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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
COMMISSION FILE NUMBER 0-23533
MYSTIC FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3401049
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
60 High Street, Medford, Massachusetts 02155
(Address of principal executive office-zip code)
Telephone (781) 395-2800
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding twelve 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 .
----- -----
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 registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this form
10-K [X]
As of August 30, 2002, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the Registrant was
approximately $18,652,230.
As of August 30, 2002, 1,465,803 shares of Registrant's common stock
were outstanding.
Documents Incorporated by Reference:
Portions of the Registrant's Proxy Statement for its 2002 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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MYSTIC FINANCIAL, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
JUNE 30, 2002
TABLE OF CONTENTS
PART I
ITEM 1. Business 1
ITEM 2. Properties 27
ITEM 3. Legal Proceedings 28
ITEM 4. Submission of Matters to a Vote of Security Holders 28
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters 28
ITEM 6. Selected Financial Data 30
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 31
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 42
ITEM 8. Financial Statements and Supplementary Data 43
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 43
PART III
ITEM 10. Directors and Executive Officers of the Registrant 44
ITEM 11. Executive Compensation 44
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management 44
ITEM 13. Certain Relationships and Related Transactions 45
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 45
SIGNATURES 48
PART I
Forward Looking Statement
Mystic Financial, Inc. ("Mystic" or the "Company") and Medford Co-
operative Bank (the "Bank") may from time to time make written or oral
"forward-looking statements." These forward-looking statements may be
contained in this annual filing with the Securities and Exchange Commission
(the "SEC"), the Annual Report to Shareholders, other filings with the SEC,
and in other communications by the Company and the Bank, which are made in
good faith pursuant to the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. The words "may," "could,"
"should," "would," "believe," "anticipate," "estimate," "expect," "intend,"
"plan" and similar expressions are intended to identify forward-looking
statements.
Forward-looking statements include statements with respect to the
Company's beliefs, plans, objectives, goals, expectations, anticipations,
estimates and intentions, that are subject to significant risks and
uncertainties. The following factors, many of which are subject to change
based on various other factors beyond the Company's control, and other
factors discussed in this Form 10-K, as well as other factors identified in
the Company's filings with the SEC and those presented elsewhere by
management from time to time, could cause its financial performance to
differ materially from the plans, objectives, expectations, estimates and
intentions expressed in such forward-looking statements:
* the strength of the United States economy in general and the
strength of the local economies in which the Company and the Bank
conduct operations;
* the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the Federal Reserve
Board;
* inflation, interest rate, market and monetary fluctuations;
* the timely development of and acceptance of new products and services
and the perceived overall value of these products and services by
users, including the features, pricing and quality compared to
competitors' products and services;
* the willingness of users to substitute competitors' products and
services for the Company's and the Bank's products and services;
* the Company's and the Bank's success in gaining regulatory approval
of their products and services, when required;
* the impact of changes in financial services' laws and regulations
(including laws concerning taxes, banking, securities and insurance);
* the impact of technological changes;
* acquisitions;
* changes in consumer spending and saving habits; and
* the Company's and the Bank's success at managing the risks involved
in their business.
This list of important factors is not exclusive. The Company or the
Bank do not undertake to update any forward-looking statement, whether
written or oral, that may be made from time to time by or on behalf of the
Company or the Bank.
ITEM 1. BUSINESS
General
On January 8, 1998, the Bank completed its conversion from mutual to
stock form and became a wholly owned subsidiary of the Company. On such
date, the Company sold 2,711,125 shares of its common stock, par value
$0.01 per share (the "Common Stock"), to the public, at a per share price
of $10.00. The conversion of the Bank from mutual to stock form, the
formation of the Company as the
1
holding company for the Bank and the issuance and sale of the Common Stock
are herein referred to collectively as the "Conversion." The Conversion
raised $25.7 million in net proceeds. Mystic used $3.2 million of retained
net proceeds to fund a loan to its Employee Stock Ownership Plan ("ESOP")
to purchase 216,890 shares of the Common Stock in open-market purchases
following completion of the Conversion. In April 2002, the Company formed
Mystic Financial Capital Trust I and became the owner of 100% of this
entity, which completed the sale of $5.0 million trust preferred
securities. See Note 8 to the Audited Financial Statements.
The Company's principal business activity consists of the ownership
of the Bank and Mystic Financial Capital Trust I (the 'Trust"), formed in
2002. The Company also invests in short-term investment grade marketable
securities and other liquid investments. The Trust issued $5.0 million of
trust preferred securities on April 10, 2002 and used the proceeds to
purchase subordinated debentures from the Company. The Company has no
significant liabilities (other than those of the Bank). The Company
neither owns nor leases any property but instead uses the premises and
equipment of the Bank. At the present time, the Company does not employ
any persons other than certain officers of the Bank who do not receive any
extra compensation as officers of the Company. The Company utilizes the
support staff of the Bank from time to time, as needed. Additional
employees may be hired as deemed appropriate by the management of the
Company.
The Bank is a Massachusetts chartered stock co-operative bank founded
in 1886 with three full-service offices in Medford, Massachusetts and full-
service offices in Lexington, Arlington and Bedford, Massachusetts. The
Bank's deposits have been federally insured since 1986 and are currently
insured by the Bank Insurance Fund ("BIF") of the Federal Deposit
Insurance Corporation ("FDIC") and the Share Insurance Fund of the Co-
operative Central Bank. The Bank has been a member of the Co-operative
Central Bank since 1932 and a member of the Federal Home Loan Bank ("FHLB")
since 1988. The Bank is subject to comprehensive examination, supervision
and regulation by the Commissioner of Banks of the Commonwealth of
Massachusetts (the "Commissioner") and the FDIC. These regulations are
intended primarily for the protection of depositors and borrowers. The
Bank exceeded all of its regulatory capital requirements at June 30, 2002.
The business of the Bank consists of attracting deposits from the
general public and using these funds to originate various types of loans
primarily in eastern Middlesex County, Massachusetts, including mortgage
loans secured by one- to four-family residences, commercial loans secured
by general business assets and commercial real estate loans secured by
commercial property, and to invest in U.S. Government and Federal Agency
and other securities. To a lesser extent, the Bank engages in various
forms of consumer and home equity lending. The Bank's profitability
depends primarily on its net interest income, which is the difference
between the interest income it earns on its loans and investment portfolio
and its cost of funds, which consists mainly of interest paid on deposits
and on borrowings from the FHLB. Net interest income is affected by the
relative amounts of interest-earning assets and interest-bearing
liabilities and the interest rates earned or paid on these balances. When
interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income.
The Bank has one active subsidiary, Mystic Securities Corporation,
which was established for the sole purpose of acquiring and holding
securities. All securities held by Mystic Securities Corporation are
investments which are permissible for banks to hold under Massachusetts
law.
2
Market Area
The Bank's main office and two branch offices are located in Medford,
Middlesex County, Massachusetts. The Bank has a full-service office in
Lexington, Middlesex County, Massachusetts, which opened in November 1998,
in Arlington, Middlesex County, Massachusetts, which opened in May 2000 and
Bedford, Middlesex County, Massachusetts, which opened in June 2002. The
city of Medford, containing approximately 60,000 residents, is located
approximately seven miles from downtown Boston in the northern suburbs of
Boston, bounded by the towns of Malden, Everett, Somerville, Stoneham,
Winchester and Arlington. The city of Medford is easily accessible from
downtown Boston via Interstate 93 and is accessible via other state roads
connecting the communities within the Route 128 corridor surrounding
Boston. As an established metropolitan suburb, Medford consists mostly of
developed single- and multi-family properties within a network of well-
maintained neighborhoods. The towns of Lexington and Bedford are
communities consisting mainly of single-family homes while the town of
Arlington contains a greater mix of small businesses and single- and multi-
family housing. The Bank considers its primary market area to be the
communities of Medford, Malden, Everett, Stoneham, Arlington, Winchester,
Somerville, Melrose, Lexington, and Bedford, Massachusetts.
The economic base of the Bank's market area is diversified and
includes a number of financial service institutions, industrial and
manufacturing companies, hospitals and other health care facilities and
educational institutions. The major employers in the Medford area are Tufts
University, the city of Medford, Lawrence Memorial Hospital, and the Meadow
Glen Mall, with approximately 1,900, 1,400, 900 and 900 employees each,
respectively. Management believes that the housing vacancy rate in Medford
is very low. The majority of the Bank's lending and deposit activity has
historically been in Medford, although the commercial loan department has
been largely responsible for expanded business throughout eastern Middlesex
County. Middlesex County, located in eastern Massachusetts to the north
and west of the city of Boston, is part of the Boston metropolitan area.
Based on US Census and HUD estimates for 2002, the median household income
for Middlesex County is $74,200.
Management believes that the Bank's lending success has been due, in
part, to the favorable income, population and housing demographics in
Medford and in the Bank's market area. At the same time, the growth of the
market area and delineated lending area and their proximity to Boston has
resulted in a highly competitive environment among the many financial
institutions competing for deposits and loans.
Competition
The Bank experiences competition both in attracting and retaining
savings deposits and in the making of mortgage, commercial and other loans.
Direct competition for savings deposits primarily comes from larger
commercial banks and other savings institutions located in or near the
Bank's primary market area who often have significantly greater financial
and technological resources than the Bank. Additional significant
competition for savings deposits comes from credit unions, money market
funds and brokerage firms.
With regard to lending competition in the local market area, the Bank
experiences the most significant competition from the same institutions
providing deposit services, most of whom have placed an emphasis on real
estate lending as a line of business. In addition, the Bank competes with
local and regional mortgage companies, independent mortgage brokers and
credit unions in originating mortgage and non-mortgage loans. The primary
factors in competing for loans are interest rates and loan origination fees
and the range of services offered by the various financial institutions.
3
While the Bank is subject to competition from other financial
institutions, which may have greater financial and marketing resources, the
Bank believes it benefits by its community bank orientation as well as its
relatively high core deposit base. Management believes that the variety,
depth and stability of the communities in which the Bank is located support
the service and lending activities conducted by the Bank. The relative
economic stability of the Bank's lending area is reflected in the small
number of mortgage delinquencies experienced by the Bank during the past
several years.
Lending Activities
The Bank originates loans through its three offices located in
Medford and its offices in Lexington, Arlington and Bedford, Massachusetts.
The principal lending activities of the Bank are the origination of
conventional mortgage loans for the purpose of purchasing or refinancing
owner-occupied, one- to four-family residential properties in its
designated community reinvestment area, consisting of the Massachusetts
communities of Medford, Malden, Everett, Stoneham, Arlington, Winchester,
Somerville, Lexington, Bedford and Melrose, and the origination of
commercial loans secured by commercial real estate and commercial assets
within eastern Middlesex County. To a lesser extent, the Bank also
originates consumer loans including home equity and passbook loans.
The Bank also lends to commercial businesses in the communities
that we serve. The Bank has senior lending officers with considerable
lending expertise and a support staff to the commercial lending department.
These loan officers are strategically located in our branch system to
support local community business.
The Bank's ten largest loan relationships, outstanding as of June 30,
2002, ranged from $1.6 million to $4.4 million. As of the same date, all
such relationships were performing in accordance with their respective
terms.
4
Loan Portfolio. The following table presents selected data relating to
the composition of the Bank's loan portfolio by type of loan on the dates
indicated.
At June 30,
------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------ ------------------ ------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ --------
(Dollars in Thousands)
Residential mortgage loans $153,915 63.1% $138,163 64.2% $127,862 67.6% $107,216 69.3% $106,412 76.8%
Commercial real estate
loans 58,889 24.2 50,483 23.5 41,294 21.8 33,980 22.0 24,475 17.7
Commercial loans 16,215 6.7 13,514 6.3 10,881 5.8 7,109 4.6 4,579 3.3
Consumer loans 1,004 0.4 1,532 0.7 1,526 0.8 1,546 1.0 1,787 1.3
Home equity loans 4,965 2.0 3,880 1.8 3,470 1.8 2,076 1.3 1,716 1.2
Construction loans 11,015 4.5 9,282 4.3 5,686 3.0 4,122 2.7 877 0.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans 246,003 100.9 216,854 100.8 190,719 100.8 156,049 100.9 139,846 100.9
Less:
Deferred loan origination
fees (costs) 197 0.1 35 - (12) - 12 - 17 -
Allowance for loan losses 2,063 0.8 1,784 0.8 1,531 0.8 1,348 0.9 1,236 0.9
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Loan, net $243,743 100.0% $215,035 100.0% $189,200 100.0% $154,689 100.0% $138,593 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
5
One-to-Four Family Residential Real Estate Lending. The primary
emphasis of the Bank's lending activity is the origination of conventional
mortgage loans on one-to-four family residential dwellings located in the
Bank's primary market area. As of June 30, 2002, loans on one-to-four
family residential properties accounted for 59.7% of the Bank's net loan
portfolio.
The Bank's mortgage loan originations are for terms of up to 30
years, amortized on a monthly basis with interest and principal due each
month. Residential real estate loans often remain outstanding for
significantly shorter periods than their contractual terms as borrowers may
refinance or prepay loans at their option, without penalty. Conventional
residential mortgage loans granted by the Bank customarily contain "due-on-
sale" clauses which permit the Bank to accelerate the indebtedness of the
loan upon transfer of ownership of the mortgaged property.
The Bank makes conventional mortgage loans and uses standard Fannie
Mae documents, to allow for the sale of qualifying loans in the secondary
mortgage market. The Bank's lending policies generally limit the maximum
loan-to-value ratio on mortgage loans secured by owner-occupied properties
to 95% of the lesser of the appraised value or purchase price of the
property, with the condition that private mortgage insurance is required on
loans with a loan-to-value ratio in excess of 80%.
Since the early 1980s, the Bank has offered adjustable-rate mortgage
loans with terms of up to 30 years. Adjustable-rate loans offered by the
Bank include loans which reprice every one or three years and provide for
an interest rate which is based on the interest rate paid on U.S. Treasury
securities of a corresponding term, plus a margin of up to 250 basis
points, or 2.5%. Additionally, the Bank offers an adjustable-rate loan
which is fixed for five years and then reprices every five years
thereafter. The Bank also has on its books an adjustable interest rate
loan product with an interest rate fixed for seven years which reprices
annually for its term thereafter. The Bank currently offers adjustable-
rate loans with initial rates below those which would prevail under the
foregoing computations, based upon the Bank's determination of market
factors and competitive rates for adjustable-rate loans in its market area.
For adjustable-rate loans, borrowers are qualified at the initial rate.
Historically, the Bank has retained all adjustable-rate mortgages it
originates. The Bank's adjustable-rate mortgages include limits on
increases or decreases of the interest rate of the loan. The interest rate
may increase or decrease by 2% per year and 5% over the life of the loan
for the Bank's one-year adjustable rate mortgages, by 3% per adjustment
period and 6% over the life of the loan for the Bank's three-year
adjustable rate mortgages, by 2% per adjustment period and 6% over the life
of the loan for the Bank's five-year adjustable-rate loans, and by 2% per
adjustment period and 5% over the life of the loan for the Bank's seven-
year adjustable-rate mortgages. The retention of adjustable-rate mortgage
loans in the Bank's loan portfolio helps reduce the Bank's exposure to
increases in interest rates. However, there are unquantifiable credit
risks resulting from potential increased costs to the borrower as a result
of the repricing of adjustable-rate mortgage loans. During periods of
rising interest rates, the risk of default on adjustable-rate mortgage
loans may increase due to the upward adjustment of interest cost to the
borrower.
During the year ended June 30, 2002, the Bank originated $40.2
million in adjustable-rate mortgage loans and $42.4 million in fixed-rate
mortgage loans. Of the fixed-rate loans originated, the Bank sold $9.2
million of fixed-rate loans with terms of greater than 15 years and
retained $33.2 million of fixed-rate loans, which had terms of 15 to 30
years. Approximately 32.0% of all loan originations during fiscal 2002
were refinances of loans already in the Bank's loan portfolio. At June 30,
2002, the Bank's loan portfolio included $72.5 million in adjustable-rate
one-to-four family residential mortgage loans or 29.7% of the Bank's net
loan portfolio, and $81.4 million in fixed-rate one-to-four family
residential mortgage loans, or 33.4% of the Bank's net loan portfolio.
6
Commercial Real Estate Loans. At June 30, 2002, the Bank's
commercial real estate loan portfolio consisted of 155 loans, totaling
$58.9 million, or 24.2% of net loans. The Bank's largest aggregate loan
relationship is a commercial borrower with an outstanding balance of $4.4
million at June 30, 2002 secured by various properties in Massachusetts.
Commercial real estate loans are administered by the commercial loan
department as described below under "Commercial Loans."
Commercial real estate lending entails additional risks compared with
one-to-four family residential lending. Because payments on loans secured
by commercial real estate properties are often dependent on the successful
operation or management of the properties, repayment of such loans may be
subject, to a greater extent, to adverse conditions in the real estate
market or the economy. Also, commercial real estate loans typically
involve large loan balances to single borrowers or groups of related
borrowers and the payment experience on such loans is typically dependent
on the successful operation of a real estate project and/or the collateral
value of the commercial real estate securing the loan.
Commercial Loans. In the past several years, the Bank has emphasized
commercial business loans in order to address the needs of business
commercial borrowers. The Bank has worked to develop a greater share of
making commercial loans to companies which have from $500,000 to $15.0
million in sales. At June 30, 2002, the Bank's commercial loan portfolio
consisted of 181 loans, totaling $16.2 million, or 6.7% of net loans.
Commercial loans are expected to comprise a growing portion of the
Bank's loan portfolio in the future. Unless otherwise structured as a
mortgage on commercial real estate, such loans generally are limited to
terms of five years or less. Substantially all such commercial loans have
variable interest rates tied to the prime rate as reported in The Wall
Street Journal. Whenever possible, the Bank collateralizes these loans
with a lien on commercial real estate, or alternatively, with a lien on
business assets and equipment and the personal guarantees from principals
of the borrower.
Commercial business loans are generally considered to involve a
higher degree of risk than residential mortgage loans because the
collateral may be in the form of intangible assets and/or inventory subject
to market obsolescence. Commercial loans may also involve relatively large
loan balances to single borrowers or groups of related borrowers, with the
repayment of such loans typically dependent on the successful operation and
income stream of the borrower. Such risks can be significantly affected by
economic conditions. In addition, commercial business lending generally
requires substantially greater oversight efforts compared to residential
real estate lending.
Consumer Loans. The Bank's consumer loans consist of share-secured
loans, and other consumer loans, including automobile loans and credit card
loans. At June 30, 2002, the consumer loan portfolio totaled $1.0 million
or 0.4% of net loans. Consumer loans are generally offered for terms of up
to five years at fixed interest rates. Consumer loans generally do not
exceed $25,000 individually.
The Bank makes share-secured loans up to 90% of the amount of the
depositor's savings account balance. The interest rate on the loan is 4%
higher than the rate being paid on the account. The Bank also makes other
consumer loans, which may or may not be secured. The terms of such loans
usually depend on the collateral.
The Bank makes loans for automobiles, both new and used, directly to
the borrowers. The loans are generally limited to 90% of the purchase price
or the retail value listed by the National Automobile Dealers Book. The
terms of the loans are determined by the age and condition of the
collateral. Collision insurance policies are required on all of these
loans.
7
The Bank makes unsecured credit card loans generally up to $5,000 at
fixed rates of interest. At June 30, 2002, the Bank had unsecured credit
card loans totaling $342,000.
Consumer loans are generally originated at higher interest rates than
residential mortgage loans but also tend to have a higher credit risk than
residential loans due to the loan being unsecured or secured by rapidly
depreciable assets. Despite these risks, the Bank's level of consumer loan
delinquencies generally have been low. No assurance can be given, however,
that the Bank's delinquency rate on consumer loans will continue to remain
low in the future, or that the Bank will not incur future losses on these
activities.
Home Equity Loans. The Bank also originates home equity loans that
are secured by available equity based on the appraised value of owner-
occupied one-to-four family residential property. Home equity loans will
be made for up to 80% of the appraised value of the property (less the
amount of the first mortgage). Home equity loans are offered at adjustable
rates and fixed rates. The adjustable interest rate is the prime rate as
reported in The Wall Street Journal. Fixed rate home equity loans have
terms of ten years or less and adjustable rate home equity loans have terms
of 15 years or less with up to a five year final payment if the loan is not
fully amortized at the end of the 15 year term. At June 30, 2002, the Bank
had $5.0 million in home equity loans with unused credit available to
existing borrowers of $5.7 million.
