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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, 2003
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]
Indicate by check mark if the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
----- -----
As of September 5, 2003, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the Registrant was
approximately $26,986,203.
As of September 5, 2003, 1,542,810 shares of Registrant's common stock were
outstanding.
Documents Incorporated by Reference:
Portions of the Registrant's Proxy Statement for its 2003 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, 2003
TABLE OF CONTENTS
PART I
ITEM 1. Business 1
ITEM 2. Properties 29
ITEM 3. Legal Proceedings 30
ITEM 4. Submission of Matters to a Vote of Security Holders 30
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters 31
ITEM 6. Selected Financial Data 32
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 33
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 45
ITEM 8. Financial Statements and Supplementary Data 46
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 46
ITEM 9A. Contacts and Procedures 46
PART III
ITEM 10. Directors and Executive Officers of the Registrant 47
ITEM 11. Executive Compensation 47
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management 47
ITEM 13. Certain Relationships and Related Transactions 48
PART IV
ITEM 14. Principal Accounting Fees and Service 48
ITEM 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 48
SIGNATURES 51
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 and 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 in February 2003, the Company formed
Mystic Financial Capital Trust II (the "Trusts"). The Company owns all of
the voting stock of the Trusts. The Trusts have issued $12.0 million in
trust preferred securities. See Note 9 of the Notes to Consolidated
Financial Statements.
The Company's principal business activity consists of the ownership
of the Bank and the Trusts. The Company also invests in short-term
investment grade marketable securities and other liquid investments. The
Trusts issued $5.0 million of floating rate trust preferred securities on
April 10, 2002 and are scheduled to mature on 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, 2003 was 4.99%.
Distributions on these securities are payable semi-annually in arrears on
April 22nd and October 22nd. In February 2003, the Trusts issued $7 million
of floating rate trust preferred securities which are scheduled to mature
in 2033, callable at the option of the Company on February 15, 2008, with
the prior approval of the Federal Reserve Board. The floating rate as of
June 30, 2003 was 4.54%. Distributions on these securities are payable
every three months in arrears on February 15th, May 15th, August 15th, and
November 15th. The proceeds were used to purchase subordinated debentures
from the Company. The Company has no significant liabilities (other than
the subordinated debentures and 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, Bedford and Malden, 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 of
Boston ("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, 2003.
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.
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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.
Market Area
The Bank's main office and two of its branch offices are located in
Medford, Massachusetts. The Bank has a full-service office in Lexington,
Arlington, Bedford and Malden, Massachusetts, which opened in September
2003. All locations are located in Middlesex County.
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, and Lawrence Memorial Hospital, with
approximately 1,900, 1,400, 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 U.S.
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 that 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
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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.
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 residential and commercial loan 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, Bedford and Malden,
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
it serves. 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,
2003, ranged from $2.6 million to $4.5 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,
---------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Residential mortgage loans $165,463 59.1% $153,915 63.1% $138,163 64.2% $127,862 67.6% $107,216 69.3%
Commercial real estate loans 69,785 24.9 58,889 24.2 50,483 23.5 41,294 21.8 33,980 22.0
Commercial loans 20,250 7.2 16,215 6.7 13,514 6.3 10,881 5.8 7,109 4.6
Consumer loans 767 0.3 1,004 0.4 1,532 0.7 1,526 0.8 1,546 1.0
Home equity loans 9,385 3.4 4,965 2.0 3,880 1.8 3,470 1.8 2,076 1.3
Construction loans 16,557 5.9 11,015 4.5 9,282 4.3 5,686 3.0 4,122 2.7
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans 282,207 100.8 246,003 100.9 216,854 100.8 190,719 100.8 156,049 100.9
Less:
Deferred loan origination
fees (costs) (89) --- 197 0.1 35 --- (12) --- 12 ---
Allowance for loan losses 2,347 0.8 2,063 0.8 1,784 0.8 1,531 0.8 1,348 0.9
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Loans, net $279,949 100.0% $243,743 100.0% $215,035 100.0% $189,200 100.0% $154,689 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
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, 2003, loans on one-to four-
family residential properties accounted for 58.9% 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 year 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 275 basis points, or 2.75%.
Additionally, the Bank offers an adjustable-rate loan which is fixed for
five years and then reprices every five years thereafter and an adjustable-
rate loan product with an interest rate fixed for five years which reprices
annually for its term thereafter. Also, the Bank offers an adjustable-rate
loan product with an interest rate fixed for three years which reprices
annually for its term thereafter. The Bank also has on its books an
adjustable-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 2% 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. 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, 2003, the Bank originated $31.7
million in adjustable-rate mortgage loans and $77.2 million in fixed-rate
mortgage loans. Of the fixed-rate loans originated, the Bank sold $36.8
million fixed-rate loans with terms of greater than 15 years and retained
$40.4 million fixed-rate loans, which had terms of 15 to 30 years.
Approximately 29.2% of all loan originations during fiscal 2003 were
refinances of loans already in the Bank's loan portfolio. At June 30, 2003,
the Bank's loan portfolio included $68.0 million in adjustable-rate one-to
four-family residential mortgage loans or
6
24.3% of the Bank's net loan portfolio, and $97.5 million in fixed-rate
one-to four-family residential mortgage loans, or 34.8% of the Bank's net
loan portfolio.
Commercial Real Estate Loans. At June 30, 2003, the Bank's
commercial real estate loan portfolio consisted of 164 loans, totaling
$69.8 million, or 24.9% of net loans. The Bank's largest aggregate loan
relationship is a commercial borrower with an outstanding balance of $4.5
million at June 30, 2003 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 increase its lending to
companies which have from $500,000 to $15.0 million in sales. At June 30,
2003, the Bank's commercial loan portfolio consisted of 211 loans, totaling
$20.2 million, or 7.2% 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 most 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, 2003, the consumer loan portfolio totaled $800,000 or
0.3% 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
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,
2003, the Bank had $9.4 million in home equity loans with unused credit
available to existing borrowers of $11.6 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 is 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, 2003, the Bank's construction loan
portfolio totaled $38.6 million offset by $14.0 million in unadvanced
principal.
Loan Commitments. The Bank generally makes loan commitments to
borrowers not exceeding 60 days. At June 30, 2003, the Bank had $18.6
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 and lines of credit totaled $36.4 million on June 30,
2003.
