Item 1.BUSINESS
Salisbury Bancorp, Inc.
Salisbury Bancorp, Inc., a Connecticut corporation, formed in 1998, is the bank holding company for Salisbury Bank and Trust Company (the "Bank"), a Connecticut-chartered and Federal Deposit Insurance Corporation (the "FDIC") insured commercial bank headquartered in Lakeville, Connecticut. Salisbury’s common stock is traded on the NASDAQ Capital Market under the symbol “SAL.” Salisbury's principal business consists of its operation and control of the business of the Bank.
The Bank, formed in 1848, currently provides commercial banking, consumer financing, retail banking and trust and wealth advisory services through a network of fourteen banking offices and ten ATMs located in: Litchfield County, Connecticut; Dutchess, Orange and Ulster Counties, New York; and Berkshire County, Massachusetts and through its internet website (salisburybank.com).
Abbreviations Used Herein
Lending Activities
The Bank originates commercial loans, commercial real estate loans, residential and commercial construction loans, residential real estate loans collateralized by one-to-four family residences, home equity lines of credit and fixed rate loans and other consumer loans predominately in Connecticut’s Litchfield County, New York’s Dutchess, Orange and Ulster Counties and Massachusetts’ Berkshire County in towns proximate to the Bank’s fourteen full service offices.
The majority of the Bank’s loans as of December 31, 2020, including some loans classified as commercial loans, were secured by real estate. Interest rates charged on loans are affected principally by the Bank’s current asset/liability strategy, the demand for such loans, the cost and supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by general economic and credit conditions, monetary policies of the federal government, including the FRB, federal and state tax policies and budgetary matters.
Residential Real Estate Loans
A principal lending activity of the Bank is to originate loans secured by first mortgages on one-to-four family residences. The Bank typically originates residential real estate loans through employees who are commissioned licensed mortgage originators (in accordance with the mortgage lending compensation guidelines issued by the CFPB). The Bank originates both fixed rate and adjustable rate mortgages.
The Bank currently sells the majority of the fixed rate 30 year residential mortgage loans it originates to the FHLBB under the Mortgage Partnership Finance Program. The Bank typically retains loan servicing. The Bank retains some fixed rate residential mortgage loans and those loans originated under its first-time home owner program.
The retention of adjustable rate residential mortgage loans in the portfolio and the sale of longer term, fixed rate residential mortgage loans helps reduce the Bank’s exposure to interest rate risk. However, adjustable rate mortgages generally pose credit risks different from the credit risks inherent in fixed rate loans primarily because as interest rates rise, the underlying debt service payments of the borrowers rise, thereby increasing the potential for default. Management believes that these risks, which have not had a material adverse effect on the Bank to date, generally are less onerous than the interest rate risks associated with holding long-term fixed rate loans in the loan portfolio.
Commercial Real Estate Loans
The Bank makes commercial real estate loans for the purpose of allowing borrowers to acquire, develop, construct, improve or refinance 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. Office buildings, light industrial, retail facilities or multi-family income properties, normally collateralize commercial real estate loans. Among the reasons for management’s continued emphasis on commercial real estate lending is the desire to invest in assets with yields which are generally higher than yields on one-to-four family residential mortgage loans, and are more sensitive to changes in interest rates. These loans typically have terms/amortizations of up to ten and twenty-five years, respectively, and interest rates, which adjust over periods of three to ten years, based on one of various rate indices.
Commercial real estate lending generally poses a greater credit risk than residential mortgage lending to owner-occupants. The repayment of commercial real estate loans depends on the business and financial condition of the borrower. Economic events and changes in government regulations, which the Bank and its borrowers do not control, could have an adverse impact on the cash flows generated by properties securing commercial real estate loans and on the market value of such properties.
Construction Loans
The Bank originates both residential and commercial construction loans. Typically, loans are made to owner-borrowers who will occupy the properties as either their primary or secondary residence and to licensed and experienced developers for the construction of single-family homes or commercial properties.
The proceeds of commercial construction loans are disbursed in stages. Bank officers, appraisers and/or independent engineers inspect each project’s progress before additional funds are disbursed to verify that borrowers have completed project phases.
Residential construction loans to owner-borrowers generally convert to a fully amortizing long-term mortgage loan upon completion of construction. The typical construction phase is generally twelve months.
Construction lending, particularly commercial construction lending, poses greater credit risk than mortgage lending to owner-occupants. The repayment of commercial construction loans depends on the business, the financial condition of the borrower, and on the economic viability of the project financed. Economic events and changes in government regulations, which the Bank and its borrowers do not control, could have an adverse impact on the value of properties securing construction loans and on the borrower’s ability to complete projects financed and sell them for amounts anticipated at the time the projects commenced.
Commercial Loans
Commercial loans are generally made on a secured basis and are primarily collateralized by equipment, inventory, accounts receivable and/or leases. Commercial loans primarily provide working capital, equipment financing, financing for leasehold improvements and financing for expansion. The Bank offers both term and revolving commercial loans. Term loans have either fixed or adjustable rates of interest and, generally, terms of between two and seven years. Term loans generally amortize during their life, although some loans require a balloon payment at maturity if the amortization exceeds seven years. Revolving commercial lines of credit typically are renewable annually and have a floating rate of interest normally indexed to the prime rate as published in the Wall Street Journal.
Commercial lending generally poses a higher degree of credit risk than real estate lending. Repayment of both secured and unsecured commercial loans depends substantially on the success of the borrower’s underlying business, financial condition and cash flows. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is primarily dependent upon the success of the borrower’s business.
Secured commercial loans are generally collateralized by equipment, inventory, accounts receivable and leases. Compared to real estate, such collateral is more difficult to monitor, its value is more difficult to validate, it may depreciate more rapidly and it may not be as readily saleable if repossessed.
Consumer Loans
The Bank originates various types of consumer loans, including home equity loans and lines of credit, auto and personal installment loans. Home equity loans and lines of credit are generally secured by second mortgages placed on one-to-four family owner-occupied properties. Home equity loans have fixed interest rates, while home equity lines of credit adjust based on the prime rate as published in the Wall Street Journal. Consumer loans are originated through the branch network with the exception of Home Equity Lines of Credit, which are originated by licensed Mortgage Lending Originator staff.
Municipal Loans
The Bank makes commercial loans to municipalities and municipal entities (i.e., fire districts, school districts) located within its geographic market area. The most common loans are one-year interest-only Bond Anticipation Notes. The Bank also makes medium-term amortizing loans (two to seven years) for acquisition of capital equipment. The Bank has also underwritten several long-term amortizing loans to finance municipal buildings and infrastructure. These loans, which are unsecured, are general obligations of each municipality backed by its full faith and credit and taxing authority. Most municipal borrowers maintain a strong deposit relationship with the Bank. Loans to municipalities and municipal entities are bank-qualified tax-exempt loans and are considered to be a lower credit risk relative to most other commercial loans.
Credit Risk Management and Asset Quality
One of the Bank’s key objectives is to maintain a high level of asset quality. The Bank utilizes the following general practices to manage credit risk: ensuring compliance with prudent written policies; limiting the amount of credit that individual lenders may extend; establishing a process for credit approval accountability; careful initial underwriting and analysis of borrower, transaction, market and collateral risks; ongoing servicing of individual loans and lending relationships; continuous monitoring and risk rating of the portfolio, market dynamics and the economy; and periodically reevaluating the Bank’s strategy and overall exposure as economic, market and other relevant conditions change.
Credit Administration is responsible for determining loan loss reserve adequacy and preparing monthly and quarterly reports regarding the credit quality of the loan portfolio, which are submitted to the Loan Committee to ensure compliance with the credit policy, and managing non-performing and classified assets as well as oversight of all collection activity.
In addition to loan review’s performed by Credit Administration, loan review activities are also performed by an independent third-party loan review firm that evaluates the creditworthiness of borrowers and the appropriateness of the Bank’s risk rating classifications. The firm’s findings are reported to Credit Administration, Senior Management, and the Board level Loan and Audit Committees.
Trust and Wealth Advisory Services
The Bank provides a range of fiduciary services including trust and estate administration, wealth advisory, and investment management to individuals, families, businesses and institutions.
Securities
Salisbury’s securities portfolio is structured to diversify the earnings, assets and risk structure of Salisbury, provide liquidity consistent with both projected and potential needs, collateralize certain types of deposits, assist with maintaining a satisfactory net interest margin and comply with regulatory capital and liquidity requirements. Types of securities in the portfolio generally include U.S. Government and Agency securities, mortgage-backed securities, collateralized mortgage obligations, corporate bonds and tax-exempt municipal bonds, among others.
Sources of Funds
The Bank uses deposits, proceeds from loan and security maturities, repayments and sales, and borrowings to fund lending, investing and general operations. Deposits represent the Bank’s primary source of funds.
Deposits
The Bank offers a variety of deposit accounts with a range of interest rates and other terms, which are designed to meet customer financial needs. Retail and commercial deposits are primarily received through the Bank’s banking offices. Additional depositor related services provided to customers include Landlord/Tenant Lease Security Accounts and Services, Merchant Services, Payroll Services, Cash Management (Remote Deposit Capture, ACH Origination, Wire Transfers and Positive Pay), ATM, Bank-by-Phone, Internet Banking, Internet Bill Pay, Person to Person Payments, Bank to Bank Transfers, Mobile Banking with remote deposit, and Online Financial Management with Account Aggregation Services.
The FDIC provides separate insurance coverage of $250 thousand per depositor for each account ownership category. Deposit flows are significantly influenced by economic conditions, the general level of interest rates and the relative attractiveness of competing deposit and investment alternatives. When determining deposit pricing, the Bank considers strategic objectives, competitive market rates, deposit flows, funding commitments and investment alternatives, FHLBB advance rates and rates on other sources of funds.
National, regional and local economic and credit conditions, changes in competitor money market, savings and time deposit rates, prevailing market interest rates and competing investment alternatives all have a significant impact on the level of the Bank’s deposits. Deposit generation is a key focus for the Bank as a source of liquidity and to fund continuing asset growth. Competition for deposits has been, and is expected to, remain strong.
Borrowings
The Bank is a member of the FHLBB, which provides credit facilities for regulated, federally insured depository institutions and certain other home financing institutions. Members of the FHLBB are required to own capital stock in the FHLBB and are authorized to apply for advances on the security of their FHLBB stock and certain home mortgages and other assets (principally securities, which are obligations of, or guaranteed by, the United States Government or its agencies) provided certain creditworthiness standards have been met. Under its current credit policies, the FHLBB limits advances based on a member’s assets, total borrowings and net worth. Long-term and short-term FHLBB advances may be utilized as a source of funding to meet liquidity and planning needs when the cost of these funds is favorable as compared to deposits or alternate funding sources. During 2015, Salisbury issued $10 million of subordinated debentures; See “Deposits and Borrowings” in Item 7.
Additional funding sources are available through securities sold under agreements to repurchase and the Federal Reserve Bank of Boston.
Subsidiaries
Salisbury has one wholly-owned subsidiary, Salisbury Bank and Trust Company. The Bank has two wholly-owned subsidiaries, SBT Mortgage Service Corporation and S.B.T. Realty, Inc. SBT Mortgage Service Corporation is a passive investment company ("PIC") that holds loans collateralized by real estate originated or purchased by the Bank. Income of the PIC and its dividends to Salisbury are exempt from the Connecticut Corporate Business Tax. S.B.T. Realty, Inc. was formed to hold New York state real estate.
Human Capital Resources
At December 31, 2020, the Bank had 174 full-time employees and 20 part-time employees. The employees are not represented by a collective bargaining group. The Bank maintains a comprehensive employee benefit program providing, among other benefits, group medical and dental insurance, life insurance, disability insurance, an ESOP and an employee 401(k) plan. Management considers relations with its employees to be good. Salisbury believes its human capital is the most valuable asset it has. The collective sum of the individual differences, life experiences, knowledge, inventiveness, innovation, self-expression, unique capabilities and talent that Salisbury’s employees invest in their work represents a significant part of not only Salisbury’s culture, but its reputation and Salisbury’s achievement as well. Salisbury’s employees are encouraged to develop their skills, experience and potential, and Salisbury provides employees with opportunities for promotion and transfer and professional training.
Salisbury embraces those characteristics of its employees and directors that make them unique, and Salisbury appreciates a work environment that is diverse in terms of such areas as age, color, disability status, ethnicity, family or marital status, gender identity or expression, national origin, political affiliation, race, religion, sexual orientation, and veteran/military status.
Salisbury is committed and focused on the health and safety of its employees, customers, and communities. As a result of the challenges presented by the COVID-19 pandemic, Salisbury launched a proactive response to the escalating COVID-19 outbreak that included the creation of an internal coronavirus resource page to manage Salisbury’s pandemic response, including providing access to recent safety standards from the Centers for Disease Control and Prevention, the World Health Organization, and other agencies; as well as Salisbury’s workplace guidelines for non-customer and customer environments. In addition, current information is shared through regular emails and other digital communications with employees and customers facing financial hardships due to COVID-19. Additional actions included adjusting banking center hours, lobby usage, and encouraging certain employees to work remotely where possible during the pandemic.
Salisbury employees actively share their talents in their communities through volunteer activities in education, economic development, human and health services, and Community Reinvestment. Salisbury’s employees devote time and energy to strengthen and support the charitable causes in the communities surrounding the Bank’ branches. This year Salisbury’s employees volunteered more than 7,000 hours to help people in need.
Market Area
Salisbury and the Bank are headquartered in Lakeville, Connecticut, which is located in the northwestern quadrant of Connecticut’s Litchfield County. The Bank has a total of fourteen banking offices, four of which are located in Connecticut's Litchfield County; three of which are located in Massachusetts’ Berkshire County; five of which are located in New York’s Dutchess County, one of which is located in New York’s Ulster County, and one of which is located in New York’s Orange County. The Bank’s primary deposit gathering and lending area consists of the communities and surrounding towns that are served by its branch network in these counties. The Bank also has deposit, lending and trust relationships outside of these areas.
Competition
The Bank faces strong competition in attracting and retaining deposits and in making loans. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations, automated services and office hours. Its most direct competition for deposits and loans has come from other commercial banks, savings institutions and credit unions located in its market area. Competition for deposits also comes from mutual funds and other investment alternatives, which offer a range of deposit and deposit-like products. Although the Bank expects this continuing competition to have an effect upon the cost of funds, it does not anticipate any substantial adverse effect on maintaining the current deposit base. The Bank is competitive within its market area in the various deposit products it offers to depositors. Due to this fact, management believes the Bank has the ability to maintain its deposit base.
The Bank's competition for real estate loans comes primarily from mortgage banking companies, savings banks, commercial banks, insurance companies, and other institutional lenders. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized service. Factors that affect competition include, among others, the general availability of funds and credit, general and local economic conditions, current interest rate levels and volatility in the mortgage markets.
The banking industry is also experiencing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Technological advances are likely to increase competition by enabling more companies to provide cost effective products and services.
Regulation and Supervision
General
Salisbury is required to file reports and otherwise comply with the rules and regulations of the FRB, the FDIC, the SEC and NASDAQ as well as the state banking supervisory authorities in Connecticut, New York and Massachusetts.
The Bank is subject to extensive regulation by the CTDOB, as its chartering agency, and by the FDIC, as its primary federal supervisory agency. The Bank is required to file reports with, and is periodically examined by, the FDIC and the CTDOB concerning its activities and financial condition. It must obtain regulatory approvals prior to entering into certain transactions, such as mergers.
The following discussion of the laws, regulations and policies material to the operations of Salisbury and the Bank is a summary and is qualified in its entirety by reference to such laws, regulations and policies. Such statutes, regulations and policies are continually under review by Congress and the Connecticut, New York and Massachusetts State Legislatures and federal and state regulatory agencies. Changes in such laws, regulations, or policies could potentially have a material adverse impact on the banking industry, including Salisbury and the Bank.
Bank Holding Company Regulation
SEC and NASDAQ
Salisbury is subject to the rules and regulations of the SEC and is required to comply with the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. Salisbury’s common stock is listed on the NASDAQ under the trading symbol “SAL” and, accordingly, Salisbury is also subject to the rules of NASDAQ for listed companies.
Federal Reserve Board Regulation
Salisbury is a registered bank holding company under the BHCA and is subject to comprehensive regulation and regular examinations by the FRB. The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
Under FRB policy, a bank holding company must serve as a source of financial and managerial strength for its subsidiary bank. Under this policy, Salisbury is expected to commit resources to support the Bank. The FRB may require a holding company to contribute additional capital to an undercapitalized subsidiary bank.
Bank holding companies must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of any company, which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities, which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among other things: (i) operating a savings institution, mortgage company, finance company, credit card company or factoring company; (ii) performing certain data processing operations; (iii) providing certain investment and financial advice; (iv) underwriting and acting as an insurance agent for certain types of credit-related insurance; (v) leasing property on a full-payout, non-operating basis; (vi) selling money orders; (vii) real estate and personal property appraising; (viii) providing tax planning and preparation services; (ix) financing and investing in certain community development activities; and (x) subject to certain limitations, providing securities brokerage services for customers.
Connecticut Bank Holding Company Regulation
Salisbury is a Connecticut corporation and is also subject to the Connecticut Business Corporation Act and Connecticut banking law applicable to Connecticut bank holding companies. Under Connecticut banking law, no person may acquire beneficial ownership of more than 10% of any class of voting securities of a Connecticut-chartered bank, or any bank holding company of such a bank, without prior notification to, and lack of disapproval by, the CTDOB. The CTDOB will disapprove the acquisition if the bank or holding company to be acquired has been in existence for less than five years, unless the CTDOB waives this five-year restriction, or if the acquisition would result in the acquirer controlling 30% or more of the total amount of deposits in insured depository institutions in Connecticut. Similar restrictions apply to any person who holds in excess of 10% of any such class and desires to increase its holdings to 25% or more of such class.
Dividends
Salisbury’s dividends to shareholders are substantially dependent upon Salisbury’s receipt of dividends from the Bank. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should be a “source of strength” to its bank subsidiary and should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The FRB also indicated its view that, generally, it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, the FRB may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized” or if the dividend would violate applicable law or would be an unsafe or unsound banking practice.
Financial Modernization
GLBA permits greater affiliation among banks, securities firms, insurance companies, and other companies under a type of financial services company known as a “financial holding company.” A financial holding company essentially is a bank holding company with expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The act also permits the FRB and the Treasury to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is “well capitalized” and “well managed” as defined in the FRB’s Regulation Y, and has at least a “satisfactory” Community Reinvestment Act rating. A financial holding company must provide notice to the FRB within 30 days after commencing activities previously determined to be permissible by statute or by the FRB and the Treasury. Salisbury is a registered financial holding company.
All financial institutions are required to establish policies and procedures with respect to the ability of the Bank to share nonpublic customer data with nonaffiliated parties and to protect customer data from unauthorized access. The Bank has developed policies and procedures, and believes it is in compliance with all privacy, information sharing, and notification provisions of GLBA and the FACT Act.
State Banking Laws and Supervision
The Bank is a state-chartered commercial bank under Connecticut law and as such is subject to regulation and examination by the CTDOB. In addition, because the Bank operates branch offices in Massachusetts and New York, the Bank is also subject to certain Massachusetts and New York laws and the supervisory authority of the Massachusetts Division of Banks, and New York Department of Financial Services (“NYDFS”) with respect to its branch offices in Massachusetts and New York, respectively. The approval of the state banking regulators is generally required for, among other things, the establishment of branch offices and business combination transactions. The CTDOB conducts periodic examinations of Connecticut-chartered banks. The FDIC also regulates many of the areas regulated by the CTDOB, and federal law may limit some of the authority provided to Connecticut-chartered banks by Connecticut law.
Lending Activities
Connecticut banking laws grant commercial banks broad lending authority. With certain limited exceptions, total secured and unsecured loans made to any one obligor generally may not exceed 15% of the Bank’s equity capital and reserves for loan and lease losses. However, if the loan is fully secured, such limitations generally may be increased by an additional 10%.
Dividends
The Bank may pay cash dividends only out of its net profits. For purposes of this restriction, “net profits” represents the remainder of all earnings from current operations. Further, the total amount of all dividends declared by any Connecticut Bank in any year may not exceed the sum of its net profits for the year in question combined with its retained net profits from the preceding two years, unless the CTDOB approves the larger dividend. Federal law also prevents the Bank from paying dividends or making other capital distributions that would cause it to become “undercapitalized.” The FDIC may also limit a bank’s ability to pay dividends based upon safety and soundness considerations.
Powers
Connecticut law permits Connecticut banks to sell insurance and fixed and variable-rate annuities if licensed to do so by the Connecticut Insurance Department. With the prior approval of the CTDOB, Connecticut banks are also authorized to engage in a broad range of activities related to the business of banking, or that are financial in nature or that are permitted under the BHCA, other federal statutes, or the regulations promulgated pursuant to these statutes. Connecticut banks generally are also authorized to engage in any activity permitted for a federal bank or upon filing prior written notice of its intention to engage in such activity with the CTDOB, unless the CTDOB disapproves the activity.
Assessments
Connecticut banks are required to pay assessments to the CTDOB based upon a bank’s asset size to fund the CTDOB’s operations. The assessments are generally made annually.
Enforcement Authority
Under Connecticut law, the CTDOB has extensive enforcement authority over Connecticut banks and, under certain circumstances, affiliated parties, insiders, and agents. The CTDOB’s enforcement authority includes cease and desist orders, fines, receivership, conservatorship, removal of officers and directors, emergency closures, dissolution and liquidation.
New York and Massachusetts Banking Laws and Supervision
The Bank conducts activities and operates branch offices in New York and Massachusetts as well as Connecticut. Generally, with respect to its business in New York and Massachusetts, the Bank may conduct any activity that is authorized under Connecticut law that is permissible for either New York or Massachusetts state banks or for an out-of-state national bank, at its New York and Massachusetts branch offices, respectively. The New York State Superintendent of Financial Services may exercise regulatory authority with respect to the Bank’s New York branch offices. The Bank is subject to certain rules related to community reinvestment, consumer protection, fair lending, establishment of intra-state branches and the conduct of banking activities with respect to its branches located in New York State. The Massachusetts Commissioner of Banks may exercise similar authority, and the Bank is subject to similar rules under Massachusetts Banking Law with respect to the Bank’s Massachusetts branch offices. Federal and state laws authorize the interstate merger of banks. Among other things, banks may establish new branches on an interstate basis provided that such action is specifically authorized by the law of the host state.
Federal Regulations
Capital Requirements
Under FDIC regulations, federally insured state-chartered banks, such as the Bank, that are not members of the Federal Reserve System (“state non-member banks”) are required to comply with the following minimum leverage capital requirements: common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. The existing capital requirements became effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of accumulated other comprehensive income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. The Bank chose the opt-out election. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
The FDIC regulations require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of regulatory capital to regulatory risk-weighted assets is referred to as a bank’s “risk-based capital ratio.” Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items (including recourse obligations, direct credit substitutes and residual interests) to risk-weighted categories ranging from 0% to 1,250%, with higher levels of capital being required for the categories perceived as representing greater risk.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement began phasing in January 1, 2016 at 0.625% of risk-weighted assets and increased each year until it was fully implemented at 2.5% on January 1, 2019.
In assessing an institution’s capital adequacy, the FDIC takes into consideration not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where deemed necessary. As a bank holding company, the Company is also subject to regulatory capital requirements, as described in a subsequent section.
As a bank holding company, Salisbury is subject to FRB capital adequacy guidelines for bank holding companies similar to those of the FDIC for state-chartered banks.
As of December 31, 2020, the Company and the Bank met each of their capital requirements and the most recent notification from the FDIC categorized the Bank as “well-capitalized.” There are no conditions or events since that notification that management believes have changed the Bank’s category.
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes five capital categories:
•Well capitalized - at least 5% leverage capital, 6.5% Common Equity Tier 1 capital, 8% Tier 1 risk-based capital and 10% total risk-based capital.
•Adequately capitalized - at least 4% leverage capital, 4.5% Common Equity Tier 1 capital, 6% Tier 1 risk-based capital and 8% total risk-based capital.
•Undercapitalized - less than 4% leverage capital, 4.5% Common Equity Tier 1 capital, 6% Tier 1 risk-based capital and 8% total risk-based capital. “Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. A bank’s compliance with such a plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5% of the institution’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized.
•Significantly undercapitalized - less than 3% leverage capital, 3% Common Equity Tier 1 capital, 4% Tier 1 risk-based capital and 6% total risk-based capital. “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company.