Construction Loans. The Bank engages in construction lending
primarily for the construction of single-family residences and a limited
number of construction loans for commercial properties. At present all are
construction loans for the construction/renovation of single-family housing
developments. All construction loans are secured by first liens on the
property. Loan proceeds are disbursed as construction progresses and
inspections warrant. Loans involving construction financing present a
greater risk than loans for the purchase of existing homes, since
collateral values and construction costs can only be estimated at the time
the loan is approved. Because payment on loans secured by construction
properties are dependent upon the sale of completed homes or the successful
operation of the completed property, repayment of such loans may be
subject, to a greater extent, to adverse conditions in the real estate
market or the economy. At June 30, 2002, the Bank's construction loan
portfolio totaled $21.0 million offset by $10.0 million in unadvanced
principal.
Loan Commitments. The Bank generally makes loan commitments to
borrowers not exceeding 60 days. At June 30, 2002, the Bank had $12.8
million in loan commitments outstanding, all for the origination of one-to-
four family residential real estate loans, home equity loans, commercial
loans and commercial real estate loans. In addition, unadvanced funds on
construction loans, lines of credit and credit card loans were $26.5
million on June 30, 2002.
Loan Solicitation and Loan Fees. Loan originations are derived from
a number of sources, including the Bank's existing customers, referrals,
realtors, advertising and "walk-in" customers at the Bank's office.
Additionally, the Bank has three residential loan originators, all of whom
actively cover the local community, working with local real estate brokers
and agents to identify and contact potential new customers.
Upon receipt of a loan application from a prospective borrower, a
credit report and verifications are ordered to verify specific information
relating to the loan applicant's employment, income and credit standing.
For all mortgage loans, an appraisal of real estate intended to secure the
proposed loan is obtained from an independent appraiser who has been
approved by the Bank's Board of Directors. Fire and casualty insurance are
required on all loans secured by improved real estate. Insurance on other
collateral is required unless waived by the Loan Committee. The Board of
Directors of the Bank has the responsibility and authority for the general
supervision over the loan policies of the Bank. The Board has established
written lending policies for the Bank. All residential and commercial real
estate mortgages
8
and commercial business loans must be ratified by the Bank's Board of
Directors. In addition, certain designated officers of the Bank have
authority to approve loans not exceeding specified levels, while the Board
of Directors must approve loans in excess of (a) $300,000 for commercial
real estate loans; (b) $100,000 for commercial loans; (c) loans over the
current Fannie Mae limit for residential mortgage loans; and (d) $20,000
for consumer loans.
Interest rates charged by the Bank on all loans are primarily
determined by competitive loan rates offered in its market area and
interest rate costs of the source of funding for the loan. The Bank may
charge an origination fee on new mortgage loans. The net origination fees
are deferred and amortized into income over the life of the loan. At June
30, 2002, the amount of net deferred loan origination fees was $197,000.
Loan Maturities. The following table sets forth certain information
at June 30, 2002 regarding the dollar amount of loans maturing in the
Bank's portfolio based on their contractual terms to maturity, including
scheduled repayments of principal. Demand loans and loans having no stated
schedule of repayments and no stated maturity are reported as due in one
year or less.
Residential Commercial
Mortgage Real Estate Construction Commercial Consumer Total
Loan (1) Loans Loans Loans Loans Loans
----------- ----------- ------------ ---------- -------- -----
(In Thousands)
Total loans schedule to mature:
In 1 year or less $ 47 $ - $10,247 $ 5,276 $ 59 $ 15,629
After 1 year through 5 years 1,973 786 10,744 8,152 351 22,006
Beyond 5 years 156,860 58,103 - 2,787 594 218,344
-------- ------- ------- ------- ------ -------
Total $158,880 $58,889 $20,991 $16,215 $1,004 $255,979
======== ======= ======= ======= ====== ========
Loan balance by type scheduled
to mature after 1 year:
Fixed-rate $ 81,376 $ 3,626 $ 500 $ 3,301 $ 945 $ 89,748
Adjustable-rate 77,457 55,263 10,244 7,638 - 150,602
- --------------------
For purposes of this schedule, home equity loans with revolving and
fixed rates, have been included in residential mortgage loans.
Originations and Sales of Loans. The Bank is a qualified
seller/servicer for Fannie Mae. Beginning in 1987, the Bank began to sell a
portion of its fixed-rate loans with terms in excess of 15 years to Fannie
Mae. All of the Bank's sales to Fannie Mae have been made with servicing
retained on the loans. At June 30, 2002, the Bank was servicing $18.8
million in loans for Fannie Mae and $4.4 million in loans for the Federal
Home Loan Bank of Boston as part of their Mortgage Partnership Finance
program. Depending upon market conditions, the Bank retains a portion of
its fixed-rate loans from time to time. In addition, the Bank has also
sold loans to other private investors. At June 30, 2002, the Bank was
servicing $773,000 of such loans.
Originations for the year ended June 30, 2002 increased in all loan
categories except commercial loans which decreased by $10.8 million. Loan
sales increased during the same period as the Bank sold long term fixed-
rate residential loans with servicing retained. Historically, the Bank has
not purchased loans. However, the Bank may in the future consider making
limited loan purchases, including purchases of commercial loans and
commercial real estate loans.
9
The following table sets forth information with respect to
originations and sales of loans during the periods indicated.
Years Ended June 30,
--------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands)
Beginning balance $215,035 $189,200 $154,689 $138,593 $114,568
-------- -------- -------- -------- --------
Mortgage originations 82,615 43,378 37,513 47,662 43,141
Consumer loan originations 5,538 3,834 3,716 2,494 2,218
Commercial real estate loan originations 14,575 12,004 13,260 13,713 6,338
Commercial loan originations 9,256 20,053 12,598 5,313 3,680
Construction loan originations 19,849 11,859 9,569 3,080 -
-------- -------- -------- -------- --------
Total loans originated 131,833 91,128 76,656 72,262 57,291
-------- -------- -------- -------- --------
Less:
Amortization and payoffs 93,582 60,716 39,937 42,901 27,675
Provision for loan losses 305 275 200 145 245
Total loans sold 9,238 4,302 1,433 13,120 5,346
Loan participations sold - - 575 - -
-------- -------- -------- -------- --------
Ending balance $243,743 $215,035 $189,200 $154,689 $138,593
======== ======== ======== ======== ========
Non-Performing Assets, Asset Classification and Allowances for
Losses. Management and the Security Committee of the Bank perform a
monthly review of all delinquent loans and loans are placed on a non-
accrual status when loans are over 90 days past due or, in the opinion of
management, the collection of principal and interest are doubtful. One of
the primary tools used to manage and control problem loans is the Bank's
"Watch-List," a listing of all loans or commitments larger than $50,000,
that are considered to have characteristics that could result in loss to
the Bank if not properly supervised. The list is managed by the Senior
Lending Officer, Chief Executive Officer and other officers as needed from
the commercial, residential and consumer loan areas, who meet periodically
to discuss the status of the loans on the Watch-List and to add or delete
loans from the list. The Board of Directors can request that a loan
relationship be placed on Watch-List status.
Real estate acquired by the Bank as a result of foreclosure is
classified as real estate owned until such time as it is sold. When such
property is acquired, it is recorded at the lower of the unpaid principal
balance or its fair value. Any required write-down of the loan to its fair
value is charged to the allowance for loan losses.
10
The following table sets forth the Bank's problem assets and loans at
the dates indicated.
Years Ended June 30,
--------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands)
Loans 30-89 days past due
(not included in non-performing loans) $1,191 $1,854 $ 540 $1,685 $1,374
Loans 90 days or more past due
(not included in non-performing loans) - 276 148 - -
------ ------ ----- ------ ------
Total delinquent loans $1,191 $2,130 $ 688 $1,685 $1,374
====== ====== ===== ====== ======
Delinquent loans as a percentage of net loans 0.49% 0.99% 0.36% 1.09% 0.99%
====== ====== ===== ====== ======
Non-performing loans (over 90 days past due) $ 108 $ 15 $ 2 $ 0 $ 150
------ ------ ----- ------ ------
Total non-performing loans $ 108 $ 15 $ 2 $ 0 $ 150
====== ====== ===== ====== ======
Non-performing loans as a percent of net loans 0.04% 0.01% 0.00% 0.00% 0.11%
Non-performing assets as a percent of total loans 0.04% 0.01% 0.00% 0.00% 0.11%
At June 30, 2002, management was not aware of any loans not currently
classified as non-accrual, 90 days past due or restructured but which may
be so classified in the near future because of concerns over the borrower's
ability to comply with repayment terms.
Federal regulations require each banking institution to classify its
asset quality on a regular basis. In addition, in connection with examinations
of such banking institutions, federal and state examiners have authority to
identify problem assets and, if appropriate, classify them. An asset is
classified substandard if it is determined to be inadequately protected by
the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. As a general rule, the Bank will classify a
loan as substandard if the Bank can no longer rely on the borrower's income
as the primary source for repayment of the indebtedness and must look to
secondary sources such as guarantors or collateral. An asset is classified
as doubtful if full collection is highly questionable or improbable. An
asset is classified as loss if it is considered uncollectible, even if a
partial recovery could be expected in the future. The regulations also
provide for a special mention designation, described as assets which do not
currently expose a banking institution to a sufficient degree of risk to
warrant classification but do possess credit deficiencies or potential
weaknesses deserving management's close attention. Assets classified as
substandard or doubtful require a banking institution to establish general
allowances for loan losses. If an asset or portion thereof is classified
as a loss, a banking institution must either establish specific allowances
for loan losses in the amount of the portion of the asset classified as a
loss, or charge off such amount. Examiners may disagree with a banking
institution's classifications and amounts reserved. If a banking
institution does not agree with an examiner's classification of an asset,
it may appeal this determination to the Regional Director of the FDIC. At
June 30, 2002, the Bank had no assets classified as doubtful or loss, and
$764,000 classified as substandard.
In originating loans, the Bank recognizes that credit losses will
occur and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term
of the loan, general economic conditions and, in the case of a secured
loan, the quality of the security for the loan. It is management's policy
to maintain an adequate general allowance for loan losses based on, among
other things, evaluation of economic conditions and regular reviews of
delinquencies and loan portfolio quality. Further, after properties are
acquired following loan defaults, additional losses may occur with respect
to such properties while the Bank is holding them for sale. The Bank
increases its allowances for loan losses and losses on real estate owned by
charging provisions for losses against the
11
Bank's income. Specific reserves are also recognized against specific
assets when management believes it is warranted.
While the Bank believes it has established its existing allowances
for loan losses in accordance with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing the
Bank's loan portfolio, will not request the Bank to increase its allowance
for loan losses, thereby negatively affecting the Bank's financial
condition and earnings. Alternately, there can be no assurance that
increases in the Bank's allowance for loan losses will occur.
The following table analyzes activity in the Bank's allowance for
loan losses for the years indicated.
Years Ended June 30,
--------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars in thousands)
Average loans, net $226,711 $205,837 $173,319 $144,663 $124,971
======== ======== ======== ======== ========
Year-end net loans $243,743 $215,035 $189,200 $154,689 $138,593
======== ======== ======== ======== ========
Allowance for loan losses at beginning of year $ 1,784 $ 1,531 $ 1,348 $ 1,236 $ 977
Provision charged to operations 305 275 200 145 245
Recoveries:
Real estate mortgage:
Residential - - - - -
Commercial - - - - -
Commercial loans - 2 - - -
Consumer and home equity 4 3 6 3 16
Construction - - - - -
-------- -------- -------- -------- --------
Total Recoveries 4 5 6 3 16
-------- -------- -------- -------- --------
Charge offs:
Real estate mortgage:
Residential - - - - -
Commercial - - - - -
Commercial loans (12) - - (2) -
Consumer and home equity (18) (27) (23) (34) (2)
Construction - - - - -
-------- -------- -------- -------- --------
Total charge-offs (30) (27) (23) (36) (2)
-------- -------- -------- -------- --------
Net (charge-offs) recoveries (26) (22) (17) (33) 14
-------- -------- -------- -------- --------
Allowance for loan losses at end of year $ 2,063 $ 1,784 $ 1,531 $ 1,348 $ 1,236
======== ======== ======== ======== ========
Ratios:
Allowance for loan losses to year-end net loans 0.85% 0.83% 0.81% 0.87% 0.89%
Net charge-offs to average loans, net 0.01% 0.01% 0.01% 0.02% (0.01)%
Net charge-offs to allowance for loan losses 1.26% 1.23% 1.11% 2.45% (1.13)%
12
The following table sets forth a breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that
the allowance can be allocated by category only on an approximate basis.
These allocations are not necessarily indicative of future losses and do
not restrict the use of the allowance to absorb losses in any other loan
category.
At June 30,
-------------------------------------------------------------------------------------------------
2002 2001 2000 1999
---------------------- ---------------------- ---------------------- ----------------------
Percent of Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each Loans in Each
Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
------ ------------- ------ ------------- ------ ------------- ------ -------------
(Dollars in Thousands)
Real estate-mortgage:
Residential $ 588 62.6% $ 578 63.7% $ 563 67.0% $ 563 68.7%
Commercial 827 23.9 767 23.3 687 21.7 592 21.8
Commercial Loans 373 6.6 240 6.2 172 5.7 133 4.6
Consumer and home equity 30 2.4 34 2.5 19 2.6 15 2.3
Construction 245 4.5 165 4.3 90 3.0 45 2.6
------ ----- ------ ----- ------ ----- ------ -----
Total allowance for loan losses $2,063 100.0% $1,784 100.0% $1,531 100.0% $1,348 100.0%
====== ===== ====== ===== ====== ===== ====== =====
At June 30,
----------------------
1998
----------------------
Percent of
Loans in Each
Category to
Amount Total Loans
------ -------------
(Dollars in Thousands)
Real estate-mortgage:
Residential $ 559 76.1%
Commercial 531 17.5
Commercial Loans 100 3.3
Consumer and home equity 46 2.5
Construction - 0.6
------ -----
Total allowance for loan losses $1,236 100.0%
====== =====
13
Investment Activities
General. The investment policy of the Bank, which is approved by the
Bank's Board of Directors, is based upon its asset and liability management
goals and is designed primarily to provide and maintain adequate liquidity,
maintain a balance of high quality, diversified investments, minimize risks
to the Bank and compliment the Bank's lending activities. The investment
policy is implemented by the President and Chief Financial Officer. Under
applicable federal and state regulations, the Bank is required to maintain
an amount of liquid assets appropriate for its level of net savings
withdrawals and current borrowings. It has generally been the Bank's policy
to maintain a liquidity portfolio in excess of regulatory requirements.
The Bank uses several measures to assess the adequacy of its liquidity. At
June 30, 2002, the Bank's liquidity was adequate to meet its foreseeable
needs. Liquidity levels may be increased or decreased depending upon the
yields on investment alternatives, management's judgment as to the
attractiveness of the yields then available in relation to other
opportunities, management's expectations of the level of yield that will be
available in the future and management's projections as to the short-term
demand for funds to be used in the Bank's loan origination and other
activities.
The Bank invests in U.S. Government and federal agency securities,
mortgage-backed securities, equity securities, corporate debt securities
and overnight federal funds. The balance of securities maintained by the
Bank in excess of regulatory requirements reflects management's historical
objective of maintaining liquidity at a level that assures the availability
of adequate funds, taking into account anticipated cash flows and available
sources of credit, for meeting withdrawal requests and loan commitments and
making other investments.
The Bank purchases securities through a primary dealer of U.S.
Government obligations or such other mortgage-backed securities, securities
dealers authorized by the Board of Directors and requires that the
securities be delivered to a safekeeping agent before the funds are
transferred to the broker or dealer. The Bank purchases securities pursuant
to its investment policy.
Available-for-sale securities are reported at fair value with unrealized
gains or losses reported as a separate component of other comprehensive
income/loss. The following table sets forth the Company's securities at
the dates indicated.
At June 30,
------------------------------------------------------------------
2002 2001 2000
-------------------- ------------------- -------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ----- --------- ----- --------- -----
(In thousands)
Securities available for sale:
- ------------------------------
Marketable equity securities $ 2,698 $ 2,586 $ 3,222 $ 3,537 $ 2,459 $ 3,054
U.S. Government and federal
agency obligations 25,198 25,517 9,498 9,505 18,821 18,337
Other bonds and obligations 8,668 8,685 5,542 5,489 2,547 2,393
Mortgage-backed securities 28,759 29,112 10,389 10,289 8,709 8,668
------- ------- ------- ------- ------- -------
Total $65,323 $65,900 $28,651 $28,820 $32,536 $32,452
======= ======= ======= ======= ======= =======
14
The following table sets forth the scheduled maturities, carrying
values and average yields for the Company's debt securities at June 30,
2002.
At June 30, 2002
--------------------------------------------------------------------------------------------
One Year of Less One to Five Years Over Five Years Totals
-------------------- -------------------- -------------------- --------------------
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- ------- --------- ------- --------- ------- --------- -------
(Dollars in thousands)
Securities available for sale:
- ------------------------------
U.S. Government and federal
agency obligations $3,036 4.10% $22,162 4.14% $ - -% $25,198 4.13%
Other bonds and obligations 3,064 5.82 4,119 5.02 1,485 2.82 8,668 4.93
Mortgage-backed securities - - - - 28,759 5.39 28,759 5.39
------ ------- ------- -------
Total $6,100 4.97% $26,281 4.28% $30,244 5.26% $62,625 4.82%
====== ======= ======= =======
Deposit Activity and Other Sources Of Funds
General. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank
derives funds from principal repayments and interest payments on loans and
investments as well as other sources arising from operations in the
production of net earnings. Loan repayments and interest payments are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources, or on a longer
term basis for general business purposes.
Deposits. Deposits are attracted principally from within the Bank's
primary market area through the offering of a broad selection of deposit
instruments, including checking accounts, passbook savings, NOW accounts,
demand deposits, money market accounts and certificates of deposit. Deposit
account terms vary, with the principal differences being the minimum
balance required, the time periods the funds must remain on deposit and the
interest rate.
The Bank's policies are designed primarily to attract deposits from
local residents and businesses rather than to solicit deposits from areas
outside its primary market. The Bank does not accept deposits from brokers
due to the volatility and rate sensitivity of such deposits. Interest rates
paid, maturity terms, service fees and withdrawal penalties are established
by the Bank on a periodic basis. Determination of rates and terms are
predicated upon funds acquisition and liquidity requirements, rates paid by
competitors, growth goals and federal regulations.
During the past several years, there has been an increase in demand
deposit NOW and IOLTA accounts, resulting from the increase in commercial
customers during this time period. IOLTA account balances are volatile due
to large deposit relationships with law firms which maintain short-term
deposits in real estate conveyancing accounts and have significant
fluctuations in deposit account balances, particularly at month-end.
15
The following table sets forth the various types of deposit accounts
at the Bank and the balances in these accounts at the dates indicated.
At June 30,
-----------------------------------------------------------------
2002 2001 2000
------------------- ------------------- -------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Savings deposit $ 52,762 19.7% $ 44,302 19.7% $ 42,413 21.8%
NOW accounts 26,971 10.1 22,342 9.9 17,055 8.8
IOLTA accounts 22,397 8.4 16,202 7.2 16,872 8.7
Money market deposits 21,466 8.0 18,591 8.3 8,370 4.3
Demand deposits 19,856 7.4 18,889 8.4 16,346 8.4
Certificate of deposits 123,986 46.4 104,424 46.5 93,079 48.0
-------- ----- -------- ----- -------- -----
Total deposits $267,438 100.0% $224,750 100.0% $194,135 100.0%
======== ===== ======== ===== ======== =====
For more information on the Bank's deposit accounts, see Note 6 of
Notes to Consolidated Financial Statements.
The following table indicates the amount of the Bank's certificates
of deposit of $100,000 or more by time remaining until maturity at June 30,
2002.
Weighted
Average
Maturity Period Certificates of Deposit Rate
--------------- ----------------------- --------
(Dollars in thousands)
0-3 months $12,197 4.52%
3-6 months 5,865 4.12
6-12 months 9,554 3.54
1-2 years 19,390 4.07
2-3 years 129 6.10
> 3 years 3,976 5.97
-------
Total $51,111 4.24%
=======
Borrowings. Deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from
the FHLB to supplement its supply of lendable funds and to meet liquidity
requirements. Due to recent lending activity and demand for liquidity, the
Bank has utilized this borrowing power, and has received advances from the
FHLB. Advances from the FHLB are secured by a portion of the Bank's
mortgage loan portfolio. The Bank had FHLB advances of $58.1 million
outstanding at June 30, 2002.
The FHLB functions as a central reserve bank providing credit for
savings institutions and certain other financial institutions. As a member,
the Bank is required to own capital stock in the FHLB and is authorized to
apply for advances on the security of its home mortgages provided certain
standards related to creditworthiness have been met.
