SIFI 03.31.2014 10-Q1

 
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 March 31, 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 May 2, 2014, there were 12,828,406 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 March 31, 2014 and December 31, 2013
 
 
 
 
 
 
Consolidated Statements of Operations for the three months ended March 31, 2014 and 2013
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2014 and 2013
 
 
 
 
 
 
Consolidated Statement of Changes in Shareholders’ Equity for the three months ended March 31, 2014
 
 
 
 
 
 
Consolidated Statements of Cash Flows for the three months ended March 31, 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)
 
March 31,
2014
 
December 31,
2013
ASSETS:
 
 
 
Cash and due from banks:
 
 
 
Noninterest-bearing
$
18,728

 
$
20,554

Interest-bearing
34,999

 
6,767

Total cash and cash equivalents
53,727

 
27,321

 
 
 
 
Available for sale securities, at fair value
169,985

 
170,220

Loans held for sale
686

 
1,764

Loans receivable (net of allowance for loan losses of $7,252 at March 31, 2014 and $6,916 at December 31, 2013)
1,042,037

 
1,047,410

Federal Home Loan Bank stock, at cost
13,109

 
13,109

Bank-owned life insurance
20,868

 
20,726

Premises and equipment, net
20,634

 
21,090

Goodwill and other intangibles
19,402

 
19,566

Accrued interest receivable
3,920

 
4,021

Deferred tax asset, net
9,536

 
9,705

Other real estate owned, net
2,037

 
2,429

Other assets
7,188

 
9,018

Total assets
$
1,363,129

 
$
1,346,379

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY:
 

 
 

Liabilities:
 

 
 

Deposits:
 

 
 

Noninterest-bearing
$
136,185

 
$
139,428

Interest-bearing
868,098

 
845,321

Total deposits
1,004,283

 
984,749

 
 
 
 
Mortgagors' and investors' escrow accounts
1,617

 
3,214

Federal Home Loan Bank advances
169,922

 
176,272

Junior subordinated debt owed to unconsolidated trust
8,248

 
8,248

Accrued expenses and other liabilities
24,761

 
21,054

Total liabilities
1,208,831

 
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; 12,822,157 and 12,798,461 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively)
128

 
128

Additional paid-in-capital
125,621

 
125,277

Unallocated common shares held by ESOP
(4,488
)
 
(4,608
)
Unearned restricted shares
(1,637
)
 
(1,751
)
Retained earnings
35,182

 
34,644

Accumulated other comprehensive loss
(508
)
 
(848
)
Total shareholders' equity
154,298

 
152,842

Total liabilities and shareholders' equity
$
1,363,129

 
$
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 March 31,
 
2014
 
2013
Interest and dividend income:
 
 
 
Loans, including fees
$
11,087

 
$
7,523

Securities:
 

 
 

Taxable interest
880

 
1,022

Tax-exempt interest
42

 

Dividends
49

 

Other
13

 
10

Total interest and dividend income
12,071

 
8,555

 
 
 
 
Interest expense:
 

 
 

Deposits
1,319

 
1,352

Federal Home Loan Bank advances
682

 
775

Subordinated debt and other borrowings
83

 
83

Total interest expense
2,084

 
2,210

 
 
 
 
Net interest income
9,987

 
6,345

 
 
 
 
Provision for loan losses
430

 
135

 
 
 
 
Net interest income after provision for loan losses
9,557

 
6,210

 
 
 
 
Noninterest income:
 

 
 

Service fees
1,718

 
1,216

Wealth management fees
323

 
257

Increase in cash surrender value of bank-owned life insurance
142

 
68

Net gain on sales of securities
35

 
3

Mortgage banking
160

 
579

Net gain on fair value of derivatives
17

 
47

Other
377

 
270

Total noninterest income
2,772

 
2,440

 
 
 
 
Noninterest expenses:
 

 
 

Salaries and employee benefits
5,200

 
4,408

Occupancy and equipment
2,107

 
1,383

Computer and electronic banking services
1,352

 
868

Outside professional services
449

 
268

Marketing and advertising
226

 
130

Supplies
168

 
100

FDIC deposit insurance and regulatory assessments
349

 
233

Merger expenses

 
684

Core deposit intangible amortization
164

 

Other real estate operations
169

 
127

Other
770

 
380

Total noninterest expenses
10,954

 
8,581

 
 
 
 
Income before income tax provision
1,375

 
69

Income tax provision
469

 
146

Net income (loss)
$
906

 
$
(77
)
 
 
 
 
Earnings (loss) per share:
 

 
 

Basic
$
0.07

 
$
(0.01
)
Diluted
$
0.07

 
$
(0.01
)
 

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
March 31,
 
 
 
2014
 
2013
Net income (loss)
 
$
906

 
$
(77
)
Other comprehensive income (loss), net of tax:
 
 
 
 
Available for sale securities:
 
 
 
 
Net unrealized holding gains (losses)
 
340

 
(4
)
Reclassification adjustment for gains recognized in net income (loss) (1)
 
(23
)
 
(2
)
Plus: noncredit portion of OTTI loss
 

 
(35
)
Net unrealized gains (losses) on available for sale securities
 
317

 
(41
)
 Net unrealized gain on interest-rate swap derivative
 
23

 
28

Other comprehensive income (loss)
 
340

 
(13
)
Comprehensive income (loss)
 
$
1,246

 
$
(90
)
 
 
 
 
 
 
(1) Amounts are included in net gain on the sales of securities in noninterest income on the consolidated statements of operations. Income tax expense associated with the reclassification adjustment for the three months ended March 31, 2014 and 2013 was $12,000 and $1,000, respectively.


See accompanying notes to unaudited interim consolidated financial statements.

    
 



3



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 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

 

 

 

 

 
906

 
340

 
1,246

Cash dividends declared ($0.03 per share)

 

 

 

 

 
(368
)
 

 
(368
)
Equity incentive plan compensation

 

 
75

 

 
114

 

 

 
189

Allocation of 12,159 ESOP shares

 

 
22

 
120

 

 

 

 
142

Tax benefit from share-based compensation

 

 
3

 

 

 

 

 
3

Stock options exercised
29,890

 

 
316

 

 

 

 

 
316

Common shares repurchased
(6,194
)
 

 
(72
)
 

 

 

 

 
(72
)
Balance at March 31, 2014
12,822,157

 
$
128

 
$
125,621

 
$
(4,488
)
 
$
(1,637
)
 
$
35,182

 
$
(508
)
 
$
154,298

 
See accompanying notes to unaudited interim consolidated financial statements.


