UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2004
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-25251
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CENTRAL BANCORP, INC.
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(Exact Name of Registrant as Specified in Its Charter)
MASSACHUSETTS 04-3447594
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
399 HIGHLAND AVENUE, SOMERVILLE, MASSACHUSETTS 02144
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (617) 628-4000
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Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $1.00 PER SHARE
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(Title of Class)
STOCK PURCHASE RIGHTS
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(Title of Class)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
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The aggregate market value of voting stock held by nonaffiliates of the
registrant at March 31, 2004 was approximately $22.4 million based on the
closing sale price of the registrant's Common Stock as listed on the Nasdaq
National MarketSM as of September 30, 2003 ($34.73 per share). Solely for
purposes of this calculation, directors, executive officers and greater than 5%
stockholders are treated as affiliates.
At June 25, 2004, the registrant had 1,664,957 shares of its Common Stock,
$1.00 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders
(the "Proxy Statement") are incorporated by reference in Part III of this Form
10-K.
CENTRAL BANCORP, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Page
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Item 1. Business.............................................................................. 3
Item 2. Properties............................................................................ 21
Item 3. Legal Proceedings..................................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders................................... 22
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............. 23
Item 6. Selected Financial Data............................................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 34
Item 8. Financial Statements and Supplementary Data........................................... 35
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure............................................................. 64
Item 9A. Controls and Procedures............................................................... 64
PART III
Item 10. Directors and Executive Officers of the Registrant.................................... 65
Item 11. Executive Compensation................................................................ 65
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.................................................. 65
Item 13. Certain Relationships and Related Transactions........................................ 66
Item 14. Principal Accountant Fees and Services................................................ 66
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 66
PART I
NOTE ON FORWARD-LOOKING STATEMENTS
When used in this Annual Report on Form 10-K, 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 advises readers that various factors, including changes in regional
and national economic conditions, changes in local demographics, unfavorable
judicial decisions, substantial changes in levels of market interest rates,
technological innovations, 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 the occurrence of anticipated
or unanticipated events or circumstances after the date of such statements.
ITEM 1. BUSINESS
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GENERAL
THE COMPANY. Central Bancorp, Inc. (the "Company"), a Massachusetts
corporation, was organized by Central Co-operative Bank (the "Bank") on
September 30, 1998, to acquire all of the capital stock of the Bank as part of
its reorganization into the holding company form of ownership, which was
completed on January 8, 1999. Upon completion of the holding company
reorganization, the Company's common stock, par value $1.00 per share (the
"Common Stock"), became registered under the Securities Exchange Act of 1934, as
amended (the "Act"). The Company is a registered bank holding company subject to
regulation and examination by the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board"). The Company has no significant assets
other than the common stock of the Bank and various other liquid assets in which
it invests in the ordinary course of business. For that reason, substantially
all of the discussion in this Annual Report on Form 10-K relates to the
operations of the Bank and its subsidiaries.
THE BANK. Central Co-operative Bank ("Central" or the "Bank") was organized
as a Massachusetts chartered co-operative bank in 1915 and converted from mutual
to stock form in 1986. The primary business of the Bank is to generate funds in
the form of deposits and use the funds to make mortgage loans for the
construction, purchase and refinancing of residential properties, and to make
loans on commercial real estate in its market area. In addition, the Bank makes
a limited amount of consumer loans including secured and unsecured personal
loans, and commercial and industrial loans. The Bank also maintains an
investment portfolio of various types of debt securities, including corporate
bonds and mortgage-backed securities, and a limited amount of equity securities.
In fiscal 2002, the Bank began to offer investment services (including
annuities) to its customers through a third party broker-dealer and its
insurance affiliate.
The Bank is headquartered in Somerville, Massachusetts and its operations
are conducted through eight full-service office facilities located in
Somerville, Arlington, Burlington, Chestnut Hill, Malden, Melrose and Woburn,
Massachusetts, a limited service high school branch in Woburn, Massachusetts, as
well as over the Internet. Each full-service branch office also has a 24-hour
automated teller machine ("ATM"). The Bank is a member of the Federal Home Loan
Bank ("FHLB") of Boston and its deposits are insured to applicable limits by the
Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation
("FDIC").
All Massachusetts chartered co-operative banks are required to be members
of the Share Insurance Fund. The Share Insurance Fund maintains a deposit
insurance fund which insures all deposits in member banks which are not covered
by federal insurance, which in the case of the Bank are its deposits in excess
of $100,000 per insured account. In past years, a premium of 1/24 of 1% of
insured deposits has been assessed annually on member banks such as the Bank for
this deposit insurance. However, no premium has been assessed in recent years.
3
The Company's and Bank's main office is located at 399 Highland Avenue,
Somerville, Massachusetts 02144 and their telephone number is (617) 628-4000.
The Bank also maintains a website at www.centralbk.com.
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The operations of the Bank are generally influenced by overall economic
conditions, the related monetary and fiscal policies of the federal government
and the regulatory policies of financial institution regulatory authorities,
including the Massachusetts Commissioner of Banks (the "Commissioner"), the
Federal Reserve Board and the FDIC.
MARKET AREA
All of the Bank's offices are located in the northwestern suburbs of
Boston, which are its principal market area for deposits. The majority of the
properties securing the Bank's loans are located in Middlesex County. The Bank's
market area consists of established suburban areas and includes portions of the
Route 128 high-technology corridor.
COMPETITION
The Bank's competition for savings deposits has historically come from
other co-operative banks, savings banks, credit unions, savings and loan
associations and commercial banks located in Massachusetts generally, and in the
Boston metropolitan area, specifically. With the advent of interstate banking
the Bank, also faces competition from out-of-state banking organizations. In the
past, during times of high interest rates, the Bank has also experienced
additional significant competition for investors' funds from short-term money
market funds and other corporate and government securities. The Bank has faced
continuing competition from other financial intermediaries for deposits.
The Bank competes for deposits principally by offering depositors a wide
variety of savings programs, convenient branch locations, 24-hour automated
teller machines, Internet banking, preauthorized payment and withdrawal systems,
tax-deferred retirement programs and other miscellaneous services such as money
orders, travelers' checks and safe deposit boxes. The Bank does not rely upon
any individual, group or entity for a material portion of its deposits.
The Bank's competition for real estate loans comes principally from
mortgage banking companies, co-operative banks and savings banks, credit unions,
savings and loan associations, commercial banks, insurance companies and other
institutional lenders. The Bank competes for loan originations primarily through
the interest rates and loan fees it charges and the efficiency and quality of
services it provides borrowers, real estate brokers and builders. The
competition for loans encountered by the Bank, as well as the types of
institutions with which the Bank competes, varies from time to time depending
upon certain factors, including the general availability of lendable funds and
credit, general and local economic conditions, current interest rate levels,
volatility in the mortgage markets and other factors which are not readily
predictable.
Changes in bank regulation, such as changes in the products and services
banks can offer and involvement in non-banking activities by bank holding
companies, as well as bank mergers and acquisitions, can affect the Bank's
ability to compete successfully. Legislation and regulations have also expanded
the activities in which depository institutions may engage. The ability of the
Bank to compete successfully will depend upon how successfully it can respond to
the evolving competitive, regulatory, technological and demographic developments
affecting its operations.
FUTURE EXPANSION PLANS
The Board of Directors has recently adopted a five-year strategic plan to
enhance long-term shareholder value through franchise growth. The strategic plan
calls for expansion and core deposit growth through marketing and de novo
branching within the Bank's market area of Middlesex County in order to enable
the Bank to take greater advantage of the opportunities afforded by the
favorable demographics of this market. The strategic plan also calls for the
Bank to continue to focus primarily on its traditional businesses of residential
and commercial real estate lending and to grow its mortgage banking
capabilities. The Board and management believe that the increased
4
asset size and the greater access to deposits as a source of funds to be
achieved through the planned expansion will enable the Bank to better leverage
operating efficiencies and technology without compromising its focus on personal
service and relationships. The strategic plan provides for this planned branch
expansion to be funded with the Company's current capital plus future earnings
and does not call for the raising of additional capital.
While the Board and management anticipate that this planned expansion will
enhance long-term shareholder value, new branches generally require a
significant initial capital investment and marketing and operational expenses
before they become profitable. As a result, management anticipates that, in the
short-term, net income may be negatively affected as the Bank incurs significant
capital expenditures and non-interest expenses in opening, operating and
marketing new branches before these branches can produce sufficient net interest
income to offset the increased expenses.
LENDING ACTIVITIES
The Bank's lending focus is concentrated in real estate secured
transactions, including residential mortgage and home equity loans, commercial
mortgage loans and construction loans. For the year ended March 31, 2004, the
Bank originated loans totaling $137.3 million. Of the total loans originated
during fiscal 2004, $64.3 million, or 46.8%, were residential mortgage loans and
$64.2 million, or 46.8%, were commercial mortgage loans. During the years ended
March 31, 2004 and 2003, the Bank sold $32.6 million and $35.7 million,
respectively, of current year residential mortgage loan originations. The sale
of loans in the secondary market allows the Bank to continue to make loans
during periods when savings flows decline or funds are not otherwise available
for lending purposes and to manage interest rate risk.
The Bank's loan portfolio decreased by $33.4 million, or 8.7%, to $353.1
million at March 31, 2004 from $386.5 million at March 31, 2003. The decrease
occurred as a result of the continuing high level of loan refinancing activity,
particularly residential mortgage loans, and management's decision to sell many
fixed-rate residential mortgages originated in fiscal 2004. While the loan
portfolio decreased overall, commercial real estate loans grew by $39.0 million,
or 36.4%, in fiscal 2004. This growth is consistent with management's strategic
intent due to the generally more favorable yields and repricing frequency of
these assets, as compared to other interest-earning assets.
LOAN PORTFOLIO COMPOSITION. The following table summarizes the composition
of the Bank's loan portfolio by type of loan and the percentage each type
represents of the total loan portfolio at the dates indicated.
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Amount % Amount % Amount % Amount % Amount %
------ -- ------ --- ------ --- ------ --- ------ ---
(Dollars in thousands)
Mortgage loans:
Residential............ $171,682 48.2% $236,649 60.7% $246,045 66.2% $248,459 71.9% $243,570 76.1%
Commercial............. 146,107 41.0 107,140 27.5 87,013 23.4 69,949 20.2 54,228 16.9
Construction........... 25,112 7.0 30,294 7.8 20,998 5.6 9,152 2.6 9,765 3.1
Home equity............ 9,397 2.6 9,128 2.3 9,154 2.5 10,977 3.2 7,403 2.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total mortgage loans 352,298 98.8 383,211 98.3 363,210 97.7 338,537 97.9 314,966 98.4
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Other loans:
Commercial and
industrial............ 3,198 0.9 5,319 1.4 6,901 1.9 4,979 1.4 3,349 1.1
Consumer............... 1,129 0.3 1,287 0.3 1,596 0.4 2,277 0.7 1,698 0.5
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total other loans.... 4,327 1.2 6,606 1.7 8,497 2.3 7,256 2.1 5,047 1.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans.......... 356,625 100.0% 389,817 100.0% 371,707 100.0% 345,793 100.0% 320,013 100.0%
-------- ===== -------- ===== -------- ===== -------- ===== -------- =====
Less:
Allowance for loan
losses................ 3,537 3,284 3,292 3,106 2,993
-------- -------- -------- -------- --------
Loans, net........... $353,088 $386,533 $368,415 $342,687 $317,020
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5
LOAN PORTFOLIO SENSITIVITY. The following table sets forth certain maturity
information as of March 31, 2004 regarding the dollar amount of commercial and
industrial loans as well as construction loans in the Bank's portfolio,
including scheduled repayments of principal, based on contractual terms to
maturity. Demand loans, loans having no schedule of repayments and no stated
maturity and overdrafts are reported as due in one year or less.
DUE AFTER
DUE WITHIN ONE THROUGH DUE AFTER
ONE YEAR FIVE YEARS FIVE YEARS TOTAL
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(In thousands)
Construction loans.................. $ 19,657 $ 2,689 $ 2,766 $ 25,112
Commercial and industrial loans..... 2,440 419 339 3,198
---------- ---------- ---------- ----------
Total.......................... $ 22,097 $ 3,108 $ 3,105 $ 28,310
========== ========== ========== ==========
Of construction loans and commercial and industrial loans maturing more
than one year after March 31, 2004, $953 thousand have fixed rates and $5.3
million, have floating or variable rates.
RESIDENTIAL LENDING. The Bank's residential mortgage loans at March 31,
2004 totaled $171.7 million, or 48.2%, of the total loan portfolio. Fixed-rate
residential mortgages totaled $129.6 million, or 75.5%, of the residential loan
portfolio and adjustable-rate loans totaled $42.1 million, or 24.5%, of the
residential loan portfolio.
With the implementation of its mortgage banking initiative in fiscal 2003,
whereby the Bank is seeking to increase its origination of residential mortgage
loans and to generate additional noninterest income via loan sale gains,
management regularly assesses the desirability of holding newly originated
long-term, fixed-rate residential mortgage loans in its portfolio. A number of
factors are evaluated to determine whether or not to hold such loans including,
current and projected liquidity, current and projected interest rate risk
profile, projected growth in other interest-earning assets, e.g., commercial
real estate loans, and projected interest rates. With the rate on the 30-year
fixed-rate residential mortgage loan reaching a 45-year low in 2003, the Company
experienced $88.3 million in residential mortgage loan prepayments in fiscal
2004. Customers who refinanced their mortgages generally refinanced their
existing home loans with either a 15 or 30 year fixed-rate mortgage loan.
The Bank's adjustable-rate residential mortgage loans have a maximum term
of 30 years, and allow for periodic interest rate adjustments. The Bank prices
the initial rate competitively, but generally avoids initial deep discounts from
contracted indices and margins. The Bank has adopted the U.S. Treasury
Securities Index, adjusted to a constant maturity of one to three years, as its
primary index. The margin at which adjustable-rate loans are generally set is
2.875 percentage points over the stated index. Interest rate adjustments on
adjustable mortgage loans are capped at two percentage points per adjustment and
six percentage points over the life of the loan.
Residential loans may be granted as construction loans or permanent loans
on residential properties. Construction loans on owner-occupied residential
properties may convert to residential loans at fixed or adjustable rates upon
completion of construction. Loans secured by one- to four-family residential
properties are typically written in amounts up to 80% of the appraised value of
the residential property. The Bank generally requires private mortgage insurance
for loans in excess of 80% of appraised value. The maximum loan-to-value ratio
on owner occupied residential properties is 95%. The maximum loan-to-value ratio
on non-owner occupied residential properties is 80%.
COMMERCIAL REAL ESTATE AND CONSTRUCTION LENDING. The Bank originates
permanent and construction loans on commercial real estate. Commercial real
estate loans are typically secured by income-producing properties such as
apartment buildings, office buildings, industrial buildings and various retail
properties and are written with either fixed or adjustable interest rates.
Commercial real estate loans with fixed interest rates have terms generally
ranging from one to five years while the interest rate on adjustable rate loans
is generally set to the five year FHLB classic advance rate plus a margin of
2.00 to 3.00 percentage points. As of March 31, 2004, commercial real estate
loans totaled $146.1 million and constituted 41.0% of the total loan portfolio.
Commercial real estate loans may be made for up to 80% of the appraised
value of the property up to $6.0 million, the Bank's "house lending limit" for
an individual borrower. Commercial real estate loans currently offered
6
by the Bank have terms of one to 20 years. Title insurance, fire, casualty
insurance and flood insurance are required in amounts sufficient to protect the
Bank's interest, where applicable. In some cases, commercial real estate loans
are granted in participation with other lenders.
The Bank's construction loans totaled $25.1 million, or 7.0%, of the Bank's
loan portfolio at March 31, 2004. Construction loans are short-term in nature
and have maturities ranging from six months to two years. The Bank grants loans
to construct residential and commercial real estate, as well as land development
for individual residential lots. Currently, construction loans are made for up
to 80% of the projected value of the completed property, based on independent
appraisals. Funds are disbursed based on a schedule of completed work presented
to the Bank and confirmed by physical inspection of the property by a
construction consultant and only after receipt of title updates.
The Bank also originates loans for the construction of single-family homes
for resale by professional builders. The Bank also lends to individuals for
construction of one- to four-family homes which they intend to occupy. Borrowers
are required to have a firm contract with a qualified builder or developer or to
have demonstrated prior home building experience. Construction loans are
normally made for a term of not more than eighteen months and based on a
completed value of not more than 80%, as determined by an independent certified
and licensed appraiser.
The growth in the commercial mortgage loan portfolio in fiscal 2004, which
totaled $39.0 million, or 36.4%, is attributable to the expanded team of
experienced commercial lenders and credit administration personnel established
in 2002. This planned growth was aided by opportunities created by the declining
rate environment prevailing during the past three years.
HOME EQUITY LINES OF CREDIT. The Bank offers home equity lines of credit
that are secured by the borrower's equity in his or her primary residence and
may take the form of a first or second mortgage. Equity loans are made in
amounts up to 80% of the appraised value less any first mortgage. Payment of
interest is required monthly and the rate is adjusted monthly based on changes
in the prime rate, as quoted in the Wall Street Journal. Loans are not
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contingent upon proceeds being used for home improvement. The Bank's home equity
loans outstanding totaled $9.4 million, or 2.6%, of the Bank's loan portfolio at
March 31, 2004.
COMMERCIAL AND INDUSTRIAL, CONSUMER AND OTHER LOANS. The Bank's commercial
and industrial, consumer and other loans totaled $4.3 million, or 1.2%, of the
total loan portfolio on March 31, 2004. The Bank's commercial and industrial
portfolio consists primarily of time, demand and line-of-credit loans to a
variety of local small businesses generally done on a secured basis. The Bank
engages in consumer lending primarily as an accommodation to existing customers.
RISKS OF COMMERCIAL REAL ESTATE, CONSTRUCTION AND COMMERCIAL AND INDUSTRIAL
LENDING. Commercial real estate, construction and commercial and industrial
lending entail significant additional risks compared to residential mortgage
lending. The repayment of loans secured by income-producing properties is
typically dependent on the successful operation of the properties and thus may
be subject to a greater extent to adverse conditions in the local real estate
market or in the economy generally. Construction loans involve additional risks,
because of the uncertainties inherent in estimating construction costs, delays
arising from labor problems, material shortages, and other unpredictable
contingencies, which make it relatively difficult to evaluate accurately the
total loan funds required to complete a project, and related loan-to-value
ratios. Commercial and industrial loans are generally not secured by real estate
and may involve greater risks than other types of lending. Because payments on
such loans are often dependent on the successful operation of the business
involved, repayment of such loans may be subject to a greater extent to adverse
conditions in the economy. For more information see "-- Non-Performing Assets."
ORIGINATION FEES AND OTHER FEES. The Bank currently collects origination
fees on some of the real estate loan products offered. Fees to cover the cost of
appraisals, credit reports and other direct costs are also collected. Loan
origination fees collected vary in proportion to the level of lending activity,
as well as competitive and economic conditions.
7
The Bank imposes late charges on all loans with the exception of equity
lines of credit and loans secured by deposits. The Bank also collects prepayment
premiums and partial release fees on commercial real estate and construction
loans where such items are negotiated as part of the loan agreement.
LOAN SOLICITATION AND PROCESSING. Loan originations come from a number of
sources. Residential real estate loans are attributable to walk-in customers,
existing customers, real estate brokers and builders. The Bank also utilizes
both in-house and traveling originators in the origination of residential real
estate loans. Commercial real estate loans are originated by the Bank's team of
commercial loan officers. Consumer loans result from walk-in customers and
depositors.
Each loan originated by the Bank is underwritten by lending personnel of
the Bank or, in the case of certain residential mortgage loans to be sold,
qualified independent contract underwriters. Individual lending officers, a
committee of loan officers and the Bank's Security Committee have the authority
to approve loans up to various limits. Applications are received in each of the
offices of the Bank. Independent certified and licensed appraisers are used to
appraise the property intended to secure real estate loans. The Bank's
underwriting criteria are designed to minimize the risks of each loan. There are
detailed guidelines concerning the types of loans that may be made, the nature
of the collateral, the information that must be obtained concerning the loan
applicant and follow-up inspections of collateral after the loan is made.
NON-PERFORMING ASSETS. The Bank notifies a borrower of a delinquency when
any payment becomes 15 days past due. Repeated contacts are made if the loan
remains delinquent for 30 days or more. The Bank will consider working out a
payment schedule with a borrower to clear a delinquency, if necessary. If,
however, a borrower is unwilling or unable to resolve such a default after 60
days, the Bank will generally proceed to foreclose and liquidate the property to
satisfy the debt.
Loans on which the accrual of interest has been discontinued are designated
as non-accrual loans. Accrual of interest on loans and amortization of net
deferred loan fees or costs are discontinued either when reasonable doubt exists
as to the full and timely collection of interest or principal, or when a loan
becomes contractually past due 90 days with respect to interest or principal.
When a loan is placed on non-accrual status, all interest previously accrued but
not collected is reversed against current period interest income. Interest
accruals are resumed on such loans only when they are brought fully current with
respect to interest and principal and when, in the judgment of management, the
loans are estimated to be fully collectable as to both principal and interest.
The Bank has instituted additional procedures to closely monitor loans and
bring potential problems to management's attention early in the collection
process. The Bank prepares a monthly watch list of potential problem loans
including currently performing loans. The Senior Loan Officer reviews
delinquencies with the Security Committee of the Board of Directors at least
monthly. Due to the high priority given to monitoring asset quality, Senior
Management is involved in the early detection and resolution of problem loans.