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 most 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 is
required on all loans secured by improved real estate. Insurance on other
collateral is required unless waived by the Security 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,
commercial real estate mortgages, commercial business loans and consumer
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
8
levels, while the Security Committee must approve loans in excess of (a)
$1,000,000 for commercial real estate loans; (b) $1,000,000 for commercial
loans; and (c) $1,000,000 for residential mortgage 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/costs are deferred and amortized into income over the life of the
loan. At June 30, 2003, the amount of net deferred loan origination costs
was $89,000.
Loan Maturities. The following table sets forth certain information
at June 30, 2003 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 $ 51,827 $12,296 $19,709 $13,426 $108 $ 97,366
After 1 year through 5 years 99,442 56,431 10,864 6,805 135 173,677
Beyond 5 years 23,579 1,058 --- 19 524 25,180
-------- ------- ------- ------- ---- --------
Total $174,848 $69,785 $30,573 $20,250 $767 $296,223
======== ======= ======= ======= ==== ========
Loan balance by type scheduled
to mature after 1 year:
Fixed-rate $ 74,156 $ 2,484 $ --- $ 2,790 $659 $ 80,089
Adjustable-rate 48,865 55,005 10,864 4,034 --- 118,768
- --------------------
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, 2003, the Bank was servicing $37.2
million in loans for Fannie Mae and $1.5 million in loans for the FHLB 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, 2003, the Bank was servicing $242,000 of such
loans.
Originations for the year ended June 30, 2003 increased in all loan
categories except commercial loans which decreased by $287,000. 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.
At June 30,
------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands)
Beginning balance $243,743 $215,035 $189,200 $154,689 $138,593
-------- -------- -------- -------- --------
Mortgage originations 108,934 82,615 43,378 37,513 47,662
Consumer and home equity loan originations 13,478 5,538 3,834 3,716 2,494
Commercial real estate loan originations 20,931 14,575 12,004 13,260 13,713
Commercial loan originations 8,969 9,256 20,053 12,598 5,313
Construction loan originations 21,419 19,849 11,859 9,569 3,080
-------- -------- -------- -------- --------
Total loans originated 173,731 131,833 91,128 76,656 72,262
-------- -------- -------- -------- --------
Less:
Amortization and payoffs 100,415 93,582 60,716 39,937 42,901
Provision for loan losses 300 305 275 200 145
Total loans sold 36,810 9,238 4,302 1,433 13,120
Loan participations sold --- --- --- 575 ---
-------- -------- -------- -------- --------
Ending balance $279,949 $243,743 $215,035 $189,200 $154,689
======== ======== ======== ======== ========
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. All
delinquent loans are ratified by the Bank's Board of Directors on a monthly
basis. One of the primary tools used to manage and control problem loans
is the Bank's "Watch-List," a listing of loans or commitments, 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.
At June 30,
-------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands)
Loans 30-89 days past due
(not included in non-performing loans) $1,297 $1,191 $1,854 $ 540 $1,685
Loans 90 days or more past due
(not included in non-performing loans) --- --- 276 148 ---
------ ------ ------ ----- ------
Total delinquent loans $1,297 $1,191 $2,130 $ 688 $1,685
====== ====== ====== ===== ======
Delinquent loans as a percentage of net loans 0.46% 0.49% 0.99% 0.36% 1.09%
====== ====== ====== ===== ======
Non-performing loans (over 90 days past due) $ 223 $ 108 $ 15 $ 2 $ 0
------ ------ ------ ----- ------
Total non-performing loans $ 223 $ 108 $ 15 $ 2 $ 0
====== ====== ====== ===== ======
Non-performing loans as a percent of net loans 0.08% 0.04% 0.01% 0.00% 0.00%
Non-performing loans as a percent of total loans 0.05% 0.04% 0.01% 0.00% 0.00%
At June 30, 2003, 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, 2003, the Bank had no
assets classified as doubtful or loss, and $415,000 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,
------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(Dollars in thousands)
Average loans, net $257,519 $226,711 $205,837 $173,319 $144,663
======== ======== ======== ======== ========
Year-end net loans $279,949 $243,743 $215,035 $189,200 $154,689
======== ======== ======== ======== ========
Allowance for loan losses at beginning of year $ 2,063 $ 1,784 $ 1,531 $ 1,348 $ 1,236
Provision charged to operations 300 305 275 200 145
Recoveries:
Real estate mortgage:
Residential --- --- --- --- ---
Commercial --- --- --- --- ---
Commercial loans 3 --- 2 --- ---
Consumer and home equity 21 4 3 6 3
Construction --- --- --- --- ---
-------- -------- -------- -------- --------
Total recoveries 24 4 5 6 3
-------- -------- -------- -------- --------
Charge-offs:
Real estate mortgage:
Residential --- --- --- --- ---
Commercial --- --- --- --- ---
Commercial loans --- (12) --- --- (2)
Consumer and home equity (40) (18) (27) (23) (34)
Construction --- --- --- --- ---
-------- -------- -------- -------- --------
Total charge-offs (40) (30) (27) (23) (36)
-------- -------- -------- -------- --------
Net charge-offs (16) (26) (22) (17) (33)
-------- -------- -------- -------- --------
Allowance for loan losses at end of year $ 2,347 $ 2,063 $ 1,784 $ 1,531 $ 1,348
======== ======== ======== ======== ========
Ratios:
Allowance for loan losses to year-end net loans 0.84% 0.85% 0.83% 0.81% 0.87%
Net charge-offs to average loans, net 0.01% 0.01% 0.01% 0.01% 0.02%
Net charge-offs to allowance for loan losses 0.68% 1.26% 1.23% 1.11% 2.45%
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,
----------------------------------------------------------------------------------
2003 2002 2001
------------------------ ------------------------ ------------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
Real estate-mortgage:
Residential and home equity $ 628 58.6% $ 588 62.6% $ 578 63.7%
Commercial 947 24.7 827 23.9 767 23.3
Commercial loans 466 7.2 373 6.6 240 6.2
Consumer 11 3.6 30 2.4 34 2.5
Construction 295 5.9 245 4.5 165 4.3
------ ----- ------ ----- ------ -----
Total allowance for loan losses $2,347 100.0% $2,063 100.0% $1,784 100.0%
====== ===== ====== ===== ====== =====
At June 30,
-----------------------------------------------------
2000 1999
------------------------ ------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
------ ------------- ------ -------------
(Dollars in thousands)
Real estate-mortgage:
Residential and home equity $ 563 67.0% $ 563 68.7%
Commercial 687 21.7 592 21.8
Commercial loans 172 5.7 133 4.6
Consumer 19 2.6 15 2.3
Construction 90 3.0 45 2.6
------ ----- ------ -----
Total allowance for loan losses $1,531 100.0% $1,348 100.0%
====== ===== ====== =====
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 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,
2003, 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 Bank's
securities at the dates indicated.