4



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands / Unaudited)
 
Three Months Ended
March 31,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income (loss)
$
906

 
$
(77
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 

Provision for loan losses
430

 
135

Employee stock ownership plan expense
142

 
144

Equity incentive plan expense
189

 
192

Excess tax benefit from share-based compensation
(3
)
 
(3
)
Amortization of investment premiums and discounts, net
282

 
307

Amortization of loan premiums and discounts, net
322

 
346

Depreciation and amortization of premises and equipment
629

 
424

Amortization of core deposit intangible
164

 

Amortization of deferred debt issue costs
46

 
53

Net gain on sales of securities
(35
)
 
(3
)
Net gain on fair value of derivatives
(17
)
 
(47
)
Deferred income tax provision (benefit)
(6
)
 
26

Loans originated for sale
(4,307
)
 
(13,136
)
Proceeds from sale of loans held for sale
5,410

 
13,520

Net gain on sales of loans held for sale
(94
)
 
(522
)
Net gain on sales of loans held for investment

 
(201
)
Net loss on sales or write-downs of other real estate owned
35

 
25

Increase in cash surrender value of bank-owned life insurance
(142
)
 
(68
)
Change in operating assets and liabilities:
 

 
 

Accrued interest receivable
101

 
60

Other assets
1,899

 
(264
)
Accrued expenses and other liabilities
3,762

 
(493
)
Net cash provided by operating activities
9,713

 
418

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of available for sale securities
(12,297
)
 
(31,359
)
Proceeds from sales of available for sale securities
81

 
1,000

Proceeds from maturities of and principal repayments on available for sale securities
12,684

 
10,406

Redemption of Federal Home Loan Bank stock

 
325

Loan principal collections, net of originations
5,064

 
13,190

Purchases of loans
(443
)
 
(3,549
)
Proceeds from sales of loans held for investment

 
3,197

Proceeds from sales of other real estate owned
357

 
552

Purchases of premises and equipment
(173
)
 
(868
)
Net cash provided by (used in) investing activities
5,273

 
(7,106
)
 
 
 
 

5



SI FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
(In Thousands / Unaudited)
 
Three Months Ended
March 31,
 
2014
 
2013
Cash flows from financing activities:
 

 
 

Net increase in deposits
19,534

 
8,030

Net decrease in mortgagors' and investors' escrow accounts
(1,597
)
 
(1,490
)
Proceeds from Federal Home Loan Bank advances
10,000

 
4,000

Repayments of Federal Home Loan Bank advances
(16,396
)
 
(6,000
)
Excess tax benefit from share-based compensation
3

 
3

Cash dividends on common stock
(368
)
 
(287
)
Stock options exercised
316

 

Common shares repurchased
(72
)
 
(6
)
Net cash provided by financing activities
11,420

 
4,250

 
 
 
 
 
 
 
 
Net change in cash and cash equivalents
26,406

 
(2,438
)
Cash and cash equivalents at beginning of period
27,321

 
37,689

Cash and cash equivalents at end of period
$
53,727

 
$
35,251

 
 
 
 
Supplemental cash flow information:
 

 
 

Interest paid
$
2,075

 
$
2,184

Income taxes paid (refunded), net
(1,816
)
 
862

Transfer of loans to other real estate owned

 
283


 See accompanying notes to unaudited interim consolidated financial statements.

6

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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"), the holding company for Newport Federal Savings Bank. The acquisition added six full-service banking offices located 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, 803 Financial Corp., 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 March 31, 2014 and for the three months ended March 31, 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 period covered herein. The results of operations for the three months ended March 31, 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
MARCH 31, 2014 AND 2013 AND DECEMBER 31, 2013
 
 
 
 
 
 

Reclassifications
Certain amounts in the Company’s prior year consolidated financial statements have been reclassified to conform to the current year presentation.  Such reclassifications had 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

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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 and nonaccrual loans; level of loan charge-offs; trends in volume, nature and terms of loans; existence and effect of/or changes in the level of credit concentrations; effects of changes in risk selection, underwriting standards and other changes in lending policies, procedures and practices; experience/ability and depth of lending management and staff, national and local economic trends and conditions and impact on value of underlying collateral for collateral dependent loans.

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, 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. To a lesser but increasing extent, the Bank 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.


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SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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, the regulatory agencies, 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 and direct loan origination costs 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
MARCH 31, 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 and retained earnings balances.

Recent Accounting Pronouncements
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.

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 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 394,497 and 481,254 for the three months ended March 31, 2014 and 2013, respectively. For the quarter ended March 31, 2013, all common stock equivalents were anti-dilutive and were not included in the computation of loss per share because it would result in a reduction in the net loss per share.


11

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

The computation of earnings (loss) per share is as follows:
 
Three Months Ended March 31,
 
2014
 
2013
 
(Dollars in Thousands, Except Per Share Data)
Net income (loss)
$
906

 
$
(77
)
 
 
 
 
Weighted average common shares outstanding:
 

 
 

Basic
12,295,225

 
9,555,940

Effect of dilutive stock options
48,252

 

Diluted
12,343,477

 
9,555,940

 
 
 
 
Earnings (loss) per share:
 

 
 

Basic
$
0.07

 
$
(0.01
)
Diluted
$
0.07

 
$
(0.01
)

NOTE 3.  SECURITIES

Available for sale securities:
The amortized cost, gross unrealized gains and losses and approximate fair values of available for sale securities at March 31, 2014 and December 31, 2013 are as follows:
 
 
March 31, 2014
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(In Thousands)
Debt securities:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
54,887

 
$
388

 
$
(188
)
 
$
55,087

Government-sponsored enterprises
22,663

 
88

 
(224
)
 
22,527

Mortgage-backed securities:(1)
 
 
 

 
 

 
 

Agency - residential
77,645

 
881

 
(1,505
)
 
77,021

Non-agency - residential
412

 
16

 
(2
)
 
426

Corporate debt securities
2,961

 
64

 

 
3,025

Collateralized debt obligation
1,190

 

 
(9
)
 
1,181

Obligations of state and political subdivisions
4,056

 
182

 
(57
)
 
4,181

Tax-exempt securities
6,664

 

 
(127
)
 
6,537

Total available for sale securities
$
170,478

 
$
1,619

 
$
(2,112
)
 
$
169,985

 
 
 
 
 
 
 
 
 
(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 one of the GSEs or the U.S. Government.



12

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 one of the GSEs or the U.S. Government.

The amortized cost and fair value of debt securities by contractual maturities at March 31, 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
$
7,477

 
$
7,569

After 1 but within 5 years
24,141

 
24,203

After 5 but within 10 years
21,534

 
21,385

After 10 years
39,269

 
39,381

 
92,421

 
92,538

Mortgage-backed securities
78,057

 
77,447

Total debt securities
$
170,478

 
$
169,985


The following is a summary of realized gains and losses on the sales of securities for the three months ended March 31, 2014 and 2013:
 
Three Months Ended
March 31,
 
2014
 
2013
 
(In Thousands)
Gross gains on sales
$
35

 
$
3

Gross losses on sales

 

Net gain on sale of securities
$
35

 
$
3


Proceeds from the sale of available for sale securities were $81,000 and $1.0 million for the three months ended March 31, 2014, and 2013, respectively.