8
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
At March 31,
------------------------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- ------- -------- --------
(Dollars in thousands)
Loans accounted for on a non-accrual basis,
non-performing loans...................... $ -- $ -- $ -- $ -- $ 235
Restructured loans........................... -- -- -- -- --
Real estate acquired by foreclosure.......... -- -- -- -- --
------- ------- -------- -------- ------
Total non-performing assets............... $ -- $ -- $ -- $ -- $ 235
======= ======= ======== ======== ======
Impaired loans, accruing..................... $ -- $ -- $ -- $ -- $ --
Non-performing loans to total loans.......... 0.00% 0.00% 0.00% 0.00% 0.07%
Non-performing assets to total assets........ 0.00% 0.00% 0.00% 0.00% 0.06%
At March 31, 2004, there were no loans where known information about
possible credit problems of borrowers caused management to have serious doubts
as to the ability of such borrowers to comply with present loan repayment terms.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained at a
level which management considers adequate to provide for probable losses based
on an evaluation of known and inherent risks in the portfolio. Such evaluation
for each of the periods reported includes identification of adverse situations
which may affect the ability of certain borrowers to repay, a review of overall
portfolio size, quality, composition and an assessment of existing and
anticipated economic conditions. Regular reviews of the loan portfolio are
performed to identify loans for which specific allowance allocations are
considered prudent. Specific allocations are made based on the risk
classification assigned to individual loans. Additionally, general risk
allocations are determined by a formula whereby the loan portfolio is stratified
by loan type and by risk rating category. Loss factors are then applied to each
strata based on various considerations including historical loss experience,
delinquency trends, current economic conditions, collateral type, loan-to-value
ratios, industry standards and regulatory guidelines. While management uses
available information in establishing the allowance for loan losses, future
adjustments to the allowance may be necessary if economic conditions differ
substantially from the assumptions used in making the evaluations. Additions to
the allowance are charged to earnings and realized losses, net of recoveries,
are charged to the allowance.
Various regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan losses. Such agencies
may require the Bank to recognize additions to the allowance based on their
judgment of information available to them at their examination date.
9
The following table presents activity in the allowance for loan losses
during the years indicated.
AT OR FOR THE YEARS ENDED MARCH 31,
------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Balance at beginning of year........... $ 3,284 $3,292 $ 3,106 $ 2,993 $ 2,913
-------- -------- -------- -------- --------
Provision.............................. 200 -- -- -- --
Charge-offs:
Residential mortgage................. -- -- -- -- --
Commercial mortgage.................. -- -- -- -- --
Other loans.......................... (29) (21) (4) (4) (9)
-------- -------- -------- -------- --------
Total charge-offs.................. (29) (21) (4) (4) (9)
-------- -------- -------- -------- --------
Recoveries:
Residential mortgage................. 19 -- 80 60 9
Commercial mortgage.................. 33 -- 103 48 36
Other loans.......................... 30 13 7 9 44
-------- -------- -------- -------- --------
Total recoveries................... 82 13 190 117 89
-------- -------- -------- -------- --------
Net (charge-offs) recoveries........... 53 (8) 186 113 80
-------- -------- -------- -------- --------
Balance at end of year................. $ 3,537 $ 3,284 $ 3,292 $ 3,106 $ 2,993
======== ======== ======== ======== ========
Average loans outstanding during the year $367,094 $378,502 $335,271 $341,732 $300,089
Ratio of net charge-offs to average loans n/a n/a n/a n/a n/a
Total loans outstanding at end of year. $357,424 $390,464 $371,707 $345,793 $320,013
Ratio of allowance for loan
losses to loans at end of year....... 0.99% 0.84% 0.89% 0.90% 0.94%
- -----------
n/a means either not applicable or not meaningful
10
The allowance for loan losses is available for offsetting credit losses in
connection with any loan, but is internally allocated among loan categories as
part of the process for evaluating the adequacy of the allowance for loan
losses. The following table presents the allocation of the Bank's allowance for
loan losses, by type of loan, at the dates indicated.
MARCH 31,
-----------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ----------------- ----------------- ---------------- -------------------
% OF % OF % OF % OF % OF
LOANS TO LOANS TO LOANS TO LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------- ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Mortgage loans:
Residential mortgage ............ $ 446 48.2% $ 583 60.8% $ 636 66.2% $1,637 71.9% $1,333 76.1%
Commercial mortgage ............. 2,434 41.0 2,009 27.4 1,956 23.4 1,058 20.2 1,202 16.9
Construction .................... 494 7.0 457 7.8 462 5.6 169 2.6 198 3.1
Home equity ..................... 101 2.6 94 2.3 98 2.5 163 3.2 178 2.3
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total mortgage loans .......... 3,475 98.8 3,143 98.3 3,152 97.7 3,027 97.9 2,911 98.4
Other loans ....................... 62 1.2 141 1.7 140 2.3 79 2.1 82 1.6
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total.......................... $3,537 100.0% $3,284 100.0% $3,292 100.0% $3,106 100.0% $2,993 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
11
INVESTMENT ACTIVITIES
The primary objectives of the investment portfolio are to achieve a
competitive rate of return over a reasonable period of time and to provide
liquidity. As a Massachusetts-chartered bank, the Bank is authorized to invest
in various obligations of federal and state governmental agencies, corporate
bonds and other obligations and, within certain limits, marketable equity
securities. The Bank's investment policy requires that corporate debt securities
be rated as "investment grade" at the time of purchase. The Bank's investment in
marketable equity securities is generally limited to large, well-known
corporations whose shares are actively traded. The size of the Bank's holdings
in an individual company's stock is also limited by policy. A portion of the
Bank's investment portfolio consists of mortgage-backed securities which
represent interests in pools of residential mortgages. Such securities include
securities issued and guaranteed by the Federal National Mortgage Association
("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and the Government
National Mortgage Association ("GNMA") as well as collateralized mortgage
obligations ("CMOs") issued primarily by FNMA and FHLMC.
Investments are classified as "held to maturity", "available for sale" or
"trading." Investments classified as trading securities are reported at fair
value with unrealized gains and losses included in earnings. Investments
classified as available for sale are reported at fair value, with unrealized
gains and losses, net of taxes, reported as a separate component of
stockholders' equity. Securities held to maturity are carried at amortized cost.
At March 31, 2004, all of the Bank's marketable investments were classified as
available for sale.
The following table sets forth a summary of the Bank's investment
securities, as well as the percentage such investments comprise of the Bank's
total assets, at the dates indicated.
At March 31,
--------------------------------------------------
2004 2003 2002
----- ------ -----
(Dollars in thousands)
U. S. Government and agency obligations................. $ 10,086 $ 8,247 $ 13,996
Corporate bonds......................................... 38,638 38,727 38,568
Mortgage-backed securities.............................. 31,575 12,056 18,340
Marketable equity securities............................ 3,472 2,081 2,980
---------- ---------- ----------
Total investment securities......................... $ 83,771 $ 61,111 $ 73,884
========== ========== ==========
Percentage of total assets.......................... 17.1% 12.8% 15.8%
==== ==== ====
At March 31, 2004, the Bank owned securities issued by several companies
having a fair value that exceeded 10% of the Company's stockholders' equity.
Such securities consisted primarily of debt obligations. The following table
summarizes the Bank's aggregate holdings of each issuer.
ISSUER AMORTIZED COST MARKET VALUE
------ -------------- ------------
(In thousands)
AT&T $5,161 $5,557
Ford Motor Credit 5,054 5,312
Boeing Capital Corp. 5,026 5,431
Hewlett Packard 5,012 5,506
GMAC 4,618 4,904
12
The following table sets forth the scheduled maturities, amortized cost,
fair values and average yields for the Bank's debt securities at March 31, 2004.
More Than More Than
One Year or Less One to Five Years Five to Ten Years More than Ten Years Total Investment Portfolio
---------------- ----------------- ----------------- ------------------- --------------------------
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Fair Average
Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield
--------- ------- --------- ------- --------- ------- --------- ------- --------- ----- -------
(Dollars in thousands)
U.S. government and agency
obligations.................$ -- --% $ 7,998 4.56% $ 2,000 4.00% $ -- --% $ 9,998 $10,086 4.45%
Corporate bonds.............. 500 7.41 32,179 6.15 3,109 6.52 -- -- 35,788 38,638 6.20
Mortgage-backed securities... -- -- 686 7.00 14,784 4.18 15,807 4.21 31,277 31,575 4.26
------- ------- -------- ------- ------- -------
Total........................$ 500 $40,863 $ 19,893 $15,807 $77,063 $80,299
======= ======= ======== ======= ======= =======
DEPOSITS AND BORROWED FUNDS
GENERAL. Savings accounts and other types of deposits have traditionally
been an important source of the Bank's funds for use in lending and for other
general business purposes. In addition to deposits, the Bank derives funds from
loan repayments, loan sales, borrowings and from other operations. The
availability of funds is influenced by the general level of interest rates and
other market conditions. Scheduled loan repayments are a relatively stable
source of funds while deposit inflows and outflows vary widely and are
influenced by prevailing interest rates and market conditions. Borrowings may be
used on a short-term basis to compensate for reductions in deposits or deposit
inflows at less than projected levels and may be used on a longer term basis to
support expanded lending activities.
DEPOSITS. Consumer deposits are attracted principally from within the
Bank's market area through the offering of a broad selection of deposit
instruments including demand deposit accounts, NOW accounts, money market
deposit accounts, regular savings accounts, term deposit accounts and retirement
savings plans. The Bank has historically not actively solicited or advertised
for deposits outside of its market area or solicited brokered deposits. During
fiscal 2003, the Bank did enter into a retail CD brokerage agreement with a
major brokerage firm and considers this arrangement to be a secondary source of
liquidity. The Bank attracts deposits through its branch office network,
automated teller machines, the Internet and by paying rates competitive with
other Massachusetts financial institutions.
DEPOSIT ACCOUNTS. The following table shows the distribution of the average
balance of the Bank's deposit accounts at the dates indicated and the weighted
average rate paid for each category of account for the years indicated.
Years Ended March 31,
--------------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- ----------------------------- ---------------------------
Average Average Average
Average % of Rate Average % of Rate Average % of Rate
Balance Deposits Paid Balance Deposits Paid Balance Deposits Paid
-------- -------- ------ --------- -------- ------ -------- --------- ----
(Dollars in thousands)
Demand deposit accounts....... $ 29,998 10.5% --% $ 29,586 10.7% --% $ 24,535 9.0% --%
NOW accounts.................. 36,980 13.0 .53 37,271 13.4 .64 36,177 13.2 1.12
Passbook and other savings
accounts.................. 72,925 25.5 .63 70,489 25.4 1.10 67,322 24.7 1.32
Money market deposit accounts. 44,125 15.4 1.55 33,695 12.1 1.83 16,869 6.2 1.75
Term deposit certificates..... 101,688 35.6 3.06 106,572 38.4 3.72 127,906 46.9 5.13
--------- ------ ---------- ----- -------- -----
Total deposits............ $ 285,716 100.0% 1.56% $ 277,613 100.0% 2.02% $272,809 100.0% 2.98%
========= ====== ========== ===== ======== =====
13
TIME DEPOSITS IN EXCESS OF $100,000. The following table indicates the
amount of the Bank's time deposits of $100,000 or more by time remaining until
maturity as of March 31, 2004 (in thousands).
Maturity Period:
Three months or less..............................$ 5,106
Three through six months.......................... 4,329
Six through twelve months......................... 5,624
Over twelve months................................ 12,548
---------
Total.......................................$ 27,607
=========
BORROWINGS. From time to time, the Bank borrows funds from the FHLB of
Boston. All advances from the FHLB of Boston are secured by a blanket lien on
residential first mortgage loans, certain investment securities and commercial
real estate loans and all the Bank's stock in the FHLB of Boston. At March 31,
2004, the Bank had advances outstanding from the FHLB of Boston of $141.1
million. Proceeds from these advances were primarily used to fund the Bank's
loan growth. Additional sources of borrowed funds include The Co-operative
Central Bank Reserve Fund and the Federal Reserve Bank.
The following table sets forth certain information regarding borrowings
from the FHLB of Boston, including short-term borrowings under a line of credit,
at the dates and for the periods indicated.
At or for the
Years Ended March 31,
------------------------------------------------
2004 2003 2002
---------- ---------- ----------
(Dollars in thousands)
Amounts outstanding at end of period......................... $ 141,100 $ 144,400 $164,000
Weighted average rate at end of period....................... 4.82% 4.81% 4.39%
Maximum amount of borrowings outstanding
at any month end........................................... $ 144,400 $ 165,500 $164,000
Approximate average amounts outstanding...................... $ 143,455 $ 155,590 $124,680
Approximate weighted average rate during the year............ 4.89% 4.67% 5.41%
SUBSIDIARIES
In April 1998 and July 2003, the Bank established Central Securities
Corporation and Central Securities Corporation II, respectively, Massachusetts
corporations, as wholly owned subsidiaries of the Bank for the purpose of
engaging exclusively in buying, selling and holding, on their own behalf,
securities that may be held directly by the Bank. These subsidiaries hold
government agency obligations, corporate bonds and mortgage-backed securities
and qualify under Section 38B of Chapter 63 of the Massachusetts General Laws as
a Massachusetts security corporation.
In July 1999, the Bank established Central Preferred Capital Corporation
("CPCC"), a Massachusetts corporation which elected to be taxed as a real estate
investment trust ("REIT") for federal and Massachusetts tax purposes. CPCC held
mortgage loans which were previously originated by the Bank. In December 2003,
the Bank liquidated its REIT subsidiary in a tax-free transaction.
14
REGULATION AND SUPERVISION
REGULATION AND SUPERVISION OF THE COMPANY
GENERAL. The Company is a bank holding company subject to regulation by the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended
(the "BHCA"). As a result, the activities of the Company are subject to certain
limitations, which are described below. In addition, as a bank holding company,
the Company is required to file annual and quarterly reports with the Federal
Reserve Board and to furnish such additional information as the Federal Reserve
Board may require pursuant to the BHCA. The Company is also subject to regular
examination by the Federal Reserve Board.
ACTIVITIES. With certain exceptions, the BHCA prohibits a bank holding
company from acquiring direct or indirect ownership or control of more than 5%
of the voting shares of a company that is not a bank or a bank holding company,
or from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve Board regulation or
order, have been identified as activities closely related to the business of
banking. The activities of the Company are subject to these legal and regulatory
limitations under the BHCA and the related Federal Reserve Board regulations.
Notwithstanding the Federal Reserve Board's prior approval of specific
nonbanking activities, the Federal Reserve Board has the power to order a
holding company or its subsidiaries to terminate any activity, or to terminate
its ownership or control of any subsidiary, when it has reasonable cause to
believe that the continuation of such activity or such ownership or control
constitutes a serious risk to the financial safety, soundness or stability of
any bank subsidiary of that holding company.
Effective with the enactment of the Gramm-Leach-Bliley Act (the "G-L-B
Act") on November 12, 1999, bank holding companies whose financial institution
subsidiaries are well capitalized and well managed and have satisfactory
Community Reinvestment Act ("CRA") records can elect to become "financial
holding companies" which are permitted to engage in a broader range of financial
activities than are permitted to bank holding companies. Financial holding
companies are authorized to engage in, directly or indirectly, financial
activities. A financial activity is an activity that is: (i) financial in
nature; (ii) incidental to an activity that is financial in nature; or (iii)
complementary to a financial activity and that does not pose a safety and
soundness risk. The G-L-B Act includes a list of activities that are deemed to
be financial in nature. Other activities also may be decided by the Federal
Reserve Board to be financial in nature or incidental thereto if they meet
specified criteria. A financial holding company that intends to engage in a new
activity or to acquire a company to engage in such an activity is required to
give prior notice to the Federal Reserve Board. If the activity is not either
specified in the G-L-B Act as being a financial activity or one that the Federal
Reserve Board has determined by rule or regulation to be financial in nature,
the prior approval of the Federal Reserve Board is required.
ACQUISITIONS. Under the BHCA, a bank holding company must obtain the prior
approval of the Federal Reserve Board before (1) acquiring direct or indirect
ownership or control of any voting shares of any bank or bank holding company
if, after such acquisition, the bank holding company would directly or
indirectly own or control more than 5% of such shares; (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or (3)
merging or consolidating with another bank holding company. Satisfactory
financial condition, particularly with regard to capital adequacy, and
satisfactory CRA ratings generally are prerequisites to obtaining federal
regulatory approval to make acquisitions.
Under the BHCA, any company must obtain approval of the Federal Reserve
Board prior to acquiring control of the Company or the Bank. For purposes of the
BHCA, "control" is defined as ownership of more than 25% of any class of voting
securities of the Company or the Bank, the ability to control the election of a
majority of the directors, or the exercise of a controlling influence over
management or policies of the Company or the Bank. In addition, the Change in
Bank Control Act and the related regulations of the Federal Reserve Board
require any person or persons acting in concert (except for companies required
to make application under the BHCA), to file a written notice with the Federal
Reserve Board before such person or persons may acquire control of the Company
or the Bank. The Change in Bank Control Act defines "control" as the power,
directly or indirectly, to vote 25% or more of any voting securities or to
direct the management or policies of a bank holding company or an insured bank.
14
Under Massachusetts banking law, prior approval of the Massachusetts
Division of Banks is also required before any person may acquire control of a
Massachusetts bank or bank holding company. Massachusetts law generally
prohibits a bank holding company from acquiring control of an additional bank if
the bank to be acquired has been in existence for less than three years or, if
after such acquisition, the bank holding company would control more than 30% of
the FDIC-insured deposits in the Commonwealth of Massachusetts.
CAPITAL REQUIREMENTS. The Federal Reserve Board has adopted guidelines
regarding the capital adequacy of bank holding companies, which require bank
holding companies to maintain specified minimum ratios of capital to total
assets and capital to risk-weighted assets. See "Regulation and Supervision of
the Bank--Capital Requirements."
DIVIDENDS. The Federal Reserve Board has the power to prohibit dividends by
bank holding companies if their actions constitute unsafe or unsound practices.
The Federal Reserve Board has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the Federal Reserve Board's
view that a bank holding company should pay cash dividends only to the extent
that the company's net income for the past year is sufficient to cover both the
cash dividends and a rate of earnings retention that is consistent with the
company's capital needs, asset quality and overall financial condition. The
Federal Reserve Board also indicated that it would be inappropriate for a bank
holding company experiencing serious financial problems to borrow funds to pay
dividends. Under the prompt corrective action regulations adopted by the Federal
Reserve Board pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"), the Federal Reserve Board may prohibit a bank holding
company from paying any dividends if the holding company's bank subsidiary is
classified as "undercapitalized." See "Regulation and Supervision of the Bank --
Prompt Corrective Regulatory Action."
STOCK REPURCHASES. As a bank holding company, the Company is required to
give the Federal Reserve Board prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption, when combined with the net consideration paid for
all such purchases or redemptions during the preceding 12 months, is equal to
10% or more of the Company's consolidated net worth. The Federal Reserve Board
may disapprove such a purchase or redemption if it determines that the proposal
would violate any law, regulation, Federal Reserve Board order, directive or any
condition imposed by, or written agreement with, the Federal Reserve Board. This
requirement does not apply to bank holding companies that are
"well-capitalized," received one of the two highest examination ratings at their
last examination and are not the subject of any unresolved supervisory issues.
SARBANES-OXLEY ACT OF 2002. On July 30, 2002, the Sarbanes-Oxley Act of
2002 ("SOX") was signed into law which mandated a variety of reforms intended to
address corporate and accounting fraud. SOX contained provisions which amend the
Securities Exchange Act of 1934, as amended (the "Act") and provisions which
directed the SEC to promulgate rules. The resultant law and regulations under
the Act as of the time of this annual report is set forth in the following
paragraphs. SOX provides for the establishment of a new Public Company
Accounting Oversight Board ("PCAOB"), which enforces auditing, quality control
and independence standards for firms that audit Securities and Exchange
Commission ("SEC")-reporting companies and is funded by fees from all
SEC-reporting companies. SOX imposes higher standards for auditor independence
and restricts the provision of consulting services by auditing firms to
companies they audit. Any non-audit services being provided to an audit client
will require preapproval by the Company's audit committee members. In addition,
certain audit partners must be rotated periodically. SOX requires chief
executive officers and chief financial officers, or their equivalent, to certify
to the accuracy of periodic reports filed with the SEC, subject to civil and
criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under SOX, counsel is required to report evidence of a
material violation of the securities laws or a breach of fiduciary duty by a
company to its chief executive officer or its chief legal officer, and, if such
officer does not appropriately respond, to report such evidence to the audit
committee or other similar committee of the board of directors or the board
itself.
Longer prison terms will be applied to corporate executives who violate
federal securities laws, the period during which certain types of suits can be
brought against a company or its officers has been extended, and bonuses issued
to top executives prior to restatement of a company's financial statements are
now subject to disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from trading during retirement plan "blackout"
periods, and loans to company executives are restricted. In addition, a
provision directs that civil penalties levied by the SEC as a result of any
judicial or administrative action under the Act be deposited in a fund
16
for the benefit of harmed investors. Directors and executive officers must also
report most changes in their ownership of a company's securities within two
business days of the change, and all ownership reports now must be
electronically filed.