At June 30,
--------------------------------------------------------------------------
2003 2002 2001
---------------------- --------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ----- --------- ----- --------- -----
(In thousands)
Securities available for sale:
- ------------------------------
Marketable equity securities $ 3,009 $ 3,033 $ 2,698 $ 2,586 $ 3,222 $ 3,537
U.S. Government and federal
agency obligations 41,468 42,002 25,198 25,517 9,498 9,505
Other bonds and obligations 13,736 13,820 8,668 8,685 5,542 5,489
Mortgage-backed securities 58,414 59,016 28,759 29,112 10,389 10,289
-------- -------- ------- ------- ------- -------
Total $116,627 $117,871 $65,323 $65,900 $28,651 $28,820
======== ======== ======= ======= ======= =======
14
The following table sets forth the scheduled maturities, carrying
values and average yields for the Bank's debt securities at June 30, 2003.
At June 30, 2003
--------------------------------------------------------------------------------------------
One Year or 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 $ 9,019 3.53% $30,949 3.30% $ 1,500 4.18% $ 41,468 3.38%
Other bonds and obligations 2,457 2.12 7,916 3.89 3,363 2.08 13,736 3.13
Mortgage-backed securities --- --- 3,728 3.12 54,686 4.17 58,414 4.10
------- ------- ------- --------
Total $11,476 3.22% $42,593 3.39% $59,549 4.05% $113,618 3.72%
======= ======= ======= ========
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,
----------------------------------------------------------------------
2003 2002 2001
-------------------- -------------------- --------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Savings deposit $ 69,015 20.1% $ 52,762 19.7% $ 44,302 19.7%
NOW accounts 26,342 7.7 26,971 10.1 22,342 9.9
IOLTA accounts 28,659 8.4 22,397 8.4 16,202 7.2
Money market deposits 51,719 15.1 21,466 8.0 18,591 8.3
Demand deposits 25,871 7.5 19,856 7.4 18,889 8.4
Certificate of deposits 141,958 41.2 123,986 46.4 104,424 46.5
-------- ----- -------- ----- -------- -----
Total deposits $343,564 100.0% $267,438 100.0% $224,750 100.0%
======== ===== ======== ===== ======== =====
For more information on the Bank's deposit accounts, see Note 7 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,
2003.
Weighted
Average
Maturity Period Certificates of Deposit Rate
--------------- ----------------------- --------
(Dollars in thousands)
0-3 months $ 9,326 2.83%
3-6 months 9,324 3.05
6-12 months 22,232 3.45
1-2 years 4,823 2.97
2-3 years 7,905 4.60
> 3 years 3,042 4.36
-------
Total $56,652 3.45%
=======
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 $41.2 million
outstanding at June 30, 2003.
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, 2003, the Bank had 75 full-time employees and 20 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 10 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, 2003. Prompt corrective action provisions are
not applicable to financial holding companies.
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 $36,326 14.7% $19,775 8.0% N/A N/A
Bank 37,730 15.4 19,583 8.0 $24,479 10.0%
Tier 1 Capital to Risk Weighted Assets
Consolidated 33,968 13.7 9,888 4.0 N/A N/A
Bank 35,372 14.5 9,792 4.0 14,688 6.0
Tier 1 Capital to Average Assets
Consolidated 33,968 8.2 16,657 4.0 N/A N/A
Bank 35,372 8.5 16,589 4.0 20,737 5.0
As the preceding table shows, the Company and the Bank exceeded the
minimum capital adequacy requirements at June 30, 2003.
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.
Effective April 1, 2003, the Federal Reserve Board, or FRB, is
rescinding its interpretations of Sections 23A and 23B of the FRA and is
replacing these interpretations with Regulation W. In addition, Regulation
W makes various changes to existing law regarding Sections 23A and 23B,
including expanding the definition of what constitutes an affiliate subject
to Sections 23A and 23B and exempting certain subsidiaries of state-
chartered banks from the restrictions of Sections 23A and 23B.
Under Regulation W, all transactions entered into on or before
December 12, 2002, which either became subject to Sections 23A and 23B
solely because of Regulation W, and all transactions covered by Sections
23A and 23B, the treatment of which will change solely because of
Regulation W, will become subject to Regulation W on July 1, 2003. All
other covered affiliate transactions become subject to Regulation W on
April 1, 2003. The Federal Reserve Board expects each depository
institution that is
22
subject to Sections 23A and 23B to implement policies and procedures to
ensure compliance with Regulation W. We do not expect that the changes
made by Regulation W will have a material adverse effect on our business.
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.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension
of personal loans to directors and executive officers of issuers (as
defined in Sarbanes-Oxley). The prohibition, however, does not apply to
mortgages advanced by an insured depository institution, such as the Bank,
that are subject to the insider lending restrictions of Section 22(h) of
the FRA.
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
23
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, 2003, 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.
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, 2003, 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
24
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:
* 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, 2003, 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
25
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, 2003, 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 FHFB
System. It offers advances to members in accordance with policies and
procedures established by the FHLB and the Board of Directors of the FHLB.
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 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.
Pursuant to regulations promulgated by the Federal Housing Finance
Board, as required by Gramm-Leach, the FHLB of Boston has adopted a capital
plan, which is expected to become effective during the second half of 2003,
that will change the foregoing minimum stock ownership requirements for
FHLB of Boston stock. Under the new capital plan, each member of the FHLB
of Boston will have to maintain a minimum investment in FHLB of Boston
capital stock in an amount equal to the sum of (i) .35% of member eligible
collateral (subject to a minimum of $10,000 and a maximum of $25,000,000,
per member), and (ii) 4.50% of the member's activity-based assets.
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, 2003, the Bank met its reserve requirements.
Sarbanes-Oxley Act
On July 30, 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
generally applies to all companies, both U.S. and non-U.S., that file or
are required to file periodic reports with the Securities and Exchange
Commission (the "SEC"), under the Securities Exchange Act. Given the
extensive SEC role in implementing rules relating to many of the Sarbanes
Oxley Act's new requirements, the final scope of these requirements remains
to be determined.
26
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules and mandates further studies of
specified issues by the SEC and the Comptroller General. The Sarbanes-
Oxley Act represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of
the accounting profession, and to state corporate law, such as the
relationship between a board of directors and management and between a
board of directors and its committees.
