 31, 2013. Deposits increased $13.1 million, or 1.3%, which included increases in certificates of deposit and noninterest-bearing deposits of $15.4 million and $1.6 million, respectively, offset by a decrease in NOW and money market accounts of $4.0 million. Deposit growth remained strong due to marketing and promotional initiatives and competitively-priced deposit products. Borrowings decreased $22.1 million from $184.5 million at December 31, 2013 to $162.4 million at September 30, 2014, resulting from net repayments of FHLB advances.

Equity:
Summary. Shareholders’ equity increased $3.3 million from $152.8 million at December 31, 2013 to $156.1 million at September 30, 2014. The increase in shareholders’ equity was attributable to net income of $3.0 million, the exercise of stock options of $552,000 and a decrease in net unrealized loss on available for sale securities aggregating $504,000 (net of taxes), offset by dividends of $1.1 million and common shares repurchased totaling $761,000.

Accumulated Other Comprehensive Loss. Accumulated other comprehensive loss is comprised of the unrealized gains and losses on available for sale securities and unrealized gains and losses on an interest rate swap designated as a hedge, net of taxes. The net unrealized losses on available for sale securities, net of taxes, totaled $138,000 at September 30, 2014 compared to net unrealized losses of $642,000 at December 31, 2013. The net unrealized loss on the interest rate swap, net of taxes, totaled $129,000 at September 30, 2014 compared to a net unrealized loss on the interest rate swap, net of taxes, of $206,000 at December 31, 2013.

Results of Operations for the Three and Nine Months Ended September 30, 2014 and 2013

General. The Company’s results of operations depend primarily on net interest income, which is the difference between the interest income earned on the Company’s interest-earning assets, such as loans and investments, and the interest expense on its interest-bearing liabilities, such as deposits and borrowings. The Company also generates noninterest income such as gains on the sale of securities, fees earned from mortgage banking activities, fees from deposits, trust and investment management services, insurance commissions and other fees. The Company’s noninterest expenses primarily consist of employee compensation and benefits, occupancy, computer services, furniture and equipment, outside professional services, electronic banking fees, FDIC deposit insurance and regulatory assessments, marketing and other general and administrative expenses. The Company’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, governmental policies and actions of regulatory agencies.

Summary. The Company reported net income of $1.2 million for the three months ended September 30, 2014, representing an increase of $2.9 million, compared to a net loss of $1.7 million for the three months ended September 30, 2013. The Company reported net income of $3.0 million for the nine months ended September 30, 2014, representing an increase of $4.9 million, compared to a net loss of $1.9 million for the nine months ended September 30, 2013. The acquisition of Newport in September 2013 contributed to the higher net income for the three and nine months ended September 30, 2014, as a result of increases in net interest income and noninterest income. Lower net income for the three and nine months ended September 30, 2013 was the result of costs totaling $1.3 million and $2.2 million (pre-tax), respectively, associated with the acquisition of Newport, losses realized on security sales and penalties related to the prepayment of FHLB advances.

Interest and Dividend Income. Total interest and dividend income increased $2.6 million, or 28.2%, to $11.7 million for the quarter ended September 30, 2014, compared to the same period in 2013. The increase in interest and dividend income was due to an increase in the average balance of loans, offset by lower yields on loans versus the same period in 2013. Interest income on loans and securities reflect net amortization of $108,000 and $88,000 for the three months ended September 30, 2014 and 2013, respectively, related to fair value adjustments of loans and securities resulting from the Newport acquisition. The average yield earned on interest-earning assets increased 3 basis points to 3.71%, despite the 8 basis points decline in the yield on loans to 4.08%. Average

40



interest-earning assets increased $270.4 million to $1.26 billion during the third quarter of 2014, due to an increase in the average balance of loans of $271.3 million and other interest earning assets of $9.9 million, offset by a decrease of $10.7 million in the average balance of securities compared to the same quarter in 2013.

Total interest and dividend income increased $9.5 million, or 36.4%, to $35.5 million for the nine months ended September 30, 2014, compared to the same period in 2013, offset by lower yields on loans. The increase in interest and dividend income was due to an increase in the average balance of loans and an increase of 3 basis points in the average yield earned on interest-earning assets versus the same period in 2013. Interest income on loans and securities reflect net amortization of $124,000 and $88,000 for the nine months ended September 30, 2014 and 2013, respectively, related to fair value adjustments of loans and securities resulting from the Newport acquisition. The average yield earned on interest-earning assets increased to 3.76%, despite the decline of 14 basis points in the yield on loans to 4.14%. Average interest-earning assets increased $329.9 million to $1.26 billion during the first nine months of 2014, due to an increase in the average balance of loans of $336.7 million and other interest-earning assets of $5.0 million, offset by a decrease in the average balance of securities of $11.8 million compared to the same period in 2013.