SOX also increases the oversight and authority of audit committees of
publicly traded companies. Audit committee members must be independent and are
barred from accepting consulting, advisory or other compensatory fees from the
issuer. In addition, all SEC-reporting companies must disclose whether at least
one member of the committee is an audit committee "financial expert" (as such
term is defined by the SEC rules) and if not, an explanation must be provided.
Audit committees of publicly traded companies will have authority to retain
their own counsel and other advisors funded by the company. Audit committees
must establish procedures for the receipt, retention and treatment of complaints
regarding accounting and auditing matters and procedures for the confidential
and anonymous submission of employee concerns regarding questionable accounting
or auditing matters. It is the responsibility of the audit committee to hire,
oversee and work on disagreements with the Company's independent auditor.
Beginning six months after the SEC determines that the PCAOB is able to
carry out its functions, it will be unlawful for any person that is not a
registered public accounting firm ("RPAF") to audit an SEC-reporting company.
Under the Act, a RPAF is prohibited from performing statutorily mandated audit
services for a company if such company's chief executive officer, chief
financial officer, comptroller, chief accounting officer or any person serving
in equivalent positions has been employed by such firm and participated in the
audit of such company during the one-year period preceding the audit initiation
date. SOX also prohibits any officer or director of a company or any other
person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the Company's financial statements for the
purpose of rendering the financial statement's materially misleading. The SEC
has prescribed rules requiring inclusion of an internal control report and
assessment by management in the annual report to shareholders, with which the
Company will be required to comply beginning with its fiscal year ending March
31, 2006. SOX requires the RPAF that issues the audit report to attest to and
report on management's assessment of the Company's internal controls. In
addition, SOX requires that each financial report required to be prepared in
accordance with (or reconciled to) generally accepted accounting principles and
filed with the SEC reflect all material correcting adjustments that are
identified by a RPAF in accordance with generally accepted accounting principles
and the rules and regulations of the SEC.
Although the Company anticipates it will incur additional expense in
complying with the provisions of the Act and the related rules, management does
not expect that such compliance will have a material impact on the Company's
financial condition or results of operations.
REGULATION AND SUPERVISION OF THE BANK
GENERAL. The Bank is subject to extensive regulation by the Commissioner
and the FDIC. The lending activities and other investments of the Bank must
comply with various regulatory requirements. The Commissioner and FDIC
periodically examine the Bank for compliance with these requirements. The Bank
must file reports with the Commissioner and the FDIC describing its activities
and financial condition. The Bank is also subject to certain reserve
requirements promulgated by the Federal Reserve Board. This supervision and
regulation is intended primarily for the protection of depositors.
CAPITAL REQUIREMENTS. Under FDIC regulations, state-chartered banks that
are not members of the Federal Reserve System are required to maintain a minimum
leverage capital requirement consisting of a ratio of Tier 1 capital to total
assets of 3% if the FDIC determines that the institution is not anticipating or
experiencing significant growth and has well-diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high liquidity, good
earnings and, in general, a strong banking organization, rated composite 1 under
the Uniform Financial Institutions Rating System (the CAMELS rating system)
established by the Federal Financial Institutions Examination Council. For all
but the most highly-rated institutions meeting the conditions set forth above,
the minimum leverage capital ratio is 3% plus an additional "cushion" amount of
at least 100 to 200 basis points with a minimum leverage capital requirement of
not less than 4%. Tier 1 capital is the sum of common stockholders' equity,
noncumulative perpetual preferred stock (including any related surplus) and
minority interests in consolidated subsidiaries, minus all intangible assets
(other than certain mortgage and non-mortgage servicing
17
assets, purchased credit card relationships and qualifying supervisory goodwill)
minus identified losses, disallowed deferred tax assets and investments in
financial subsidiaries and certain non-financial equity investments.
In addition to the leverage ratio (the ratio of Tier 1 capital to total
assets), state-chartered nonmember banks must maintain a minimum ratio of
qualifying total capital to risk-weighted assets of at least 8%, of which at
least half must be Tier 1 capital. Qualifying total capital consists of Tier 1
capital plus Tier 2 or supplementary capital items. Tier 2 capital items include
allowances for loan losses in an amount of up to 1.25% of risk-weighted assets,
cumulative preferred stock and preferred stock with a maturity of over 20 years,
certain other capital instruments and up to 45% of pre-tax net unrealized
holding gains on equity securities. The includable amount of Tier 2 capital
cannot exceed the institution's Tier 1 capital. Qualifying total capital is
further reduced by the amount of the bank's investments in banking and finance
subsidiaries that are not consolidated for regulatory capital purposes,
reciprocal cross-holdings of capital securities issued by other banks, most
intangible assets and certain other deductions. Under the FDIC risk-weighting
system, all of a bank's balance sheet assets and the credit equivalent amounts
of certain off-balance sheet items are assigned to one of four broad risk weight
categories from 0% to 100%, based on the risks inherent in the type of assets or
item. The aggregate dollar amount of each category is multiplied by the risk
weight assigned to that category. The sum of these weighted values equals the
bank's risk-weighted assets.
At March 31, 2004, the Bank's ratio of Tier 1 capital to average assets was
7.92%, its ratio of Tier 1 capital to risk-weighted assets was 10.75% and its
ratio of total risk-based capital to risk-weighted assets was 11.80%.
DIVIDEND LIMITATIONS. The Bank may not pay dividends on its capital stock
if its regulatory capital would thereby be reduced below the amount then
required for the liquidation account established for the benefit of certain
depositors of the Bank at the time of its conversion to stock form.
Earnings of the Bank appropriated to bad debt reserves and deducted for
Federal income tax purposes are not available for payment of cash dividends or
other distributions to stockholders without payment of taxes at the then current
tax rate by the Bank on the amount of earnings removed from the reserves for
such distributions. The Bank intends to make full use of this favorable tax
treatment and does not contemplate use of any earnings in a manner which would
limit the Bank's bad debt deduction or create federal tax liabilities.
Under FDIC regulations, the Bank is prohibited from making any capital
distributions if, after making the distribution, the Bank would have: (i) a
total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based
capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
DEPOSIT INSURANCE. The Bank is required to pay assessments to the FDIC for
insurance of its deposits by the BIF based on a percentage of its insured
deposits. Under the Federal Deposit Insurance Act, the FDIC is required to set
semi-annual assessments for BIF-insured institutions at a rate determined by the
FDIC to be necessary to maintain the designated reserve ratio of the BIF at
1.25% of estimated insured deposits or at a higher percentage of insured
deposits that the FDIC determines to be justified for that year by circumstances
raising a significant risk of substantial future losses to the BIF. In the event
the BIF should fail to meet the statutory reserve ratio, the FDIC would be
required to set semi-annual assessments for BIF members that are sufficient to
increase the reserve ratio to 1.25% within one year or in accordance with such
other schedule that the FDIC adopts by regulation to restore the reserve ratio.
The assessment rate for an insured depository institution is determined by
the assessment risk classification assigned to the institution by the FDIC based
on the institution's capital level and supervisory evaluations. Based on data
reported to regulators, institutions are assigned to one of three capital
groups--well capitalized, adequately capitalized or undercapitalized--using the
same percentage criteria as in the prompt corrective action regulations. See "--
Prompt Corrective Regulatory Action." Within each capital group, institutions
are assigned to one of three subgroups on the basis of supervisory evaluations
by the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund.
The FDIC has adopted an assessment schedule for BIF deposit insurance
pursuant to which the assessment rate for well capitalized institutions with the
highest supervisory ratings was reduced to zero and institutions in the worst
risk assessment classification will be assessed at the rate of 0.27% of insured
deposits. At March 31, 2004,
18
the Bank was considered well capitalized. In addition, FDIC-insured institutions
are required to pay assessments to the FDIC to help fund interest payments on
certain bonds issued by the Financing Corporation ("FICO"), an agency of the
federal government established to finance takeovers of insolvent thrifts.
All Massachusetts chartered co-operative banks are required to be members
of the Share Insurance Fund. The Share Insurance Fund maintains a deposit
insurance fund which insures all deposits in member banks which are not covered
by federal insurance, which in the case of the Bank are its deposits in excess
of $100,000 per insured account. In past years, a premium of 1/24 of 1% of
insured deposits has been assessed annually on member banks such as the Bank for
this deposit insurance. However, no premium has been assessed in recent years.
PROMPT CORRECTIVE REGULATORY ACTION. Federal banking regulators are
required to take prompt corrective action if an insured depository institution
fails to satisfy certain minimum capital requirements, including a leverage
limit, a risk-based capital requirement and any other measure deemed appropriate
by the federal banking regulators for measuring the capital adequacy of an
insured depository institution. All institutions, regardless of their capital
levels, are restricted from making any capital distribution or paying any
management fees if the institution would thereafter fail to satisfy the minimum
levels for any of its capital requirements. An institution that fails to meet
the minimum level for any relevant capital measure (an "undercapitalized
institution") may be: (i) subject to increased monitoring by the appropriate
federal banking regulator; (ii) required to submit an acceptable capital
restoration plan within 45 days; (iii) subject to asset growth limits; and (iv)
required to obtain prior regulatory approval for acquisitions, branching and new
lines of businesses. The capital restoration plan must include a guarantee by
the institution's holding company that the institution will comply with the plan
until it has been adequately capitalized on average for four consecutive
quarters, under which the holding company would be liable up to the lesser of 5%
of the institution's total assets or the amount necessary to bring the
institution into capital compliance as of the date it failed to comply with its
capital restoration plan. A "significantly undercapitalized" institution, as
well as any undercapitalized institution that does not submit an acceptable
capital restoration plan, may be subject to regulatory demands for
recapitalization, broader application of restrictions on transactions with
affiliates, limitations on interest rates paid on deposits, asset growth and
other activities, possible replacement of directors and officers, and
restrictions on capital distributions by any bank holding company controlling
the institution. Any company controlling the institution may also be required to
divest the institution or the institution could be required to divest
subsidiaries. The senior executive officers of a significantly undercapitalized
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt. In their discretion, the federal banking
regulators may also impose the foregoing sanctions on an undercapitalized
institution if the regulators determine that such actions are necessary to carry
out the purposes of the prompt corrective provisions. If an institution's ratio
of tangible capital to total assets falls below the "critical capital level"
established by the appropriate federal banking regulator, the institution will
be subject to conservatorship or receivership within specified time periods.
Under the implementing regulations, the federal banking regulators
generally measure an institution's capital adequacy on the basis of its total
risk-based capital ratio (the ratio of its total capital to risk-weighted
assets), Tier 1 risk-based capital ratio (the ratio of its core capital to
risk-weighted assets) and leverage ratio (the ratio of its core capital to
adjusted total assets). The following table shows the capital ratios required
for the various prompt corrective action categories.
Adequately Significantly
Well Capitalized Capitalized Undercapitalized Undercapitalized
---------------- ----------- ---------------- ----------------
Total risk-based
capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0%
Tier 1 risk-based
capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0%
Leverage ratio 5.0% or more 4.0% or more * Less than 4.0% * Less than 3.0%
- -----------
* 3.0% if the institution has a composite 1 CAMELS rating.
A "critically undercapitalized" institution is defined as an institution
that has a ratio of "tangible equity" to total assets of less than 2.0%.
Tangible equity is defined as core capital plus cumulative perpetual preferred
stock (and related surplus) less all intangible assets other than qualifying
19
supervisory goodwill and certain purchased mortgage servicing rights. The FDIC
may reclassify a well capitalized depository institution as adequately
capitalized and may require an adequately capitalized or undercapitalized
institution to comply with the supervisory actions applicable to institutions in
the next lower capital category (but may not reclassify a significantly
undercapitalized institution as critically undercapitalized) if the FDIC
determines, after notice and an opportunity for a hearing, that the savings
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMELS rating
category.
USA PATRIOT ACT. The USA Patriot Act is intended to strengthen U.S. law
enforcement's and the intelligence communities' abilities to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the USA Patriot
Act on financial institutions of all kinds is significant and wide ranging. The
USA Patriot Act contains sweeping anti-money laundering and financial
transparency laws and imposes various regulations including standards for
verifying client identification at account opening, and rules to promote
cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering.
LOANS TO EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS. Loans to
directors, executive officers and principal stockholders of a state non-member
bank like the Bank must be made on substantially the same terms as those
prevailing for comparable transactions with persons who are not executive
officers, directors, principal stockholders or employees of the Bank unless the
loan is made pursuant to a compensation or benefit plan that is widely available
to employees and does not favor insiders. Loans to any executive officer,
director and principal stockholder, together with all other outstanding loans to
such person and affiliated interests, generally may not exceed 15% of the bank's
unimpaired capital and surplus, and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Loans to directors,
executive officers and principal stockholders, and their respective affiliates,
in excess of the greater of $25,000 or 5% of capital and surplus (up to
$500,000) must be approved in advance by a majority of the board of directors of
the bank with any "interested" director not participating in the voting. State
non-member banks are prohibited from paying the overdrafts of any of their
executive officers or directors unless payment is made pursuant to a written,
pre-authorized interest-bearing extension of credit plan that specifies a method
of repayment or transfer of funds from another account at the bank. Loans to
executive officers may not be made on terms more favorable than those afforded
other borrowers and are restricted as to type, amount and terms of credit. In
addition, Section 106 of the BHCA prohibits extensions of credit to executive
officers, directors and greater than 10% stockholders of a depository
institution by any other institution which has a correspondent banking
relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features. Extensions of credit to
executive officers are subject to additional restrictions.
TRANSACTIONS WITH AFFILIATES. A state non-member bank or its subsidiaries
may not engage in "covered transactions" with any one affiliate in an amount
greater than 10% of such bank's capital stock and surplus, and for all such
transactions with all affiliates a state non-member bank is limited to an amount
equal to 20% of capital stock and surplus. All such transactions must also be on
terms substantially the same, or at least as favorable, to the bank or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. An affiliate of a state non-member bank is
any company or entity which controls or is under common control with the state
non-member bank and, for purposes of the aggregate limit on transactions with
affiliates, any subsidiary that would be deemed a financial subsidiary of a
national bank. In a holding company context, the parent holding company of a
state non-member bank (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the state non-member
bank. The BHCA and Regulation W further prohibit a depository institution from
extending credit to or offering any other services, or fixing or varying the
consideration for such extension of credit or service, on the condition that the
customer obtain some additional service from the institution or certain of its
affiliates or not obtain services of a competitor of the institution, subject to
certain limited exceptions.
MASSACHUSETTS STATE LAW. As a Massachusetts-chartered co-operative bank,
the Bank is subject to the applicable provisions of Massachusetts law and the
regulations of the Commissioner adopted thereunder. The Bank derives its lending
and investment powers from these laws, and is subject to periodic examination
and reporting requirements by and of the Commissioner. In addition, the Bank is
required to make periodic reports to the Co-operative Central Bank. In 1990,
legislation was enacted permitting banks nationwide to enter the Bank's market
20
area and compete for deposits and loan originations. The approval of the
Commissioner is required prior to any merger or consolidation, or the
establishment or relocation of any branch office.
EMPLOYEES
At March 31, 2004, the Company and the Bank employed 102 full-time and 40
part-time employees. The Company's and Bank's employees are not represented by
any collective bargaining agreement. Management of the Company and Bank
considers its relations with its employees to be good.
ITEM 2. PROPERTIES
- -------------------
The Bank owns all its offices, except the Burlington, Malden and Woburn
High School offices, and the loan and operations centers located in Somerville.
Net book value includes the cost of land, buildings and improvements as well as
leasehold improvements, net of depreciation and amortization. At March 31, 2004,
all of the Bank's offices were in reasonable condition and met the business
needs of the Bank. The following table sets forth the location of the Bank's
offices, as well as certain information relating to these offices as of March
31, 2004:
NET BOOK
YEAR VALUE AT
OFFICE LOCATION OPENED MARCH 31, 2004
--------------- ------ --------------
(in thousands)
MAIN OFFICE
399 Highland Avenue
Somerville, MA............................................. 1974 $ 309
BRANCH OFFICES:
175 Broadway
Arlington, MA.............................................. 1982 131
85 Wilmington Road
Burlington, MA............................................. 1978 (a) 3
1192 Boylston Street
Chestnut Hill (Brookline), MA.............................. 1954 124
137 Pleasant Street
Malden, MA................................................. 1975 (b) 31
846 Main Street
Melrose, MA................................................ 1994 212
275 Main Street
Woburn, MA................................................. 1980 459
198 Lexington Street
Woburn, MA................................................. 1974 160
Woburn High School
Woburn, MA................................................. 2002 (c) 30
OPERATIONS CENTER
17 Inner Belt Road
Somerville, MA............................................. 1994 (d) 10
21
NET BOOK
YEAR VALUE AT
OFFICE LOCATION OPENED MARCH 31, 2004
--------------- ------ --------------
(in thousands)
COMMERCIAL LOAN CENTER
401 Highland Avenue........................................ 2002 (e) $ 38
Somerville, MA
RESIDENTIAL LOAN CENTER
403 Highland Avenue
Somerville, MA............................................. 2002 (f) 42
- ---------------
(a) The lease for the Burlington branch expires in 2007 with no renewal option.
(b) The lease for the Malden branch expires in 2005 with an option to extend
the lease for one ten-year term.
(c) The lease for the Woburn High School branch is for one year, renewable
annually.
(d) The lease for the Operations Center expires in 2005 with no renewal option.
(e) The lease for the Commercial Loan Center expires in 2006 with an option to
extend for one three-year term.
(f) The lease for the Residential Loan Center expires in 2005 with an option to
extend for one three-year term.
At March 31, 2004, the net book value of the Bank's premises and equipment
was $2.1 million.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
The Company from time to time is involved as a plaintiff or defendant in
various legal actions incidental to its business, none of which are believed to
be material, either individually or collectively, to the results of operations
and financial condition of the Company. See Note 12 to the accompanying
consolidated financial statements for additional information related to
litigation which was resolved during fiscal 2004.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
22
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF SECURITIES
- --------------------------------------------------------------------------------
The Company's common stock is quoted on the Nasdaq National MarketSM under
the symbol "CEBK." At March 31, 2004, there were 1,664,957 shares of the common
stock outstanding and approximately 244 holders of record. The foregoing number
of holders does not reflect the number of persons or entities who held the stock
in nominee or "street name" through various brokerage firms. In October 1996,
the Company established a quarterly cash dividend policy and made its first
dividend distribution on November 15, 1996; it has paid cash dividends on a
quarterly basis since initiating the dividend program.
The following tables list the high and low prices for the Common Stock
during each quarter of fiscal 2004 and fiscal 2003 as reported by the Nasdaq
National MarketSM, and the amounts and payable dates of the cash dividends paid
during each quarter of fiscal 2004 and fiscal 2003. The stock quotations
constitute interdealer prices without retail markups, markdowns or commissions,
and may not necessarily represent actual transactions.
Common Stock Prices Cash Dividends (payable dates)
Fiscal 2004 High Low Fiscal 2004 Amount
-------------------------------------------------------- ------------------------
6/30/03 $35.00 $31.05 5/16/03 $0.12
9/30/03 35.74 34.37 8/15/03 0.12
12/31/03 38.00 34.41 11/14/03 0.12
3/31/04 38.00 33.00 2/13/04 0.12
Fiscal 2003 High Low Fiscal 2003 Amount
-------------------------------------------------------- -----------------------
6/30/02 $31.95 $26.50 5/17/02 $0.10
9/30/02 33.50 28.05 8/16/02 0.10
12/31/02 31.50 28.31 11/15/02 0.12
3/31/03 36.55 30.11 2/14/03 0.12
The following table sets forth information regarding the Company's
repurchases of its Common Stock during the quarter ended March 31, 2004.
(c)
Total (d)
Number of Maximum
(a) Shares Purchased Number of Shares
Total (b) as Part of that May Yet Be
Number of Average Publicly Purchased Under
Shares Price Paid Announced Plans the Plans or
Period Purchased per Share or Programs Programs
------ --------- ---------- ----------------- ----------------
January 2004
Beginning date: January 1 -- -- -- --
Ending date: January 31
February 2004
Beginning date: February 1 -- -- -- --
Ending date: February 29
March 2004
Beginning date: March 1 511 (1) $36.55 -- --
Ending date: March 31
Total 511 $36.55 -- --
- ---------------------
(1) These shares were purchased by a grantor trust of the Company
established pursuant to the Company's Deferred Compensation Plan for
Non-Employee Directors. The shares were not part of an announced
repurchase program.