16
Personnel
As of June 30, 2002, the Bank had 66 full-time employees and 25 part-
time employees. The employees are not represented by a collective
bargaining unit and the Bank considers its relationship with its employees
to be good.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The following is intended only as a discussion of material
tax matters and does not purport to be a comprehensive description of the
tax rules applicable to the Bank or the Company. The Bank has not been
audited by the IRS during the last five years. For federal income tax
purposes, the Company and the Bank file consolidated income tax returns and
report their income on a fiscal year basis using the accrual method of
accounting and are subject to federal income taxation in the same manner as
other corporations with some exceptions, including particularly the Bank's
tax reserve for bad debts.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to shareholders, such distributions will be considered to
result in distributions from the Bank's "base year reserve," i.e., its
reserve as of April 30, 1988, to the extent thereof and then from its
supplemental reserve for losses on loans, and an amount based on the amount
distributed will be included in the Bank's taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. However, dividends paid
out of the Bank's current or accumulated earnings and profits, as
calculated for federal income tax purposes, will not constitute non-
dividend distributions and, therefore, will not be included in the Bank's
income.
The amount of additional taxable income created from a non-dividend
distribution is equal to the lesser of the Bank's base year reserve and
supplemental reserve for losses on loans; or an amount that, when reduced
by the tax attributable to the income, is equal to the amount of the
distribution. Thus, in certain situations, approximately one and one-half
times the non-dividend distribution would be includable in gross income for
federal income tax purposes, assuming a 34% federal corporate income tax
rate.
Corporate Alternative Minimum Tax. The Internal Revenue Code of
1986, as amended, imposes a tax ("AMT") on alternative minimum taxable
income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net
operating loss carryovers. AMTI is also adjusted by determining the tax
treatment of certain items in a manner that negates the deferral of income
resulting from the regular tax treatment of those items. The Bank does not
expect to be subject to the AMT.
Elimination of Dividends; Dividends Received Deduction. The Company
may exclude from its income 100% of dividends received from the Bank as a
member of the same affiliated group of corporations. A 70% dividends
received deduction generally applies with respect to dividends received
from domestic corporations that are not members of such affiliated group,
except that an 80% dividends received deduction applies if the Company and
the Bank own more than 20% of the stock of a corporation paying a dividend.
17
State and Local Taxation
The Bank is subject to an annual Massachusetts excise (income) tax
equal to 10.50% of its pre-tax income, adjusted for certain items. Taxable
income includes gross income as defined under the Code, plus interest from
bonds, notes and evidences of indebtedness of any state, including
Massachusetts, less deductions, but not the credits, allowable under the
provisions of the Code. In addition, carryforwards and carrybacks of net
operating losses are not allowed.
The Bank's active subsidiary, Mystic Securities Corporation, was
established solely for the purpose of acquiring and holding securities
which are permissible for banks to hold under Massachusetts law. Mystic
Securities Corporation is classified with the Massachusetts Department of
Revenue as a "security corporation" under Massachusetts law, qualifying it
to take advantage of the low 1.32% income tax rate on gross income
applicable to companies that are so classified.
State of Delaware. As a Delaware holding company not earning income
in Delaware, the Company is exempted from Delaware corporate income tax but
is required to file an annual report with and has paid an annual franchise
tax to the State of Delaware.
For additional information regarding taxation, see Note 9 of the
Notes to Consolidated Financial Statements.
REGULATION
General
As a co-operative bank chartered by the Commonwealth of
Massachusetts, the Bank is subject to extensive regulation under state law
with respect to many aspects of its banking activities; this state
regulation is administered by the Commissioner of the Massachusetts
Division of Banks (the "Commissioner"). In addition, as a bank whose
deposits are insured by the FDIC under the Bank Insurance Fund, the Bank is
subject to deposit insurance assessments by the FDIC, and the FDIC has
examination and supervisory authority over the Bank, with a broad range of
enforcement powers. Finally, the Bank is required to maintain reserves
against deposits according to a schedule established by the Federal Reserve
System. These laws and regulations have been established primarily for the
protection of depositors and the deposit insurance funds, not bank
stockholders.
The following references to the laws and regulations under which the
Bank and the Company are regulated are brief summaries thereof, do not
purport to be complete, and are qualified in their entirety by reference to
such laws and regulations.
Massachusetts Banking Laws and Supervision
Massachusetts co-operative banks such as the Bank are regulated and
supervised by the Commissioner. The Commissioner is required to regularly
examine each state-chartered bank. The approval of the Commissioner is
required to establish or close branches, to merge with another bank, to
form a bank holding company, to issue stock or to undertake many other
activities. Any Massachusetts bank that does not operate in accordance
with the regulations, policies and directives of the Commissioner is
subject to sanctions. The Commissioner may under certain circumstances
suspend or remove directors or officers of a bank who have violated the
law, conducted a bank's business in a manner which is unsafe, unsound or
contrary to the depositors' interests, or been negligent in the performance
of their duties.
18
All Massachusetts-chartered co-operative banks are required to be
members of the Co-operative Central Bank and are subject to its
assessments. The Co-operative Central Bank maintains the Share Insurance
Fund, a private deposit insurer, which insures all deposits in member banks
in excess of FDIC deposit insurance limits. In addition, the Co-operative
Central Bank acts as a source of liquidity to its members in supplying them
with low-cost funds, and purchasing certain qualifying obligations from
them.
Lending Activities. A Massachusetts chartered co-operative bank may
make a wide variety of mortgage loans. Fixed-rate loans, adjustable-rate
loans, participation loans, graduated payment loans, construction loans,
condominium and co-operative loans, second mortgage loans and other types
of loans may be made in accordance with applicable regulations. Mortgage
loans may be made on real estate in Massachusetts or in another New England
state if the bank making the loan has an office there or under certain
other circumstances. In addition, certain mortgage loans may be made on
improved real estate located anywhere in the United States. Commercial
loans may be made to corporations and other commercial enterprises with or
without security. With certain exceptions, such loans may be made without
geographic limitation. Consumer and personal loans may be made with or
without security and without geographic limitation. Loans to individual
borrowers generally will be limited to 20% of the total of the Bank's
capital accounts and stockholders' equity.
Investments Authorized. Massachusetts-chartered co-operative banks
have broad investment powers under Massachusetts law, including so-called
"leeway" authority for investments that are not otherwise specifically
authorized. The investment powers authorized under Massachusetts law are
restricted by federal law to permit, in general, only investments of the
kinds that would be permitted for national banks. The Bank has authority to
invest in all of the classes of loans and investments that are permitted by
its existing loan and investment policies.
Payment of Dividends. Under Massachusetts banking laws, a stock co-
operative bank may declare and pay a dividend on its capital stock out of
the bank's net profits. Net profits means the remainder of all earnings
from current operations plus actual recoveries on loans and investments and
other assets after deducting from the total, all current operating
expenses, actual losses, accrued dividends on preferred stock, if any, and
all federal and state taxes. A dividend, however, may not be declared,
credited or paid by a stock co-operative bank so long as there is
impairment of capital stock.
Prior approval of the Commissioner is required if the Bank intends to
declare dividends on its common stock for any period other than for which
dividends are declared upon the preferred stock; or the total of all
dividends declared by the Bank in any calendar year shall exceed the total
of its net profits for that year combined with its retained net profit of
the preceding two years, less any required transfer to surplus or a fund
for the retirement of any preferred stock.
In addition, federal law also may limit the amount of dividends that
may be paid by the Bank.
Branches. With the approval of the Commissioner, bank branches may
be established in any city or town in Massachusetts; in addition, co-
operative banks may operate automated teller machines (ATMs) at any of
their offices or, with the Commissioner's approval, anywhere in
Massachusetts. Sharing of ATMs or "networking" is also permitted with the
Commissioner's approval. Massachusetts chartered co-operative banks may
also operate ATMs outside of Massachusetts if permitted to do so by the law
of the jurisdiction in which the ATM is located.
Interstate Acquisitions. An out-of-state bank may (subject to
various regulatory approvals and to reciprocity in its home state)
establish and maintain bank branches in Massachusetts by (i) merging with a
Massachusetts bank that has been in existence for at least three years,
(ii) acquiring a branch or branches
19
of a Massachusetts bank without acquiring the entire bank, or (iii) opening
such branches de novo. Massachusetts banks' ability to exercise similar
interstate banking powers in other states depends upon the laws of the
other states. For example, according to the law of the bordering state of
New Hampshire, out-of-state banks may acquire New Hampshire banks by
merger, but may not establish de novo branches in New Hampshire.
Other Powers. Massachusetts-chartered co-operative banks may also
lease machinery and equipment, act as trustee or custodian for tax
qualified retirement plans, establish trust departments and act as
professional trustee or fiduciary, provide payroll services for their
customers, issue or participate with others in the issuance of mortgage-
backed securities and establish mortgage banking companies and discount
securities brokerage operations. Some of these activities require the
prior approval of the Commissioner.
Federal Banking Regulations
Capital Requirements. Under FDIC regulations, state-chartered banks
that are not members of the Federal Reserve System ("state non-member
banks"), such as the Bank, are required to comply with minimum leverage
capital requirements. The FDIC Regulations define two tiers, or classes,
of capital - Tier I Capital and Tier 2 Capital. For an institution with a
rating of 1, the highest examination rating of the FDIC for banks, under
the Uniform Financial Institutions Ranking System, the minimum capital
leverage requirement is a ratio of Tier 1 capital to total assets of 3%.
For all other institutions, the minimum leverage capital ratio is 4% unless
a higher leverage capital ratio is warranted by the particular
circumstances or risk profile of the bank.
The FDIC regulations also require that co-operative banks meet a
risk-based capital standard. The risk-based capital standard requires the
maintenance of a ratio of total capital, which is defined as the sum of
Tier 1 capital and Tier 2 capital, to risk-weighted assets of at least 8%
and a ratio of Tier 1 capital to risk-weighted assets of at least 4%. In
determining the amount of risk-weighted assets, all assets, plus certain
off balance sheet items, are multiplied by a risk-weight of 0% to 100%,
based on the risks the FDIC believes are inherent in the type of asset or
item.
The federal banking agencies, including the FDIC, have also adopted
regulations to require an assessment of an institution's exposure to
declines in the economic value of a bank's capital due to changes in
interest rates when assessing the bank's capital adequacy. Under such a
risk assessment, examiners will evaluate a bank's capital for interest rate
risk on a case-by-case basis, with consideration of both quantitative and
qualitative factors.
Institutions with significant interest rate risk may be required to hold
additional capital. The agencies also issued a joint policy statement
providing guidance on interest rate risk management, including a discussion
of the critical factors affecting the agencies' evaluation of interest rate
risk in connection with capital adequacy.
20
The following table shows the Company's and the Bank's leverage
ratio, its Tier 1 risk-based capital ratio, and its total risk-based
capital ratio, at June 30, 2002.
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
---------------- ---------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Total Capital to Risk Weighted Assets
Consolidated $30,522 14.9% $16,114 8.0% N/A N/A
Bank 25,790 12.9 16,006 8.0 $20,007 10.0%
Tier 1 Capital to Risk Weighted Assets
Consolidated 28,461 13.9 8,057 4.0 N/A N/A
Bank 23,727 11.9 8,003 4.0 12,004 6.0
Tier 1 Capital to Average Assets
Consolidated 28,461 8.0 13,906 4.0 N/A N/A
Bank 23,727 7.0 12,908 4.0 16,135 5.0
As the preceding table shows, the Company and the Bank exceeded the
minimum capital adequacy requirements at June 30, 2002.
Enforcement. The FDIC has extensive enforcement authority over
insured co-operative banks, including the Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties,
to issue cease and desist orders and to remove directors and officers. In
general, these enforcement actions may be initiated in response to
violations of laws and regulations and to unsafe or unsound practices.
The FDIC has authority under federal law to appoint a conservator or
receiver for an insured bank under certain circumstances. The FDIC is
required, with certain exceptions, to appoint a receiver or conservator for
an insured state bank if that bank was "critically undercapitalized." For
this purpose, "critically undercapitalized" means having a ratio of
tangible equity to total assets equal to or less than 2%. See "-Prompt
Corrective Action." The FDIC may also appoint a conservator or receiver
for a state bank on the basis of the institution's financial condition or
upon the occurrence of certain events, including: (i) insolvency (whereby
the assets of the bank are less than its liabilities to depositors and
others); (ii) substantial dissipation of assets or earnings through
violations of law or unsafe or unsound practices; (iii) existence of an
unsafe or unsound condition to transact business; (iv) likelihood that the
bank will be unable to meet the demands of its depositors or to pay its
obligations in the normal course of business; and (v) insufficient capital,
or the incurring or likely incurring of losses that will deplete
substantially all of the institution's capital with no reasonable prospect
of replenishment of capital without federal assistance.
21
Deposit Insurance. The FDIC has adopted a risk-based deposit
insurance assessment system. The FDIC assigns an institution to one of
three capital categories based on the institution's financial information,
as of the reporting period ending seven months before the assessment
period, consisting of (1) well capitalized, (2) adequately capitalized or
(3) undercapitalized, and one of three supervisory subcategories within
each capital group. The supervisory subgroup to which an institution is
assigned is based on a supervisory evaluation provided to the FDIC by the
institution's primary federal regulator and information that the FDIC
determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment
rate depends on the capital category and supervisory category to which it
is assigned. Assessment rates for BIF deposits currently range from 0
basis points to 27 basis points. The Bank's assessment rate is currently 0
basis points. The FDIC is authorized to raise the assessment rates in
certain circumstances, including to maintain or achieve the designated
reserve ratio of 1.25%, which requirement the BIF currently meets. The
FDIC has exercised its authority to raise rates in the past and may raise
insurance premiums in the future. If such action is taken by the FDIC, it
could have an adverse effect on the earnings of the Bank. In addition,
legislation requires BIF-insured institutions like the Bank to assist in
the payment of FICO bonds.
Under the Federal Deposit Insurance Act (the "FDICIA Act"), insurance
of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable
law, regulation, rule, order or condition imposed by the FDIC or the
Division. The management of the Bank does not know of any practice,
condition or violation that might lead to termination of deposit insurance.
Transactions with Affiliates and Insiders of the Bank. Transactions
between an insured bank, such as the Bank, and any of its affiliates is
governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate
of a bank is any company or entity which controls, is controlled by or is
under common control with the bank. Currently, a subsidiary of a bank that
is not also a depository institution is not treated as an affiliate of the
bank for purposes of Sections 23A and 23B, but the FRB has proposed
comprehensive regulations implementing Sections 23A and 23B, which would
establish certain exceptions to this policy. Generally, Sections 23A and
23B (i) limit the extent to which the bank or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal to 10%
of such institution's capital stock and surplus, and limit all such
transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all such transactions be on terms
that are consistent with safe and sound banking practices. The term
"covered transaction" includes the making of loans, purchase of assets,
issuance of guarantees and similar other types of transactions. In
addition, any covered transaction and certain other transactions, including
the sale of assets or purchase of services, between a bank and any of its
affiliates must be on terms that are substantially the same, or at least as
favorable, to the bank as those that would be provided to a non-affiliate.
Further, most loans by a bank to its affiliate must be supported by
collateral in amounts ranging from 100 to 130 percent of the loan amounts.
A bank's loans to its executive officers, directors, any owner of 10%
or more of its stock and any of certain entities affiliated to any such
person (each an "insider") are subject to the conditions and limitations
imposed by Section 22(h) of the Federal Reserve Act and the Federal Reserve
Board's Regulation O thereunder. Under Section 22(h), loans to an insider
may not exceed, together with all other outstanding loans to such person
and affiliated interests, the loans-to-one-borrower limit applicable to
national banks (generally 15% of the institution's unimpaired capital and
surplus), and all loans to all such persons in the aggregate may not exceed
the institution's unimpaired capital and unimpaired surplus. Regulation O
also prohibits the making of loans in an amount greater than either (a)
$500,000 or (b) the greater of $25,000 or 5% of the bank's unimpaired
capital and surplus, unless certain requirements are met.
22
State chartered non-member banks are further subject to the
requirements and restrictions of 12 U.S.C. [SECTION]1972 on certain tying
arrangements and extensions of credit by correspondent banks. Specifically,
this statute (i) prohibits a depository institution from extending credit
to or offering any other service, 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 exceptions, and (ii) also 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.
Real Estate Lending Policies. FDIC regulations require that state-
chartered non-member banks adopt and maintain written policies that
establish appropriate limits and standards for extensions of credit that
are secured by liens or interest in real estate or are made for the purpose
of financing permanent improvements to real estate. These policies must
establish loan portfolio diversification standards, prudent underwriting
standards, including loan-to-value limits that are clear and measurable,
loan administration procedures and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration
of the Interagency Guidelines for Real Estate Lending Policies that have
been adopted by the federal bank regulators.
Safety and Soundness Standards. Pursuant to the requirements of
FDICIA, as amended by the Riegle Community Development and Regulatory
Improvement Act of 1994, each federal banking agency, including the FDIC,
has adopted guidelines establishing general standards relating to internal
controls, information and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, asset quality,
earnings, and compensation, fees and benefits. In general, the guidelines
require, among other things, appropriate systems and practices to identify
and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound
practice and describe compensation as excessive when the amounts paid are
unreasonable or disproportionate to the services performed by an executive
officer, employee, director, or principal shareholder. In addition, the
FDIC adopted regulations to require a bank that is given notice by the FDIC
that it is not satisfying any of such safety and soundness standards to
submit a compliance plan to the FDIC. If, after being so notified, a bank
fails to submit an acceptable compliance plan or fails in any material
respect to implement an accepted compliance plan, the FDIC may issue an
order directing corrective and other actions of the types to which a
significantly undercapitalized institution is subject under the "prompt
corrective action" provisions of FDICIA. If a bank fails to comply with
such an order, the FDIC may seek to enforce such an order in judicial
proceedings and to impose civil monetary penalties.
Prompt Corrective Action. FDICIA also established a system of prompt
corrective action to resolve the problems of undercapitalized institutions.
The FDIC, as well as the other federal banking regulators, adopted
regulations governing the supervisory actions that may be taken against
undercapitalized institutions. The regulations establish five categories,
consisting of "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." At June 30, 2002, the Bank was categorized as "well
capitalized".
The severity of the action authorized or required to be taken under
the prompt corrective action regulations increases as a bank's capital
deteriorates within the three undercapitalized categories. All banks are
prohibited from paying dividends or other capital distributions or paying
management fees to any controlling person if, following such distribution,
the bank would be undercapitalized.
23
Community Reinvestment. Under the Community Reinvestment Act
("CRA"), as implemented by FDIC regulations, a bank savings association has
a continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including
low and moderate income neighborhoods. The CRA does not establish specific
lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and
services that it believes are best suited to its particular community. The
CRA requires the FDIC, in connection with its examination of a bank, to
assess the bank's record of meeting the credit needs of its community. The
FDIC is also required to assess the depository institution's record of
meeting the credit needs of its community. The CRA also requires all
institutions to make public disclosure of their CRA ratings. The Bank
received a "High Satisfactory" CRA rating in its most recent examination
from the Commonwealth of Massachusetts.
Holding Company Regulation
Federal Regulation. The Company is subject to examination,
regulation and periodic reporting under the Bank Holding Company Act (the
"BHCA"), as administered by the Federal Reserve Board (the "FRB"). The FRB
has adopted capital adequacy guidelines for bank holding companies on a
consolidated basis substantially similar to those of the FDIC for the Bank.
As of June 30, 2002, the Company's total capital and Tier 1 capital ratios
exceeded these minimum capital requirements.
The Company will be required to obtain the prior approval of the FRB
to acquire all, or substantially all, of the assets of any bank or bank
holding company. Prior FRB approval will be required for the Company to
acquire direct or indirect ownership or control of any voting securities of
any bank or bank holding company if, after giving effect to such
acquisition, it would, directly or indirectly, own or control more than 5%
of any class of voting shares of such bank or bank holding company.
The Company will be required to give the FRB 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, will be equal to 10% or more of the Company's
consolidated net worth. The FRB may disapprove such a purchase or
redemption if it determines that the proposal would constitute an unsafe
and unsound practice, or would violate any law, regulation, FRB order or
directive, or any condition imposed by, or written agreement with, the FRB.
Such notice and approval is not required for a bank holding company that
would be treated as "well capitalized" under applicable regulations of the
FRB, that has received a composite "1" or "2" rating at its most recent
bank holding company inspection by the FRB, and that is not the subject of
any unresolved supervisory issues.
The status of the Company as a registered bank holding company under
the BHCA does not exempt it from certain federal and state laws and
regulations applicable to corporations generally, including, without
limitation, certain provisions of the federal securities laws.