13

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


The following tables present information pertaining to securities with gross unrealized losses at March 31, 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
March 31, 2014:
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In Thousands)
U.S. Government and agency obligations
$
29,614

 
$
164

 
$
760

 
$
24

 
$
30,374

 
$
188

Government sponsored enterprises
14,406

 
224

 

 

 
14,406

 
224

Mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Agency - residential
37,700

 
1,123

 
6,846

 
382

 
44,546

 
1,505

Non-agency - residential
163

 
2

 

 

 
163

 
2

Collateralized debt obligation

 

 
1,181

 
9

 
1,181

 
9

Obligations of state and political subdivisions
1,204

 
57

 

 

 
1,204

 
57

Tax-exempt securities
6,365

 
127

 

 

 
6,365


127

Total
$
89,452

 
$
1,697

 
$
8,787

 
$
415

 
$
98,239

 
$
2,112


 
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 March 31, 2014, fifty debt securities with gross unrealized losses had aggregate depreciation of approximately 2.10% of the Company’s amortized cost basis. The majority of the unrealized losses are related to the Company’s agency MBS. There were no impairment charges recognized on investments deemed other-than-temporarily impaired for the three months ended March 31, 2014 and 2013, respectively. The following summarizes, by security type, the basis for management’s determination during the preparation of the financial statements of whether the applicable investments within the Company’s securities portfolio were other-than-temporarily impaired at March 31, 2014.

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

14

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

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 March 31, 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 March 31, 2014.
 
Collateralized Debt Obligation. The unrealized losses on the Company’s collateralized debt obligations relate to one investment in a pooled trust preferred security (“PTPS”). The PTPS market has stabilized at depressed market values as a result of market saturation. Transactions for PTPS have been limited and have occurred primarily as a result of distressed or forced liquidation sales. The securities were widely held by hedge funds and European banks and used to offset interest rate exposure tied to LIBOR. As the positions have unwound, an excess supply of these securities has saturated the market.

Management evaluated current credit ratings, credit support and stress testing for future defaults related to the Company’s PTPS. Management also reviewed analytics provided by the trustee. The unrealized loss on the Company’s PTPS investment was caused by a lack of liquidity, credit downgrades and decreasing credit support. The increased number of bank and insurance company failures has decreased the level of credit support for this investment. A number of lower tranches have foregone payments or have received payment in kind through increased principal allocations. However, the number of deferring securities has been decreasing and a number of reinstatements have occurred recently. The Company's PTPS was upgraded to investment grade and based on its senior credit profile, management does not believe that this investment will suffer credit-related losses. Because the Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be at maturity, the Company did not record impairment losses at March 31, 2014.  

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 months ended March 31, 2014 and 2013.
 
 
Three Months Ended March 31,
 
2014
 
2013
 
(In Thousands)
Balance at beginning of period
$

 
$
259

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

 

Reduction for securities sold during the period (realized)

 

Balance at end of period
$

 
$
259



15

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 2014 and December 31, 2013 is as follows:
 
 
 
March 31, 2014
 
December 31, 2013
 
 
(In Thousands)
Real estate loans:
 
 
 
Residential - 1 to 4 family
$
439,970

 
$
449,812

Multi-family and commercial
291,276

 
285,660

Construction
10,621

 
10,162

Total real estate loans
741,867

 
745,634

 
 
 
 
 
Commercial business loans:
 

 
 

SBA and USDA guaranteed
128,433

 
137,578

Time share
38,022

 
28,615

Condominium association
18,608

 
18,442

Other
67,772

 
69,705

Total commercial business loans
252,835

 
254,340

 
 
 
 
 
Consumer loans:
 

 
 

Home equity
45,489

 
44,284

Indirect automobile
5,677

 
6,354

Other
1,819

 
2,116

Total consumer loans
52,985

 
52,754

 
 
 
 
 
Total loans
1,047,687

 
1,052,728

 
 
 
 
 
Deferred loan origination costs, net of fees
1,602

 
1,598

Allowance for loan losses
(7,252
)
 
(6,916
)
Loans receivable, net
$
1,042,037

 
$
1,047,410


The Company purchased commercial business loans totaling $443,000 during the three months ended March 31, 2014. For the twelve months ended December 31, 2013, the Company purchased commercial business loans totaling $23.0 million.


16

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

Allowance for Loan Losses
Changes in the allowance for loan losses for the three months ended March 31, 2014 and 2013 are as follows:
Three Months Ended
March 31, 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
33

 
207

 
15

 
130

 
45

 
430

Loans charged-off
(74
)
 

 

 
(13
)
 
(29
)
 
(116
)
Recoveries of loans previously charged-off
14

 

 

 
3

 
5

 
22

Balance at end of period
$
948

 
$
3,602

 
$
184

 
$
1,995

 
$
523

 
$
7,252


Three Months Ended
March 31, 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 (credit) for loan losses
242

 
71

 
5

 
(201
)
 
18

 
135

Loans charged-off
(266
)
 

 

 

 
(40
)
 
(306
)
Recoveries of loans previously charged-off

 
69

 

 

 
43

 
112

Balance at end of period
$
1,101

 
$
3,168

 
$
27

 
$
1,534

 
$
498

 
$
6,328


Further information pertaining to the allowance for loan losses at March 31, 2014 and December 31, 2013 is as follows:
March 31, 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
$
316

 
$
238

 
$

 
$
4

 
$

 
$
558

Allowance for loans individually or collectively evaluated and not deemed to be impaired
632

 
3,364

 
184

 
1,991

 
523

 
6,694

Allowance for loans acquired with deteriorated credit quality

 

 

 

 

 

Total allowance for loan losses
$
948

 
$
3,602

 
$
184

 
$
1,995

 
$
523

 
$
7,252

 
 
 
 
 
 
 
 
 
 
 
 
Loans individually evaluated and deemed to be impaired
$
5,830

 
$
2,926

 
$

 
$
355

 
$

 
$
9,111

Loans individually or collectively evaluated and not deemed to be impaired
433,760

 
283,956

 
10,621

 
252,107

 
52,985

 
1,033,429

Amount of loans acquired with deteriorated credit quality
380

 
4,394

 

 
373

 

 
5,147

Total loans
$
439,970

 
$
291,276

 
$
10,621

 
$
252,835

 
$
52,985

 
$
1,047,687


17

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

 
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


Past Due Loans
The following represents an aging of loans at March 31, 2014 and December 31, 2013:
 