23
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
At or for the Year Ended March 31,
------------------------------------------------------------
2004 2003 2002 2001 2000
-------- ----------- -------- -------- --------
(Dollars and shares in thousands, except per share data)
BALANCE SHEET
Total assets................................ $ 490,897 $ 477,208 $ 468,219 $ 449,337 $ 409,557
Total loans................................. 357,424 390,464 371,707 345,793 320,013
Investment securities, available for sale... 83,771 61,111 73,884 49,388 68,316
Deposits.................................... 295,920 287,959 261,907 287,167 258,339
Borrowings.................................. 145,256 144,576 164,000 121,000 111,000
Total stockholders' equity.................. 43,454 39,443 38,954 38,212 37,397
Shares outstanding.......................... 1,665 1,662 1,633 1,684 1,810
STATEMENTS OF OPERATIONS
Net interest and dividend income............ $ 15,570 $ 17,257 $ 14,413 $ 13,914 $ 13,375
Provision for loan losses................... 200 -- -- -- --
Net gain (loss) from sale and write-down of
investment securities................... (135) (308) (150) 680 1,013
Gain on sale of loans....................... 295 796 -- -- --
Other non-interest income................... 966 917 838 608 656
Total non-interest expenses................. 12,401 13,877 10,464 10,330 9,345
Income before cumulative effect of
accounting change....................... 2,936 2,187 2,860 3,109 3,567
Net income.................................. 2,936 2,187 2,860 3,109 3,333
Earnings per common share after cumulative
effect of accounting change - diluted... 1.88 1.37 1.72 1.81 1.77
SELECTED RATIOS
Interest rate spread........................ 2.96% 3.29% 2.85% 2.80% 3.11%
Net yield on interest-earning assets........ 3.36 3.71 3.36 3.38 3.64
Non-interest expenses to average assets..... 2.60 2.91 2.38 2.44 2.47
Equity-to-assets............................ 8.85 8.27 8.32 8.50 9.13
Return on average assets before cumulative
effect of change in accounting principle 0.62 0.46 0.65 0.74 0.94
Return on average stockholders' equity
before cumulative effect of change in
accounting principle.................... 6.98 5.52 7.62 8.11 9.49
Dividend payout ratio....................... 23.23 33.24 23.39 22.42 20.67
Book value per share........................ $26.10 $23.73 $23.85 $22.69 $20.66
Tangible book value per share............... 24.76 22.38 22.49 21.19 19.11
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
GENERAL
The operations of the Company and its subsidiary, the Bank, are generally
influenced by overall economic conditions, the related monetary and fiscal
policies of the federal government and the regulatory policies of financial
institution regulatory authorities, including the Commissioner, the Federal
Reserve Board and the FDIC.
The Bank monitors its exposure to earnings fluctuations resulting from
market interest rate changes. Historically, the Bank's earnings have been
vulnerable to changing interest rates due to differences in the terms to
maturity or repricing of its assets and liabilities. For example, in a rising
interest rate environment, the Bank's net interest income and net income could
be negatively affected as interest-sensitive liabilities (deposits and
borrowings) could adjust more quickly to rising interest rates than the Bank's
interest-sensitive assets (loans and investments).
The following is a discussion and analysis of the Company's results of
operations for the last three fiscal years and its financial condition at the
end of fiscal years 2004 and 2003. Management's discussion and analysis of
financial condition and results of operations should be read in conjunction with
the consolidated financial statements and accompanying notes.
FUTURE EXPANSION PLANS
For information regarding the Bank's future expansion plans, see "Item 1.
Business - Future Expansion Plans."
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of the Company's financial condition
and results of operations are based on the consolidated financial statements
which are prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of such financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. On an ongoing basis, management evaluates its
estimates, including those related to the allowance for loan losses. Management
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis in making judgments about the carrying values of assets that are
not readily apparent from other sources. Actual results could differ from the
amount derived from management's estimates and assumptions under different
assumptions or conditions.
Management believes the allowance for loan losses policy is a critical
accounting policy that requires the most significant estimates and assumptions
used in the preparation of the consolidated financial statements. The allowance
for loan losses is based on management's evaluation of the level of the
allowance required in relation to the estimated loss exposure in the loan
portfolio. Management believes the allowance for loan losses is a significant
estimate and therefore regularly evaluates it for adequacy by taking into
consideration factors such as prior loan loss experience, the character and size
of the loan portfolio, business and economic conditions and management's
estimation of inherent losses. The use of different estimates or assumptions
could produce different provisions for loan losses. Refer to the discussion of
Allowance for Loan Losses in the Business Section and Notes 1 and 4 to
Consolidated Financial Statements for a detailed description of management's
estimation process and methodology related to the allowance for loan losses.
RESULTS OF OPERATIONS
OVERVIEW. The Company's results of operations during the past three fiscal
years have been influenced by several significant factors. From a recurring
operating perspective, the generally declining trend in both short and long-term
interest rates from January 2001 until March 2004 has had a significant impact
on both the balance sheet and income statement. Most notably, residential
mortgage loans, which have historically been the Company's largest asset, have
declined $76.8 million, or 30.9%, from $248.5 million at March 31, 2001 to
25
$171.7 million at March 31, 2004. With home mortgage rates declining and
ultimately hitting a 45 year low in 2003, consumers have refinanced their
mortgages, oftentimes on multiple occasions, to take advantage of the
opportunity to lock in these low rates for up to 30 years. Since the second half
of fiscal 2003, the Company has sold the majority of its current originations of
fixed-rate residential mortgage loans in order to better manage its exposure to
changing rates and, as a result, has experienced a shift in its asset mix from
residential to commercial mortgage loans. Management has favored commercial real
estate lending in recent years due to the shorter repricing characteristics of
these loans (generally every 5 years), acceptable yields and the favorable
economic market conditions in the Company's lending area.
With the declining rate trend referred to above, the Company experienced
reductions in both its yield on interest-earning assets and its cost of
interest-bearing liabilities since fiscal 2001, as summarized in the following
table:
YIELD COST SPREAD
----- ---- ------
Fiscal 2001 7.50% 4.70% 2.80%
Fiscal 2002 6.83 3.98 2.85
Fiscal 2003 6.48 3.19 3.29
Fiscal 2004 5.84 2.88 2.96
As this table indicates, the declining rate trend had a favorable impact on
the Company's net interest margin through fiscal 2003. This trend was also aided
by the relatively high ratio of loans to interest-earning assets maintained
during this entire period, especially through fiscal 2003. In fiscal 2004, this
favorable trend reversed as more assets were repriced downward (mostly due to
loan prepayments and modifications) than were liabilities.
The unfavorable trend in the net interest margin in fiscal 2004 is
primarily reflective of the limitations the Company had in reducing its overall
cost of funds. This limitation is due to two factors. First, the Company's
utilization of long-term FHLB advances, which averaged $143.4 million during the
year, had limited repricing opportunity as only $5.3 million in advances matured
in fiscal 2004. These advances can not be prepaid without a substantial penalty,
which management has elected not to pay. Second, the ability to reduce deposit
rates in the current year was limited after the two prior years of rate
reductions as well as competitive market factors.
The Company's overall financial results in fiscal 2003 and 2004 were also
affected by two significant non-operating items, namely, state legislation
affecting the taxation of its former REIT subsidiary and shareholder and other
litigation. Each of these items adversely affected overall financial results in
fiscal 2003 and favorably affected financial results in fiscal 2004 as
demonstrated in the following table (in thousands):
2004 2003
---- ----
Net income, as reported $2,936 $2,187
REIT taxation (374) 835
Shareholder and other litigation,
net of insurance recoveries (329) 1,080
------ ------
Pro forma earnings $2,233 $4,102
------ ------
The Company's earnings in fiscal 2003 were adversely affected by state
legislation (the "REIT legislation") passed in March 2003 that retroactively
eliminated the dividends received deduction on dividends received from the
Bank's former REIT subsidiary. The REIT legislation resulted in an increase in
the Company's provision for income taxes of $835 thousand in fiscal 2003. In
June 2003, a group of banks negotiated a settlement with the Massachusetts
Department of Revenue ("DOR") and, as a result, the Bank recognized in fiscal
2004 a reduction in the Company's provision for income taxes of $374 thousand.
The legal fees associated with the litigation with certain shareholders,
who initially filed suit against the Company in October 2002 following the
annual meeting of shareholders and an accrual for a commercial claim, totaled
approximately $1.1 million, net of taxes, in fiscal 2003. The Company has
coverage under its directors' and
26
officers' liability insurance policy for reimbursement of certain legal fees.
During fiscal 2004, insurance recoveries in excess of related legal fees totaled
$329 thousand, net of taxes.
INTEREST RATE SPREAD. The Company's and the Bank's operating results are
significantly affected by its net interest spread, which is the difference
between the yield on loans and investments and the interest cost of deposits and
borrowings. The interest spread is affected by economic conditions and market
factors that influence interest rates, loan demand and deposit flows. The
following table presents average balances, interest income and expense and
yields earned or rates paid on all interest-earning assets and interest-bearing
liabilities for the years indicated.
Years Ended March 31,
-------------------------------------------------------------------------------------------------
2004 2003 2002
---------------------------------- --------------------------- --------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- -------- -------- ------- -------- --------
(Dollars in thousands)
ASSETS:
Interest-earning assets:
Mortgage loans........ $ 361,305 $ 22,797 6.31% $370,505 $25,033 6.76% $327,743 $ 23,682 7.23%
Other loans........... 5,769 363 6.29 7,997 505 6.31 7,528 555 7.37
--------- -------- -------- ------- -------- --------
Total loans.......... 367,094 23,160 6.31 378,502 25,538 6.75 335,271 24,237 7.23
Short-term investments 20,342 204 1.00 7,620 125 1.64 22,076 866 3.92
Investment securities. 76,637 3,743 4.88 78,928 4,466 5.66 71,427 4,170 5.84
--------- -------- -------- ------- -------- --------
Total investments.... 96,979 3,947 4.07 86,548 4,591 5.30 93,503 5,036 5.39
--------- -------- -------- ------- -------- --------
Total interest-earning
assets 464,073 27,107 5.84 465,050 30,129 6.48 428,774 29,273 6.83
-------- ------- --------
Allowance for loan losses (3,400) (3,287) (3,234)
Non-interest-earning assets 16,317 14,406 14,951
--------- -------- --------
Total assets..... $ 476,991 $476,169 $440,491
========= ======== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Deposits.............. $ 255,718 $ 4,436 1.73 $248,027 $ 5,601 2.26 $248,274 8,119 3.27
Other borrowings...... 1,977 82 4.15 505 9 1.78 477 10 2.10
Advances from FHLB of
Boston............... 143,381 7,019 4.90 155,085 7,262 4.68 124,203 6,731 5.42
--------- -------- -------- ------- -------- --------
Total interest-bearing
liabilities.... 401,074 11,537 2.88 403,617 12,872 3.19 372,954 14,860 3.98
-------- ----- ------- ----- -------- -----
Non-interest-bearing deposits 29,998 29,586 24,535
Other liabilities....... 3,862 3,371 4,481
--------- -------- --------
Total liabilities 434,934 436,574 401,970
Stockholders' equity.... 42,057 39,595 38,521
--------- -------- --------
Total liabilities and
stockholders' equity $ 476,991 $476,169 $440,491
========= ======== ========
Net interest and dividend
income $ 15,570 $17,257 $14,413
======== ======= =======
Interest rate spread.... 2.96% 3.29% 2.85%
===== ===== =====
Net yield on interest-earning
assets................ 3.36% 3.71% 3.36%
===== ===== =====
27
RATE/VOLUME ANALYSIS. The effect on net interest income of changes in
interest rates and changes in the amounts of interest-earning assets and
interest-bearing liabilities is shown in the following table. Information is
provided on changes for the fiscal years indicated attributable to changes in
interest rates and changes in volume. Changes due to combined changes in
interest rates and volume are allocated between changes in rate and changes in
volume proportionally to the change due to volume and the change due to rate.
2004 vs. 2003 2003 vs. 2002
--------------------------------- ------------------------------
Changes due to Changes due to
increase (decrease) in: increase (decrease) in:
------------------------------ ------------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
Interest income:
Mortgage loans....................... $ (608) $(1,628) $ (2,236) $ 2,958 $(1,607) $ 1,351
Other loans.......................... (139) (3) (142) 33 (83) (50)
-------- ------- -------- ------- ------- -------
Total income from loans.......... (747) (1,631) (2,378) 2,991 (1,690) 1,301
-------- ------- -------- ------- ------- -------
Short-term investments............... 143 (64) 79 (393) (348) (741)
Investment securities................ (126) (597) (723) 428 (132) 296
-------- ------- -------- ------- ------- -------
Total income from investments.... 17 (661) (644) 35 (480) (445)
-------- ------- -------- ------- ------- -------
Total interest and dividend income (730) (2,292) (3,022) 3,026 (2,170) 856
-------- ------- -------- ------- ------- -------
Interest expense:
Deposits............................. 171 (1,336) (1,165) (8) (2,510) (2,518)
Other borrowings..................... 51 22 73 1 (2) (1)
Advances from FHLB of Boston......... (562) 319 (243) 1,529 (998) 531
------- ------- -------- ------- ------- -------
Total interest expense........... (340) (995) (1,335) 1,522 (3,510) (1,988)
------- ------- -------- ------- ------- -------
Net interest and dividend income....... $ (390) $(1,297) $ (1,687) $ 1,504 $ 1,340 $ 2,844
======= ======= ======== ======= ======= =======
INTEREST AND DIVIDEND INCOME. The Company experienced a $1.7 million
overall decrease in net interest and dividend income for the year ended March
31, 2004 compared to fiscal 2003. The balance of average interest-earning assets
was virtually unchanged between years, however, the Company shifted its asset
mix towards shorter-term investments in response to the decline in residential
mortgage rates to forty-five year lows. With the decline in interest rates,
management decided that most fixed-rate residential mortgage loans would be sold
in the secondary market rather than put into the loan portfolio. During fiscal
2004, $32.6 million of such loans were sold. This strategy, combined with loan
prepayments of $88.3 million caused by the desire of customers to refinance
their mortgages at favorable rates, lead to a reduction in the average balance
of loans of $11.4 million in fiscal 2004. This reduction occurred despite an
increase in the commercial real estate portfolio of $39.0 million between years.
The decline in average loan balances was offset by an increase in investments of
$10.4 million which increase was entirely in short-term investments.
Interest income on loans decreased by $2.4 million to $23.2 million due to
the aforementioned decline in the average balance of loans and a 44 basis point
decline in the average rate earned. Interest income on investments decreased by
$644 thousand in fiscal 2004 due to a 123 basis point yield reduction, partially
offset by the aforementioned increase in average holdings. The reduction in
yield on investments reflects the $12.7 million increase in the average balance
of short-term investments which had a yield of 1.0% in fiscal 2004.
The Company experienced a $2.8 million overall increase in net interest and
dividend income for the year ended March 31, 2003 compared to fiscal 2002.
Interest income on loans increased by $1.3 million to $25.5 million due to a
$43.2 million increase in average loan balances partially offset by a 48 basis
point decline in the average rate earned. During fiscal 2003, the Bank commenced
its mortgage banking initiative and sought to increase its origination of
residential mortgage loans and to eliminate the purchase of such loans. With the
continuing decline of interest rates which reached a forty-year low in fiscal
2003, the Bank was able to double its origination of such loans to $118.4
million, of which $35.7 million were sold in the secondary market. The Bank has
continued to emphasize commercial real estate lending in order to diversify the
loan portfolio and improve overall portfolio yield. Interest and dividend income
on investments decreased by $445 thousand in fiscal 2003 due primarily to a 9
basis point decrease in the rate earned on investments and a $7.0 million
decrease in the average balance of investments. The
28
overall total average balance of interest-earning assets increased by $36.3
million from fiscal 2002 to fiscal 2003, and the average yield on all
interest-earning assets decreased by 35 basis points between the two fiscal
years.
INTEREST EXPENSE. Interest expense decreased $1.3 million from $12.9
million in fiscal 2003 to $11.5 million in fiscal 2004. This decrease is
attributable to a 31 basis point reduction in the overall cost of funds in
fiscal 2004 and a $2.5 million decline in the average balance of
interest-bearing liabilities. This overall decrease is entirely attributable to
a 53 basis point reduction in the cost of deposits as the cost of FHLB advances
increased 22 basis points in fiscal 2004. This increase was caused by the
maturing of lower cost advances during the year. This trend is likely to
continue in fiscal 2005 as the advances maturing during the coming year bear an
average cost of 3.38%, or 1.44% less than the average cost of all advances
outstanding at March 31, 2004.
Interest expense on deposits decreased $2.5 million from $8.1 million in
fiscal 2002 to $5.6 million in fiscal 2003. The decrease can be attributed
primarily to a 101 basis point reduction in the cost of deposits in fiscal 2003
reflecting the series of reductions in interest rates initiated by the Federal
Reserve Board beginning in January 2001. Interest expense on borrowings
increased $530 thousand as the average balance of borrowings rose to $155.6
million during fiscal 2003 from $124.7 million during fiscal 2002, which was
partially offset by a decrease of 74 basis points in the rate paid on these
borrowings to 4.67% in fiscal 2003 from 5.41% in fiscal 2002. There was an
overall increase in the average balance of interest-bearing liabilities of $30.7
million during fiscal 2003 compared to fiscal 2002.
PROVISION FOR LOAN LOSSES. During the year ended March 31, 2004, the
Company provided $200 thousand for loan losses while no provision was recorded
in the prior two years. While the Company's loan 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 allowance for loan losses in fiscal 2004. At March 31, 2004 and
2003, the Company had no non-performing loans.
NON-INTEREST INCOME. Total non-interest income declined $279 thousand in
fiscal 2004 from $1.4 million in fiscal 2003 to $1.1 million in the current
year. This decline was attributable to an overall reduction in gains on asset
sales, net of impairment write-downs, of $328 thousand. Loan sale gains declined
by $501 thousand as a greater portion of loans were sold in fiscal 2003 on a
"mandatory delivery" basis which results in a higher gain rate than the "best
efforts delivery" basis used in 2004. In addition, loan sale gains in fiscal
2004 were adversely affected by the late delivery of certain loans to the
investor, which caused the selling price of such loans to be reduced by $240
thousand. During fiscal 2004, the Company recognized additional impairment
write-downs of $130 thousand in marketable equity securities which had
experienced a decline in fair value judged to be other than temporary compared
to $803 thousand in such write-downs in the prior year.
Total non-interest income for fiscal 2003 was $1.4 million, compared to
$688 thousand during fiscal 2002. During the second half of fiscal 2003, the
Bank commenced its mortgage banking initiative and sold $35.7 million of fixed
rate residential mortgage loans in the secondary market. These loans were sold
on a servicing released basis. The Bank realized a gain of $796 thousand on the
sale of these loans. Non-interest income in fiscal 2003 was adversely affected
by the additional write-down of $803 thousand in certain equity securities,
which had experienced a decline in fair value judged to be other than temporary.
NON-INTEREST EXPENSES.
2004 v. 2003. Non-interest expenses decreased $1.5 million during fiscal
2004 as compared to the year ended March 31, 2003. Exclusive of the impact of
the costs of litigation and related insurance recoveries for a commercial claim
and shareholder litigation, both of which were settled in fiscal 2004,
non-interest expenses would have increased $694 thousand, or 5.7%. This increase
is primarily due to increases in salaries and employee benefits ($325 thousand),
marketing expenses ($381 thousand) and other non-interest expenses ($215
thousand), partially offset by a decrease in professional fees ($206 thousand).
Salaries and employee benefits increased $325 thousand, or 4.7%, in fiscal
2004 as compared to the prior year. This increase was primarily due to average
salary increases of 4.0%, increases in staffing in the residential
29
lending area, as well as increases in health insurance and pension expense.
These increase were substantially offset by a $461 thousand reduction in
incentive compensation.
Professional fees decreased $2.1 million in fiscal 2004 as compared to the
prior year. Exclusive of the legal fees associated with shareholder litigation
incurred in both fiscal 2003 and 2004, and an insurance recovery of $3.1 million
recognized in fiscal 2004, professional fees would have decreased $206 thousand
in fiscal 2004. This decrease is largely due to the additional legal and other
professional fees incurred in fiscal 2003 in connection with the contested
election of directors at the Company's September 2002 annual stockholders
meeting.
Marketing expenses increased $381 thousand, or 96.7%, in fiscal 2004 as
compared to the prior year. This significant increase resulted from additional
promotion of residential and commercial loan products throughout the year as
well as deposit promotions during the second half of the year. The Bank
initiated a major marketing initiative, including its first-ever use of radio
advertisements, in March 2004 to promote the Bank, in general, and its new free
checking account. The Bank anticipates that competition for deposit customers
will continue to increase as a result of the recent Bank of America acquisition
of Fleet Bank. Other financial institutions, including credit unions, have also
been more active in their promotions in recent months, which will likely result
in the continuation of marketing spending at higher rates than in the past
though not at the level which occurred in fiscal 2004.
Other non-interest expenses decreased $85 thousand in fiscal 2004 as
compared to the prior year. Exclusive of settlement costs associated with a
commercial claim, such expenses would have increased $215 thousand, or 13.5%, in
fiscal 2004. This increase is primarily due to increases in insurance costs,
primarily directors and officers liability insurance, a record retention
project, contributions and lending related costs.
2003 v. 2002. Non-interest expenses increased $3.4 million during fiscal
2003, as compared to the year ended March 31, 2002. This increase was due to
increases in salaries and employee benefits ($1.3 million), data processing
expenses ($170 thousand), professional fees ($1.4 million), advertising ($133
thousand) and other non-interest expenses ($726 thousand), partially offset by
the elimination of goodwill amortization ($288 thousand).
Salaries and employee benefits increased by $1.3 million, or 23.4%, in
fiscal 2003 as compared to fiscal 2002 due to several factors including
additional lending personnel in both the residential and commercial real estate
areas, an overall salary increase of approximately 4%, additional ESOP expense
associated with shares acquired during the year and bonuses of $461 thousand
earned in connection with the Bank's management incentive compensation plan (no
bonuses were earned in fiscal 2002).
Data processing expenses increased by $170 thousand, or 17.6%, in
fiscal 2003 as compared to fiscal 2002 due primarily to volume related charges
for both data processing and item processing.