In addition, a bank holding company which does not qualify as a
financial holding company under the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 (the "GLBA") is generally prohibited from
engaging in, or acquiring direct or indirect control of any company engaged
in non-banking activities. One of the principal exceptions to this
prohibition is for activities found by the Federal Reserve Board to be so
closely related to banking or managing or controlling banks as to be
permissible. Some of the principal activities that the Federal Reserve
Board has determined by regulation to be so closely related to banking as
to be permissible are:
24
* making or servicing loans;
* performing certain data processing services;
* providing discount brokerage services;
* acting as fiduciary, investment or financial advisor;
* leasing personal or real property;
* making investments in corporations or projects designed primarily
to promote community welfare; and
* acquiring a savings and loan association.
Bank holding companies that do qualify as a financial holding company
may engage in activities that are financial in nature or incident to
activities which are financial in nature. Bank holding companies may
qualify to become a financial holding company if:
* each of its depository institution subsidiaries is "well
capitalized";
* each of its depository institution subsidiaries is "well
managed";
* each of its depository institution subsidiaries has at least a
"satisfactory" Community Reinvestment Act rating at its most
recent examination; and
* the bank holding company has filed a certification with the
Federal Reserve Board that it elects to become a financial
holding company.
As of June 30, 2002, the Company had registered as a financial
holding company.
Under the Federal Deposit Insurance Act, depository institutions are
liable to the FDIC for losses suffered or anticipated by the FDIC in
connection with the default of a commonly controlled depository institution
or any assistance provided by the FDIC to such an institution in danger of
default. This law would potentially be applicable to the Company if it
ever acquired as a separate subsidiary a depository institution in addition
to the Bank.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12
regional Federal Home Loan Banks subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks
provide a central credit facility primarily for member institutions. As a
member of the FHLB, the Bank is required to acquire and hold shares of
capital stock in the FHLB in an amount equal to 1% of the aggregate unpaid
principal of its home mortgage loans, home purchase contracts, and similar
obligations, but not less than $500. The Bank was in compliance with this
requirement with an investment in FHLB stock at June 30, 2002, of $2.9
million.
The FHLB serves as a reserve or central bank for its member
institutions within its assigned region. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB
System. It offers advances to members in accordance with policies and
procedures established by the FHFB and the Board of Directors of the FHLB.
Long-term advances may only be made for the purpose of providing funds for
residential housing finance.
Federal Home Loan Bank System Modernization Act of 1999. Title 6 of
the GLBA, entitled the Federal Home Loan Bank System Modernization Act of
1999 ("FHLB Modernization Act"), has amended the FHLB Act by allowing for
voluntary membership and modernizing the capital structure and governance
of the FHLB system. The new capital structure established under the FHLB
Modernization Act sets forth new leverage and risk-based capital
requirements based on permanence of capital. It also requires some minimum
investment in FHLB stock of all member entities. Capital will include
retained earnings and two forms of stock: Class A stock redeemable within
six months, written notice and Class B
25
stock redeemable within five years, written notice. The FHLB
Modernization Act provides a transition period to the new capital regime,
which will not be effective until the FHLB enacts implementing regulations.
The FHLB Modernization Act also reduces the period of time in which a
member exiting the FHLB system must stay out of the system.
Federal Reserve System
Pursuant to regulations of the FRB, a bank must maintain average
daily reserves equal to 3% on the first $46.5 million of net transaction
accounts (subject to an exemption for the first $4.9 million), plus 10% on
the remainder. This percentage is subject to adjustment by the FRB. Because
required reserves must be maintained in the form of vault cash or in a non-
interest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's interest-
earning assets. As of June 30, 2002, the Bank met its reserve requirements.
Sarbanes-Oxley Act
On July 31, 2002, President George W. Bush signed into law the
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act implements a broad
range of corporate governance and accounting measures for public companies
designed to promote honesty and transparency in corporate America and
better protect investors from the type of corporate wrongdoing that
occurred in Enron, WorldCom and similar companies. The Sarbanes-Oxley
Act's principal legislation includes:
* the creation of an independent accounting oversight board;
* auditor independence provisions which restrict non-audit services
that accountants may provide to their audit clients;
* additional corporate governance and responsibility measures;
* including the requirement that the chief executive officer and
chief financial officer certify financial statements and the
expansion of powers of audit committees;
* expanded disclosure requirements, including accelerated reporting
of stock transactions by insider;
* mandatory disclosure by analysts of potential conflicts of
interest; and
* a range of enhanced penalties for fraud and other violations.
We do not believe that the Sarbanes-Oxley Act will have a material
adverse affect upon our operations in the near term.
Federal Securities Laws
The Company's common stock is registered with the SEC under Section
12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Accordingly, the Company is subject to the information, proxy
solicitation, insider trading restrictions and other requirements of the
Exchange Act.
Other Federal Regulation
In response to the events of September 11th, President George W. Bush
signed into law the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001,
or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the
federal government new powers to address terrorist threats through enhanced
domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. By
way of amendments to the Bank Secrecy Act, Title III of the USA
26
PATRIOT Act takes measures intended to encourage information sharing among
bank regulatory agencies and law enforcement bodies. Further, certain
provisions of Title III impose affirmative obligations on a broad range of
financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes
the following requirements with respect to financial institutions:
* Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls, (ii)
specific designation of an anti-money laundering compliance
officer, (iii) ongoing employee training programs, and (iv) an
independent audit function to test the anti-money laundering
program.
* Section 326 of the Act authorizes the Secretary of the Department
of Treasury, in conjunction with other bank regulators, to issue
regulations by October 26, 2002 that provide for minimum
standards with respect to customer identification at the time new
accounts are opened.
* Section 312 of the Act requires financial institutions that
establish, maintain, administer, or manage private banking
accounts or correspondent accounts in the United States for non-
United States persons or their representatives (including foreign
individuals visiting the United States) to establish appropriate,
specific, and, where necessary, enhanced due diligence policies,
procedures, and controls designed to detect and report money
laundering.
* Effective December 25, 2001, financial institutions are
prohibited from establishing, maintaining, administering or
managing correspondent accounts for foreign shell banks (foreign
banks that do not have a physical presence in any country), and
will be subject to certain recordkeeping obligations with respect
to correspondent accounts of foreign banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on
Federal Reserve Act and Bank Merger Act applications.
ITEM 2. PROPERTIES
The following table sets forth certain information at June 30, 2002
regarding the Bank's office facilities, which are owned by the Bank,
Lexington, Arlington and Bedford offices, which are leased, and certain
other information relating to its property at that date.
Year Square Net Book
Completed Footage Value
--------- ------- --------
(In thousands)
Main Office 60 High Street
Medford, MA 02155 1931 7,000 $ 984
West Medford Office 430 High Street
Medford, MA 02155 1970 2,500 21
Salem Street Office 201 Salem Street
Medford, MA 02155 1995 3,500 861
Lexington Office 1793 Massachusetts Avenue
Lexington, MA 02420 1998 3,000 75
Arlington Office 856 Massachusetts Avenue
Arlington, MA 02476 2000 500 173
27
Bedford Office 168 Great Road
Bedford, MA 01730 2002 2,500 257
------
Net Book Value $2,371
======
The Bank also owns an office building adjacent to its main office,
located at 66 High Street, Medford, MA 02155, which had a net book value
of $1.6 million at June 30, 2002. The Bank uses a portion of the top floor
of this building to house some of its administrative and clerical services
and leases the remaining space to third-party tenants.
At June 30, 2002, the net book value of the Bank's computer equipment
and other furniture, fixtures and equipment at its existing offices totaled
$514,000. For more information, see Note 4 of the Notes to Consolidated
Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Banks is involved in any pending legal
proceedings other than routine legal proceedings occurring in the ordinary
course of business. Such routine legal proceedings in the aggregate are
believed by management to be immaterial to the Company's consolidated
financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to security holders, through the solicitation
of proxies or otherwise, during the quarter ended June 30, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq National Market
under the symbol "MYST." The table below shows the high and low sales
price during the periods indicated. The Company's common stock began
trading on January 8, 1998, the date of the conversion and initial public
offering. At June 28, 2002, the last trading date in the Company's fiscal
year, the Company's common stock closed at $16.91. On August 31, 2002,
there were 1,465,803 shares of the Company's common stock outstanding,
which were held of record by approximately 880 stockholders, not including
persons or entities who hold the stock in nominee or "street" name through
various brokerage firms.
The Board of Directors considers paying dividends, dependent on the
results of operations and financial condition of the Company, tax
considerations, industry standards, economic conditions, regulatory
restrictions and other factors. There are significant regulatory
limitations on the Company's ability to pay dividends depending on the
dividends it receives from its subsidiary, Medford Co-operative Bank, which
are subject to regulations and the Bank's continued compliance with all
regulatory capital requirements and the overall health of the institution.
28
Quarter Ended High Low Dividends
------------- ---- --- ---------
Fiscal year ended June 30, 2002:
Fourth Quarter ended June 30, 2002 $19.750 $16.500 $0.09
Third Quarter ended March 31, 2002 17.580 13.800 0.08
Second Quarter ended December 31, 2001 15.250 13.320 0.08
First Quarter ended September 30, 2001 15.700 14.850 0.08
Fiscal year ended June 30, 2001:
Fourth Quarter ended June 30, 2001 16.100 14.250 0.08
Third Quarter ended March 31, 2001 16.000 13.875 0.08
Second Quarter ended December 31, 2000 14.000 13.125 0.08
First Quarter ended September 30, 2000 13.750 12.000 0.07
29
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data concerning the
Company at the dates and for the years indicated. The following information
is only a summary and should be read in conjunction with the consolidated
financial statements and notes beginning on page F-1.
At or for the Years Ended June 30,
-------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Balance sheet data:
Total assets $ 356,733 $ 300,402 $ 263,888 $ 215,214 $ 199,049
Loans, net 243,743 215,035 189,200 154,689 138,593
Securities:
Available for sale 65,900 28,820 32,452 31,772 14,749
Held to maturity - - - 1,500 12,006
Deposits 267,438 224,750 194,135 160,867 144,766
Borrowings 58,135 44,618 38,750 18,978 16,505
Subordinated debt 5,000 - - - -
Total stockholders' equity 23,923 29,015 29,189 34,052 36,127
Asset quality data:
Non-performing loans 108 15 2 - 150
Allowance for loan losses 2,063 1,784 1,531 1,348 1,236
Number of:
Mortgage loans outstanding 1,749 1,694 1,609 1,626 1,548
Deposit accounts 25,075 22,252 21,661 19,644 18,920
Full service offices 6 5 5 4 3
Number of employees:
Full-time 66 55 62 52 48
Part-time 25 25 28 21 21
Statement of income data:
Interest and dividend income $ 19,868 $ 19,422 $ 16,177 $ 13,745 $ 12,210
Interest expense 10,171 9,967 7,446 6,211 5,648
--------- --------- --------- --------- ---------
Net interest income 9,697 9,455 8,731 7,524 6,562
Provision for loan losses 305 275 200 145 245
--------- --------- --------- --------- ---------
Net interest income after provision
for loan losses 9,392 9,180 8,531 7,379 6,317
Other income 1,137 1,196 945 1,136 1,035
Operating expenses 7,871 8,470 6,715 6,042 4,774
--------- --------- --------- --------- ---------
Income before income taxes 2,658 1,906 2,761 2,473 2,578
Provision for income taxes 1,031 721 1,072 971 1,031
--------- --------- --------- --------- ---------
Net income $ 1,627 $ 1,185 $ 1,689 $ 1,502 $ 1,547
========= ========= ========= ========= =========
Per share data:
Weighted average shares
outstanding - basic 1,462,309 1,731,874 2,024,201 2,375,440 N/A
Basic earnings per share $ 1.11 $ 0.68 $ 0.83 $ 0.63 N/A
Weighted average shares
outstanding - diluted 1,504,249 1,767,902 2,024,201 2,375,440 N/A
Diluted earnings per share $ 1.08 $ 0.67 $ 0.83 $ 0.63 N/A
Cash dividends paid per share $ 0.33 $ 0.31 $ 0.26 $ 0.21 $ 0.05
Book value per share $ 17.56 $ 16.39 $ 16.43 $ 15.06 $ 14.50
30
At or for the Years Ended June 30,
-------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Selected operating ratios:
Interest rate spread (1) 2.88% 3.11% 3.43% 3.26% 3.54%
Net interest margin (2) 3.29 3.70 4.04 3.96 4.05
Return on average assets 0.53 0.44 0.74 0.75 0.90
Return on average equity 6.27 4.04 5.37 4.29 6.70
Operating expenses as a percent
of average total assets 2.54 3.15 2.95 3.01 2.79
Efficiency ratio (3) 72.65 79.52 69.40 69.77 62.84
Asset quality ratios:
Non-performing loans as a percent
of net loans 0.04 0.01 0.00 0.00 0.11
Non-performing loans as a percent
of total assets 0.03 0.01 0.00 0.00 0.08
Allowance for loan losses as a percent
of non-performing loans 1,910 11,893 76,550 N/A 824
Net charge-offs (recoveries) to average
loans 0.01 0.01 0.01 0.02 (0.01)
Capital ratios:
Average equity to average assets 8.38 10.91 13.81 17.48 13.48
Regulatory Tier 1 leverage capital ratio 8.69 10.12 11.35 16.05 19.07
Total equity to total assets 8.67 9.66 11.06 15.82 18.15
- --------------------
Interest rate spread represents the difference between weighted
average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
Net interest margin represents net interest income divided by average
interest-earning assets.
Operating expenses divided by the sum of net interest income and
other income.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Medford Co-operative Bank (the "Bank") completed its conversion from
a mutual to a stock institution and was simultaneously acquired by Mystic
Financial, Inc. ("Mystic" or the "Company") on January 8, 1998. The
following discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes thereto included within
this report.
The business of the Bank consists of attracting deposits from the
general public and using these funds to originate various types of loans
primarily in eastern Middlesex County, Massachusetts, including mortgage
loans secured by one-to-four family residences, commercial loans secured by
general business assets, commercial real estate loans secured by commercial
property, and to invest in U.S. Government and federal agency and other
securities. To a lesser extent, the Bank engages in various forms of
consumer and home equity lending.
The Company's profitability depends primarily on its net interest
income, which is the difference between the interest income it earns on its
loans and investment portfolio and its cost of funds, which consists mainly
of interest paid on deposits and on borrowings from the FHLB. Net interest
income is affected by the relative amounts of interest-earning assets and
interest-bearing liabilities and the interest rates earned or paid on these
balances. When interest-earning assets approximate or exceed interest-
bearing liabilities, any positive interest rate spread will generate net
interest income.
31
The Company's profitability is also affected by the level of other
(noninterest) income and operating expenses. Other income consists
primarily of service fees, loan servicing and other loan fees and gains on
sales of securities. Operating expenses consist of salaries and benefits,
occupancy related expenses and other general operating expenses.
The operations of the Bank, and banking institutions in general, are
significantly influenced by general economic conditions and related
monetary and fiscal policies of financial institution's regulatory
agencies. Deposit flows and the cost of funds are influenced by interest
rates on competing investments and general market rates of interest.
Lending activities are affected by the demand for financing real estate and
other types of loans, which in turn are affected by the interest rates at
which such financing may be offered and other factors affecting loan demand
and the availability of funds.
Business Strategy
The Bank's business strategy is to operate as a well-capitalized,
profitable community bank dedicated to financing home ownership, small
business and consumer needs in its market area and providing quality
service to its customers. The Bank has implemented this strategy by: (i)
monitoring the needs of customers and providing quality service; (ii)
emphasizing consumer-oriented banking by originating residential mortgage
loans and consumer loans, and by offering various deposit accounts and
other financial services and products; (iii) recently increasing its
emphasis on commercial banking and lending by originating loans for small
businesses and providing greater services in its commercial and commercial
real estate loan department; (iv) maintaining high asset quality through
conservative underwriting; and (v) producing stable earnings.
Critical Accounting Policy
The Notes to our Audited Consolidated Financial Statements for the year
ended June 30, 2002 included in our Annual Report on Form 10-K for the
year ended June 30, 2002, contain a summary of our significant accounting
policies. We believe our policy with respect to the methodology for our
determination of the allowance for loan losses, involves a higher degree of
complexity and requires management to make difficult and subjective
judgments which often require assumptions or estimates about highly
uncertain matters. Changes in these judgments, assumptions or estimates
could cause reported results to differ materially. These critical policies
and their application are periodically reviewed with the Audit Committee
and our Board of Directors.
Asset/Liability Management
A principal operating objective of the Bank is to produce stable
earnings by achieving a favorable interest rate spread that can be
sustained during fluctuations in prevailing interest rates. Since the
Bank's principal interest-earning assets have longer terms to maturity than
its primary source of funds, i.e., deposit liabilities, increases in
general interest rates will generally result in an increase in the Bank's
cost of funds before the yield on its asset portfolio adjusts upward. The
Bank has sought to reduce its exposure to adverse changes in interest rates
by attempting to achieve a closer match between the periods in which its
interest-bearing liabilities and interest-earning assets can be expected to
reprice through the origination of adjustable-rate mortgages and loans with
shorter terms and the purchase of other shorter term interest-earning
assets.
The term "interest rate sensitivity" refers to those assets and
liabilities which mature and reprice periodically in response to
fluctuations in market rates and yields. As noted above, one of the
principal goals of the Bank's asset/liability program is to maintain and
match the interest rate sensitivity characteristics of the asset and
liability portfolios.
32
In order to properly manage interest rate risk, the Bank's Board of
Directors has established an Asset/Liability Management Committee ("ALCO")
made up of members of management to monitor the difference between the
Bank's maturing and repricing assets and liabilities and to develop and
implement strategies to decrease the "negative gap" between the two. The
primary responsibilities of the committee are to assess the Bank's
asset/liability mix, recommend strategies to the Board that will enhance
income while managing the Bank's vulnerability to changes in interest rates
and report to the Board the results of the strategies used.
Since the early 1980s, the Bank has stressed the origination of
adjustable-rate residential mortgage loans and adjustable-rate home equity
loans. The Bank regularly sells fixed rate loans with terms in excess of 15
years. Since 1995, the Bank has also emphasized commercial loans with short-
term maturities or repricing intervals as well as commercial real estate
mortgages with short-term repricing intervals. In addition, the Bank has
used borrowings from the FHLB to fund the maturity or repricing interval of
certain commercial real estate mortgages. At June 30, 2002, the Bank's
loan portfolio included $72.5 million of adjustable-rate one-to-four family
mortgage loans, $56.2 million of adjustable-rate commercial real estate
loans, $8.0 million of adjustable-rate or short-term commercial loans, and
$4.1 million of adjustable-rate home equity loans. Together, these loans
represent 57.8% of the Bank's net loans at June 30, 2002. See "Business-
Lending Activities."
33
Average Balances, Interest and Average Yields
The following table sets forth certain information relating to the
Company's average balance sheet and reflects the average yield on assets
and average cost of liabilities for the years indicated and the average
yields earned and rates paid for the years indicated. Such yields and
costs are derived by dividing income or expense by the average monthly
balances of assets and liabilities, respectively, for the years presented.
Average balances are derived from daily balances. Loans on nonaccrual
status are included in the average balances of loans shown in the table.
The securities in the following table are presented at amortized cost.