March 31, 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
$
3,866

 
$
205

 
$
1,897

 
$
5,968

 
$
434,002

 
$
439,970

 
Multi-family and commercial
671

 
42

 
1,558

 
2,271

 
289,005

 
291,276

 
Construction

 

 

 

 
10,621

 
10,621

 
Commercial Business:
 

 
 

 
 

 
 

 
 

 
 

 
SBA and USDA guaranteed
3,528

 
860

 

 
4,388

 
124,045

 
128,433

 
Time share

 

 

 

 
38,022

 
38,022

 
Condominium association

 

 

 

 
18,608

 
18,608

 
Other(1)
905

 
143

 
338

 
1,386

 
66,386

 
67,772

 
Consumer:
 

 
 

 
 

 
 

 
 

 
 

 
Home equity

 

 

 

 
45,489

 
45,489

 
Indirect automobile
72

 

 

 
72

 
5,605

 
5,677

 
Other

 
1

 

 
1

 
1,818

 
1,819

 
Total
$
9,042

 
$
1,251

 
$
3,793

 
$
14,086

 
$
1,033,601

 
$
1,047,687

 



18

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

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 March 31, 2014 or December 31, 2013.

Impaired and Nonaccrual Loans
The following is a summary of impaired loans and nonaccrual loans at March 31, 2014 and December 31, 2013:
 
Impaired Loans(1)
 
 
March 31, 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
$
3,804

 
$
3,983

 
$

 
$
3,408

Multi-family and commercial
4,825

 
5,022

 

 
376

Commercial business - Other
720

 
720

 

 
346

Consumer - Home equity

 

 

 
49

Total impaired loans without valuation allowance
9,349

 
9,725

 

 
4,179

 
 
 
 
 
 
 
 
Impaired loans with valuation allowance:
 

 
 

 
 

 
 

Real Estate:
 
 
 
 
 
 
 
Residential - 1 to 4 family
2,406

 
2,433

 
316

 
474

Multi-family and commercial
2,495

 
2,585

 
238

 
1,322

Commercial business - Other
8

 
8

 
4

 
8

Total impaired loans with valuation allowance
4,909

 
5,026

 
558

 
1,804

Total impaired loans
$
14,258

 
$
14,751

 
$
558

 
$
5,983

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

19

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

 
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.

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 March 31, 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
March 31, 2014
 
Three Months Ended
March 31, 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
$
6,143

 
$
22

 
$
1

 
$
7,353

 
$
31

 
$
15

Multi-family and commercial
7,716

 
163

 
72

 
4,597

 
45

 

Commercial business - Other
1,102

 
17

 
10

 
454

 
6

 
4

Consumer - Home equity
59

 

 

 
392

 
16

 
15

Total
$
15,020

 
$
202

 
$
83

 
$
12,796

 
$
98

 
$
34




20

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 2014 and December 31, 2013:
March 31, 2014
Not Rated
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
 
(In Thousands)
Real Estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential - 1 to 4 family
$

 
$
431,375

 
$
1,287

 
$
7,308

 
$

 
$

 
$
439,970

Multi-family and commercial

 
259,031

 
16,448

 
15,797

 

 

 
291,276

Construction

 
10,621

 

 

 

 

 
10,621

Total real estate loans

 
701,027

 
17,735

 
23,105

 

 

 
741,867

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial Business:
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA guaranteed
128,433

 

 

 

 

 

 
128,433

Time share

 
38,022

 

 

 

 

 
38,022

Condominium association

 
18,608

 

 

 

 

 
18,608

Other

 
63,775

 
2,172

 
1,825

 

 

 
67,772

Total commercial business loans
128,433

 
120,405

 
2,172

 
1,825

 

 

 
252,835

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity

 
45,329

 
64

 
96

 

 

 
45,489

Indirect automobile

 
5,662

 

 
15

 

 

 
5,677

Other

 
1,819

 

 

 

 

 
1,819

Total consumer loans

 
52,810

 
64

 
111

 

 

 
52,985

Total loans
$
128,433

 
$
874,242

 
$
19,971

 
$
25,041

 
$

 
$

 
$
1,047,687


21

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 the year of 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.
 

22

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

The following table provides information on loans modified as TDRs during the three months ended March 31, 2014 and 2013.   
 
Three Months Ended March 31,
 
2014
 
2013
 
 
 
 
 
Allowance for Loan Losses (End of Period)
 
 
 
 
 
Allowance for Loan Losses (End of Period)
 
Number
 
Recorded
 
 
Number
 
Recorded
 
 
of Loans
 
Investment
 
 
of Loans
 
Investment
 
 
(Dollars in Thousands)
Residential - 1 to 4 family
 
$

 
$

 
1
 
$
413

 
$
72

Multi-family and commercial
1
 
1,173

 
55

 
 

 

Total
1
 
$
1,173

 
$
55

 
1
 
$
413

 
$
72


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 months ended March 31, 2014 and 2013 for modified loans identified as TDRs.
 
 
Three Months Ended March 31,
 
 
2014
 
2013
 
 
(In Thousands)
Combination of rate and maturity (1)
$
1,173

 
$
413

Total
$
1,173

 
$
413

 
 
 
 
 
(1) 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 months ended March 31, 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
March 31, 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
(35
)
 
(35
)
 

 

 
(35
)
Dispositions
(1,722
)
 
(1,367
)
 
(355
)
 

 
(1,367
)
Balance at March 31, 2014
$
6,019

 
$
5,147

 
$
872

 
$

 
$
5,147




23

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

NOTE 5.  PREMISES AND EQUIPMENT
 
Premises and equipment at March 31, 2014 and December 31, 2013 are summarized as follows:
 
March 31, 2014
 
December 31, 2013
 
(In Thousands)
Land
$
4,311

 
$
4,311

Buildings
11,506

 
11,497

Leasehold improvements
10,766

 
10,762

Furniture and equipment
12,680

 
12,549

Construction in process
75

 
45

 
39,338

 
39,164

Accumulated depreciation and amortization
(18,704
)
 
(18,074
)
Premises and equipment, net
$
20,634

 
$
21,090


At March 31, 2014 and December 31, 2013, construction in process related to design and site costs associated with a new branch location.
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:
 
Three Months Ended March 31, 2014
 
Before Tax
Amount
 
Tax
Effects
 
Net of Tax
Amount
Securities:
(In Thousands)
Unrealized holding gains on available for sale securities
$
515

 
$
(175
)
 
$
340

Reclassification adjustment for gains recognized in net income
(35
)
 
12

 
(23
)
Unrealized holding gains on available for sale securities, net of taxes
480

 
(163
)
 
317

Derivative instrument:
 

 
 

 
 

Change in fair value of effective cash flow hedging derivative
35

 
(12
)
 
23

Other comprehensive income
$
515

 
$
(175
)
 
$
340


The components of accumulated other comprehensive loss included in shareholders’ equity are as follows:
 
 
March 31, 2014
 
Before Tax
Amount
 
Tax
Effects
 
Net of Tax
Amount
 
(In Thousands)
Net unrealized losses on available for sale securities
$
(493
)
 
$
168

 
$
(325
)
Net unrealized loss on effective cash flow hedging derivative
(277
)
 
94

 
(183
)
Accumulated other comprehensive loss
$
(770
)
 
$
262

 
$
(508
)


24

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

 
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 March 31, 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.