Professional fees increased by $1.4 million in fiscal 2003 as compared to
fiscal 2002 due primarily to legal fees associated with litigation with certain
of the Company's shareholders and, to a lesser extent, legal and other
professional fees incurred in connection with the contested election of
directors at the 2002 annual meeting of stockholders. Professional fees incurred
for such activities aggregated approximately $1.65 million in fiscal 2003.
Exclusive of such costs, professional fees would have been approximately $758
thousand in fiscal 2003.
Marketing expense increased by $133 thousand, or 51.0%, in fiscal 2003 as
compared to fiscal 2002 due to increased promotion of the Bank's expanded
residential and commercial real estate lending programs. During fiscal 2002, the
Bank had reduced its use of advertising to promote certificates of deposit.
Other non-interest expenses increased by $726 thousand, or 59.9%, in fiscal
2003 as compared to fiscal 2002. Such increase was due to several factors,
including the accrual for the Bank's portion of the estimated cost of resolution
of a commercial claim filed in 2002, as well as increases in ATM expense,
memberships and contributions, communication costs and directors fees.
INCOME TAXES. The effective rates of income tax expense for the years ended
March 31, 2004, 2003 and 2002 were 28.3%, 54.3% and 38.3%, respectively.
Exclusive of the impact of an additional state tax provision necessitated by
2003 tax legislation and the related settlement of such taxes in fiscal 2004,
the Company's effective tax rate was 36.9% and 38.2% in fiscal 2004 and 2003,
respectively.
30
The Governor of Massachusetts signed legislation on March 5, 2003,
expressly disallowing deductions for dividends received from a REIT, resulting
in such dividends being subject to state taxation. In addition, the legislation
applied retroactively to tax years ending on or after December 31, 1999. In
fiscal 2003, the Company provided additional income taxes of $835 thousand as a
result of this legislation.
Given the significant financial impact of this issue on numerous
Massachusetts financial institutions and the considerable uncertainty of the
constitutionality of the retroactive provisions of the legislation, a settlement
was reached in June 2003 among the DOR and the majority of affected financial
institutions. This settlement provided that 50% of all dividends received by the
Bank from its REIT subsidiary from 1999 through December 2002 were subject to
state income taxes. In addition, interest on the related taxes was also
assessed. In settlement of this matter, the Bank paid $431 thousand in June 2003
and also recognized a reduction in its tax provision of $374 thousand, which
increased net income by the same amount in fiscal 2004.
FINANCIAL CONDITION
Total assets at March 31, 2004 amounted to $490.9 million, an increase of
$13.7 million, or 2.9%, from $477.2 million at March 31, 2003. Total assets at
March 31, 2003 amounted to $477.2 million, an increase of $9.0 million, or 1.9%,
from $468.2 million at March 31, 2002. The modest growth in assets in fiscal
2004 was primarily caused by the deposit increase of $7.9 million. During fiscal
2003, the increase in the deposits of $26.1 million was used to repay FHLB
advances, which contributed to the modest asset growth in fiscal 2003.
Net loans decreased $33.4 million to $353.1 million at March 31, 2004 from
$386.5 million at March 31, 2003 while short-term investments and investment
securities increased $22.0 million and $22.6 million, respectively, during this
same period. This shift in asset mix reflects the impact of the reduction in
longer-term interest rates to a forty-five year low in 2003 and the resulting
decision by management to allow the residential loan portfolio, which consists
primarily of 15 to 30 year fixed-rate loans, to decline by $65.0 million during
fiscal 2004. During this same period, commercial mortgage loans increased $39.0
million reflecting management's preference for these loans, which have an
adjustable interest rate generally adjusting every 5 years based on the 5-year
FHLB classic advance rate. This shift in asset mix is part of management's
strategy to better balance its exposure to a sustained increase in interest
rates in future periods.
Net loans increased $18.1 million to $386.5 million at March 31, 2003 from
$368.4 million at March 31, 2002. At March 31, 2003, mortgage loans were $383.2
million, a $20.0 million increase from March 31, 2002. The increase in mortgage
loans was entirely attributable to increases in commercial real estate and
construction loans, which increased $20.1 million and $9.3 million,
respectively. The growth in commercial real estate loans and construction loans
is attributable to the addition of experienced commercial lenders and expansion
of the credit administration function in recent years. Residential mortgage
loans decreased $9.4 million during fiscal 2003 and represented 60.7% of loans
at March 31, 2003 compared to 66.2% at March 31, 2002. During fiscal 2003, the
Bank commenced operation of its mortgage banking initiative, which resulted in
the sale of $35.7 million in fixed rate residential mortgage loans.
Total deposits at March 31, 2004 were $295.9 million, a $7.9 million
increase from $288.0 million in the prior year. This increase includes core
deposit growth of $10.9 million, or 5.9%, partially offset by a decrease in
certificates of deposit of $3.0 million. This shift in deposit mix continues a
trend which began in 2001. Since March 31, 2001, certificates of deposit have
declined from 52.9% of total deposits to 34.2% at March 31, 2004. This change
largely reflects the declining interest rates and the Company's decision to
reduce the promotion of term deposits during this period. Money market deposit
accounts continued to be the primary area of core deposit growth again in fiscal
2004. Because of the tiered pricing used with these accounts, they continue to
attract larger depositors as approximately 80% of such deposits at March 31,
2004 are in accounts with a balance in excess of $50,000. It is uncertain what
impact a sustained rise in interest rates may have on the balances being
maintained in these accounts.
Total deposits at March 31, 2003 were $288.0 million, a $26.1 million
increase from $261.9 million one year earlier. This increase is attributable to
core deposit growth of $31.3 million, or 20.5%, partially offset by a decrease
in certificates of deposit of $5.2 million. The majority of core deposit growth
was in money market accounts, the highest paying core deposit account. This
growth has been aided by the introduction and promotion of
31
the Bank's Community Package Account product, low interest rates and the
---------------------------
continuing uncertainty in the stock market.
Advances from the FHLB of Boston decreased to $141.1 million at March 31,
2004 from $144.4 million at March 31, 2003. The Bank decreased its borrowings
from the FHLB of Boston in both fiscal 2004 and 2003 consistent with its intent
of reducing the utilization of FHLB advances.
Stockholders' equity increased to $43.5 million at March 31, 2004 from
$39.4 million at March 31, 2003 due primarily to $4.2 million in comprehensive
income.
LIQUIDITY
The Company's primary sources of liquidity are dividends from its bank
subsidiary. In addition, the Company has access to the capital markets to raise
additional equity.
The Bank's principal sources of liquidity are customer deposits, repayments
of loans and mortgage-backed securities, FHLB of Boston advances and maturities
of various other investments. These various sources of liquidity, as well as the
Bank's ability to sell residential mortgage loans in the secondary market, are
used to fund deposit withdrawals, loan originations and investment purchases.
Deposits have been a relatively stable source of funds for the Bank despite
significant competition. During fiscal 2004, deposit balances increased by $7.9
million to $295.9 million from $288.0 million at March 31, 2003. As previously
noted, the mix of deposits continued to shift towards core deposits, including
money market deposits, in fiscal 2004. Core deposits currently make up about
two-thirds of the Bank's total deposits, with certificates of deposits making up
the remaining one-third of deposits. Money market deposits have been the fastest
growing component of core deposits, partially because of the larger individual
balances typical of these accounts. At March 31, 2004, approximately 80%, or
$45.0 million, of such deposits were in accounts with a balance in excess of
$50,000. While the balances in these accounts have consistently increased in
recent years, it is uncertain what impact a sustained rise in interest rates may
have on the balances being maintained in these accounts.
The Bank is a member of the FHLB of Boston and has the ability to borrow
from the FHLB of Boston for any sound business purpose for which the Bank has
legal authority, subject to such regulations and limitations as may be
prescribed. At March 31, 2004 and 2003, the Bank had outstanding FHLB of Boston
advances of $141.1 million and $144.4 million, respectively. The FHLB of Boston
advances are secured primarily by a blanket lien on residential first mortgage
loans, U.S. Government and agency securities and all stock in the FHLB of
Boston. At March 31, 2004, the Bank had approximately $28.0 million in unused
borrowing capacity at the FHLB of Boston.
The Bank also may obtain funds from the Federal Reserve Bank of Boston, the
Co-operative Central Bank Reserve Fund and through a retail CD brokerage
agreement with a major brokerage firm. The Bank views these borrowing facilities
as secondary sources of liquidity and has had no need to use them.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to originate and sell loans. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheets.
32
Off-balance sheet financial instruments whose contract amounts represent
credit and interest rate risk are summarized as follows:
March 31, 2004 March 31, 2003
-------------- --------------
(In thousands)
Commitments to originate new loans................................... $ 21,379 $ 31,376
Unfunded commitments to extend credit under existing ................ 26,648 25,338
equity line and commercial lines of credit
Commitments to sell loans held for sale.............................. 5,603 4,810
The Company does not have any special purpose entities or other similar
forms of off-balance sheet financing arrangements. Management believes that the
Bank has adequate sources of liquidity to fund these commitments.
Commitments to originate new loans or to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Loan commitments generally expire within 30 to 45 days. Most
home equity line commitments are for a term of 15 years, and commercial lines of
credit are generally renewable on an annual basis. Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amounts of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.
Commitments to sell loans held for sale are agreements to sell loans on a
best efforts delivery basis to a third party at an agreed upon price. At March
31, 2004, the aggregate fair value of these commitments exceeded the book value
of the loans to be sold.
CONTRACTUAL OBLIGATIONS
The following table sets forth information regarding the Company's
contractual obligations as of March 31, 2004.
Payments Due by Period
-----------------------------------------------------------------------------
Less than More than
Total 1 year 2-3 years 4-5 years Over 5 years
----- --------- --------- --------- ------------
(in thousands)
Deposits.............................$ 295,920 $ 256,913 $ 23,517 $ 15,490 $ --
Advances from FHLB................... 141,100 13,300 24,800 33,000 70,000
Short-term borrowings................ 845 845 -- -- --
ESOP loan............................ 3,311 388 776 776 1,371
Operating lease obligations.......... 317 133 144 40 --
---------- --------- --------- -------- --------
Total obligations....................$ 441,493 $ 271,579 $ 49,237 $ 49,306 $ 71,371
========== ========= ========= ======== ========
33
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented in this
Form 10-K have been prepared in conformity with accounting principles generally
accepted in the United States of America, which require the measurement of
financial position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation. Unlike many industrial companies, substantially all of the assts and
liabilities of the Bank are monetary in nature. As a result, interest rates have
a more significant impact on the Bank's performance than the general level of
inflation. Over short periods of time, interest rates may not necessarily move
in the same direction or in the same magnitude as inflation.
CAPITAL RESOURCES
The Company and the Bank are required to maintain minimum capital ratios
pursuant to federal banking regulations. The first standard establishes a
risk-adjusted ratio relating capital to different categories of balance sheet
assets and off-balance sheet obligations. Two categories of capital are defined:
Tier 1 or core capital (stockholders' equity) and Tier 2 or supplementary
capital. Total capital is the sum of both Tier 1 and Tier 2 capital. According
to the standards, Tier 1 capital must represent at least 50% of qualifying total
capital. At March 31, 2004, the minimum total risk-based capital ratio required
was 8.00%. The Company's and the Bank's risk-based total capital ratios at March
31, 2004 were 12.14% and 11.80%, respectively.
To complement the risk-based standards, the FDIC adopted a leverage ratio
(adjusted stockholders' equity divided by total average assets) of 3% for the
most highly rated banks and 4%-5% for all others. The leverage ratio is to be
used in tandem with the risk-based capital ratios as the minimum standards for
banks. The Company's and the Bank's leverage ratios were 8.13% and 7.92%,
respectively, at March 31, 2004.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
The Bank'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 Bank 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 Bank'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 the Bank's net interest income
and preserve capital, while adjusting the Bank's 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 Bank 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 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 forecasted cash flows and management's
assumptions is compared to net interest income projections based on immediate
shifts of 300 basis points upward and 75 (2004) and 100 (2003) 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%.
34
The following table indicates the projected change in net interest income,
and sets forth such change as a percentage of estimated net interest income, for
the twelve month period following the date indicated assuming an immediate and
parallel shift for all market rates with other rates adjusting to varying
degrees in each scenario based on both historical and expected spread
relationships:
AT MARCH 31,
------------------------------------------------------------
2004 2003
------------------------------------------------------------
AMOUNT % CHANGE AMOUNT % CHANGE
------ -------- ------ --------
(DOLLARS IN THOUSANDS)
300 basis point increase in rates.............. $(1,236) (8.1)% $ (1,325) (7.6)%
100 basis point decrease in rates (2003)....... (342) (2.0)
75 basis point decrease in rates (2004)........ (315) (2.1)
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------- PAGE
----
Consolidated Balance Sheets........................................ 36
Consolidated Statements of Income.................................. 37
Consolidated Statement of Changes in Stockholders' Equity.......... 38
Consolidated Statements of Cash Flows.............................. 40
Notes to Consolidated Financial Statements......................... 41
Reports of Independent Registered Public Accounting Firms.......... 62
35
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(Dollars in thousands)
March 31,
---------------------------------
2004 2003
----------- -----------
ASSETS
Cash and due from banks $ 7,113 $ 5,996
Short-term investments 27,224 5,226
----------- -----------
Cash and cash equivalents 34,337 11,222
----------- -----------
Certificate of deposit (note 11) 1,211 --
Investment securities available for sale (amortized cost of $80,201
in 2004 and $59,500 in 2003) (note 2) 83,771 61,111
Stock in Federal Home Loan Bank of Boston (notes 2 and 7) 8,300 8,300
The Co-operative Central Bank Reserve Fund (note 2) 1,576 1,576
----------- -----------
Total investments 93,647 70,987
----------- -----------
Loans held for sale (note 1) 799 647
Loans (note 3) 356,625 389,817
Less allowance for loan losses (note 4) 3,537 3,284
----------- -----------
Net loans 353,088 386,533
----------- -----------
Accrued interest receivable 2,203 2,380
Banking premises and equipment, net (note 5) 2,113 1,869
Deferred tax asset, net (note 8) 243 719
Goodwill, net (note 1) 2,232 2,232
Other assets 1,024 619
----------- -----------
Total assets $ 490,897 $ 477,208
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (note 6) $ 295,920 $ 287,959
Short-term borrowings 845 176
Federal Home Loan Bank advances (notes 2 and 7) 141,100 144,400
ESOP loan (note 11) 3,311 --
Advance payments by borrowers for taxes and insurance 1,182 999
Accrued expenses and other liabilities 5,085 4,231
----------- -----------
Total liabilities 447,443 437,765
----------- -----------
Commitments and Contingencies (notes 8, 9 and 12) Stockholders' equity (note
10):
Preferred stock $1.00 par value; authorized 5,000,000 shares; none issued -- --
Common stock $1.00 par value; authorized 15,000,000 shares;
2,030,251 shares issued at March 31, 2004 and
2,027,727 shares issued at March 31, 2003 2,030 2,028
Additional paid-in capital 12,920 12,751
Retained income 36,855 34,601
Treasury stock (365,294 shares at March 31, 2004 and
2003), at cost (7,311) (7,249)
Accumulated other comprehensive income 2,293 1,002
Unearned compensation - ESOP (note 11) (3,333) (3,690)
------------ -----------
Total stockholders' equity 43,454 39,443
----------- -----------
Total liabilities and stockholders' equity $ 490,897 $ 477,208
=========== ===========
See accompanying notes to consolidated financial statements.
36
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
Years Ended March 31,
---------------------------------------------
2004 2003 2002
------------ ---------- ----------
Interest and dividend income:
Mortgage loans $ 22,797 $ 25,033 $ 23,682
Other loans 363 505 555
Short-term investments 204 125 866
Investments 3,743 4,466 4,170
---------- ---------- ---------
Total interest and dividend income 27,107 30,129 29,273
---------- ---------- ---------
Interest expense:
Deposits 4,436 5,601 8,119
Advances from Federal Home Loan Bank of Boston 7,019 7,262 6,731
Other borrowings 82 9 10
---------- ---------- ---------
Total interest expense 11,537 12,872 14,860
---------- ---------- ---------
Net interest and dividend income 15,570 17,257 14,413
Provision for loan losses (note 4) 200 -- --
---------- ---------- ---------
Net interest and dividend income after
provision for loan losses 15,370 17,257 14,413
---------- ---------- ---------
Non-interest income:
Deposit service charges 600 571 492
Net losses from sales and write-downs
of investment securities (note 2) (135) (308) (150)
Gain on sales of loans 295 796 --
Brokerage income 138 94 100
Other income 228 252 246
---------- ---------- ---------
Total non-interest income 1,126 1,405 688
---------- ---------- ---------
Non-interest expenses:
Salaries and employee benefits (note 11) 7,187 6,862 5,562
Occupancy and equipment (note 5) 1,159 1,137 1,124
Data processing service fees 1,093 1,136 966
Professional fees (note 12) 334 2,410 1,051
Marketing 775 394 261
Other expenses (note 1) 1,853 1,938 1,500
---------- ---------- ---------
Total non-interest expenses 12,401 13,877 10,464
---------- ---------- ---------
Income before income taxes 4,095 4,785 4,637
Provision for income taxes (note 8) 1,159 2,598 1,777
---------- ---------- ---------
Net income $ 2,936 $ 2,187 $ 2,860
========== ========== =========
Earnings per common share (note 1):
Basic $ 1.89 $ 1.38 $ 1.73
========== ========== =========
Diluted $ 1.88 $ 1.37 $ 1.72
========== ========== =========
Weighted average common shares outstanding - basic 1,551 1,584 1,650
Weighted average common and equivalent shares
outstanding - diluted 1,565 1,599 1,665
See accompanying notes to consolidated financial statements.
37
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands, Except Per Share Data)
Accumulated
Additional Other
Common Paid-In Retained Treasury Comprehensive
Stock Capital Income Stock Income (Loss)
-------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2001 $ 1,970 $ 11,190 $ 30,950 $ (5,230) $ (431)
Net income -- -- 2,860 -- --
Other comprehensive income net of tax:
Unrealized loss on securities, net
of reclassification adjustment -- -- -- -- (195)
Comprehensive income
Purchase of shares by ESOP (note 11) -- -- -- -- --
Purchase of treasury stock -- -- -- (1,924) --
Dividends paid ($.40 per share) -- -- (669) -- --
Proceeds from exercise of stock options 30 462 -- -- --
Amortization of unearned compensation
- ESOP -- 175 -- -- --
Other equity transactions -- 107 -- (35) --
--------- ----------- ----------- ---------- -----------
Balance at March 31, 2002 $ 2,000 $ 11,934 $ 33,141 $ (7,189) $ (626)
Net income -- -- 2,187 -- --
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- -- -- -- 1,628
Comprehensive income
Purchase of shares by ESOP (note 11) -- -- -- -- --
Proceeds from exercise of stock options 28 488 -- -- --
Tax benefit of stock options -- 66 -- -- --
Director deferred compensation transactions -- 45 -- (60) --
Dividends paid ($.44 per share) -- -- (727) -- --
Amortization of unearned compensation
- ESOP -- 218 -- -- --
--------- ----------- ----------- ---------- -----------
Balance at March 31, 2003 $ 2,028 $ 12,751 $ 34,601 $ (7,249) $ 1,002
Net income -- -- 2,936 -- --
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- -- -- -- 1,291
Comprehensive income
Proceeds from exercise of stock options 2 45 -- -- --
Tax benefit of stock options -- 18 -- -- --
Director deferred compensation transactions -- 60 -- (62) --
Dividends paid ($.48 per share) -- -- (682) -- --
Amortization of unearned compensation
- ESOP -- 46 -- -- --
--------- ----------- ---------- ---------- -----------
Balance at March 31, 2004 $ 2,030 $ 12,920 $ 36,855 $ (7,311) $ 2,293
========= =========== ========== ========== ===========
Unearned Total
Compensation Stockholders'
ESOP Equity
-----------------------------------
Balance at March 31, 2001 $ (237) $ 38,212
Net income -- 2,860
Other comprehensive income net of tax:
Unrealized loss on securities, net
of reclassification adjustment -- (195)
-----------
Comprehensive income 2,665
-----------
Purchase of shares by ESOP (note 11) (199) (199)
Purchase of treasury stock -- (1,924)
Dividends paid ($.40 per share) -- (669)
Proceeds from exercise of stock options -- 492
Amortization of unearned compensation
- ESOP 130 305
Other equity transactions -- 72
---------- -----------
Balance at March 31, 2002 $ (306) $ 38,954
Net income -- 2,187
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- 1,628
-----------
Comprehensive income 3,815
-----------
Purchase of shares by ESOP (note 11) (3,595) (3,595)
Proceeds from exercise of stock options -- 516
Tax benefit of stock options -- 66
Director deferred compensation transactions -- (15)
Dividends paid ($.44 per share) -- (727)
Amortization of unearned compensation
- ESOP 211 429
---------- -----------
Balance at March 31, 2003 $ (3,690) $ 39,443
Net income -- 2,936
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- 1,291
-----------
Comprehensive income 4,227
-----------
Proceeds from exercise of stock options -- 47
Tax benefit of stock options -- 18
Director deferred compensation transactions -- (2)
Dividends paid ($.48 per share) -- (682)
Amortization of unearned compensation
- ESOP 357 403
---------- -----------
Balance at March 31, 2004 $ (3,333) $ 43,454
========== ===========
See accompanying notes to consolidated financial statements.
