UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1937

Commission File No. 001-16101

BANCORP RHODE ISLAND, INC.

(Exact name of Registrant as specified in its charter)

Rhode Island		05-0509802
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
(Address of principal executive offices)

(401) 456-5000

Not Applicable

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

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

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

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

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock, as of May 3, 2010:

Common Stock — Par Value $0.01		4,670,582 shares
(class)		(outstanding)

 

 

BANCORP RHODE ISLAND, INC.
Quarterly Report on Form 10-Q
Table of Contents

Description		Page Number
Cover Page			1
Table of Contents			2
Part I — Financial Information
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets			3
Consolidated Statements of Operations			4
Consolidated Statements of Changes in Shareholders’ Equity			5
Consolidated Statements of Cash Flows			6
Condensed Notes to Consolidated Financial Statements			7-19
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20-37
Item 3. Quantitative and Qualitative Disclosures About Market Risk			38
Item 4. Controls and Procedures			39
Part II — Other Information
Item 1. Legal Proceedings			40
Item 1A. Risk Factors			40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			40
Item 3. Defaults Upon Senior Securities			40
Item 5. Other Information			40
Item 6. Exhibits			41
Signature Page			42
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Special Note Regarding Forward Looking Statements

We make certain forward looking statements in this Quarterly Report on Form 10-Q and in other documents that we incorporate by reference into this report that are based upon our current expectations and projections about future events. We intend these forward looking statements to be covered by the safe harbor provisions for “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we are including this statement for purposes of these safe harbor provisions. You can identify these statements by reference to a future period or periods by our use of the words “estimate,” “project,” “may,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar terms or variations of these terms.

Actual results may differ materially from those set forth in forward looking statements as a result of risks and uncertainties, including those detailed from time to time in our filings with the Federal Deposit Insurance Corporation (“FDIC”) and the Securities and Exchange Commission (“SEC”). Our forward looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. We do not assume any obligation to update any forward looking statements.

BANCORP RHODE ISLAND, INC.

		March 31,				December 31,
		2010				2009
		(In thousands)
ASSETS:
Cash and due from banks		$	16,845			$	18,866
Overnight investments			600				1,964
Total cash and cash equivalents			17,445				20,830
Available for sale securities (amortized cost of $361,410 and $380,108, respectively)			365,110				381,839
Stock in Federal Home Loan Bank of Boston			16,274				16,274
Loans and leases receivable:
Commercial loans and leases			752,193				732,397
Residential mortgage loans			170,200				173,294
Consumer and other loans			201,445				206,156
Total loans and leases receivable			1,123,838				1,111,847
Allowance for loan and lease losses			(16,625	)			(16,536	)
Net loans and leases receivable			1,107,213				1,095,311
Premises and equipment, net			12,230				12,378
Goodwill, net			12,262				12,239
Accrued interest receivable			4,863				4,964
Investment in bank-owned life insurance			30,325				30,010
Prepaid expenses and other assets			21,056				16,101
Total assets		$	1,586,778			$	1,589,946
LIABILITIES:
Deposits:
Demand deposit accounts		$	203,193			$	204,281
NOW accounts			68,724				74,558
Money market accounts			78,824				65,076
Savings accounts			378,228				367,225
Certificate of deposit accounts			378,102				387,144
Total deposits			1,107,071				1,098,284
Overnight and short-term borrowings			37,851				40,171
Wholesale repurchase agreements			20,000				20,000
Federal Home Loan Bank of Boston borrowings			270,090				277,183
Subordinated deferrable interest debentures			13,403				13,403
Other liabilities			14,684				20,244
Total liabilities			1,463,099				1,469,285
SHAREHOLDERS’ EQUITY:
Common stock, par value $0.01 per share, authorized 11,000,000 shares: Issued: 5,007,190 and 4,969,444 shares, respectively			50				50
Additional paid-in capital			73,306				72,783
Treasury stock, at cost:373,850 and 364,750 shares, respectively			(12,527	)			(12,309	)
Retained earnings			60,445				59,012
Accumulated other comprehensive income, net			2,405				1,125
Total shareholders’ equity			123,679				120,661
Total liabilities and shareholders’ equity		$	1,586,778			$	1,589,946

See accompanying notes to unaudited consolidated financial statements

BANCORP RHODE ISLAND, INC.