Interest Expense. For the quarter ended September 30, 2014, interest expense decreased $23,000, or 1.1%, resulting from lower rates paid on deposits and borrowings, offset by a higher average balance of deposits and FHLB advances. Lower interest expense on deposits and borrowings reflect net accretion of $482,000 and $645,000 for the three months ended September 30, 2014 and 2013, respectively, related to fair value adjustments of deposits and borrowings resulting from the Newport acquisition. Average interest-bearing deposits increased $185.8 million to $863.3 million and the average rate paid decreased 11 basis points to 0.62%. Increases in the average balance of NOW and money market deposits, certificates of deposit and savings accounts totaled $100.7 million, $82.0 million and $2.9 million, respectively. The average balance of FHLB advances increased $39.2 million while the average rate declined 99 basis points to 1.54%.

For the nine months ended September 30, 2014, interest expense decreased $152,000, or 2.4%, to $6.2 million compared to $6.4 million for the comparable period in 2013 resulting from lower rates paid on deposits and borrowings, offset by a higher average balance of deposits and FHLB advances. Lower interest expense on deposits and borrowings reflect net accretion of $1.5 million and $645,000 for the nine months ended September 30, 2014 and 2013, respectively, related to fair value adjustments of deposits and borrowings resulting from the Newport acquisition. Average interest-bearing deposits increased $223.5 million to $864.6 million and the average rate paid decreased 19 basis points to 0.62%. Increases in the average balance of NOW and money market deposits, certificates of deposit and savings accounts totaled $132.6 million, $85.9 million and $4.9 million, respectively. The average balance of FHLB advances increased $63.3 million while the average rate declined 136 basis points to 1.55%.

Average Balance Sheet. The following sets forth information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resulting yields and rates paid, interest rate spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities for the periods indicated.


41



 
At or For the Three Months Ended September 30,
 
2014
 
2013
 
Average
Balance
 
Interest &
Dividends
 
Average
Yield/
Rate
 
Average
Balance
 
Interest &
Dividends
 
Average
Yield/
Rate
 
(Dollars in Thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1) (2)
$
1,044,702

 
$
10,735

 
4.08
%
 
$
773,439

 
$
8,105

 
4.16
%
Securities (3)
184,376

 
1,002

 
2.16

 
195,119

 
1,050

 
2.13

Other interest-earning assets
28,237

 
11

 
0.15

 
18,314

 
10

 
0.22

Total interest-earning assets
1,257,315

 
11,748

 
3.71

 
986,872

 
9,165

 
3.68

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets
91,287

 
 

 
 

 
75,664

 
 

 
 

Total assets
$
1,348,602

 
 

 
 

 
$
1,062,536

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 

 
 

 
 

Business checking
$
180

 

 

 
$
(14
)
 

 

NOW and money market
450,011

 
143

 
0.13

 
349,346

 
122

 
0.14

Savings (4)
46,854

 
20

 
0.17

 
43,909

 
18

 
0.16

Certificates of deposit (5)
366,219

 
1,192

 
1.29

 
284,216

 
1,101

 
1.54

Total interest-bearing deposits
863,264

 
1,355

 
0.62

 
677,457

 
1,241

 
0.73

 
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank advances
154,664

 
602

 
1.54

 
115,508

 
736

 
2.53

Subordinated debt
8,248

 
84

 
4.04

 
8,248

 
85

 
4.09

Other borrowed funds

 

 

 
3,931

 
2

 
0.20

Total interest-bearing liabilities
1,026,176

 
2,041

 
0.79

 
805,144

 
2,064

 
1.02

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities
165,503

 
 

 
 

 
119,042

 
 

 
 

Total liabilities
1,191,679

 
 

 
 

 
924,186

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total shareholders' equity
156,923

 
 

 
 

 
138,350

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
$
1,348,602

 
 

 
 

 
$
1,062,536

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest-earning assets
$
231,139

 
 

 
 

 
$
181,728

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent net interest income (3)
 

 
9,707

 
 

 
 

 
7,101

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent interest rate spread (6)
 

 
 

 
2.92
%
 
 

 
 

 
2.66
%
 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent net interest margin as a percentage of interest-earning assets (7)
 

 
 

 
3.06
%
 
 

 
 

 
2.85
%
 
 
 
 
 
 
 
 
 
 
 
 
Average of interest-earning assets to average interest-bearing liabilities
 

 
 

 
122.52
%
 
 

 
 