The Bank’s actual capital amounts and ratios as of March 31, 2014 and December 31, 2013 were as follows:
 
 
Actual
 
For Capital
Adequacy
Purposes
 
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
March 31, 2014
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
(Dollars in Thousands)
Tier I Capital Ratio
$
119,743

 
8.98
%
 
$
53,332

 
4.00
%
 
$
66,665

 
5.00
%
Tier I Risk-based Capital Ratio
119,743

 
14.80

 
32,370

 
4.00

 
48,555

 
6.00

Total Risk-based Capital Ratio
127,516

 
15.76

 
64,740

 
8.00

 
80,925

 
10.00

Tangible Equity Ratio
119,743

 
8.98

 
20,000

 
1.50

 
N/A

 
      N/A



25

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

 
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.    

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.


26

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

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.

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

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

27

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

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 March 31, 2014 and December 31, 2013.  The Company had no significant transfers into or out of Levels 1, 2 or 3 during the three months ended March 31, 2014.
 
March 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(In Thousands)
Assets:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
11,551

 
$
43,536

 
$

 
$
55,087

Government-sponsored enterprises

 
22,527

 

 
22,527

Mortgage-backed securities

 
77,447

 

 
77,447

Corporate debt securities

 
3,025

 

 
3,025

Collateralized debt obligation

 

 
1,181

 
1,181

Obligations of state and political subdivisions

 
4,181

 

 
4,181

Tax-exempt securities

 
6,537

 

 
6,537

Forward loan sale commitments and derivative loan commitments

 

 
45

 
45

Total assets
$
11,551

 
$
157,253

 
$
1,226

 
$
170,030

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Interest rate swap agreements
$

 
$
434

 
$

 
$
434

Total liabilities
$

 
$
434

 
$

 
$
434


28

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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

 
23

Total unrealized losses included in other comprehensive income
(10
)
 

Balance at March 31, 2014
$
1,181

 
$
45


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 March 31, 2014 and December 31, 2013. There were no liabilities measured at fair value on a nonrecurring basis at March 31, 2014 and December 31, 2013.
 
 
At March 31, 2014
 
At December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
(In Thousands)
Impaired loans
$

 
$

 
$
1,620

 
$

 
$

 
$
1,384

Other real estate owned

 

 
2,037

 

 

 
2,429

Total assets
$

 
$

 
$
3,657

 
$

 
$

 
$
3,813





29

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31,
 
2014
 
2013
 
(In Thousands)
Impaired loans
$
56

 
$
316

Other real estate owned
35

 
12

Total losses
$
91

 
$
328


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 March 31, 2014 and December 31, 2013. The estimated fair value amounts at March 31, 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.


30

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

As of March 31, 2014 and December 31, 2013, the recorded carrying amounts and estimated fair values of the Company's financial instruments are as follows:
 
March 31, 2014
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
(In Thousands)
Cash and cash equivalents
$
53,727

 
$
53,727

 
$

 
$

 
$
53,727

Available for sale securities
169,985

 
11,551

 
157,253

 
1,181

 
169,985

Loans held for sale
686

 

 

 
696

 
696

Loans receivable, net
1,042,037

 

 

 
1,047,134

 
1,047,134

Federal Home Loan Bank stock
13,109

 

 

 
13,109

 
13,109

Accrued interest receivable
3,920

 

 

 
3,920

 
3,920

Financial Liabilities:
 

 
 

 
 

 
 

 
 
Deposits
1,004,283

 

 

 
1,007,458

 
1,007,458

Mortgagors' and investors' escrow accounts
1,617

 

 

 
1,617

 
1,617

Federal Home Loan Bank advances
169,922

 

 
171,783

 

 
171,783

Junior subordinated debt owed to unconsolidated trust
8,248

 

 
6,112

 

 
6,112

On-balance Sheet Derivative Financial Instruments:
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Derivative loan commitments
32

 

 

 
32

 
32

    Forward loan sale commitments
13

 

 

 
13

 
13

Liabilities:
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
434

 

 
434

 

 
434


 
 
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



31

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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, generally hedges a portion of its variable-rate interest payments. 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 March 31, 2014 and December 31, 2013, information pertaining to the outstanding interest rate swap agreement used to hedge variable rate debt is as follows:
 
 
 
March 31, 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
1.7

 
2.0

 
Unrealized loss relating to interest rate swap
$
277

 
$
312


At March 31, 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 March 31, 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.


32

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 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 other noninterest income.

Interest Rate Swap Agreement - During the first quarter of 2012, management 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. Changes in fair value of this instrument are recorded as a component of noninterest income. At March 31, 2014 and December 31, 2013, information pertaining to the Company's interest rate swap agreement not designated as a hedge is as follows:
 
March 31, 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
0.24
%
 
0.25
%
Weighted average maturity in years
2.8

 
3.0

Unrealized loss relating to interest rate swap
$
157

 
$
174


The Company reported a gain in fair value on the interest rate swap not designated as a hedge of $17,000 and $44,000 in noninterest income for the three months ended March 31, 2014 and 2013, 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 value 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 $4.4 million at March 31, 2014. At March 31, 2014, the fair value of such commitments was a net asset of $32,000.

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.


33

Table of Contents
SI FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 $2.4 million at March 31, 2014. At March 31, 2014, the fair value of such commitments was a net asset of $13,000.

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 March 31, 2014 and December 31, 2013.
 
 
 
March 31, 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

 
$
(277
)
 
$
8,000

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

 
(157
)
 
15,000

 
(174
)
Derivative loan commitments
Other Assets
 
4,392

 
32

 
3,129

 
14

Forward loan sale commitments
Other Assets
 
2,419

 
13

 
3,581

 
8



34



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 March 31, 2014 and December 31, 2013 and the results of operations for the three months ended March 31, 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, difficulties in integrating Newport Federal Savings Bank or failing to achieve the expected cost savings or revenue synergies, 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.


35



Comparison of Financial Condition at March 31, 2014 and December 31, 2013

Assets:
Summary. Assets increased $16.8 million, or 1.2%, to $1.36 billion at March 31, 2014 from $1.35 billion at December 31, 2013, principally due to increases of $26.4 million in cash and cash equivalents, partially offset by decreases of $5.4 million in net loans receivable, $1.8 million in other assets and $1.1 million in loans held for sale.