		Three Months Ended
		March 31,
		2010				2009
		(In thousands, except per share data)
Interest and dividend income:
Overnight investments		$	5			$	9
Mortgage-backed securities			3,229				3,403
Investment securities			550				451
Loans and leases			14,568				14,697
Total interest and dividend income			18,352				18,560
Interest expense:
Deposits			2,278				4,494
Overnight and short-term borrowings			18				27
Wholesale repurchase agreements			139				133
Federal Home Loan Bank of Boston borrowings			2,665				2,625
Subordinated deferrable interest debentures			164				199
Total interest expense			5,264				7,478
Net interest income			13,088				11,082
Provision for loan and lease losses			1,600				1,610
Net interest income after provision for loan and lease losses			11,488				9,472
Noninterest income:
Total other-than-temporary impairment losses on available for sale securities			(1,592	)			—
Non-credit component of other-than-temporary losses recognized in other comprehensive income			1,021				—
Credit component of other-than-temporary impairment losses on available for sale securities			(571	)			—
Service charges on deposit accounts			1,264				1,210
Gain on sale of available for sale securities			475				61
Income from bank-owned life insurance			315				289
Commissions on nondeposit investment products			237				156
Loan related fees			189				399
Net gains on lease sales and commissions on loans originated for others			36				29
Other income			370				213
Total noninterest income			2,315				2,357
Noninterest expense:
Salaries and employee benefits			5,843				5,153
Occupancy			861				956
Data processing			654				620
Professional services			632				698
FDIC insurance			475				387
Loan workout and other real estate owned			336				128
Marketing			258				315
Equipment			255				241
Loan servicing			176				159
Other expenses			998				966
Total noninterest expense			10,488				9,623
Income before income taxes			3,315				2,206
Income tax expense			1,096				743
Net income			2,219				1,463
Preferred stock dividends			—				(375	)
Prepayment charges and accretion of preferred stock discount			—				(61	)
Net income applicable to common shares		$	2,219			$	1,027
Per share data:
Basic earnings per common share		$	0.48			$	0.22
Diluted earnings per common share		$	0.48			$	0.22
Cash dividends declared per common share		$	0.17			$	0.17
Weighted average common shares outstanding — basic			4,622				4,590
Weighted average common shares outstanding — diluted			4,650				4,610

See accompanying notes to unaudited consolidated financial statements

BANCORP RHODE ISLAND, INC.

																						Accumulated
																						Other
										Additional												Comprehensive
		Preferred				Common				Paid-in				Treasury				Retained				Income
Three months ended March 31,		Stock				Stock				Capital				Stock				Earnings				(Loss)				Total
		(In thousands, except per share data)
2009
Balance at December 31, 2008		$	28,595			$	49			$	73,323			$	(12,055	)		$	58,763			$	415			$	149,090
Net income			—				—				—				—				1,463				—				1,463
Other comprehensive income:
Unrealized holding gains on securities available for sale, net of taxes of $(370)			—				—				—				—				—				688				688
Reclassification adjustment for net gains included in net income, net of taxes of $21			—				—				—				—				—				(40	)			(40	)
Total comprehensive income			—				—				—				—				—				—				2,111
Exercise of stock options			—				1				412				—				—				—				413
Macrolease acquisition			—				—				78				—				—				—				78
Share repurchases			—				—				—				(254	)			—				—				(254	)
Share-based compensation			—				—				77				—				—				—				77
Tax benefit from exercise of stock options			—				—				88				—				—				—				88
Preferred stock discount accretion			61				—				—				—				(61	)			—				—
Dividends on preferred stock ($12.50 per preferred share)			—				—				—				—				(375	)			—				(375	)
Dividends on common stock ($0.17 per common share)			—				—				—				—				(781	)			—				(781	)
Balance at March 31, 2009		$	28,656			$	50			$	73,978			$	(12,309	)		$	59,009			$	1,063			$	150,447
2010
Balance at December 31, 2009		$	—			$	50			$	72,783			$	(12,309	)		$	59,012			$	1,125			$	120,661
Net income			—				—				—				—				2,219				—				2,219
Other comprehensive income:
Unrealized holding gains on securities available for sale, net of taxes of $(1,213)			—				—				—				—				—				2,252				2,252
Reclassification adjustment for net gains included in net income, net of taxes of $166			—				—				—				—				—				(309	)			(309	)
Non-credit portion OTTI, net of taxes of $358			—				—				—				—				—				(663	)			(663	)
Total comprehensive income			—				—				—				—				—				—				3,499
Exercise of stock options			—				—				220				—				—				—				220
Macrolease acquisition			—				—				211				—				—				—				211
Share repurchases			—				—				—				(218	)			—				—				(218	)
Share-based compensation			—				—				92				—				—				—				92
Dividends on common stock ($0.17 per common share)			—				—				—				—				(786	)			—				(786	)
Balance at March 31, 2010		$	—			$	50			$	73,306			$	(12,527	)		$	60,445			$	2,405			$	123,679

See accompanying notes to unaudited consolidated financial statements

BANCORP RHODE ISLAND, INC.