 
122.57
%
 
 
 
 
 
 
 
 
 
 
 
 
Less tax equivalent adjustment (3)
 
 
(20
)
 
 
 
 
 
(14
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 

 
$
9,687

 
 

 
 

 
$
7,087

 
 

 
 
(1) Amount is net of deferred loan origination fees and costs.  Average balances include nonaccrual loans and loans held for sale and excludes the allowance for loan losses.
(2) Loan fees are included in interest income and are immaterial.
(3) Municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%.  The tax equivalent adjustment is deducted from tax equivalent net interest income to agree to the amounts reported in the statements of operations.
(4) Includes mortgagors’ and investors’ escrow accounts.
(5) Includes brokered deposits.
(6) Tax equivalent net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(7) Tax equivalent net interest margin represents tax equivalent net interest income divided by average interest-earning assets.

42



 
At or For the Nine Months Ended September 30,
 
2014
 
2013
 
Average
Balance
 
Interest &
Dividends
 
Average
Yield/
Rate
 
Average
Balance
 
Interest &
Dividends
 
Average
Yield/
Rate
 
(Dollars in Thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1) (2)
$
1,048,969

 
$
32,489

 
4.14
%
 
$
712,285

 
$
22,822

 
4.28
%
Securities (3)
185,649

 
3,008

 
2.17

 
197,408

 
3,176

 
2.15

Other interest-earning assets
28,558

 
39

 
0.18

 
23,574

 
31

 
0.18

Total interest-earning assets
1,263,176

 
35,536

 
3.76

 
933,267

 
26,029

 
3.73

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets
91,825

 
 

 
 

 
55,512

 
 

 
 

Total assets
$
1,355,001

 
 

 
 

 
$
988,779

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 

 
 

 
 

Business checking
$
155

 

 

 
$
33

 

 

NOW and money market
454,573

 
441

 
0.13

 
321,930

 
344

 
0.14

Savings (4)
47,026

 
61

 
0.17

 
42,175

 
55

 
0.17

Certificates of deposit (5)
362,829

 
3,531

 
1.30

 
276,966

 
3,478

 
1.68

Total interest-bearing deposits
864,583

 
4,033

 
0.62

 
641,104

 
3,877

 
0.81

 
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank advances
165,472

 
1,921

 
1.55

 
102,158

 
2,227

 
2.91

Subordinated debt
8,248

 
251

 
4.07

 
8,248

 
251

 
4.07

Other borrowed funds

 

 

 
1,325

 
2

 
0.20

Total interest-bearing liabilities
1,038,303

 
6,205

 
0.80

 
752,835

 
6,357

 
1.13

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities
160,653

 
 

 
 

 
105,574

 
 

 
 

Total liabilities
1,198,956

 
 

 
 

 
858,409

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total shareholders' equity
156,045

 
 

 
 

 
130,370

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
$
1,355,001

 
 

 
 

 
$
988,779

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest-earning assets
$
224,873

 
 

 
 

 
$
180,432

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent net interest income (3)
 

 
29,331

 
 

 
 

 
19,672

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent interest rate spread (6)
 

 
 

 
2.96
%
 
 

 
 

 
2.60
%
 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent net interest margin as a percentage of interest-earning assets (7)
 

 
 

 
3.10
%
 
 

 
 

 
2.82
%
 
 
 
 
 
 
 
 
 
 
 
 
Average of interest-earning assets to average interest-bearing liabilities
 

 
 

 
121.66
%
 
 

 
 

 
123.97
%
 
 
 
 
 
 
 
 
 
 
 
 
Less tax equivalent adjustment (3)
 
 
(54
)
 
 
 
 
 
(21
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 

 
$
29,277

 
 

 
 

 
$
19,651

 
 

 
 
(1) Amount is net of deferred loan origination fees and costs.  Average balances include nonaccrual loans and loans held for sale and excludes the allowance for loan losses.
(2) Loan fees are included in interest income and are immaterial.
(3) Municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%.  The tax equivalent adjustment is deducted from tax equivalent net interest income to agree to the amounts reported in the statements of operations.
(4) Includes mortgagors’ and investors’ escrow accounts.
(5) Includes brokered deposits.
(6) Tax equivalent net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(7) Tax equivalent net interest margin represents tax equivalent net interest income divided by average interest-earning assets.