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;
* the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by
directors and senior officers in the twelve month period
following initial publication of any financial statements that
later require restatement;
* an increase in the oversight of, and enhancement of certain
requirements relating to audit committees of public companies
and how they interact with the company's independent auditors;
* requirement that audit committee members must be independent
and are absolutely barred from accepting consulting, advisory
or other compensatory fees from the issuer;
* requirement that companies disclose whether at least one member
of the committee is an "audit committee financial expert" (as
such term is defined by the Securities and Exchange Commission)
and if not, why not;
* expanded disclosure requirements for corporate insiders,
including accelerated reporting of stock transactions by
insiders and a prohibition on insider trading during pension
blackout periods;
* a prohibition on personal loans to directors and officers,
except certain loans made by insured financial institutions;
* disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
* mandatory disclosure by analysts of potential conflicts of
interest; and
* a range of enhanced penalties for fraud and other violations.
The SEC has been delegated the task of enacting rules to implement
various provisions with respect to, among other matters, disclosure in
periodic filings pursuant to the Securities Exchange Act. To date, the SEC
has implemented some of the provisions of the Sarbanes-Oxley Act. However,
the SEC continues to issue final rules, reports, and press releases. As
the SEC provides new requirements, we review those rules and comply as
required.
Furthermore, the Nasdaq Stock Market (the "NASDAQ") has also proposed
corporate governance rules which would implement the mandates of the
Sarbanes-Oxley Act. The proposed NASDAQ rules include ensuring that a
majority of the board of directors are independent of management,
establishing and publishing a code of conduct for directors and officers
and requiring stockholder approval of all new stock option plans and all
modifications. The NASDAQ rules are still tentative in nature because they
are subject to SEC review and approval, which is expected to occur later
this year. Once finalized, the rules will not be effective until at least
January 1, 2004. These rules, if adopted, would affect the Company because
its common stock is listed on the NASDAQ under the symbol "MYST."
27
Although we anticipate that we will incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, management does not expect that such compliance will have a
material impact on our results of operations or financial condition.
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.
USA PATRIOT Act
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 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. Interim final rules implementing Section 352 were
issued by the Treasury Department on April 29, 2002 and were
subsequently amended on November 6, 2002 and November 14, 2002.
Such rules state that a financial institution is in compliance
with Section 352 if it implements and maintains an anti-money
laundering program that complies with the anti-money laundering
regulations of its federal functional regulator. Astoria
Federal is in compliance with the OTS's anti-money laundering
regulations.
* Pursuant to Section 326, on May 9, 2003 the OTS, in conjunction
with other bank regulators, issued a Joint Final Rule that
provides for minimum standards with respect to customer
identification and verification. The rules require financial
institutions to establish a program specifying procedures for
obtaining identifying information from customers seeking to
open new accounts. This identifying information would be
essentially the same information currently obtained by most
financial institutions for individual customers generally. A
financial institution's program would also have to contain
procedures to verify the identity of customers within a
reasonable period of time, generally through the use of the
same forms of identity verification currently in use, such as
through driver's licenses, passports, credit reports and other
similar means.
* Section 312 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
28
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to detect
and report money laundering. A final rule under Section 312
was issued by the Treasury Department on September 26, 2002.
The rule states that a due diligence program is reasonable if
it comports with existing best practices standards for banks
that maintain correspondent accounts for foreign banks and
evidences good faith efforts to incorporate due diligence
procedures for accounts posing increased risk of money
laundering. In addition, an enhanced due diligence program is
reasonable if it comports with best practices standards and
focuses enhanced due diligence measures on those correspondent
accounts posing a particularly high risk of money laundering
based on the bank's overall assessment of the risk posed by the
foreign correspondent bank. Finally, a private banking due
diligence program must be reasonably designed to detect and
report money laundering and the existence of proceeds of
foreign corruption. Such a program is reasonable if it focuses
on those private banking accounts the present a high risk of
money laundering. The deadline for compliance with this rule,
as extended, was March 31, 2003.
* 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.
Although we anticipate that we will incur additional expense in complying
with the provisions of the USA PATRIOT Act and the resulting regulations,
management does not expect that such compliance will have a material impact
on our results of operations or financial condition.
ITEM 2. PROPERTIES
The following table sets forth certain information at June 30, 2003
regarding the Bank's office facilities, which are owned by the Bank, the
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 $ 948
West Medford Office 430 High Street
Medford, MA 02155 1970 2,500 21
Salem Street Office 201 Salem Street
Medford, MA 02155 1995 3,500 841
Lexington Office 1793 Massachusetts Avenue
Lexington, MA 02420 1998 3,000 54
Arlington Office 856 Massachusetts Avenue
Arlington, MA 02476 2000 500 112
29
Bedford Office 168 Great Road
Bedford, MA 01730 2002 2,500 233
------
Net Book Value $2,209
======
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 $1.5 million at June 30, 2003. The Bank uses a portion of the second
and third floors of this building to house some of its administrative and
clerical services and leases the remaining space to third-party tenants.
At June 30, 2003, the net book value of the Bank's computer equipment
and other furniture, fixtures and equipment at its existing offices totaled
$840,000. For more information, see Note 5 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, 2003.
30
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 30, 2003, the last trading date in the Company's fiscal
year, the Company's common stock closed at $22.00. On September 5, 2003,
there were 1,542,810 shares of the Company's common stock outstanding,
which were held of record by approximately 870 stockholders, not including
persons or entities that hold the stock in nominee or "street" name through
various brokerage firms. The number of shares outstanding has been
adjusted to reflect the 5% stock dividend paid to stockholders of record of
July 31, 2003.
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.
The following table does not reflect the 5% stock dividend that was
declared July 9, 2003 and paid to stockholders of record on July 31, 2003.