		Three Months Ended
		March 31,
		2010				2009
		(In thousands)
Cash flows from operating activities:
Net income		$	2,219			$	1,463
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation, amortization and accretion, net			(1,444	)			(1,367	)
Provision for loan and lease losses			1,600				1,610
Income from bank-owned life insurance			(315	)			(289	)
Share-based compensation expense			92				77
Net gains on lease sales			(17	)			(22	)
Gain on sale of available for sale securities			(475	)			(61	)
Credit component of other-than-temporary impairment losses on available for sale securities			571				—
Loss (gain) on sale of other real estate owned			56				(17	)
Proceeds from sales of leases			907				1,122
Leases originated for sale			(890	)			(944	)
Decrease in accrued interest receivable			101				406
Decrease (increase) in prepaid expenses and other assets			146				(444	)
Decrease in other liabilities			(5,372	)			(593	)
Net cash (used in) provided by operating activities			(2,821	)			941
Cash flows from investing activities:
Available for sale securities:
Purchases			(31,313	)			(76,520	)
Maturities and principal repayments			41,081				50,411
Proceeds from sales			3,311				1,880
Net increase in loans and leases			(12,368	)			(26,964	)
Capital expenditures for premises and equipment			(210	)			(135	)
Proceeds from sale of other real estate owned			345				332
Net cash provided by (used in) investing activities			846				(50,996	)
Cash flows from financing activities:
Net increase in deposits			8,787				13,669
Net decrease in overnight and short-term borrowings			(2,320	)			(13,936	)
Proceeds from long-term borrowings			33,700				15,190
Repayment of long-term borrowings			(40,793	)			(752	)
Exercise of stock options			220				413
Repurchase of common stock			(218	)			(254	)
Tax benefit from exercise of stock options			—				88
Dividends on preferred stock			—				(375	)
Dividends on common stock			(786	)			(781	)
Net cash (used in) provided by financing activities			(1,410	)			13,262
Net decrease in cash and cash equivalents			(3,385	)			(36,793	)
Cash and cash equivalents at beginning of period			20,830				55,457
Cash and cash equivalents at end of period		$	17,445			$	18,664
Supplementary Disclosures:
Cash paid for interest		$	5,749			$	7,598
Cash paid for income taxes			43				167
Non-cash investing and financing transactions:
Change in accumulated other comprehensive income, net of taxes			1,943				648
Sale (purchase) of available for sale securities not yet settled			5,467				(5,000	)
Macrolease acquisition			23				78
Transfer of loans to other real estate owned			724				—
Non-credit component of other-than-temporary impairment, net of taxes			663				155

See accompanying notes to unaudited consolidated financial statements

BANCORP RHODE ISLAND, INC.

(1) Basis of Presentation

Bancorp Rhode Island, Inc. (the “Company”), a Rhode Island corporation, is the holding company for Bank Rhode Island (the “Bank”). The Company has no significant assets other than the common stock of the Bank. For this reason, substantially all of the discussion in this Quarterly Report on Form 10-Q relates to the operations of the Bank and its subsidiaries.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. These estimates and assumptions are based on management’s estimates and judgment and are evaluated on an ongoing basis using historical experiences and other factors, including the current economic environment. Estimates and assumptions are adjusted when facts and circumstances dictate. A recessionary environment, illiquid credit markets and declines in consumer spending have combined to increase the uncertainty inherent in management’s estimates and assumptions. As future events cannot be determined with precision, actual results could differ significantly from management’s estimates. Material estimates that are particularly susceptible to change relate to the determination of the allowance for loan and lease losses, evaluation of investments for other-than-temporary impairment, review of goodwill for impairment and income taxes.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Bank Rhode Island, along with the Bank’s wholly-owned subsidiaries, BRI Investment Corp. (a Rhode Island passive investment company), Macrolease Corporation (an equipment leasing company), Acorn Insurance Agency, Inc. (a licensed insurance agency) and BRI Realty Corp. (a real estate holding company). All significant intercompany accounts and transactions have been eliminated in consolidation.

The unaudited interim consolidated financial statements of the Company conform to U.S. generally accepted accounting principles and prevailing practices within the banking industry and include all necessary adjustments (consisting of only normal recurring adjustments) that, in the opinion of management, are required for a fair presentation of the results and financial condition of the Company. Prior period amounts are reclassified whenever necessary to conform to the current year classifications.

The Company considers events or transactions that occur after the balance sheet date but before the consolidated financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated through the date of the issuance of these consolidated financial statements.

The unaudited interim results of consolidated operations are not necessarily indicative of the results for any future interim period or for the entire year. These interim consolidated financial statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the annual consolidated financial statements and accompanying notes included in the Company’s 2009 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”).

(2) Earnings Per Share

Basic earnings per share (“EPS”) exclude dilution and are computed by dividing net income available to common shareholders by the weighted average number of common shares and participating securities outstanding during 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 additional common stock that then share in the earnings of the Company.

(3) Recently Adopted Accounting Pronouncements

The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 860, “Transfers and Servicing,” incorporates former Statements of Financial Accounting Standards (“SFAS”) No. 166, “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140,” which was issued in June 2009. These provisions of ASC 860 eliminate the concept of a “qualifying special-purpose entity” (“QSPE”), create more stringent conditions for reporting a transfer of a portion of financial assets as a sale, clarify other sale-accounting criteria and change the initial measurement of a transferor’s interest in transferred financial assets. These provisions of ASC 860 also require enhanced interim and year-end disclosures about a transferor’s continuing involvement with transfers of financial assets accounted for as sales, the risks inherent in the transferred financial assets that have been retained and the nature and financial effect of restrictions on the transferor’s assets that continue to be reported in the balance sheet. The adoption of these provisions of ASC 860 on January 1, 2010 did not have a material impact on the Company’s consolidated financial statements.