43




The following table sets forth the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have on the Company’s interest income and interest expense for the periods presented. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the rate and volume columns. For purposes of this table, changes attributable to both changes in rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
 
 
Three Months Ended
September 30, 2014 and 2013
 
Nine Months Ended
September 30, 2014 and 2013
 
Increase (Decrease) Due To
 
Increase (Decrease) Due To
 
Rate
 
Volume
 
Net
 
Rate
 
Volume
 
Net
 
(In Thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Interest and dividend income:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
(160
)
 
$
2,790

 
$
2,630

 
$
(785
)
 
$
10,452

 
$
9,667

Securities (3)
10

 
(58
)
 
(48
)
 
19

 
(187
)
 
(168
)
Other interest-earning assets
(3
)
 
4

 
1

 
1

 
7

 
8

Total interest-earning assets
(153
)
 
2,736

 
2,583

 
(765
)
 
10,272

 
9,507

Interest-bearing liabilities:
 

 
 

 
 

 
 
 
 
 
 
Interest expense:
 

 
 

 
 

 
 
 
 
 
 
Deposits (4)
(205
)
 
319

 
114

 
(919
)
 
1,075

 
156

Federal Home Loan Bank advances
(338
)
 
204

 
(134
)
 
(1,318
)
 
1,012

 
(306
)
Subordinated debt
(1
)
 

 
(1
)
 

 

 

Other borrowed funds
(1
)
 
(1
)
 
(2
)
 
(1
)
 
(1
)
 
(2
)
Total interest-bearing liabilities
(545
)
 
522

 
(23
)
 
(2,238
)
 
2,086

 
(152
)
Change in net interest income
$
392

 
$
2,214

 
$
2,606

 
$
1,473

 
$
8,186

 
$
9,659

 
 
(1) Amount is net of deferred loan origination fees and costs.  Average balances include nonaccrual loans and loans held for sale.
(2) Loan fees are included in interest income and are immaterial.
(3) Municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 34%.  The tax equivalent adjustment is deducted from tax equivalent net interest income to agree to the amount reported in the statements of operations.
(4) Includes mortgagors’ and investors’ escrow accounts and brokered deposits.

Provision for Loan Losses. The provision for loan losses decreased $93,000 for the third quarter of 2014 compared to the same period in 2013, as a result of reductions in nonperforming loans and reserves for impaired loans, offset by increased net loan charge-offs. The provision for loan losses increased $562,000 for the nine months ended September 30, 2014, compared to the same period in 2013, primarily due to an increase in commercial loans outstanding which carry a higher degree of risk than other loans held in portfolio, offset by decreases in nonperforming loans and loan charge-offs. At September 30, 2014, nonperforming loans totaled $4.9 million, compared to $7.7 million at September 30, 2013, resulting from decreases in nonperforming multi-family and commercial mortgage loans and residential mortgage loans of $1.7 million and $1.3 million, respectively. Net loan charge-offs were $176,000 and $492,000 for the three and nine months months ended September 30, 2014, respectively, consisting primarily of residential and commercial mortgage loan charge-offs, compared to net loan charge-offs of $128,000 and $698,000 for the three and nine months ended September 30, 2013, respectively.





44



Noninterest Income.  The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
 
Three Months Ended September 30,
 
Change
 
Nine Months Ended
September 30,
 
Change
 
2014
 
2013
 
Dollars
 
Percent
 
2014
 
2013
 
Dollars
 
Percent
 
(Dollars in Thousands)
Net impairment losses
$

 
$

 
$

 
 %
 
$

 
$
(8
)
 
$
8

 
(100.0
)%
Service fees
1,762

 
1,515

 
247

 
16.3

 
5,265

 
3,964

 
1,301

 
32.8

Wealth management fees
293

 
302

 
(9
)
 
(3.0
)
 
926

 
846

 
80

 
9.5

Increase in cash surrender value of bank-owned life insurance
147

 
90

 
57

 
63.3

 
433

 
226

 
207

 
91.6

Net gain (loss) on sales of securities

 
(922
)
 
922

 
(100.0
)
 
64

 
(919
)
 
983

 
(107.0
)
Mortgage banking
81

 
69

 
12

 
17.4

 
396

 
919

 
(523
)
 
(56.9
)
Net gain on fair value of derivatives
78

 
18

 
60

 
333.3

 
69

 
191

 
(122
)
 
(63.9
)
Other
85

 
161

 
(76
)
 
(47.2
)
 