•Critically undercapitalized - less than 2% tangible capital. “Critically undercapitalized” institutions are subject to additional measures including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
Transactions with Affiliates
Under federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the FRA. In a holding company structure, at a minimum, the parent holding company of a bank, and any companies that are controlled by such parent holding company, are deemed affiliates of its subsidiary bank. Generally, Sections 23A and 23B are intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates by limiting the extent to which a bank or its subsidiaries may engage in covered transactions with any one affiliate and with all affiliates of the bank in the aggregate, and by requiring that such transactions be on terms that are consistent with safe and sound banking practices.
The FRA and Regulation O impose restrictions on loans to directors, executive officers, and principal shareholders (“insiders”). Loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors and must be made on terms substantially the same as offered in comparable transactions to other persons. The FRA imposes additional limitations on loans to executive officers.
Enforcement
The FDIC has extensive enforcement authority over insured banks, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices.
Standards for Safety and Soundness
The FDIC, together with the other federal bank regulatory agencies, prescribe standards of safety and soundness by regulations or guidelines, relating generally to operations and management, asset growth, asset quality, earnings, stock valuation and compensation. The federal bank regulatory agencies have adopted a set of guidelines prescribing safety and soundness standards, which establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the federal bank regulatory agencies adopted regulations that authorize, but do not require, the agencies to order an institution that has been given notice that it is not satisfying the safety and soundness guidelines to submit a compliance plan. The federal bank regulatory agencies have also adopted guidelines for asset quality and earning standards. As a state-chartered bank, the Bank is also subject to state statutes, regulations and guidelines relating to safety and soundness, in addition to the federal requirements.
Insurance of Deposit Accounts
The Bank’s deposit accounts are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to applicable legal limits (generally, $250 thousand per depositor for each account ownership category and $250 thousand for certain retirement plan accounts) and are subject to deposit insurance assessments. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.
The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that considers a bank’s capital level and supervisory rating. The FDIC assigns an institution to one of the following capital categories based on the institution’s financial condition consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation by the institution’s primary federal regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds. An institution’s assessment rate depends on the capital category and supervisory category to which it is assigned.
FDIC insured institutions are required to pay assessments to the FDIC to fund the DIF. The Bank’s current annual assessment rate is approximately 4.85 basis points of total assets. Additionally, FDIC insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by The Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. The assessment rate is adjusted quarterly to reflect changes in the assessment bases of the DIF based on quarterly Call Report submissions. From time to time, the FDIC may impose a supplemental special assessment in addition to other special assessments and regular premium rates to replenish the DIF during periods of economic difficulty. The amount of an emergency special assessment imposed on a bank will be determined by the FDIC if such amount is necessary to provide sufficient assessment income to repay amounts borrowed from the Treasury; to provide sufficient assessment income to repay obligations issued to and other amounts borrowed from insured depository institutions; or for any other purpose the FDIC may deem necessary.
The FDIC may terminate insurance of deposits, after notice and a hearing, if it finds that the institution is in an unsafe or unsound condition to continue operations, has engaged in unsafe or unsound practices, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”)
The Dodd-Frank Act, enacted in July 2010, significantly changed the bank regulatory landscape and has impacted lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act revised the statutory authorities governing the FDIC’s management of the DIF. The Dodd-Frank Act granted the FDIC new DIF management tools: maintaining a positive fund balance even during a banking crisis and maintaining moderate, steady assessment rates throughout economic and credit cycles.
Among other things, the Dodd-Frank Act: (1) raised the minimum Designated Reserve Ratio (“DRR”), which the FDIC must set each year, to 1.35% (from the former minimum of 1.15%) and removed the upper limit on the DRR (which was formerly capped at 1.5%) and therefore on the size of the DIF; (2) required that the DIF reserve ratio reach 1.35% by September 30, 2020 (rather than 1.15% by the end of 2016, as formerly required); (3) required that, in setting assessments, the FDIC offset the effect of requiring that the reserve ratio reach 1.35% by September 30, 2020 (rather than 1.15% by the end of 2016) on insured depository institutions with total consolidated assets of less than $10 billion; (4) eliminated the requirement that the FDIC provide dividends from the Fund when the reserve ratio is between 1.35% and 1.50%; and (5) continued the FDIC’s authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.50%, but granted the FDIC sole discretion in determining whether to suspend or limit the declaration or payment of dividends.
The Dodd-Frank Act also required that the FDIC amend its regulations to redefine the assessment base used for calculating deposit insurance assessments. Under the Dodd-Frank Act, the assessment base must, with some possible exceptions, equal average consolidated total assets minus average tangible equity.
The FDIC amended 12 CFR 327 to implement revisions to the Federal Deposit Insurance Act made by the Dodd-Frank Act by modifying the definition of an institution’s deposit insurance assessment base; to change the assessment rate adjustments; to revise the deposit insurance assessment rate schedules in light of the new assessment base and altered adjustments; to implement the Dodd-Frank Act’s dividend provisions; to revise the large insured depository institution assessment system to better differentiate for risk and better take into account losses from large institution failures that the FDIC may incur; and to make technical and other changes to the FDIC's assessment rules. The FDIC Board of Directors adopted the final rule, which redefined the deposit insurance assessment base as required by the Dodd-Frank Act; made changes to assessment rates; implemented the Dodd-Frank Act’s DIF dividend provisions; and revised the risk-based assessment system for all large insured depository institutions, generally, those institutions with at least $10 billion in total assets. Nearly all institutions with assets less than $10 billion, including the Bank, have benefited from a reduction in their assessments as a result of this final rule.
The Dodd-Frank Act requires publicly traded companies to give shareholders a non-binding vote of executive compensation at least every three (3) years. The legislation also authorizes the SEC to prohibit broker discretion on any voting on election of directors, executive compensation matters, and any other significant matter.
The Dodd-Frank Act also adopts various mortgage lending and predatory lending provisions and requires loan originators to retain 5% of any loan sold and securitized, unless it is a “qualified residential mortgage,” which includes standard 30 and 15-year fixed rate loans.
The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”), which was enacted in May 2018, repealed or modified several provisions of the Dodd-Frank Act. Certain key provisions of the Economic Growth Act and its implementing regulations include:
·Eliminating supervisory stress testing and company run stress testing for bank holding companies with less than $250 billion in assets;
·Prohibiting federal banking regulators from imposing higher capital standards on High Volatility Commercial Real Estate exposures unless they are for acquisition, development, or construction;
·Exempting from appraisal requirements certain transactions involving real property in rural areas and valued at less than $400,000; and
·Requiring the CFPB to provide guidance on how the Truth in Lending Act-Real Estate Settlement Procedures Act Integrated Disclosure applies to mortgage assumption transactions and construction-to-permanent home loans, as well as the extent to which lenders can rely on model disclosures that do not reflect recent regulatory changes.
Consumer Protection and the Financial Protection Bureau
The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”). As required by the Dodd-Frank Act, jurisdiction for all existing consumer protection laws and regulations has been transferred to the CFPB. In addition, the CFPB is granted authority to promulgate new consumer protection regulations for banks and nonbank financial firms offering consumer financial services or products to ensure that consumers are protected from “unfair, deceptive, or abusive” acts or practices.
Salisbury is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, various state law counterparts, and the Consumer Financial Protection Act of 2010, which constitutes part of the Dodd-Frank Act and establishes the CFPB, as described above.
The CFPB issued a final rule implementing the ability-to-repay and qualified mortgage (“QM”) provisions of the Truth in Lending Act, as amended by the Dodd-Frank Act (the “QM Rule”), which became effective on January 10, 2014. The ability-to-repay provision requires creditors to make reasonable, good faith determinations that borrowers are able to repay their mortgages before extending the credit based on a number of factors and consideration of financial information about the borrower from reasonably reliable third-party documents. Under the Dodd-Frank Act and the QM Rule, loans meeting the definition of “qualified mortgage” are entitled to a presumption that the lender satisfied the ability-to-repay requirements. The presumption is a conclusive presumption/safe harbor for prime loans meeting the QM requirements and a rebuttable presumption for higher-priced/subprime loans meeting the QM requirements. The definition of a “qualified mortgage” incorporates the statutory requirements, such as not allowing negative amortization or terms longer than 30 years. The QM Rule also adds an explicit maximum 43% debt-to-income ratio limit for borrowers if the loan is to meet the QM definition, with some exceptions.
The CARES Act and Initiatives Related to COVID-19
In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020 to provide national emergency economic relief measures. Many of the CARES Act’s programs are dependent upon the direct involvement of U.S. financial institutions, such as the Bank, and have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Federal Reserve and other federal banking agencies, including those with direct supervisory jurisdiction over Salisbury. As the ongoing COVID-19 pandemic evolves, federal regulatory authorities continue to issue additional guidance with respect to the implementation, lifecycle, and eligibility requirements for the various CARES Act programs as well as industry-specific recovery procedures for COVID-19. It is possible that Congress will enact supplementary COVID-19 response legislation, including amendments to the CARES Act or new bills comparable in scope to the CARES Act. The Company continues to assess the impact of the CARES Act and other statutes, regulations and supervisory guidance related to the COVID-19 pandemic.
Paycheck Protection Program. Section 1102 of the CARES Act created the PPP, a program administered by the SBA to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. The Bank has participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will be deferred for the first six months of the loan term. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. No collateral or personal guarantees were required. Neither the government nor lenders are permitted to charge the recipients any fees. It is anticipated that additional revisions to the SBA’s interim final rules on forgiveness and loan review procedures will be forthcoming to address these and related changes. On December 27, 2020, the President signed into law omnibus federal spending and economic stimulus legislation titled the “Consolidated Appropriations Act” that included the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “HHSB Act”). Among other things, the HHSB Act renewed the PPP, allocating $284.45 billion for both new first time PPP loans under the existing PPP and the expansion of existing PPP loans for certain qualified, existing PPP borrowers. In addition to extending and amending the PPP, the HHSB Act also creates a new grant program for “shuttered venue operato7rs.” As a participating lender in the PPP, the Bank continues to monitor legislative, regulatory, and supervisory developments related thereto, including the most recent changes implemented by the HHSB Act.
Guidance on Non-TDR Loan Modifications due to COVID-19. On March 22, 2020, a statement was issued by banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act further provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President under the National Emergencies Act terminates. Section 541 of the Consolidated Appropriations Act extends this relief to the earlier of January 1, 2022 or 60 days after the national emergency termination date. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations.
In accordance with such guidance, the Bank has implemented a loan payment deferral program which allows residential, commercial and consumer borrowers, who have been adversely affected by the virus and whose loans were not more than 30 days past due at December 31, 2019, to defer loan payments for up to three months. See Note 4 to the consolidated financial statements for further information on non-TDR loans.
Main Street Lending Program. The CARES Act encouraged the Federal Reserve, in coordination with the Secretary of the Treasury, to establish or implement various programs to help midsize businesses, nonprofits, and municipalities. On April 9, 2020, the Federal Reserve proposed the creation of the Main Street Lending Program to implement certain of these recommendations. The Bank continues to monitor developments related to the Main Street Lending Program.
Federal Reserve System
Historically, all depository institutions must hold a percentage of certain types of deposits as reserves. Reserve requirements generally are assessed on the depository institution's net transaction accounts (mostly checking accounts). Depository institutions must also regularly submit deposit reports of their deposits and other reservable liabilities. Effective March 26, 2020, the FRB reduced reserve requirement ratios to 0%, thus eliminating reserve requirements for all depository institutions at least temporarily.
Federal Home Loan Bank System
The Bank is a member of the Boston region of the Federal Home Loan Bank System, which consists of 11 regional Federal Home Loan Banks. The FHLBB provides a central credit facility primarily for member institutions. Member institutions are required to acquire and hold shares of capital stock in the FHLBB calculated periodically based primarily on its level of borrowings from the FHLBB. The Bank was in compliance with this requirement. At December 31, 2020, the Bank had FHLBB stock of $1.7 million and FHLBB advances of $12.6 million.
No market exists for shares of the FHLBB and, therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB.
Other Regulations
Sarbanes-Oxley Act of 2002
The stated goals of SOX are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
SOX includes very specific disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC and the Comptroller General. SOX represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
SOX addresses, among other matters, audit committees; certification of financial statements and internal controls by the Chief Executive Officer and Chief Financial Officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve-month period following initial publication of any financial statements that later require restatement; a prohibition on insider trading during pension plan black-out periods; disclosure of off-balance sheet transactions; a prohibition on certain loans to directors and officers; expedited filing requirements for Forms 4; disclosure of a code of ethics and filing a Form 8-K for significant changes or waivers of such code; “real time” filing of periodic reports; the formation of a Public Company Accounting Oversight Board; auditor independence; and various increased criminal penalties for violations of securities laws. The SEC has enacted rules to implement various provisions of SOX.
On March 12, 2020 the Securities and Exchange Commission finalized amendments to the definitions of “accelerated” and “large accelerated filer”. The categorization of “accelerated” or “large accelerated filer” determines the requirement for a public company to obtain auditor attestation of its internal control over financial reporting. Salisbury meets the new definition of a “non-accelerated filer” and as such, as of December 31, 2020, the Bank is no longer subject to section 404(b) of SOX, which requires public companies' annual reports to include the company's own assessment of internal control over financial reporting, and an auditor's attestation.
USA PATRIOT Act
Under the USA PATRIOT Act, all financial institutions are required to take certain measures to identify their customers, prevent money laundering, monitor customer transactions and report suspicious activity to U.S. law enforcement agencies. Financial institutions also are required to respond to requests for information from federal banking regulatory authorities and law enforcement agencies. Information sharing among financial institutions for the above purposes is encouraged by an exemption granted to complying financial institutions from the privacy provisions of GLBA and other privacy laws. Financial institutions that hold correspondent accounts for foreign banks or provide private banking services to foreign individuals are required to take measures to avoid dealing with certain foreign individuals or entities, including foreign banks with profiles that raise money laundering concerns, and are prohibited from dealing with foreign “shell banks” and persons from jurisdictions of particular concern. The primary federal banking regulators and the Secretary of the Treasury have adopted regulations to implement several of these provisions. All financial institutions are also required to establish internal anti-money laundering programs. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act or the BHCA. Salisbury has in place a Bank Secrecy Act and USA PATRIOT Act compliance program, and has implemented internal practices, procedures, and controls to comply with anti-money laundering requirements.
Community Reinvestment Act and Fair Lending Laws
The Bank has a responsibility under the CRA to help meet the credit needs of our communities, including low and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. In connection with its examination, the FDIC assesses the Bank’s record of compliance with the CRA. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit discrimination in lending practices on the basis of characteristics specified in those statutes. The Bank’s failure to comply with the provisions of the CRA could, at a minimum, result in regulatory restrictions on our activities. The Bank’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions against the Bank by the FDIC as well as other federal regulatory agencies and the Department of Justice. The Bank’s most recent FDIC CRA rating was “satisfactory.”
The Electronic Funds Transfer Act, Regulation E and Related Laws
The Electronic Funds Transfer Act (the “EFTA”) provides a basic framework for establishing the rights, liabilities, and responsibilities of consumers who use electronic funds transfer (“EFT”) systems. The EFTA is implemented by the Federal Reserve's Regulation E, which governs transfers initiated through ATMs, point-of-sale terminals, payroll cards, automated clearing house (“ACH”) transactions, telephone bill-payment plans, or remote banking services. Regulation E requires consumers to opt in (affirmatively consent) to participation in a bank's overdraft service program for ATM and one-time debit card transactions before overdraft fees may be assessed on the consumer’s account. Notice of the opt-in right must be provided to all new customers who are consumers, and the customer's affirmative consent must be obtained, before charges may be assessed on the consumer's account for paying such overdrafts.
Regulation E also provides bank customers with an ongoing right to revoke consent to participation in an overdraft service program for ATM and one-time debit card transactions and prohibits banks from conditioning the payment of overdrafts for checks, ACH transactions, or other types of transactions that overdraw the consumer's account on the consumer's opting into an overdraft service for ATM and one-time debit card transactions. For customers who do not affirmatively consent to overdraft service for ATM and one-time debit card transactions, a bank must provide those customers with the same account terms, conditions, and features that it provides to consumers who do affirmatively consent, except for the overdraft service for ATM and one-time debit card transactions. Salisbury does not provide an overdraft service with respect to one time point-of-sale or ATM transactions.
Future Legislative Initiatives
In light of the recent changes in the composition of Congress and many state legislatures, it is anticipated that state legislatures and financial regulatory agencies will introduce various legislative and regulatory initiatives that may impact the financial services industry, generally. Such initiatives may include proposals to expand or contract the powers of bank holding companies and/or depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of Salisbury in significant and unpredictable ways. For example, if enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. Salisbury cannot predict whether any such legislation will be enacted, and, if enacted, what effects that such legislation would have on the financial condition or results of operations of Salisbury. A change in statutes, regulations, or regulatory policies applicable to Salisbury or any of its subsidiaries could have a material effect on the business of Salisbury.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and their Notes presented within this document have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of Salisbury’s operations. Unlike the assets and liabilities of industrial companies, nearly all of the assets and liabilities of Salisbury are monetary in nature. As a result, interest rates have a greater impact on Salisbury’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Availability of Securities and Exchange Commission Filings
Salisbury makes available free of charge on its website (salisburybank.com) under shareholder relations a link to its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as practicable after such reports are electronically filed with or furnished to the SEC. Such reports filed with the SEC are also available on its website (www.sec.gov). Information about accessing company filings can be obtained by calling 1-800-SEC-0330. Information on Salisbury’s website is not incorporated by reference into this report. Investors are encouraged to access these reports and the other information about Salisbury’s business and operations on its website. Copies of these filings may also be obtained from Salisbury free of charge upon request.
Guide 3 Statistical Disclosure by Bank Holding Companies
The following information required by Securities Act Guide 3 “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
Item 1A.
Item 1A.RISK FACTORS
Salisbury is the registered bank holding company for the Bank, its wholly-owned subsidiary. Salisbury's business and activity are currently limited to the holding of the Bank's outstanding capital stock, and the Bank is Salisbury's primary investment.
An investment in Salisbury common stock entails certain risks, some of which are inherent in the financial services industry and others of which are more specific to the Bank’s business. Salisbury considers the most significant factors of which we are aware affecting risk in Salisbury common stock as those that are set forth below. These are not the only risks to which an investment in Salisbury common stock is subject, and none of the factors set forth below relates to the personal circumstances of individual investors. Investors should read this entire Form 10-K, as well as other documents and exhibits that are incorporated by reference in the 10-K and that have been filed with the SEC, in order to better understand these risks and to evaluate investment in Salisbury common stock.
Changes in interest rates and spreads could have a negative impact on earnings and financial condition.
Salisbury’s earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments, and the interest rates paid on deposits and borrowings, could adversely affect Salisbury’s earnings and financial condition. Salisbury cannot predict with certainty or control changes in interest rates. Global, national, regional, and local economic conditions and the policies of regulatory authorities, including monetary policies of the FRB, affect interest income and interest expense. Salisbury has ongoing policies and procedures designed to manage the risks associated with changes in market interest rates.
However, changes in interest rates still may have an adverse effect on Salisbury’s profitability. For example, high interest rates could also affect the volume of loans that Salisbury originates, because higher rates could cause customers to apply for fewer mortgages, or cause depositors to shift funds from accounts that have a comparatively lower rate, to accounts with a higher rate, or experience customer attrition due to competitor pricing or disintermediation. If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets increase, net interest income will be negatively affected. Changes in the asset and liability mix may also affect net interest income. Similarly, lower interest rates cause higher yielding assets to prepay and floating or adjustable rate assets to reset to lower rates. If Salisbury is not able to reduce its funding costs sufficiently, due to either competitive factors or the maturity schedule of existing liabilities, then Salisbury’s net interest margin will decline.
Financial stress on borrowers could reduce Salisbury’s net income and profitability.
Financial stress on borrowers as a result of job losses, or other factors, could have further adverse effects on borrowers that result in higher delinquencies and greater charge-offs in future periods beyond that which is provided for in Salisbury’s allowance for loan losses, which would adversely affect Salisbury’s financial condition or results of operations.
Fluctuations in economic conditions and collateral values could impact the adequacy of Salisbury’s allowance for loan losses.
Salisbury’s business is subject to periodic fluctuations based on national and local economic conditions. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on Salisbury’s operations and financial condition. For example, declines in housing activity including declines in building permits, housing sales and home prices may make it more difficult for Salisbury’s borrowers to sell their homes or refinance their debt. Slow sales could strain the resources of real estate developers and builders. The ongoing economic uncertainty has affected employment levels and could impact the ability of Salisbury’s borrowers to service their debt. Bank regulatory agencies also periodically review Salisbury’s allowance for loan losses and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses Salisbury will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on Salisbury’s financial condition and results of operations. Salisbury may suffer higher loan losses as a result of these factors and the resulting impact on its borrowers.
Credit market conditions may impact Salisbury’s investments.
Significant credit market anomalies may impact the valuation and liquidity of Salisbury’s investment securities. Illiquidity could reduce the market value of Salisbury’s investments, even those with no apparent credit exposure. The valuation of Salisbury’s investments requires judgment, and as market conditions change investment values may also change.
Salisbury’s securities portfolio performance in difficult market conditions could have adverse effects on Salisbury’s results of operations.
Under GAAP, Salisbury is required to review Salisbury’s investment portfolio periodically for the presence of other-than-temporary impairment of its securities, taking into consideration current market conditions, the extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, Salisbury’s ability and intent to hold investments until a recovery of amortized cost, as well as other factors. Adverse developments with respect to one or more of the foregoing factors may require Salisbury to deem particular securities to be other-than-temporarily impaired, with the credit related portion of the reduction in the value recognized as a charge to Salisbury’s earnings. Market volatility may make it extremely difficult to value certain securities of Salisbury. Subsequent valuations, in light of factors prevailing at that time, may result in significant changes in the values of these securities in future periods. Any of these factors could require Salisbury to recognize further impairments in the value of Salisbury’s securities portfolio, which may have an adverse effect on Salisbury’s results of operations in future periods.
If the goodwill that Salisbury has recorded in connection with its acquisitions becomes impaired, it could have a negative impact on Salisbury’s profitability.
Applicable accounting standards require that the acquisition method of accounting be used for all business combinations. Under acquisition accounting, if the purchase price of an acquired company exceeds the fair value of the acquired company’s net assets, the excess is carried on the acquirer’s balance sheet as goodwill. At December 31, 2020, Salisbury had $13.8 million of goodwill on its balance sheet. Salisbury must evaluate goodwill for impairment at least annually. Write-downs of the amount of any impairment, if necessary, are to be charged to the results of operations in the period in which the impairment occurs. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on Salisbury’s financial condition and results of operations.
Salisbury’s ability to pay dividends substantially depends upon its receipt of dividends from the Bank.
Cash dividends from the Bank and Salisbury’s liquid assets are the principal sources of funds for paying cash dividends on Salisbury’s common stock. Unless Salisbury receives dividends from the Bank or chooses to use its liquid assets, it may not be able to pay dividends. The Bank’s ability to pay dividends to Salisbury is subject to its condition and profitability as well as its regulatory requirements.
Strong competition within Salisbury’s market areas may limit growth and profitability.
Competition in the banking and financial services industry is intense. Salisbury competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. As Salisbury grows, it may expand into contiguous market areas where it may not be as well-known as other institutions that have been operating in those areas for some time. In addition, larger banking institutions may become increasingly active in Salisbury’s market areas, may have substantially greater resources and lending limits and may offer certain services that Salisbury does not, or cannot efficiently, provide. Salisbury’s profitability depends upon its continued ability to successfully compete in its market areas. The greater resources and deposit and loan products offered by some competitors may limit its ability to grow profitably.
Salisbury and the Bank are subject to extensive federal and state regulation and supervision.
Salisbury and the Bank are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect Salisbury’s lending practices, capital structure, investment practices, and dividend policy and growth, among other things. State and federal legislatures and regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect Salisbury in substantial and unpredictable ways. Such changes could subject Salisbury to additional costs, limit the types of financial services and products it may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on Salisbury’s business, financial condition and results of operations. While Salisbury has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the section captioned “Regulation and Supervision” in Item 1 of this report for further information.
Salisbury’s stock price may be volatile.