ASC 810, “Consolidations,” incorporates former SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” which was issued in June 2009. These provisions of ASC 810 address the effects of eliminating the QSPE concept, changes the approach to determining the primary beneficiary of a variable interest entity (“VIE”) and requires companies to assess more frequently whether a VIE must be consolidated. These provisions also require enhanced interim and year-end disclosures about the significant judgments and assumptions considered in determining whether a VIE must be consolidated, the nature of restrictions on a consolidated VIE’s assets, the risks associated with a company’s involvement with a VIE and how that involvement affects the company’s financial position, financial performance and cash flows. The adoption of these provisions of ASC 810 on January 1, 2010 did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Instruments.” ASU No. 2010-06 amends ASC 820 to require additional disclosures regarding fair value measurements. Specifically, the ASU requires entities to disclose the amounts and reasons for significant transfers between Level 1 and Level 2 of the fair value hierarchy, to disclose reasons for any transfers in or out of Level 3 and to separately disclose information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements. In addition, the ASU also amends ASC 820 to clarify certain existing disclosure requirements. Except for the requirement to disclose information about purchases, sales, issuances and settlements in the reconciliation of recurring Level 3 measurements separately, the amendments to ASC 820 made by ASU No. 2010-06 are effective for interim and annual reporting periods beginning after December 15, 2009. The adoption of these provisions of ASU No. 2010-06 did not have a material impact on the Company’s consolidated financial statements. The requirement to separately disclose purchases, sales, issuances and settlements of recurring Level 3 measurements is effective for interim and annual reporting periods beginning after December 15, 2010. The Company does not expect the adoption of the remaining provisions of this ASU to have a material impact on the Company’s consolidated financial statements.

(4) Available for Sale Securities

The Company categorizes available for sale securities by major category. Major categories are determined by the nature and risks of the securities and consider, among other things, the issuing entity, type of investment and underlying collateral. The Company categorizes securities issued by the Federal Home Loan Bank, Federal Home Loan Mortgage Corporation, Federal National Mortgage Association and Federal Farm Credit Banks Funding Corporation as government-sponsored enterprise (“GSE”) securities.

A summary of available for sale securities by major categories follows:

		Amortized				Unrealized								Fair
		Cost (1)				Gains				Losses				Value
		(In thousands)
At March 31, 2010:
GSE obligations		$	83,348			$	326			$	(182	)		$	83,492
Trust preferred collateralized debt obligations			1,979				—				(1,446	)			533
Collateralized mortgage obligations			40,977				692				(2,116	)			39,553
GSE mortgage-backed securities			235,106				6,766				(340	)			241,532
Total		$	361,410			$	7,784			$	(4,084	)		$	365,110
At December 31, 2009:
GSE obligations		$	80,866			$	347			$	(287	)		$	80,926
Trust preferred collateralized debt obligations			2,550				—				(2,085	)			465
Collateralized mortgage obligations			45,641				697				(2,311	)			44,027
GSE mortgage-backed securities			251,051				6,353				(983	)			256,421
Total		$	380,108			$	7,397			$	(5,666	)		$	381,839

The following table sets forth certain information regarding temporarily impaired investment securities:

		Less than One Year								One Year or Longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
		(In thousands)
At March 31, 2010:
GSE obligations		$	32,178			$	(182	)		$	—			$	—			$	32,178			$	(182	)
Trust preferred collateralized debt obligations			—				—				533				(1,446	)			533				(1,446	)
Collateralized mortgage obligations			1,349				(26	)			11,397				(2,090	)			12,746				(2,116	)
GSE mortgage-backed securities			43,484				(340	)			—				—				43,484				(340	)
Total		$	77,011			$	(548	)		$	11,930			$	(3,536	)		$	88,941			$	(4,084	)
At December 31, 2009:
GSE obligations		$	37,081			$	(287	)		$	—			$	—			$	37,081			$	(287	)
Trust preferred collateralized debt obligations			—				—				465				(2,085	)			465				(2,085	)
Collateralized mortgage obligations			5,520				(182	)			12,088				(2,129	)			17,608				(2,311	)
GSE mortgage-backed securities			69,310				(982	)			140				(1	)			69,450				(983	)
Total		$	111,911			$	(1,451	)		$	12,693			$	(4,215	)		$	124,604			$	(5,666	)

The following table sets for the maturities of available for sale securities:

		After One, But								After Five, But
		Within Five Years								Within Ten Years								After Ten Years
		Amortized				Fair				Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value				Cost				Value
		(In thousands)
At March 31, 2010:
GSE obligations		$	53,385			$	53,672			$	29,963			$	29,820			$	—			$	—
Trust preferred collateralized debt obligations			—				—				—				—				1,979				533
Collateralized mortgage obligations			—				—				20,953				21,296				20,024				18,257
GSE mortgage-backed securities			1,421				1,475				22,078				23,259				211,607				216,798
Total		$	54,806			$	55,147			$	72,994			$	74,375			$	233,610			$	235,588
At December 31, 2009:
GSE obligations		$	75,866			$	76,013			$	5,000			$	4,913			$	—			$	—
Trust preferred collateralized debt obligations			—				—				—				—				2,550				465
Collateralized mortgage obligations			—				—				23,156				22,957				22,485				21,070
GSE mortgage-backed securities			1,548				1,604				23,589				24,624				225,914				230,193
Total		$	77,414			$	77,617			$	51,745			$	52,494			$	250,949			$	251,728

At March 31, 2010 and December 31, 2009, respectively, $256.6 million and $271.5 million of available for sale securities were pledged as collateral for repurchase agreements, municipal deposits, treasury, tax and loan deposits, swap agreements, current and future Federal Home Loan Bank of Boston (“FHLB”) borrowings and future Federal Reserve “discount window” borrowings.