527

 
526

 
1

 
0.2

Total noninterest income
$
2,446

 
$
1,233

 
$
1,213

 
98.4
 %
 
$
7,680

 
$
5,745

 
$
1,935

 
33.7
 %
 
Increases in service fees and the cash surrender value of bank-owned life insurance ("BOLI") contributed to higher noninterest income during 2014, offset for the nine-month period by a decline in mortgage banking activities and a reduction in the fair value of certain derivative instruments. Service fees increased $247,000 and $1.3 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in the prior year, as a result of additional deposit customers from the Newport acquisition. The increase in the cash surrender value of BOLI for 2014 was the result of additional BOLI policies acquired in the Newport acquisition. Mortgage banking fees increased $12,000 during the third quarter of 2014 and decreased $523,000 during the nine months ended September 30, 2014, as compared to the same periods in the prior year. The decrease for the nine-month period was due to a lower volume of residential mortgage loan sales as compared to 2013 due to higher interest rates. Other noninterest income for the first nine months of 2014 included the reimbursement of $250,000 in legal fees and other foreclosure expenses incurred in a prior period on two commercial loans, offset by an impairment charge of $175,000 to reduce the carrying value of one of the Bank's small business investment company limited partnerships. For the three and nine months ended September 30, 2013, the Company recognized net losses of $922,000 and $919,000, primarily related to the sale of $3.4 million in collateralized debt obligations and non-agency mortgage-backed securities previously classified as substandard, offset by a gain of $201,000 on the sale of $3.0 million in commercial business loans held for investment reported in other noninterest income.
  

45



Noninterest Expenses. The following table shows the components of noninterest expenses and the dollar and percentage changes for the periods presented.
 
Three Months Ended September 30,
 
Change
 
Nine Months Ended September 30,
 
Change
 
2014
 
2013
 
Dollars
 
Percent
 
2014
 
2013
 
Dollars
 
Percent
 
(Dollars in Thousands)
Salaries and employee benefits
$
4,897

 
$
4,394

 
$
503

 
11.4
 %
 
$
15,128

 
$
12,923

 
$
2,205

 
17.1
 %
Occupancy and equipment
1,883

 
1,417

 
466

 
32.9

 
5,852

 
4,104

 
1,748

 
42.6

Computer and electronic banking services
1,417

 
1,057

 
360

 
34.1

 
4,082

 
2,896

 
1,186

 
41.0

Outside professional services
420

 
298

 
122

 
40.9

 
1,422

 
948

 
474

 
50.0

Marketing and advertising
216

 
170

 
46

 
27.1

 
754

 
471

 
283

 
60.1

Supplies
146

 
110

 
36

 
32.7

 
465

 
316

 
149

 
47.2

FDIC deposit insurance and regulatory assessments
303

 
251

 
52

 
20.7

 
953

 
714

 
239

 
33.5

Merger expenses

 
1,305

 
(1,305
)
 
(100.0
)
 

 
2,198

 
(2,198
)
 
(100.0
)
Core deposit intangible amortization
150

 
55

 
95

 
172.7

 
463

 
55

 
408

 
741.8

Other real estate operations
72

 
83

 
(11
)
 
(13.3
)
 
303

 
402

 
(99
)
 
(24.6
)
Other
500

 
1,234

 
(734
)
 
(59.5
)
 
1,873

 
2,137

 
(264
)
 
(12.4
)
Total noninterest expenses
$
10,004

 
$
10,374

 
$
(370
)
 
(3.6
)%
 
$
31,295

 
$
27,164

 
$
4,131

 
15.2
 %

Noninterest expenses decreased $370,000 for the third quarter of 2014 and increased $4.1 million for the first nine months of 2014, compared to the same periods in 2013. Excluding merger costs, noninterest expenses increased for both the three and nine months ended September 30, 2014 as a result of incremental operating costs attributable to the six acquired branches from the Newport merger. Increases in salaries and benefits included additional staff and higher benefit costs. An increase in outside professional services expense was primarily related to contractual payments to former Newport officers under their noncompetition agreements. Other noninterest expenses for the first nine months of 2014 included increases of $380,000 in fraudulent debit card transactions, core deposit intangible amortization of $463,000 associated with the assumption of Newport deposits and prepayment penalties totaling $75,000 for the early extinguishment of certain FHLB borrowings. For the three and nine months ended September 30, 2013, noninterest expenses included pre-tax merger costs for the acquisition of Newport of $1.3 million and $2.2 million, respectively, and prepayment penalties totaling $659,000 for the early extinguishment of FHLB borrowings.

Income Tax Provision. The provision for income taxes increased $1.3 million and $2.0 for the three and nine months ended September 30, 2014, respectively, compared to the same period in 2013. The effective tax rate for the three months ended September 30, 2014 and 2013 was 32.6% and 30.2%, respectively. The effective tax rate for the first nine months of 2014 and 2013 was 32.4% and 21.7%, respectively. Higher net income in 2014 contributed to a higher effective tax rate for both periods presented.
 
Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short- and long-term nature. The Bank's primary sources of funds consist of deposit inflows, loan sales and repayments, maturities and sales of securities and FHLB borrowings. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, mortgage prepayments and loan and security sales are greatly influenced by general interest rates, economic conditions and competition.

The Bank's most liquid assets are cash and cash equivalents. The levels of these assets depend on the Bank's operating, financing, lending and investing activities during any given period. At September 30, 2014, cash and

46



cash equivalents totaled $33.6 million. Securities classified as available for sale, which provide additional sources of liquidity, totaled $170.8 million at September 30, 2014. In addition, at September 30, 2014, the Bank had the ability to borrow $106.7 million from the FHLB, which includes overnight lines of credit of $10.0 million. On that date, the Bank had FHLB advances outstanding of $154.1 million and no overnight advances outstanding. Additionally, the Bank has the ability to access the Federal Reserve Bank’s Discount Window on a collateralized basis and maintains a $7.0 million unsecured line of credit with a financial institution to access federal funds. The Bank believes that its liquid assets combined with the available line from the FHLB provide adequate liquidity to meet its current financial obligations.

The Bank's primary investing activities are the origination, purchase and sale of loans and the purchase and sale of securities. For the nine months ended September 30, 2014, the Bank originated $111.8 million of loans and purchased $24.6 million of securities and $38.6 million of loans. For the year ended December 31, 2013, the Bank originated $217.5 million of loans and purchased $54.7 million of securities and $23.0 million of loans.

Financing activities consist primarily of activity in deposit accounts and in borrowed funds. The net increase in total deposits, including mortgagors’ and investors’ escrow accounts, was $11.7 million for the nine months ended September 30, 2014. Certificates of deposit due within one year of September 30, 2014 totaled $156.9 million, or 15.7% of total deposits. Management believes that the amount of deposits in shorter-term certificates of deposit reflects customers’ hesitancy to invest their funds in longer-term certificates of deposit due to the uncertain interest rate environment. The Bank will be required to seek other sources of funds, including other certificates of deposit and lines of credit, if maturing certificates of deposit are not retained. Depending on market conditions, the Bank may be required to pay higher rates on such deposits or other borrowings than are currently paid on certificates of deposit. Additionally, a shorter duration in the securities portfolio may be necessary to provide liquidity to compensate for any deposit outflows. The Bank believes, however, based on past experience, a significant portion of its certificates of deposit will be retained. The Bank has the ability, if necessary, to adjust the interest rates offered to its customers in an effort to attract and retain deposits.  

Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Bank and its local competitors and other factors. The Bank generally manages the pricing of its deposits to be competitive and to increase core deposits and commercial banking relationships. Occasionally, the Bank offers promotional rates on certain deposit products to attract deposits.

FHLB advances decreased $22.1 million during the nine months ended September 30, 2014 and increased $78.6 million during the year ended December 31, 2013.

The Company repurchased 67,145 shares of the Company's common stock at a cost of $761,000 during the first nine months of 2014 and 8,336 shares of the Company’s common stock at a cost of $98,000 during the year ended December 31, 2013. Additional discussion about the Company’s liquidity and capital resources is contained in Item 7 in the Company’s 2013 Annual Report on Form 10-K.

SI Financial Group, Inc. is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, SI Financial Group is responsible for paying any dividends declared to its shareholders and making payments on its subordinated debentures. SI Financial Group may continue to repurchase shares of its common stock in the future. SI Financial Group’s primary sources of funds are interest and dividends on securities and dividends received from the Bank. The amount of dividends that the Bank may declare and pay to SI Financial Group in any calendar year, without the receipt of prior approval from the Office of the Comptroller of the Currency (“OCC”) but with prior notice to the OCC, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. SI Financial Group believes that such restriction will not have an impact on SI Financial Group's ability to meet its ongoing cash obligations. At September 30, 2014, SI Financial Group had cash and cash equivalents of $12.7 million and available for sale securities of $3.0 million.



47



Payments Due Under Contractual Obligations

Information relating to payments due under contractual obligations is presented in the Company’s Form 10-K for the year ended December 31, 2013. There were no material changes in the Company’s payments due under contractual obligations between December 31, 2013 and September 30, 2014.

Off-Balance Sheet Arrangements

As a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit, standby letters of credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of the commitments to extend credit may expire without being drawn upon. The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Financial instruments whose contract amounts represent credit risk at September 30, 2014 and December 31, 2013 are as follows:
 
 
September 30, 2014
 
December 31, 2013
 
(In Thousands)
Commitments to extend credit:
 
 
 
Commitments to originate loans
$
11,045

 
$
8,742

Undisbursed construction loans
9,770

 
9,193

Undisbursed home equity lines of credit
45,106

 
41,031

Undisbursed commercial lines of credit
66,360

 
59,930

Overdraft protection lines
1,224

 
1,221

Standby letters of credit
81

 
81

Total commitments
$
133,586

 
$
120,198

 
Future loan commitments at September 30, 2014 and December 31, 2013 included fixed-rate loan commitments of $4.8 million and $6.9 million, respectively, at interest rates ranging from 2.50% to 5.00% and 2.75% to 5.75%, respectively.

