U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act
of 1934 for the quarter ended September 30, 2003
------------------
Commission File Number: 0-25251
-------
CENTRAL BANCORP, INC.
--------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
MASSACHUSETTS
-------------------------------------------------------------
(State or Other Jurisdiction of Incorporation or Organization)
I.R.S. Employer Identification No. 04-3447594
399 HIGHLAND AVENUE, SOMERVILLE, MASSACHUSETTS 02144
----------------------------------------------------
(Address of Principal Executive Offices)
(617) 628-4000
-----------------------------
Registrant's Telephone Number
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 such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Common Stock, $1.00 par value 1,664,957
----------------------------- --------------------------------
Class Outstanding at November 13, 2003
CENTRAL BANCORP, INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
--------
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Condition
at September 30, 2003 and March 31, 2003 1
Consolidated Statements of Income for the three
and six months ended September 30, 2003 and 2002 2
Consolidated Statements of Changes in Stockholders'
Equity for the six months ended September 30,
2003 and 2002 3
Consolidated Statements of Cash Flows for the
six months ended September 30, 2003 and 2002 4
Notes to Unaudited Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Liquidity and Capital Resources 13
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 14
Item 4. Controls and Procedures 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES AND CERTIFICATIONS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CENTRAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
September 30, March 31,
(Dollars in Thousands) 2003 2003
- ----------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 5,525 $ 5,996
Short-term investments 46,753 5,226
----------- -----------
Cash and cash equivalents 52,278 11,222
----------- -----------
Investment securities available for sale (amortized cost of $55,106
at September 30, 2003 and $59,500 at March 31, 2003) 58,278 61,111
Stock in Federal Home Loan Bank of Boston, at cost 8,300 8,300
The Co-operative Central Bank Reserve Fund 1,576 1,576
----------- -----------
Total investments 68,154 70,987
----------- -----------
Loans held for sale 4,152 647
Loans (Note 2) 349,974 389,817
Less allowance for loan losses 3,389 3,284
----------- -----------
Net loans 346,585 386,533
----------- -----------
Accrued interest receivable 2,043 2,380
Banking premises and equipment, net 2,011 1,869
Deferred tax asset, net 214 719
Goodwill, net (Note 1) 2,232 2,232
Other assets 713 619
----------- -----------
Total assets $ 478,382 $ 477,208
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (Note 3) $ 284,515 $ 287,959
Federal Home Loan Bank advances 144,400 144,400
Short-term borrowings 27 176
Advance payments by borrowers for taxes and insurance 1,073 999
Accrued expenses and other liabilities 5,831 4,231
----------- -----------
Total liabilities 435,846 437,765
----------- -----------
Commitments and Contingencies (Note 5)
Stockholders' equity (Note 6):
Preferred stock $1.00 par value; authorized 5,000,000 shares;
none issued or outstanding -- --
Common stock $1.00 par value; authorized 15,000,000 shares;
2,028,427 shares issued at September 30, 2003 and
2,027,727 shares issued at March 31, 2003 2,028 2,028
Additional paid-in capital 12,816 12,751
Retained income 36,408 34,601
Treasury stock (365,294 shares at September 30, 2003 and
at March 31, 2003), at cost (7,266) (7,249)
Accumulated other comprehensive income (loss) (Note 4) 2,060 1,002
Unearned compensation - ESOP (3,510) (3,690)
----------- -----------
Total stockholders' equity 42,536 39,443
----------- -----------
Total liabilities and stockholders' equity $ 478,382 $ 477,208
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
1
CENTRAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended Six Months Ended
September 30, September 30,
------------------------------- ------------------------------
2003 2002 2003 2002
------ ------ ------ ------
Interest and dividend income:
Mortgage loans $ 5,793 $ 6,088 $ 11,814 $ 12,292
Other loans 104 147 248 293
Short-term investments 75 68 93 95
Investments 844 1,147 1,684 2,328
---------- --------- --------- --------
Total interest and dividend income 6,816 7,450 13,839 15,008
---------- --------- --------- --------
Interest expense:
Deposits 1,100 1,486 2,257 2,981
Advances from Federal Home Loan Bank of Boston 1,775 1,848 3,531 3,631
Short-term borrowings -- -- 1 --
---------- --------- --------- --------
Total interest expense 2,875 3,334 5,789 6,612
---------- --------- --------- --------
Net interest and dividend income 3,941 4,116 8,050 8,396
Provision for loan losses 50 -- 100 --
---------- --------- --------- --------
Net interest and dividend income after
provision for loan losses 3,891 4,116 7,950 8,396
---------- --------- --------- --------
Non-interest income:
Deposit service charges 157 133 318 262
Net losses from sales and write-downs
of investment securities (130) (221) (135) (210)
Gain on sales of loans 68 1 209 1
Other income 68 145 185 228
---------- --------- --------- --------
Total non-interest income 163 58 577 281
---------- --------- --------- --------
Non-interest expenses:
Salaries and employee benefits 1,723 1,653 3,523 3,291
Occupancy and equipment 270 288 540 569
Data processing service fees 265 255 546 546
Professional fees (Note 5) (117) 454 13 703
Advertising 126 115 247 182
Other expenses 489 367 890 732
---------- --------- --------- --------
Total non-interest expenses 2,756 3,132 5,759 6,023
---------- --------- --------- --------
Income before income taxes 1,298 1,042 2,768 2,654
Provision for income taxes (Note 5) 468 374 650 959
---------- --------- --------- --------
Net income $ 830 $ 668 $ 2,118 $ 1,695
========== ========= ========= ========
Earnings per common share - basic $ 0.54 $ 0.42 $ 1.37 $ 1.06
========== ========= ========= ========
Earnings per common share - diluted $ 0.53 $ 0.42 $ 1.36 $ 1.05
========== ========= ========= ========
Weighted average common shares outstanding - basic 1,549 1,585 1,547 1,592
Weighted average common and equivalent shares
outstanding - diluted 1,563 1,600 1,561 1,609
See accompanying notes to unaudited consolidated financial statements.