The Company performs regular analysis on the available for sale securities portfolio to determine whether a decline in fair value indicates that an investment is other-than-temporarily impaired. In making these other-than-temporary determinations, management considers, among other factors, the length of time and extent to which the fair value has been less than amortized cost, projected future cash flows, credit subordination and the creditworthiness, capital adequacy and near-term prospects of the issuers. Management also considers the Company’s capital adequacy, interest rate risk, liquidity and business plans in assessing whether it is more likely than not that the Company will sell or be required to sell the securities before recovery.

If the Company determines that a decline in fair value is other-than-temporary and that it is more likely than not that the Company will not sell or be required to sell the security before recovery of its amortized cost, the credit portion of the impairment loss is recognized in earnings and the noncredit portion is recognized in accumulated other comprehensive income. The credit portion of the other-than-temporary impairment represents the difference between the amortized cost and the present value of the expected future cash flows of the security. If the Company determines that a decline in fair value is other-than-temporary and it will more likely than not sell or be required to sell the security before recovery of its amortized cost, the entire difference between the amortized cost and the fair value of the security will be recognized in earnings.

In performing the analysis for the two collateralized debt obligations (“CDO A” and “CDO B”) held by the Company, which are backed by pools of trust preferred securities, future cash flow scenarios for each security were estimated based on varying levels of severity for assumptions of future delinquencies, recoveries and prepayments. These estimated cash flow scenarios were used to determine whether the Company expects to recover the amortized cost basis of the securities. Projected credit losses were compared to the current level of credit enhancement to assess whether the security is expected to incur losses in any future period and therefore become other-than-temporarily impaired.

CDO A has not experienced additional deferred/defaulted collateral from the time when management performed its December 31, 2009 other-than-temporary impairment analysis of the security. In addition, the Company continues to receive interest payments due. To date, CDO A has experienced $69.0 million, or 24.9%, in deferrals/defaults of its underlying collateral. Projected credit loss severity assumptions were increased in estimated future cash flow scenarios and it was determined that management expects to recover the security’s amortized cost. The Company has previously recorded credit related other-than-temporary impairment losses totaling $271,000.

During the first quarter of 2010, CDO B experienced an additional $20.0 million in deferred/defaulted collateral, totaling $159.0 million, or 27.4%, of the security’s underlying collateral. In addition, the Company has not received its scheduled quarterly interest payments for the past three quarters because the security is adding interest to the principal rather than paying out. Projected credit loss severity assumptions were increased in estimated future cash flow scenarios and it was determined that management does not expect to recover an additional $571,000 of the security’s amortized cost. The Company recorded other-than-temporary impairment charges totaling $1.6 million, representing the difference between the security’s fair value and book value. The portion deemed to be credit related of $571,000 has been recorded as a reduction to noninterest income, while the non-credit portion of $1.0 million has been recorded as a reduction of other comprehensive income. Through March 31, 2010, credit related other-than-temporary impairment losses on this security total $684,000.

The following table provides a reconciliation of the beginning and ending balances for credit losses on debt securities for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:

		Credit Component of Other-Than-
		Temporary Impairment Losses For Which
		a Portion Was Recognized in Other
		Comprehensive Income
(In thousands)		2010				2009
Balance, January 1		$	(384	)		$	—
Credit losses for which an other-than-temporary impairment was previously recognized			(571	)			—
Balance, March 31		$	(955	)		$	—

The decline in fair value of the remaining available for sale securities in an unrealized loss position (comprised of 22 available for sale securities totaling $2.6 million in unrealized losses) is due to the continued illiquidity and uncertainty of the securities markets. Management believes that it will recover the amortized cost basis of the securities and that it is more likely than not that it will not sell the securities before recovery. As such, management has determined that the securities are not other-than-temporarily impaired as of March 31, 2010. If market conditions for securities worsen or the creditworthiness of the underlying issuers deteriorates, it is possible that the Company may recognize additional other-than-temporary impairments in future periods.

(5) Derivatives

All derivatives are recognized as either assets or liabilities on the balance sheet and are measured at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and resulting designation. Derivatives used to hedge the exposure to changes in 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 used to hedge the exposure to variability in expected cash flows or other types of forecasted transactions are considered cash flow hedges. For derivatives designated as fair value hedges, changes in the fair value of the derivative are recognized in earnings together with the changes in the fair value of the related hedged item. The net amount, if any, representing hedge ineffectiveness, is reflected in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is recorded in other comprehensive income and recognized in earnings when the hedged transaction affects earnings. The ineffective portion of changes in the fair value of cash flow hedges is recognized directly in earnings. For derivatives not designated as hedges, changes in fair value are recognized in earnings, in noninterest income. The Company may use interest rate contracts (swaps, caps and floors) as part of interest rate risk management strategy. Interest rate swap, cap and floor agreements are entered into as hedges against future interest rate fluctuations on specifically identified assets or liabilities. The Company did not have derivative fair value or derivative cash flow hedges at March 31, 2010 or December 31, 2009.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets as of March 31, 2010 and December 31, 2009:

		Asset Derivatives												Liability Derivatives
						As of				As of								As of				As of
		Balance				March 31,				December 31,				Balance				March 31,				December 31,
		Sheet				2010				2009				Sheet				2010				2009
(In thousands)		Location				Fair Value								Location				Fair Value
Derivatives not designated as hedging instruments
Interest rate products		Other assets				$	464			$	391			Other liabilities				$	467			$	426
Total derivatives not designated as hedging instruments						$	464			$	391							$	467			$	426

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers for a fee. The Company executes interest rate swaps with commercial banking customers to aid them in managing their interest rate risk. The interest rate swap contracts allow the commercial banking customers to convert floating rate loan payments to fixed rate loan payments. The Company concurrently enters into mirroring swaps with a third party financial institution, effectively minimizing its net risk exposure resulting from such transactions. The third party financial institution exchanges the customer’s fixed rate loan payments for floating rate loan payments.

As the interest rate swaps associated with this program do not meet hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of March 31, 2010, the Company had ten interest rate swaps with an aggregate notional amount of $35.4 million related to this program. During the three months ended March 31, 2010 and 2009, the Company recognized net gains of $32,000 and net losses of $63,000 respectively, related to changes in the fair value of these swaps.

The table below presents the effect of the Company’s derivative financial instruments on the consolidated income statements for the three months ended March 31, 2010 and 2009:

						Amount of Gain Recognized in Income on
		Location of Gain or (Loss)				Derivative(1)
Derivatives Not Designated as		Recognized in Income on				Three Months Ended March 31,
Hedging Instruments		Derivative				2010				2009
						(In thousands)
Interest Rate Products		Loan related fees				$	32			$	253
Total						$	32			$	253

By using derivative financial instruments, the Company exposes itself to credit risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk for the Company. When the fair value of a derivative is negative, the Company owes the counterparty and, therefore, it does not possess credit risk. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that management believes to be creditworthy and by limiting the amount of exposure to each counterparty. At March 31, 2010, the Company does not expect future nonperformance by counterparties.

Certain of the derivative agreements contain provisions that require the Company to post collateral if the derivative exposure exceeds a threshold amount. As of March 31, 2010, the Company has posted collateral of $406,000 in the normal course of business.

The Company has agreements with certain of its derivative counterparties that contain credit-risk-related contingent provisions. These provisions provide the counterparty with the right to terminate its derivative positions and require the Company to settle its obligations under the agreements if the Company defaults on certain of its indebtedness or if the Company fails to maintain its status as a well-capitalized institution. As of March 31, 2010, the Company had no derivative agreements in a net liability position, excluding fair value adjustments for credit risk.

(6) Fair Value of Financial Instruments

ASC 820, “Fair Value Measurements and Disclosures,” defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities. Market participants are buyers and sellers in the principal market that are independent, knowledgeable, able to transact and willing to transact.

ASC 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about what assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. A fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs is included in ASC 820. The fair value hierarchy is as follows:

Level 1: Inputs are unadjusted quoted prices in active markets for assets or liabilities identical to those reported at fair value.

Level 2: Inputs other than quoted prices included within Level 1, Level 2 inputs are observable either directly or indirectly. These inputs include quoted prices in active or not active markets or inputs derived from or corroborated by observable market data.

Level 3: Inputs are unobservable inputs for an asset or liability. These inputs are used to determine fair value only when observable inputs are not available.

The following tables summarize the financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2010 and December 31, 2009, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

						Fair Value Measurements at March 31, 2010 Using
						Quoted Prices in				Significant				Significant
						Active Markets				Other				Other
						for Identical				Observable				Unobservable
						Assets				Inputs				Inputs
(In thousands)		Total				(Level 1)				(Level 2)				(Level 3)
GSE obligations		$	83,492			$	—			$	83,492			$	—
Trust preferred CDOs			533				—				533				—
Collateralized mortgage obligations			39,553				—				39,553				—
GSE mortgage-backed securities			241,532				—				241,532				—
Total available for sale securities			365,110				—				365,110				—
Interest rate swap assets			464				—				464				—
Interest rate swap liabilities			467				—				467				—

						Fair Value Measurements at December 31, 2009 Using
						Quoted Prices in				Significant				Significant
						Active Markets				Other				Other
						for Identical				Observable				Unobservable
						Assets				Inputs				Inputs
(In thousands)		Total				(Level 1)				(Level 2)				(Level 3)
GSE obligations		$	80,926			$	—			$	80,926			$	—
Trust preferred CDOs			465				—				465				—
Collateralized mortgage obligations			44,027				—				44,027				—
GSE mortgage-backed securities			256,421				—				256,421				—
Total available for sale securities			381,839				—				381,839				—
Interest rate swap assets			391				—				391				—
Interest rate swap liabilities			426				—				426				—

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Financial assets and financial liabilities measured at fair value on a recurring basis include the following:

Available for sale securities are reported at fair value primarily utilizing Level 2 inputs. The Company obtains fair value measurements from independent pricing sources, which base their fair value measurements upon observable inputs such as reported trades of comparable securities, broker quotes, the U.S. Treasury (“the Treasury”) yield curve, benchmark interest rates, market spread relationships, historic and consensus prepayment rates, credit information and the security’s terms and conditions.