The Bank is a limited partner in two small business investment corporations ("SBICs"). At September 30, 2014, the Bank’s remaining off-balance sheet commitment for the capital investment in the SBICs was $572,000. The Bank recognized write-downs of $175,000 and $81,000 on its investment in one of the SBICs during the nine months ended September 30, 2014 and 2013, respectively.

For the nine months ended September 30, 2014, with the exception of the aforementioned commitments, the Company did not engage in any additional off-balance sheet transactions reasonably likely to have a material effect on the Company’s financial condition, results of operations or cash flows. See Notes 6 and 12 to the consolidated financial statements contained in the Company’s 2013 Annual Report on Form 10-K.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

Qualitative Aspects of Market Risk
The primary market risk affecting the financial condition and operating results of the Company is interest rate risk. Interest rate risk is the exposure of current and future earnings and capital arising from movements in interest rates. The Company manages the interest rate sensitivity of its interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. To reduce the volatility of its earnings, the Company has sought to improve the match between asset and liability maturities and

48



rates, while maintaining an acceptable interest rate spread. The Company’s strategy for managing interest rate risk generally is to emphasize the origination of adjustable-rate mortgage loans for retention in its loan portfolio. However, the ability to originate adjustable-rate loans depends to a great extent on market interest rates and borrowers’ preferences. As an alternative to adjustable-rate mortgage loans, the Company purchases variable-rate SBA and USDA loans in the secondary market that are fully guaranteed by the U.S. government. These loans have a significantly shorter duration than fixed-rate mortgage loans. Fixed-rate mortgage loans typically have an adverse effect on interest rate sensitivity compared to adjustable-rate loans. Accordingly, the Company has sold more longer-term fixed-rate mortgage loans in the secondary market in recent periods to manage interest rate risk. The Company may offer attractive rates for existing certificates of deposit accounts to extend their maturities. The Company also uses shorter-term investment securities and longer-term borrowings from the FHLB to help manage interest rate risk.

The Company has an Asset/Liability Committee to communicate, coordinate and control all aspects involving asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.
 
In July 2010, the Company entered into an interest rate swap agreement with a third-party financial institution with a notional amount of $8.0 million, whereby the counterparty will pay a variable rate equal to three-month LIBOR and the Company will pay a fixed rate of 2.44%. The agreement was effective on December 15, 2010 and terminates on December 15, 2015. This agreement was designated as a cash flow hedge against the trust preferred securities issued by SI Capital Trust II, which effectively converts the variable interest rate on the $8.0 million of trust preferred securities to a fixed rate of 4.14% for the period of December 15, 2010 through December 15, 2015.

In January 2012, the Company entered into an interest rate swap agreement with a third-party financial institution with a notional amount of $15.0 million, whereby the counterparty will pay a variable rate equal to three-month LIBOR and the Company will pay a fixed rate of 1.255%. The agreement was effective on January 11, 2012 and terminates on January 11, 2017. This agreement was not designated as a hedging instrument.

Quantitative Aspects of Market Risk
The Company analyzes its interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income simulation. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The Company’s goal is to manage asset and liability positions to moderate the effect of interest rate fluctuations on net interest income.

Net Interest Income Simulation Analysis
Interest income simulations are completed quarterly and presented to the Asset/Liability Committee. The simulations provide an estimate of the impact of changes in interest rates on net interest income under a range of assumptions. The numerous assumptions used in the simulation process are reviewed by the Asset/Liability Committee on a quarterly basis. Changes to these assumptions can significantly affect the results of the simulation. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change adversely over time due to competition or other factors. Simulation analysis is only an estimate of the Company’s interest rate risk exposure at a particular point in time. The Company continually reviews the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.

The table below sets forth an approximation of the Company’s exposure as a percentage of estimated net interest income for the next 12- and 24-month periods using interest income simulation. The simulation uses projected

49



repricing of assets and liabilities at September 30, 2014 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the large percentage of loans and mortgage-backed securities the Company holds, rising or falling interest rates have a significant impact on the prepayment speeds of the Company’s earning assets that in turn affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. The Company’s asset sensitivity would be reduced if prepayments slow and vice versa. While the Company believes such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

The following table reflects changes in estimated net interest income for the Company at September 30, 2014.
 