2
CENTRAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
Accumulated
Additional Other Unearned Total
Common Paid-In Retained Treasury Comprehensive Compensation Stockholders'
(In Thousands) Stock Capital Income Stock Income (Loss) ESOP Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended September 30, 2003
- -----------------------------------
Balance at March 31, 2003 $ 2,028 $ 12,751 $ 34,601 $ (7,249) $ 1,002 $ (3,690) $ 39,443
Net Income -- -- 2,118 -- -- -- 2,118
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- -- -- -- 1,058 -- 1,058
--------
Comprehensive income 3,176
--------
Proceeds from exercise of stock options -- 13 -- -- -- -- 13
Tax benefit of stock options -- 4 -- -- -- -- 4
Director deferred compensation
transactions -- 52 -- (48) -- -- 4
Dividends paid ($0.24 per share) -- -- (311) -- -- -- (311)
Amortization of unearned compensation -
ESOP -- 17 -- -- -- 180 197
Other Equity Transactions -- (21) -- 31 -- -- 10
--------- --------- ---------- -------- --------- -------- --------
Balance at September 30, 2003 $ 2,028 $ 12,816 $ 36,408 $ (7,266) $ 2,060 $ (3,510) $ 42,536
========= ========= ========== ======== ========= ======== ========
Six Months Ended September 30, 2002
- -----------------------------------
Balance at March 31, 2002 $ 2,000 $ 11,934 $ 33,141 $ (7,189) $ (626) (306) $ 38,954
Net Income -- -- 1,695 -- -- -- 1,695
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- -- -- -- 518 -- 518
--------
Comprehensive income 2,213
--------
Proceeds from exercise of stock options 25 449 -- -- -- -- 474
Tax benefit of stock options -- 55 -- -- -- -- 55
Purchase of shares by ESOP -- -- -- -- -- (2,123) (2,123)
Director deferred compensation
transactions -- 9 -- (15) -- -- (6)
Dividends paid ($0.20 per share) -- -- (330) -- -- -- (330)
Amortization of unearned compensation -
ESOP -- 126 -- -- -- 56 182
--------- --------- ---------- -------- --------- -------- --------
Balance at September 30, 2002 $ 2,025 $ 12,573 $ 34,506 $ (7,204) $ (108) $ (2,373) $ 39,419
========= ========= ========== ======== ========= ======== ========
See accompanying notes to unaudited consolidated financial statements.
3
CENTRAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
September 30,
--------------------------
(In thousands) 2003 2002
- ------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 2,118 $ 1,695
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization 154 157
Amortization of premiums 97 115
Provision for loan losses 100 --
Stock-based compensation 127 182
Net losses from sales and write-downs of
investment securities 135 210
Gain on sale of loans (209) --
Originations of loans held for sale (25,147) --
Proceeds from sales of loans originated for sale 21,851 --
(Increase) decrease in accrued interest receivable 337 (96)
Increase in other assets (94) (276)
Increase (decrease) in advance payments by borrowers for
taxes and insurance 74 (82)
Increase (decrease) in accrued expenses and other liabilities, net (1,313) (467)
----------- ----------
Net cash provided by (used in) operating activities (1,770) 1,438
----------- ----------
Cash flows from investing activities:
Net decrease in loans 39,843 1,866
Principal payments on mortgage-backed securities 2,684 3,142
Purchase of investment securities (3,000) (5,183)
Maturities and calls of investment securities 4,000 2,000
Proceeds from sales of investment securities 482 4,096
Increase in due to broker 3,000 --
Purchase of banking premises and equipment (296) (186)
----------- ----------
Net cash provided by investing activities 46,713 5,735
----------- ----------
Cash flows from financing activities:
Increase (decrease) in deposits (3,444) 14,541
Proceeds from advances from FHLB of Boston -- 24,000
Repayments on advances from FHLB of Boston -- (36,300)
Proceeds from exercise of stock options 13 474
Decrease in short-term borrowings (149) --
Purchase of shares by ESOP -- (2,123)
Dividends paid, net (311) (330)
Net directors deferred compensation 4 (6)
----------- ----------
Net cash provided by (used in) financing activities (3,887) 256
----------- ----------
Net increase in cash and cash equivalents 41,056 7,429
Cash and cash equivalents at beginning of period 11,222 7,564
----------- ----------
Cash and cash equivalents at end of period $ 52,278 $ 14,993
=========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 5,762 $ 6,612
Income taxes $ 1,146 $ 1,820
See accompanying notes to unaudited consolidated financial statements.