Salisbury’s stock is inactively traded and its stock price may fluctuate widely in response to a variety of factors including:
•Actual or anticipated variations in quarterly operating results
•Recommendations by securities analysts
•New technology used, or services offered, by competitors
•Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving Salisbury or Salisbury’s competitors
•Failure to integrate acquisitions or realize anticipated benefits from acquisitions
•Operating and stock price performance of other companies that investors deem comparable to Salisbury
•News reports relating to trends, concerns and other issues in the financial services industry
•Changes in government regulations
•Geopolitical conditions such as acts or threats of terrorism or military conflicts
•Changes in the economic environment of the market areas the Bank serves
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations could also cause Salisbury’s stock price to decrease regardless of Salisbury’s operating results. In addition, the annual reconstitution of the Russell 3000 index is likely to result in a market capitalization requirement for inclusion that significantly exceeds Salisbury’s market capitalization, which could result in Salisbury no longer qualifying for inclusion in the index. As a result, such change could adversely affect the liquidity of the market for Salisbury’s shares and reduce trading.
Salisbury’s ability to attract and retain skilled personnel may impact its success.
Salisbury’s success depends, in large part, on its ability to attract and retain key people. Competition for people with specialized knowledge and skills can be intense, and Salisbury may not be able to hire people or to retain them. The unexpected loss of services of one or more of Salisbury’s key personnel could have a material adverse impact on the business because of their skills, knowledge of the market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Salisbury continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services as well as the emergence of online bank competitors. The effective use of technology can increase efficiency and enable financial institutions to better serve customers and to reduce costs. However, some new technologies needed to compete effectively result in incremental operating costs. Salisbury’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. Many of Salisbury’s competitors have substantially greater resources to invest in technological improvements. Salisbury may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on Salisbury’s business and, in turn, its financial condition and results of operations.
A failure involving controls and procedures may have an adverse effect on Salisbury.
Management regularly reviews and updates Salisbury’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Salisbury’s business, results of operations and financial condition.
If customer information was to be misappropriated and used fraudulently, due to a breach of our systems, or those of third-party vendors or service providers, including as a result of cyberattacks, Salisbury could be exposed to potential liability and reputation risk as well as increased costs.
Risk of theft of customer information resulting from security breaches by third parties exposes banks to reputation risk and potential monetary loss. Like other financial institutions, Salisbury has exposure to fraudulent misuse of its customers’ personal information resulting from its general business operations through loss or theft of the information and through misappropriation of information by third parties in connection with customer use of financial instruments, such as debit cards.
In addition, Salisbury relies upon a variety of computing platforms and networks over the internet for the purposes of data processing, communications and information exchange. Despite the safeguards instituted by Salisbury, any system is susceptible to a breach of security. In addition, Salisbury relies on the services of a variety of third-party vendors to meet Salisbury’s data processing and communication needs. The occurrence of any failures, interruptions or security breaches of Salisbury’s information systems or that of its vendors could damage Salisbury’s reputation, result in a loss of customer business or expose Salisbury to civil litigation and possible financial loss. Such costs and/or losses could materially impact Salisbury’s earnings.
Changes in accounting standards can materially impact Salisbury’s financial statements.
Salisbury’s accounting policies and methods are fundamental to how Salisbury records and reports its financial condition and results of operations. From time to time, the Financial Accounting Standards Board or regulatory authorities change the financial accounting and reporting standards that govern the preparation of Salisbury’s financial statements. These changes can be hard to predict and can materially impact how Salisbury records and reports its financial condition and results of operations. In some cases, Salisbury could be required to apply a new or revised standard retroactively, resulting in Salisbury restating prior period financial statements.
Changes and interpretations of tax laws and regulations may adversely impact Salisbury’s financial statements.
Local, state or federal tax authorities may interpret tax laws and regulations differently than Salisbury and challenge tax positions that Salisbury has taken on its tax returns. This may result in the disallowance of deductions or differences in the timing of deductions and result in the payment of additional taxes, interest or penalties that could materially affect Salisbury’s performance.
In addition, changes in tax law may adversely affect Salisbury’s lending business and performance, especially those provisions regarding the deductibility of residential mortgage interest and state property taxes.
The risks presented by recent or future acquisitions could adversely affect our financial condition and results of operations.
Our business strategy has included, and may continue to include, growth through acquisition from time to time. Any recent and future acquisitions will be accompanied by the risks commonly encountered in acquisitions. These risks may include, among other things: our ability to realize anticipated cost savings; the difficulty of integrating operations and personnel; the loss of key employees; the potential disruption of our or the acquired company’s ongoing business in such a way that could result in decreased revenues; the inability of our management to maximize our financial and strategic position; the inability to maintain uniform standards, controls, procedures and policies; and the impairment of relationships with the acquired company’s employees and customers as a result of changes in ownership and management.
Salisbury may be adversely impacted by the discontinuance of LIBOR as a short-term interest rate utilized for the Company’s issued subordinated debentures and other financing agreements.
In July 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee ("ARRC") has proposed that the Secured Overnight Financing Rate ("SOFR") is the rate that represents best practice as the alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a paced market transition plan to SOFR from USD-LIBOR and organizations are currently working on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to USD-LIBOR. The Company has subordinated notes in connection with its issuance of subordinated debt in 2015, which transitioned to variable rates that are indexed to USD-LIBOR in December 2020. Salisbury is monitoring the transition from LIBOR to a new reference rate and its impact on the repricing of Salisbury’s subordinated debt. In addition, the uncertainty as to the nature of alternative reference rates and the replacement of LIBOR may adversely affect the value of certain loans and investment securities.
The Bank’s active participation in the PPP, or in other relief programs, may expose Salisbury to credit losses as well as litigation and compliance risk.
To support customers, businesses, and communities, the Bank has participated as a lender in the PPP. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. As of December 31, 2020, the Bank had approximately $85 million of PPP loans on its balance sheet. The Bank’s participation in the PPP, and participation in any other relief programs now or in the future, including those under the CARES Act, exposes Salisbury to certain credit, compliance, and other risks.
Among other regulatory requirements, PPP loans are subject to forbearance of loan payments for a six-month period to the extent that loans are not eligible for forgiveness. If PPP borrowers fail to qualify for loan forgiveness, including by failing to use the funds appropriately in order to qualify for forgiveness under the program, the Bank has a greater risk of holding these loans at unfavorable interest rates. In addition, because of the short time period between the passing of the CARES Act and the implementation of the PPP, there is ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes Salisbury to risks relating to noncompliance with the PPP. There is risk that the SBA or another governmental entity could conclude there is a deficiency in the manner in which the Bank originated, funded, or serviced PPP loans, which may or may not be related to the ambiguity in the CARES Act or the rules and guidance promulgated by the SBA and the U.S. Treasury regarding the operation of the PPP. In the event of such deficiency, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from us.
Since the commencement of the PPP, several other banks have been subject to litigation regarding the process and procedures that such banks followed in accepting and processing applications for the PPP. Salisbury may be exposed to the risk of similar litigation. Any financial liability, litigation costs, or reputational damage caused by PPP-related litigation could have a material adverse impact on Salisbury’s reputation, business, financial condition, and results of operations.
In addition, Salisbury may be subject to regulatory scrutiny regarding the Bank’s processing of PPP applications or its origination or servicing of PPP loans. While the SBA has said that in many instances, banks may rely on the certifications of borrowers regarding their eligibility for PPP loans, the Bank has several obligations under the PPP, and if the SBA found that the Bank did not meet those obligations, the remedies the SBA may seek against the Bank, while unknown, may include not guarantying the PPP loans resulting in credit exposure to borrowers who may be unable to repay their loans. The PPP program may also attract significant interest from federal and state enforcement authorities, oversight agencies, regulators, and Congressional committees. State Attorneys General and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations entitling the Bank to rely on borrower certifications, and take more aggressive action against us for alleged violations of the provisions governing the Bank’s participation in the PPP.
The outbreak of COVID-19, or other such epidemic, pandemic, or outbreak of a highly contagious disease, occurring in the United States or in the communities in which Salisbury conducts operations, could adversely affect Salisbury’s business operations, asset valuations, financial condition, and results of operations.
The COVID-19 pandemic (hereafter referred to as “COVID-19”, “pandemic” or “virus”) has had a substantial adverse impact in the United States, including threats to public health, increased volatility in markets, and significant effects on national and local economies. The ultimate effect of the virus on Salisbury’s and the Bank’s business will depend on numerous factors and future developments that are highly uncertain and cannot be predicted with certainty. Salisbury’s business is dependent upon the willingness and ability of our customers to conduct banking and other financial transactions. COVID-19, or another highly contagious or infectious disease, could negatively impact the ability of our employees and customers to conduct such transactions and disrupt the business activities and operations of the Bank’s customers in the communities in which the Bank operates. The spread of the COVID-19 virus had an impact on Salisbury’s operations during fiscal year 2020, and Salisbury expects that the virus will continue to have an impact on the business, financial condition, and results of operations of Salisbury, as well as on its customers, during fiscal year 2021. The COVID-19 pandemic has caused changes in the behavior of customers, businesses, and their employees, including illness, quarantines, social distancing practices, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability. Future effects, including additional actions taken by federal, state, and local governments to contain COVID-19 or treat its impact, are unknown. Any sustained disruption to the Bank’s operations is likely to negatively impact Salisbury’s financial condition and results of operations. Notwithstanding Salisbury’s contingency plans and other safeguards against pandemics or other contagious diseases, the spread of COVID-19 could also negatively impact the availability of the Bank’s personnel who are necessary to conduct business operations, as well as potentially impact the business and operations of Salisbury’s third-party service providers who perform critical services for Salisbury. If the response to contain COVID-19, or another highly infectious or contagious disease, is unsuccessful, Salisbury could experience a material adverse effect on its business operations, asset valuations, financial condition, and results of operations. Material adverse impacts may include all or a combination of valuation impairments on Salisbury’s intangible assets, investments, loans, loan servicing rights, or deferred tax assets.
In addition, Salisbury may experience changes in the value of collateral securing outstanding loans, reductions in the credit quality of borrowers and the inability of borrowers to repay loans in accordance with their terms. These and similar factors and events may have substantial negative effects on the business, financial condition, ability to pay dividends and results of operations of Salisbury, the Bank and its customers.
Salisbury may be adversely affected by legislation enacted by the new administration following the 2020 election.
Legislation enacted by the new administration following the 2020 election may have an adverse impact on the conduct and profitability of businesses, including companies like Salisbury and the Bank through increased regulation and taxes.
Item 1B.
Item 1B.UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2.PROPERTIES
Salisbury does not directly own or lease any properties. The properties described below are owned or leased by the Bank.
The Bank conducts its business at its main office, located at 5 Bissell Street, Lakeville, Connecticut, and through an additional thirteen full service branch offices located in Canaan, Salisbury and Sharon, Connecticut; Great Barrington, South Egremont and Sheffield, Massachusetts; and Dover Plains, Fishkill, Millerton, Newburgh, New Paltz, Poughkeepsie, and Red Oaks Mill, New York. The Bank owns its main office and seven of its branch offices and its Canaan and Operations office, and currently leases six branch offices.
In September 2019, the Bank completed the purchase of its New Paltz, New York branch, which had been previously treated as a finance lease. For additional information, see Note 8, “Bank Premises and Equipment,” and Note 5 “Leases” to the Consolidated Financial Statements.
The following table includes all property owned or leased by the Bank, but does not include Other Real Estate Owned.
Item 3.
Item 3.LEGAL PROCEEDINGS
The Bank is involved in various claims and legal proceedings arising in the ordinary course of business, which management currently believes are not material, individually or in the aggregate, to the business, financial condition or operating results of Salisbury or any of its subsidiaries.
There are no material pending legal proceedings, other than ordinary routine litigation incidental to Salisbury’s business, to which Salisbury is a party or any of its subsidiaries is a party or of which any of their property is subject.
Item 4.
Item 4.MINE SAFETY DISCLOSURES
Not applicable.
PART II
Item 5.
Item 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Salisbury’s common stock trades on the NASDAQ Capital Market under the symbol “SAL.”
Holders
There were approximately 2,439 holders of record of the common stock of Salisbury as of March 9, 2021. This number includes brokerage firms and other financial institutions that hold stock in their name, but which is actually beneficially owned by third parties.
Dividends
For a discussion of Salisbury's dividend policy and restrictions on dividends see "Management’s Discussion and Analysis of Financial Condition and Results of Operations" under the caption “Dividends.” See also, Note 14 - “Shareholders’ Equity” of Notes to Consolidated Financial Statements.
Equity Compensation Plan Information
For the information required by this item see Note 16 - “Long Term Incentive Plans” of Notes to Consolidated Financial Statements.
Recent Sales of Unregistered Securities and Use of Proceeds
None.
Issuer Purchases of Equity Securities
None.
Item 6.
Item 6.SELECTED FINANCIAL DATA
The following table contains certain information concerning the financial position and results of operations of Salisbury at the dates and for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements and related notes.
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except ratios and per share amounts)
Item 7.
Item 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
Salisbury, a Connecticut corporation, formed in 1998, is the bank holding company for the Bank, a Connecticut-chartered and FDIC insured commercial bank headquartered in Lakeville, Connecticut. Salisbury's principal business consists of the business of the Bank. The Bank, formed in 1848, is engaged in customary banking activities, including general deposit taking and lending activities to both retail and commercial markets, and trust and wealth advisory services. The Bank conducts its banking business from fourteen full-service offices in the towns of: Canaan, Lakeville, Salisbury and Sharon, Connecticut; Great Barrington, South Egremont and Sheffield, Massachusetts; and, Fishkill, Newburgh, New Paltz, Poughkeepsie, Red Oaks Mill, Dover Plains and Millerton, New York, and its trust and wealth advisory services from offices in Lakeville, Connecticut.
Critical Accounting Policies and Estimates
Salisbury’s consolidated financial statements follow U.S. GAAP as applied to the banking industry in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event.
Salisbury’s significant accounting policies are presented in Note 1 of Notes to Consolidated Financial Statements, which, along with this Management’s Discussion and Analysis, provide information on how significant assets are valued in the financial statements and how those values are determined. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating Salisbury’s reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.
The allowance for loan losses represents management’s estimate of credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet. Note 1 describes the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses is included in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis.
Management, with the assistance of a third party, evaluates goodwill and identifiable intangible assets for impairment annually using valuation techniques that involve observations and adjustments as to comparable transactions, estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors.
For both goodwill and for the core deposit intangible, the comparable transaction methodology was used to assess, and conclude that there was no impairment at November 30, 2020. The current discounted economic value methodology was also used to test for goodwill impairment.
Future events, or changes in the estimates, which are used to determine the carrying value of goodwill and identifiable intangible assets or which otherwise adversely affect their value or estimated lives could have a material adverse impact on the results of operations.
Management evaluates securities for other-than-temporary impairment giving consideration to the extent to which the fair value has been less than cost, estimates of future cash flows, delinquencies and default severity, the intent and ability of Salisbury to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and the likelihood that Salisbury will be required to sell the security before recovery in fair value to meet liquidity needs. The consideration of the above factors is subjective and involves estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.
The following discussion and analysis of Salisbury's consolidated results of operations should be read in conjunction with the Consolidated Financial Statements and footnotes.
RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 2020 and 2019
COVID-19 has placed significant health and economic pressure on the communities the Bank serves, the State of Connecticut, the United States and other countries. In response, the Bank has proactively implemented several steps such as those set forth below to support the safety and well-being of its employees and customers, which procedures continue through the date of this Report:
·The Bank is practicing social distancing following the guidelines of the Center for Disease Control and requires many of its employees to work from home or from alternate locations. As of December 31, 2020, approximately 25% of Salisbury’s employees worked from home or alternate locations.
·The Bank continues to leverage the drive-up windows in twelve of its fourteen branches as well as its electronic banking platform to continue to serve customers.
Salisbury will continue to monitor this pandemic as the situation continues to evolve and adjust its operating model accordingly.
Net Interest and Dividend Income
Net interest and dividend income (presented on a tax-equivalent basis) increased $4.1 million, or 11.9%, in 2020 over 2019. The net interest margin increased 1 basis point to 3.28% from 3.27%, due to a 57 basis point decrease in the average cost of interest-bearing liabilities partly offset by a 43 basis point decrease in the average yield on interest-earning assets. The net interest margin was affected by changes in the mix of interest-earning assets and funding liabilities, asset and liability growth, and the effects of changes in market interest rates on the pricing and re-pricing of assets and liabilities. The following table sets forth the components of Salisbury's net interest income and yields on average interest-earning assets and interest-bearing funds. Income and yields on tax-exempt securities are presented on a fully taxable equivalent basis.
(a)Includes non-accrual loans.
(b)Includes interest-bearing deposits in other banks and federal funds sold.
(c)Average balances of securities are based on amortized cost.
(d)Includes tax exempt income of $0.7 million, $0.6 million and $0.5 million, respectively for 2020, 2019 and 2018 on tax-exempt securities and loans for which income and yields are calculated on a tax-equivalent basis.
(e)Net interest income divided by average interest-earning assets.
(f)Interest income for 2020, 2019 and 2018 reflected net accretion related to the fair value adjustments of loans acquired in the Riverside Bank acquisition in the amount of $0 million, $0 million and $0.8 million, respectively.
The following table sets forth the changes in net interest income (presented on a tax-equivalent basis) due to volume and rate.
Net interest and dividend income represents the difference between interest and dividends earned on loans and securities and interest expense incurred on deposits and borrowings. The level of net interest income is a function of volume, rates and mix of both earning assets and interest-bearing liabilities. Net interest income can be affected by changes in interest rate levels, changes in the volume of assets and liabilities that are subject to re-pricing within different future time periods, and in the level of non-performing assets.
Interest and Dividend Income
Tax equivalent interest and dividend income of $44.1 million in 2020 was essentially unchanged from 2019. Loan income increased $1.1 million, or 2.7%, to $41.3 million in 2020. The increase was primarily due to a $97.1 million, or 10.5%, increase in average loans, which was partly offset by a 33 basis point decrease in average yield.
Tax equivalent interest and dividend income from securities decreased $377 thousand, or 12.8%, to $2.6 million in 2020, as a result of a $6.5 million, or 6.8%, decrease in average security balances, and a 20 basis point decrease in average yield. Interest from short term funds decreased $521 thousand in 2020 as a result of a 164 basis point decrease in average yield, partially offset by a $29.8 million, or 82.6%, increase in average short term balances.
Interest Expense
Interest expense decreased $4.0 million, or 75.9%, to $5.3 million in 2020. Interest expense on interest bearing deposit accounts decreased $3.4 million, or 46.9%, to $3.9 million in 2020, as a result of a $47.5 million, or 6.7%, increase in average interest-bearing deposits and a 52 basis point decrease in the average rate to 0.51%. Interest expense on money market accounts decreased $1.2 million, or 50.9%, due to a 60 basis point decline in the average rate partly offset by a $34.3 million, or 15.4% increase in average balance. Interest expense on savings and other accounts decreased $1.1 million, or 69.4%, due to a 61 basis point decline in the average rate. Interest expense on certificates of deposits decreased $1.0 million, or 35.9%,due to 53 basis point decline in the average rate and a $15.3 million, or 9.6% decrease in average balance. The decrease in the average certificate of deposit balance from 2019 reflected a $12.5 million decrease in average one-way buys executed through the Certificate of Deposit Account Registry Service (“CDARS”). CDARS is a product offered by Promontory Interfinancial Network that enables participating financial institutions to buy or sell excess funds to other members to fund operations and to manage liquidity.
Interest expense on FHLBB advances decreased $538 thousand, or 47.1%, due to a 149 basis point decrease in the average borrowing rate to 1.49%, partly offset by a $1.8 million, or 4.7%, increase in average advances.
In December 2015, Salisbury issued $10 million of subordinated debentures. The proceeds of such issuance, along with cash-on-hand, were used by Salisbury to fully redeem $16 million of its outstanding Series B Preferred Stock, which was issued pursuant to the participation in the U.S. Treasury’s SBLF program. Interest expense on the subordinated debt for 2020 and 2019 was $0.6 million and $0.6 million, respectively.
Provision and Allowance for Loan Losses
The provision for loan losses was $5.0 million for 2020, compared with $1.0 million for 2019. Net loan charge-offs were $0.2 million and $0.6 million, for the respective years. The higher provision for loan losses in 2020 primarily reflected management’s assessment of the impact of COVID-19 on certain qualitative and environmental factors and impaired loans as well as loan growth. Management will continue to monitor the impact of the virus on its borrowers and adjust the allowance as appropriate. The length of time required for the economy to substantially recover from the virus will have a direct impact on Salisbury’s provision and allowance for loan losses. A longer recovery or another forced shutdown that leads to sustained levels of unemployment will likely result in an increase in Salisbury’s provision and allowance for loan losses.
The following table sets forth changes in the allowance for loan losses and other statistical data:
The reserve coverage at December 31, 2020, as measured by the ratio of allowance for loan losses to gross loans, was 1.32%, as compared with 0.95% at December 31, 2019. Excluding loans advanced under the SBA’s Paycheck Protection Program, the ratio of the allowance to gross loans was 1.44% at December 31, 2020. Non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) increased $2.0 million to $5.6 million, or 0.54% of gross loans receivable, at December 31, 2020, up from $3.6 million or 0.39% of gross loans receivable at December 31, 2019. The increase in non-performing loans from the prior year end primarily reflected loans of $3.7 million placed on non-accrual status partly offset by loan sales of $0.7 million, loan payments of $0.5 million and loans returned to accruing status of $0.5 million. Accruing loans past due 30-89 days increased from $2.1 million, or 0.22%, of gross loans receivable at December 31, 2019 to $6.8 million, or 0.66%, of gross loans receivable at December 31, 2020. The increase included loans of $3.0 million that matured in fourth quarter 2020, most of which are expected to renew in first quarter 2021. See “Overview - Loan Credit Quality” below for further discussion and analysis.
Non-Interest Income
The following table details the principal categories of non-interest income.
Non-interest income increased $1.0 million, or 11.6%, in 2020 versus 2019. Trust and Wealth Advisory revenues increased $199 thousand mainly due to growth in asset-based fees. Service charges and fees decreased $956 thousand from 2019. During the twelve-month period ended December 31, 2020, Salisbury waived approximately $754 thousand in various deposit fees, including overdraft and ATM fees, to support customers affected by COVID-19. These fees were reinstituted in late November 2020. Mortgage banking activities, net increased $1.2 million on higher sales volume. Mortgage loan sales totaled $59.8 million in 2020 versus $6.4 million in 2019. Loans serviced under the FHLBB Mortgage Partnership Finance Program totaled $134.4 million and $106.3 million at December 31, 2020 and 2019, respectively. In 2020, the Bank recorded a non-taxable gain of $601 thousand related to proceeds received from a BOLI policy due to the death of a covered former employee. Other income primarily includes rental property income.
Non-Interest Expense
The following table details the principal categories of non-interest expense.
Non-interest expenses increased $126 thousand, or 0.4%, in 2020 versus 2019. Salaries decreased $220 thousand as higher production and incentive accruals as well as higher overtime costs were more than offset by an increase in deferred compensation costs associated with originating loans, including PPP loans. Benefits increased $149 thousand compared to the same period in 2019. The increase was primarily due to a one-time reduction of $328 thousand received in the fourth quarter 2019 due to the modification of key terms of agreements related to BOLI policies and higher accruals for performance based restricted stock units, partly offset by lower expenses for phantom stock appreciation units. See Note 16 for a further discussion of Salisbury’s Long-Term Incentive Compensation Plans. Premises and equipment increased $3 thousand mainly due to increased software expense partially offset by lower depreciation, building maintenance and utilities costs. Data processing increased $10 thousand mainly due to ATM fees and core data processing costs partially offset by lower Trust and Wealth data processing expense. The increase in professional fees of $528 thousand versus the twelve month period 2019 primarily reflected higher consulting and investment management expenses, partly offset by lower legal costs. Collections, OREO and loan related expense decreased $113 thousand due to OREO losses in the twelve month period 2019. The increase in FDIC insurance expense primarily reflected non-recurring assessment credits of $240 thousand received in 2019. Marketing and community support costs decreased $46 thousand compared to the same period in 2019 primarily due to lower marketing expenditures partially offset by increased contributions. Amortization of intangible assets decreased $67 thousand due to the aging off of expenses related to previous acquisitions. Other expenses increased $85 thousand and primarily reflected accruals related to litigation matters occurring in the normal course of business.
Income Taxes
The effective income tax rates for 2020 and 2019 were 17.0% and 17.5%, respectively. Salisbury’s effective tax rate was less than the 21% federal statutory rate due to tax-exempt income, primarily from municipal bonds, tax advantaged loans and bank-owned life insurance. Fluctuations in the effective tax rate generally result from changes in the mix of taxable and tax-exempt income. For further information on income taxes, see Note 13 of Notes to Consolidated Financial Statements.