38
The Company's other comprehensive income (loss) and related tax effect for the
years ended March 31 are as follows:
2004
-------------------------------------------------
Before-Tax Tax (Benefit) After-Tax
in thousands Amount Expense Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Unrealized gains on securities:
Unrealized net holding gains during period $ 1,824 $ 622 $ 1,202
Add reclassification adjustment for net losses included in net
income 135 46 89
--------------------------------------------
Other comprehensive income $ 1,959 $ 668 $ 1,291
============================================
2003
-------------------------------------------------
Before-Tax Tax (Benefit) After-Tax
In thousands Amount Expense Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Unrealized gains on securities:
Unrealized net holding gains during period $ 2,306 $ 901 $ 1,405
Add reclassification adjustment for net losses included in net
income 308 85 223
--------------------------------------------
Other comprehensive income $ 2,614 $ 986 $ 1,628
============================================
2002
-------------------------------------------------
Before-Tax Tax (Benefit) After-Tax
in thousands Amount Expense Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Unrealized losses on securities:
Unrealized net holding losses during period $ (451) $ (163) $ (288)
Add reclassification adjustment for net losses included in net
income 150 57 93
-------------------------------------------
Other comprehensive loss $ (301) $ (106) $ (195)
===========================================
See accompanying notes to consolidated financial statements.
39
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Dollars In Thousands)
Years Ended March 31,
------------------------------------------
2004 2003 2002
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 2,936 $ 2,187 $ 2,860
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization 319 314 372
Amortization of premiums and discounts 165 269 176
Amortization of goodwill -- -- 288
Provision for loan losses 200 -- --
Stock-based compensation 332 429 305
Increase in deferred tax assets, net (194) (462) (380)
Net losses from sales and write-downs of
investment securities 135 308 150
Gain on sale of loans (295) (796) --
Originations of loans held for sale (32,823) (36,364) --
Proceeds from the sale of loans originated for sale 32,966 36,513 --
(Increase) decrease in accrued interest receivable 177 150 (104)
(Increase) decrease in other assets, net (348) (26) 109
Increase (decrease) in advance payments by borrowers for
taxes and insurance 183 (112) (109)
Increase (decrease) in accrued expenses and other liabilities (2,175) 2,043 509
---------- -------- ----------
Net cash provided by operating activities 1,578 4,453 4,176
--------- -------- ----------
Cash flows from investing activities:
Net (increase) decrease in loans 33,245 (18,110) (25,728)
Principal payments on mortgage-backed securities 5,453 7,426 7,246
Purchases of investment securities (40,431) (6,210) (61,256)
Proceeds from sales of investment securities 482 7,638 2,885
Maturities and redemptions of investment securities 13,500 6,000 26,000
Due to broker 3,029 -- --
Purchase of certificate of deposit (1,200) -- --
Purchase of stock in FHLB of Boston -- -- (2,150)
Purchase of banking premises and equipment, net (563) (346) (190)
---------- -------- ----------
Net cash provided by (used in) investing activities 13,515 (3,602) (53,193)
--------- -------- ----------
Cash flows from financing activities:
Net increase (decrease) in deposits 7,961 26,052 (25,260)
Proceeds from FHLB advances 2,000 39,000 65,000
Repayments of FHLB advances (5,300) (55,600) (25,000)
Proceeds from ESOP loan 3,506 -- --
Repayments of ESOP loan (195) -- --
Net increase (decrease) in short-term borrowings 669 (2,824) 3,000
Proceeds from exercise of stock options 47 516 492
Purchase of treasury stock -- -- (1,924)
Payments of dividends, net (682) (727) (669)
Purchase of stock by ESOP -- (3,595) (199)
Other equity transactions 16 (15) 72
--------- -------- ----------
Net cash provided by financing activities 8,022 2,807 15,512
--------- -------- ----------
Net increase (decrease) in cash and cash equivalents 23,115 3,658 (33,505)
Cash and cash equivalents at beginning of year 11,222 7,564 41,069
--------- -------- ----------
Cash and cash equivalents at end of year $ 34,337 $ 11,222 $ 7,564
========= ======== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 11,591 $ 12,938 $ 14,883
Income taxes $ 2,005 $ 2,820 $ 1,715
See accompanying notes to consolidated financial statements.
40
CENTRAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of
Central Bancorp, Inc. (the "Company"), a Massachusetts corporation, and its
wholly-owned subsidiary, Central Co-operative Bank (the "Bank"), as well as
wholly-owned subsidiaries of the Bank.
The Company was organized at the direction of the Bank in September 1998 to
acquire all of the capital stock of the Bank upon the consummation of the
reorganization of the Bank into the holding company form of ownership. This
reorganization was completed in January 1999. The Bank was organized as a
Massachusetts chartered co-operative bank in 1915 and converted from mutual to
stock form in 1986. The primary business of the Bank is to generate funds in the
form of deposits and use the funds to make mortgage loans for the construction,
purchase and refinancing of residential properties, and to make loans on
commercial real estate in its market area. The Bank is subject to competition
from other financial institutions. The Company is subject to the regulations of,
and periodic examinations by, the Federal Reserve Bank ("FRB"). The Bank is also
subject to the regulations of, and periodic examination by, the Federal Deposit
Insurance Corporation ("FDIC") and the Massachusetts Division of Banks. The
Bank's deposits are insured by the Bank Insurance Fund of the FDIC for deposits
up to $100,000 and the Share Insurance Fund ("SIF") for deposits in excess of
$100,000.
The Company conducts its business through one operating segment, the Bank.
Most of the Bank's activities are with customers located in eastern
Massachusetts. As set forth in Note 3 herein, the Bank concentrates in real
estate lending. Management believes that the Bank does not have any significant
concentrations in any one customer or industry.
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America. All significant intercompany balances and transactions have been
eliminated in consolidation. 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 income and expenses for the year. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change relate
to the determination of the allowance for loan losses.
Certain prior year amounts have been reclassified to conform to the current
year's presentation. The following is a summary of the more significant
accounting policies adopted by the Bank.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks, money market mutual fund investments, federal funds
sold and other short-term investments having an original maturity of 90 days or
less.
The Bank is required to maintain cash and reserve balances with the Federal
Reserve Bank. Such reserves are calculated based upon deposit levels and
amounted to approximately $400,000 at March 31, 2004.
Investments
Debt securities that management has the positive intent and ability to hold
to maturity are classified as held-to-maturity and reported at cost, adjusted
for amortization of premiums and accretion of discounts, both computed by a
method that approximates the effective yield method. Debt and equity securities
that are bought and held principally for the purpose of selling them in the near
term are classified as trading and reported at fair value, with unrealized gains
and losses included in earnings. Debt and equity securities not classified as
either held-to-maturity or trading are classified as available-for-sale and
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of stockholders' equity and comprehensive
income.
Gains and losses on sales of securities are recognized when realized with
the cost basis of investments sold determined on a specific-identification
basis. Premiums and discounts on investment and mortgage-backed securities
41
are amortized or accreted to interest income over the actual or expected lives
of the securities using the level-yield method.
If a decline in fair value below the amortized cost basis of an investment
is judged to be other-than-temporary, the cost basis of the investment is
written down to fair value as a new cost basis and the amount of the write-down
is included in the results of operations.
The Company's investments in the Federal Home Loan Bank of Boston and the
Co-operative Central Bank Reserve Fund are accounted for at cost.
Loans
Loans are reported at the principal amount outstanding, adjusted by
unamortized discounts, premiums, and net deferred loan origination costs and
fees. Loans classified as held for sale are stated at the lower of aggregate
cost or market value. The Company enters into forward commitments (generally on
a best efforts delivery basis) to sell loans in order to reduce market risk
associated with the origination of loans held for sale. Market value is
estimated based on outstanding investor commitments. Net unrealized losses, if
any, are provided for in a valuation allowance by charges to operations. Loans
are sold on a servicing released basis.
Loan origination fees, net of certain direct loan origination costs, are
deferred and are amortized into interest income over the contractual loan term
using the level-yield method. At March 31, 2004 and 2003, net deferred loan fees
of $521,000 and $781,000, respectively, were offset against the related loan
balances for financial presentation purposes.
Interest income on loans is recognized on an accrual basis using the simple
interest method. Loans on which the accrual of interest has been discontinued
are designated as non-accrual loans. Accrual of interest on loans and
amortization of net deferred loan fees or costs are discontinued either when
reasonable doubt exists as to the full and timely collection of interest or
principal, or when a loan becomes contractually past due 90 days with respect to
interest or principal. The accrual on some loans, however, may continue even
though they are more than 90 days past due if management deems it appropriate,
provided that the loans are well secured and in the process of collection. When
a loan is placed on non-accrual status, all interest previously accrued but not
collected is reversed against current period interest income. Interest accruals
are resumed on such loans only when they are brought fully current with respect
to interest and principal and when, in the judgment of management, the loans are
estimated to be fully collectible as to both principal and interest. The Bank
records interest income on non-accrual and impaired loans on the cash basis of
accounting.
Loans are classified as impaired when it is probable that the Bank will not
be able to collect all amounts due in accordance with the contractual terms of
the loan agreement. Impaired loans, except those loans that are accounted for at
fair value or at lower of cost or fair value, are accounted for at the present
value of the expected future cash flows discounted at the loan's effective
interest rate or as a practical expedient in the case of collateral dependent
loans, the lower of the fair value of the collateral or the recorded amount of
the loan. Management considers the payment status, net worth and earnings
potential of the borrower, and the value and cash flow of the collateral as
factors to determine if a loan will be paid in accordance with its contractual
terms. Management does not set any minimum delay of payments as a factor in
reviewing for impaired classification. Impaired loans are charged off when
management believes that the collectibility of the loan's principal is remote.
Management considers non-accrual loans, except for smaller balance, homogeneous
residential mortgage loans, to be impaired.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level determined to be
adequate by management to absorb probable losses based on an evaluation of known
and inherent risks in the portfolio. This allowance is increased by provisions
charged to operating expense and by recoveries on loans previously charged off,
and reduced by charge-offs on loans.
Arriving at an appropriate level of allowance for loan losses necessarily
involves a high degree of judgment. The allowance for loan losses is evaluated
on a quarterly basis. Primary considerations in this evaluation are prior loan
loss experience, the character and size of the loan portfolio, business and
economic conditions, loan growth, delinquency trends, nonperforming loan trends
and other asset quality factors. The Bank evaluates specific loan status reports
on certain commercial and commercial real estate loans rated "substandard" or
worse. 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. The remaining
42
commercial and commercial real estate loans are provided for as part of pools of
similar loans based on a combination of historical loss experience and
qualitative adjustments including collateral type and loan-to-value ratios.
Smaller balance, homogeneous loans, including residential real estate loans and
consumer loans, are evaluated as a group by applying estimated charge off and
recovery percentages, based on historical experience and certain qualitative
factors, to the current outstanding balance in each category. Based on these
analyses, the resulting allowance is deemed adequate to absorb all probable
credit losses in the portfolio.
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 a
changes in economic conditions and other factors. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize adjustments to the allowance based on their
judgments about information available to them at the time of their examination.
Changes in estimates are provided currently in earnings.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the accounting basis and the
tax basis of the Bank's assets and liabilities. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
realized or settled. The Bank's deferred tax asset is reviewed periodically and
adjustments to such asset are recognized as deferred income tax expense or
benefit based on management's judgments relating to the realizability of such
asset.
Banking Premises and Equipment
Land is stated at cost. Buildings, leasehold improvements and equipment are
stated at cost, less allowances for depreciation and amortization. Depreciation
and amortization are computed on the straight-line method over the estimated
useful lives of the assets or terms of the leases, if shorter.
Goodwill
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142") which is effective for fiscal years beginning
after December 15, 2001. The Company adopted SFAS 142 as of April 1, 2002. SFAS
142 addresses the method of identifying and measuring goodwill and other
intangible assets having indefinite lives acquired in a business combination,
eliminates further amortization of goodwill, and requires periodic impairment
evaluations of goodwill using a fair value methodology prescribed in the
statement. As a result of adopting SFAS 142, the Company no longer amortizes the
goodwill balance of $2,232,000. Impairment testing is required at least annually
or more frequently as a result of an event or change in circumstances (e.g.,
recurring operating losses by the acquired entity) that would indicate an
impairment adjustment may be necessary. Impairment testing was performed during
2003 and 2004 and in each analysis, it was determined that an impairment charge
was not required.
The following table sets forth the reconciliation of net income and
earnings per share excluding goodwill amortization for the year ended March 31,
2002 (Dollars in thousands, except per share data):
Net Income Basic EPS Diluted EPS
---------- --------- -----------
As reported................................... $2,860 $1.73 $1.72
Goodwill amortization......................... 288 0.18 0.17
------ ------- ------
As adjusted................................... $3,148 $1.91 $1.89
====== ===== =====
Pension Benefits
The Bank provides pension benefits for its employees in a multi-employer
pension plan through membership in the Co-operative Banks Employees Retirement
Association. Pension costs are funded as they are accrued and are accounted for
on a defined contribution plan basis.
43
Stock-Based Compensation
The Company follows the intrinsic value method set forth in APB Opinion No.
25 "Accounting for Stock Issued to Employees" (APB No. 25) under which there is
generally no charge to earnings for stock option grants. Companies that elect to
use this method are required to disclose the pro forma effect of using the fair
value method of accounting for stock-based compensation that is encouraged by
SFAS No. 123, "Accounting for Stock-Based Compensation."
No options were granted during the years 2002 to 2004 and forfeitures
during these years were insignificant. Consequently, no material difference in
net income occurred in this period as a result of the Company's use of the
intrinsic value method rather than the fair value method of accounting for
stock-based compensation.
Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing income available
to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock, such as
stock options, were exercised or converted into common stock. Unallocated ESOP
shares are not treated as being outstanding in the computation of either basic
or diluted EPS. At March 31, 2004 and 2003, there were approximately 107,000 and
118,000 unallocated ESOP shares, respectively.
Recent Accounting Pronouncements
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 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 ended after December 15, 2002. The Company
is not currently considering the adoption of fair value based compensation of
stock options.
In December 2003, the FASB issued Interpretation No. 46R (FIN 46R),
"Consolidation of Variable Interest Entities -An Interpretation of ARB No. 51,"
to expand upon and strengthen existing accounting guidance that addresses when a
company should include in its financial statements the assets, liabilities and
activities of another entity. Until now, a company generally has included
another entity in its combined financial statements only if it controlled the
entity through voting interests. FIN 46R changes that guidance by requiring a
variable interest entity, as defined, to be combined by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or is entitled to receive a majority of the entity's
residual returns or both. FIN 46R also requires disclosure about variable
interest entities that the company is not required to consolidate but in which
it has a significant variable interest. Application of FIN 46R is required in
financial statements for periods ending after March 15, 2004. The Company does
not believe that the application of FIN 46R will have a material impact on the
Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity,"
which establishes standards for how certain financial instruments with
characteristics of both liabilities and equity should be measured and
classified. Certain financial instruments with characteristics of both
liabilities and equity will be required to be classified as a liability. This
statement is effective for financial instruments entered into or modified after
May 31, 2003, and July 1, 2003 for all other financial instruments with the
exception of existing mandatorily redeemable financial instruments issued by
limited life subsidiaries which have been indefinitely deferred from the scope
of the statement. The Company does not believe the adoption of SFAS 150 will
have a material impact on the Company's financial position or results of
operations.
In December 2003, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 03-3, "Accounting for Certain
Loans or Debt Securities Acquired in a Transfer." SOP 03-3 requires loans
acquired through a transfer, such as a business combination, where there are
44
differences in expected cash flows and contractual cash flows due in part to
credit quality be recognized at their fair value. The excess of contractual cash
flows over expected cash flows is not to be recognized as an adjustment of
yield, loss accrual, or valuation allowance. Valuation allowances cannot be
created nor "carried over" in the initial accounting for loans acquired in a
transfer on loans subject to SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." This SOP is effective for loans acquired after December
31, 2004, with early adoption encouraged. The Company does not believe the
adoption of SOP 03-3 will have a material impact on the Company's financial
position or results of operations.
In March 2004, FASB's Emerging Issues Task Force ("EITF") reached a
consensus on EITF 03-01, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." The Issue provides guidance in determining
the meaning of other-than-temporary impairment and its application to debt and
equity investments within the scope of SFAS No. 115 and equity securities
accounted for under the cost method. The Issue also provides a model for
determining whether investments within its scope are other-then-temporarily
impaired. Certain disclosure requirements of this Issue are effective for fiscal
years ended after December 15, 2003. Certain other disclosure requirements and
the use of the impairment model is effective in reporting interim periods
beginning after June 15, 2004. The Company has provided the disclosures required
by this Issue in Note 2 herein. The Company believes its methodology for
assessing the existence of an other-than-temporary impairment of a security is
similar to that set forth in EITF 03-01 and that the adoption of this standard
will not have a material impact on the Company's financial position or results
of operations.
NOTE 2. INVESTMENTS (DOLLARS IN THOUSANDS)
The amortized cost and fair value of investments securities available for
sale are summarized as follows:
MARCH 31, 2004
-----------------------------------------------------------------------
AMORTIZED GROSS UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------------- -------------------- --------------- ----------------
U.S. Government and agency obligations $ 9,998 $ 88 $ -- $ 10,086
Corporate bonds 35,788 2,850 -- 38,638
Mortgage-backed securities 31,277 405 (107) 31,575
--------- -------- -------- --------
Total debt securities 77,063 3,343 (107) 80,299
Marketable equity securities 3,138 453 (119) 3,472
--------- --------- ------- --------
Total $ 80,201 $ 3,796 $ (226) $ 83,771
========= ======== ======= ========
MARCH 31, 2003
-----------------------------------------------------------------------
AMORTIZED GROSS UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------------- -------------------- --------------- ----------------
U.S. Government and agency obligations $ 8,000 $ 247 $ -- $ 8,247
Corporate bonds 36,912 2,006 (191) 38,727
Mortgage-backed securities 11,840 298 (82) 12,056
--------- -------- ------ --------
Total debt securities 56,752 2,551 (273) 59,030
Marketable equity securities 2,748 32 (699) 2,081
--------- -------- ------ --------
Total $ 59,500 $ 2,583 $ (972) $ 61,111
========= ======== ====== ========
45
Gross unrealized losses and fair value at March 31, 2004, aggregated by
investment category and length of time that individual securities have been in a
continuous unrealized loss position follows:
LESS THAN GREATER THAN
12 MONTHS 12 MONTHS
------------------------------------ ------------------------------
FAIR UNREALIZED FAIR VALUE UNREALIZED
VALUE LOSSES LOSSES
------------------ ---------------- -------------- ---------------
Mortgage-backed securities $ 6,958 $ 58 $1,974 $ 49
Marketable equity securities 589 12 593 107
-------- ----- ------ -------
Total temporarily impaired securities $ 7,547 $ 70 $2,567 $ 156
======== ===== ====== =======
As of March 31, 2004, securities held in the investment portfolio with
unrealized losses have been evaluated by management and management has concluded
that an other-than-temporary impairment does not exist at March 31, 2004. The
primary reason these securities are in an unrealized loss position is due to
changes in market conditions and interest rates. Most of the securities are debt
securities whose values fluctuate daily based on the current interest rate
environment. Management considers the credit worthiness of the issuer in
evaluating impairment.
The maturity distribution (based on contractual maturities) and annual
yields of debt securities at March 31, 2004 are as follows:
Amortized Fair Annual
Cost Value Yield
---------------- ----------------- -------------
Due within one year $ 500 $ 525 7.41%
Due after one year but within five years 40,863 43,381 5.85
Due after five years but within ten years 19,893 20,392 4.54
Due after ten years 15,807 16,001 4.21
--------- ---------
$ 77,063 $ 80,299 5.16
========= =========
Mortgage-backed securities are shown at their contractual maturity dates
but actual maturities may differ as borrowers have the right to prepay
obligations without incurring prepayment penalties.
Proceeds from sales of investment securities and related gains and losses
for the years ended March 31, 2004, 2003, and 2002 (all classified as available
for sale) were as follows:
2004 2003 2002
---- ---- ----
Proceeds from sales $ 482 $7,638 $2,885
Gross gains -- 495 546
Gross losses 5 -- 54
During the years ended March 31, 2004, 2003 and 2002, the Bank recognized
write-downs in certain equity securities totaling $130, $803 and $642,
respectively, as a result of declines in the fair value of such securities
judged to be other-than-temporary. These write-downs are not included in the
preceding table.
A mortgage-backed security with an amortized cost of $1,612 and fair value
of $1,566 at March 31, 2004, was pledged to provide collateral for certain
customers. In addition, investment securities carried at $30,769 were pledged
under a blanket lien to partially secure the Bank's advances from the Federal
Home Loan Bank of Boston ("FHLB of Boston").
As a member of the FHLB of Boston, the Bank was required to invest in stock
of the FHLB of Boston in an amount which, until April 2004, was equal to 1% of
its outstanding home loans or 1/20th of its outstanding advances from the FHLB
of Boston, whichever was higher. In April 2004, the FHLB of Boston amended its
capital structure at which time the Company's FHLB of Boston stock was converted
to Class B stock. Such stock is redeemable at
46
par value five years after filing for a redemption or upon termination of
membership. The FHLB of Boston may, but is not obligated to, repurchase Class B
stock prior to expiration of the five-year redemption notice. Under the new
capital structure, the Bank's stock investment requirement is an amount equal to
the sum of .35% of certain specified assets (such assets totaled $265,000 at the
time of the change in capital structure) plus 4.5% of the Bank's advances and
certain other specified items. In connection with the adoption of the new
capital structure, the Bank was not required to increase its investment in FHLB
stock.