4
CENTRAL BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
(1) BASIS OF PRESENTATION
The unaudited consolidated financial statements of Central Bancorp, Inc.
and its wholly-owned subsidiary Central Co-operative Bank (collectively referred
to as "the Company") presented herein should be read in conjunction with the
consolidated financial statements of the Company as of and for the year ended
March 31, 2003, included in the Company's Annual Report on Form 10-K filed with
the Securities and Exchange Commission. In the opinion of management, the
accompanying unaudited consolidated financial statements reflect all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation. Interim results are not necessarily indicative of results to be
expected for the entire year.
The Company's significant accounting policies are described in Note 1 of
the Notes to Consolidated Financial Statements included in its Form 10-K for the
year ended March 31, 2003. For interim reporting purposes, the Company follows
the same significant accounting policies.
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation. Such reclassifications
have no effect on previously reported net income.
(2) LOANS
Loans as of September 30, 2003 and March 31, 2003 are summarized below (in
thousands):
September 30, March 31,
2003 2003
------------- ---------------
Real estate loans:
Residential real estate $ 181,170 $ 236,649
Commercial real estate 125,434 107,140
Construction 28,545 30,294
Second mortgage and home equity lines of credit 9,636 9,128
----------- -----------
Total real estate loans 344,785 383,211
Commercial loans 4,152 5,319
Consumer loans 1,037 1,287
----------- -----------
Total loans 349,974 389,817
Less: allowance for loan losses (3,389) (3,284)
----------- -----------
Total loans, net $ 346,585 $ 386,533
=========== ===========
There were no non-accrual loans at September 30, 2003 and March 31, 2003.
5
CENTRAL BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(3) DEPOSITS
Deposits at September 30, 2003 and March 31, 2003 are summarized as follows
(in thousands):
September 30, March 31,
2003 2003
------------- ------------
Demand deposit accounts $ 32,263 $ 31,523
NOW accounts 34,957 38,047
Passbook and other savings accounts 73,276 71,629
Money market deposit accounts 42,357 42,687
----------- -----------
Total non certificate accounts 182,853 183,886
----------- -----------
Term deposit certificates
Certificates of $100 and above 26,207 26,259
Certificates less than $100 75,455 77,814
----------- -----------
Total term deposit certificates 101,662 104,073
----------- -----------
Total deposits $ 284,515 $ 287,959
=========== ===========
(4) REPORTING COMPREHENSIVE INCOME
The Company has established standards for reporting and displaying
comprehensive income, which is defined as all changes to equity except
investments by, and distributions to, shareholders. Net income is a component of
comprehensive income, with all other components referred to, in the aggregate,
as other comprehensive income.
The Company's other comprehensive income and related tax effect is as
follows (in thousands):
For the Six Months Ended
September 30, 2003
-------------------------------------
Before-
Tax Tax(Benefit) After-Tax
Amount Expense Amount
------- ------------ ---------
Unrealized gains on securities:
Unrealized holding gains arising during period $ 1,427 $ 458 $ 969
Less: reclassification adjustment for net
losses included in net income 135 46 89
------- ------- -------
Other comprehensive income $ 1,562 $ 504 $ 1,058
======= ======= =======
6
CENTRAL BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(4) REPORTING COMPREHENSIVE INCOME (CONTINUED)
For the Six Months Ended
September 30, 2002
------------------------------------
Before-
Tax Tax(Benefit) After-Tax
Amount Expense Amount
------- ------------ ---------
Unrealized gains on securities:
Unrealized net holding gains arising during period $ 608 $ 229 $ 379
Less: reclassification adjustment for net
losses included in net income 210 71 139
------- ------- -------
Other comprehensive income $ 818 $ 300 $ 518
======= ======= =======
(5) CONTINGENCIES
Legal Proceedings
The Company from time to time is involved as plaintiff or defendant in
various legal actions incident to its business. Except as described herein, none
of these actions are believed to be material, either individually or
collectively, to the results of operations and financial condition of the
Company.
Central Co-operative Bank (the Bank) has been named as defendant in a civil
suit filed March 28, 2002 in Middlesex Superior Court under the caption Yi v.
Central Bank in which it is alleged, inter alia, that the Bank committed an
unfair or deceptive trade practice by failing to pay surplus foreclosure
proceeds to a junior lien holder in 1994. Plaintiff seeks damages of $165,000
plus interest of approximately $175,000 and has applied for a multiple damage
award under Chapter 93A of the Massachusetts General Laws which provides for up
to treble damages if a violation is found to be willful or knowing. The parties
have reached a preliminary settlement, which is expected to be finalized by
December 31, 2003. As of September 30, 2003, the Company had fully reserved for
its costs under the preliminary settlement.