Quarter Ended High Low Dividends
------------- ---- --- ---------
Fiscal year ended June 30, 2003:
Fourth Quarter ended June 30, 2003 $23.080 $17.710 $0.09
Third Quarter ended March 31, 2003 18.520 17.540 0.09
Second Quarter ended December 31, 2002 18.500 16.200 0.09
First Quarter ended September 30, 2002 18.150 16.230 0.09
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
31
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,
-----------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Balance sheet data:
Total assets $ 429,316 $ 356,733 $ 300,402 $ 263,888 $ 215,214
Loans, net 279,949 243,743 215,035 189,200 154,689
Securities:
Available for sale 117,871 65,900 28,820 32,452 31,772
Held to maturity - - - - 1,500
Deposits 343,564 267,438 224,750 194,135 160,867
Borrowings 41,200 58,135 44,618 38,750 18,978
Subordinated debt 12,000 5,000 - - -
Total stockholders' equity 26,244 23,923 29,015 29,189 34,052
Asset quality data:
Non-performing loans 223 108 15 2 -
Allowance for loan losses 2,347 2,063 1,784 1,531 1,348
Number of:
Mortgage loans outstanding 1,790 1,749 1,694 1,609 1,626
Deposit accounts 30,224 25,075 22,252 21,661 19,644
Full service offices 6 6 5 5 4
Number of employees:
Full-time 75 66 55 62 52
Part-time 20 25 25 28 21
Statement of income data:
Interest and dividend income $ 21,388 $ 19,868 $ 19,422 $ 16,177 $ 13,745
Interest expense 10,342 10,171 9,967 7,446 6,221
--------- --------- --------- --------- ---------
Net interest income 11,046 9,697 9,455 8,731 7,524
Provision for loan losses 300 305 275 200 145
--------- --------- --------- --------- ---------
Net interest income after provision
for loan losses 10,746 9,392 9,180 8,531 7,379
Other income 2,165 1,137 1,196 945 1,136
Operating expenses 10,081 7,871 8,470 6,715 6,042
--------- --------- --------- --------- ---------
Income before income taxes 2,830 2,658 1,906 2,761 2,473
Provision for income taxes 1,114 1,031 721 1,072 971
--------- --------- --------- --------- ---------
Net income $ 1,716 $ 1,627 $ 1,185 $ 1,689 $ 1,502
========= ========= ========= ========= =========
Per share data:
Weighted average shares
outstanding - basic 1,332,769 1,462,309 1,731,874 2,024,201 2,375,440
Basic earnings per share $ 1.29 $ 1.11 $ 0.68 $ 0.83 $ 0.63
Weighted average shares
outstanding - diluted 1,390,807 1,504,249 1,767,902 2,024,201 2,375,440
Diluted earnings per share $ 1.23 $ 1.08 $ 0.67 $ 0.83 $ 0.63
Cash dividends paid per share $ 0.36 $ 0.33 $ 0.31 $ 0.26 $ 0.21
Book value per share $ 18.90 $ 17.56 $ 16.39 $ 16.43 $ 15.06
32
At or for the Years Ended June 30,
-----------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Selected operating ratios:
Interest rate spread (1) 2.70% 2.88% 3.11% 3.43% 3.26%
Net interest margin (2) 2.96 3.29 3.70 4.04 3.96
Return on average assets 0.44 0.53 0.44 0.74 0.75
Return on average equity 6.86 6.27 4.04 5.37 4.29
Operating expenses as a percent
of average total assets 2.58 2.54 3.15 2.95 3.01
Efficiency ratio (3) 76.31 72.65 79.52 69.40 69.77
Asset quality ratios:
Non-performing loans as a percent
of net loans 0.08 0.04 0.01 0.00 0.00
Non-performing loans as a percent
of total assets 0.05 0.04 0.01 0.00 0.00
Net charge-offs to average loans 0.01 0.01 0.01 0.01 0.02
Regulatory Capital ratios:
Regulatory Tier 1 leverage capital ratio 8.16 8.69 10.12 11.35 16.05
Total risk-based capital 13.74 13.92 16.39 19.22 26.25
- --------------------
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 Federal Home Loan
Bank of Boston ("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.
33
The Company's profitability is also affected by the level of non-
interest income and non-interest expense. Non-interest income consists
primarily of service fees, loan servicing and other loan fees and gains on
sales of securities. Non-interest expense consists 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 Consolidated Financial Statements for the year ended
June 30, 2003 included in our Annual Report on Form 10-K for the year ended
June 30, 2003, contain a summary of the Company's significant accounting
policies. The Company believes its policy with respect to the methodology
for its 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
Company's Audit Committee and 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.
34
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 the Board and 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. 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, 2003,
the Bank's loan portfolio included $68.0 million of adjustable-rate one-to
four-family mortgage loans, $69.8 million of adjustable-rate commercial
real estate loans, $10.3 million of adjustable-rate or short-term
commercial loans, and $9.0 million of adjustable-rate home equity loans.
Together, these loans represent 55.8% of the Bank's net loans at June 30,
2003. See "Business-Lending Activities."
35
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,
---------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- -----------------------------
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 $257,519 $17,542 6.81% $226,711 $16,972 7.49% $205,837 $16,597 8.06%
Securities 90,206 3,467 3.84% 50,765 2,405 4.74% 29,595 1,785 6.03%
Other earning assets (1) 25,310 379 1.50% 17,564 491 2.80% 19,883 1,040 5.23%
-------- ------- -------- ------- -------- -------
Total interest-earning assets 373,035 21,388 5.73% 295,040 19,868 6.73% 255,315 19,422 7.61%
------- ------- -------
Cash and due from banks 9,109 7,558 6,320
Other assets 8,178 6,981 6,867
-------- -------- --------
Total assets $390,322 $309,579 $268,502
======== ======== ========
Interest-bearing liabilities:
Regular and other deposits $ 60,695 843 1.39% $ 47,710 990 2.08% $ 42,640 946 2.22%
NOW accounts 39,821 277 0.70% 34,384 344 1.00% 29,472 433 1.47%
Money market deposits 45,521 1,036 2.28% 19,952 469 2.35% 12,415 485 3.91%
Certificates of deposit 134,408 4,967 3.70% 111,193 5,510 4.96% 92,451 5,332 5.77%
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits 280,445 7,123 2.54% 213,239 7,313 3.43% 176,978 7,196 4.07%
FHLB borrowings 53,321 2,820 5.29% 49,854 2,789 5.59% 44,400 2,771 6.24%
Subordinated debt 7,627 399 5.23% 1,250 69 5.52% - - -
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 341,393 10,342 3.03% 264,343 10,171 3.85% 221,378 9,967 4.50%
------- ------- -------
Demand deposit accounts 22,073 17,837 16,258
Other liabilities 1,846 1,458 1,562
-------- -------- --------
Total liabilities 365,312 283,638 239,198
Stockholders' equity 25,010 25,941 29,304
-------- -------- --------
Total liabilities and
stockholders' equity $390,322 $309,579 $268,502
======== ======== ========
Net interest income $11,046 $ 9,697 $ 9,455
======= ======= =======
Interest rate spread 2.70% 2.88% 3.11%
Net interest margin 2.96% 3.29% 3.70%
Interest-earning assets/
interest-bearing liabilities 1.09x 1.12x 1.15x
- --------------------
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.