Salisbury did not incur Connecticut income tax in 2020, 2019 or 2018, other than minimum state income tax, as a result of a Connecticut law that permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a special purpose entity called a Passive Investment Company or PIC. Salisbury avails itself of this benefit through its PIC, SBT Mortgage Service Corporation. Salisbury's income tax provision reflects the full impact of the Connecticut legislation. Salisbury does not expect to pay other than minimum Connecticut state income tax in the foreseeable future unless there is a change in Connecticut tax law.
Comparison of the Years Ended December 31, 2019 and 2018
Net Interest and Dividend Income
Net interest and dividend income represents the difference between interest and dividends earned on loans and securities and interest expense incurred on deposits and borrowings. The level of net interest income is a function of volume, rates and mix of both earning assets and interest-bearing liabilities. Net interest income can be affected by changes in interest rate levels, changes in the volume of assets and liabilities that are subject to re-pricing within different future time periods, and in the level of non-performing assets.
Interest and Dividend Income
Tax equivalent interest and dividend income increased $3.2 million, or 7.8%, to $44.0 million in 2019. Loan income increased $2.7 million, or 7.1%, to $40.2 million in 2019. The increase was primarily due to a $51.3 million, or 5.9%, increase in average loans, and a 5 basis point increase in average yield. Interest income for 2019 and 2018 reflects purchase accounting adjustments consisting of net accretion related to the fair value adjustments of loans acquired in the Riverside Bank acquisition in the amount of $0 million and $0.8 million, respectively.
Tax equivalent interest and dividend income from securities increased $0.5 million, or 22.2%, to $2.9 million in 2019, as a result of a $8.3 million, or 9.4%, increase in average security balances, and a 32 basis point increase in average yield. Interest from short term funds decreased $20 thousand in 2019 as a result of a 19 basis point increase in average yield, partially offset by a $5.2 million, or 12.7%, decrease in average short term balances.
Interest Expense
Interest expense increased $2.1 million, or 28.8%, to $9.3 million in 2019. Interest expense on interest bearing deposit accounts increased $2.7 million, or 57.2%, to $7.3 million in 2019, as a result of a $63.2 million, or 9.7%, increase in average interest-bearing deposits and a 31 basis point increase in the average rate to 1.03%. The increase in the average certificate of deposit balance from 2018 reflected higher average brokered certificates of deposits balances of $20.3 million and a $3.0 million increase in average one-way buys executed through the Certificate of Deposit Account Registry Service (“CDARS”). CDARS is a product offered by Promontory Interfinancial Network that enables participating financial institutions to buy or sell excess funds to other members to fund operations and to manage liquidity.
Interest expense on FHLBB advances decreased $0.6 million, or 34.1%, due to a $25.9 million, or 40.4%, decrease in average advances, partially offset by a 28 basis point increase in the average borrowing rate to 2.98%.
In December 2015, Salisbury issued $10 million of subordinated debentures. The proceeds of such issuance, along with cash-on-hand, were used by Salisbury to fully redeem $16 million of its outstanding Series B Preferred Stock, which was issued pursuant to the participation in the U.S. Treasury’s SBLF program. Interest expense on the subordinated debt for 2019 and 2018 was $0.6 million and $0.6 million, respectively.
Provision and Allowance for Loan Losses
The provision for loan losses was $1.0 million for 2019, compared with $1.7 million for 2018. Net loan charge-offs were $0.6 million and $0.7 million, for the respective years. The lower provision for loan losses in 2019 primarily reflected lower originations. In first quarter 2019, Salisbury transferred the remaining unearned credit-related discount on loans acquired in its 2014 acquisition of Riverside Bank to the allowance for loan loss reserves. As a result of this transfer, gross loans receivable and the allowance for loan losses increased by $0.7 million. The balance of net loans receivable did not change as a result of this transfer.	
The reserve coverage at December 31, 2019, as measured by the ratio of allowance for loan losses to gross loans, was 0.95%, as compared with 0.85% at December 31, 2018. Non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) decreased $2.9 million to $3.6 million, or 0.39% of gross loans receivable, at December 31, 2019, down from $6.5 million or 0.71% of gross loans receivable at December 31, 2018. The decline in non-performing loans from the prior year end primarily reflected pay-offs of $1.6 million, upgrades to performing status of $0.9 million and write-downs of $0.4 million. Accruing loans past due 30-89 days decreased $0.1 million to $2.1 million, or 0.22% of gross loans receivable at December 31, 2019. See “Overview - Loan Credit Quality” below for further discussion and analysis.
Non-Interest Income
Non-interest income increased $305 thousand, or 3.4%, in 2019 versus 2018. Trust and Wealth Advisory revenues increased $295 thousand primarily due to increased market values and a higher volume of assets under management. Service charges and fees increased $310 thousand from 2018 on higher interchange and wire fees as well as higher loan prepayment penalties. Gains on sales of mortgage loans increased $27 thousand on higher sales volume. Mortgage loans sales totaled $6.4 million in 2019 versus $4.6 million in 2018. Loans serviced under the FHLBB Mortgage Partnership Finance Program totaled $106.3 million and $111.4 million at December 31, 2019 and 2018, respectively. In 2018, the Bank recorded a non-taxable gain of $341 thousand related to proceeds received from a BOLI policy due to the death of a covered former employee.
Non-Interest Expense
Non-interest expenses decreased $923 thousand, or 3.1%, in 2019 versus 2018. Salaries expense increased $45 thousand due to higher base salaries, merit increases, and short-term incentive accruals partly offset by lower production accruals due to lower loan volume. Employee benefits expense for 2019 included a non-recurring reduction of $328 thousand, which reflected changes to the calculation of death benefits for bank-owned life insurance policies. This credit, as well as lower 401K and ESOP accruals, was more than offset by higher medical insurance costs and higher deferred compensation accruals. Premises and equipment expense decreased $519 thousand from 2018 as the prior year included a charge of $171 thousand to write-off the remainder of the lease and fixed assets related to the Bank’s previously occupied Fishkill, New York branch location as well as a charge of $95 thousand to write-off the remaining term of a third-party software contract. Software maintenance costs and depreciation costs were also lower. Data processing expense increased $82 thousand mainly as a result of higher core data processing costs. The decrease of $23 thousand in professional fees reflected lower consulting and internal audit costs partly offset by higher external audit and regulatory exam costs, as well as higher investment management expenses. OREO losses and write-downs increased $133 thousand from 2018. Collections, OREO and appraisal expenses decreased $142 thousand primarily due to lower appraisal fees, lower carrying costs and lower taxes. The $318 thousand decrease in FDIC insurance reflected $240 thousand in non-recurring assessment credits received by the Bank in 2019. Marketing and community support decreased $196 thousand due to costs incurred in the prior year for the Fishkill, New York branch relocation, the timing of contributions and lower overall marketing spend. Amortization of intangibles and all other operating expenses collectively decreased $89 thousand from 2018.
Income Taxes
The effective income tax rates for 2019 and 2018 were 17.5% and 16.2%, respectively. Salisbury’s effective tax rate was less than the 21% federal statutory rate due to tax-exempt income, primarily from municipal bonds, tax advantaged loans and bank-owned life insurance. Fluctuations in the effective tax rate generally result from changes in the mix of taxable and tax-exempt income. For further information on income taxes, see Note 13 of Notes to Consolidated Financial Statements.
Salisbury did not incur Connecticut income tax in 2019, 2018 or 2017, other than minimum state income tax, as a result of a Connecticut law that permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a special purpose entity called a Passive Investment Company or PIC. Salisbury avails itself of this benefit through its PIC, SBT Mortgage Service Corporation. Salisbury's income tax provision reflects the full impact of the Connecticut legislation. Salisbury does not expect to pay other than minimum Connecticut state income tax in the foreseeable future unless there is a change in Connecticut tax law.
Overview
Assets
During 2020, Salisbury’s assets increased by $181.2 million to $1.294 billion, while net loans increased $100.3 million at December 31, 2020. Asset and loan growth included approximately $85 million of PPP loans. Salisbury also experienced a significant build up in cash balances as a result of the funding of the PPP loans. The balance of cash and cash equivalents increased $66.3 million to $93.2 million at December 31, 2020. Salisbury has employed excess cash to pay down borrowings and invest in additional available-for-sale securities. At December 31, 2020, Salisbury’s tangible book value and book value per common share were $38.78 and $43.88, respectively. At December 31, 2020, the Bank’s Tier 1 leverage and total risk-based capital ratios were 8.90% and 13.57%, respectively. As of December 31, 2020, the Bank was categorized as "well capitalized."
Securities and Short-Term Funds
During 2020, securities increased $5.1 million to $101.0 million, while short-term funds (cash and due from banks and interest-bearing deposits with other banks) increased $66.3 million to $93.2 million. The carrying values of securities are as follows:
Salisbury evaluates securities for OTTI where the fair value of a security is less than its amortized cost basis at the balance sheet date. As part of this process, Salisbury considers whether it has the intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI.
Salisbury evaluates securities for strategic fit and may reduce its position in securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Management does not consider any of its securities to be OTTI at December 31, 2020. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI. Salisbury evaluates securities for strategic fit and may reduce its position in securities, although it is not more likely than not that Salisbury will be required to sell securities before recovery of their cost basis, which may be maturity.
Accumulated other comprehensive income at December 31, 2020 included net unrealized holding gains, net of tax, of $3.0 million, which is an increase of $1.6 million from December 31, 2019.
Loans
During 2020, net loans receivable increased $100.3 million, or 11%, to $1.027 billion at December 31, 2020. Salisbury’s retail lending department originates residential mortgage, home equity loans and lines of credit, and consumer loans for the portfolio. During 2020, Salisbury originated a record $147.6 million of residential mortgage loans and $9.0 million of home equity loans for the portfolio, compared with $53.4 million and $7.5 million, respectively, in 2019. During 2020, total residential mortgage and home equity loans receivable declined by $1.7 million to $425.7 million at December 31, 2020, and represent 40.9% of gross loans receivable. During 2020, Salisbury’s residential mortgage lending department also originated and sold $59.8 million of residential mortgage loans, compared with $6.4 million during 2019. All such sold loans were sold through the FHLBB Mortgage Partnership Finance Program with servicing retained by Salisbury. Consumer loans, amounted to $7.9 million at December 31, 2020, representing 0.7% of gross loans receivable.
Salisbury’s commercial lending department specializes in lending to small and mid-size companies, businesses and municipalities. More specifically, we meet our clients’ credit needs by providing short-term and long-term financing, construction loans, commercial mortgages, equipment, working capital, property improvement loans and municipal financing. The department also works with both the Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”) Government Guaranteed Lending Programs; however, such loans represent a very small percent of the commercial loan portfolio. Salisbury originated $221.8 million of commercial loans during 2020 compared with $155.4 million in 2019. Total commercial loans, which include commercial real estate, commercial and industrial and municipal loans, increased $101.6 million to $591.2 million at December 31, 2020, and represent 56.7% of gross loans receivable. Additionally, in 2020, Salisbury processed 932 loan applications for nearly $100 million under the SBA’s PPP program. At December 31, 2020 approximately $85 million of these loans remained on Salisbury’s balance sheet. These loans are categorized as “commercial and industrial” in the table below.
The principal categories of loans receivable and loans held-for-sale are as follows:
The composition of loans receivable by forecasted maturity distribution is as follows:
The composition of loans receivable with either fixed, variable or adjustable interest rates is as follows:
Loan Credit Quality
Salisbury has cooperative relationships with the vast majority of its non-performing loan customers. Substantially all non-performing loans are collateralized with real estate and the repayment of such loans is largely dependent on the return of such loans to performing status or the liquidation of the underlying real estate collateral. Salisbury pursues the resolution of all non-performing loans through collections, restructures, voluntary liquidation of collateral by the borrower and, where necessary, legal action. When attempts to work with a customer to return a loan to performing status, including restructuring the loan, are unsuccessful, Salisbury will initiate appropriate legal action seeking to acquire property by deed in lieu of foreclosure or through foreclosure, or to liquidate business assets.
On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”, this guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of the virus. The guidance goes on to explain that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of the relief program are not Troubled Debt Restructurings (“TDRs”). Section 4013 of the CARES Act addresses modifications resulting from the pandemic and specified that virus related modifications on loans that were current as of December 31, 2019 are not TDRs. The Bank has applied Section 4013 guidance and implemented a loan payment deferral program which allows residential, commercial and consumer borrowers, who have been adversely affected by the virus and whose loans were not more than 30 days past due at December 31, 2019, to defer loan payments for up to three months. Borrowers may apply to the Bank for additional deferments, which will be evaluated on a case-by-case basis.
As of December 31, 2020, 15 commercial loans ($29.8 million loan balances) were granted payment deferrals. Approximately sixty percent of the deferred loan payments ($17.9 million loan balance) related to borrowers in the hospitality industry and another thirty percent ($8.5 million loan balance) related to borrowers in the entertainment & recreation industry. The loan balance for which payments were deferred represented approximately 3.1% of Salisbury’s gross loan balance at December 31, 2020, excluding loans granted under the SBA’s Paycheck Protection Program. There were no outstanding deferrals related to residential and consumer loans as of December 31, 2020. The Bank will continue to accrue interest on such deferred payments, which will be added to a borrower’s final payment. Salisbury evaluated each borrower’s request for loan payment deferrals on a case-by case-basis. Salisbury also reviewed the credit characteristics and internal risk rating assigned to each borrower that was granted a deferral. This review considered several factors, which included an assessment of COVID-19’s impact on the operations of the business, other sources of liquidity available to a borrower for loan payments, the borrower’s cooperation, the value of collateral and the number of payment deferrals granted to that borrower. Salisbury also considered a borrower’s ability to make partial payments, which represent a subset or combination of principal, interest and mortgage taxes. At December 31, 2020, six of the loans deferring payments were deferring principal only, eight loans were deferring principal and interest and one loan was deferring principal and mortgage taxes.
The CARES Act provides emergency economic relief to individuals and businesses impacted by the virus. The CARES Act authorized the SBA to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (“PPP”). As a qualified SBA lender, the Bank was automatically qualified to originate loans under the PPP. Salisbury processed 932 PPP loans for a principal balance of approximately $100 million primarily for existing customers. The expected forgiveness amount is the amount of loan principal the lender reasonably expects the borrower to spend on payroll costs, mortgage interest, rent and utilities during the covered period after the loans are funded. On June 5, 2020, the Paycheck Protection Program Flexibility Act (“PPPFA”) was signed into law. The PPPFA increased the covered period from eight weeks to twenty-four weeks, reduced the portion of the loan that must be spent on payroll costs from 75% to 60% and extended the term of loans that are not forgiven from two years to five years. For PPP loans originated prior to June 5, 2020, borrowers and lenders may mutually agree to increase the loan term to five years. The vast majority of PPP loans processed by Salisbury have a two-year term. Management funded these short-term loans through a combination of deposits, short-term Federal Home Loan Bank (“FHLB”) advances, and brokered deposits. Salisbury did not participate in the Federal Reserve’s Paycheck Protection Program Liquidity Facility (“PPPLF”). As of December 31, 2020, Salisbury had approximately $85 million of PPP loans on its balance sheet.
On December 27, 2020 the Consolidated Appropriations Act, 2021 was signed into law. Certain provisions of the CARES Act were modified and extended by the Act. One of the features of the Act was the provision of $284 billion in additional funding for the PPP program, including a Second draw Paycheck Protection Program for qualifying businesses for which there was a quarterly revenue reduction of at least 25% compared to the same quarter in 2019. Salisbury will participate in the additional PPP program, which began in January 2021. Salisbury expects the demand for second draws to be lower. The Bank will fund the loans through deposits, short-term FHLB advances or brokered certificate of deposits, as necessary.
Past Due Loans
Loans past due 30 days or more increased $5.5 million during 2020 to $9.9 million, or 0.95% of gross loans receivable at December 31, 2020, compared with $4.4 million, or 0.47% of gross loans receivable at December 31, 2019. The increase included loans of $3.0 million that matured during fourth quarter 2020, most of which are expected to renew in first quarter 2021.
The components of loans past due 30 days or greater are as follows:
Credit Quality Segments
Salisbury categorizes loans receivable into the following credit quality segments.
·Impaired loans consist of all non-accrual loans and troubled debt restructured loans, and represent loans for which it is probable that Salisbury will not be able to collect all principal and interest amounts due according to the contractual terms of the loan agreements.
·Non-accrual loans, a sub-set of impaired loans, are loans for which the accrual of interest has been discontinued because, in the opinion of management, full collection of principal or interest is unlikely.
·Non-performing loans consist of non-accrual loans, and accruing loans past due 90 days and over that are well collateralized, in the process of collection and where full collection of principal and interest is reasonably assured. Non-performing assets consist of non-performing loans plus real estate acquired in settlement of loans.
·Troubled debt restructured loans are loans for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower’s financial condition. Loan restructuring is employed when management believes the granting of a concession will increase the probability of the full or partial collection of principal and interest.
·Potential problem loans consist of performing loans that have been assigned a substandard credit risk rating and are not classified as impaired.
Non-Performing Assets
Non-performing assets increased $1.7 million to $5.6 million at December 31, 2020, or 0.44% of assets, from $3.9 million or 0.35% of assets at December 31, 2019. The increase from the prior year end primarily reflected loans of $3.7 million placed on non-accrual status partly offset by loan sales of $0.7 million, loan payments of $0.5 million and loans of $0.5 million which returned to accruing status. The components of non-performing assets are as follows:
Reductions in interest income associated with non-accrual loans are as follows:
The past due status of non-performing loans is as follows:
At December 31, 2020, 45.06% of non-performing loans were current with respect to loan payments, compared with 35.39% at December 31, 2019. Loans past due 180 days and over are substantially all mortgage loans in the process of foreclosure or litigation.
Salisbury endeavors to work constructively to resolve its non-performing loan issues with customers. Substantially all non-performing loans are collateralized with real estate and the repayment of such loans is largely dependent on the return of such loans to performing status or the liquidation of the underlying real estate collateral.
Troubled Debt Restructured Loans
Troubled debt restructured loans decreased $1.0 million in 2020 to $7.8 million, or 0.75% of gross loans receivable, from $8.8 million, or 0.94% of gross loans receivable at December 31, 2019. The components of troubled debt restructured loans are as follows:
The past due status of troubled debt restructured loans is as follows:
At December 31, 2020, 76.41% of troubled debt restructured loans were current with respect to loan payments, as compared with 82.43% at December 31, 2019. As of December 31, 2020, 2019 and 2018, there were specific reserves on troubled debt restructured loans amounting to $397 thousand, $582 thousand, and $252 thousand, respectively.
Potential Problem Loans
Potential problem loans consist of performing loans that have been assigned a substandard credit risk rating and are not classified as impaired. Potential problem loans increased $8.3 million during 2020 to $18.2 million, or 1.75% of gross loans receivable at December 31, 2020, compared with $9.9 million, or 1.06% of gross loans receivable at December 31, 2019. The increase reflected the downgrade of two commercial loans of $9.5 million, partly offset by the payoff of a commercial & industrial line of credit of $0.8 million and other activity of $0.4 million. The components of potential problem loans were as follows:
The past due status of potential problem loans was as follows:
At December 31, 2020, 96.70% of potential problem loans were current with respect to loan payments, as compared with 97.49% at December 31, 2019. Management cannot predict the extent to which economic or other factors may impact such borrowers’ future payment capacity, and there can be no assurance that such loans will not be placed on nonaccrual status, restructured, or require increased provisions for loan losses.
Deposits and Borrowings
Deposits increased $209.6 million during 2020, or 23%, to $1.1 billion at December 31, 2020, compared with $919.5 million at December 31, 2019. The increase in deposits partly reflected the funding of PPP loans in 2020. Retail repurchase agreements decreased $1.4 million during 2020 to $7.1 million at December 31, 2020, compared with $8.5 million at December 31, 2019.
The distribution of average total deposits by account type was as follows:
The classification of certificates of deposit by interest rates was as follows:
The distribution of certificates of deposit by interest rate and maturity was as follows:
Scheduled maturities of time certificates of deposit in denominations of $100 thousand or more were as follows:
FHLBB advances decreased $38.2 million during 2020 to $12.6 million at December 31, 2020, compared with $50.9 million at December 31, 2019. The net decrease primarily reflected net new amortizing borrowings of $10.0 million offset by $30.0 million of maturities and $3.2 million of amortization in 2020. In addition, in fourth quarter 2020 Salisbury utilized excess cash to prepay a $15 million advance that was scheduled to mature in July 2021. Salisbury incurred a penalty of approximately $60 thousand as a result of this prepayment. Salisbury also has an Irrevocable Letter of Credit Reimbursement Agreement with the FHLBB, whereby upon the Bank’s request an irrevocable letter of credit is issued to secure municipal and certain other transactional deposit accounts. These letters of credit are secured primarily by residential mortgage loans. The amount of funds available from the FHLBB to the Bank is reduced by any letters of credit outstanding. At December 31, 2020, $20.0 million of letters of credit were outstanding compared with $18.0 million at December 31, 2019. Salisbury’s excess borrowing capacity at the FHLB was $255.5 million compared with $233.7 million at December 31, 2019. The increase in capacity reflected the pledging of additional residential and commercial loans as collateral.
The following table sets forth certain information concerning short-term FHLBB advances:
Subordinated Debentures
In December 2015, Salisbury completed the issuance of $10.0 million in aggregate principal amount of 6.00% Fixed to Floating Rate Subordinated Notes Due 2025 (the “Notes”) in a private placement transaction to various accredited investors including $500 thousand to certain of Salisbury’s related parties. The Notes have a maturity date of December 15, 2025 and bear interest at an annual rate of 6.00% from and including the original issue date of the Notes to, but excluding, December 15, 2020 or the earlier redemption date payable semi-annually in arrears on June 15 and December 15 of each year. Thereafter, from and including December 15, 2020 to, but excluding, December 15, 2025, the terms of the note payable provide that the annual interest rate will be reset quarterly and equal to the three-month LIBOR, plus 430 basis points, as described in the Notes, payable quarterly, in arrears, on March 15, June 15, September 15 and December 15 of each year during the time that the Notes remain outstanding through December 15, 2025 or earlier redemption date. Salisbury is monitoring the industry’s transition from LIBOR as a market reference rate. The Notes are redeemable, without penalty, on or after December 15, 2020 and, in certain limited circumstances, prior to that date. As more completely described in the Notes, the indebtedness evidenced by the Notes, including principal and interest, is unsecured and subordinate and junior in right of Salisbury’s payments to general and secured creditors and depositors of the Bank. The Notes also contain provisions with respect to redemption features and other matters pertaining to the Notes. The Notes have been structured to qualify as Tier 2 capital for regulatory capital purposes, subject to applicable limitations. As a result of the Notes being within five (5) years of their maturity date, Tier 2 capital at the parent company only will decrease in an amount equal to 20.0% of the outstanding Notes per year until the Notes mature in 2025 or are earlier redeemed.
Subordinated debentures totaled $9.9 million at December 31, 2020, which includes $117 thousand of remaining unamortized debt issuance costs. The debt issuance costs are being amortized to maturity. The effective interest rate of the subordinated debentures is 6.25%.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL CASH OBLIGATIONS
In the normal course of business, Salisbury enters into various contractual obligations that may require future cash payments. Contractual obligations at December 31, 2020 include operating leases, capital leases, contractual purchases and certain other benefit plans. For further discussion regarding leases see Note 5 to the Consolidated Financial Statements.
The accompanying table summarizes Salisbury’s off-balance sheet lending-related financial instruments and significant cash obligations, by remaining maturity, at December 31, 2020. Salisbury’s lending-related financial instruments include commitments that have maturities over one year. Contractual purchases include commitments for future cash expenditures, primarily for services and contracts that reflect the minimum contractual obligation under legally enforceable contracts with contract terms that are both fixed and determinable. Excluded from the following table are a number of obligations to be settled in cash, primarily in under one year. These obligations are reflected in Salisbury’s Consolidated Balance Sheets and include deposits, FHLBB advances and repurchase agreements that settle within standard market timeframes.