The Company and certain present and former directors had been named in
related federal and state court lawsuits brought by PL Capital, LLC and
affiliates ("PL Capital") and also by Lawrence B. Seidman and affiliates
("Seidman"), respectively, current and former stockholders, in which PL Capital
and Seidman had challenged the directors' determination that PL Capital and
Seidman secretly acted in concert in violation of the Company's Shareholder
Rights Agreement ("Rights Plan"). On August 4, 2003, the Company and the
directors, former directors and affiliated entities that were parties to the
litigation entered into an Agreement (the "Agreement") with PL Capital, LLC and
its affiliated persons and entities, pursuant to which all the parties settled
all of the pending litigation between them and filed with the appropriate courts
the filings necessary for the litigation to be dismissed. As part of the
Agreement, a payment of $400,000, which was reimbursed by insurance, was made to
PL Capital.
The Company has been working with its insurance carrier to recover its
legal defense costs, including the settlement payment noted in the preceding
paragraph, incurred in connection with the PL Capital and Seidman litigation. In
connection therewith, the Company recognized insurance recoveries of $1,134,000
and $3,013,000 during the three and six month periods ended September 30, 2003,
respectively. These recoveries have been classified with professional fees in
the accompanying consolidated statements of income.
7
CENTRAL BANCORP, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(5) CONTINGENCIES (CONTINUED)
State Income Taxes
During 2002, the Massachusetts Department of Revenue ("DOR") issued notices
of intent to assess additional state excise taxes to numerous financial
institutions in Massachusetts that have formed a real estate investment trust
(REIT) subsidiary. The DOR contended that dividends received by the banks from
such subsidiaries were fully taxable in Massachusetts.
The Governor of Massachusetts signed legislation on March 5, 2003, which
expressly disallows deductions for dividends received from a REIT, resulting in
such dividends being subject to state taxation. In addition, this law applies
retroactively to tax years ending on or after December 31, 1999. In the fourth
quarter of fiscal 2003, the Company provided additional state taxes, including
interest, net of the related federal tax benefit, of $835,000.
In June 2003, a settlement of this matter was reached between the DOR and
the majority of affected financial institutions. The settlement provides that
50% of all dividends received from REIT subsidiaries from 1999 through 2002 are
subject to state taxation. Interest on such additional taxes is also to be
assessed. Payment of such taxes and interest totaling $431,000 was made in June
2003. As a result of this settlement, the Bank recognized a recovery of $374,000
in income taxes, which increased net income by the same amount in the quarter
ended June 30, 2003.
(6) SUBSEQUENT EVENTS
ESOP Loan
On October 16, 2003, the Central Co-operative Bank Employee Stock Ownership
Plan Trust (the "ESOP") refinanced the loan it had from the Company with a third
party lender. The Company received proceeds of $3,505,629, of which $2,250,000
was contributed to the Bank's capital. The loan bears interest at the prevailing
prime rate plus 1/2% and matures in March 2012. The loan is collateralized by
the ESOP's unallocated shares of Company stock, a certificate of deposit of
$1,200,000 and a pledge of the Company's stock in the Bank. In addition, the
Company guarantees repayment of the loan.
Dividend
On October 9, 2003, the Board of Directors voted the payment of a quarterly
cash dividend of $.12 per share. The dividend is payable on November 14, 2003 to
stockholders of record on October 31, 2003.
Investment Purchases
In October 2003, the Company commenced a program to invest approximately
$40,000,000 of funds, which were invested on an overnight basis at September 30,
2003. The purpose of this program is to increase the yield on the Bank's
interest-earning assets. Management intends to invest these funds in a
combination of callable government agency securities having final maturities of
approximately five years and mortgage-backed securities collateralized by either
10-year fixed-rate residential mortgages or hybrid adjustable-rate mortgages
("hybrid ARMs"). The interest rate on the hybrid ARMs will initially be reset in
five years and annually thereafter subject to certain limitations. As of
November 13, 2003, approximately $27.9 million in investments had been
purchased.
(7) RECENT ACCOUNTING PRONOUNCEMENT
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS No. 148 amends SFAS Statement
No. 123, to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
Companies are able to eliminate a "ramp-up" effect that the SFAS No. 123
transition rule creates in
8
CENTRAL BANCORP, INC. AND SUBSIDIARY NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(7) RECENT ACCOUNTING PRONOUNCEMENT (CONTINUED)
the year of adoption. Companies can choose to elect a method that will provide
for comparability amongst years reported. In addition, this Statement amends the
disclosure requirement of Statement 123 to require prominent disclosures in both
annual compensation and the effect of the method used on reported results. The
amendments to SFAS No. 123 are effective for financial statements for fiscal
years ending after December 15, 2002. The Company is not currently considering
the adoption of fair value based compensation of stock options.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this Quarterly Report on Form
10-Q, the words or phrases "will likely result," "are expected to." "will
continue," "is anticipated," "estimate," "project," or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company cautions readers
not to place undue reliance on any such forward-looking statements, which speak
only as of the date made, and to advise readers that various factors, including
changes in regional and national economic conditions, unfavorable judicial
decisions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
CRITICAL ACCOUNTING POLICIES
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying value
of certain assets and impact income, are considered critical accounting
policies. The Company considers the allowance for loan losses to be its critical
accounting policy. There have been no significant changes in the methods or
assumptions used in the accounting policies that require material estimates and
assumptions.