Years Ended June 30,
---------------------------------------------------------------------------------------------
2002 2001 2000
----------------------------- ----------------------------- -----------------------------
Interest Average Interest Average Interest Average
Average Earned Yield/ Average Earned Yield/ Average Earned Yield/
Balance or Paid Rate Balance or Paid Rate Balance or Paid Rate
------- -------- ------- ------- -------- ------- ------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans, net $226,711 $16,972 7.49% $205,837 $16,597 8.06% $173,319 $13,699 7.90%
Securities 50,765 2,405 4.74% 29,595 1,785 6.03% 31,196 1,822 5.84%
Other earning assets (1) 17,564 491 2.80% 19,883 1,040 5.23% 11,822 656 5.55%
-------- ------- -------- ------- -------- -------
Total interest-earning assets 295,040 19,868 6.73% 255,315 19,422 7.61% 216,337 16,177 7.48%
------- ------- -------
Cash and due from banks 7,558 6,320 4,905
Other assets 6,981 6,867 6,576
-------- -------- --------
Total assets $309,579 $268,502 $227,818
======== ======== ========
Interest-bearing liabilities:
Regular and other deposits $ 47,710 990 2.08% $ 42,640 946 2.22% $ 41,498 940 2.27%
NOW accounts 34,384 344 1.00% 29,472 433 1.47% 23,954 358 1.49%
Money market deposits 19,952 469 2.35% 12,415 485 3.91% 6,947 160 2.30%
Certificates of deposit 111,193 5,510 4.96% 92,451 5,332 5.77% 79,063 4,061 5.14%
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits 213,239 7,313 3.43% 176,978 7,196 4.07% 151,462 5,519 3.64%
FHLB borrowings 49,854 2,789 5.59% 44,400 2,771 6.24% 32,314 1,927 5.96%
Subordinated Debt 1,250 69 5.52%
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 264,343 10,171 3.85% 221,378 9,967 4.50% 183,776 7,446 4.05%
------- ------- -------
Demand deposit accounts 17,837 16,258 11,149
Other liabilities 1,458 1,562 1,438
-------- -------- --------
Total liabilities 283,638 239,198 196,363
Stockholders' equity 25,941 29,304 31,455
-------- -------- --------
Total liabilities and
stockholders' equity $309,579 $268,502 $227,818
======== ======== ========
Net interest income $ 9,697 $ 9,455 $ 8,731
======= ======= =======
Interest rate spread 2.88% 3.11% 3.43%
Net interest margin 3.29% 3.70% 4.04%
Interest-earning assets/
interest-bearing liabilities 1.12x 1.15x 1.18x
- --------------------
Other earning assets include Bank Investment Fund, Liquidity Fund, FHLB overnight deposits, federal funds
sold, the Co-operative Central Bank Reserve Fund and money market accounts.
34
Rate/Volume Analysis
The following table sets forth certain information regarding changes
in interest income and interest expense of the Company for the years
indicated. For each category of interest-earning assets and interest-
bearing liabilities, information is provided on changes attributable to:
(i) changes in volume (changes in volume multiplied by old rate) and (ii)
changes in rates (change in rate multiplied by old volume). Changes in
rate-volume (changes in rate multiplied by the changes in volume) are
allocated between changes in rate and changes in volume.
Year Ended June 30, Year Ended June 30,
2002 vs 2001 2001 vs 2000
Increase (decrease) Increase (decrease)
------------------------------ ------------------------------
Due to Due to
------------------------------ ------------------------------
Rate Volume Total Rate Volume Total
---- ------ ----- ---- ------ -----
(In thousands)
Interest and dividend income:
Loans, net $ (899) $ 1,274 $ 375 $ 283 $ 2,615 $ 2,898
Securities (266) 886 620 58 (95) (37)
Other earning assets (439) (110) (549) (40) 424 384
------- ------- ----- ----- ------- -------
Total (1,604) 2,050 446 301 2,944 3,245
------- ------- ----- ----- ------- -------
Interest expense:
Regular and other deposits (53) 96 43 (17) 24 7
NOW accounts (186) 97 (89) (6) 81 75
Money market deposits 31 (47) (16) 153 172 325
Certificates of deposit (405) 584 179 554 716 1,270
Borrowed funds (100) 118 18 93 751 844
Subordinated debt 0 69 69 - - -
------- ------- ----- ----- ------- -------
Total (713) 917 204 777 1,744 2,521
------- ------- ----- ----- ------- -------
Change in net interest income $ (891) $ 1,133 $ 242 $(476) $ 1,200 $ 724
======= ======= ===== ===== ======= =======
Financial Condition and Results of Operations
The Company's operating results depend primarily upon its net
interest income, which is the difference between the interest income earned
on its interest-bearing assets (loans and securities), and the interest
expense paid on its interest-bearing liabilities (deposits and FHLB
borrowings). Operating results are also significantly affected by
provisions for loan losses, other income and operating expenses. Each of
these factors is significantly affected not only by the Company's policies,
but, to varying degrees, by general economic and competitive conditions and
by policies of state and federal regulatory authorities.
Comparison of Financial Condition at June 30, 2002 and 2001
The Company's total assets amounted to $356.7 million at June 30,
2002 compared to $300.4 million at June 30, 2001, an increase of $56.3
million or 18.7%. The increase in total assets is primarily attributable
to an increase in net loans of $28.7 million or 13.4% and an increase in
securities available for sale of $37.1 million or 128.7%.
Cash and cash equivalents was $34.6 million at June 30, 2002 compared
to $46.1 million at June 30, 2001, a decrease of $11.5 million or 25.0%.
The decrease in short-term investments, of $10.9 million, was due to the
increased loan demand in both the residential and commercial real estate
areas and an increase in securities available for sale.
35
Net loans increased by $28.7 million or 13.4% to $243.7 million or
68.3% of total assets at June 30, 2002 as compared to $215.0 million or
71.6% of total assets at June 30, 2001 as the Bank continued its emphasis
on originating and retaining residential mortgage loans, commercial loans
and commercial real estate loans. Securities, including FHLB stock, held
by the Company increased by $37.5 million or 119.5% to $68.8 million at
June 30, 2002 from $31.3 million at June 30, 2001. The increase in the
Company's securities portfolio reflects the Company's decision to invest a
greater portion of its assets in US Government and federal agency
obligations and mortgage-backed securities, which results in higher yields
than cash and cash equivalents.
Total deposits increased by $42.7 million or 19.0% to $267.4 million
at June 30, 2002 from $224.8 million at June 30, 2001. Money market
deposits increased to $21.5 million at June 30, 2002 from $18.6 million at
June 30, 2001, an increase of $2.9 million or 15.5%. Certificates of
deposit increased to $124.0 million at June 30, 2002 from $104.4 million at
June 30, 2001, an increase of $19.6 million or 18.7%. Demand deposits and
IOLTA accounts increased to $42.3 million at June 30, 2002 from $35.1
million at June 30, 2001, an increase of $7.2 million or 20.4% as a result
of the Bank's continuing emphasis on developing relationships with small
business. There were also increases in other deposit categories.
Total borrowings increased by $13.5 million to $58.1 million at June
30, 2002 from $44.6 million at June 30, 2001. The Company's continued use
of borrowed funds reflects additional funding needed to support its growth
in net loans and increases in its securities portfolio.
In April 2002, Mystic Financial Capital Trust I was formed for the
purpose of issuing trust preferred securities and investing the proceeds of
the sale of these securities in subordinated debentures. A total of $5.0
million of floating rate trust preferred securities were outstanding at
June 30, 2002. See Note 8 to the Audited Financial Statements for more
information.
Stockholders' equity decreased by $5.1 million to $23.9 million at
June 30, 2002 from $29.0 million at June 30, 2001 as a result of the
repurchase of 433,281 shares of common stock held in treasury at a cost of
$7.1 million, dividends paid of $484,000, offset by an increase in the net
unrealized gain on securities available for sale of $232,000, net income of
$1.6 million, proceeds from exercise of stock options of $36,000, a
reduction in unearned RRP stock of $201,000, and a reduction in unearned
ESOP shares of $365,000.
Book value per share of common stock was $17.56 as of June 30, 2002
as compared to $16.39 as of June 30, 2001. In calculating book value per
share, the number of shares of common stock outstanding is reduced by the
number of shares held by the ESOP that have not been allocated or not
committed to be released to participants' individual accounts, unearned RRP
shares and treasury stock. There were 1,362,717 shares of common stock
outstanding as of June 30, 2002 for purposes of calculating the Company's
book value per share.
Comparison of the Operating Results for the Years Ended June 30, 2002 and 2001
Net Income. Net income was $1.6 million for the year ended June 30,
2002 as compared to $1.2 million for the year ended June 30, 2001. This
$442,000 increase in net income during the year was the result of an
increase in net interest income of $242,000 and a decrease in operating
expenses of $599,000 offset by an increase in provision for loan losses of
$30,000, a decrease in other income of $59,000 and an increase in provision
for income taxes of $310,000. The decrease in operating expenses during
the year was largely related to a one-time non-recurring pre-tax charge of
$861,000 in May 2001 pertaining to a contractural payment made to the
Company's former President and Chief Executive Officer. The return on
average assets for the year ended June 30, 2002 was .53% compared to .44%
for the year ended June
36
30, 2001. The return on average equity for the year ended June 30, 2002
was 6.27% compared to 4.04% for the year ended June 30, 2001.
Earnings per share on a basic and diluted basis was $1.11 and $1.08,
respectively, for the year ended June 30, 2002 compared to $.68 and $.67 on
a basic and diluted basis for the year ended June 30, 2001.
Interest Income. Total interest and dividend income increased by
$446,000 or 2.3% to $19.9 million for the year ended June 30, 2002 from
$19.4 million for the year ended June 30, 2001. The increase in interest
income was primarily the result of a higher level of loans and securities
offset by a decrease in other earning assets. The average balance of net
loans for the year ended June 30, 2002 was $226.7 million compared to
$205.8 million for the year ended June 30, 2001. The average yield on net
loans was 7.49% for the year ended June 30, 2002 compared to 8.06% for the
year ended June 30, 2001. The average balance of securities for the year
ended June 30, 2002 was $50.8 million compared to $29.6 million for the
year ended June 30, 2001. The average yield on securities was 4.74% for
the year ended June 30, 2002 compared to 6.03% for the year ended June 30,
2001. The average balance of other earning assets for the year ended June
30, 2002 was $17.6 million compared to $19.9 million for the year ended
June 30, 2001. The average yield on other earning assets was 2.80% for the
year ended June 30, 2002 compared to 5.23% for the year ended June 30,
2001.
Interest Expense. Total interest expense increased by $204,000 or
2.0% to $10.2 million for the year ended June 30, 2002 from $10.0 million
for the year ended June 30, 2001. The increase in interest expense
resulted from an increase in the overall deposit balances as well as an
increase in FHLB borrowings. Average interest-bearing deposits increased
by $36.3 million or 20.5% to $213.2 million for the year ended June 30,
2002 from $177.0 million for the year ended June 30, 2001. Average
borrowings increased by $5.5 million to $49.9 million for the year ended
June 30, 2002 from $44.4 million for the year ended June 30, 2001. The
average rate on interest-bearing deposits decreased 64 basis points to
3.43% for the year ended June 30, 2002 from 4.07% for the year ended June
30, 2001, while the average rate on borrowed funds decreased 65 basis
points to 5.59% from 6.24% during the same period.
Net Interest Income. Net interest income for the year ended June 30,
2002 was $9.7 million as compared to $9.5 million for the year ended June
30, 2001. The $242,000 or 2.6% increase is attributed to the $446,000
increase in interest and dividend income partially offset by the $204,000
increase in interest expense on deposits, borrowed funds and subordinated
debt. The average yield on interest earning assets decreased 88 basis
points to 6.73% for the year ended June 30, 2002 from 7.61% for the year
ended June 30, 2001, while the average cost on interest-bearing liabilities
decreased by 65 basis points to 3.85% for the year ended June 30, 2002 from
4.50% for the year ended June 30, 2001. As a result, the interest rate
spread decreased by 23 basis points to 2.88% for the year ended June 30,
2002 from 3.11% for the year ended June 30, 2001.
Provision for Loan Losses. The provision for loan losses was
$305,000 for the year ended June 30, 2002 as compared to $275,000 for the
year ended June 30, 2001. The increase reflects the growth in net loans
and continued emphasis on small business lending. At June 30, 2002, the
balance of the allowance for loan losses was $2.1 million or .84% of total
loans. During the year ended June 30, 2002, $30,000 was charged against
the allowance for loan losses while $4,000 in recoveries was credited to
the allowance for loan losses. At June 30, 2001, the balance of the
allowance for loan losses was $1.8 million or .82% of total loans. During
the year ended June 30, 2001, $27,000 was charged against allowance for
loan losses while $5,000 in recoveries was credited to the allowance for
loan losses. There were two non-performing loans of $108,000 at June 30,
2002. At June 30, 2001, there was one non-performing loan of $15,000.
37
Other Income. Other income was $1.1 million for the year ended June
30, 2002 compared to $1.2 million for the year ended June 30, 2001. The
$59,000 decrease was the result of an increase in customer service fees of
$81,000, offset by a decrease in the gain on the sale of securities of
$129,000 and a decrease in miscellaneous income of $11,000. The decrease
in miscellaneous income includes an increase in the gain on loans sold of
$103,000, an increase in rental income of $27,000, offset by a decrease in
gains from covered call options of $77,000 and a decrease of miscellaneous
income of $58,000.
Operating Expenses. Operating expenses decreased by $599,000 or
7.1% to $7.9 million for the year ended June 30, 2002 from $8.5 million for
the year ended June 30, 2001. Salaries and employee benefits decreased by
$757,000, of which $861,000 is attributable to a one-time, non-recurring
pre-tax charge related to a contractual payment made to the Company's
former President and Chief Executive Officer. Other general and
administrative expenses increased by $74,000 and occupancy and equipment
expense increased by $94,000 attributable to operating expenses associated
with the Bedford branch location which opened in June 2002. Annual
operating expenses are expected to increase in future periods due to the
increased cost of operating as a publicly held stock institution.
Comparison of Financial Condition at June 30, 2001 and 2000
The Company's total assets amounted to $300.4 million at June 30,
2001 compared to $263.9 million at June 30, 2000, an increase of $36.5
million or 13.8%. The increase in total assets is primarily attributable
to an increase in net loans of $25.8 million or 13.7% and an increase in
cash and cash equivalents of $14.8 million or 47.2%.
Cash and cash equivalents was $46.1 million at June 30, 2001 compared
to $31.3 million at June 30, 2000. Cash and cash equivalents increased at
June 30, 2001 due to an increase of $13.4 million in short-term investments
to $16.7 million at June 30, 2001 from $3.3 million at June 30, 2000. The
increase in short-term investments was caused by increased deposits
resulting from a money market deposit promotion, and an increase in
liquidity needed for a large deposit relationship with a law firm which
maintains short-term deposits in real estate conveyancing accounts and has
significant fluctuations in its deposit account balances, particularly at
month-end. The Company's increased liquidity position also reflects
generally slower loan demand and a decision not to extend long-term
investments in the current interest rate environment.
Net loans increased by $25.8 million or 13.7% to $215.0 million or
71.6% of total assets at June 30, 2001 as compared to $189.2 million or
71.7% of total assets at June 30, 2000 as the Bank continued its emphasis
on originating and retaining residential mortgage loans and commercial and
commercial real estate loans. Securities held by the Company decreased by
$3.5 million or 10.1% to $31.3 million at June 30, 2001 from $34.9 million
at June 30, 2000. The slight decrease in the Company's securities
portfolio reflects the Company's decision to invest a greater portion of
its assets in cash and cash equivalents in the current interest rate
environment.
Total deposits increased by $30.6 million or 15.8% to $224.8 million
at June 30, 2001 from $194.1 million at June 30, 2000. The increase
occurred primarily in money market deposits as a result of a deposit
promotion. Money market deposits increased to $18.6 million at June 30,
2001 from $8.4 million at June 30, 2000, an increase of $10.2 million or
122.1%. Certificates of deposit increased to $104.4 million at June 30,
2001 from $93.1 million at June 30, 2000, an increase of $11.3 million or
12.2%. Demand deposits increased to $18.9 million at June 30, 2001 from
$16.3 million at June 30, 2000, an increase of $2.5 million or 15.6% as a
result of the Bank's continuing emphasis on developing relationships with
small business. There was also an increase in all deposit categories.
38
Total borrowings increased by $5.9 million to $44.6 million at June
30, 2001 from $38.8 million at June 30, 2000. The Company's continued use
of borrowed funds reflects additional funding needed to support its growth
in net loans. In addition, the Bank has secured longer-term borrowed funds
with original maturities ranging up to 15 years in order to improve its
interest rate risk and fund longer-term assets including fixed-rate
residential mortgage loans held for portfolio and mortgage-backed
securities held for investment.
Stockholders' equity decreased by $200,000 to $29.0 million at June
30, 2001 from $29.2 million at June 30, 2000 as a result of the repurchase
of 117,614 shares of common stock held in treasury at a cost of $1.6
million, dividends paid of $524,000, offset by an increase in the net
unrealized gain on securities available for sale of $173,000, net income of
$1.2 million, proceeds from exercise of stock options of $60,000, a
reduction in unearned RRP stock of $224,000, and a reduction in unearned
ESOP shares of $339,000.
Book value per share of common stock was $16.39 as of June 30, 2001
as compared to $16.43 as of June 30, 2000. In calculating book value per
share, the number of shares of common stock outstanding is reduced by the
number of shares held by the ESOP that have not been allocated or not
committed to be released to participants' individual accounts, unearned RRP
shares and treasury stock. There were 1,769,902 shares of common stock
outstanding as of June 30, 2001 for purposes of calculating the Company's
book value per share.
Comparison of the Operating Results for the Years Ended June 30, 2001 and 2000
Net Income. Net income was $1.2 million for the year ended June 30,
2001 as compared to $1.7 million for the year ended June 30, 2000. This
$504,000 decrease in net income during the period was the result of an
increase in operating expenses of $1.8 million largely related to a one-
time, non-recurring pre-tax charge of $861,000 relating to a contractual
payment made to the Company's former President and Chief Executive Officer
and a full year's operating expense for the Company's branch office opened
in Arlington, Massachusetts in May 2000, offset by an increase in other
income of $251,000, and a decrease in provision for income taxes of
$351,000. The return on average assets for the year ended June 30, 2001
was .44% compared to .74% for the year ended June 30, 2000. The return on
average equity for the year ended June 30, 2001 was 4.04% compared to 5.37%
for the year ended June 30, 2000.
Earnings per share on a basic and diluted basis was $.68 and $.67,
respectively, for the year ended June 30, 2001 compared to $.83 on a basic
and diluted basis for the year ended June 30, 2000.
Interest Income. Total interest and dividend income increased by
$3.2 million or 20.1% to $19.4 million for the year ended June 30, 2001
from $16.2 million for the year ended June 30, 2000. The increase in
interest income was primarily the result of a higher level of loans and
other earning assets, partially offset by a decrease in securities. The
average balance of net loans for the year ended June 30, 2001 was $205.8
million compared to $173.3 million for the year ended June 30, 2000. The
average yield on net loans was 8.06% for the year ended June 30, 2001
compared to 7.90% for the year ended June 30, 2000. The average balance of
other earning assets for the year ended June 30, 2001 was $19.9 million
compared to $11.8 million for the year ended June 30, 2000. The average
yield on other earning assets was 5.23% for the year ended June 30, 2001
compared to 5.55% for the year ended June 30, 2000. The average balance of
securities for the year ended June 30, 2001 was $29.6 million compared to
$31.2 million for the year ended June 30, 2000. The average yield on
securities was 6.03% for the year ended June 30, 2001 compared to 5.84% for
the year ended June 30, 2000.
39>
Interest Expense. Total interest expense increased by $2.5 million
or 33.9% to $10.0 million for the year ended June 30, 2001 from $7.4
million for the year ended June 30, 2000. The increase in interest expense
resulted from an increase in the overall deposit balances as well as an
increase in FHLB borrowings. Average interest-bearing deposits increased
by $25.5 million or 16.8% to $177.0 million for the year ended June 30,
2001. Average borrowings increased by $12.1 million to $44.4 million for
the year ended June 30, 2001 from $32.3 million for the year ended June 30,
2000. The average rate on interest-bearing deposits increased 43 basis
points to 4.07% for the year ended June 30, 2001 from 3.64% for the year
ended June 30, 2000, while the average rate on borrowed funds increased 28
basis points to 6.24% from 5.96% during the same period.
Net Interest Income. Net interest income for the year ended June 30,
2001 was $9.5 million as compared to $8.7 million for the year ended June
30, 2000. The $724,000 or 8.3% increase is attributed to the $3.2 million
increase in interest and dividend income partially offset by the $2.6
million increase in interest expense on deposits and borrowed funds. The
average yield on interest earning assets increased 13 basis points to 7.61%
for the year ended June 30, 2001 from 7.48% for the year ended June 30,
2000, while the average cost on interest-bearing liabilities increased by
45 basis points to 4.50% for the year ended June 30, 2001 from 4.05% for
the year ended June 30, 2000. As a result, the interest rate spread
decreased by 32 basis points to 3.11% for the year ended June 30, 2001 from
3.43% for the year ended June 30, 2000. The interest rate spread decreased
due to a higher volume of interest bearing liabilities during a period of
generally rising interest rates.