LIQUIDITY
Salisbury manages its liquidity position to ensure it has sufficient funding availability at all times to meet both anticipated and unanticipated deposit withdrawals, loan originations and advances, securities purchases and other operating cash outflows. Salisbury’s primary source of liquidity is deposits and though its preferred funding strategy is to attract and retain low cost deposits, its ability to do so is affected by competitive interest rates and terms in its marketplace, and other financial market conditions. Other sources of funding include cash flows from loan and securities principal payments and maturities, funds provided by operations, and discretionary use of national market certificates of deposit and FHLBB advances. Liquidity can also be provided through sales of securities and loans. Salisbury manages its liquidity in accordance with a liquidity funding policy, and also maintains a contingency funding plan that provides for the prompt and comprehensive response to unexpected demands for liquidity. Management believes Salisbury’s funding sources will meet anticipated funding needs.
Operating activities for 2020 provided net cash of $13.8 million. Investing activities utilized net cash of $114.0 million, principally from purchases of securities of $37.4 million, net loan originations and principal collections of $107.4 million, a $3.5 million investment in BOLI and capital expenditures of $4.4 million, offset by sales, calls, and maturities of securities of $32.5 million, BOLI proceeds of $4.0 million and proceeds from the redemption of FHLB stock of $1.5 million. Financing activities provided net cash of $166.5 million, principally from a net deposit increase of $209.5 million and advances from FHLBB for $16.0 million, partly offset by FHLB advances payments of $54.3 million, and common stock dividends of $3.3 million, and a decrease of $1.4 million in securities sold under agreements to repurchase.
Operating activities for 2019 provided net cash of $14.3 million. Investing activities utilized net cash of $23.4 million, principally from purchases of securities of $53.5 million, loan originations and principal collections, net of $19.2 million, a $5.8 million investment in BOLI and capital expenditures of $2.0 million, offset by sales, calls, and maturities of securities of $55.4 million. Financing activities utilized net cash of $22.5 million, principally from the maturity of FHLBB advances of $37.0 million, a net deposit decrease of $7.2 million, and common stock dividends of $3.2 million, partly offset by FHLB advances of $20.5 million and an increase of $4.4 million in securities sold under agreements to repurchase.
Operating activities for 2018 provided net cash of $13.3 million. Investing activities utilized net cash of $118.1 million, principally from loan originations and principal collections, net of $102.3 million and purchases of securities of $41.6 million, offset by sales, calls, and maturities of securities of $27.8 million. Financing activities provided net cash of $114.8 million, principally from a net deposit increase of $103.0 million, FHLBB advances of $37.0 million and an increase of $2.4 million in securities sold under agreements to repurchase, partly offset by net principal payments on FHLB advances of $24.5 million and common stock dividends of $3.1 million.
CAPITAL RESOURCES
Shareholders’ Equity
Shareholders’ equity increased $11.1 million in 2020 to $124.7 million at December 31, 2020. Contributing to the increase in shareholders’ equity was net income of $11.9 million, a gain in other comprehensive income of $1.7 million and restricted stock awards of $0.7 million to certain of Salisbury’s directors and employees, partially offset by common stock dividends declared of $3.3 million.
Capital Requirements
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Under current regulatory definitions, the Bank meets all capital adequacy requirements to which it is subject and the Bank is considered to be well-capitalized. As a result, the Bank pays lower federal deposit insurance premiums than those banks that are not “well capitalized.” Requirements for classification as a well-capitalized institution and for minimum capital adequacy along with the Bank's regulatory capital ratios are as follows at December 31, 2020 and 2019 under the regulatory capital rules then in effect:
Excluding average PPP loan balances of $62.0 million, the Bank’s Tier 1 Capital (to average assets) ratio would have been approximately 9.35% at December 31, 2020.
A well-capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective Action regulations issued by the FDIC and the FRB, is one which maintains a Total Risk-Based ratio of 10% or above, a Tier 1 Risk-Based ratio of 8% or above, a Common Equity Tier 1 ratio of 6.5% or above, and a Leverage ratio of 5% or above, and is not subject to any written order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level. Maintaining strong capital is essential to Salisbury and the Bank’s safety and soundness. However, the effective management of capital resources requires generating attractive returns on equity to build value for shareholders while maintaining appropriate levels of capital to fund growth, meet regulatory requirements and be consistent with prudent industry practices.
The FRB’s final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for bank holding companies and their bank subsidiaries include a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, require a minimum ratio of Total capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer began phasing in January 1, 2016 at 0.625% of risk-weighted assets and increased each subsequent year by an additional 0.625% until it reached its final level of 2.50% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules.
As of December 31, 2020, the Company and the Bank met each of their capital requirements and the most recent notification from the FDIC categorized the Bank as “well-capitalized.” There are no conditions or events since that notification that management believes have changed the Bank’s category.
On September 17, 2019, the Office of the Comptroller of the Currency, the FRB and the FDIC published its final rule establishing a “Community Bank Leverage Ratio” (“CBLR”) that simplifies capital requirements for certain community banking organizations with less than $10 billion in total consolidated assets (such as the Bank). Under the final rule, depository institutions and their holding companies that meet certain criteria (generally, those with limited amounts of off-balance sheet exposures, trading assets and liabilities, mortgage servicing assets, and temporary difference deferred tax assets) (“qualifying community banking organizations”) may elect to report the components of its Tier 1 leverage ratio as a measure of capital adequacy. A qualifying community banking organization with a CBLR of greater than 9% that “elects to use the CBLR framework” will not be subject to other risk-based and leverage capital requirements and will be considered to have met the well-capitalized ratio requirements for purposes of the agencies’ Prompt Corrective Action (“PCA”) framework. Under the final rule, if a bank that has opted to use the CBLR framework subsequently fails to satisfy one or more of the qualifying criteria, but continues to report a leverage ratio of greater than 8 %, the bank may continue to use the framework and will be deemed “well capitalized” for a grace period of up to two quarters. A qualifying community banking organization will be required to comply with the generally applicable capital rule and file the relevant regulatory reports if the banking organization: (1) is unable to restore compliance with all qualifying criteria during the two-quarter grace period( including achieving compliance with the greater than 9% leverage ratio requirement); (2) reports a leverage ratio of 8% or less; or (3) ceases to satisfy the qualifying criteria due to consummation of a merger transaction. The final rule became effective on January 1, 2020. The Bank would qualify for the CBLR methodology and would also be considered to be well capitalized if it elected to utilize such methodology. The Bank is currently evaluating the benefits of transitioning to this simplified methodology for assessing capital adequacy.
On April 6, 2020, the regulators announced that the CBLR will be modified so that: (1) beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (2) community banks will have until January 1, 2022 before the CBLR requirement is re-established at greater than 9%. Under the interim final rules, the CBLR will be 8% beginning in the second quarter 2020 and for the remainder of the calendar year, 8.5% for calendar year 2021 and 9% thereafter. The Bank is currently evaluating the benefits of transitioning to this simplified methodology for assessing capital adequacy.
Dividends
In January 2020, the Board of Directors of Salisbury Bank approved a $0.01 increase in the quarterly dividend. During 2020 and 2019, Salisbury declared and paid four quarterly common stock dividends of $0.29 and $0.28 per common share each quarter, respectively, totaling $3.3 million and $3.2 million, respectively. The Board of Directors of Salisbury declared a common stock dividend of $0.29 per common share payable on February 26, 2021 to shareholders of record on February 12, 2021. Common stock dividends, when declared, will generally be paid the last business day of February, May, August and November, although Salisbury is not obligated to pay dividends on those dates or at any other time.
Salisbury's ability to pay cash dividends is dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law, the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations. The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.
FRB Supervisory Letter SR 09-4, February 24, 2009, revised March 30, 2009, states that, as a general matter, the Board of Directors of a Bank Holding Company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital position.
Salisbury believes that the payment of common stock cash dividends is appropriate, provided that such payment considers Salisbury's capital needs, asset quality, and overall financial condition and does not adversely affect the financial stability of Salisbury or the Bank. The continued payment of common stock cash dividends by Salisbury will be dependent on Salisbury's future core earnings, financial condition and capital needs, regulatory restrictions, and other factors deemed relevant by the Board of Directors of Salisbury.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 1 to the Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on Salisbury’s consolidated financial statements.
IMPACT OF INFLATION AND CHANGING PRICES
Salisbury’s consolidated financial statements and related notes thereto presented elsewhere in this Form 10-K are prepared in conformity with U.S. GAAP, which require the measurement of financial condition and operating results in terms of historical dollars without considering changes in the relative purchasing power of money, over time, due to inflation. Unlike some other types of companies, the financial nature of Salisbury’s consolidated financial statements is more clearly affected by changes in interest rates than by inflation. Interest rates do not necessarily fluctuate in the same direction or in the same magnitude as the prices of goods and services. However, inflation does affect Salisbury to some extent because, as prices increase, the money supply grows and interest rates are affected by inflationary expectations. There is no precise method, however, to measure the effects of inflation on the Company’s consolidated financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation. Although not a material factor in recent years, inflation could impact earnings in future periods.
Item 7A.
Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Salisbury manages its exposure to interest rate risk through its internal Asset/Liability Management Committee (“ALCO”) using risk limits and policy guidelines to manage assets and funding liabilities to produce financial results that are consistent with Salisbury’s liquidity, capital adequacy, growth, risk and profitability targets. Interest rate risk is the risk of a negative impact to future earnings due to changes in interest rates.
The ALCO manages interest rate risk using income simulation to measure interest rate risk inherent in Salisbury’s financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 24-month horizon. In management’s December 31, 2020 analysis, the simulations incorporate static growth assumptions over the simulation horizons for regulatory compliance and interest rate risk measurement purposes. In the dynamic growth scenarios, allowances are made for loan, deposit and security product mix shifts in selected interest rate scenarios, such as movements between lower rate savings and money market deposit accounts and higher rate time deposits, and changes in the reinvestment of loan and securities cash flows. Additionally, the simulations take into account the specific re-pricing, maturity and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios.
The ALCO reviews the simulation results to determine whether Salisbury’s exposure to change in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. Salisbury’s tolerance levels for changes in net interest income in its income simulations varies depending on the magnitude of interest rate changes and level of risk-based capital. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where interest rates remain stable over the forecast horizon. The ALCO also evaluates the directional trends of net interest income, net interest margin and other financial measures over the forecast horizon for consistency with its liquidity, capital adequacy, growth, risk and profitability targets.
ALCO uses four interest rate scenarios to evaluate interest risk exposure and may vary these interest rate scenarios to show the effect of steepening or flattening changes in yield curves as well as parallel changes in interest rates. At December 31, 2020, ALCO used the following interest rate scenarios: (1) unchanged interest rates; (2) immediately rising interest rates - immediate parallel upward shift in market interest rates of 300 basis points across the yield curve; (3) immediately falling interest rates - immediate parallel downward shift in market interest rates of 100 basis points across the yield curve; and (4) gradual and non-parallel changes in interest rates - little to no change in rates through the end of the second quarter of 2021 with the yield curve rise beginning in the third quarter 2021 and a gradual rise through 2021 with the treasury yield curve ultimately ending up higher as of December 31, 2022. The two year, five year and 10 year treasury as of December 31, 2022 are ultimately 0.57%, 0.89% and 0.77% higher than actual rates as of December 31, 2020 and the Fed Funds rate does not increase over this horizon. The yield curve is ultimately positive sloping as treasury yields are projected to increase while the fed funds rate is not projected to increase. Simulations do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.
As of December 31, 2020, net interest income simulations indicated that Salisbury’s exposure to changing interest rates over the simulation horizons remained within its tolerance levels.
The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for changes in market interest rates using Salisbury’s financial instruments as of December 31, 2020.
The negative exposure to net interest income to immediately and gradually rising rates as compared to the unchanged rate scenario results from a faster projected rise in the cost of funds versus income from earning assets, as relatively rate-sensitive money market and time deposits re-price faster than longer duration earning assets. The negative exposure to net interest income to immediately falling rates as compared to an unchanged rate scenario results from a greater decline in earning asset yields compared to rates paid on funding liabilities, as a result of faster prepayments on existing assets and lower reinvestment rates on future loans originated and securities purchased.
While the ALCO reviews simulation assumptions and back-tests simulation results to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the re-pricing, maturity and prepayment characteristics of financial instruments and the composition of Salisbury’s balance sheet may change to a different degree than estimated. Simulation modeling assumes Salisbury’s expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The relationship between short-term interest rate changes and core deposit rate and balance changes may differ from those used in ALCO’s estimates for income simulation. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.
Salisbury also monitors the potential change in market value of its available-for-sale debt securities in changing interest rate environments. The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to Salisbury’s capital and liquidity position. Results are calculated using industry-standard analytical techniques and securities data. Equity securities are excluded from this analysis because the market value of such securities cannot be directly correlated with changes in interest rates. The following table summarizes the potential change in market value of available-for-sale debt securities resulting from immediate parallel rate shifts:
Item 8.
Item 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors
of Salisbury Bancorp, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Salisbury Bancorp, Inc. and Subsidiary (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
To the Shareholders and the Board of Directors
of Salisbury Bancorp, Inc.
Allowance for Loan Losses - General Reserve Qualitative Adjustments
As described in Notes 1 and 4 to the financial statements, the Company has recorded an allowance for loan losses (ALL) in the amount of $13.8 million as of December 31, 2020, representing management’s estimate of the probable losses inherent in the loan portfolio as of that date. The ALL at December 31, 2020, consists of two components: the ALL individually evaluated for impairment (specific reserves), representing $663 thousand, and the ALL collectively evaluated for impairment (general reserves), representing $13.1 million. The ALL is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. The general reserve component is based on a quantitative and qualitative analysis, whereby qualitative adjustments are applied to historical loss rates by loan segment. The development of the qualitative adjustments involves significant and subjective assumptions which require a high degree of judgment relating to: 1) the general economic and external operating environment, 2) the composition, terms and performance of the Company’s loan portfolio, 3) existing loan policies and the pace of portfolio growth, and 4) the expected impact of the disruption of the COVID-19 pandemic on the Company’s loan customers and the related impact on credit risk.
General reserve factors are based on specific quantitative and qualitative criteria representing key sources of risk within the loan portfolio. Such sources of risk include those relating to: changes in lending policies and procedures, changes in national and local economic and business conditions and developments, including the disruptive impact of the COVID-19 pandemic, changes in the nature and volume of the loan portfolio, changes in lending management and staff, trends in past due, classified, nonaccrual, and other loan categories, changes in the Company’s loan review system and oversight, changes in collateral values, credit concentration risk, and the competitive environment.
The qualitative adjustments contribute significantly to the general reserve component of the ALL and the ALL as a whole. Management’s identification and analysis of these considerations and related adjustments requires significant judgment. We identified the estimate of the qualitative adjustments in developing the general reserve component of the ALL as a critical audit matter as it required especially subjective auditor judgment.
How the Critical Audit Matter was addressed in the Audit
The primary procedures we performed to address this critical audit matter included:
·Testing the effectiveness of controls over the evaluation of the general reserve qualitative adjustments, including controls addressing:
oManagement’s review of the accuracy of data inputs used in the determination of and as the basis for the qualitative adjustments.
oManagement’s review of the reasonableness of the judgments and assumptions used to develop the qualitative adjustments for the general reserve.
oManagement’s review of the mathematical accuracy of the ALL calculation.
·Substantively testing management’s process, including evaluating their judgments and assumptions, for developing the general reserve qualitative adjustments, which included:
oEvaluation of the completeness and accuracy of data inputs used as a basis for the adjustments relating to qualitative general reserve factors.
oEvaluation of the reasonableness of management’s judgements related to the qualitative and quantitative assessment of the data used in the determination of the general reserve qualitative adjustments and the resulting allocation to the ALL. Among other procedures, our evaluation considered evidence from internal and external sources, loan portfolio performance and whether such assumptions were applied consistently period to period.
oAnalytically evaluating the qualitative adjustments year over year for directional consistency and testing for reasonableness, including the qualitative adjustment attributed to the estimated impact of the disruption of the COVID-19 pandemic on the Company’s loan customers.
To the Shareholders and the Board of Directors
of Salisbury Bancorp, Inc.
oTesting the mathematical accuracy of the ALL calculation, including the application of the qualitative adjustments.
Goodwill Impairment Evaluation
As described in Notes 1 and 9 to the financial statements, the Company’s consolidated goodwill balance was $13.8 million at December 31, 2020, which is allocated to the Company’s single reporting unit. Goodwill is tested for impairment at the reporting unit level at least annually, or more frequently whenever events or circumstances occur that indicate that it is more-likely-than-not that an impairment loss has occurred. The annual quantitative assessment of goodwill was performed utilizing a combination of (1) a market peer acquisition approach, comprised of a regional and national peer acquisition group, (2) a discounted cash flow analysis (income approach), and (3) a quoted market value approach. The evaluation of goodwill for impairment requires considerable judgment on the part of management and is sensitive to changes in underlying assumptions and factors. This judgment includes, but is not limited to, the selection of appropriate discount rates, the identification of relevant market comparables, and the development of cash flow projections. Additionally, the selection of one fair value technique over another, in assessing goodwill for impairment, may result in higher or lower fair value.
We identified the goodwill impairment assessment of the Company as a critical audit matter. The principal consideration for this determination was the degree of auditor judgment required in assessing the appropriateness and reliability of key assumptions used by management, including discounted cash flows, discount rate, and prospective financial information, including the expected effects of the COVID-19 pandemic and resulting duration of its impact on the economy.
How the Critical Audit Matter was addressed in the Audit
The primary procedures we performed to address this critical audit matter included:
·Testing the effectiveness of controls over management’s goodwill impairment test including controls addressing:
oManagement’s review of the reasonableness and accuracy of the Company’s prospective financial information used in the discounted cash flow methodology.
oManagement’s evaluation of key assumptions used by a third-party valuation specialist, including discount rate, terminal growth rate, and other adjustments to market comparables.
·Substantively testing management’s estimate, including evaluating their judgements and assumptions for estimating the fair value of the Company which included:
oEvaluation of key financial data for accuracy, including comparison of prospective financial information to the Company’s approved budget.
oTesting the completeness and accuracy of the underlying data provided to management’s third-party valuation specialist.
oEvaluation of the appropriateness of valuation methodologies, discount rate, and overall reasonableness of the fair value.
/s/ Baker Newman & Noyes LLC
Portsmouth, New Hampshire
March 12, 2021
We have served as the Company’s auditor consecutively since 2015.
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these audited consolidated financial statements.
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these audited consolidated financial statements.
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these audited consolidated financial statements.
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these audited consolidated financial statements.
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(1)Includes branch acquisition of Orange Bank & Trust Company’s Fishkill, New York branch in 2018.
The accompanying notes are an integral part of these audited consolidated financial statements.
Salisbury Bancorp, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Salisbury Bancorp, Inc. (“Salisbury” or the “Company”) is the bank holding company for Salisbury Bank (the “Bank”), a State chartered commercial bank. Salisbury's activity is currently limited to the holding of the Bank's outstanding capital stock and the Bank is Salisbury's only subsidiary and its primary investment. The Bank is a Connecticut chartered and Federal Deposit Insurance Corporation (the "FDIC") insured commercial bank headquartered in Lakeville, Connecticut. The Bank's principal business consists of attracting deposits from the public and using such deposits, with other funds, to make various types of loans and investments. The Bank conducts its business through fourteen full-service offices located in the Counties of Litchfield Connecticut, Berkshire, Massachusetts and Dutchess, Orange and Ulster, New York.
Principles of Consolidation
The consolidated financial statements include those of Salisbury and the Bank after elimination of all inter-company accounts and transactions.
Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and general practices within the financial services industry. In preparing the consolidated financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet, and revenues and expenses for the period. Actual results could differ significantly 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, potential other-than-temporary impairment of securities and potential impairment of goodwill and intangibles.
Certain reclassifications have been made to the 2019 and 2018 consolidated financial statements to make them consistent with the 2020 presentation.
Cash and Cash Equivalents
Cash and cash equivalents include cash and balances due from banks and interest-bearing demand deposits in other banks. Due to the nature of cash and cash equivalents, Salisbury estimated that the carrying amount of such instruments approximated fair value. The nature of the Bank’s business requires that it maintain amounts due from banks which, at times, may exceed federally insured limits. The Bank has not experienced any losses on such amounts and all amounts are maintained with well-capitalized institutions.
Interest Bearing Time Deposits with Financial Institutions
Interest bearing time deposits are balances held in CD’s in a CDARS program. Due to the nature of time deposits, Salisbury estimated that the carrying amount of such instruments are at par.
Securities
Securities that may be sold as part of Salisbury's asset/liability or liquidity management or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for other similar factors, are classified as available-for-sale and carried at their fair value. Unrealized holding gains and losses on such securities are reported net of related taxes, if applicable, as a separate component of shareholders' equity. Securities that Salisbury has the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Realized gains and losses on the sales of all securities are reported in earnings and computed using the specific identification cost basis. Securities are reviewed regularly for other-than-temporary impairment (“OTTI”). Premiums and discounts are amortized or accreted utilizing the interest method over the life or call of the term of the investment security. For any debt security with a fair value less than its amortized cost basis, Salisbury will determine whether it has the intent to sell the debt security or whether it is more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis. If either condition is met, Salisbury will recognize a full impairment charge to earnings. For all other debt securities that are considered OTTI and do not meet either condition, the credit loss portion of impairment will be recognized in earnings as realized losses.
Mutual Funds
The Company holds a mutual fund investment which is reported as an equity investment with a readily determined fair value. Changes in the fair value of the mutual fund holding are reported in income as gains (losses) on CRA mutual fund with a corresponding increase or decrease in its carrying value on the consolidated balance sheet.
Federal Home Loan Bank of Boston Stock
The Bank is a member of the Federal Home Loan Bank of Boston (“FHLBB”). The FHLBB is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank’s FHLBB stock as of December 31, 2020. Deterioration of the FHLBB’s capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock.
Loans
Loans receivable consist of loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off. Loans receivable are reported at their outstanding principal balance, net of unamortized deferred loan origination fees and costs on originated loans and unamortized premiums on purchased loans. Interest income is accrued on the unpaid principal balance. Deferred loan origination fees and costs are amortized as an adjustment to yield over the lives of the related loans.
Loans receivable includes loans processed under the SBA’s PPP program. The PPP loans are reported at their outstanding principal balance, net of unamortized deferred loan origination fees and costs on originated loans. Interest income is accrued on the unpaid principal balance. Deferred loan origination fees and costs are amortized as an adjustment to yield over the lives of the related loans.
The Bank’s loans collateralized by real estate and all other real estate owned (“OREO”) are located principally in northwestern Connecticut and New York and Massachusetts towns, which constitute Salisbury's service area. Accordingly, the collectability of a substantial portion of the loan portfolio and OREO is susceptible to changes in market conditions in Salisbury’s service area. While management uses available information to recognize losses on loans and OREO, future additions to the allowance or write-downs of OREO may be necessary based on changes in local economic conditions, particularly in Salisbury’s service area.
Loans held-for-sale consist of residential mortgage loans that management has the intent to sell. Loans held-for-sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis, net of deferred loan origination fees and costs. Changes in the carrying value, deferred loan origination fees and costs, and realized gains and losses on sales of loans held-for-sale are reported in earnings as gains and losses on sales of mortgage loans, net, when the proceeds are received from investors.
The accrual of interest on loans, including troubled debt restructured loans, is generally discontinued when principal or interest is past due by 90 days or more, or earlier when, in the opinion of management, full collection of principal or interest is unlikely, except for loans that are well collateralized, in the process of collection and where full collection of principal and interest is assured. When a loan is placed on non-accrual status, interest previously accrued but not collected is reversed against current income. Income on such loans, including impaired loans, is then recognized only to the extent that cash is received and future collection of principal is probable. Loans, including troubled debt restructured loans, are restored to accrual status when principal and interest payments are brought current and future payments are reasonably assured, following a sustained period of repayment performance by the borrower in accordance with the loan's contractual terms.
Troubled debt restructured loans include those for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower’s financial condition. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit Salisbury by increasing the ultimate probability of collection.
Troubled debt restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans which are already on non-accrual status at the time of the troubled debt restructuring generally remain on non-accrual status for approximately six months before management considers such loans for return to accruing status. Accruing troubled debt restructured loans are generally placed into non-accrual status if and when the borrower fails to comply with the restructured terms.
On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”. This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of the virus. The guidance goes on to explain that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of the relief program are not Troubled Debt Restructurings (“TDRs”). Section 4013 of the CARES Act addresses modifications resulting from the pandemic and specified that virus related modifications on loans that were current as of December 31, 2019 are not TDRs. The Bank has applied Section 4013 guidance and implemented a loan payment deferral program which allows residential, commercial and consumer borrowers, who have been adversely affected by the virus and whose loans were not more than 30 days past due at December 31, 2019, to defer loan payments for up to three months. Borrowers may apply to the Bank for additional deferments, which will be evaluated on a case-by-case basis. The Bank will continue to accrue interest on such deferred payments, which will be added to a borrower’s final payment.