Percentage Change in Estimated
Net Interest Income Over
 
12 Months
 
24 Months
100 basis point decrease in rates
(2.10
)%
 
(3.44
)%
300 basis point increase in rates
(0.38
)
 
(0.99
)
400 basis point increase in rates
(0.46
)
 
(1.45
)

As indicated by the results of the above scenarios, net interest income would be adversely affected (within our internal guidelines) in the 12- and 24-month periods if rates decreased 100 basis points or increased 300 or 400 basis points. Net interest income would be only minimally impacted if rates increased 300 and 400 basis points as a result of the Company's initiative to position the balance sheet for the anticipated increase in market interest rates. The Company’s strategy for mitigating interest rate risk includes the purchase of adjustable-rate investment securities and SBA and USDA loans that will reprice in a rising rate environment, selling longer-term and lower fixed-rate residential mortgage loans in the secondary market, restructuring FHLB advances to current lower market interest rates while extending their duration and utilizing certain derivative instruments such as forward loan sale commitments to manage the risk of loss associated with its mortgage banking activities. Additionally, the interest rate swap agreement used to hedge the interest rate of the Company’s long-term variable-rate debt effectively converts the debt to a fixed-rate of interest, which reflects favorably on net interest income in a rising rate environment.

Item 4.  Controls and Procedures.

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. No changes in the Company’s internal control over financial reporting occurred during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings.

The Company is not involved in any pending legal proceedings believed by management to be material to the Company’s financial condition or results of operations.  Periodically, there have been various claims and lawsuits against the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds

50



a security interest, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business.  Management believes that these legal proceedings would not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Item 1A.  Risk Factors.

There are no material changes from the risk factors set forth under Part I, Item 1A.  “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which could materially and adversely affect the Company’s business, financial condition or future results.  The risks described in the Company’s Annual Report on Form 10-K are not the only risks that the Company faces.  Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.
 
The Company's repurchases of equity securities for the three months ended September 30, 2014 were as follows:
Period
 
Total Number of Shares Purchased (1)
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs
July 1 - 31, 2014
 

 
$

 

 
22,963

August 1 - 31, 2014
 
22,963

 
11.07

 
22,963

 

September 1 - 30, 2014
 
163

 
11.15

 

 

Total
 
23,126

 
$
11.07

 
22,963

 
 
 
 
(1) On May 8, 2012, the Company announced that the Board of Directors had approved a stock repurchase program authorizing the Company to repurchase up to 5%, or 528,815 shares, of its common stock from time to time, depending on market conditions. All shares have been repurchased under this repurchase program.

Item 3.  Defaults Upon Senior Securities.

None.

Item 4.  Mine Safety Disclosures.

None.

Item 5.  Other Information.

None.


51



Item 6.  Exhibits.
 
3.1
Articles of Incorporation of SI Financial Group, Inc. (1)
3.2
Bylaws of SI Financial Group, Inc. (2)
4
Specimen Stock Certificate of SI Financial Group, Inc. (1)
31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32
18 U.S.C. Section 1350 Certifications
101
The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in eXtensible Business Reporting Language (XBRL):  (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income (Loss), (iv) the Condensed Statement of Changes in Shareholders' Equity, (v) the Condensed Consolidated Statements of Cash Flows and (vi) related Notes to Consolidated Financial Statements.
 
 
(1) Incorporated herein by reference into this document from the Exhibits on the Registration Statement on Form S-1 (File No. 333-169302), and any amendments thereto, filed with the Securities and Exchange Commission on September 10, 2010.
(2) Incorporated herein by reference into this document from the Exhibits to the Company’s Current Report on Form 8-K (File No. 000-54241) filed with the Securities and Exchange Commission on December 19, 2012.


 


52



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
SI FINANCIAL GROUP, INC.
 
 
 
 
 
 
 
 
Date:
November 6, 2014
 
/s/ Rheo A. Brouillard
 
 
 
Rheo A. Brouillard
 
 
 
President and Chief Executive Officer
 
 
 
(principal executive officer)

Date:
November 6, 2014
 
 /s/ Brian J. Hull
 
 
 
Brian J. Hull
 
 
 
Executive Vice President, Chief Financial Officer, Treasurer and Chief Operating Officer
 
 
 
(principal financial officer)
 
 
 
 
Date:
November 6, 2014
 
 /s/ Lauren L. Murphy
 
 
 
Lauren L. Murphy
 
 
 
Senior Vice President, Corporate Controller and Principal Accounting Officer
 
 
 
(principal accounting officer)




53