Provision for Loan Losses. The provision for loan losses was
$275,000 for the year ended June 30, 2001 as compared to $200,000 for the
year ended June 30, 2000. The increase reflects the growth in net loans
and continued emphasis on small business lending. At June 30, 2001, the
balance of the allowance for loan losses was $1.8 million or .82% of total
loans. During the year ended June 30, 2001, $27,000 was charged against
the allowance for loan losses while $5,000 in recoveries was credited to
the allowance for loan losses. At June 30, 2000, the balance of the
allowance for loan losses was $1.5 million or .80% of total loans. During
the year ended June 30, 2000, $23,000 was charged against allowance for
loan losses while $6,000 in recoveries was credited to the allowance for
loan losses. There was one non-performing loan of $15,000 at June 30,
2001. At June 30, 2000, there was one non-performing loan of $2,000.
Other Income. Other income was $1.2 million for the year ended June
30, 2001 compared to $945,000 for the year ended June 30, 2000. The
$251,000 or 26.6% increase was the result of an increase in customer
service fees of $125,000, an increase in miscellaneous income of $80,000,
and an increase in the gain on the sale of securities of $46,000.
Operating Expenses. Operating expenses increased by $1.8 million or
26.1% to $8.5 million for the year ended June 30, 2001 from $6.7 million
for the year ended June 30, 2000. Salaries and employee benefits increased
by $1.3 million, of which $861,000 is attributable to a one-time, non-
recurring pre-tax charge related to a contractual payment made to the
Company's former President and Chief Executive Officer. Other general and
administrative expenses increased by $220,000 reflecting increases in
professional fees of $213,000. Occupancy and equipment expense increased
by $155,000 attributable to a full year's worth of operating expenses
associated with the Arlington branch location opened in May 2000. Data
processing expenses increased by $49,000 due to increased computer service
bureau costs. Annual operating expenses are expected to increase in future
periods due to the increased cost of operating as a publicly held stock
institution.
40
Liquidity and Capital Resources
The Company's primary sources of funds consist of deposits,
borrowings, repayment and prepayment of loans, sales and participations of
loans, maturities of securities and interest-bearing deposits, and funds
provided from operations. While scheduled repayments of loans and
maturities of securities are predictable sources of funds, deposit flows
and loan prepayments are greatly influenced by the general level of
interest rates, economic conditions, and competition. Liquidity resources
are used primarily to fund existing and future loan commitments, to fund
net deposit outflows, to invest in other interest-earning assets, to
maintain liquidity, and to meet operating expenses.
The Bank is required to maintain adequate levels of liquid assets.
This guideline, which may be varied depending upon economic conditions and
deposit flows, is based upon a percentage of deposits and short-term
borrowings. The Bank has historically maintained a level of liquid assets
in excess of regulatory requirements. The Bank's liquidity ratio at June
30, 2002 was 66.9%, using the short-term assets to short-term liabilities
formula defined under the Federal Deposit Insurance Corporation's Uniform
Bank Performance Reports.
A major portion of the Bank's liquidity consists of cash and cash
equivalents, short-term U.S. Government and federal agency obligations, and
corporate bonds. The level of these assets is dependent upon the Company's
operating, investing, lending and financing activities during any given
period.
Liquidity management is both a daily and long-term function of
management. If the Company or the Bank requires funds beyond its ability
to generate them internally, the Bank believes it could borrow additional
funds from the FHLB. At June 30, 2002, the Bank had borrowings of $58.1
million from the FHLB.
At June 30, 2002, the Bank had $12.8 million in outstanding
commitments to originate loans. The Bank anticipates that it will have
sufficient funds available to meet its current loan origination
commitments. Certificates of deposit, which are scheduled to mature in one
year or less, totaled $63.9 million at June 30, 2002. Based upon
historical experience, management believes that a significant portion of
such deposits will remain with the Bank.
On April 10, 2002, Mystic Financial Capital Trust I (the "Trust"), a
Delaware business trust formed by the Company, completed the sale of $5.0
million capital securities designated the Floating Rate TRUPS(R) (liquidation
amount of $1,000 per security) (the "Capital Securities") in a private
placement as part of a pooled capital securities transaction. The Trust
also issued common securities to the Company and used the net proceeds from
the offering to purchase a like amount of Junior Subordinated Deferrable
Interest Debentures (the "Subordinated Debentures") of the Company. The
Subordinated Debentures are the sole assets of the Trust and are
eliminated, along with the related income statement effects, in the
consolidated financial statements of the Company. The Capital Securities
provide for cumulative cash distributions calculated at a rate based on
six-month LIBOR plus 3.70%. The Company may, at one or more times, defer
interest payments on the capital securities for up to 10 consecutive semi-
annual periods, but not beyond April 22, 2032. The Company has fully and
unconditionally guaranteed all of the obligations of the Trust, including
the semi-annual distributions and payments on liquidation or redemption of
the Capital Securities. The Capital Securities are mandatorily redeemable
upon the maturing of the Subordinated Debentures April 22, 2032 or upon
earlier redemption as provided in the Indenture Agreement. The Company has
the right to redeem the Subordinated Debentures, in whole or in
41
part, on any April 22 and October 22 on or after April 22, 2007 at the
liquidation amount, plus any accrued but unpaid interest to the redemption
date.
At June 30, 2002, the Company and the Bank exceeded all of their
regulatory capital requirements. For further information regarding the
Company's and the Bank's regulatory capital at June 30, 2002 see
"Regulation-Federal Banking Regulations-Capital Requirements."
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented
herein have been prepared in accordance with accounting principles
generally accepted in the United States of America, which require the
measurement of financial position and results of operations in terms of
historical dollars without considering changes in the relative purchasing
power of money over time because of inflation. Unlike most industrial
companies, virtually all of the assets and liabilities of the Company are
monetary in nature. As a result, interest rates have a more significant
impact on the Company's performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or
in the same magnitude as the prices of goods and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising
from adverse changes in market rates/prices such as interest rates, foreign
currency exchange rates, commodity prices, and equity prices. The
Company's primary market risk exposure is interest rate risk. The ongoing
monitoring and management of this risk is an important component of the
Company's asset/liability management process which is governed by policies
established by its Board of Directors that are reviewed and approved
annually. The Board of Directors delegates responsibility for carrying out
the asset/liability management policies to the Asset/Liability Management
Committee ("ALCO"). In this capacity, ALCO develops guidelines and
strategies affecting the Company's asset/liability management related
activities based upon estimated market risk sensitivity, policy limits and
overall market interest rate levels and trends.
The ALCO is composed of members of management and the Board of
Directors to monitor the difference between the Company's maturing and
repricing assets and liabilities and to develop and implement strategies to
manage the possible change in the Company's net interest margin resulting
from changes in interest rates. The primary responsibilities of the ALCO
are to assess the Company's asset/liability mix, recommend strategies to
the board that will enhance income while managing the Company's
vulnerability to changes in interest rates and report to the board the
results of the strategies used.
Interest rate risk represents the sensitivity of earnings to changes
in market interest rates. As interest rates change the interest income and
expense streams associated with the Company's financial instruments also
change thereby affecting net interest income ("NII"), the primary component
of the Company's earnings. During the year ended June 30, 2002, the
Company continued working with a consulting group to perform its interest
rate risk simulation analysis. ALCO utilizes the results of a simulation
model to quantify the estimated exposure of NII to sustained interest rate
changes. While ALCO routinely monitors simulated NII sensitivity over a
rolling one-year horizon, it also utilizes additional tools to monitor
potential longer-term risk.
The simulation model captures the impact of changing interest rates
on the interest income received and interest expense paid on all assets and
liabilities reflected on the Company's balance sheet.
42
This sensitivity analysis is compared to board and ALCO policy limits which
specify a maximum tolerance level for NII exposure over a one year horizon,
assuming no balance sheet growth, given both a 200 basis point upward and
downward shift in interest rates. The Company uses various other
assumptions in its sensitivity analysis. For securities, in the event of a
call provision, if the interest rate is lower than the contractual rate,
reinvestment is assumed at the lower rate. For residential mortgage loans,
the Company uses the PSA method to generate different prepayment
assumptions. Commercial loans and commercial real estate loans do not
include any amortization or prepayment amounts. For money market accounts,
NOW accounts, and regular savings deposits, not all deposits within these
categories are assumed to increase by the full extent of the interest rate
shift based upon management's judgment as to deposit elasticity. The
following reflects the Company's NII sensitivity analysis as of April 30,
2002 (most recent).
Estimated NII Sensitivity
-------------------------
Rate Change Year One Year Two
----------- -------- --------
+200 basis points 2.97% 8.51%
-200 basis points (1.99%) (5.65%)
The preceding sensitivity analysis does not represent a Company
forecast and should not be relied upon as being indicative of expected
operating results. These hypothetical estimates are based upon numerous
assumptions including: the nature and timing of interest rate levels
including yield curve shape, prepayments on loans and securities, changes
in deposit levels, pricing decisions on loans and deposits, reinvestment of
asset and liability cash flows, and others. While assumptions are
developed based upon current economic and local market conditions, the
Company cannot make any assurances as to the predictive nature of these
assumptions including how customer preferences or competitor influences
might change.
In addition, as market conditions vary from those assumed in the
sensitivity analysis, actual results will also differ due to: prepayment
and refinancing levels likely deviating from those assumed, the varying
impact of interest rate changes caps or floors on adjustable rate assets,
the potential effect of changing debt service levels on customers with
adjustable rate loans, depositor early withdrawals and product preference
changes, and other internal and external variables. Furthermore, the
sensitivity analysis does not reflect actions that ALCO might take in
responding to or anticipating changes in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Mystic Financial, Inc. and
Subsidiary are included in pages F-1 through F-39 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included on pages 6 through 10, and page 23
of the Company's Proxy Statement for the 2002 Annual Meeting of
Stockholders (the "Proxy Statement") is incorporated herein by reference:
"Election of Directors," "Information as to Nominees and Continuing
Directors," "Nominees for Election as Director," "Executive Officers," and
" - Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
The following information included on pages 11 through 23 of the
Proxy Statement is incorporated herein by reference: "Compensation of
Directors and Executive Officers-Directors' Compensation," "-Executive
Compensation," "-Employment Agreements," and "-Benefits."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included on pages 3 through 5 of the Proxy
Statement is incorporated herein by reference: "Security Ownership of
Certain Beneficial Owners and Management-Principal Stockholders of the
Company" and "-Security Ownership of Management."
The following table sets forth the aggregate information of the
Company's equity compensation plans as in effect as of June 30, 2002.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities future issuance under
to be issued Weighted-average equity compensation
upon exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
Plan category warrants and rights warrants and rights column (a))
- ------------- -------------------- -------------------- -----------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders 257,355 $12.06 -
Equity compensation
plans not approved
by security holders - - -
------- --
Total 257,355 $12.06 -
======= ==
44
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included on page 23 of the Proxy Statement
is incorporated herein by reference: "Compensation of Directors and
Executive Officers-Transactions with Certain Related Persons."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Listed below are all financial statements and exhibits
filed as part of this report:
(1) The consolidated balance sheets of Mystic Financial, Inc.
and subsidiaries as of June 30, 2002 and 2001 and the
related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the years
in the three-year period ended June 30, 2002, together
with the related notes and the independent auditors'
report of Wolf & Company, P.C. independent certified
public accountants.
(2) Schedules omitted as they are not applicable.
(3) Exhibits
45
Exhibit No. Description
- ----------- -----------
3.1 Certificate of Incorporation of Mystic Financial, Inc.*
3.2 Bylaws of Mystic Financial, Inc.*
4.3 Specimen of Stock Certificate of Mystic Financial, Inc.*
10.1 Employee Stock Ownership Plan and Trust Agreement of Mystic Financial, Inc.*
10.2 Employment Agreement between Mystic Financial, Inc. and Ralph W. Dunham. *
10.3 Employment Agreement between Mystic Financial, Inc. and John M. O'Donnell. *
10.4 Employment Agreement between Mystic Financial, Inc. and Anthony J. Patti. ****
10.5 Employment Agreement between Medford Co-operative Bank and Thomas G. Burke. *
10.6 Employment Agreement between Medford Co-operative Bank and Robert Kaminer **
10.7 Severance Pay Plan of Medford Co-operative Bank **
10.8 Mystic Financial, Inc. Retirement Plan for Non-employee Directors ***
10.9 Guarantee Agreement dated April 10, 2002 by Mystic Financial, Inc.
and Wilmington Trust Company. ****
10.10 Indenture Agreement dated April 10, 2002 by Mystic Financial, Inc.
and Wilmington Trust Company. ****
10.11 Amendment to the Employee Stock Ownership Plan and Trust Agreement of Mystic Financial, Inc. ****
21.1 Subsidiaries of the Registrant. *
23.1 Consent of Wolf & Company, P.C.
99.1 Proxy Statement for the 2002 Annual Meeting of Stockholders of Mystic Financial, Inc.
(previously filed with the Securities and Exchange Commission on September 20, 2002).
99.2 Certifications of the CEO and CFO Pursuant to 18 U.S.C. Section 1350, as added by
Section 906 of the Sarbanes-Oxley Act of 2002.
- --------------------
* Incorporated herein by reference to Registration Statement No.
333-34447 on Form S-1 of Mystic Financial, Inc. filed with the
Securities and Exchange Commission on August 27, 1997, as
amended.
** Incorporated herein by reference to the Quarterly Report on Form
10-Q of Mystic Financial, Inc. filed with the Securities and
Exchange Commission on November 14, 2000.
46
*** Incorporated herein by reference to the Quarterly Report on Form
10-Q of Mystic Financial, Inc. filed with the Securities and
Exchange Commission on February 12, 2001.
**** Incorporated herein by reference to the Quarterly Report on Form
10-Q of Mystic Financial, Inc. filed with the Securities and
Exchange Commission on May 14, 2002.
(b) The Company has not filed any reports on Form 8-K for the
quarter ended June 30, 2002.
47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant certifies that it has duly caused this
report to be signed on its behalf by the undersigned, hereunto duly
authorized, in the City of Medford, Commonwealth of Massachusetts, on
September 11, 2002.
Mystic Financial, Inc.
BY: /s/ Ralph W. Dunham
-------------------------------
Ralph W. Dunham
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this report has been signed by the following persons in the
capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Ralph W. Dunham Director, President, Chief September 11, 2002
- ---------------------------- Executive Officer, and
Ralph W. Dunham Treasurer (Principal
executive officer)
/s/ Anthony J. Patti Senior Vice-President and September 11, 2002
- ---------------------------- Chief Financial Officer
Anthony J. Patti (Principal financial officer)
/s/ Julie Bernardin Director September 11, 2002
- ----------------------------
Julie Bernardin
/s/ Frederick N. Dello Russo Director September 11, 2002
- ----------------------------
Frederick N. Dello Russo
/s/ John A. Hackett Director September 11, 2002
- ----------------------------
John A. Hackett
/s/ Richard M. Kazanjian Director September 11, 2002
- ----------------------------
Richard M. Kazanjian
/s/ John W. Maloney Director September 11, 2002
- ----------------------------
John W. Maloney
/s/ John J. McGlynn Director, Chairman of the September 11, 2002
- ---------------------------- Board
John J. McGlynn
/s/ Lorraine P. Silva Director September 11, 2002
- ----------------------------
Lorraine P. Silva
48
CERTIFICATIONS
I, Ralph W. Dunham, certify that:
1. I have reviewed this annual report on Form 10-K of Mystic Financial,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
Date: September 11, 2002 /s/ Ralph W. Dunham
-------------------
Ralph W. Dunham
President and Chief Executive Officer
49
I, Anthony J. Patti, certify that:
1. I have reviewed this annual report on Form 10-K of Mystic Financial,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
Date: September 11, 2002 /s/ Anthony J. Patti
--------------------
Anthony J. Patti
Senior vice President, Chief
Financial Officer and Treasurer
50
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report F-2
Consolidated Balance Sheets as of June 30, 2002 and 2001 F-3
Consolidated Statements of Income for each of the years
in the three-year period ended June 30, 2002 F-4
Consolidated Statements of Changes in Stockholders' Equity
for each of the years in the three-year period ended
June 30, 2002 F-5
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended June 30, 2002 F-6
Notes to Consolidated Financial Statements F-8
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of Mystic Financial, Inc.
We have audited the consolidated balance sheets of Mystic Financial, Inc.
and subsidiaries as of June 30, 2002 and 2001, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for
each of the years in the three-year period ended June 30, 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 auditing standards generally
accepted in the United States of America. 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 Mystic
Financial, Inc. and subsidiaries as of June 30, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 2002 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
July 18, 2002
F-2
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
----------------------
2002 2001
---- ----
(Dollars In Thousands)
Cash and due from banks $ 18,155 $ 10,459
Federal funds sold 10,653 18,992
Short-term investments 5,804 16,678
-------- --------
Total cash and cash equivalents 34,612 46,129
Securities available for sale, at fair value 65,900 28,820
Federal Home Loan Bank stock, at cost 2,932 2,532
Mortgage loans held for sale 1,231 274
Loans, net of allowance for loan losses of $2,063 and
$1,784, respectively 243,743 215,035
Banking premises and equipment, net 2,885 2,493
Real estate held for investment, net 1,586 1,649
Accrued interest receivable 1,784 1,410
Due from Co-operative Central Bank 929 929
Other assets 1,131 1,131
-------- --------
$356,733 $300,402
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $267,438 $224,750
Federal Home Loan Bank borrowings 58,135 44,618
Subordinated debt 5,000 -
Mortgagors' escrow accounts 792 756
Accrued interest payable 611 558
Accrued expenses and other liabilities 834 705
-------- --------
Total liabilities 332,810 271,387
-------- --------
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000
shares authorized; none issued - -
Common stock, $.01 par value, 5,000,000
shares authorized; 2,719,125 and 2,716,125
shares issued, respectively 27 27
Additional paid-in capital 25,699 25,643
Retained earnings 17,099 15,956
Treasury stock, at cost - 1,253,322 shares and
820,041 shares, respectively (17,124) (10,055)
Accumulated other comprehensive income 350 118
Unearned ESOP shares (1,622) (1,967)
Unearned RRP shares (506) (707)
-------- --------
Total stockholders' equity 23,923 29,015
-------- --------
$356,733 $300,402
======== ========
See accompanying notes to consolidated financial statements.
F-3
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars In Thousands, Except Per Share Data)
Interest and dividend income:
Interest and fees on loans $ 16,972 $ 16,597 $ 13,699
Interest and dividends on securities 2,405 1,785 1,822
Other interest 491 1,040 656
---------- ---------- ----------
Total interest and dividend income 19,868 19,422 16,177
---------- ---------- ----------
Interest expense:
Deposits 7,313 7,196 5,519
Federal Home Loan Bank borrowings 2,789 2,771 1,927
Subordinated debt 69 - -
---------- ---------- ----------
Total interest expense 10,171 9,967 7,446
---------- ---------- ----------
Net interest income 9,697 9,455 8,731
Provision for loan losses 305 275 200
---------- ---------- ----------
Net interest income, after provision for loan
losses 9,392 9,180 8,531
---------- ---------- ----------
Other income:
Customer service fees 890 809 684
Gain on sales of securities available for
sale, net 45 174 128
Miscellaneous 202 213 133
---------- ---------- ----------
Total other income 1,137 1,196 945
---------- ---------- ----------
Operating expenses:
Salaries and employee benefits 4,680 5,437 4,106
Occupancy and equipment expenses 1,001 907 752
Data processing expenses 335 345 296
Other general and administrative expenses 1,855 1,781 1,561
---------- ---------- ----------
Total operating expenses 7,871 8,470 6,715
---------- ---------- ----------
Income before income taxes 2,658 1,906 2,761
Provision for income taxes 1,031 721 1,072
---------- ---------- ----------
Net income $ 1,627 $ 1,185 $ 1,689
========== ========== ==========
Earnings per share - basic $ 1.11 $ 0.68 $ 0.83
========== ========== ==========
Weighted average shares outstanding - basic 1,462,309 1,731,874 2,024,201
========== ========== ==========
Earnings per share - diluted $ 1.08 $ 0.67 $ 0.83
========== ========== ==========
Weighted average shares outstanding - diluted 1,504,249 1,767,902 2,024,201
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-4
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended June 30, 2002, 2001 and 2000
Accumulated
Additional Other Unearned Unearned Total
Common Paid-In Retained Treasury Comprehensive ESOP RRP Stockholders'
Stock Capital Earnings Stock Income (Loss) Shares Shares Equity
------ ---------- -------- -------- ------------- -------- -------- -------------
(Dollars In Thousands)
Balance at June 30, 1999 $27 $25,688 $14,128 $ (3,485) $ 394 $(2,700) $ - $34,052
-------
Comprehensive income:
Net income - - 1,689 - - - - 1,689
Change in net unrealized
gains/losses on securities
available for sale, net of
reclassification adjustment
and tax effects - - - - (449) - - (449)
-------
Total comprehensive income 1,240
-------
Cash dividends paid ($0.26 per
share) - - (522) - - - - (522)
Purchase of treasury stock
(436,180 shares) - - - (4,939) - - - (4,939)
Decrease in unearned ESOP
shares - (87) - - - 376 - 289
Purchase of RRP shares - - - - - - (1,295) (1,295)
Decrease in unearned RRP shares - - - - - - 364 364
--- ------- ------- -------- ----- ------- ------- -------
Balance at June 30, 2000 27 25,601 15,295 (8,424) (55) (2,324) (931) 29,189
-------
Comprehensive income:
Net income - - 1,185 - - - - 1,185
Change in net unrealized
gains/losses on securities
available for sale, net of
reclassification adjustment
and tax effects - - - - 173 - - 173
-------
Total comprehensive income 1,358
-------
Cash dividends paid ($0.31
per share) - - (524) - - - - (524)
Purchase of treasury stock
(117,614 shares) - - - (1,631) - - - (1,631)
Stock options exercised
(5,000 shares) - 60 - - - - - 60
Decrease in unearned ESOP shares - (18) - - - 357 - 339
Decrease in unearned RRP shares - - - - - - 224 224
--- ------- ------- -------- ----- ------- ------- -------
Balance at June 30, 2001 27 25,643 15,956 (10,055) 118 (1,967) (707) 29,015
-------
Comprehensive income:
Net income - - 1,627 - - - - 1,627
Change in net unrealized
gains/losses on securities
available for sale, net of
reclassification adjustment
and tax effects - - - - 232 - - 232
-------
Total comprehensive income 1,859
-------
Cash dividends paid ($0.33
per share) - - (484) - - - - (484)
Purchase of treasury stock
(433,281 shares) - - - (7,069) - - - (7,069)
Stock options exercised
(3,000 shares) - 36 - - - - - 36
Decrease in unearned ESOP shares - 20 - - - 345 - 365
Decrease in unearned RRP shares - - - - - - 201 201
--- ------- ------- -------- ----- ------- ------- -------
Balance at June 30, 2002 $27 $25,699 $17,099 $(17,124) $ 350 $(1,622) $ (506) $23,923
=== ======= ======= ======== ===== ======= ======= =======
See accompanying notes to consolidated financial statements.