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of the probable credit losses inherent in the loan portfolio as of the reporting date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. Loan charge-offs are recognized when management determines a loan or portion of a loan to be uncollectible.
The determination of the adequacy of the allowance is based on management’s ongoing review of numerous factors, including the growth and composition of the loan portfolio, historical loss experience over an economic cycle, probable credit losses based upon internal and external portfolio reviews, credit risk concentrations, changes in lending policy, current economic conditions, analysis of current levels and asset quality, delinquency levels and trends, estimates of the current value of underlying collateral, the performance of individual loans in relation to contract terms, and other pertinent factors.
Determining the adequacy of the allowance and reserves at any given period is difficult, particularly during deteriorating or uncertain economic periods, and management must make estimates using assumptions and information that are often subjective and changing rapidly. The review of credit exposure related to loans is a continuing event in light of the pandemic, a changing economy and the dynamics of the banking and regulatory environment. Should the economic climate deteriorate, borrowers could experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise, requiring increased provisions and reserves. Changes in the estimate are recorded in the results of operations in the period in which they become known, along with provisions for estimated losses incurred during that period. In management's judgment, Salisbury remains adequately reserved both against total loans and non-performing loans at December 31, 2020.
Management’s loan risk rating assignments, loss percentages and specific reserves are subjected annually to an independent credit review by an external firm. In addition, the Bank is examined annually on a rotational basis by one of its two primary regulatory agencies, the FDIC and CTDOB. As an integral part of their examination process, the FDIC and CTDOB review the adequacy and methodology of the Bank's credit risk ratings and allowance for loan losses.
The allowance for loan losses is computed by segregating the portfolio into three components: (1) loans collectively evaluated for impairment: general loss allocation factors for non-impaired loans based on loan product, collateral type and abundance, loan risk rating, historical loss experience, delinquency factors and other similar economic indicators, (2) loans individually evaluated for impairment: individual loss allocations for loans deemed to be impaired based on discounted cash flows or collateral value, and (3) unallocated: general loss allocations for other environmental factors.
Loans collectively evaluated for impairment
The component of the allowance for loan losses for loans collectively evaluated for impairment is estimated by stratifying loans into segments and credit risk ratings and then applying management’s general loss allocation factors. Salisbury stratified its loans into the following loan segments: residential real estate secured (residential 1-4 family and 5+ multifamily, construction of residential 1-4 family, and home equity lines of credit), commercial real estate secured (commercial and construction of commercial), secured by land (farm and vacant land), commercial and industrial, municipal and consumer. The general loss allocation factors are based on expected loss experience adjusted for historical loss experience and other qualitative factors, including levels or trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. The qualitative factors are determined based on the various risk characteristics of each loan segment and are risk-weighted such that higher risk loans generally have a higher reserve percentage. In second quarter 2020, management added a new discrete loan pool for loans deemed to be a higher risk due to COVID-19. This new loan pool included commercial real estate and commercial and industrial loans that were deemed by management to be a higher risk of default as a result of the pandemic as well as residential and consumer loans which have been granted a second loan payment deferral by management. In addition, management increased the risk weights for loans with an internal risk rating of “4” (Watch), “5” (Special Mention) and “6” (Substandard”) to reflect the higher degree of inherent credit risk associated with these loans as a result of COVID-19. Management will actively monitor the population of loans in the new loan pool and evaluate the risk weightings to determine if further adjustments are warranted based on the impact of COVID-19.
The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:
Residential real estate - Salisbury generally does not originate loans with a loan-to-value ratio greater than 80 percent and generally does not grant subprime loans. Loans in this segment are collateralized primarily 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 in this segment.
Commercial real estate - Loans in this segment are primarily owner-occupied businesses or income-producing investment properties throughout Salisbury’s market area. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by decreased sales or increased vacancy rates which, in turn, will have an effect on the credit quality in this segment. For commercial loans management annually obtains business and personal financial statements, tax returns, and, where applicable, rent rolls, and continually monitors the repayment of these loans.
Construction loans - Loans in this segment are primarily residential construction loans which typically roll into a permanent residential mortgage loan when construction is completed, or commercial construction which consist primarily of owner-occupied commercial construction projects.
Commercial and industrial loans - Loans in this segment are made to businesses and are generally secured by assets of the business, including equipment and/or inventory. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased retail or wholesale spending, has an effect on the credit quality in this segment.
Farm - Loans in this segment are made to independent agricultural businesses and may be affected by adverse weather conditions or weak commodity prices.
Vacant land - Loans in this segment are primarily dependent on the credit quality of the individual borrowers. Loan-to-value ratios for loans with vacant land for collateral are more conservative than for commercial or residential real estate loans.
Municipal loans - Loans in this segment are extensions of credit to municipal and other governmental entities throughout Salisbury’s market area. The bank-qualified, tax-exempt loans are backed by the full faith and credit of the borrowing entity with taxing or appropriating authority, as appropriate. Maturities range from one year for bond anticipation notes to twenty years for long-term project finance. The ability of the borrower to pay may be affected by an economic downturn resulting in a severe reduction in tax or other revenues coupled with the depletion of an entity’s reserve liquidity. Historical default rates for bank-qualified (small issuer) general obligation municipal credit facilities have been 0% since the asset class was created in 1986.
Consumer loans - Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower.
Loans individually evaluated for impairment
This component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for all portfolio loans (except consumer loans and homogeneous residential real estate loans) by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the collateral if the loan is collateral dependent or third-party market loan pricing. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan are lower than the carrying value of that loan.
A loan is considered impaired when, based on current information and events, it is probable that Salisbury will be unable to collect the scheduled payments of principal or interest when due according to the contractual 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. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
In seeking to protect the best interests of the Bank, Salisbury may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). All TDRs are classified as impaired.
Unallocated
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.
Transfers of Financial Assets
Transfers of an entire financial asset, a group of entire financial assets, or participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not retain control over the assets. During the normal course of business, the Company may transfer a portion of a financial asset, for example, a participation loan or the government guaranteed portion of a loan. In order to be eligible for sales treatment, the transfer of the portion of the loan must meet the criteria of a participating interest. If it does not meet the criteria of a participating interest, the transfer must be accounted for as a secured borrowing. In order to meet the criteria for a participating interest, all cash flows from the loan must be divided proportionately, the rights of each loan holder must have the same priority, the loan holders must have no recourse to the transferor other than standard representations and warranties and no loan holder has the right to pledge or exchange the entire loan.
Mortgage Servicing Rights
As part of our growth and risk management strategy, Salisbury from time to time sells whole loans. These are typically fixed rate residential loans. Salisbury’s ability to sell whole loans benefits the Bank by freeing up capital and funding to lend to new customers. Additionally, we typically earn a gain on the sale of loans sold and receive a servicing fee while maintaining the customer relationship. Mortgage Servicing Rights (“MSRs”), which the bank evaluates with the assistance of a third party on a quarterly basis, are included in other assets on the consolidated balance sheets and are accounted for under the amortization method. Under that method mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues. Refinance activities are considered in estimating the period of net servicing revenues.
Other Real Estate Owned (“OREO”)
OREO consists of properties acquired through foreclosure or a deed in lieu of foreclosure. These properties are initially transferred at fair value less estimated costs to sell. Any write-down from cost to estimated fair value required at the time of foreclosure is charged to the allowance for loan losses. A valuation allowance is maintained for declines in market value and for estimated selling expenses. Increases to the valuation allowance, expenses associated with ownership of these properties, and gains and losses from their sale are included in OREO expense.
As of December 31, 2020, and 2019, the recorded investment in residential mortgage loans collateralized by residential real estate that were in the process of foreclosure was $0.1 million and $0.1 million, respectively.
Income Taxes
Deferred income taxes are provided for differences arising in the timing of income and expenses for financial reporting and for income tax purposes using the asset/liability method of accounting for income taxes. Deferred income taxes and tax benefits are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Salisbury provides deferred taxes for the estimated future tax effects attributable to temporary differences and carry-forwards when realization is assured beyond a reasonable doubt. A valuation allowance is established against deferred tax assets when, based upon all available evidence, it is determined that it is more likely than not that some or all of the deferred tax assets will not be realized.
Bank Premises and Equipment
Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line basis over the shorter of the estimated useful lives of the improvements or the term of the related leases. Guidelines for expected useful life are as follows:
• Buildings/Improvements - 39 years
• Land Improvements - 15 years
• Furniture and Fixtures - 7 years
• Computer Equipment - 5 years
• Software - 3 years
Intangible Assets
Intangible assets consist of core deposit intangibles and goodwill. Intangible assets equal the excess of the purchase price over the fair value of the tangible net assets acquired in business combinations accounted for using the acquisition method of accounting. Salisbury’s intangible assets at December 31, 2020, and 2019, include goodwill of $2.4 million arising from the purchase of a branch office in 2001, $7.2 million arising from the 2004 acquisition of Canaan National Bancorp, Inc., $319 thousand arising from the 2007 purchase of a branch office in New York State, $2.7 million arising from the acquisition of Riverside Bank in December 2014 and $1.3 million from the purchase of an additional branch office in New York in 2017. See Note 9.
On an annual basis, management assesses intangible assets for impairment. For fiscal year 2019, this assessment was performed as of December 31, 2019. For fiscal year 2020, however, management performed the assessment as of November 30, 2020. Management changed the date of the assessment to ensure that there was adequate time to review the results and record an impairment charge, if necessary, prior to finalizing the financial statements for fiscal year 2020. There were no material changes in the Bank’s operating environment or financial results during the month of December 2020 that would have affected the outcome of the assessment. Based on the assessment, intangible assets were not impaired as of November 30, 2020. If a permanent loss in value was indicated, an impairment charge to income would have been recognized.
Derivative Instruments and Hedging Activities
As required by ASC 815, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
In accordance with the FASB’s fair value measurement guidance in Topic 825, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
Bank-Owned Life Insurance
Bank-owned life insurance policies are reflected on the consolidated balance sheet at cash surrender value. Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are reflected in non-interest income on the consolidated statements of income and are generally not subject to income taxes. The Bank reviews the financial strength of the insurance carriers prior to the purchase of life insurance policies and no less than annually thereafter. A life insurance policy with any individual carrier is limited to 15% of tier one capital and the total cash surrender value of the life insurance policies is limited to 25% of tier one capital.
Stock Based Compensation
Stock based compensation expense is recognized, based on the fair value at the date of grant on a straight-line basis over the period of time between the grant date and vesting date. The expense for performance based restricted stock awards is accrued over a three year performance period based on the probability of achieving pre-determined thresholds or metrics.
Advertising Expense
Advertising costs of $393 thousand and $480 thousand in 2020 and 2019, respectively, are expensed as incurred and not capitalized.
Statements of Cash Flows
For the purpose of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and due from banks and interest-bearing demand deposits with other financial institutions.
Computation of Earnings per Share
The Company defines unvested share-based payment awards that contain non-forfeitable rights to dividends as participating securities that are included in computing earnings per share (“EPS”) using the two-class method. Unvested performance based restricted stock units issued by the Company do not contain non-forfeitable rights to dividends and are not deemed to be participating securities.
The two-class method is an earnings allocation formula that determines earnings per share for each share of common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. Basic EPS excludes dilution and is computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
Revenue Recognition
A significant portion of Salisbury’s revenue, including interest income from loans and investments, falls outside the scope of ASC 606. Revenue from Salisbury’s Trust and Wealth Advisory business, service charges and fees and interchange fees, however, are within the scope of ASC 606. Revenue for these in-scope services are recognized when, or as, obligations under the terms of a contract are satisfied, which occurs when the services are transferred to customers. Revenue is measured as the amount of consideration Salisbury expects to receive in exchange for providing the services to a customer (“transaction price”). To the extent the transaction price includes variable consideration, Salisbury estimates the amount of variable consideration that should be included in the transaction price utilizing the most likely amount to which Salisbury expects to be entitled. Variable consideration is included in the transaction price if, in Salisbury’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of Salisbury’s anticipated performance and all information (historical, current, and forecasted) that is reasonably available. Sales, value add, and other taxes collected on behalf of third parties are excluded from revenue.
Contracts with customers may contain multiple performance obligations. For such arrangements, the transaction price is allocated to each performance obligation based on the estimated relative standalone selling prices of the promised services underlying each performance obligation. Salisbury determines standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through fee schedules provided to its customers or through past transactions, Salisbury estimates the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.
Contracts are often modified to account for changes in contract specifications and requirements. Contract modifications exist when the modification either creates new or changes the existing enforceable rights and obligations. Generally, contract modifications are for products or services that are distinct from the existing contract and are accounted for as if they were a new and separate contract. The original contract is still accounted for according to its original terms.
Trust and Wealth Advisory
The Trust and Wealth Advisory business generates revenue through a range of fiduciary services including trust and estate administration, wealth advisory, and investment management to individuals, families, businesses and institutions. Revenue from these services is generally recognized over time and are typically based on the market value of assets under administration and established fee schedules. Certain fees, such as real estate sale fees, asset liquidation fees, special asset fees, and daily money management fees, are recorded as revenue at a point in time at the completion of the service.
Service Charges and Fees
Salisbury offers a variety of deposit accounts with a range of interest rates and other terms, which are designed to meet customer financial needs. Monthly deposit account fees and account research fees are recognized over time using the right to invoice measure of progress. Overdraft protection, ATM services, cash management, bill pay, money transfers, among others, are generally recognized at point in time at the completion of the service.
Interchange Fees
Salisbury earns interchange fee revenue through customers’ use of the Bank’s debit cards. Interchange fees are generally recognized as revenue at a point in time when customers make a purchase using their debit card.
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which adds a new Topic 326 to the Codification and removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s contractual life. ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. In April 2019, the FASB issued ASU 2019-04 which clarified the treatment of accrued interest when measuring credit losses. Entities may: (1) measure the allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis of associated financial assets; (2) make various accounting policy elections regarding the treatment of accrued interest receivable; or (3) elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements. ASU 2019-04 also clarified that expected recoveries of amounts previously written off and expected to be written off should be included in the valuation account and should not exceed the aggregate of amounts previously written off and expected to be written off by the entity. In addition, for collateral dependent financial assets, the amendments clarify that an allowance for credit losses that is added to the amortized cost basis of the financial asset(s) should not exceed amounts previously written off. In November 2019, the FASB issued ASU 2019-10, which delayed the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for smaller reporting companies, although early adoption is permitted. Salisbury meets the definition of a smaller reporting company. In November 2019, the FASB issued ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses” which clarified or addressed specific issues about certain aspects of the amendments in ASU 2016-13. The amendments in ASU 2019-11 clarified the following: (1) The allowance for credit losses (ACL) for purchased financial assets with credit deterioration should include expected recoveries of amounts previously written off and expected to be written off by the entity and should not exceed the aggregate of amounts of the amortized cost basis previously written off and expected to be written off by an entity. In addition, the amendments clarify that when a method other than a discounted cash flow method is used to estimate expected credit losses, expected recoveries should not include any amounts that result in an acceleration of the noncredit discount. An entity may include increases in expected cashflows after acquisition; (2) Transition relief will be provided by permitting entities an accounting policy election to adjust the effective interest rate on existing troubled debt restructurings using prepayment assumptions on the date of adoption of Topic 326 rather than the prepayment assumptions in effect immediately before the restructuring; (3) Disclosure relief will be extended for accrued interest receivable balances to additional relevant disclosures involving amortized cost basis; (4) An entity should assess whether it reasonably expects the borrower will be able to continually replenish collateral securing the financial asset to apply the practical expedient. The amendments clarify that an entity applying the practical expedient should estimate expected credit losses for any difference between the amount of the amortized cost basis that is greater than the fair value of the collateral securing the financial asset (that is, the unsecured portion of the amortized cost basis). An entity may determine that the expectation of nonpayment for the amount of the amortized cost basis equal to the fair value of the collateral securing the financial asset is zero.
Upon adoption, Salisbury will apply the standards’ provisions as a cumulative effect adjustment to retained earnings as of the first reporting period in which the guidance is effective. Salisbury anticipates that the adoption of ASU 2016-13 and related updates will impact the consolidated financial statements as it relates to the balance in the allowance for loan losses. Salisbury has engaged a third-party software vendor to model the allowance for loan losses in conformance with this ASU. Salisbury will continue to refine this model and assess the impact to its consolidated financial statements.
The Bank is working towards the completion of its ACL methodology. To estimate the ACL for loans and off-balance sheet credit exposures, such as unfunded loan commitments, the Corporation will utilize a discounted cash flow model that contains additional assumptions to calculate credit losses over the estimated life of financial assets and off-balance sheet credit exposures and will include the impact of forecasted economic conditions. The estimate is expected to include a one-year reasonable and supportable forecast period and thereafter a one-year reversion period to the historical mean of its macroeconomic assumption. The estimate will also include qualitative factors that may not be reflected in quantitatively derived results to ensure that the ACL reflects a reasonable estimate of current expected credit losses.
Based on the credit quality of our existing available for sale debt securities portfolio, which primarily consists of obligations of U.S. government agency and U.S. government-sponsored enterprise securities, including mortgage-backed securities, Salisbury does not expect the adoption of ASU 2016-13, as it relates to debt securities, to be significant. For available for sale debt securities with unrealized losses, credit losses will be recognized as an allowance rather than a reduction in the amortized cost of the securities. As a result, improvements to estimated credit losses will be recognized immediately in earnings rather than as interest income over time.
The Bank is currently refining various ACL assumptions and running parallel calculations on a monthly basis. Salisbury expects to complete independent model validation and to finalize its documentation of ACL processes and controls by the first quarter of 2023.
In January 2017, the FASB issued ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This ASU is intended to allow companies to simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The FASB is researching whether similar amendments should be considered for other entities, including public business entities. ASU 2017-04 is effective for public business entities that are SEC filers for fiscal years beginning after December 15, 2019 and interim periods within those years. Entities should apply the guidance prospectively. On January 1, 2020, Salisbury adopted the new standard, which did not have a material impact on Salisbury’s Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-13, “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. On January, 1, 2020, the Bank adopted the new standard, which only revised disclosure requirements and did not have a material impact on Salisbury’s Consolidated Financial Statements.
In December 2019, the FASB issued ASU 2019-12, “Simplifying the Accounting for Income Taxes.” The amendments in this Update simplify the accounting for income taxes by removing the following exceptions:1. Exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or a gain from other items (for example, discontinued operations or other comprehensive income) 2. Exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment 3. Exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary 4. Exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. The amendments in this Update also simplify the accounting for income taxes by doing the following: 1. Requiring that an entity recognize a franchise tax (or similar tax) that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax. 2. Requiring that an entity evaluate when a step-up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction. 3. Specifying that an entity is not required to allocate the consolidated amount of current and deferred tax expense to a legal entity that is not subject to tax in its separate financial statements. However, an entity may elect to do so (on an entity-by-entity basis) for a legal entity that is both not subject to tax and disregarded by the taxing authority. 4. Requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. 5. Making minor Codification improvements for income taxes related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years; early adoption is permitted. Salisbury does not believe that the new standard will have a material impact on Salisbury’s Consolidated Financial Statements.
In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs.” Under current generally accepted accounting principles, entities amortize the premium on purchased callable debt securities to the earliest call date. If a callable debt security contains additional future call dates, entities should consider whether the amortized cost basis exceeded the amount repayable by the issuer at the next call date. If so, the excess or premium should be amortized to the next call date. This ASU clarifies that the next call date is the first date when a call option at a specified price becomes exercisable. Once that date has passed, the next call date is when the next call option at a specified price becomes exercisable, if applicable. If there is no remaining premium or if there are no further call dates, the entity shall reset the effective yield using the payment terms of the debt security. ASU 2020-08 is effective for interim and annual reporting periods beginning after December 15, 2020; early adoption is not permitted. ASU 2020-08 is not expected to have a material impact on Salisbury’s Consolidated Financial Statements.
In January 2021, the FASB issued ASU 2021-01, “Reference Rate Reform (Topic 848).” In response to the risk of cessation of the London Interbank Offered Rate (LIBOR) as a reference rate, this ASU clarifies the scope of Topic 848 so that derivatives affected by this transition are explicitly eligible for certain optional expedients and exceptions in Topic 848. An entity may elect to apply the amendments in this ASU on a full retrospective basis as of any date from the beginning interim period that includes or is subsequent to March 12, 2020 or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final Update, up to the date that the financial statements are available to be issued. Salisbury is currently evaluating the impact of the transition from LIBOR to a new reference rate.
Other Regulatory Pronouncements
On March 12, 2020 the Securities and Exchange Commission finalized amendments to the definitions of “accelerated” and “large accelerated filer”. The amendments increase the threshold criteria for meeting these categories and were effective on April 27, 2020 and apply to annual reports due on or after such effective date. Prior to these changes, Salisbury was designated as a “smaller reporting company” and an “accelerated” filer as it had more than $75 million in public float but less than $700 million at the end of Salisbury’s most recent second quarter. The rule changed the definition of “accelerated filer” and expands the category of “non-accelerated filer” to include entities with public float of less than $700 million and less than $100 million in annual revenues. Salisbury meets the new definition of non-accelerated filer while continuing to qualify as a “smaller reporting company”. The categorization of “accelerated” or “large accelerated filer” determines the requirement for a public company to obtain an auditor attestation of its internal control over financial reporting. Non-accelerated filers also have additional time to file quarterly and annual reports. All public companies are required to obtain and file annual financial statements audits as well as provide management’s assertion on the effectiveness of internal controls over financial reporting, but the external auditor attestation of internal control over financial reporting is not required for non-accelerated filers. As the Bank has total assets exceeding $1.0 billion, it remains subject to the rules of the Federal Deposit Insurance Corporation, which requires an auditor attestation of internal controls over the Bank’s regulatory financial reporting.
NOTE 2 - MERGERS AND ACQUISITIONS
On December 5, 2014, the Company acquired Riverside Bank. Riverside Bank operated four banking offices serving Dutchess, Ulster and Orange Counties in New York, and was merged with and into the Bank. In first quarter 2019, Salisbury transferred the remaining unearned credit-related discount on loans acquired in its 2014 acquisition of Riverside Bank to the allowance for loan losses. There has been no activity on mergers and acquisitions in 2020.
The following table summarizes activity in the accretable yield for the acquired loan portfolio that falls under the purview of ASC 310-30.
NOTE 3 - SECURITIES
The composition of securities is as follows:
Sales of securities available-for-sale and gross gains and gross losses realized are as follows:
The following table summarizes the aggregate fair value and gross unrealized loss of securities that have been in a continuous unrealized loss position as of the dates presented:
The table below presents the amortized cost, fair value and tax equivalent yield of securities, by maturity. Debt securities issued by U.S. Government agencies (SBA securities), MBS, and CMOS are disclosed separately in the table below as these securities may prepay prior to the scheduled contractual maturity dates.
(1) Yield is based on amortized cost.
Salisbury evaluates debt securities for OTTI where the fair value of a security is less than its amortized cost basis at the balance sheet date. As part of this process, Salisbury considers whether it has the intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI.
The following summarizes, by security type, the basis for evaluating if the applicable debt securities were OTTI at December 31, 2020.
U.S. Government Agency notes: The contractual cash flows are guaranteed by the U.S. government. Six securities had unrealized losses at December 31, 2020, which approximated 1.41% of their amortized cost. Changes in fair values are a function of changes in investment spreads and interest rate movements and not changes in credit quality since time of purchase. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Management evaluated the impairment status of these debt securities, and concluded that the gross unrealized losses were temporary in nature. Therefore, management does not consider these investments to be other-than temporarily impaired at December 31, 2020.
Municipal bonds: Salisbury performed a detailed analysis of the municipal bond portfolio. One security was in an unrealized loss position at December 31, 2020, which approximated 0.12% of its amortized cost. Management believes the unrealized loss position is attributable to interest rate and spread movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Management evaluated the impairment status of these debt securities, and concluded that the gross unrealized losses were temporary in nature. Therefore, management does not consider these investments to be other-than temporarily impaired at December 31, 2020.
U.S. Government agency and U.S. Government-sponsored mortgage-backed securities and collateralized mortgage obligations: The contractual cash flows are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Five securities had unrealized losses at December 31, 2020, which approximated 1.11% of their amortized cost. Changes in fair values are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. Furthermore, Salisbury evaluates these securities for strategic fit and may reduce its position in these securities, although it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity, and does not intend to sell these securities. Therefore, management does not consider these investments to be other-than-temporarily impaired at December 31, 2020.