36
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,
2003 vs 2002 2002 vs 2001
Due to Increase Due to Increase
(Decrease) (Decrease)
----------------------------- -----------------------------
Rate Volume Total Rate Volume Total
---- ------ ----- ---- ------ -----
(In thousands)
Interest and dividend income:
Loans, net $(1,611) $2,181 $ 570 $ (899) $ 1,274 $ 375
Securities (523) 1,585 1,062 (266) 886 620
Other earning assets (280) 168 (112) (439) (110) (549)
------- ------ ------- ------- ------- -----
Total (2,414) 3,934 1,520 (1,604) 2,050 446
------- ------ ------- ------- ------- -----
Interest expense:
Regular and other deposits (376) 229 (147) (53) 96 43
NOW accounts (116) 49 (67) (186) 97 (89)
Money market deposits (15) 582 567 31 (47) (16)
Certificates of deposit (1,562) 1,019 (543) (405) 584 179
Borrowed funds (157) 188 31 (100) 118 18
Subordinated debt (4) 334 330 0 69 69
------- ------ ------- ------- ------- -----
Total (2,230) 2,401 171 (713) 917 204
------- ------ ------- ------- ------- -----
Change in net interest income $ (184) $1,533 $ 1,349 $ (891) $ 1,133 $ 242
======= ====== ======= ======= ======= =====
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 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, 2003 and 2002
The Company's total assets amounted to $429.3 million at June 30,
2003 compared to $356.7 million at June 30, 2002, an increase of $72.6
million or 20.4%. The increase in total assets is primarily attributable
to an increase in net loans of $36.2 million or 14.9% and an increase in
securities available for sale of $52.0 million or 78.9%.
Cash and cash equivalents totaled $19.8 million at June 30, 2003
compared to $34.6 million at June 30, 2002, a decrease of $14.8 million or
42.8%. The $4.3 million decrease in short-term investments and the $3.9
million decrease in federal funds sold were due to the increased loan
demand in both the residential and commercial real estate areas and an
increase in securities available for sale.
37
Net loans increased by $36.2 million or 14.9% to $279.9 million or
65.2% of total assets at June 30, 2003 as compared to $243.7 million or
68.3% of total assets at June 30, 2002, 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
$52.0 million or 75.5% to $120.8 million at June 30, 2003 from $68.8
million at June 30, 2002. The increase was funded by additional growth in
deposits and proceeds from the trust preferred securities. The increase in
the Company's securities portfolio reflects the Company's decision to
invest a greater portion of its assets in U.S. Government and federal
agency obligations and mortgage-backed securities, which results in higher
yields than cash and cash equivalents.
Total deposits increased by $76.2 million or 28.5% to $343.6 million
at June 30, 2003 from $267.4 million at June 30, 2002. Money market
deposits increased to $51.7 million at June 30, 2003 from $21.5 million at
June 30, 2002, an increase of $30.2 million or 140.5%. Certificates of
deposit increased to $142.0 million at June 30, 2003 from $124.0 million at
June 30, 2002, an increase of $18.0 million or 14.5%. Demand deposits and
IOLTA accounts increased to $54.5 million at June 30, 2003 from $42.3
million at June 30, 2002, an increase of $12.2 million or 28.8% as a result
of the Bank's continuing emphasis on developing relationships with small
business. There were also increases in other deposit categories.
During the year ended June 30, 2003, as part of our interest rate
risk management strategy, total borrowings decreased by $16.9 million to
$41.2 million at June 30, 2003 from $58.1 million at June 30, 2002. The
decrease of $16.9 million was the result of maturing advances totaling
$11.5 million and the early retirement of $5.4 million. The decrease in
borrowed funds was offset by an increase in total deposits.
In February 2003, Mystic Financial Capital Trust II 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 $7.0 million of floating rate trust preferred
securities were issued and are scheduled to mature in 2033, callable at the
option of the Company on February 15, 2008, with the prior approval of the
Federal Reserve Board. The floating rate as of June 30, 2003 was 4.54%.
Distributions on these securities are payable quarterly in arrears on
February 15th, May 15th, August 15th and November 15th. A total of $12.0
million of floating rate trust preferred securities were outstanding at
June 30, 2003.
Stockholders' equity increased by $2.3 million to $26.2 million at
June 30, 2003 from $23.9 million at June 30, 2002 as a result of dividends
paid of $477,000, offset by an increase in the net unrealized gain on
securities available for sale of $417,000, net income of $1.7 million,
proceeds from exercise of stock options of $49,000, a reduction in unearned
Recognition and Retention Plan ("RRP") stock of $223,000, and a reduction
in unearned Employee Stock Ownership Plan ("ESOP") shares of $400,000.
Book value per share of common stock was $18.90 as of June 30, 2003
as compared to $17.56 as of June 30, 2002. 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 1,388,860 shares of common stock
outstanding as of June 30, 2003 for purposes of calculating the Company's
book value per share.
38
Comparison of the Operating Results for the Years Ended June 30, 2003 and
2002
Net Income. Net income was $1.7 million for the year ended June 30,
2003 as compared to $1.6 million for the year ended June 30, 2002. This
$89,000 increase in net income during the year was the result of an
increase in net interest income of $1.3 million and an increase in non-
interest income of $1.0 million partially offset by an increase in non-
interest expense of $2.2 million and an increase in provision for income
taxes of $83,000. The return on average assets for the year ended June 30,
2003 was .44% compared to .53% for the year ended June 30, 2002. The
return on average equity for the year ended June 30, 2003 was 6.86%
compared to 6.27% for the year ended June 30, 2002.
Earnings per share on a basic and diluted basis was $1.29 and $1.23,
respectively, for the year ended June 30, 2003 compared to $1.11 and $1.08
on a basic and diluted basis for the year ended June 30, 2002.
Interest Income. Total interest and dividend income increased by
$1.5 million or 7.7% to $21.4 million for the year ended June 30, 2003 from
$19.9 million for the year ended June 30, 2002. 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 and a decrease in average
yields due to the declining interest rate environment. The average balance
of net loans for the year ended June 30, 2003 was $257.5 million compared
to $226.7 million for the year ended June 30, 2002. The average yield on
net loans was 6.81% for the year ended June 30, 2003 compared to 7.49% for
the year ended June 30, 2002. The average balance of securities for the
year ended June 30, 2003 was $90.2 million compared to $50.8 million for
the year ended June 30, 2002. The average yield on securities was 3.84%
for the year ended June 30, 2003 compared to 4.74% for the year ended June
30, 2002. The average balance of other earning assets for the year ended
June 30, 2003 was $25.3 million compared to $17.6 million for the year
ended June 30, 2002. The average yield on other earning assets was 1.50%
for the year ended June 30, 2003 compared to 2.80% for the year ended June
30, 2002.