F-5
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
------------------------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Cash flows from operating activities:
Net income $ 1,627 $ 1,185 $ 1,689
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 305 275 200
Net amortization (accretion) of securities 164 (51) (29)
Amortization of unearned ESOP shares 365 339 289
Amortization of unearned RRP stock 201 224 364
Gain on sales of securities available for sale, net (45) (174) (128)
Depreciation and amortization expense 386 418 375
Deferred income tax benefit (247) (75) (82)
Net change in:
Loans held for sale (957) 269 (137)
Accrued interest receivable (374) (86) (59)
Other assets 71 58 (646)
Accrued interest payable 53 77 147
Accrued expenses and other liabilities 129 44 466
-------- -------- --------
Net cash provided by operating activities 1,678 2,503 2,449
-------- -------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales 1,967 20,388 9,888
Maturities, prepayments and calls 11,637 14,769 331
Purchases (50,395) (31,048) (11,432)
Maturities, prepayments and calls of held to maturity
securities - - 1,500
Purchase of Federal Home Loan Bank stock (400) (94) (1,358)
Loans originated, net of payments received (29,013) (26,110) (34,711)
Purchases of banking premises and equipment (715) (45) (466)
Additions to real estate held for investment - (37) -
-------- -------- --------
Net cash used by investing activities (66,919) (22,177) (36,248)
-------- -------- --------
(continued)
See accompanying notes to consolidated financial statements.
F-6
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
Years Ended June 30,
------------------------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Cash flows from financing activities:
Net increase in deposits 42,688 30,615 33,268
Proceeds from borrowings 22,500 17,900 35,200
Repayment of borrowings (8,983) (12,032) (15,428)
Proceeds from issuance of subordinated debt 5,000 - -
Net increase in mortgagors' escrow accounts 36 84 125
Purchase of treasury stock (7,069) (1,631) (4,939)
Proceeds from exercise of stock options 36 60 -
Purchase of RRP shares - - (1,295)
Cash dividends paid (484) (524) (522)
-------- -------- --------
Net cash provided by financing activities 53,724 34,472 46,409
-------- -------- --------
Net change in cash and cash equivalents (11,517) 14,798 12,610
Cash and cash equivalents at beginning of year 46,129 31,331 18,721
-------- -------- --------
Cash and cash equivalents at end of year $ 34,612 $ 46,129 $ 31,331
======== ======== ========
Supplemental information:
Interest paid $ 10,118 $ 9,890 $ 7,299
Income taxes paid, net 962 969 1,215
See accompanying notes to consolidated financial statements.
F-7
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended June 30, 2002, 2001 and 2000
l. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and business
The consolidated financial statements include the accounts of Mystic
Financial, Inc. (the "Company") and its wholly-owned subsidiary, Medford
Co-operative Bank (the "Bank") and Mystic Financial Capital Trust I (the
"Trust"). The Bank has two wholly-owned subsidiaries, Mystic Securities
Corp., which engages in the purchase and sale of securities and Mystic
Investment Inc. which is inactive. The Trust was formed in April 2002 for
the purpose of issuing trust preferred securities and investing the
proceeds of the sale of these securities in subordinated debentures issued
by the Company. Mystic Financial, Inc. became the Bank's holding company on
January 8, 1998 in connection with the Bank's conversion from mutual to
stock form. Effective May 25, 2000, the Company changed its classification
from a bank holding company to a financial holding company. All significant
intercompany accounts have been eliminated in consolidation.
The Bank provides a variety of financial services to individuals and
businesses through its six offices in Medford, Arlington, Lexington, and
Bedford, Massachusetts. Its primary deposit products are checking, savings
and term certificate accounts, and its primary lending products are
residential and commercial mortgage, commercial and consumer loans.
Use of estimates
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the balance sheet date and
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that
are particularly susceptible to significant change in the near term relate
to the determination of the allowance for loan losses.
Cash equivalents
Cash equivalents include amounts due from banks, federal funds sold and
short-term investments with original maturities of three months or less.
Short-term investments
Short-term investments are carried at cost, which approximates fair value,
and consist of money market funds and interest-bearing deposits in the Bank
Investment Fund-Liquidity Fund.
F-8
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Restrictions on cash and amounts due from banks
The Company is required to maintain average balances on hand or with the
Federal Reserve Bank. At June 30, 2002 and 2001, these reserve balances
amounted to $1,747,000 and $1,500,000, respectively.
Securities
Debt securities that management has the positive intent and ability to hold
to maturity are classified as "held to maturity" and recorded at amortized
cost. Securities not classified as held to maturity or trading, including
equity securities with readily determinable fair values, are classified as
"available for sale" and recorded at fair value, with unrealized gains and
losses excluded from earnings and reported in other comprehensive
income/loss.
Purchase premiums and discounts are recognized in interest income by the
interest method over the terms of the securities. Declines in the fair
value of securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses. Gains and losses on
the sale of securities are recorded on the trade date using the specific
identification method.
Mortgage loans held for sale
Loans originated and intended for sale in the secondary market are carried
at the lower of cost or estimated fair value in the aggregate. Fair value
is based on commitments on hand from investors or prevailing market prices.
Net unrealized losses, if any, are recognized through a valuation allowance
by charges to income.
Loans
The Bank grants mortgage, commercial and consumer loans to customers. A
substantial portion of the loan portfolio consists of mortgage loans in the
Greater Boston area. The ability of the Bank's debtors to honor their
contracts is dependent upon the local real estate market and economy in
this area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are reported at
their outstanding unpaid principal balances adjusted for charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated
loans. Interest income is accrued on the unpaid principal balance. Loan
origination fees, net of certain direct origination costs, are deferred and
recognized as an adjustment of the related loan yield using the interest
method.
The accrual of interest on loans is discontinued at the time the loan is
over 90 days delinquent. Loans are placed on nonaccrual or charged-off at
an earlier date if collection of principal or interest is considered
doubtful.
F-9
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loans (concluded)
All interest accrued but not collected for loans that are placed on
nonaccrual or charged off is reversed against interest income. The interest
on these loans is accounted for on the cash-basis or cost-recovery method,
until qualifying for return to accrual. Loans are returned to accrual
status when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured.
A loan is considered impaired when, based on current information and
events, it is probable that a creditor will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Impaired loans are generally
maintained on a non-accrual basis. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Impairment is measured
on a loan by loan basis by the fair value of the existing collateral.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Bank does not separately
identify individual consumer loans for impairment disclosures.
Allowance for loan losses
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of the loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.
F-10
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for loan losses (concluded)
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the collateral value of the
impaired loan is lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. An unallocated component is
maintained to cover uncertainties that could affect management's estimate
of probable losses. The unallocated component of the allowance reflects the
margin if imprecision inherent in the underlying assumptions used in the
methodologies for estimating losses in the portfolio.
Banking premises and equipment and real estate held for investment
Land is carried at cost. Buildings, improvements, leasehold improvements
and equipment are stated at cost, less accumulated depreciation and
amortization, computed on the straight-line method over the estimated
useful lives of the assets, or the terms of the leases, if shorter.
Pension plan
It is the Company's policy to fund pension plan costs in the year of
accrual.
Transfers of financial assets
Transfers of financial assets are accounted for as sales, when control over
the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when (1) the assets have been isolated from the Bank, (2)
the transferee obtains the right (free of conditions that constrain it from
taking advantage of that right) to pledge or exchange the transferred
assets, and (3) the Bank does not maintain effective control over the
transferred assets through an agreement to repurchase them before their
maturity.
F-11
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Income taxes
Deferred tax assets and liabilities are reflected at currently enacted
income tax rates applicable to the period in which the deferred tax assets
or liabilities are expected to be realized or settled. As changes in tax
laws or rates are enacted, deferred tax assets and liabilities are adjusted
accordingly through the provision for income taxes. The Bank's base amount
of its federal income tax reserve for loan losses is a permanent difference
for which there is no recognition of a deferred tax liability. However, the
loan loss allowance maintained for financial reporting purposes is a
temporary difference with allowable recognition of a related deferred tax
asset, if it is deemed realizable.
F-12
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Employee stock ownership plan ("ESOP")
Compensation expense is recognized based on the current market price of
shares committed to be released to employees. All shares released and
committed to be released are deemed outstanding for purposes of earnings
per share calculations. Dividends declared on all allocated shares held by
the ESOP are charged to retained earnings. The value of unearned shares to
be allocated to ESOP participants for future services not yet performed is
reflected as a reduction of stockholders' equity.
Stock compensation plans
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation," encourages all entities to adopt a fair
value based method of accounting for employee stock compensation plans,
whereby compensation cost is measured at the grant date based on the value
of the award and is recognized over the service period, which is usually
the vesting period. However, it also allows an entity to continue to
measure compensation cost for those plans using the intrinsic value based
method of accounting prescribed by Accounting Principles Board ("APB") No.
25, "Accounting for Stock Issued to Employees," whereby compensation cost
is the excess, if any, of the quoted market price of the stock at the grant
date (or other measurement date) over the amount an employee must pay to
acquire the stock. Stock options issued under the Company's stock option
plan have no intrinsic value at the grant date, and under APB No. 25 no
compensation cost is recognized for them. The Company has elected to
continue with the accounting methodology in APB No. 25 and, as result, has
provided pro forma disclosures of net income and earnings per share and
other disclosures, as if the fair value based method of accounting had been
applied. (See note 13.)
Advertising costs
Advertising costs are expensed as incurred.
Earnings per common share
Basic earnings per share represents income available to common stock
divided by the weighted-average number of common shares outstanding during
the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential common shares had
been issued, as well as any adjustment to income that would result from the
assumed conversion. Potential common shares that may be issued by the
Company relate solely to outstanding stock options and unearned RRP shares,
and are determined using the treasury stock method.
F-13
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Comprehensive income/loss
Accounting principles generally require that recognized revenue, expenses,
gains and losses be included in net income. Although certain changes in
assets and liabilities, such as unrealized gains and losses on available-
for-sale securities, are reported as a separate component of the equity
section of the consolidated balance sheet, such items, along with net
income, are components of comprehensive income/loss.
The components of other comprehensive income/loss and related tax effects
are as follows:
Years Ended June 30,
----------------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Change in unrealized holding gains/losses
on available-for-sale securities $ 453 $ 427 $(562)
Reclassification adjustment for gains
realized in income (45) (174) (128)
----- ----- -----
Change in net unrealized gains/losses 408 253 (690)
Tax effect (176) (80) 241
----- ----- -----
Net-of-tax amount $ 232 $ 173 $(449)
===== ===== =====
Segments
The Company, through the branch network of its subsidiary, Medford Co-
operative Bank, provides a broad range of financial services to individuals
and businesses. These services include checking, savings and term
certificate deposits; lending; credit card servicing; and ATM processing
services. While the Company's chief decision-makers monitor the revenue
streams of the various Company products and services, operations are
managed and financial performance is evaluated on a Company-wide basis.
Accordingly, all of the Company's banking operations are considered by
management to be aggregated in one reportable operating segment.
F-14
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SECURITIES AVAILABLE FOR SALE
The amortized cost and estimated fair value of securities with gross
unrealized gains and losses is as follows:
June 30, 2002
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In Thousands)
U.S. Government and
federal agency obligations $25,198 $ 319 $ - $25,517
Mortgage-backed securities 28,759 360 (7) 29,112
Other bonds and obligations 8,668 153 (136) 8,685
Marketable equity securities 2,698 250 (362) 2,586
------- ------ ----- -------
Total $65,323 $1,082 $(505) $65,900
======= ====== ===== =======
F-15
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES AVAILABLE FOR SALE (concluded)
June 30, 2001
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In Thousands)
U.S. Government and
federal agency obligations $ 9,498 $ 14 $ (7) $ 9,505
Mortgage-backed securities 10,389 4 (104) 10,289
Other bonds and obligations 5,542 30 (83) 5,489
Marketable equity securities 3,222 604 (289) 3,537
------- ---- ----- -------
Total $28,651 $652 $(483) $28,820
======= ==== ===== =======
The amortized cost and estimated fair value of debt securities by
contractual maturity at June 30, 2002 is shown below. Expected maturities
will differ from contractual maturities because issuers may have the right
to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
--------- -----
(In Thousands)
Within 1 year $ 6,100 $ 6,186
Over 1 year to 5 years 26,281 26,667
Over 5 years 1,485 1,349
------- -------
33,866 34,202
Mortgage-backed securities 28,759 29,112
------- -------
Total $62,625 $63,314
======= =======
During the years ended June 30, 2002, 2001 and 2000, proceeds from sales of
securities available for sale amounted to $1,967,000, $20,388,000 and
$9,888,000, respectively. Gross realized gains for 2002, 2001 and 2000
amounted to $457,000, $637,000 and $420,000, respectively, and gross
realized losses were $412,000, $463,000 and $292,000, respectively.
F-16
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. LOANS
A summary of the balances of loans follows:
June 30,
----------------------
2002 2001
---- ----
(In Thousands)
Mortgage loans on real estate:
Fixed residential $ 81,423 $ 71,729
Adjustable residential 72,492 66,434
Commercial 58,889 50,483
Construction 11,015 9,282
Home equity lines of credit 4,965 3,880
-------- --------
228,784 201,808
Other loans:
Commercial 8,051 6,792
Commercial lines of credit 8,164 6,722
Personal 1,004 1,532
-------- --------
17,219 15,046
-------- --------
Total loans 246,003 216,854
Net deferred loan fees (197) (35)
Allowance for loan losses (2,063) (1,784)
-------- --------
Loans, net $243,743 $215,035
======== ========
An analysis of the allowance for loan losses follows
Years Ended June 30,
------------------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Balance at beginning of year $1,784 $1,531 $1,348
Provision for loan losses 305 275 200
Recoveries 4 5 6
Charge-offs (30) (27) (23)
------ ------ ------
Balance at end of year $2,063 $1,784 $1,531
====== ====== ======
F-17
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (concluded)
At June 30, 2002 and 2001, the recorded investment in impaired loans
amounted to $103,000 and $15,000, respectively, none of which related to
loans with a corresponding valuation allowance. No additional funds are
committed to be advanced in connection with impaired loans. The average
investment in impaired loans for the years ended June 30, 2002, 2001, and
2000 amounted to $28,000, $19,000 and $36,000, respectively, and interest
income recognized on a cash basis on impaired loans amounted to $1,000, $0
and $5,000, respectively. Non-accrual loans amounted to $108,000 and
$15,000 at June 30, 2002 and 2001, respectively.
On a fee basis, the Bank services loans it has originated and sold to
others. At June 30, 2002 and 2001, such loans amounted to $23,873,000 and
$23,749,000, respectively. All loans serviced for others were sold without
recourse provisions.
4. BANKING PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization of
banking premises and equipment is as follows:
June 30,
---------------------
2002 2001
---- ----
(In Thousands)
Banking premises:
Land $ 242 $ 242
Buildings and improvements 2,452 2,447
Leasehold improvements 564 305
Equipment 2,687 2,236
------- -------
5,945 5,230
Less accumulated depreciation and amortization (3,060) (2,737)
------- -------
$ 2,885 $ 2,493
======= =======
Depreciation and amortization expense for the years ended June 30, 2002,
2001 and 2000 amounted to $323,000, $357,000 and $318,000, respectively.
F-18
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. REAL ESTATE HELD FOR INVESTMENT
Real estate held for investment represents property adjacent to the Bank's
main office which is primarily leased as commercial retail and office
space. The Bank occupies a portion of the building for its own activities.
A summary of the cost and accumulated depreciation is as follows:
June 30,
-----------------
2002 2001
---- ----
(In Thousands)
Land $ 34 $ 34
Building 2,266 2,266
------ ------
2,300 2,300
Less accumulated depreciation (714) (651)
------ ------
$1,586 $1,649
====== ======
Depreciation expense for the years ended June 30, 2002, 2001 and 2000
amounted to $63,000, $61,000 and $57,000, respectively.
The following is a schedule of minimum future rental income on
noncancelable leases:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
2003 $ 84
2004 56
2005 28
2006 5
----
$173
====
The provisions of the lease agreements provide that the tenants are
responsible for utilities and certain repairs. Certain of the leases also
contain provisions that the tenants are responsible for a percentage of
real estate taxes and certain other costs.
Rental income for the years ended June 30, 2002, 2001 and 2000 amounted to
$136,000, $124,000 and $134,000, respectively.
F-19
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. DEPOSITS
A summary of deposit balances by type is as follows:
June 30,
----------------------
2002 2001
---- ----
(In Thousands)
NOW accounts $ 26,971 $ 22,342
IOLTA accounts 22,397 16,202
Demand deposits 19,856 18,889
Regular and other deposits 52,762 44,302
Money market deposits 21,466 18,591
-------- --------
Total non-certificate accounts 143,452 120,326
-------- --------
Term certificates less than $100,000 72,875 69,040
Term certificates of $100,000 or more 51,111 35,384
-------- --------
Total certificate accounts 123,986 104,424
-------- --------
Total deposits $267,438 $224,750
======== ========
A summary of certificate accounts, by maturity, is as follows:
June 30, 2002 June 30, 2001
------------------- --------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ -------- ------ --------
(Dollars In Thousands)
Within 1 year $ 63,938 3.97% $ 77,955 5.42%
Over 1 year to 3 years 53,669 3.98 23,234 5.84
Over 3 years to 5 years 6,379 5.79 3,235 6.09
-------- --------
$123,986 4.07% $104,424 5.53%
======== ========
F-20
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. FEDERAL HOME LOAN BANK BORROWINGS
Federal Home Loan Bank borrowings consist of the following at June 30, 2002
and 2001:
Amount Weighted Average Rate
-------------------- ---------------------
Maturity 2002 2001 2002 2001
-------- ---- ---- ---- ----
(In Thousands)
Year Ending June 30,
- --------------------
2002 $ - $ 2,950 - % 6.31%
2003 11,500 4,000 3.55 6.07
2004 10,600 5,600 4.71 5.80
2005 (1) 12,400 12,400 6.83 6.83
2006 600 600 6.05 6.05
2007 (2) 7,000 3,000 5.37 6.16
Thereafter (3) 15,200 15,200 4.94 4.94
Amortizing advance, due on
August 14, 2006, requiring
monthly payments of $7,793
including interest 835 868 6.97 6.97
------- -------
$58,135 $44,618 5.12% 6.15%
======= =======
Includes advances aggregating $6,000,000, callable on September 3,
2002.
Includes advances aggregating $3,000,00, callable on July 24, 2002.
Includes advances aggregating $2,000,000, $2,000,000, $5,000,000,
$3,000,000, $1,200,000 and $2,000,000, callable on July 25, 2002,
August 9, 2002, August 12, 2002, September 20, 2002, February 11,
2003, and April 8, 2003, respectively.