The Federal Home Loan Bank of Boston (FHLBB) is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank’s FHLBB stock as of December 31, 2020. Deterioration of the FHLBB’s capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock.
See Note 7 to the Consolidated Financial Statements for further information.
NOTE 4 - LOANS
The composition of loans receivable and loans held-for-sale is as follows:
Salisbury has entered into loan participation agreements with other banks and transferred a portion of its originated loans to the participating banks. Transferred amounts are accounted for as sales and excluded from Salisbury’s loans receivable. Salisbury and its participating lenders share ratably in any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. Salisbury services the loans on behalf of the participating lenders and, as such, collects cash payments from the borrowers, remits payments (net of servicing fees) to participating lenders and disburses required escrow funds to relevant parties.
Salisbury also has entered into loan participation agreements with other banks and purchased a portion of the other banks’ originated loans. Purchased amounts are accounted for as loans without recourse to the originating bank. Salisbury and its originating lenders share ratably in any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. The originating banks service the loans on behalf of the participating lenders and, as such, collect cash payments from the borrowers, remit payments (net of servicing fees) to participating lenders and disburse required escrow funds to relevant parties.
At December 31, 2020 and 2019, Salisbury serviced commercial loans for other banks under loan participation agreements totaling $65.3 million and $67.0 million, respectively.
Concentrations of Credit Risk
Salisbury's loans consist primarily of residential and commercial real estate loans located principally in Litchfield County, Connecticut; Dutchess, Orange and Ulster Counties, New York; and Berkshire County, Massachusetts, which constitute Salisbury's service area. Salisbury offers a broad range of loan and credit facilities to borrowers in its service area, including residential mortgage loans, commercial real estate loans, construction loans, working capital loans, equipment loans, and a variety of consumer loans, including home equity lines of credit, installment loans and collateral loans. All residential and commercial mortgage loans are collateralized by first or second mortgages on real estate. The ability of single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the market area and real estate values. The ability of commercial borrowers to honor their repayment commitments is dependent on the general economy as well as the health of the real estate economic sector in Salisbury’s market area.
Salisbury’s commercial loan portfolio is comprised of loans to diverse industries, several of which may experience operating challenges from the economic downturn caused by the COVID-19 virus pandemic (“virus”). Approximately 40% of the Bank’s commercial loan portfolio are to entities who operate rental properties, which include commercial strip malls, smaller rental units as well as multi-unit dwellings. Approximately 14% of the Bank’s commercial loans are to entities in the hospitality industry, which includes hotels, bed & breakfast inns and restaurants. Approximately 8% of the Bank’s commercial loans are to educational institutions and approximately 6% of Salisbury’s commercial loans are to entertainment and recreation related businesses, which include a ski resort, bowling alleys and amusement parks. Salisbury’s commercial real estate exposure as a percentage of the Bank’s total risk-based capital, which represents Tier 1 plus Tier 2 capital, was approximately 182% as of December 31, 2020 and 169% at December 31, 2019 compared to the regulatory monitoring guideline of 300%.
Salisbury’s commercial loan exposure is mitigated by a variety of factors including the personal liquidity of the borrower, real estate and/or non-real estate collateral, U.S. Department of Agriculture or Small Business Administration (“SBA”) guarantees, loan payment deferrals and economic stimulus loans from the U.S. government as a result of the virus, and other factors. The duration of the economic shutdown and the time required for businesses to recover may adversely affect the ability of some borrowers to make timely loan payments. During such economic shutdown and recovery, the Bank may experience higher loan payment delinquencies and higher loan charge-offs, which could warrant increased provisions for loan losses. Management is currently unable to predict the extent to which the COVID-19 pandemic will impact these and other borrowers.
Salisbury processed 932 applications for loans of nearly $100 million under the SBA’s PPP program. The PPP loans are reported in the Commercial and Industrial category at their outstanding principal balance, net of unamortized deferred loan origination fees and costs on originated loans. Interest income is accrued on the unpaid principal balance. Deferred loan origination fees and costs are amortized as an adjustment to yield over the lives of the related loans, which is predominately two years. For the twelve months ended December 31, 2020, Salisbury recorded net interest income of $683 thousand and net origination fees of approximately $1.4 million. Management will participate in the SBA’s 2021 PPP program which launched in January 2021. Management anticipates that the volume of applications it processes will be lower than the number processed in 2020 in part due to eligibility thresholds implemented by the SBA.
Credit Quality
Salisbury uses credit risk ratings as part of its determination of the allowance for loan losses. Credit risk ratings categorize loans by common financial and structural characteristics that measure the credit strength of a borrower. The rating model has eight risk rating grades, with each grade corresponding to a progressively greater risk of default. Grades 1 through 4 are pass ratings and 5 through 8 are criticized as defined by the regulatory agencies. Risk ratings are assigned to differentiate risk within the portfolio and are reviewed on an ongoing basis and revised, if needed, to reflect changes in the borrowers' current financial position and outlook, risk profiles and the related collateral and structural positions. Salisbury is currently evaluating certain enhancements to its credit risk rating model to further refine the assessment of credit risk in the loan portfolio.
Loans rated as "special mention" (5) possess credit deficiencies or potential weaknesses deserving management’s close attention that if left uncorrected may result in deterioration of the repayment prospects for the loans at some future date.
Loans rated as "substandard" (6) are loans where the Bank’s position is clearly not protected adequately by borrower current net worth or payment capacity. These loans have well defined weaknesses based on objective evidence and include loans where future losses to the Bank may result if deficiencies are not corrected, and loans where the primary source of repayment such as income is diminished and the Bank must rely on sale of collateral or other secondary sources of collection.
Loans rated "doubtful" (7) have the same weaknesses as substandard loans with the added characteristic that the weakness makes collection or liquidation in full, given current facts, conditions, and values, to be highly improbable. The possibility of loss is high, but due to certain important and reasonably specific pending factors, which may work to strengthen the loan, its reclassification as an estimated loss is deferred until its exact status can be determined.
Loans classified as "loss" (8) are considered uncollectible and of such little value that continuance as Bank assets is unwarranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather, it is not practical or desirable to defer writing off this loan even though partial recovery may be made in the future.
Management actively reviews and tests its credit risk ratings against actual experience and engages an independent third-party to annually validate its assignment of credit risk ratings. In addition, the Bank’s loan portfolio is examined periodically by its regulatory agencies, the FDIC and the CTDOB.
The composition of loans receivable by risk rating grade is as follows:
The composition of loans receivable by delinquency status is as follows:
Troubled Debt Restructurings (TDRs)
Troubled debt restructurings occurring during the years ended December 31, 2020 and 2019:
For the twelve months ended December 2020, there were two troubled debt restructurings. Salisbury currently does not have any commitments to lend additional funds to TDR loans.
The following table discloses the recorded investment and number of modifications for TDRs within the last year where a concession has been made, that then defaulted in the current reporting period. All TDR loans are included in the Impaired Loan schedule and are individually evaluated.
Impaired loans
Loans individually evaluated for impairment (impaired loans) are loans for which Salisbury does not expect to collect all principal and interest in accordance with the contractual terms of the loan. Impaired loans include all modified loans classified as TDRs and loans on non-accrual status. The components of impaired loans are as follows:
Allowance for Loan Losses
In first quarter 2019 Salisbury transferred the remaining unearned credit-related discount on loans acquired in its 2014 acquisition of Riverside Bank to the allowance for loan losses. As a result of this transfer, which is reflected in the table below as the “acquisition discount transfer”, gross loans receivable and the allowance for loan losses increased by $663 thousand. The balance of net loans receivable did not change as a result of this transfer. The table below shows the activity within the allowance for loan losses by loan segment.	
The composition of loans receivable and the allowance for loan losses is as follows:
The credit quality segments of loans receivable and the allowance for loan losses are as follows:
1 Potential problem loans consist of performing loans that have been assigned a substandard credit risk rating and are not classified as impaired, included in this total are purchased loans net of any purchase marks remaining on the loan.
A specific valuation allowance is established for the impairment amount of each impaired loan, calculated using the present value of expected cash flows or collateral, in accordance with the most likely means of recovery. Certain data with respect to loans individually evaluated for impairment is as follows:
NOTE 5 - LEASES
On January 1, 2019, the Bank adopted ASU 2016-02, “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Bank leases facilities and equipment with various expiration dates. The facilities leases have varying renewal options, generally require fixed annual rent, and provide that real estate taxes, insurance, and maintenance are to be paid by Salisbury. The leases for two Bank facilities were accounted for as finance leases (previously referred to as capital leases) at December 31, 2020. The remaining leases were classified as operating leases, and therefore, were previously not recognized on the Bank’s Consolidated Balance Sheet. Effective January 1, 2019, the Bank recorded approximately $1.6 million of right-of-use assets and corresponding lease liability related to these operating leases. The Bank does not have any leases with related parties and equipment leases are not material to Salisbury’s consolidated financial statements.
The following table provides the assets and liabilities as well as the costs of operating and finance leases that are included in the Bank’s consolidated balance sheet as of December 31, 2020 and 2019 and consolidated income statements for the years ended December 31, 2020 and 2019.
The following is a schedule by years of the present value of the net minimum lease payments as of December 31, 2020.
NOTE 6 - MORTGAGE SERVICING RIGHTS
Loans serviced for others are not included in the consolidated balance sheets. Balances of loans serviced for others and the fair value of mortgage servicing rights are as follows:
Changes in mortgage servicing rights are as follows:
(1)Amortization expense and changes in the impairment reserve are recorded in mortgage servicing, net.
NOTE 7 - PLEDGED ASSETS
The following securities and loans were pledged to secure public and trust deposits, securities sold under agreements to repurchase, FHLBB advances and credit facilities available.
At December 31, 2020, securities were pledged as follows: $47.44 million to secure public deposits, $7.12 million to secure repurchase agreements and $0.02 million to secure FHLBB advances.
NOTE 8 - BANK PREMISES AND EQUIPMENT
The components of premises and equipment are as follows:
NOTE 9 - GOODWILL AND INTANGIBLE ASSETS
Changes in the carrying values of goodwill and intangible assets were as follows:
(1)Not subject to amortization.
Management evaluates goodwill and identifiable intangible assets for impairment at least annually using valuation techniques that involve observations and adjustments as to comparable transactions, estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. The COVID-19 pandemic triggered significant volatility in the global financial markets. Throughout 2020, Salisbury’s stock price primarily traded below its book value. On December 31, 2020, Salisbury’s closing stock price was $37.27 per share compared with its book value of $43.88 per share. Salisbury’s stock price has declined approximately 18% from December 31, 2019 consistent with financial stocks, as measured by the S&P United States BMI Banks Index, which declined approximately 16% over the same period. As a result of the stock market volatility and the negative impact from COVID-19 on the national and regional economy, in addition to the required annual assessment, the Bank periodically assessed during the year ended December 31, 2020 whether it was more likely than not that the carrying value of goodwill was impaired.
During fiscal year 2020, management evaluated several qualitative factors including macroeconomic conditions, the Bank’s financial performance and the short-term volatility in Salisbury’s share price and concluded that it was not more likely than not that goodwill was impaired. Salisbury performed its annual quantitative impairment analysis as of November 30, 2020 instead of December 31, 2020. Management changed the date of the assessment to ensure that there was adequate time to review the results of the analysis and record an impairment charge, if necessary, prior to finalizing the financial statements for fiscal year 2020. There were no material changes in the Bank’s operating environment or financial results during the month of December 2020 that would have affected the outcome of the impairment analysis. As a result of the analysis, management concluded that goodwill and other intangible assets were not impaired as of November 30, 2020. No impairment charges were recognized in 2019 or 2018.
The core deposit intangibles were recorded as identifiable intangible assets and are being amortized over ten years using the sum-of-the-years’ digits method. Estimated annual amortization expense of core deposit intangibles is as follows:
NOTE 10 - DEPOSITS
Scheduled maturities of time certificates of deposit are as follows:
The total amount and scheduled maturities of time certificates of deposit in denominations of $250 thousand or more are as follows:
Included in certificates of deposit at December 31, 2020 and 2019 are brokered and reciprocal deposits of approximately $25.4 million and $8.0 million, respectively. Included in money market funds at December 31, 2020 and 2019 are approximately $51.5 million and $66.0 million, respectively of brokered money market accounts.
NOTE 11 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Salisbury enters into overnight and short-term repurchase agreements with its customers. Securities sold under repurchase agreements are as follows:
NOTE 12 - FEDERAL HOME LOAN BANK OF BOSTON ADVANCES AND OTHER BORROWED FUNDS
Federal Home Loan Bank of Boston (“FHLBB”) advances are as follows:
(1)Net of modification costs.
(2)Weighted average rate based on scheduled maturity dates.
In addition to outstanding FHLBB advances, Salisbury has additional available borrowing capacity, based on current capital stock levels, of $255.5 million including access to an unused FHLBB line of credit of $3.5 million at December 31, 2020. Advances from the FHLBB are secured by a blanket lien on qualified collateral, consisting primarily of loans with first mortgages secured by one-to-four family properties, certain unencumbered investment securities and other qualified assets. At December 31, 2020, the available borrowing capacity was reduced by the amount of letters of credit provided to the Company by the FHLBB in the amount of $20.0 million and $18.0 million, respectively as of December 31, 2019.
Subordinated Debentures:
In December 2015, Salisbury completed the issuance of $10.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes Due 2025 (the “Notes”) in a private placement transaction to various accredited investors including $100 thousand to certain of Salisbury’s related parties. The Notes have a maturity date of December 15, 2025 and bear interest at an annual rate of 6.00% from and including the original issue date of the Notes to, but excluding, December 15, 2020 or the earlier redemption date payable semi-annually in arrears on June 15 and December 15 of each year. Thereafter, from and including December 15, 2020 to, but excluding, December 15, 2025, the annual interest rate will be reset quarterly and equal to the three-month LIBOR, plus 430 basis points, as described in the Notes, payable quarterly, in arrears, on March 15, June 15, September 15 and December 15 of each year during the time that the Notes remain outstanding through December 15, 2025 or earlier redemption date. The notes are redeemable, without penalty, on or after December 15, 2020. As more completely described in the Notes, the indebtedness evidenced by the Notes, including principal and interest, is unsecured and subordinate and junior in right of Salisbury’s payments to general and secured creditors and depositors of the Bank. The Notes also contain provisions with respect to redemption features and other matters pertaining to the Notes. The Notes have been structured to qualify as Tier 2 capital for regulatory capital purposes, subject to applicable limitations.
Subordinated debentures totaled $9.9 million at December 31, 2020 compared to $9.9 million at December 31, 2019, which includes $117 thousand and $141 thousand, respectively of remaining unamortized debt issuance costs. The debt issuance costs are being amortized to maturity. The effective interest rate of the subordinated debentures is 6.25% at December 31, 2020 compared to 6.33% at December 31, 2019.
LIBOR is due to be phased out as a market reference rate by the end of 2021. In December 2014, a group of market participants, known as the Alternative Reference Rates Committee (AARC) was initially convened by the Board of Governors of the Federal Reserve System and the New York Fed in cooperation with the U.S. Department of the Treasury, the U.S. Commodity Futures Trading Commission, and the U.S. Office of Financial Research to identify an alternative reference rate for use primarily in derivatives contracts. The AARC recommended the Secured Overnight Financing Rate (SOFR) as an alternative to LIBOR and the Federal Reserve began publishing the SOFR in April 2018. Salisbury will continue to monitor the transition from LIBOR to a new reference rate and its impact on Salisbury’s subordinated debt, which began to reprice on a quarterly basis on December 15, 2020.
Notes Payable:
In October 2015, Salisbury entered into a private mortgage for $380 thousand to purchase the Sharon, Connecticut branch property. The mortgage, which has an interest rate of 6%, will mature in September 2030. The outstanding mortgage balance at December 31, 2020 and December 31, 2019 was $208 thousand and $246 thousand, respectively.
NOTE 13 - NET DEFERRED TAX ASSET AND INCOME TAXES
Salisbury provides deferred taxes for the estimated future tax effects attributable to temporary differences and carry-forwards when realization is more likely than not. The components of the income tax provision were as follows:	
The following is a reconciliation of the expected federal statutory tax to the income tax provision:
The components of Salisbury's net deferred tax assets are as follows:
Salisbury will only recognize a deferred tax asset when, based upon available evidence, realization is more likely than not. In accordance with Connecticut legislation, in 2004, Salisbury formed a PIC, SBT Mortgage Service Corporation. Salisbury does not expect to pay Connecticut state income tax in the foreseeable future unless there is a change in Connecticut law.
Salisbury’s policy is to provide for uncertain tax positions and the related interest and penalties (recorded as a component of income tax expense, if any) based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. As of December 31, 2020, and 2019, there were no material uncertain tax positions related to federal and state tax matters. Salisbury is currently open to audit under the statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended December 31, 2017 through December 31, 2020.
NOTE 14 - SHAREHOLDERS’ EQUITY
Capital Requirements
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 and discretionary actions by the regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific guidelines that involve quantitative measures of its 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.
The Bank became subject to capital regulations adopted by the Board of Governors of the Federal Reserve System (FRB) and the FDIC, which implemented the Basel III regulatory capital reforms and the changes required by the Dodd-Frank Act. The required minimum regulatory capital ratios to which the Bank is subject, and the minimum ratios required for the Bank to be categorized as “well capitalized” under the prompt corrective action framework are noted in the table below. In addition, the regulations established a capital conservation buffer of 2.5% effective January 1, 2019. Failure to maintain the capital conservation buffer will limit the ability of the Company and the Bank to pay discretionary bonuses and dividends. At December 31, 2020, The Bank exceeded the minimum requirement for the capital conservation buffer. As of December 31, 2020, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed that categorization.
The Bank’s risk-weighted assets at December 31, 2020 and December 31, 2019 were $938.0 million and $891.6 million, respectively. Actual regulatory capital position and minimum capital requirements as defined "To Be Well Capitalized Under Prompt Corrective Action Provisions" and "For Capital Adequacy Purposes" for the Bank are as follows:
Legal Limitations on Cash Dividends to Common Shareholders
Salisbury's ability to pay cash dividends is substantially dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain legal limits on the payment of cash dividends and other payments by banks to their holding companies. Under Connecticut law, a bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations. The total of all cash dividends declared by a bank in any calendar year shall not, unless specifically approved by the Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.
FRB Supervisory Letter SR 09-4, February 24, 2009, revised March 30, 2009, notes that, as a general matter, the Board of Directors of a Bank Holding Company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital structure.
NOTE 15 - OTHER BENEFITS
401(k) Plan
Salisbury offers a 401(k) Plan to eligible employees. Under the 401(k) Plan, eligible participants may contribute a percentage of their pay subject to IRS limitations. Salisbury may make discretionary contributions to the Plan. The Plan includes a safe harbor contribution of 3% for all qualifying employees. The Bank’s safe harbor contribution percentage is reviewed annually and, under provisions of the 401(k) Plan, is subject to change in the future. An additional discretionary match may also be made for all employees that meet the 401(k) Plan’s qualifying requirements for such a match. This discretionary matching percentage, if any, is also subject to review under the provisions of the 401(k) Plan. Both the safe harbor and additional discretionary match, if any, vest immediately. Salisbury’s 401(k) Plan contribution expense for 2020, 2019 and 2018 was $0.9 million $0.9 million, and $1.0 million, respectively.
Employee Stock Ownership Plan (ESOP)
Salisbury offers an ESOP to eligible employees. Under the Plan, Salisbury may make discretionary contributions to the Plan. Discretionary contributions vest in full upon six years and reflect the following schedule of qualified service:
20% after the second year, 20% per year thereafter, vesting at 100% after six full years of service. Benefit expenses totaled $263 thousand, $285 thousand, and $358 thousand, in 2020, 2019, and 2018, respectively.
Other Retirement Plans
Salisbury adopted ASC 715-60, “Compensation - Retirement Benefits - Defined Benefit Plans - Other Postretirement" and recognized a liability for Salisbury’s future postretirement benefit obligations under endorsement split-dollar life insurance arrangements. The total liability for the arrangements included in other liabilities was $771 thousand and $765 thousand at December 31, 2020, and 2019, respectively. During 2019, the related agreements were modified, which resulted in a benefit adjustment of $328 thousand with an offsetting expense of $101 thousand totaling a net credit to expense of $227 thousand. Expense under this arrangement for 2020 and 2018 were $7 thousand and $26 thousand, respectively.
The Bank assumed a Supplemental Retirement Plan Agreement with a former Chief Executive Officer of Riverside Bank that provides for supplemental post retirement payments for a fifteen-year period ending in 2025 as described in the agreement. The related liability was $312 thousand and $358 thousand at December 31, 2020 and December 31, 2019, respectively. The related expenses were immaterial for all periods presented.
A Non-Qualified Deferred Compensation Plan (the "Plan") was adopted effective January 1, 2013. This Plan was adopted by the Bank for the benefit of certain key employees ("Executive" or "Executives") who have been selected and approved by the Bank to participate in this Plan and who have evidenced their participation by execution of a Non-Qualified Deferred Compensation Plan Participation Agreement ("Participation Agreement") in a form provided by the Bank. This Plan is intended to comply with Internal Revenue Code ("Code") Section 409A and any regulatory or other guidance issued under such Section. In 2020, 2019, and 2018, the Bank awarded seven (7), seven (7), and six (6) Executives, respectively, with discretionary contributions to the plan. Expenses related to this plan amounted to $135 thousand in 2020, $114 thousand in 2019, and $115 thousand in 2018.
Management Agreements: Salisbury or the Bank has entered into various management agreements with its named executive officers, including a severance agreement with Mr. Cantele, President and Chief Executive Officer, a change in control agreement with Mr. Albero, Executive Vice President and Chief Financial Officer, and a severance agreement with Mr. Davies, President of the New York Region and Chief Lending Officer. Salisbury also entered into a change in control agreement with Carla L. Balesano dated July 29, 2020, which provides a severance payment of 1.0 times base salary, annual cash bonus and other benefits in the event employment is terminated in conjunction with a defined change in control. In addition to these agreements, Salisbury has change in control agreements or a severance agreement, with change in control provisions, with ten other executives with payouts ranging from 0.5 to 1.0 times base salary, annual cash bonus and other benefits. Such agreements, and their subsequent amendments, are designed to allow Salisbury to retain the services of the designated executives while reducing, to the extent possible, unnecessary disruptions to Salisbury’s operations.
NOTE 16 - LONG TERM INCENTIVE PLANS
The Board of Directors adopted the 2011 Long Term Incentive Plan (the “Plan”) on March 25, 2011, and the shareholders approved the Plan at the 2011 Annual Meeting. The Plan was amended on January 18, 2013, January 29, 2016 and again on April 28, 2017. The purpose of the Plan is to assist Salisbury and the Bank in attracting, motivating, retaining and rewarding employees, officers and directors by enabling such persons to acquire or increase a proprietary interest in Salisbury in order to strengthen the mutuality of interests between such persons and our shareholders, and providing such persons with stock-based long-term performance incentives to expend their maximum efforts in the creation of shareholder value.
The terms of the Plan provide for grants of Directors Stock Retainer Awards, Stock Options, Stock Appreciation Rights (“SARs”), Restricted Stock, Restricted Stock Units, Performance Awards, Deferred Stock, Dividend Equivalents, and Stock or Other Stock-Based Awards that may be settled in shares of common stock, cash, or other property (collectively, “Awards”). Under the Plan, the total number of shares of Common Stock reserved and available for issuance in the ten years following adoption of the Plan in connection with Awards under the Plan is 84,000 shares of Common Stock, which represented less than 5% of Salisbury’s outstanding shares of Common Stock at the time the Plan was adopted. Shares of Common Stock with respect to Awards previously granted under the Plan that are cancelled, terminate without being exercised, expire, are forfeited or lapse will again be available for issuance as Awards. Also, shares of Common Stock subject to Awards settled in cash and shares of Common Stock that are surrendered in payment of any Award or any tax withholding requirements will again be available for issuance as Awards. No more than 30,000 shares of Common Stock may be issued pursuant to Awards in any one calendar year. In addition, the Plan limits the total number of shares of Common Stock that may be awarded as Incentive Stock Options (“ISOs”) to 42,000 and the total number of shares of Common Stock that may be issued as Directors Stock Retainer Awards to 15,000. The Directors stock retainer awards were increased from 120 shares per year to 240 shares per year effective January 25, 2013. Effective January 29, 2016, the Directors stock retainer award was increased from 240 shares to 340 shares annually.