The Co-operative Central Bank Reserve Fund (the "Fund") was established for
liquidity purposes and consists of deposits required of all insured co-operative
banks in Massachusetts. The Fund is used by The Co-operative Central Bank to
advance funds to member banks or to make other investments.
NOTE 3. LOANS (IN THOUSANDS)
Loans as of March 31, 2004 and 2003 are summarized below:
2004 2003
-------- --------
Real estate loans:
Residential real estate $ 171,682 $ 236,649
Commercial real estate 146,107 107,140
Construction 25,112 30,294
Home equity lines of credit 9,397 9,128
--------- ---------
Total real estate loans 352,298 383,211
--------- ---------
Commercial loans 3,198 5,319
Consumer loans 1,129 1,287
--------- ---------
Total loans 356,625 389,817
Less: allowance for loan losses (3,537) (3,284)
--------- ---------
Total loans, net $ 353,088 $ 386,533
========= =========
The Bank had no non-accrual loans at March 31, 2004 and 2003. During the
years ended March 31, 2004 2003 and 2002, there were no impaired loans.
Mortgage loans serviced by the Bank for others amounted to $747 and $1,361
at March 31, 2004 and 2003, respectively.
The Bank's lending activities are conducted principally in communities in
the suburban Boston area. The Bank grants mortgage loans on residential
property, commercial real estate, construction of residential homes, second
mortgages, home equity and other loans. Substantially all loans granted by the
Bank are secured by real estate collateral. The ability and willingness of
residential mortgage borrowers to honor their repayment commitments are
generally impacted by the level of overall economic activity within the
borrowers' geographic areas and real estate values. The ability and willingness
of commercial real estate and construction loan borrowers to honor their
repayment commitments are generally impacted by the health of the real estate
market in the borrowers' geographic area and the general economy.
The following summarizes the activity with respect to loans made to
directors and officers and their related interests for the years ended March 31:
2004 2003
---------- ----------
Balance at beginning of year $ 919 $ 865
New loans 378 444
Repayment of principal (396) (390)
---------- ---------
Balance at end of year $ 901 $ 919
========= =========
Loans included above were made in the Bank's ordinary course of business,
on substantially the same terms, including interest rates and collateral
requirements, as those prevailing at the time for comparable transactions with
unrelated persons. All loans included above are performing in accordance with
the terms of the respective loan agreement.
47
NOTE 4. ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS)
A summary of changes in the allowance for loan losses follows:
Years ended March 31,
--------------------------------------------
2004 2003 2002
-------- -------- --------
Balance at beginning of year $ 3,284 $ 3,292 $ 3,106
Provision charged to expense 200 -- --
Amounts charged-off (29) (21) (4)
Recoveries on accounts previously charged-off 82 13 190
--------- -------- ---------
Balance at end of year $ 3,537 $ 3,284 $ 3,292
========= ======== =========
NOTE 5. BANKING PREMISES AND EQUIPMENT (IN THOUSANDS)
A summary of cost, accumulated depreciation and amortization of banking
premises and equipment at March 31 follows:
Estimated
2004 2003 Useful Lives
---------- ---------- ------------
Land $ 589 $ 589
Buildings and improvements 2,571 2,401 50 years
Furniture and fixtures 6,244 5,876 3-5 years
Leasehold improvements 660 635 5-6 years
--------- --------
10,064 9,501
Less accumulated depreciation and amortization (7,951) (7,632)
---------- --------
Total $ 2,113 $ 1,869
========= ========
Depreciation and amortization for the years ended March 31, 2004, 2003 and
2002 amounted to $319, $314 and $372, respectively, and is included in occupancy
and equipment expense in the accompanying consolidated statements of income.
A summary of minimum rentals of banking premises for future periods under
non-cancelable operating leases follows:
Years Ending March 31,
----------------------------
2005 $ 133
2006 80
2007 64
2008 40
Certain leases contain renewal options the potential impact of which is not
included above. Rental expense for the years ended March 31, 2004, 2003 and 2002
was $147, $145 and $133, respectively, and is included in occupancy and
equipment expense in the accompanying consolidated statements of income.
48
NOTE 6. DEPOSITS (DOLLARS IN THOUSANDS)
Deposits at March 31 are summarized as follows:
2004 2003
--------------------------
Demand deposit accounts $ 27,881 $ 31,523
NOW accounts 37,106 38,047
Passbook and other savings accounts 73,737 71,629
Money market deposit accounts 56,084 42,687
-------- --------
Total non certificate accounts 194,808 183,886
-------- --------
Term deposit certificates
Certificates of $100 and above 27,607 26,259
Certificates less than $100 73,505 77,814
-------- --------
Total term deposit certificates 101,112 104,073
-------- --------
$295,920 $287,959
======== ========
Contractual maturities of term deposit certificates with weighted average
interest rates at March 31, 2004 are as follows:
Amount Rate
----------- ----
Within 1 year $ 62,105 2.38%
Over 1 to 3 years 23,517 3.35
Over 3 years 15,490 4.40
-----------
$ 101,112 2.92
===========
NOTE 7. FEDERAL HOME LOAN BANK ADVANCES (DOLLARS IN THOUSANDS)
A summary of the maturity distribution of FHLB of Boston advances (based on
final maturity dates) with weighted average interest rates at March 31 follows:
2004 2003
------------------------ ------------------------
Amount Rate Amount Rate
--------- ---- ---------- ----
Within 1 year $ 13,300 3.38% $ 5,300 3.61%
1-2 years 15,300 4.96 13,300 3.38
2-3 years 9,500 3.67 15,300 4.96
3-4 years 18,000 5.58 7,500 3.98
4-5 years 15,000 5.13 18,000 5.58
Over 5 to 10 years 70,000 4.96 83,000 4.98
Over 10 years -- -- 2,000 5.49
--------- ---------
$ 141,100 4.82 $ 144,400 4.81
========= =========
At March 31, 2004, advances totaling $107,000 were callable prior to their
scheduled maturity of which $93,000 were callable during fiscal 2005. The Bank
is subject to a substantial penalty in the event it elects to prepay any of its
FHLB of Boston advances.
The FHLB of Boston is authorized to make advances to its members subject to
such regulations and limitations as the Federal Home Loan Bank Board may
prescribe. The advances are secured by FHLB of Boston stock and a blanket lien
on certain qualified collateral, defined principally as 90% of the fair value of
U.S. Government and federal agency obligations and 75% of the carrying value of
first mortgage loans on owner-occupied residential property. In addition,
certain multi-family property loans are pledged to secure FHLB advances. The
Bank's unused borrowing capacity with the FHLB of Boston was approximately
$28,000 at March 31, 2004.
49
NOTE 8. INCOME TAXES (DOLLARS IN THOUSANDS)
The components of the provision for income taxes for the years indicated
are as follows:
Years Ended March 31,
------------------------------------------
2004 2003 2002
------------ ---------- -----------
Current
Federal $ 1,113 $ 1,708 $ 1,930
State (148) 1,352 229
--------- -------- -------
Total current provision 965 3,060 2,159
Deferred (prepaid) 194 (462) (382)
--------- -------- -------
$ 1,159 $ 2,598 $ 1,777
========= ======== =======
The provision for income taxes for the periods presented is different from
the amounts computed by applying the statutory Federal income tax rate to income
before income taxes. The differences between expected tax rates and effective
tax rates are as follows:
Years Ended March 31,
--------------------------------------
2004 2003 2002
---------- ----------- ----------
Statutory Federal tax rate 34.0% 34.0 % 34.0 %
Items affecting Federal income tax rate:
Dividends received deduction (0.4) (0.3) (0.4)
Goodwill amortization -- -- 2.1
State income taxes 3.3 2.7 2.6
Retroactive REIT legislation and settlement (9.1) 16.1 --
ESOP expense -- 1.5 1.3
Other 0.5 0.3 (1.3)
---- ----- -----
Effective tax rate 28.3% 54.3% 38.3%
==== ===== =====
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 had 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. Subsequently, in March
2003, the Governor of Massachusetts signed legislation, expressly disallowing
deductions for dividends received from a REIT, resulting in such dividends being
subject to state taxation. In addition, this law applied retroactively to tax
years ending on or after December 31, 1999. In fiscal 2003, the Company provided
additional state taxes, including interest, net of the related federal tax
benefit, of $835.
In June 2003, a settlement of this matter was reached between the DOR and
the majority of affected financial institutions. The settlement provided that
50% of all dividends received from REIT subsidiaries from 1999 through 2002 were
subject to state taxation. Interest on such additional taxes was also assessed.
Payment of such taxes and interest totaling $431 was made in June 2003. As a
result of this settlement, the Company recognized a reduction of $374 in its
accrued tax liabilities, which increased net income by the same amount in fiscal
2004.
50
The components of gross deferred tax assets and gross deferred tax
liabilities that have been recognized as of March 31 are as follows:
2004 2003
--------- ---------
Deferred tax assets:
Allowance for loan losses $ 651 $ 549
Deferred loan origination fees 32 42
Depreciation 277 324
Post-employee retirement benefit
accrual 238 239
Write-down of investments securities 500 460
Deferred expenses -- 524
Other 88 65
------- --------
Gross deferred tax asset 1,786 2,203
------- --------
Deferred tax liabilities:
Unrealized gain on securities, net 1,277 607
Accrued dividend receivable 18 27
Deferred loan origination costs 248 219
Deferred income -- 631
------- --------
Gross deferred tax liability 1,543 1,484
------- --------
Net deferred tax asset $ 243 $ 719
======= ========
Based on the Company's historical and current pre-tax earnings, management
believes it is more likely than not that the Company will realize the net
deferred tax asset existing at March 31, 2004. Further, management believes the
existing net deductible temporary differences will reverse during periods in
which the Company generates net taxable income. At March 31, 2004, recoverable
income taxes, plus estimated taxes for fiscal 2005, exceed the amount of the net
deferred tax asset. There can be no assurance, however, that the Company will
generate any earnings or any specific level of continuing earnings.
The unrecaptured base year tax bad debt reserves will not be subject to
recapture as long as the Company continues to carry on the business of banking.
In addition, the balance of the pre-1988 bad debt reserves continues to be
subject to provision of present law that requires recapture in the case of
certain excess distributions to shareholders. The tax effect of pre-1988 bad
debt reserves subject to recapture in the case of certain excess distributions
is approximately $1,300.
NOTE 9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (IN THOUSANDS)
The Bank is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include unused lines of credit, unadvanced portions
of commercial and construction loans, and commitments to originate loans. The
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the balance sheets. The amounts of
those instruments reflect the extent of the Bank's involvement in particular
classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to its financial instruments is represented by the contractual
amount of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
51
Financial instruments with off-balance sheet risks as of March 31, included
the following:
2004 2003
------------- --------------
Unused lines of credit $14,340 $15,153
Unadvanced portions of construction loans 6,391 9,260
Unadvanced portions of commercial loans 5,917 925
Commitments to originate commercial mortgage loans 16,387 18,526
Commitments to originate residential mortgage loans 4,992 12,850
Commitments to sell residential mortgage loans 5,603 4,810
Commitments to originate loans, unused lines of credit and unadvanced
portions of commercial and construction loans are agreements to lend to a
customer, provided there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments may
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on management's credit
evaluation of the borrower.
NOTE 10. STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
The Company and the Bank may not declare or pay cash dividends on their
stock if the effect thereof would cause capital to be reduced below regulatory
requirements, or if such declaration and payment would otherwise violate
regulatory requirements.
In October 1991, the Company adopted a Shareholder Rights Agreement
("Rights Plan") entitling each shareholder, other than an Acquiring Person or an
Adverse Person as defined below, to purchase the Company's stock at a discount
price in the event any person or group of persons exceeded predetermined
ownership limitations of the Company's outstanding common stock (an "Acquiring
Person") and, in certain circumstances, engaged in specific activities deemed
adverse to the interests of the Company's shareholders (an "Adverse Person").
The Rights Plan was due to expire in October 2001, but was renewed by the Board
of Directors during fiscal 2002 and is now scheduled to expire in October 2011.
Beginning in April 1999, the Board of Directors authorized a series of four
separate 5% stock repurchase programs under which the Company has acquired
365,294 shares of its stock at an average cost of $19.56 per share. The latest
repurchase program was completed in March 2002.
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. The minimum core (leverage) capital ratio
required for banks with the highest overall rating from bank regulatory agencies
is 3.00% and is 4.00%-5.00% for all others. The Bank must also have a minimum
total risk-based capital ratio of 8.00% (of which 4.00% must be Tier I capital,
consisting of common stockholders' equity). As of March 31, 2004, the Bank met
all capital adequacy requirements to which it is subject.
52
The most recent notification from the FDIC categorized the Bank as "well
capitalized" under the regulatory framework for prompt corrective action. To be
categorized as "well capitalized," the Bank must maintain minimum risk-weighted
capital, Tier 1 capital and tangible capital ratios as set forth in the table.
There are no conditions or events, since that notification, that management
believes would cause a change in the Bank's categorization. No deduction was
taken from capital for interest-rate risk. The Company's and the Bank's Tier 1
leverage, Tier 1 risk-based and total risk-based capital ratios together with
related regulatory minimum requirements are summarized below:
To be well
For capital capitalized under
adequacy Prompt Corrective
Actual purposes Action provisions
------------------------- ---------------------------- ---------------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --------- ------------- ---------- ------------- ----------
As of March 31, 2004:
COMPANY (CONSOLIDATED)
Total capital $42,613 12.14% $28,070 =>8.00% N/A N/A
Tier 1 capital 38,929 11.09 14,035 =>4.00 N/A N/A
Tier 1 leverage capital 38,929 8.13 19,153 =>4.00 N/A N/A
BANK
Total capital 41,376 11.80 28,060 =>8.00 $35,074 =>10.00%
Tier 1 capital 37,692 10.75 14,030 =>4.00 21,044 => 6.00
Tier 1 leverage capital 37,692 7.92 19,027 =>4.00 23,783 => 5.00
As of March 31, 2003:
COMPANY (CONSOLIDATED)
Total capital 39,076 12.05 25,950 =>8.00 N/A N/A
Tier 1 capital 35,792 11.03 12,975 =>4.00 N/A N/A
Tier 1 leverage capital 35,792 7.41 19,299 =>4.00 N/A N/A
BANK
Total capital 35,949 11.08 25,950 =>8.00 32,437 =>10.00
Tier 1 capital 32,665 10.07 12,975 =>4.00 19,462 => 6.00
Tier 1 leverage capital 32,665 6.77 19,299 =>4.00 24,124 => 5.00
=> means equal or greater than
NOTE 11. EMPLOYEE BENEFITS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PENSION AND SAVINGS PLANS
As a participating employer in the Cooperative Banks Employees Retirement
Association ("CBERA"), a multi-employer plan, the Bank has in effect a
noncontributory defined benefit plan ("Pension Plan") and a defined contribution
plan ("Savings Plan") covering substantially all eligible employees.
Benefits under the Pension Plan are determined at the rate of 1% and 1.5%,
respectively, of certain elements of final average pay times years of credited
service and are generally provided at age 65 based on years of service and the
average of the participants' three highest consecutive years of compensation
from the Bank. Employee contributions are made to a Savings Plan which qualifies
under section 401(k) of the Internal Revenue Code of 1986, as amended. The Bank
matches 50% of an eligible deferral contribution on the first 5% of the deferral
amount subject to the maximum allowable under federal regulations. Pension
benefits and employer contributions to the Savings Plan become vested over six
years.
Expenses for the Pension Plan and the Savings Plan were $449, $319 and $289
for the years ended March 31, 2004, 2003 and 2002, respectively. Forfeitures are
used to reduce expenses of the plans.
53
EMPLOYEE STOCK OWNERSHIP PLAN
The Bank maintains an Employee Stock Ownership Plan ("ESOP") that is
authorized to purchase shares of outstanding common stock of the Company from
time to time in the open market or in negotiated transactions. The ESOP is a
tax-qualified defined contribution plan established for the exclusive benefit of
the Bank's employees. All full-time employees who have completed one year of
service with the Bank are eligible to participate in the ESOP.
During fiscal 2002, the Company's Board of Directors authorized a loan to
the ESOP to acquire up to an additional 5% of outstanding shares of Company
stock. During fiscal 2003, loans to purchase up to an additional $3,200 in
shares for the ESOP were authorized. At March 31, 2004, $1,942 remained
available under this authorization. During fiscal 2003 and 2002, 114,864 and
7,222 shares, respectively, were purchased at a purchase price of $3,595 and
$199, respectively.
Through October 2003, the ESOP repaid its loans to the Company with funds
from the Bank's contributions to the ESOP along with dividends on unallocated
ESOP shares. These loans had terms of up to 20 years. In October 2003, the ESOP
refinanced these loans from the Company with a third party lender. In connection
with this refinancing, the Company received proceeds of $3,506, of which $2,250
was contributed to the Bank's capital. The loan bears interest at the prevailing
prime rate plus 1/2% and matures in March 2012. Principal payments of $97 are to
be made each quarter. The loan is collateralized by the ESOP's unallocated
Company stock, a certificate of deposit of $1,200 and a pledge of the Company's
stock in the Bank. In addition, the Company guarantees repayment of the loan.
As more fully disclosed in Note 12, the Company entered into a settlement
agreement with certain shareholders in August 2003. The terms of that agreement
limit the ESOP's right to acquire shares through August 2005 to purchases from
either PL Capital, LLC and its affiliates or former employees of the Bank,
unless PL Capital, LLC and its affiliates ownership of Company stock becomes
less than 5%.
Compensation expense is recognized as the shares are allocated to
participants based upon the fair value of the shares at the time they are
allocated. As a result, changes in the market value of the Company's stock have
an effect on the Company's results of operations but have no effect on
stockholders' equity. ESOP expense for fiscal 2004, 2003 and 2002 amounted to
$332, $429 and $305, respectively.
STOCK OPTION PLAN
The Company has adopted two qualified Stock Option Plans for the benefit of
officers and other employees under which an aggregate of 281,500 shares had been
reserved for issuance. One of these plans terminated in 1997.
Stock option activity is as follows for the years indicated:
Number of Weighted Average
Shares Shares Exercise Price
----------------- ------------------------
Balance March 31, 2001 90,000 $17.830
Forfeited (799) 16.625
Exercised (29,588) 16.617
--------
Balance March 31, 2002 59,613 18.448
Exercised (28,139) 18.308
--------
Balance March 31, 2003 31,474 18.572
Exercised (2,524) 18.469
--------
Balance March 31, 2004 28,950 18.581
========
The exercise price of an option may not be less than the fair market value
of the Company's common stock on the date of grant of the option and may not be
exercisable more than ten years after the date of grant. At March 31, 2004,
33,299 shares were reserved for issuance under the remaining plan.
54
All stock options are fully vested and exercisable at the time of grant.
The range of exercise prices and weighted average remaining contractual lives of
outstanding stock options at March 31, 2004 are as follows:
EXERCISE NUMBER REMAINING
PRICE OUTSTANDING LIFE
-------- ----------- ---------
$16.625 13,325 6.7 years
20.250 15,625 5.7 years
OTHER POST-RETIREMENT BENEFITS
The Bank maintains a post-retirement medical insurance plan and life
insurance plan for certain individuals. The following tables summarize the
funded status and the actuarial benefit obligations of these plans for fiscal
2004 and 2003.
2004 2003
--------------------- ----------------------
Life Medical Life Medical
---- ------- ---- -------
Actuarial present value of benefits obligation:
Retirees $ (244) $ (377) $ (229) $ (357)
Fully eligible participants (16) (67) (14) (57)
------- ------- ------- -------
Total $ (260) $ (444) $ (243) $ (414)
======= ======= ======= =======
Change in projected benefit obligation:
Accumulated benefit obligations at prior year-end $ (243) $ (414) $ (232) $ (746)
Service cost less expense component -- -- -- --
Interest cost (16) (27) (16) (27)
Actuarial gain (loss) (1) (27) 4 330
Assumptions (10) (15) (9) (29)
Benefits paid 10 39 10 58
------- ------- ------- -------
Accumulated benefit obligations at year-end $ (260) $ (444) $ (243) $ (414)
======= ======= ======= =======
Change in plan assets:
Fair value of plan assets at prior year-end $ -- $ -- $ -- $ --
Actual return on plan assets -- -- -- --
Employer contribution 10 39 10 58
Benefits paid and expenses (10) (39) (10) (58)
------- ------- ------- -------
Fair value of plan assets at current year-end $ -- $ -- $ -- $ --
======= ======= ======= =======
Funded $ (260) $ (444) $ (243) $ (414)
Unrecognized net obligation 77 223 86 248
Unrecognized prior year service -- -- -- --
Unrecognized net loss (gain) (57) (127) (72) (180)
------- ------- ------- -------
$ (240) $ (348) $ (229) $ (346)
======= ======= ======= =======
Reconciliation of (accrual) prepaid:
(Accrued) prepaid pension cost at beginning
of year $ (229) $ (346) $ (219) $ (371)
Minus net periodic cost (21) (41) (20) (33)
Plus employer contributions, net 10 39 10 58
------- ------- ------- -------
(Accrued) prepaid cost at end of year $ (240) $ (348) $ (229) $ (346)
======= ======= ======= =======
Benefit obligation weighted average assumption
as of fiscal year-end:
Discount rate 6.00% 6.00% 6.50% 6.50%
Expected return on plan assets 6.00 6.00 6.50 6.50
Rate of compensation increase -- -- -- --
55
1 Percentage Point Increase
------------------------------------------------
2004 2003
--------------------- ----------------------
Life Medical Life Medical
---- ------- ---- -------
Impact of 1% change in health care trend rates:
Effect on total service and interest cost components $ N/A $ (2) N/A $ (2)
Effect on the post retirement benefit obligations N/A 29 N/A 27
Components of net periodic benefit cost:
Service cost $ -- $ -- $ -- $ --
Interest cost 16 27 16 27
Expected return on plan assets -- -- -- --
Amortization of prior service cost 8 25 9 25
Recognized actuarial (gain) loss (3) (11) (5) (19)
------- -------- ------- ------
Net periodic benefit cost $ 21 $ 41 $ 20 $ 33
======= ======== ======= ======
Periodic benefit cost weighted average assumptions:
Discount rate 6.50% 6.50% 7.25% 7.00%
Expected return on plan assets 6.50% 6.50% 7.25% 7.00%
Rate of compensation increase -- -- -- --
For measurement purposes, a 13.0% annual rate of increase in the per capita
cost of covered health care benefits was assumed for the fiscal year ended March
31, 2004. The rate was assumed to decrease gradually to 5.5% for the fiscal year
ending March 31, 2008 and remain at that level thereafter.