Interest Expense. Total interest expense increased by $171,000 or
1.7% to $10.3 million for the year ended June 30, 2003 from $10.2 million
for the year ended June 30, 2002. The increase in interest expense
resulted from an increase in the average balance of FHLB borrowings and an
increase in subordinated debt. Average interest-bearing deposits increased
by $67.2 million or 31.5% to $280.4 million for the year ended June 30,
2003 from $213.2 million for the year ended June 30, 2002. Average
borrowings increased by $3.5 million to $53.3 million for the year ended
June 30, 2003 from $49.9 million for the year ended June 30, 2002. Average
subordinated debt increased by $6.4 million to $7.6 million for the year
ended June 30, 2003 from $1.2 million for the year ended June 30, 2002.
The average rate on interest-bearing deposits decreased 89 basis points to
2.54% for the year ended June 30, 2003 from 3.43% for the year ended June
30, 2002, the average rate on borrowed funds decreased 30 basis points to
5.29% from 5.59% for the year ended June 30, 2002 and the average rate on
subordinated debt decreased 20 basis points to 5.23% for the year ended
June 30, 2003 from 5.52% for the year ended June 30, 2002.
Net Interest Income. Net interest income for the year ended June 30,
2003 was $11.0 million as compared to $9.7 million for the year ended June
30, 2002. The $1.3 million or 13.9% increase is attributed to the $1.5
million increase in interest and dividend income offset by the $171,000
increase in interest expense on deposits, borrowed funds and subordinated
debt. The average yield on interest earning assets decreased 100 basis
points to 5.73% for the year ended June 30, 2003 from 6.73% for the year
ended June 30, 2002, while the average cost on interest-bearing liabilities
decreased by 82 basis points to 3.03% for the year ended June 30, 2003 from
3.85% for the year ended June 30, 2002. As a result, the interest rate
spread decreased by 18 basis points to 2.70% for the year ended June 30,
2003 from 2.88% for the year ended June 30, 2002.
39
Provision for Loan Losses. The provision for loan losses was
$300,000 for the year ended June 30, 2003 as compared to $305,000 for the
year ended June 30, 2002. At June 30, 2003, the balance of the allowance
for loan losses was $2.3 million or .84% of total loans. During the year
ended June 30, 2003, $40,000 was charged against the allowance for loan
losses while $24,000 in recoveries was credited to the allowance for loan
losses. 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 allowance for loan losses while $4,000 in
recoveries was credited to the allowance for loan losses. There were two
non-performing loans with an aggregate balance of $223,000 at June 30,
2003. At June 30, 2002, there were two non-performing loans with an
aggregate balance of $108,000.
Non-interest Income. Non-interest income improved by $1.0 million or
90.4% to $2.2 million for the year ended June 30, 2003 as compared to $1.1
million for the year ended June 30, 2002. This increase was caused by
increased loan sale gains of $910,000 and an increase in net security gains
of $50,000 offset by a decrease in other income of $34,000.
Non-interest Expense. Non-interest expense increased by $2.2 million
or 28.1% to $10.1 million for the year ended June 30, 2003 as compared to
$7.9 million for the year ended June 30, 2002. This increase was caused by
higher personnel costs associated with the asset growth of the Bank,
marketing expenses incurred to capture deposit market share, expenses to
operate the branch office that opened in Bedford, MA in June 2002 and a
prepayment penalty expense of $468,000 relating to the early retirement of
various FHLB advances.
Provision for Income Taxes. The provision for income taxes was $1.1
million for the year ended June 30, 2003 as compared to $1.0 million for
the year ended June 30, 2002. The effective tax rate for the year ended
June 30, 2003 was 39.4% as compared to 38.8% for the year ended June 30,
2002.
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.
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 U.S. 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
40
$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
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, 2003 was 4.99%. Distributions on these
securities are payable semi-annually in arrears on April 22nd and October
22nd. A total of $5.0 million of floating rate trust preferred securities
were outstanding at June 30, 2002.
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 and 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 non-interest
expense of $599,000 offset by an increase in provision for loan losses of
$30,000, a decrease in non-interest 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 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
41
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. Average
subordinated debt increased by $1.2 million for the year ended June 30,
2002 from $0 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, the
average rate on borrowed funds decreased 65 basis points to 5.59% from
6.24% for the year ended June 30, 2001 and the average rate on subordinated
debt was 5.25% for the year ended June 30, 2002.
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.
Non-interest Income. Non-interest 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
42
by a decrease in gains from covered call options of $77,000 and a decrease
of miscellaneous income of $58,000.
Non-interest Expense. Non-interest expense 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.
Provision for Income Taxes. The provision for income taxes was $1.0
million for the year ended June 30, 2002 as compared to $721,000 million
for the year ended June 30, 2001. The effective tax rate for the year
ended June 30, 2002 was 38.8% as compared to 37.8% for the year ended June
30, 2001.
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, 2003 was 50.4%, 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, 2003, the Bank had borrowings of $41.2
million from the FHLB.
At June 30, 2003, the Bank had $18.6 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 $102.6 million at June 30, 2003. Based upon
historical experience, management believes that a significant portion of
such deposits will remain with the Bank.
On February 15, 2003, Mystic Financial Capital Trust II ("Trust II"),
a Delaware business trust formed by the Company, completed the sale of $7.0
million floating rate trust preferred securities in a private placement as
part of a pooled trust preferred securities transaction. Trust II also
issued common
43
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 II and are eliminated, along
with the related interest income, in the consolidated financial statements
of the Company. The trust preferred securities provide for cumulative cash
distributions calculated at a rate based on three-month LIBOR plus 3.25%.
The Company may, at one or more times, defer interest payments on the
capital securities for up to 20 consecutive quarterly interest payment
periods, but not beyond February 15, 2033. The Company has fully and
unconditionally guaranteed all of the obligations of the Trust II,
including the quarterly distributions and payments on liquidation or
redemption of the Capital Securities. The Capital Securities are
mandatorily redeemable upon the maturing of the Subordinated Debentures on
February 15, 2033 or upon earlier redemption as provided in the Indenture
Agreement. The Company has the right to redeem the Subordinated Debentures,
in whole or in part, on any February 15th, May 15th, August 15th or November
15th on or after February 15, 2008 at the liquidation amount, plus any
accrued but unpaid interest to the redemption date.
At June 30, 2003, 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, 2003 see "Notes to
Consolidated Financial Statements."