The Board of Directors adopted the 2017 Long Term Incentive Plan (the “2017 LTIP”) on February 24, 2017, which was approved by shareholders at the 2017 Annual Meeting on May 17, 2017. Pursuant to the 2017 LTIP, as of May 2017, following shareholder approval of the 2017 LTIP, no further awards will be made under the 2011 LTIP, which shall remain in existence solely for purposes of administering outstanding grants. Under the 2017 LTIP, the total number of shares of Common Stock reserved and available for issuance in the next ten years in connection with awards under the 2017 LTIP is 200,000 shares of Common Stock, which represents approximately 7% of Salisbury’s 2,770,036 outstanding shares of Common Stock as of March 20, 2017. Of the maximum shares available under the 2017 LTIP, 200,000 shares may be issued upon the exercise of stock options (all of which may be granted as incentive stock options) and 150,000 shares may be issued as restricted stock or restricted stock units (including deferred stock units), provided that, to the extent that a share is issued as a restricted stock award or a restricted stock unit, the share would no longer be available for award as a stock option, unless the restricted stock award or restricted unit is forfeited or otherwise returned to the 2017 LTIP. On March 9, 2020 the Board of Directors approved an amendment to the Salisbury Bancorp, Inc. 2017 Long Term Incentive Plan (the “Plan”) which allows the Committee, in its sole discretion, to accelerate vesting of all or a portion of an award upon the termination of service of a participant or the occurrence of a change in control.
Restricted stock
In 2020, 2019 and 2018 Salisbury granted a total of 15,475, 15,130, and 13,210 shares of restricted stock pursuant to its 2011 and 2017 LTIP to certain employees and Directors. The fair value of the stock at grant date was determined to be $554 thousand, $601 thousand, and $585 thousand, respectively. The stock will be vested three years from the grant date.
The following table presents the amount of cumulatively granted restricted stock awards under the 2011 and 2017 Long-Term Incentive Plans:
The fair value of the restricted shares that vested during 2020, 2019 and 2018 were $464 thousand, $556 and $0 thousand, respectively. Compensation expense for restricted stock awards in 2020, 2019, and 2018 was $525 thousand, $491 thousand, and $447 thousand, respectively. Unrecognized compensation cost relating to the restricted stock awards was $774 thousand, $795 thousand, and $711 thousand as of December 31, 2020, 2019 and 2018, respectively. The remaining weighted average vesting period on restricted shares as of December 31, 2020, over which unrecognized compensation cost is expected to be recognized, is 1.5 years. The tax benefit associated with restricted stock awards, which was recognized in earnings for 2020, 2019 and 2018, was approximately $95 thousand, $88 thousand and $87 thousand, respectively.
Additionally, in 2018 the Compensation Committee granted a total of 53,500, Phantom Stock Appreciation Units (“PSAUs” pursuant to the 2013 Phantom Stock Appreciation Unit and Long-Term Incentive Plan (the “Plan”) to certain employees, including the Named Executive Officers. The units will vest on the third anniversary of the grant date. Salisbury’s compensation expense related to the PSAUs was $141 thousand, $414 thousand, and $171 thousand for 2020, 2019, and 2018 respectively.
Performance-based restricted stock units
On March 29, 2019, the Compensation Committee granted 6,800 performance-based restricted stock units (RSU) pursuant to the 2017 Long-Term Incentive Plan to further align compensation with the Bank’s performance. This RSU plan replaced the Bank’s Phantom Stock Appreciation Units plan (Phantom). Salisbury will continue to record an expense for the Phantom plan until the final tranche of awards is paid out in January 2021.
The performance goal for awards granted under the RSU plan in 2019 is based on the increase in the Bank’s tangible book value by $3.50 per share over the performance period for threshold performance. Vesting will range from 75% of target for achieving threshold performance, to 100% of target for achieving target payout performance ($5.00 increase in tangible book value per share) to 150% of target for achieving in excess of target payout performance and, if the performance goals are achieved, vesting will occur no later than March 29, 2022.
On July 29, 2020, the Compensation Committee granted an additional 7,250 units under the RSU plan. The performance goal for this tranche is based on the relative increase in the Bank’s tangible book value compared with a pre-determined group of peer banks over the performance period for threshold performance. Vesting will range from 50% of target for achieving threshold performance, to 100% of target for achieving tangible book value growth of at least 50% but less than 55% of the peer group, to 150% of target for achieving in excess of target payout performance and, if the performance goal is achieved.
The fair value of the awards granted under the RSU plan at the grant date was $264 thousand and $280 thousand, respectively, for those grants awarded in 2020 and 2019. In 2020, 350 RSUs were forfeited. Compensation expense of $221 thousand and $70 thousand was recorded with respect to these RSUs in 2020 and 2019, respectively. No performance-based restricted stock units were awarded prior to 2018. The shares noted above are contingently issuable only upon attainment of the minimum performance goal.
The following table presents the amount of cumulatively granted performance based restricted stock units awarded under the 2017 Long-Term Incentive Plans:
Short Term Incentive Plan (STIP)
Salisbury offers a short-term discretionary compensation plan to eligible employees on an annual basis. Under this incentive plan, Salisbury may reward employees with cash compensation if certain pre-determined Bank and individual performance goals have been achieved. The STIP expense, which is included in compensation expenses, totaled $941 thousand, $888 thousand, and $758 thousand, in 2020, 2019, and 2018, respectively.
NOTE 17 - STOCK OPTIONS
Salisbury issued stock options in conjunction with its acquisition of Riverside Bank in 2014. The table below reflects the remaining outstanding options related to this transaction and presents a summary of the status of Salisbury's outstanding stock options as of and for the year ended December 31, 2020:
All options are vested and exercisable at December 31, 2020. The total intrinsic value is the amount by which the fair value of the underlying stock exceeds the exercise price of an option on the exercise date. The total intrinsic value of stock options exercised during the years ended December 31, 2020, 2019 and 2018 was $78 thousand, $125 thousand, and $160 thousand, respectively.
NOTE 18 - RELATED PARTY TRANSACTIONS
In the normal course of business, the Bank has granted loans to executive officers, directors, principal shareholders and associates of the foregoing persons considered to be related parties. Changes in loans to executive officers, directors and their related associates are as follows (there are no loans to principal shareholders):
NOTE 19 - OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents a reconciliation of the changes in the components of other comprehensive income (loss) for the dates indicated, including the amount of income tax benefit allocated to each component of other comprehensive loss:
(1) Reclassification adjustments include realized security gains and losses. The gains and losses have been reclassified out of other accumulated comprehensive income (loss) and have affected certain lines in the consolidated statements of income as follows: the pretax amount is reflected as gains on securities, net; the tax effect is included in the income tax provision; and the after-tax amount is included in net income. The income tax expense related to reclassification of net realized gains was approximately $41 thousand, $55 thousand, and $67 thousand in 2020, 2019 and 2018, respectively.
The components of accumulated other comprehensive income (loss) are as follows:
NOTE 20 - DERIVATIVES AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives
Salisbury is exposed to certain risk arising from both its business operations and economic conditions. The Bank principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Bank manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Bank enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Bank uses derivative financial instruments to manage differences in the amount, timing, and duration of the Bank’s known or expected cash receipts and its known or expected cash payments principally related to its portfolio of loans to first-time home buyers.
Fair Value Hedges of Interest Rate Risk
The Company is exposed to changes in the fair value of certain pools of its pre-payable fixed-rate assets due to changes in benchmark interest rates. Salisbury uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the designated benchmark interest rate, Federal Funds. Interest rate swaps designated as fair value hedges involve the payment of fixed-rate amounts to a counterparty in exchange for Salisbury receiving variable-rate payments over the life of the agreements without the exchange of the underlying notional amount.
For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in interest income.
As of December 31, 2020, the following amounts were recorded on the balance sheet related to cumulative basis adjustment for fair value hedges:
(1) These amounts include the amortized cost basis of closed portfolios used to designated hedging relationships in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. At December 31, 2020, the amortized cost basis of the closed portfolios used in these hedging relationships was $48.3 million; the cumulative basis adjustment associated with these hedging relationships was $4 thousand; and the amount of the designated hedged item was $10.0 million. Salisbury did not use derivatives as a fair value hedge prior to third quarter 2020.
The table below presents the fair value of Salisbury’s derivative financial instrument and its classification on the Balance Sheet as of December 31, 2020. Salisbury did not use derivative financial instruments prior to third quarter 2020.
The table below presents the effect of the Company’s derivative financial instruments on the Income Statement as of December 31, 2020.
Credit-Risk Related Contingent Features
Salisbury has an agreement with its derivative counterparty that contains a provision where if the Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Bank could also be declared in default on its derivative obligations.
The agreement also contains a provision where if the Bank fails to maintain its status as a well / adequately capitalized institution, then Salisbury could be required to post cash or certain marketable securities issued by the U.S. Treasury or U.S. Government-sponsored enterprises as collateral. The minimum amount that Salisbury would have to post as collateral is $250 thousand.
As of December 31, 2020, the fair value of the derivative $4 thousand in a net asset position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements. As of December 31, 2020, Salisbury has not posted any collateral related to these agreements.
NOTE 21 - COMMITMENTS AND CONTINGENT LIABILITIES
Commitments
The Bank’s agreement with the core accounting processing service provider will continue until the eighth anniversary of the commencement date, which was November 10, 2016. If the Bank cancels the agreement prior to the end of the contract term, a lump sum termination fee will have to be paid. The fee shall consist of the total amount that would have been paid or reimbursed to the service provider during the remainder of the term of the agreement.
Contingent Liabilities
The Bank is involved in various claims and legal proceedings, which are not material, arising in the ordinary course of business. There are no material pending legal proceedings, other than ordinary routine litigation incidental to the registrant’s business, to which Salisbury is a party or to which any of its property is subject.
On October 4, 2019, Salisbury entered into a contract with a construction company to construct an operations center on its Lakeville, CT. campus in 2020. The estimated construction cost is $5.6 million and Salisbury may terminate the contract at its convenience and without cause. In the event of such termination, Salisbury will be required to pay for work executed and costs incurred by reason of such termination. At December 31, 2020, Salisbury has an outstanding commitment of $789 thousand to a construction company for this project.
NOTE 22 - FINANCIAL INSTRUMENTS
The Bank, in the normal course of business and to meet the financing needs of its customers, is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to originate loans, letters of credit, and unadvanced funds on loans. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to originate loans are agreements to lend to a customer provided there are no violations of any conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies, but may include secured interests in mortgages, accounts receivable, inventory, property, plant and equipment and income producing properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. As of December 31, 2020 and 2019, the maximum potential amount of the Bank’s obligation was $4.8 million and $4.7 million, respectively, for financial, commercial and standby letters of credit. If a letter of credit is drawn upon, the Bank may seek recourse through the customer’s underlying line of credit. If the customer’s line of credit is also in default, the Bank may take possession of the collateral, if any, securing the line of credit.
Financial instruments with off-balance sheet credit risk are as follows:
The allowance for off balance sheet commitments is calculated by applying a reserve percentage discounted by a utilization factor to the sum of unguaranteed unused lines of credit and loan contracts that the Bank has committed to but not funded as of year-end. The allowance for off-balance sheet commitments was $118 thousand and $96 thousand as of December 31, 2020 and December 31, 2019, respectively.
NOTE 23 - FAIR VALUE MEASUREMENTS
Salisbury uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, other assets are recorded at fair value on a nonrecurring basis, such as loans held for sale, collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or-market accounting or write-downs of individual assets.
Salisbury adopted ASC 820-10, “Fair Value Measurement - Overall,” which provides a framework for measuring fair value under generally accepted accounting principles. In accordance with ASC 820-10, Salisbury groups its financial assets and financial liabilities measured at fair value 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. GAAP specifies a hierarchy of valuation techniques based on whether the types of valuation information (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Salisbury’s market assumptions. These two types of inputs have created the following fair value hierarchy:
Level 1. Quoted prices in active markets for identical assets. Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 may also include U.S. Treasury, other U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2. Significant other observable inputs. Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities. Currently, Salisbury uses an interest rate swap to manage its interest rate risk. The fair value of the interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with the provisions of ASC 820, Salisbury incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Bank has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Level 3. Significant unobservable inputs. Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, are not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Salisbury did not have any significant transfers of assets between levels 1 and 2 of the fair value hierarchy during the twelve-month period ended December 31, 2020.
The following is a description of valuation methodologies for assets recorded at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.
•Securities available-for-sale and the CRA mutual fund. Securities available-for-sale and the CRA mutual fund are recorded at fair value on a recurring basis. Level 1 securities include exchange-traded equity securities. Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes obligations of the U.S. Treasury and U.S. government-sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, municipal bonds, SBA bonds, corporate bonds and certain preferred equities. Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
•Derivative financial instruments. The fair value of the interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.
•Collateral dependent loans that are deemed to be impaired are valued based upon the fair value of the underlying collateral less costs to sell. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. Management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral dependent impaired loans are categorized as Level 3.
•Other real estate owned acquired through foreclosure or repossession is adjusted to fair value less costs to sell upon transfer out of loans. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral. Management adjusts appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property, and such property is categorized as Level 3.
Assets measured at fair value are as follows:
Carrying values and estimated fair values of financial instruments are as follows:
NOTE 24 - SALISBURY BANCORP, INC. (PARENT ONLY) CONDENSED FINANCIAL INFORMATION
The unconsolidated balance sheets and statements of income and cash flows of Salisbury Bancorp, Inc. are presented as follows:
NOTE 25 - EARNINGS PER SHARE
The calculation of earnings per share is as follows:
NOTE 26 - SUBSEQUENT EVENTS
Salisbury has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued. The Board of Directors of Salisbury approved a quarterly dividend of $0.29 per common share at their January 27, 2021 meeting. The dividend was paid on February 26, 2021 to shareholders of record as of February 12, 2021.
From January 1, 2021 through February 28, 2021, Salisbury processed 251 applications for loans of approximately $34 million under the SBA’s PPP program.
Item 9.
Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A.CONTROLS AND PROCEDURES
Controls and Procedures
Salisbury carried out an evaluation under the supervision and with the participation of Salisbury’s management, including Salisbury’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of Salisbury’s disclosure controls and procedures at and for the year ended December 31, 2020. Based upon that evaluation, management, including the principal executive officer and principal financial officer, concluded that Salisbury’s disclosure controls and procedures were effective as of the end of the period covered by this report and (i) designed to ensure that information required to be disclosed by Salisbury in the reports it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms; and (ii) accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Management of Salisbury and its subsidiary is responsible for establishing and maintaining effective internal control over financial reporting. Pursuant to the rules and regulations of the SEC, internal control over financial reporting is a process designed by, or under the supervision of, Salisbury’s principal executive and principal financial officers, or persons performing similar functions, and effected by Salisbury’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, and includes those policies and procedures that:
i.Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of Salisbury;
ii.Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles and that receipts and expenditures of Salisbury are being made only in accordance with authorizations of management and directors of Salisbury; and
iii.Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Salisbury’s assets that could have a material effect on the financial statements.
As of December 31, 2020, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control-Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2020 was effective.
Changes in internal control over financial reporting
There were no significant changes in internal control over financial reporting during the fourth quarter of 2020 that materially affected or are reasonably likely to materially affect Salisbury’s internal control over financial reporting.
Item 9B.
Item 9B.OTHER INFORMATION
On March 9, 2020 the Board of Directors approved an amendment to the Salisbury Bancorp, Inc. 2017 Long Term Incentive Plan (the “Plan”) which allows the Committee, in its sole discretion, to accelerate vesting of all or a portion of an award upon the termination of service of a participant or the occurrence of a change in control. See Exhibit 10.16 included herein.
PART III
Item 10.
Item 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item appears in Salisbury's Proxy Statement for the 2021 Annual Meeting of Shareholders, under the captions “Executive Officers;” “Election of Directors” and “Director Independence” and "Corporate Governance - Meetings and Committees of the Board of Directors." Such information is incorporated herein by reference and made a part hereof.
Salisbury maintains a Code of Ethics and Conflicts of Interest Policy that applies to all of Salisbury’s directors, officers and employees, including Salisbury’s principal executive officer, principal financial officer and principal accounting officer. This Code of Ethics and Conflicts of Interest Policy is available upon request, without charge, by writing to Shelly L. Humeston, Secretary, Salisbury Bank and Trust Company, 5 Bissell Street, P.O. Box 1868, Lakeville, Connecticut 06039.
Item 11.
Item 11.EXECUTIVE COMPENSATION
The information required by this item appears in Salisbury's Proxy Statement for the 2021 Annual Meeting of Shareholders, under the captions: “Elements of Compensation” and "Executive Compensation" and “Board of Directors Compensation.” Such information is incorporated herein by reference and made a part hereof.
Item 12.
Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required by this item appears in Salisbury's Proxy Statement for the 2021 Annual Meeting of Shareholders, under the captions “Security Ownership of Certain Beneficial Owners and Management” "Election of Directors” and “Director Independence" and "Executive Compensation." Such information is incorporated herein by reference and made a part hereof.
Item 13.
Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item appears in Salisbury's Proxy Statement for the 2021 Annual Meeting of Shareholders, under the captions “Election of Directors” and “Director Independence” and "Transactions with Management and Others." Such information is incorporated herein by reference and made a part hereof.
Item 14.
Item 14.PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item appears in Salisbury's Proxy Statement for the 2021 Annual Meeting of Shareholders, under the caption "Relationship with Independent Public Accountants" and “Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors.” Such information is incorporated herein by reference and made a part hereof.
PART IV
Item 15.
Item 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1)Financial Statements. The Consolidated Financial Statements of Registrant and its subsidiary are included within Item 7 of Part II of this report.
(a)(2)Financial Statement schedules. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because they are either not applicable or the required information is included in the Consolidated Financial Statements or Notes thereto included within Item 8 of this Form 10-K.
(b)Exhibits. The following exhibits are included as part of this Form 10-K.
Exhibit No.	Description
2.1Agreement and Plan of Merger by and among Salisbury Bancorp, Inc., Salisbury Bank and Trust Company and Riverside Bank dated March 18, 2014 (incorporated by reference to Exhibit 2.1 of Form 8-K filed on March 19, 2014).
3.1Certificate of Incorporation of Salisbury Bancorp, Inc. (incorporated by reference to Exhibit 3.1 of Registrant’s 1998 Registration Statement on Form S-4 filed April 23, 1998, File No.: 33-50857).
3.1.1Amendment to Article Third of Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K filed March 11, 2009).
3.1.2Certificate of Amendment to Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K filed March 19, 2009).
3.1.3Certificate of Amendment to Certificate of Incorporation for the Series B Preferred Stock (incorporated by reference to Registrant’s Form 8-K filed on August 25, 2011).
3.1.4Certificate of Amendment to Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K filed October 30, 2014).
3.2Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 of Form 8-K filed November 25, 2014).
4.1Form of Subordinated Note, dated as of December 10, 2015, issued by Salisbury Bancorp, Inc. (incorporated by reference to Exhibit 4.1of Registrant’s Form 8-K filed December 10, 2015).
4.2Description of registrant’s securities.	
10.12011 Long Term Incentive Plan adopted by the Board on March 25, 2011 and approved by the shareholders at Salisbury’s 2011 Annual Meeting of Shareholders (incorporated by reference to Exhibit 10.9 of Registrant’s Annual Report on Form 10-K filed March 19, 2012).
10.2Amendment Number One to 2011 Long Term Incentive Plan dated as of January 18, 2013 (incorporated by reference to Exhibit 10.10 of Registrant’s Annual Report on Form 10-K filed March 7, 2013).
10.3Severance Agreement between Salisbury Bank and Trust Company and Mr. Richard J. Cantele, Jr. dated January 24, 2020 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed January 30, 2020).
10.4Non-qualified Deferred Compensation Plan effective as of January 1, 2013 (incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed February 15, 2013).	
10.5Employee Stock Ownership Plan (incorporated by reference to Exhibit 10.14 of Form 10-K filed March 28, 2014).
10.6Salisbury Bancorp, Inc. 2015 Phantom Stock Appreciation Unit and Long-Term Incentive Plan (incorporated by reference to Exhibit 10.1 of Form 8-K filed January 2, 2015).
10.7Amendment Number One to Salisbury Bancorp, Inc. 2015 Phantom Stock Appreciation Unit and Long-Term Incentive Plan (incorporated by reference to Exhibit 10.1 of Form 8-K filed January 30, 2015).
10.8Amendment Number Two to 2011 Long Term Incentive Plan dated as of January 29, 2016 (incorporated by reference to Exhibit 10.12 of Form 10-K filed March 30, 2016).
10.9Form of Split-dollar Life Insurance Agreements with Senior Executive Officers (incorporated by reference to Exhibit 10.13 of Form 10-K filed March 30, 2016).
10.10Severance Agreement between Salisbury Bank and Trust Company and John M. Davies dated January 24, 2020 (incorporated by reference to Exhibit 10.2 of Form 8-K filed January 30, 2020).
10.11Form of Subordinated Note Purchase Agreement, dated as of December 10, 2015, between Salisbury Bancorp, Inc. and the Purchasers identified therein. (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed December 10, 2015). (incorporated by reference.
10.122017 Long Term Incentive Plan adopted by the Board on February 24, 2017 and approved by shareholders at Salisbury’s 2017 Annual Meeting of Shareholders (incorporated by reference to Appendix A of the Registrant’s proxy filed March 20, 2017).
10.13Amendment Number Three to 2011 Long Term Incentive Plan dated as of April 28, 2017 (incorporated by reference to Exhibit 10.2 of Form 10-Q filed May 15, 2017).
10.14Change in Control Agreement with Peter Albero dated January 24, 2020 (incorporated by reference to Exhibit 10.3 of Form 8-K filed January 30, 2020.
10.15Change in Control Agreement with Steven M. Essex dated February 22, 2019 (incorporated by reference to Exhibit 10.2 of Form 8-K filed February 25, 2019.
10.16Amendment Number One to 2017 Long Term Incentive Plan dated as of March 9, 2020 (incorporated by reference to Exhibit 10.16 of Form 10-K filed March 13, 2020)
10.17Form of Performance Award Agreement - Restricted Stock Units (incorporated by reference to Exhibit 10.1 of Form 8-K filed July 29, 2020)
10.18Split-dollar Life Insurance Agreement with Peter Albero (incorporated by reference to Exhibit 10.1 of Form 8-K filed January 29, 2020)
10.19Form of Split-dollar Life Insurance Agreements with Senior Executive Officers (incorporated by reference to Exhibit 10.2 of Form 8-K filed January 29, 2020).
10.20Split-dollar Life Insurance Agreement with Richard J. Cantele,Jr. (incorporated by reference to Exhibit 10.3 of Form 8-K filed January 29, 2020).
10.21Change in Control Agreement with Carla L. Balesano dated July 29, 2020 (incorporated by reference to Exhibit 10.2 of Form 10-Q filed November 6, 2020.
21.1Subsidiaries of the Registrant.
23.1Consent of Baker Newman & Noyes, LLC.
31.1Chief Executive Officer Certification Pursuant to 17 CFR 240.13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2Chief Financial Officer Certification Pursuant to 17 CF 240.13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1Chief Executive Officer and Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(c) Financial Statement Schedules
No financial statement schedules are required to be filed as Exhibits pursuant to Item 15(c).
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SALISBURY BANCORP, INC.
/s/ Richard J. Cantele, Jr.
Richard J. Cantele, Jr.,
President and Chief Executive Officer
March 12, 2021
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Charles M. Andola /s/ Holly J. Nelson
Charles M. Andola Holly J. Nelson
Director Director
March 12, 2021 March 12, 2021
/s/ George E. Banta /s/ John F. Perotti
George E. Banta John F. Perotti
Director Director
March 12, 2021 March 12, 2021
/s/ Arthur J. Bassin /s/ Neila B. Radin
Arthur J. Bassin Neila B. Radin
Director Director
March 12, 2021 March 12, 2021
/s/ Richard J. Cantele, Jr. /s/ Grace E. Schalkwyk
Richard J. Cantele, Jr. Grace E. Schalkwyk
Director, President and Chief Executive Officer Director
March 12, 2021 March 12, 2021
/s/ David B. Farrell /s/ Peter Albero
David B. Farrell Peter Albero
Director, Chairman of the Board Chief Financial Officer
March 12, 2021 and Chief Accounting Officer
/s/ Nancy F. Humphreys March 12, 2021
Nancy F. Humphreys
Director
March 12, 2021