Loans Receivable, Net. Net loans receivable decreased $5.4 million during the quarter ended March 31, 2014 as a result of fixed-rate residential mortgage loan sales, principal collections and a reduction in loan originations. Changes in the loan portfolio consisted of the following:

Residential Real Estate. Residential mortgage loans comprised 42.0% of the total loan portfolio at March 31, 2014. The residential mortgage portfolio decreased $9.8 million, or 2.2%, partly due to the sale of $5.4 million of fixed-rate residential mortgage loans. Residential mortgage loan originations decreased $11.7 million during the first three months of 2014 over the comparable period in 2013, primarily as a result of interest rate volatility.

Multi-family and Commercial Real Estate. Multi-family and commercial real estate loans represented 27.8% of total loans at March 31, 2014 and increased $5.6 million, or 2.0%, during the first three months of 2014. Loan originations for multi-family and commercial real estate loans were $9.4 million, representing an increase of $9.1 million during the first three months of 2014 compared to the same period in 2013 resulting from an increase in participation loans with other lenders.

Construction. Construction loans, which include both residential and commercial construction loans, increased $459,000 for the first quarter of 2014.
  
Commercial Business. Commercial business loans represented 24.1% of total loans at March 31, 2014. Commercial business loans decreased $1.5 million, or 0.6% for the first quarter of 2014, primarily due to a decrease of $9.1 million and $1.9 million in SBA and USDA guaranteed loans and other commercial business loans, respectively, offset by an increase of $9.4 million in time share loans. Commercial business loan originations decreased $2.6 million as compared to the same period in 2013. At March 31, 2014, unfunded lines of credit related to time share lending totaled $26.7 million as a result of an experienced lender dedicated to identifying new opportunities for growth within the time share industry.

Consumer. Consumer loans represented 5.0% of the Company’s total loan portfolio at March 31, 2014. Consumer loans increased $231,000 during the first three months of 2014. Home equity loans increased $1.2 million, offset by decreases in indirect automobile loans and other consumer loans of $677,000 and $297,000, respectively. Loan originations for consumer loans totaled $6.0 million, representing an increase of $3.1 million, for the three months ended March 31, 2014 over the comparable period in 2013 as a result of a home equity line of credit promotion.

The allowance for loan losses totaled $7.3 million at March 31, 2014 compared to $6.9 million at December 31, 2013. The ratio of the allowance for loan losses to total loans increased from 0.66% at December 31, 2013 to 0.69% at March 31, 2014.  


36



The following table provides information with respect to nonperforming assets and TDRs as of the dates indicated.
 
 
March 31
2014
 
December 31, 2013
Nonaccrual loans:
(Dollars in Thousands)
Real estate loans:
 
 
 
Residential - 1 to 4 family
$
3,882

 
$
3,560

Multi-family and commercial
1,698

 
2,979

Total real estate loans
5,580

 
6,539

Commercial business loans - Other
354

 
385

Consumer loans:
 
 
 
     Home equity
49

 
53

Indirect automobile

 
16

Total nonaccrual loans
5,983

 
6,993

Accruing loans past due 90 days or more

 

Total nonperforming loans (1)
5,983

 
6,993

Other real estate owned, net (2)
2,037

 
2,429

Total nonperforming assets
8,020

 
9,422

Accruing troubled debt restructurings
3,178

 
2,192

Total nonperforming assets and troubled debt restructurings
$
11,198

 
$
11,614

 
 
 
 
 
Allowance for loan losses as a percent of nonperforming loans
121.21
%
 
98.90
%
Total nonperforming loans to total loans
0.57
%
 
0.66
%
Total nonperforming loans to total assets
0.44
%
 
0.52
%
Total nonperforming assets and troubled debt restructurings to total assets
0.82
%
 
0.86
%
 
 
 
 
 
(1) Includes nonperforming TDRs totaling $474,000 and $319,000 at March 31, 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 $1.3 million while residential - 1 to 4 family real estate loans increased $322,000 at March 31, 2014.

Other real estate owned decreased $392,000 from December 31, 2013 to March 31, 2014, primarily as a result of the sale of three residential properties with a carrying value of $337,000 and write-downs of $55,000. At March 31, 2014, other real estate owned included five residential properties and four commercial properties.

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 $3.7 million at March 31, 2014, compared to $2.5 million at December 31, 2013, resulting from the addition of one commercial real estate loan with a recorded investment of $1.2 million. Of the TDRs, $3.2 million and $2.2 million were performing in accordance with their restructured terms at March 31, 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.


37



Liabilities:
Summary. Liabilities increased $15.3 million, or 1.3%, to $1.21 billion at March 31, 2014 compared to $1.19 billion at December 31, 2013. Deposits increased $19.5 million, or 2.0%, which included increases in certificates of deposit and NOW and money market accounts of $11.8 million and $11.1 million, respectively, offset by a decrease in noninterest bearing deposits of $3.2 million. Deposit growth remained strong due to marketing and promotional initiatives and competitively-priced deposit products. Borrowings decreased $6.4 million from $184.5 million at December 31, 2013 to $178.2 million at March 31, 2014, resulting from net repayments of Federal Home Loan bank advances.

Equity:
Summary. Shareholders’ equity increased $1.5 million from $152.8 million at December 31, 2013 to $154.3 million at March 31, 2014. The increase in shareholders’ equity was attributable to net income of $906,000, the exercise of stock options of $316,000 and a decrease in unrealized losses on available for sale securities aggregating $317,000 (net of taxes), offset by dividends of $368,000.

Accumulated Other Comprehensive Loss. Accumulated other comprehensive income 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. Net unrealized losses on available for sale securities, net of taxes, decreased to $325,000 at March 31, 2014. The net unrealized loss on the interest rate swap, net of taxes, totaled $183,000 at March 31, 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 Months Ended March 31, 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, 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 $906,000 for the quarter ended March 31, 2014, representing an increase of $1.0 million, compared to a net loss of $77,000 for the quarter ended March 31, 2013. The acquisition of Newport in September 2013 contributed to the higher net income for the quarter ended March 31, 2014, as a result of increases in net interest income and noninterest income and the recognition of post-acquisition cost savings for the combined entity. Lower net income for the first quarter of 2013 was the result of merger-related costs totaling $684,000 (pre-tax) associated with the acquisition of Newport. Excluding the aforementioned costs, the Company would have reported net income of $502,000, or $0.05 basic and diluted earnings per share, for the quarter ended March 31, 2013.