The following is a summary of maturities of borrowings at June 30, 2002:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
2003 $11,532
2004 10,638
2005 12,441
2006 644
2007 7,680
Thereafter 15,200
-------
$58,135
=======
F-21
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FEDERAL HOME LOAN BANK BORROWINGS (concluded)
The Bank also has an available line of credit of $3,529,000 with the
Federal Home Loan Bank of Boston ("FHLB") at an interest rate that adjusts
daily. Borrowings under the line are limited to 2% of the Bank's total
assets. All borrowings from the Federal Home Loan Bank of Boston are
secured by a blanket lien on qualified collateral, defined principally as
75% of the carrying value of first mortgage loans on owner-occupied
residential property.
8. TRUST PREFERRED SECURITIES
During the fourth quarter of 2002, Mystic Financial Capital Trust I was
formed for the purpose of issuing Trust Preferred Securities and investing
the proceeds of the sale of these securities in subordinated debentures
issued by the Company. A total of $5 million of floating rate Trust
Preferred Securities were issued and are scheduled to mature in 2032,
callable at the option of the Company on April 22, 2007, with the prior
approval of the Federal Reserve Board. The floating rate as of June 30,
2002 was 6.02%. Distributions on these securities are payable semi-annually
in arrears on April 22nd and October 22nd. The Trust Preferred Securities are
presented in the accompanying consolidated financial statements of the
Company as subordinated debt. The Company records distributions payable on
the Trust Preferred Securities as interest on subordinated debt in its
consolidated statements of income.
9. INCOME TAXES
Allocation of federal and state income taxes between current and deferred
portions is as follows:
Years Ended June 30,
----------------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Current tax provision:
Federal $ 967 $635 $ 870
State 311 161 284
------ ---- ------
Total current 1,278 796 1,154
------ ---- ------
Deferred tax benefit:
Federal (189) (55) (61)
State (58) (20) (21)
------ ---- ------
Total deferred (247) (75) (82)
------ ---- ------
Total provision $1,031 $721 $1,072
====== ==== ======
F-22
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (continued)
The reasons for the differences between the statutory federal income tax
rate and the effective tax rates are summarized as follows:
Years Ended June 30,
--------------------------
2002 2001 2000
---- ---- ----
Statutory rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 6.3 4.9 6.3
Other, net (1.5) (1.1) (1.5)
---- ---- ----
Effective tax rates 38.8% 37.8% 38.8%
==== ==== ====
F-23
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (continued)
The components of the net deferred tax asset included in other assets are
as follows:
June 30,
------------------
2002 2001
---- ----
(In Thousands)
Deferred tax asset:
Federal $ 793 $ 622
State 267 215
------ ------
1,060 837
Valuation reserve on asset (24) (24)
------ ------
1,036 813
------ ------
Deferred tax liability:
Federal (236) (112)
State (73) (45)
------ ------
(309) (157)
------ ------
Net deferred tax asset $ 727 $ 656
====== ======
The tax effects of each type of income and expense item that give rise to
deferred taxes are as follows:
June 30,
------------------
2002 2001
---- ----
(In Thousands)
Allowance for loan losses $845 $730
Net unrealized gain/loss on
securities available for sale (227) (51)
Other 133 1
---- ----
751 680
Valuation reserve (24) (24)
---- ----
Net deferred tax asset $727 $656
==== ====
F-24
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
A summary of the change in the net deferred tax asset is as follows:
Years Ended June 30,
------------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Balance at beginning of year $656 $661 $338
Deferred tax benefit 247 75 82
Deferred tax on net unrealized gain/loss on
securities available for sale (176) (80) 241
---- ---- ----
Balance at end of year $727 $656 $661
==== ==== ====
There was no change in the valuation reserve during the years ended June
30, 2002, 2001 and 2000.
The federal income tax reserve for loan losses at the Bank's base year
amounted to $2,663,000. If any portion of the reserve is used for purposes
other than to absorb the losses for which established, approximately 150%
of the amount actually used (limited to the amount of the reserve) would be
subject to taxation in the fiscal year in which used. As the Bank intends
to use the reserve only to absorb loan losses, a deferred income tax
liability of $1,090,000 has not been provided.
10. COMMITMENTS AND CONTINGENCIES
Loan commitments
The Bank is a 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 commitments to extend credit and
advance funds under lines of credit and credit card loans. These
instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the accompanying
consolidated financial statements.
F-25
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
COMMITMENTS AND CONTINGENCIES (continued)
Loan commitments (concluded)
The Bank's exposure to credit loss is represented by the contractual amount
of these instruments. The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments. A summary of
financial instruments outstanding whose contract amounts represent credit
risk is as follows:
June 30,
------------------
2002 2001
---- ----
(In Thousands)
Commitments to grant mortgage loans $5,246 $4,373
Commitments to grant commercial loans 7,570 615
Unadvanced funds on home equity lines of credit 5,717 4,284
Unadvanced funds on credit card loans 1,510 2,047
Unadvanced funds on commercial lines of credit 9,299 9,634
Unadvanced funds on construction loans 9,976 9,593
Standby letters of credit 526 412
Commitments to extend credit are agreements to lend to a customer as long
as 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. The commitments for lines of
credit and credit card loans may expire without being drawn upon;
therefore, the total commitment amounts do not necessarily represent future
cash requirements. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The commitments for mortgage loans and home equity
lines of credit are collateralized by real estate. Commercial loans and
lines of credit are secured by various assets of the borrowers. Credit card
loans are generally unsecured.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those letters of
credit are primarily issued to support public and private borrowing
arrangements. Letters of credit outstanding as of June 30, 2002 have
expiration dates within ten years. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending
loan facilities to customers. The Bank generally holds collateral
supporting those commitments if deemed necessary.
Employment agreements
The Company and the Bank have entered into employment agreements with
certain executive officers. The agreements provide for base salaries,
participation in employee benefit plans and, in the event of termination of
employment, certain lump-sum severance payments and continuation of
benefits. However, such employment may be terminated for cause, as defined
in the agreements, without incurring any continuing obligations.
F-26
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
COMMITMENTS AND CONTINGENCIES (continued)
Employment agreements (concluded)
Effective April 9, 2001, the then President retired and received the
benefits due him under his employment agreement, as amended. During the
years ended June 30, 2002, 2001 and 2000, compensation expense under these
agreements amounted to $0, $861,000 and $7,000, respectively.
Director's retirement plan
Effective November 8, 2000, the Company adopted a retirement plan for non-
employee Directors of the Company. Under the Plan, eligible directors will
receive a lump sum benefit equal to three times their annual compensation
(as defined), upon retirement from the Board of Directors, death,
disability or upon a change of control (as defined). The liability for the
benefits is being accrued over the terms of active service for the
Directors. Total expense under this Plan amounted to $34,000 and $17,000
for the years ended June 30, 2002 and 2001, respectively.
Severance pay plan
Effective November 8, 2000, the Bank established a severance pay plan which
entitles eligible employees to receive a lump sum benefit equal to one
month's salary in the event of a change of control (as defined).
Lease commitments
Pursuant to the terms of the noncancelable lease agreements in effect at
June 30, 2002, the future minimum rent commitments for leased premises are
as follows:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
2003 $ 385
2004 385
2005 328
2006 246
2007 246
Thereafter 703
------
Total $2,293
======
The leases contain certain options to extend for two to four five-year
periods and contain provisions for reimbursement of real estate taxes and
certain other costs. The costs of such rentals and reimbursements are not
included above. Rent expense for the years ended June 30, 2002, 2001 and
2000 amounted to $333,000, $260,000 and $191,000, respectively.
F-27
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
COMMITMENTS AND CONTINGENCIES (concluded)
Contingencies
Various legal claims arise from time to time in the normal course of
business which, in the opinion of management, will have no material effect
on the Company's consolidated financial position or results of operations.
11. STOCKHOLDERS' EQUITY
Stock conversion
At the time of the stock conversion in 1998, the Bank established a
liquidation account in the amount of $11,761,000. In accordance with
Massachusetts statute, the liquidation account will be maintained for the
benefit of eligible account holders who continue to maintain their accounts
in the Bank after the conversion. The liquidation account will be reduced
annually to the extent that eligible account holders have reduced their
qualifying deposits. Subsequent increases will not restore an eligible
account holder's interest in the liquidation account. In the event of a
complete liquidation, each eligible account holder will be entitled to
receive a distribution in an amount equal to their current adjusted
liquidation account balance, to the extent that funds are available.
Minimum regulatory capital requirements
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that,
if undertaken, could have a direct material effect on the Company's and the
Bank's consolidated financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Company and
the Bank must meet specific capital guidelines that involve quantitative
measures of their assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors. Prompt
corrective action provisions are not applicable to financial holding
companies.
F-28
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (concluded)
Minimum regulatory capital requirements (concluded)
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the following tables) of total and Tier I capital (as defined
in the regulations) to risk weighted assets (as defined) and of Tier I
capital (as defined) to average assets (as defined). Management believes,
as of June 30, 2002 and 2001, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
As of June 30, 2002, the most recent notification from the Federal Deposit
Insurance Corporation 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 total risk-based, Tier I
risk-based and Tier I leverage ratios as set forth in the following table.
There are no conditions or events that management believes have changed the
Bank's category. The Company's and the Bank's actual capital amounts and
ratios are also presented in the table.
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
---------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars In Thousands)
June 30, 2002:
Total Capital to Risk Weighted Assets
Consolidated $30,522 14.9% $16,114 8.0% N/A N/A
Bank 25,790 12.9 16,006 8.0 $20,007 10.0%
Tier I Capital to Risk Weighted Assets
Consolidated 28,461 13.9 8,057 4.0 N/A N/A
Bank 23,727 11.9 8,003 4.0 12,004 6.0
Tier I Capital to Average Assets
Consolidated 28,461 8.7 13,096 4.0 N/A N/A
Bank 23,727 7.4 12,908 4.0 16,135 5.0
June 30,2001:
Total Capital to Risk Weighted Assets
Consolidated $30,799 17.5% $14,106 8.0% N/A N/A
Bank 29,401 16.7 14,069 8.0 $17,586 10.0%
Tier I Capital to Risk Weighted Assets
Consolidated 28,897 16.4 7,053 4.0 N/A N/A
Bank 27,499 15.6 7,034 4.0 10,551 6.0
Tier I Capital to Average Assets
Consolidated 28,897 10.1 11,426 4.0 N/A N/A
Bank 27,499 9.7 11,365 4.0 14,206 5.0
F-29
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. RELATED PARTY TRANSACTIONS
At June 30, 2002 and 2001, total loans to directors and officers of the
Bank greater than $60,000 on an individual basis amounted to $3,615,000 and
$2,434,000, respectively. During the years ended June 30, 2002 and 2001,
total principal additions were $1,611,000 and $264,000, respectively, and
total principal payments were $430,000 and $505,000, respectively.
13. EMPLOYEE BENEFIT PLANS
Pension plans
The Bank provides pension benefits for its employees through membership in
Plan C of the Defined Benefit Plan of the Co-operative Banks Employees
Retirement Association ("CBERA"). The plan is a multi-employer plan where
the contributions by each bank are not restricted to provide benefits to
the employees of the contributing bank. Each employee reaching the age of
21 and having completed 1,000 hours of service in one consecutive twelve-
month period beginning with such employee's date of employment
automatically becomes a participant in the retirement plan. A participant
in the plan is not vested until they have performed two years of service,
at which time they become 20% vested. Participants become 100% vested when
credited with six years of service.
Total pension expense for the years ended June 30, 2002, 2001 and 2000
amounted to $127,000, $137,000 and $110,000, respectively.
In addition, the Bank has a savings and retirement plan, which qualifies
under Section 401(k) of the Internal Revenue Code, for its employees
through membership in Plan A of the Defined Benefit Plan of CBERA. Each
employee reaching the age of 21 and having completed 1,000 hours of service
in one consecutive twelve-month period beginning with such employee's date
of employment automatically becomes a participant in the savings and
retirement plan. The plan provides for voluntary contributions by
participating employees ranging from one percent to twelve percent of their
compensation, subject to certain limitations. The Bank matches 50% of an
employee's voluntary contribution up to ten percent of the employee's
compensation.
Total expense under the Section 401(k) plan for the years ended June 30,
2002, 2001 and 2000 amounted to $72,000, $69,000 and $54,000, respectively.
Employee stock ownership plan
Effective January 8, 1998, the Company established and the Bank adopted an
ESOP, for the benefit of eligible employees who have attained age 21 and
have completed one year of service.
F-30
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Employee stock ownership plan (concluded)
The Company loaned the ESOP $3,194,000 to fund the purchase of 216,890
shares of common stock of the Company in open-market purchases following
completion of the Bank's conversion from mutual to stock form. The Bank
intends to make annual contributions to the ESOP in an aggregate amount at
least equal to the principal and interest requirements on the loan. The
loan is for a term of 10 years, bears interest at 8% per annum and requires
annual principal payments of $319,000 plus interest.
Shares purchased by the ESOP are pledged as collateral for the loan, and
are held in a suspense account until released for allocation among
participants in the ESOP as the loan is repaid. The pledged shares are
released annually from the suspense account in an amount proportional to
the repayment of the ESOP loan for each plan year. The released shares are
allocated among the accounts of participants on the basis of the
participant's compensation for the year of allocation. Benefits generally
become vested at the rate of 20% per year with vesting to begin after an
employee's completion of three years of service and full vesting to occur
after seven years of service. Participants also become immediately vested
upon termination of employment due to death, retirement at age 65 or older,
permanent disability or upon the occurrence of a change of control.
Forfeitures will be reallocated among remaining participating employees, in
the same proportion as contributions. Vested benefits may be paid in a
single sum or installment payments and are payable upon death, retirement
at age 65 or older, disability or separation from service.
Shares held by the ESOP include the following:
June 30,
--------------------------
2002 2001
---- ----
Allocated 83,150 59,211
Committed to be allocated 11,316 11,418
Unallocated 122,424 146,261
---------- ----------
Total 216,890 216,890
========== ==========
Fair value of unallocated ESOP shares $2,070,000 $2,293,000
========== ==========
Cash dividends received on allocated shares are allocated to participants
and cash dividends received on shares held in suspense are applied to repay
the outstanding debt of the ESOP.
Total expense applicable to the ESOP amounted to $366,000, $338,000 and
$289,000 for the years ended June 30, 2002, 2001, and 2000, respectively.
F-31
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Stock option plan
On March 24, 1999, the Company's stockholders approved the 1999 Stock
Option Plan (the "Stock Option Plan"). Under the Stock Option Plan, the
Company may grant options to its directors, officers and employees for up
to 257,355 shares of common stock. Both incentive stock options and non-
qualified stock options may be granted under the Stock Option Plan. The
exercise price of each option equals the market price of the Company's
stock on the date of grant and an option's maximum term is ten years.
Options generally vest over a five year period.
The Company applies APB Opinion 25 and related Interpretations in
accounting for the Stock Option Plan. Accordingly, no compensation cost has
been recognized. Had compensation cost for the Company's Stock Option Plan
been determined based on the fair value at the grant dates for awards under
the plan consistent with the method prescribed by SFAS No. 123, the
Company's net income and earnings per share would have been adjusted to the
pro forma amounts indicated below:
Years Ended June 30,
------------------------------------------
2002 2001 2000
---- ---- ----
(In Thousands, except per share data)
Net income As reported $1,627,000 $1,185,000 $1,689,000
Pro forma 1,576,000 1,118,000 1,616,000
Basic earnings per share As reported 1.11 0.68 0.83
Pro forma 1.08 0.65 0.80
Diluted earnings per share As reported 1.08 0.67 0.83
Pro forma 1.05 0.63 0.80
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model. The weighted-average assumptions
used for grants during the year ended June 30, 1999 were dividend yield of
2.0%, expected life of 7 years, expected volatility of 14%, and a risk-free
interest rate of 5.2%.
F-32
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Stock option plan (concluded)
A summary of the status of the Company's stock option plan is as follows:
Year Ended June 30,
----------------------------------------------------------------------
2002 2001 2000
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Fixed Options:
Outstanding at beginning of year 184,691 $12.06 226,364 $12.06 226,364 $12.06
Granted - - - - - -
Exercised 3,000 12.06 5,000 12.06 - -
Forfeited - 12.06 36,673 12.06 - -
------- ------- -------
Outstanding at end of year 181,691 $12.06 184,691 $12.06 226,364 $12.06
======= ======= =======
Options exercisable at year-end 115,594 $12.06 85,546 $12.06 45,273 $12.06
Information pertaining to options outstanding at June 30, 2002 is as
follows:
Options Outstanding Options Exercisable
------------------------------------ ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
- -------- ----------- ----------- -------- ----------- --------
$12.06 181,691 6.75 $12.06 115,594 $12.06
F-33
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (concluded)
Recognition and retention plan
On March 24, 1999, the Company's stockholders approved the Company's
adoption of the 1999 Recognition and Retention Plan (the "RRP"), which
allows the Company to grant restricted stock awards ("Awards") to certain
officers, employees and outside directors. The RRP is authorized to acquire
no more than 102,942 shares of Common stock in the open market. Shares
generally vest at a rate of up to 20% per year with the first vesting
period ending December 31, 1999. The aggregate purchase price of all shares
acquired by the RRP will be reflected as a reduction of stockholders'
equity and amortized to compensation expense as the Company's employees and
directors become vested in their stock awards. During the years ended June
30, 2002, 2001, and 2000, awards were granted with respect to 0, 4,500, and
0 shares, respectively. Shares forfeited during the years ended June 30,
2002, 2001 and 2000 amounted to 0, 14,670 and 0 shares, respectively. As of
June 30, 2002, 54,410 vested shares had been distributed to eligible
participants. Compensation expense amounted to $211,000 $254,000 and
$290,000 for the years ended June 30, 2002, 2001 and 2000, respectively.
Compensation expense is based on the fair value of the common stock on the
grant date.
Benefit restoration plan
In June 1998, the Company adopted the Benefit Restoration Plan ("BRP") in
order to provide the then President with the benefits that would be due to
him under the defined benefit pension plan, the 401(k) Plan and the ESOP if
such benefits were not limited under the Internal Revenue Code. Effective
April 9, 2001, the then President retired and received the benefits under
the BRP. Total expense related to the BRP amounted to $48,000 and $53,000
for the years ended June 30, 2001 and 2000.
14. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Company. The
total amount of dividends which may be paid at any date is generally
limited to the retained earnings of the Bank, and loans or advances are
limited to 10% of the Bank's capital stock and surplus on a secured basis.
In addition, dividends paid by the Bank to the Company would be prohibited
if the effect thereof would cause the Bank's capital to be reduced below
applicable minimum capital requirements. At June 30, 2002, $5,432,000 of
the Company's equity in the Bank was restricted and funds available for
loans and advances amounted to $1,133,000.
F-34
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments"
requires disclosure of estimated fair values of all financial instruments
where it is practicable to estimate such values. In cases where quoted
market prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. Accordingly, the derived fair value
estimates cannot be substantiated by comparison to independent markets and,
in many cases, could not be realized in immediate settlement of the
instrument. SFAS No. 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying
value of the Company.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of cash, federal
funds sold and short-term investments approximate fair values.
Securities: Fair values for securities, excluding Federal Home Loan
Bank stock, are based on quoted market prices. The carrying value of
Federal Home Loan Bank stock approximates fair value based on the
redemption provisions of the Federal Home Loan Bank.
Loans: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying
values. Fair values for loans held for sale are based on quoted
market prices. Fair values for all other loans are estimated using
discounted cash flow analyses, using interest rates currently being
offered for loans with similar terms to borrowers of similar credit
quality. Fair values for non-performing loans are estimated using
underlying collateral values when applicable.
Deposit liabilities: Fair values for interest and non-interest
checking, passbook savings, and certain types of money market
accounts are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for
term certificates of deposit are estimated using a discounted cash
flow calculation that applies interest rates currently being offered
on certificates to a schedule of aggregated expected monthly
maturities.
Federal Home Loan Bank borrowings: Fair values for borrowings are
estimated using discounted cash flow analysis based on the Bank's
current incremental borrowing rates for similar types of borrowing
arrangements.
Subordinated debt: The carrying value of subordinated debt
approximates fair value based on the provisions of the placement
agreement.
Accrued interest: The carrying amounts of accrued interest
approximate fair value.
F-35
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
Off-balance-sheet instruments: Fair values for off-balance-sheet
lending commitments are based on fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing and are not
material.
The estimated fair values, and related carrying amounts, of the Company's
financial instruments are as follows:
June 30,
--------------------------------------------------
2002 2001
---------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
(In Thousands)