Arriving at an appropriate level of allowance for loan losses necessarily
involves a high degree of judgment. The ongoing evaluation process includes a
formal analysis of the allowance each quarter, which considers, among other
factors, the character and size of the loan portfolio, business and economic
conditions, loan growth, delinquency trends, nonperforming loans trends,
charge-off experience and other asset quality factors. The Company evaluates
specific loan status reports on certain commercial and commercial real estate
loans rated "substandard" or worse in excess of a specified dollar amount.
Estimated reserves for each of these credits is determined by reviewing current
collateral value, financial information, cash flow, payment history and trends
and other relevant facts surrounding the particular credit. Provisions for
losses on the remaining commercial and commercial real estate loans are based on
pools of similar loans using a combination of historical loss experience and
qualitative adjustments. For the residential real estate and consumer loan
portfolios, the range of reserves is calculated by applying historical
charge-off and recovery experience to the current outstanding balance in each
loan category. Although management uses available information to establish the
appropriate level of the allowance for loan losses, future additions to the
allowance may be necessary based on estimates that are susceptible to change as
a result of changes in economic conditions and other factors. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize adjustments to the allowance based on their
judgments about information available to them at the time of their examination.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2003 AND MARCH 31, 2003
Total assets increased by $1.2 million from $477.2 million at March 31,
2003 to $478.4 million at September 30, 2003. During the six months ended
September 30, 2003, loans (excluding loans held for sale) decreased by $39.8
million consisting primarily of a $55.5 million decrease in residential mortgage
loans, partially offset by an $18.3 million increase in commercial real estate
loans. During the first half of the current year, interest rates for residential
mortgages reached a 45-year low resulting in significant refinancing activity.
Management regularly assesses the desirability of holding newly originated
long-term, fixed-rate residential mortgage loans in portfolio or selling such
loans in the secondary market. A number of factors are evaluated to determine
whether or not to hold such loans in portfolio including, current and projected
liquidity, current and projected interest rates, projected growth in other
interest-earning assets and the current and projected interest rate
10
risk profile. Based on its consideration of these factors, management determined
that most fixed-rate residential mortgage loans originated during the period
should be sold in the secondary market. This decision resulted in the
aforementioned decrease in residential mortgage loans and a $41.5 million
increase in short-term investments during the six months ended September 30,
2003.
In October 2003, the Company commenced a program to invest approximately
$40 million of funds which were invested on an overnight basis at September 30,
2003. In connection with this program, the Company has purchased a combination
of callable government agency securities having final maturities in
approximately five years and mortgage-backed securities collateralized by either
10-year fixed-rate residential mortgages or hybrid adjustable-rate mortgages
(hybrid ARMs). The interest rate on the hybrid ARMs will initially be adjusted
in five years and annually thereafter subject to certain limitations. As of
November 13, 2003, approximately $27.9 million in investments had been
purchased.
The Company experienced a modest decline of $1.0 million in core deposits
in the first half of the year and a $2.4 million decrease in term deposits
resulting in a decrease in total deposits of $3.4 million. While deposits flows
can vary significantly on a daily basis, the Company has experienced a generally
flat level of total deposits during the past three quarters with a declining
level of term deposits. Management sets its term deposit rates to be competitive
in its market area, however, the desirability to customers of term deposits has
been adversely affected during this period of low interest rates.
Advances from the Federal Home Loan Bank of Boston (FHLB) were unchanged
during the first half of the year. FHLB advances totaling $5.3 million and
having a weighted average rate of 3.61% are scheduled to mature during the
second half of fiscal 2004.
The increase in stockholders' equity of $3.1 million to $42.5 million at
September 30, 2003 resulted primarily from net income of $2.1 million and other
comprehensive income of $1.1 million.
COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED SEPTEMBER 30, 2003 AND
2002
Net income increased to $830,000, or $0.53 per diluted share, for the
quarter ended September 30, 2003, from $668,000, or $0.42 per diluted share for
the corresponding quarter in the prior year. The current quarter's results
reflect an insurance recovery of $214,000, net of the related legal fees and
taxes, attributable to the dispute with certain shareholders, which was settled
during the quarter. In addition, during the quarter ended September 30, 2002,
the Company incurred substantial costs in connection with the contested election
of directors, which reduced net income by approximately $190,000.
Earnings during the quarter ended September 30, 2003 were adversely
affected by a decrease in net interest income of $175,000, as compared to the
same quarter in the prior year. The gradual reduction in interest rates in
recent years had a greater relative impact on the Company's yield on earning
assets in the current quarter than on the cost of funds due to limited
opportunity to reduce deposit rates as well as the fixed cost of FHLB advances.
As previously noted, the Company sold most of its current production of
fixed-rate residential mortgages due to the historically low rates prevailing
during the period and invested the related proceeds on an overnight basis. These
factors lead to a reduction in the net interest margin from 3.56% in the quarter
ended September 30, 2002, to 3.39% in the current quarter.