NOTE 12. LEGAL PROCEEDINGS (IN THOUSANDS)
The Bank 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 or any
subsidiary.
The Bank had 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 was
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 sought damages of $165 plus interest of approximately $175
and 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. In January 2004, the parties reached a settlement, which
resulted in a payment by the Bank, net of insurance, of $400, of which $350 had
been accrued in the year ended March 31, 2003.
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 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, which
was reimbursed by insurance, was made to PL Capital.
The Company had 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 received insurance recoveries of $3,093 during
the year ended March 31, 2004. These recoveries have been classified with
professional fees in the accompanying consolidated statements of income.
56
NOTE 13. FAIR VALUES OF FINANCIAL INSTRUMENTS (IN THOUSANDS)
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Significant assets and liabilities that are not
considered financial assets or liabilities include the intangible value inherent
in deposit relationships (i.e., core deposits) and banking premises and
equipment. In addition, the tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on fair values and
have not been considered in any of the estimates. Accordingly, the aggregate
fair value amounts presented do not represent the underlying value of the Bank.
The following methods and assumptions were used by the Bank in estimating
fair values of its financial instruments:
CASH AND DUE FROM BANKS
The carrying values reported in the balance sheet for cash and due from
banks approximate their fair value because of the short maturity of these
instruments.
SHORT-TERM INVESTMENTS AND CERTIFICATE OF DEPOSIT
The carrying values reported in the balance sheet for short-term
investments and the certificate of deposit approximate fair value because of the
short maturity of these investments.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
The fair values presented for investment and mortgage-backed securities are
based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
LOANS AND LOANS HELD FOR SALE
The fair values of loans are estimated using discounted cash flow analysis,
using interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. The incremental credit risk for
nonperforming loans has been considered in the determination of the fair value
of loans. The fair value of loans held for sale is determined based on the
unrealized gain or loss on such loans.
ACCRUED INTEREST RECEIVABLE
The carrying value reported in the balance sheet for accrued interest
receivable approximates its fair value because of the short maturity of these
accounts.
STOCK IN FHLB OF BOSTON
The carrying amount reported in the balance sheet for FHLB stock
approximates its fair value. If redeemed, the Bank will receive an amount equal
to the par value of the stock.
THE CO-OPERATIVE CENTRAL BANK RESERVE FUND
The carrying amount reported in the balance sheet for the Co-operative
Central Bank Reserve Fund approximates its fair value.
DEPOSITS
The fair values of deposits (excluding term deposit certificates) are, by
definition, equal to the amount payable on demand at the reporting date. Fair
values for term deposit certificates are estimated using a discounted cash flow
technique that applies interest rates currently being offered on certificates to
a schedule of aggregated monthly maturities on time deposits with similar
remaining maturities.
57
ADVANCES FROM FHLB OF BOSTON
Fair values of non-callable advances from the FHLB of Boston are estimated
based on the discounted cash flow of scheduled future payments using the
respective year-end published rates for advances with similar terms and
remaining maturities. Fair values of callable advances from the FHLB of Boston
are estimated using the prepayment fee payable to the FHLB of Boston assuming
all such advances were prepaid on the reporting date.
SHORT-TERM BORROWINGS, ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND
INSURANCE AND ACCRUED INTEREST PAYABLE
The carrying values reported in the balance sheet for short-term
borrowings, advance payments by borrowers for taxes and insurance and accrued
interest payable approximate their fair value because of the short maturity of
these accounts.
OFF-BALANCE SHEET INSTRUMENTS
The Bank's commitments for unused lines of credit and unadvanced portions
of loans are at floating rates, which approximate current market rates, and,
therefore, no fair value adjustment has been made.
The estimated carrying amounts and fair values of the Bank's financial
instruments are as follows:
MARCH 31, 2004 MARCH 31, 2003
------------------------- ------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
ASSETS
Cash and due from banks $ 7,113 $ 7,113 $ 5,996 $ 5,996
Short-term investments 27,224 27,224 5,226 5,226
Certificate of deposit 1,211 1,211 -- --
Investment securities 83,771 83,771 61,111 61,111
Loans held for sale 799 810 647 665
Net loans 353,088 358,753 386,533 392,700
Stock in Federal Home Loan Bank of Boston, at cost 8,300 8,300 8,300 8,300
The Co-operative Central Bank Reserve Fund 1,576 1,576 1,576 1,576
Accrued interest receivable 2,203 2,203 2,380 2,380
LIABILITIES
Deposits $295,920 $ 297,345 $287,959 $290,325
Short-term borrowings 845 845 176 176
Advances from FHLB of Boston 141,100 152,422 144,400 160,104
ESOP loan 3,311 3,311 -- --
Advance payments by borrowers for taxes and insurance 1,182 1,182 999 999
Accrued interest payable 647 647 606 606
58
NOTE 14. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS (IN THOUSANDS)
The following are the condensed financial statements for Central Bancorp,
Inc. (the "Parent Company") only:
March 31,
-----------------------------
BALANCE SHEETS 2004 2003
--------------------------------------------------------------------------------------------------------------------
ASSETS
Cash deposit in subsidiary bank $ 107 $ 93
Certificate of deposit (note 11) 1,211 --
Investment in subsidiary 42,217 36,326
ESOP loan (note 11) -- 3,660
Other assets -- 394
-------- -----------
Total assets $ 43,535 $ 40,473
======== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued taxes and other liabilities $ 81 $ 1,030
Total stockholders' equity 43,454 39,443
-------- -----------
Total liabilities and stockholders' equity $ 43,535 $ 40,473
======== ===========
Years Ended March 31,
--------------------------------------
STATEMENTS OF INCOME 2004 2003 2002
----------------------------------------------------------------------------------------------------------------------
Dividends from subsidiary $1,000 $ 2,437 $ 2,500
Interest income 98 92 --
Non-interest income (expenses) (note 12) 87 (2,006) (466)
------ ------- ---------
Income before income taxes 1,185 523 2,034
Income tax benefit (provision) (63) 650 154
------ -------- ---------
Income before equity in undistributed net income of subsidiary 1,122 1,173 2,188
Equity in undistributed net income of subsidiary 1,814 1,014 672
------ -------- ---------
Net income $2,936 $ 2,187 $ 2,860
====== ======= =========
59
Years Ended March 31,
------------------------------------
STATEMENTS OF CASH FLOWS 2004 2003 2002
----------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 2,936 $ 2,187 $ 2,860
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in undistributed net income of subsidiary (1,814) (1,014) (672)
Decrease (increase) in other assets 394 (394) --
Increase (decrease) in accrued taxes and other liabilities (949) 1,030 (71)
-------- ------- --------
Net cash provided by operating activities 567 1,809 2,117
-------- ------- --------
Cash flows from investing activities:
ESOP loans, net of repayment 3,660 (3,461) (199)
Purchase of certificate of deposit (1,200) -- --
Investment in subsidiary (2,366) -- --
------- ------- --------
Net cash provided by (used in) investing activities 94 (3,461) (199)
-------- ------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options 47 516 492
Purchase of treasury stock -- -- (1,924)
Cash dividends paid, net (682) (727) (669)
Other, net (12) (14) --
-------- ------- --------
Net cash used by financing activities (647) (225) (2,101)
-------- ------- --------
Net increase (decrease) in cash in subsidiary bank 14 (1,877) (183)
Cash in subsidiary bank at beginning of year 93 1,970 2,153
-------- ------- --------
Cash in subsidiary bank at end of year $ 107 $ 93 $ 1,970
======== ======= ========
NOTE 15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER
SHARE DATA)
The following tables summarize the operating results on a quarterly basis
for the years ended March 31, 2004 and 2003.
2004
------------------------------------------------------
First Second Third Fourth
----- ------ ----- ------
Interest and dividend income....................... $ 7,023 $ 6,816 $ 6,576 $ 6,692
Interest expense................................... 2,914 2,875 2,883 2,865
-----------------------------------------------------
Net interest and dividend income.............. 4,109 3,941 3,693 3,827
Provision for loan losses.......................... 50 50 50 50
Non-interest income................................ 414 163 307 242
Non-interest expenses.............................. 3,003 2,756 3,017 3,625
-----------------------------------------------------
Income before income taxes.................... 1,470 1,298 933 394
Income tax......................................... 182 468 358 151
-----------------------------------------------------
Net income.................................... $ 1,288 $ 830 $ 575 $ 243
=====================================================
Earnings per common share -- basic................. $ 0.83 $ 0.54 $ 0.37 $ 0.16
=====================================================
Earnings per common share -- diluted............... $ 0.83 $ 0.53 $ 0.37 $ 0.15
=====================================================
60
2003
-----------------------------------------------------
First Second Third Fourth
----- ------ ----- ------
Interest and dividend income....................... $ 7,563 $ 7,450 $ 7,600 $ 7,516
Interest expense................................... 3,283 3,334 3,248 3,007
-----------------------------------------------------
Net interest and dividend income.............. 4,280 4,116 4,352 4,509
Non-interest income................................ 223 58 306 818
Non-interest expenses.............................. 2,891 3,132 3,200 4,654
-----------------------------------------------------
Income before income taxes.................... 1,612 1,042 1,458 673
Income tax......................................... 585 374 548 1,091
-----------------------------------------------------
Net income (loss)............................. $ 1,027 $ 668 $ 910 $ (418)
=====================================================
Earnings (loss) per common share -- basic.......... $ 0.64 $ 0.42 $ 0.58 $ (0.27)
=====================================================
Earnings (loss) per common share -- diluted........ $ 0.63 $ 0.42 $ 0.58 $ (0.27)
=====================================================
During the quarter ended March 31, 2004, the Bank initiated a major
marketing program to promote the Bank and its new free checking product and,
separately, its high-yielding money market account. Total marketing expenses
during the quarter were $371, or 48% of the marketing expenses for the year
ended March 31, 2004.
During the quarter ended March 31, 2003, the Bank recognized gains on the
sales of loans of $768 and impairment write-downs of certain marketable equity
securities totaling $115.
As more fully described in Note 8, the Bank provided additional income
taxes of $835 in the quarter ended March 31, 2003 as a result of legislation
affecting the taxation of dividends received by the Bank from its REIT
subsidiary. In addition, included in non-interest expenses for the quarter ended
March 31, 2003, are an accrual of $350 for the Bank's portion of the estimated
cost of resolution of a commercial claim filed in 2002 and legal fees of $1,076
incurred in a dispute with certain of the Company's shareholders.
61
[LETTERHEAD OF VITALE, CATURANO & COMPANY, P.C.]
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Central Bancorp, Inc.:
We have audited the consolidated balance sheet of Central Bancorp, Inc. and
subsidiary (the "Company") as of March 31, 2004 and the related consolidated
statements of income, changes in stockholders' equity and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Central Bancorp,
Inc. and subsidiary as of March 31, 2004 and the results of their operations and
their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Vitale, Caturano & Company, P.C.
VITALE, CATURANO & COMPANY, P.C.
Boston, Massachusetts
April 27, 2004
62
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Central Bancorp, Inc.
We have audited the accompanying consolidated balance sheet of Central Bancorp,
Inc. and subsidiary (the Company) as of March 31, 2003 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the years ended March 31, 2003 and 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Central Bancorp,
Inc. and subsidiary as of March 31, 2003, and the results of their operations
and their cash flows for the years ended March 31, 2003 and 2002, in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the Consolidated Financial Statements, effective April
1, 2002, the Company adopted Statements of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets."
/s/ KPMG LLP
Boston, Massachusetts
April 25, 2003, except as to the fourth paragraph of Note 8, which is as of June
23, 2003
63
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
KPMG LLP served as the Company's independent auditors for the 2003 and 2002
fiscal years. On November 17, 2003, KPMG LLP's appointment as principal
accountants was terminated and the Company engaged Vitale, Caturano & Company,
P.C. ("Vitale") as its principal accountants. The engagement of Vitale was
approved by the Audit Committee of the Company's Board of Directors. A
representative of Vitale is expected to be present at the Annual Meeting to
respond to stockholders' questions and will have the opportunity to make a
statement if he or she so desires.
KPMG LLP served as the Company's independent auditors to audit the
Company's consolidated financial statements as of and for the fiscal years ended
March 31, 2003 and 2002. KPMG LLP's reports on the Company's consolidated
financial statements as of and for the fiscal years ended March 31, 2003 and
2002 did not contain an adverse opinion or disclaimer of opinion and was not
qualified or modified as to uncertainty, audit scope, or accounting principles.
During the two fiscal years ended March 31, 2003 and 2002, and the
subsequent interim period from April 1, 2003 through November 17, 2003, there
were no disagreements with KPMG LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of KPMG LLP, would have
caused KPMG LLP to make reference to the subject matter of the disagreements in
their report on the financial statements for such years.
ITEM 9A. 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. It should be noted that the design of the
Company's disclosure controls and procedures is based in part upon certain
reasonable assumptions about the likelihood of future events, and there can be
no reasonable assurance that any design of disclosure controls and procedures
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote. The Company's principal executive and
financial officers have concluded that the Company's disclosure controls and
procedures are, in fact, effective at a reasonable assurance level.
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.
64
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The information contained under the sections captioned "Proposal I --
Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive proxy statement for the Company's 2004
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
The Company has adopted a Code of Ethics that applies to the Company's
officers, directors and employees.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Executive Compensation and Other Benefits" in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The information required by this item is incorporated herein by
reference to the section captioned "Principal Holders of Voting
Securities" in the Proxy Statement.
(b) SECURITY OWNERSHIP OF MANAGEMENT
The information required by this item is incorporated herein by
reference to the section captioned "Proposal I -- Election of
Directors -- Security Ownership of Management" in the Proxy Statement.
(c) CHANGES IN CONTROL
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
Company.
(d) EQUITY COMPENSATION PLANS
The Company has adopted the 1999 Stock Option and Incentive Plan
pursuant to which equity may be awarded to participants. This plan has
been approved by stockholders.
65
The following table sets forth certain information with respect to the
Company's equity compensation plan as of March 31, 2004.
(c)
Number of securities
(a) remaining available
Number of securities to be (b) for future issuance
issued upon exercising Weighted-average exercise under equity compensation
upon exercise of outstanding price of outstanding plan (excluding securities
Plan Category options, warrants and rights options, warrants and rights reflected in column (a))
- ------------- ---------------------------- ---------------------------- --------------------------
Equity compensation plans 28,950 $18.581 33,299
approved by security holders
Equity compensation plans not
approved by security holders -- -- --
------ ------- ------
Total (1) 28,950 $18.581 33,299
====== ======= ======
- ------------
(1) The 1999 Stock Option and Incentive Plan provides for a proportionate
adjustment to the number of shares reserved thereunder in the event of
a stock split, stock dividend, reclassification or similar event.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Certain Transactions" in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
- ------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Independent Auditors" in the Proxy Statement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) The following documents are filed as part of this Annual Report on Form
10-K.
(1) FINANCIAL STATEMENTS
--------------------
For the Financial Statements filed as part of this Annual Report on
Form 10-K, reference is made to "Item 8 -- Financial Statements and
Supplementary Data."
(2) FINANCIAL STATEMENT SCHEDULES
-----------------------------
All financial statement schedules have been omitted as not applicable
or not required or because they are included in the financial
statements appearing at Item 8.
(3) EXHIBITS
--------
The exhibits required by Item 601 of Regulation S-K are either filed
as part of this Annual Report on Form 10-K or incorporated by
reference herein.
66
(b) REPORTS ON FORM 8-K. The Registrant filed the following Current
--------------------
Reports on Form 8-K during the fourth quarter of the fiscal year
ended March 31, 2004:
Date of Report Item(s) Reported Financial Statements Filed
-------------- ---------------- --------------------------
January 23, 2004 7, 12 N/A
(c) EXHIBITS
--------
The following exhibits are filed as exhibits to this report.
Exhibit No. Description
----------- -----------
3.1* Articles of Organization of Central Bancorp, Inc.
3.2 Amended Bylaws of Central Bancorp, Inc.
4.1 Shareholder Rights Agreement, dated as of October 11, 2001, by and between Central Bancorp, Inc. and
Registrar and Transfer Company, as Rights Agent, as amended and restated as of January 29, 2003, and
as amended on February 11, 2003, May 22, 2003, July 24, 2003 and August 4, 2003
10.1* Employment Agreement between the Bank and John D. Doherty, dated October 24, 1986 +
10.2* First Amendment to Employment Agreement between the Bank and John D. Doherty, dated March 31, 1992 +
10.3* Second Amendment to Employment Agreement between the Bank and John D. Doherty, dated June 8, 1995 +
10.4* Third Amendment to the Employment Agreement between the Bank and John D. Doherty, dated January 8,
1999 +
10.5* Severance Agreement between the Bank and William P. Morrissey, dated December 14, 1994 +
10.6* Severance Agreement between the Bank and David W. Kearn, dated December 14, 1994 +
10.7* Severance Agreement between the Bank and Paul S. Feeley, dated May 14, 1998 +
10.8* Amendments to Severance Agreements between the Bank and Messrs. Feeley, Kearn and Morrissey, dated
January 8, 1999. +
10.09** 1999 Stock Option and Incentive Plan +
10.10*** Deferred Compensation Plan for Non-Employee Directors +
10.11 Senior Management Incentive Plan, as amended +
10.12**** Severance Agreement between the Bank and Michael K. Devlin, dated February 25, 2002. +
14***** Code of Ethics
21 Subsidiaries of Registrant
23.1 Consent of Vitale, Caturano & Company, P.C.
23.2 Consent of KPMG LLP
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
--------------
+ Management contract or compensatory plan.
* Incorporated by reference to the Form 10-K for the fiscal year ended
March 31, 1999, filed with the SEC on June 28, 1999.
** Incorporated by reference to the Registration Statement on Form S-8
(File No. 333-87005) filed on September 13, 1999.
*** Incorporated by reference to the Registration Statement on Form S-8
(File No. 333-49264) filed on November 3, 2000.
**** Incorporated by reference to the Annual Report on Form 10-K for the
fiscal year ended March 31, 2002 filed with the SEC on June 28, 2002.
***** Incorporated by reference to the Current Report on Form 8-K filed with
the SEC on April 13, 2004.
67
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CENTRAL BANCORP, INC.
Date: June 25, 2004 By: /s/ John D. Doherty
----------------------------------------------
John D. Doherty
Chairman, President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ John D. Doherty Date: June 25, 2004
-------------------------------------------------
John D. Doherty
Chairman, President and Chief Executive Officer
By: /s/ Michael K. Devlin Date: June 25, 2004
-------------------------------------------------
Michael K. Devlin
Senior Vice President, Treasurer
and Chief Financial Officer
(Principal Financial and Accounting Officer)
By: /s/ Gregory W. Boulos Date: June 25, 2004
-------------------------------------------------
Gregory W. Boulos
Director
By: /s/ Paul E. Bulman Date: June 25, 2004
-------------------------------------------------
Paul E. Bulman
Director
By: /s/ Joseph R. Doherty Date: June 25, 2004
-------------------------------------------------
Joseph R. Doherty
Director
By: /s/ Richard J. Fates Date: June 25, 2004
-------------------------------------------------
Richard J. Fates
Director
By: /s/ Richard J. Lashley Date: June 25, 2004
-------------------------------------------------
Richard J. Lashley
Director
By: /s/ James F. Linnehan Date: June 25, 2004
-------------------------------------------------
James F. Linnehan
Director
By: /s/ Albert J. Mercuri, Jr. Date: June 25, 2004
-------------------------------------------------
Albert J. Mercuri, Jr.
Director
By: /s/ John J. Morrissey Date: June 25, 2004
-------------------------------------------------
John J. Morrissey
Director
By: /s/ Edward F. Sweeney, Jr. Date: June 25, 2004
-------------------------------------------------
Edward F. Sweeney, Jr.
Director