Interest and Dividend Income. Total interest and dividend income increased $3.5 million, or 41.1%, to $12.1 million for the quarter ended March 31, 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 and the net accretion of $86,000 related to fair value adjustments of loans and securities resulting from the Newport acquisition, offset by lower yields on loans and a decrease in the average balance of securities. The average yield earned on interest-earning assets increased 6 basis points to 3.88%, despite the 16 basis points decline in the yield on loans to 4.27%. Average interest-earning assets increased $356.8 million to $1.26 billion during the first quarter of 2014, due to an increase in the average balance of loans of $364.5 million, offset by decreases in the average balance of securities of $7.6 million and other interest earning assets of $184,000 compared to the same quarter in 2013.

38



Interest Expense. For the quarter ended March 31, 2014, interest expense decreased $126,000, or 5.7%, to $2.1 million compared to $2.2 million for the comparable period in 2013 resulting from lower rates paid on deposits and borrowings and the net amortization of $487,000 related to fair value adjustments of deposits and borrowings resulting from the Newport acquisition, offset by a higher average balance of deposits and Federal Home Loan Bank advances. Average interest-bearing deposits increased $238.2 million to $859.6 million and the average rate paid decreased 26 basis points to 0.62%. Increases in the average balance of NOW and money market deposits, certificates of deposit and savings accounts totaled $152.2 million, $80.1 million and $5.9 million, respectively. The average balance of FHLB advances increased $80.3 million while the average rate declined 167 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.


39



 
At or For the Three Months Ended March 31,
 
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)
$
1,053,192

 
$
11,087

 
4.27
%
 
$
688,697

 
$
7,523

 
4.43
%
Securities (3)
185,882

 
985

 
2.15

 
193,434

 
1,022

 
2.14

Other interest-earning assets
24,904

 
13

 
0.21

 
25,088

 
10

 
0.16

Total interest-earning assets
1,263,978

 
12,085

 
3.88

 
907,219

 
8,555

 
3.82

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets
92,965

 
 

 
 

 
45,221

 
 

 
 

Total assets
$
1,356,943

 
 

 
 

 
$
952,440

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 

 
 

 
 

Business checking
$
101

 

 

 
$
59

 

 

NOW and money market
456,713

 
150

 
0.13

 
304,556

 
116

 
0.15

Savings (4)
46,142

 
20

 
0.18

 
40,232

 
19

 
0.19

Certificates of deposit (5)
356,621

 
1,149

 
1.31

 
276,506

 
1,217

 
1.78

Total interest-bearing deposits
859,577

 
1,319

 
0.62

 
621,353

 
1,352

 
0.88

 
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank advances
177,930

 
682

 
1.55

 
97,602

 
775

 
3.22

Subordinated debt
8,248

 
83

 
4.08

 
8,248

 
83

 
4.08

Total interest-bearing liabilities
1,045,755

 
2,084

 
0.81

 
727,203

 
2,210

 
1.23

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities
156,138

 
 

 
 

 
98,835

 
 

 
 

Total liabilities
1,201,893

 
 

 
 

 
826,038

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total shareholders' equity
155,050

 
 

 
 

 
126,402

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
$
1,356,943

 
 

 
 

 
$
952,440

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest-earning assets
$
218,223

 
 

 
 

 
$
180,016

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent net interest income (3)
 

 
10,001

 
 

 
 

 
6,345

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent interest rate spread (6)
 

 
 

 
3.07
%
 
 

 
 

 
2.59
%
 
 
 
 
 
 
 
 
 
 
 
 
Tax equivalent net interest margin as a percentage of interest-earning assets (7)
 

 
 

 
3.21
%
 
 

 
 

 
2.84
%
 
 
 
 
 
 
 
 
 
 
 
 
Average of interest-earning assets to average interest-bearing liabilities
 

 
 

 
120.87
%
 
 

 
 

 
124.75
%
 
 
 
 
 
 
 
 
 
 
 
 
Less tax equivalent adjustment (3)
 
 
(14
)
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 

 
$
9,987

 
 

 
 

 
$
6,345

 
 

 
 
(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.


40




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
March 31, 2014 and 2013
 
Increase (Decrease) Due To
 
Rate
 
Volume
 
Net
 
(In Thousands)
Interest-earning assets:
 
 
 
 
 
Interest and dividend income:
 
 
 
 
 
Loans (1)(2)
$
(282
)
 
$
3,846

 
$
3,564

Securities (3)
3

 
(40
)
 
(37
)
Other interest-earning assets
3

 

 
3

Total interest-earning assets
(276
)
 
3,806

 
3,530

Interest-bearing liabilities:
 

 
 

 
 

Interest expense:
 

 
 

 
 

Deposits (4)
(392
)
 
359

 
(33
)
Federal Home Loan Bank advances
(528
)
 
435

 
(93
)
Total interest-bearing liabilities
(920
)
 
794

 
(126
)
Change in net interest income
$
644

 
$
3,012

 
$
3,656

 
 
(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 increased $295,000 for the three months ended March 31, 2014 compared to the same period in 2013 primarily due to a change in the portfolio mix of loans outstanding, offset by decreases in nonperforming loans and loan charge-offs. At March 31, 2014, nonperforming loans totaled $6.0 million, compared to $8.9 million at March 31, 2013, resulting from a decrease in nonperforming residential mortgage loans and multi-family and commercial mortgage loans of $2.0 million and $616,000, respectively. Net loan charge-offs were $94,000 and $194,000 for the three months ended March 31, 2014 and 2013, respectively, consisting primarily of residential mortgage loan charge-offs.


41



Noninterest Income.  The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
 
Three Months Ended March 31,
 
Change
 
2014
 
2013
 
Dollars
 
Percent
 
(Dollars in Thousands)
Service fees
$
1,718

 
$
1,216

 
$
502

 
41.3
 %
Wealth management fees
323

 
257

 
66

 
25.7

Increase in cash surrender value of bank-owned life insurance
142

 
68

 
74

 
108.8

Net gain on sales of securities
35

 
3

 
32

 
1,066.7

Mortgage banking
160

 
579

 
(419
)
 
(72.4
)
Net gain on fair value of derivatives
17

 
47

 
(30
)
 
(63.8
)
Other
377

 
270

 
107

 
39.6

Total noninterest income
$
2,772

 
$
2,440

 
$
332

 
13.6
 %
 
Higher noninterest income in 2014 was primarily due to increases in service fees of $502,000 and other income of $107,000, offset by a decrease in mortgage banking of $419,000 as a result of reduced margins and lower sales volume of $5.4 million in fixed-rate residential mortgage loans compared to $13.3 million in fixed-rate residential mortgage loan sales for the comparable period in 2013. The additional deposit accounts assumed in the Newport acquisition and an increase in fees associated with higher electronic banking usage contributed to higher service fees for 2014. Other noninterest income for the first quarter of 2014 included the reimbursement of $250,000 in legal fees and other foreclosure expenses incurred in a prior period on two commercial loans. Other noninterest income for the first quarter of 2013 included a gain of $201,000 on the sale of $3.0 million in loans held for investment, offset by an impairment charge of $81,000 to reduce the carrying value in one of the Bank's small business investment company limited partnerships.
  