Interest Income. Interest income for the quarter ended September 30, 2003
was $6.8 million, a decrease of $634,000, or 8.5%, compared to the same quarter
in the prior year. This decrease was due primarily to a decline in the yield on
interest-earning assets from 6.45% in the second quarter of the prior year to
5.88% in the current quarter. Average interest-earning assets increased by $3.0
million to $465.0 million during the quarter ended September 30, 2003 from
$462.0 million for the quarter ended September 30, 2002.
Interest Expense. Interest expense for the quarter ended September 30, 2003
was $2.9 million compared to $3.3 million for the quarter ended September 30,
2002, a decrease of $459,000, or 13.8%. This decrease resulted from a 45 basis
points decrease in the cost of funds from 3.33% in the quarter ended September
30, 2002 to 2.88%
11
in the quarter ended September 30, 2003. Average interest-bearing liabilities
decreased $1.2 million between periods.
Provisions for Loan Losses. The Company provides for loan losses in order to
maintain the allowance for loan losses at a level that management estimates is
adequate to absorb probable losses based on an evaluation of known and inherent
risks in the portfolio. In determining the appropriate level of the allowance
for loan losses, management considers past and anticipated loss experience,
evaluations of underlying collateral, prevailing economic conditions, the nature
and volume of the loan portfolio and the levels of non-performing and other
classified loans. The amount of the allowance is based on estimates and ultimate
losses may vary from such estimates. Management assesses the allowance for loan
losses on a quarterly basis and provides for loan losses monthly in order to
maintain the adequacy of the allowance.
During the current quarter, the Company provided $50,000 for loan losses.
While the Company's asset quality, as measured principally by delinquency rates,
charge-offs and loan classifications, continues to be outstanding, the shifting
of the mix of the loan portfolio to a greater portion of commercial real estate
loans indicated the need for an increase in the reserve for loan losses in the
current quarter. No provision was recorded in the corresponding quarter of the
prior year.
Non-interest Income. Exclusive of securities transactions, non-interest income
was $293,000 for the quarter ended September 30, 2003 compared to $279,000 in
the same period of 2002. The primary reason for the current year increase was
gains on the sale of loans as the Company commenced its mortgage banking
activities in the second half of fiscal 2003.
Net losses from sales and write-downs of investment securities were
$130,000 for the quarter ended September 30, 2003 compared to $221,000 in the
prior year period. The Company recorded write-downs of $130,000 and $220,000 in
certain equity securities which had experienced a decline in fair value judged
to be other than temporary during the quarters ended September 30, 2003 and
2002, respectively.
Non-interest Expenses. Non-interest expenses decreased $376,000 during the
quarter ended September 30, 2003, as compared to the same quarter in 2002.
Exclusive of the impact of litigation and legal fees, net of the related
insurance recovery, non-interest expenses decreased $56,000, or 1.8%, due
principally to additional costs of approximately $275,000 (primarily
professional fees) incurred in connection with the contested election of
directors at the 2002 Annual Meeting of Stockholders, partially offset by an
increase in salaries and employee benefits of $70,000, and an increase in
directors fees of $59,000.
The increase in salaries and employee benefits of $70,000, or 4.2%, during
the quarter ended September 30, 2003, was due to overall salary increases
averaging 4.0% and increases in staffing to support higher mortgage loan
originations, partially offset by a reduction in incentive compensation.
Income Taxes. The effective tax rates for the quarters ended September 30, 2003
and 2002 were 36.1% and 35.9%, respectively. These rates vary from the statutory
income tax rate for banks of approximately 40.9% due to the Company's use of
both a securities corporation and a REIT subsidiary (in fiscal 2003) for state
tax purposes.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2003 AND
2002
For the six months ended September 30, 2003, net income increased 25.0% to
$2.1 million, or $1.36 per diluted share, compared to $1.7 million, or $1.05 per
diluted share, in the year earlier period. Exclusive of the favorable impact of
$374,000, after-taxes, resulting from the settlement of the Company's
REIT-related tax liability with the Massachusetts Department of Revenue and the
favorable impact of a net insurance recovery associated with certain shareholder
litigation, which increased net income by $276,000 in the first half of the
current year, net income declined $227,000 compared to the year earlier period.
This change was largely the result of a $346,000 decrease in net interest income
between periods attributable to the factors previously disclosed herein.
Interest Income. Interest income for the six months ended September 30, 2003 was
$13.8 million, or $1.2 million less than the amount earned in the same period in
the prior year due to a decrease in the yield on interest-earning assets from
6.54% in the first six months of the prior year to 5.97% in the same period of
the current year. Average
12
interest-earning assets increased by $4.7 million, or 1.0%, to $464.0 million
during the six months ended September 30, 2003, from $459.3 million for the six
months ended September 30, 2002.
Interest Expense. Interest expense for the six months ended September 30, 2003
was $5.8 million compared to $6.6 million for the six months ended September 30,
2002, a decrease of $823,000, or 12.4%. This decrease resulted from a 41 basis
points decrease in the cost of funds from 3.31% in the six months ended
September 30, 2002 to 2.90% in the six months ended September 30, 2003. Average
interest-bearing liabilities were essentially unchanged between the periods.