The Company used significant unobservable inputs (Level 3) to value two of its available for sale securities at March 31, 2009. Each of these securities is a collateralized debt obligation backed by trust preferred securities. At the time of the valuation, there was limited trading in these and comparable securities due to recent economic conditions and observable pricing was difficult to obtain. At March 31, 2009, the Company obtained valuations from four sources, including broker quotes and cash flow scenario analyses. The fair values obtained were assigned a weighting that was dependent upon the methods used to calculate the prices. Cash flow scenarios (Level 3) were given more weight than broker quotes (Level 2) because the broker quotes were believed to be based on distressed sales, evidenced by the inactive market. The weighting was then used to determine an overall fair value of the securities.

At March 31, 2010, management reviewed the fair values provided by the same pricing sources as used in the previous reporting periods. Based on management’s understanding of the methods employed, three of the four sources were excluded from the valuation process. These sources were excluded because either the assumptions used were inappropriate or because of the uncertainty surrounding the methodology in determining the fair values, including a previous source of cash flow scenario analyses that adopted the fair value methodology of a previously excluded source. As a result, broker quotes (Level 2) were used to determine the fair value of these securities. The broker quotes given for the securities were based on executed trades of similar collateral structure and performance. Although limited trades occurred, they were likely orderly transactions when considering the number of potential buyers the transactions were marketed to and the intention by the sellers to maximize their proceeds. The cash flow scenario analyses considered varying default, recovery and prepayment assumptions discounted at a rate representative of yields available for similar investments adjusted for credit risk. Management believes that the broker quotes are the best representation of the price that would be obtained for these particular securities in an orderly transaction under current market conditions.

The fair values for the interest rate swap assets and liabilities represent a Level 2 valuation and are based on settlement values adjusted for credit risks associated with the counterparties and the Company. Credit risk adjustments consider factors such as the likelihood of default by the Company and its counterparties, its net exposures and remaining contractual life. To date, the Company has not realized any losses due to a counterparty’s inability to pay any net uncollateralized position. The change in value of interest rate swap assets and liabilities attributable to credit risk was not significant during the reported periods. See also Note 5 — Derivatives.

The following tables show a reconciliation of the beginning and ending balances for fair value measurements using significant unobservable inputs:

		Fair Value Measurements Using Significant
		Unobservable Inputs
(In thousands)		2010				2009
		Trust preferred collateralized debt obligations
Balance, January 1		$	—			$	1,480
Increase in unrealized holding losses			—				(760	)
Other-than-temporary impairment			—				—
Transfers to Level 2			—				—
Transfers to Level 3			—				—
Balance, March 31		$	—			$	720

Transfers between Level 1, Level 2 and Level 3 of the fair value hierarchy are recognized based on the valuation method used at the end of each reporting period. There were no transfers of financial assets or liabilities between Level 1, Level 2 or Level 3 during the three months ended March 31, 2010 or 2009.

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

The following tables summarize the financial assets and financial liabilities measured at fair value on a nonrecurring basis as of and for the three months ended March 31, 2010 and March 31, 2009, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

Fair Value Measurements at March 31, 2010 Using

Quoted Prices in

Significant

Significant

Active Markets

Other

Other

for Identical

Observable

Unobservable

Assets

Inputs

Inputs

(In thousands)

Total

(Level 1)

(Level 2)

(Level 3)

Collateral-dependent loans and leases

$

2,586

$

—

$

2,586

$

—

Other real estate owned

724

—

724

—

Fair Value Measurements at March 31, 2009 Using

Quoted Prices in

Significant

Significant

Active Markets

Other

Other

for Identical

Observable

Unobservable

Assets

Inputs

Inputs

(In thousands)

Total

(Level 1)

(Level 2)

(Level 3)

Collateral-dependent loans and leases

$

3,441

$

—

$

3,441

$

—

Other real estate owned

155

—

155

—

Impaired loans and leases were $8.6 million on March 31, 2010. Impaired loans and leases that are deemed collateral dependent are valued based upon the fair value of the underlying collateral. The inputs used in the appraisal of the collateral are observable and, therefore, categorized as Level 2. On March 31, 2010, the valuation allowance for collateral-dependent loans and leases was $1.2 million. The valuation allowance decreased by $700,000 during the first three months of 2010 from $1.9 million at December 31, 2009.