Noninterest Expenses. The following table shows the components of noninterest expenses and the dollar and percentage changes for the periods presented.
 
Three Months Ended March 31,
 
Change
 
2014
 
2013
 
Dollars
 
Percent
 
(Dollars in Thousands)
Salaries and employee benefits
$
5,200

 
$
4,408

 
$
792

 
18.0
 %
Occupancy and equipment
2,107

 
1,383

 
724

 
52.3

Computer and electronic banking services
1,352

 
868

 
484

 
55.8

Outside professional services
449

 
268

 
181

 
67.5

Marketing and advertising
226

 
130

 
96

 
73.8

Supplies
168

 
100

 
68

 
68.0

FDIC deposit insurance and regulatory assessments
349

 
233

 
116

 
49.8

Merger expenses

 
684

 
(684
)
 
(100.0
)
Core deposit intangible amortization
164

 

 
164

 
       N/A
Other real estate operations
169

 
127

 
42

 
33.1

Other
770

 
380

 
390

 
102.6

Total noninterest expenses
$
10,954

 
$
8,581

 
$
2,373

 
27.7
 %

Noninterest expenses were higher for 2014 compared to 2013 mainly due to additional operating costs attributable to the six acquired branches from the Newport merger. Increases in salaries and benefits include additional lending staff and higher benefit costs. Occupancy costs were also higher as a result of snow removal and utility costs associated with the poor weather conditions in the region during the first quarter of 2014. The increase in outside professional services expense related to contractual payments to former officers of Newport

42



under their noncompetition agreements. The core deposit intangible amortization is related to the assumption of deposits as a result of the Newport merger. Higher other noninterest expenses for the first quarter of 2014 included increases of $240,000 in fraudulent debit card transactions, core deposit intangible amortization of $165,000 associated with the assumption of Newport's deposits and prepayment penalties totaling $75,000 for the early extinguishment of certain higher rate FHLB borrowings. Noninterest expenses for the first quarter of 2013 included merger-related costs of $684,000 for the acquisition of Newport.

Income Tax Provision. The provision for income taxes increased $323,000 for the three months ended March 31, 2014, compared to the same period in 2013. The effective tax rate for the three months ended March 31, 2014 and 2013 was 34.1% and 211.6%, respectively. The higher effective tax rate for 2013 was impacted by certain nondeductible costs associated with the Newport merger.
 
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 March 31, 2014, cash and cash equivalents totaled $53.7 million. Securities classified as available for sale, which provide additional sources of liquidity, totaled $170.0 million at March 31, 2014. In addition, at March 31, 2014, the Bank had the ability to borrow $97.0 million from the FHLB, which includes overnight lines of credit of $10.0 million. On that date, the Bank had FHLB advances outstanding of $167.1 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 three months ended March 31, 2014, the Bank originated $46.2 million of loans and purchased $12.3 million of securities and $443,000 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 $17.9 million, for the three months ended March 31, 2014. Certificates of deposit due within one year of March 31, 2014 totaled $130.8 million, or 13.0%, 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. To compensate, the Bank has increased the duration of its borrowings with the FHLB. 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.

43




FHLB advances increased $6.4 million during the three months ended March 31, 2014 and $78.6 million during the year ended December 31, 2013.

The Company repurchased 6,194 shares of the Company's common stock at a cost of $72,000 during the three months ended March 31, 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 March 31, 2014, SI Financial Group had cash and cash equivalents of $8.9 million and available for sale securities of $2.5 million.

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 March 31, 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 March 31, 2014 and December 31, 2013 are as follows:
 
 
March 31, 2014
 
December 31, 2013
 
(In Thousands)
Commitments to extend credit:
 
 
 
Commitments to originate loans
$
21,139

 
$
8,742

Undisbursed construction loans
7,876

 
9,193

Undisbursed home equity lines of credit
43,345

 
41,031

Undisbursed commercial lines of credit
55,529

 
59,930

Overdraft protection lines
1,241

 
1,221

Standby letters of credit
81

 
81

Total commitments
$
129,211

 
$
120,198

 

44



Future loan commitments at March 31, 2014 and December 31, 2013 included fixed-rate loan commitments of $6.8 million and $6.9 million, respectively, at interest rates ranging from 2.75% to 6.38% and 2.75% to 5.75%, respectively.

The Bank is a limited partner in three SBICs. At March 31, 2014, the Bank’s remaining off-balance sheet commitment for the capital investment in the SBICs was $691,000. The Bank recognized write-downs of $81,000 on its investment in one of the SBICs during the three months ended March 31, 2013. No write-downs were recorded for the three months ended March 31, 2014.

For the three months ended March 31, 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 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.


45



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 repricing of assets and liabilities at March 31, 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 March 31, 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 in the 12-month period 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.

46





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 March 31, 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 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 March 31, 2014 were as follows:
Period
 
Total Number of Shares Purchased (1)(2)
 
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
January 1 - 31, 2014
 

 
$

 

 
63,715

February 1 - 28, 2014
 
3,083

 
11.71

 

 
63,715

March 1 - 31, 2014
 
3,111

 
11.65

 
2,927

 
60,788

Total
 
6,194

 
$
11.68

 
2,927

 
 

47



 
 
(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. The repurchase program will continue until it is completed or terminated by the Company's Board of Directors.
(2) This table includes 3,267 shares withheld from employees to satisfy tax withholding requirements upon vesting of restricted stock awards. These shares are not included in the total number of shares purchased as part of the Company's publicly announced repurchase plan.

Item 3.  Defaults Upon Senior Securities.

None.

Item 4.  Mine Safety Disclosures.

None.

Item 5.  Other Information.

None.

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 March 31, 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.


 


48



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:
May 8, 2014
 
/s/ Rheo A. Brouillard
 
 
 
Rheo A. Brouillard
 
 
 
President and Chief Executive Officer
 
 
 
(principal executive officer)

Date:
May 8, 2014
 
 /s/ Brian J. Hull
 
 
 
Brian J. Hull
 
 
 
Executive Vice President, Chief Financial Officer, Treasurer and Chief Operating Officer
 
 
 
(principal financial officer)
 
 
 
 
Date:
May 8, 2014
 
 /s/ Lauren L. Murphy
 
 
 
Lauren L. Murphy
 
 
 
Senior Vice President, Corporate Controller and Principal Accounting Officer
 
 
 
(principal accounting officer)




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