The decrease in the cost of funds during the first half of the current year
was entirely due to a reduction in the cost of deposits from 2.46% during the
prior year period to 1.76% during the six months ended September 30, 2003. The
cost of FHLB advances, the Company's other primary interest-bearing liability,
increased during the first half of the current year to 4.87% from 4.60% in the
comparable prior year period. As FHLB advances can not be prepaid without a
substantial penalty, these longer-term, fixed-rate borrowings have been a
significant factor in the compression of the Company's net interest margin
during the most recent period of declining rates.
Provision for Loan Losses. During the first half of the current year, the
Company provided $100,000 for loan losses. While the Company's asset quality, as
measured principally by delinquency rates, charge-offs and loan classifications,
continues to be outstanding, the shifting of the mix of the loan portfolio to a
greater portion of commercial real estate loans indicated the need for an
increase in the reserve for loan losses in the current quarter. No provision was
recorded in the corresponding period of the prior year.
Non-interest Income. Exclusive of securities transactions, non-interest income
was $712,000 for the six months ended September 30, 2003 compared to $491,000 in
the prior year period. The primary reason for the $221,000 increase in the
current year was gains on the sale of loans as the Company commenced its
mortgage banking activities in the second half of fiscal 2003.
Net losses from sales and write-downs of investment securities were
$135,000 for the six months ended September 30, 2003 compared to $210,000 in the
comparable prior year period. During the six months ended September 30, 2003 and
2002, the Company recorded write-downs of $130,000 and $440,000, respectively,
in certain equity securities which had experienced a decline in fair value
judged to be other than temporary.
Non-interest Expenses. Non-interest expenses decreased $264,000 during the six
months ended September 30, 2003, as compared to the corresponding period in the
prior year. Exclusive of the impact of litigation and legal fees, net of the
related insurance recovery, non-interest expenses increased $150,000, or 2.5%,
due principally to increases in salaries and employee benefits of $232,000,
increased advertising costs of $65,000 and an increase in directors fees of
$73,000. These increases were partially offset by the additional professional
fees incurred in connection with the contested election of directors at the 2002
Annual Meeting of Stockholders.
The increase in salaries and employee benefits of $232,000, or 7.0%, during
the six months ended September 30, 2003, was due to overall salary increases
averaging 4.0%, increases in staffing to support higher mortgage loan
originations, as well as increases in health insurance and pension expense.
These increases were partially offset by a reduction in incentive compensation.
Income Taxes. The effective tax rates for the six months ended September 30,
2003 and 2002 were 23.5% and 36.1%, respectively. As previously noted, the
Company recovered $374,000 in taxes during the first half of the current year as
a result of the settlement of the REIT tax dispute with the Massachusetts
Department of Revenue. Exclusive of this item, the effective tax rate for the
six months ended September 30, 2003 was 37.0%. This increase from the prior year
is entirely due to the change in state tax law eliminating the use of the
dividends received deduction on dividends received by a bank from its REIT
subsidiary. The Company's effective tax rate is expected to be slightly higher
throughout the current year as compared to fiscal 2003 as a result of this
change in state tax law.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity are loan amortization, loan
prepayments, increases in deposits, advances from the Federal Home Loan Bank
(FHLB) of Boston and funds from operations. The Bank is a
13
voluntary member of the FHLB of Boston and as such is entitled to borrow up to
the value of its qualified collateral that has not been pledged to others.
Qualified collateral generally consists of residential first mortgage loans, U.
S. Government and agencies securities and funds on deposit at the FHLB of
Boston. At September 30, 2003, the Bank had approximately $12.6 million in
unused borrowing capacity at the FHLB of Boston.
During the quarter ended September 30, 2003, the Company formed a new
securities corporation subsidiary. This new entity was formed to own only assets
that are qualified for collateral purposes by the FHLB and is being utilized in
connection with the $40 million reinvestment program disclosed elsewhere herein.
The Company is working with the FHLB to properly pledge these assets as
collateral in order to enhance its liquidity position.
At September 30, 2003, the Company had commitments to originate loans,
unused outstanding lines of credit and undisbursed proceeds of loans totaling
$51.6 million. Since many of the commitments may expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company anticipates that it will have sufficient funds
available to meet its current loan commitments.
The Company's and the Bank's capital ratios at September 30, 2003 were as
follows:
Company Bank
------- -----
Total Capital (to risk-weighted assets) 12.95% 11.75%
Tier 1 Capital (to risk-weighted assets) 11.90 10.70
Tier 1 Capital (to average assets) 8.06 7.24
These ratios placed the Company in excess of regulatory standards and the
Bank in the "well capitalized" category as set forth by the FDIC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's earnings are largely dependent on its net interest income,
which is the difference between the yield on interest-earning assets and the
cost of interest-bearing liabilities. The Company seeks to reduce its exposure
to changes in interest rate, or market risk, through active monitoring and
management of its interest-rate risk exposure. The policies and procedures for
managing both on- and off-balance sheet activities are established by the Bank's
asset/liability management committee ("ALCO"). The Board of Directors reviews
and approves the ALCO policy annually and monitors related activities on an
ongoing basis.
Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises primarily from interest rate risk
inherent in its lending, borrowing and deposit taking activities.
The main objective in managing interest rate risk is to minimize the
adverse impact of changes in interest rates on net interest income and preserve
capital, while adjusting the asset/liability structure to control interest-rate
risk. However, a sudden and substantial increase or decrease in interest rates
may adversely impact earnings to the extent that the interest rates borne by
assets and liabilities do not change at the same speed, to the same extent, or
on the same basis.
The Company quantifies its interest-rate risk exposure using a
sophisticated simulation model. Simulation analysis is used to measure the
exposure of net interest income to changes in interest rates over a specific
time horizon. Simulation analysis involves projecting future interest income and
expense under various rate scenarios. The simulation is based on both actual and
forecasted cash flows and assumptions of management about the future changes in
interest rates and levels of activity (loan originations, loan prepayments,
deposit flows, etc). The assumptions are inherently uncertain and, therefore,
actual results will differ from simulated results due to timing, magnitude and
frequency of interest rate changes as well as changes in market conditions and
strategies. The net interest income projection resulting from use of actual and
forecasted cash flows and management's assumptions
14
is compared to net interest income projections based on an immediate shift of
300 basis points upward and 50/100 basis points downward. Internal guidelines on
interest rate risk state that for every 100 basis points immediate shift in
interest rates, estimated net interest income over the next twelve months should
decline by no more than 5%.
The following table indicates the estimated exposure, as a percentage of
estimated net interest income, for the twelve-month period following the date
indicated assuming an immediate shift in interest rates as set forth below:
September 30, March 31,
2003 2003
------------- ---------
300 basis point increase in rates......... (3.4)% (7.6)%
50 basis point decrease in rates
(September 30 only)....................... (1.8)
100 basis point decrease in rates
(March 31 only)........................... (2.0)
For each one percentage point change in net interest income in the
September 2003 projections, the effect on net income would be $99,000 assuming a
37% tax rate.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the
Company carried out an evaluation, under the supervision and with the
participation of the Company's principal executive officer and principal
financial officer, of the effectiveness of the Company's disclosure controls and
procedures. Based on this evaluation, the Company's principal executive officer
and principal financial officer concluded that the Company's disclosure controls
and procedures are effective in ensuring that information required to be
disclosed by the Company in reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms.
In addition, there have been no changes in the Company's internal control
over financial reporting (to the extent that elements of internal control over
financial reporting are subsumed within disclosure controls and procedures)
identified in connection with the evaluation described in the above paragraph
that occurred during the Company's last fiscal quarter, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company from time to time is involved as plaintiff or defendant in
various legal actions incidental to its business. Except as described herein,
none of these actions are believed to be material, either individually or
collectively, to the results of operations and financial condition of the
Company.
The Bank has been named as defendant in a civil suit filed March 28, 2002
in Middlesex Superior Court under the caption Yi v. Central Bank in which it is
alleged, inter alia, that the Bank committed an unfair or deceptive trade
practice by failing to pay surplus foreclosure proceeds to a junior lien holder
in 1994. Plaintiff seeks damages of $165,000 plus interest of approximately
$175,000 and has applied for a multiple damage award under Chapter 93A of the
Massachusetts General Laws which provides for up to treble damages if a
violation is found to be willful or knowing. The parties have reached a
preliminary settlement, which is expected to be finalized by December 31, 2003.
Item 2. Changes in Securities and Use of Proceeds
Not Applicable
Item 3. Defaults upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
On September 30, 2003, the Registrant convened its Annual Meeting of
Stockholders. The only item submitted to a vote of stockholders was the election
of three directors. Joseph R. Doherty, Richard J. Lashley and Edward F. Sweeney,
Jr. were elected directors and the terms of office of the following directors
continued after the meeting: John D. Doherty, Gregory W. Boulos, Richard J.
Fates, Paul E. Bulman, Albert J. Mercuri, Jr., John J. Morrissey and James F.
Linnehan. The following is a record of the voting in the election of directors:
ELECTION OF DIRECTORS FOR WITHHELD
Joseph D. Doherty 1,325,578 136,777
Richard J. Lashley 1,419,466 42,889
Edward F. Sweeney, Jr. 1,327,169 135,186
There were no abstentions or broker non-votes.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32 Section 1350 Certifications
(b) Reports on Form 8-K
-------------------
The Registrant filed the following Current Reports on Form
8-K during the quarter ended September 30, 2003:
DATE OF REPORT ITEM(S) REPORTED FINANCIAL STATEMENT FILED
-------------- ---------------- -------------------------
July 25, 2003 5, 7 N/A
August 4, 2003 7, 12 N/A
August 4, 2003 5, 7 N/A
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CENTRAL BANCORP, INC.
---------------------
Registrant
November 13, 2003 /s/ John D. Doherty
- ---------------- -----------------------------------------
Date John D. Doherty
President and Chief Executive Officer
November 13, 2003 /s/ Michael K. Devlin
- ---------------- -----------------------------------------
Date Michael K. Devlin
Senior Vice President, Treasurer
and Chief Financial Officer