The aggregate fair value of financial assets and financial liabilities presented do not represent the underlying value of the Company taken as a whole. The fair value estimates provided are made at a specific point in time, based on relevant market information and the characteristics of the financial instrument. The estimates do not provide for any premiums or discounts that could result from concentrations of ownership of a financial instrument. Because no active market exists for some of the Company’s financial instruments, certain fair value estimates are based on subjective judgments regarding current economic conditions, risk characteristics of the financial instruments, future expected loss experience, prepayment assumptions and other factors. The resulting estimates involve uncertainties and therefore cannot be determined with precision. Changes made to any of the underlying assumptions could significantly affect the estimates. The estimated fair value approximates the carrying value for cash and cash equivalents, overnight investments and accrued interest receivable and payable. The methodologies for other financial assets and financial liabilities are discussed below:

Loans and leases receivable — Fair value estimates are based on loans and leases with similar financial characteristics. Loans and leases have been segregated by homogenous groups into residential mortgage, commercial, and consumer and other loans. Fair values are estimated by discounting contractual cash flows, adjusted for prepayment estimates, using discount rates approximately equal to current market rates on loans with similar characteristics and maturities. The incremental credit risk for nonperforming loans has been considered in the determination of the fair value of loans.

Stock in the Federal Home Loan Bank of Boston — The fair value of stock in the FHLB equals the carrying value reported in the balance sheet. This stock is redeemable at full par value only by the FHLB. The nation’s Federal Home Loan Bank System (the “FHLB System”) is under stress due to deterioration in the financial markets, particularly in relation to valuation of mortgage securities. Several Federal Home Loan Banks have announced impairment charges of these and other assets and as such their capital positions have deteriorated to the point that several have suspended or reduced their dividends, or eliminated the ability of members to redeem capital stock. These institutions obtain their funding primarily through issuance of consolidated obligations of the FHLB System. The U.S. Government does not guarantee these obligations and each of the 12 Federal Home Loan Banks is generally jointly and severally liable for repayment of each other’s debt. We are a member of the FHLB-Boston which in February 2009 announced that, while it meets all of its regulatory capital requirements, it has suspended its quarterly dividend and will continue its moratorium on excess stock repurchase. The FHLB — Boston is currently operating with retained earnings below its targeted level. Should financial conditions continue to weaken, the FHLB System (including FHLB-Boston) in the future may have to curtail advances to member institutions like us. Should the FHLB System deteriorate to the point of not being able to fund future advances to banks, including the Bank, this would place increased pressure on other wholesale funding sources. Furthermore, we are required to invest in FHLB stock in order to borrow from the FHLB System and our investment in the FHLB — Boston could be adversely impacted if the financial health of the FHLB System worsens.

Deposits — The fair values reported for demand deposit, NOW, money market, and savings accounts are equal to their respective book values reported on the balance sheet. The fair values disclosed are, by definition, equal to the amount payable on demand at the reporting date. The fair values reported for certificate of deposit accounts are based on the discounted value of contractual cash flows. The discount rates used are representative of approximate rates currently offered on certificate of deposit accounts with similar remaining maturities. The estimated fair value of deposits does not take into account the value of the Company’s long-term relationships with depositors. Nonetheless, the Company would likely realize a core deposit premium if its deposit portfolio was sold in the principal market for such deposits.

Wholesale repurchase agreements — The fair values reported for wholesale repurchase agreements are based on the discounted value of contractual cash flows. The discount rates used are representative of approximate rates currently offered on borrowings with similar characteristics and maturities.

Federal Home Loan Bank of Boston borrowings — The fair values reported for FHLB borrowings are based on the discounted value of contractual cash flows. The discount rates used are representative of approximate rates currently offered on borrowings with similar characteristics and maturities.

Subordinated deferrable interest debentures — The fair values reported for subordinated deferrable interest debentures are based on the discounted value of contractual cash flows. The discount rates used are representative of approximate rates currently offered on instruments with similar terms and maturities.

Financial instruments with off-balance sheet risk — Since the Bank’s commitments to originate or purchase loans, and for unused lines and outstanding letters of credit, are primarily at market interest rates, there is no significant fair value adjustment.

The book values and estimated fair values for the Company’s financial instruments are as follows:

		March 31, 2010								December 31, 2009
		Book				Estimated				Book				Estimated
		Value				Fair Value				Value				Fair Value
		(In thousands)
Assets:
Cash and due from banks		$	16,845			$	16,845			$	18,866			$	18,866
Overnight investments			600				600				1,964				1,964
Available for sale securities			365,110				365,110				381,839				381,839
Stock in the FHLB			16,274				16,274				16,274				16,274
Loans and leases receivable, net of allowance for loan and lease losses:
Commercial loans and leases			738,973				747,864				718,943				725,967
Residential mortgage loans			168,404				172,152				171,842				175,816
Consumer and other loans			199,836				195,324				204,526				197,137
Interest rate swaps			464				464				391				391
Accrued interest receivable			4,863				4,863				4,964				4,964
Liabilities:
Deposits:
Demand deposit accounts		$	203,193			$	203,193			$	204,281			$	204,281
NOW accounts			68,724				68,724				74,558				74,558
Money market accounts			78,824				78,824				65,076				65,076
Savings accounts			378,228				378,228				367,225				367,225
Certificate of deposit accounts			378,102				380,692				387,144				390,210
Overnight and short-term borrowings			37,851				37,851				40,171				40,171
Wholesale repurchase agreements			20,000				20,357				20,000				20,432
FHLB borrowings			270,090				293,556				277,183				301,210
Subordinated deferrable interest debentures			13,403				15,617				13,403				15,440
Interest rate swaps			467				467				426				426
Accrued interest payable			1,637				1,637				2,122				2,122