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that
have or are reasonably likely to have a current or future effect on the
Company's financial condition, revenues or expenses, results of operations,
liquidity, capital expenditures or capital resources that is material to
investors.
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.
Recent Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." This Statement amends
SFAS No. 123, "Accounting for Stock-Based Compensation," and provides three
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based compensation. In addition, this
Statement amends the disclosure requirements of SFAS No. 123. The
transition guidance and annual disclosure provisions of this Statement are
effective for fiscal years ending after December 15, 2002 and the interim
period disclosure provisions are effective for interim periods beginning
after December 31, 2002. This Statement did not have any effect on the
Company's consolidated financial statements.
44
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity." This Statement provides new rules on the accounting for certain
financial instruments that, under previous guidance, issuers could account
for as equity. Most of the guidance in SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period
beginning after June 30, 2003. This Statement is not expected to have
material effect on the Company's consolidated financial statements.
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.
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 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, 2003, 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. 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 June 30,
2003 (most recent).
45
Estimated NII Sensitivity
-------------------------
Rate Change Year One Year Two
----------- -------- --------
+200 basis points (0.92%) 2.73%
-100 basis points (0.05%) (3.23%)
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
Subsidiaries are included in pages F-1 through F-40 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Management, including the President and Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of Mystic
Financial's disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(e)) as of the end of the period covered by this
report. Based upon that evaluation, the President and Chief Executive
Officer and Chief Financial Officer concluded that the disclosure controls
and procedures were effective, in all material respects, to ensure that
information required to be disclosed in the reports that Mystic Financial
files and submits under the Exchange Act is recorded, processed, summarized
and reported as and when required.
There have been no changes in Mystic Financial's internal control
over financial reporting identified in connection with the evaluation that
occurred during Mystic Financial's last fiscal quarter that has materially
affected, or that is reasonably likely to materially affect, Mystic
Financial's internal control over financial reporting.
46
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included on pages 6 through 15, and page 27
of the Company's Proxy Statement for the 2003 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 16 through 27 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, 2003.
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 178,873 $12.31 66,584
Equity compensation
plans not approved
by security holders - - -
------- ------ ------
Total 178,873 $12.31 66,584
======= ====== ======
47
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included on page 27 of the Proxy Statement
is incorporated herein by reference: "Compensation of Directors and
Executive Officers-Transactions with Certain Related Persons."
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding principal accountant fees and services is
presented under the heading "Audit Committee Report" in Mystic Financial's
definitive Proxy Statement for the 2003 Annual Meeting of Stockholders to
be held on October 22, 2003, which has been filed with the SEC and is
incorporated herein by reference.
PART IV
ITEM 15. 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, 2003 and 2002 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, 2003, 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
48
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. *****
10.12 Guarantee Agreement dated February 14, 2003 by Mystic
Financial, Inc. and Wilmington Trust Company.
10.13 Indenture Agreement dated February 14, 2003 by Mystic
Financial, Inc. and Wilmington Trust Company.
21.1 Subsidiaries of the Registrant. *
23.1 Consent of Wolf & Company, P.C.
31.1 Certifications of the CEO and CFO Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certifications of the CEO and CFO Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
99.1 Proxy Statement for the 2003 Annual Meeting of Stockholders
of Mystic Financial, Inc. (previously filed with the
Securities and Exchange Commission on September 17, 2003).
49
- --------------------
* 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.
*** 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 February 14, 2002.
***** 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) Reports on Form 8-K.
The Company filed a current report on Form 8-K with the SEC
on April 24, 2003 reporting its earnings for the periods
ended March 31, 2003.
50
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 10, 2003.
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 and September 24, 2003
- ---------------------------- Chief Executive Officer,
Ralph W. Dunham (Principal executive
officer)
/s/ Anthony J. Patti Senior Vice-President, September 24, 2003
- ---------------------------- Chief Financial Officer
Anthony J. Patti and Treasurer (Principal
financial officer)
/s/ Julie Bernardin Director September 24, 2003
- ----------------------------
Julie Bernardin
/s/ Frederick N. Dello Russo Director September 24, 2003
- ----------------------------
Frederick N. Dello Russo
/s/ John A. Hackett Director September 24, 2003
- ----------------------------
John A. Hackett
/s/ Richard M. Kazanjian Director September 24, 2003
- ----------------------------
Richard M. Kazanjian
/s/ John W. Maloney Director September 24, 2003
- ----------------------------
John W. Maloney
/s/ John J. McGlynn Director, Chairman of September 24, 2003
- ---------------------------- the Board
John J. McGlynn
/s/ Lorraine P. Silva Director September 24, 2003
- ----------------------------
Lorraine P. Silva
51
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report F-2
Consolidated Balance Sheets as of June 30, 2003 and 2002 F-3
Consolidated Statements of Income for each of the years
in the three-year period ended June 30, 2003 F-4
Consolidated Statements of Changes in Stockholders' Equity
for each of the years in the three-year period ended June 30, 2003 F-5
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended June 30, 2003 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, 2003 and 2002, 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, 2003. 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, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 2003 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
July 16, 2003
F-2
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
----------------------
2003 2002
---- ----
(Dollars In Thousands)
Cash and due from banks $ 11,548 $ 18,155
Federal funds sold 6,734 10,653
Short-term investments 1,518 5,804
-------- --------
Total cash and cash equivalents 19,800 34,612
Securities available for sale, at fair value 117,871 65,900
Federal Home Loan Bank stock, at cost 2,932 2,932
Mortgage loans held for sale - 1,231
Loans, net of allowance for loan losses of $2,347
and $2,063, respectively 279,949 243,743
Banking premises and equipment, net 3,049 2,885
Real estate held for investment, net 1,541 1,586
Accrued interest receivable 1,780 1,784
Due from Co-operative Central Bank 929 929
Other assets 1,465 1,131
-------- --------
$429,316 $356,733
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $343,564 $267,438
Federal Home Loan Bank borrowings 41,200 58,135
Subordinated debt 12,000 5,000
Mortgagors' escrow accounts 925 792
Accrued interest payable 568 611
Due to broker 3,891 -
Accrued expenses and other liabilities 924 834
-------- --------
Total liabilities 403,072 332,810
-------- --------
Commitments and contingencies (Note 11)
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000
shares authorized; none issued - -
Common stock, $.01 par value, 5,000,000
shares authorized; 2,723,025 and 2,719,125
shares issued, respectively 27 27
Additional paid-in capital 25,819 25,699
Retained earnings 18,338 17,099
Treasury stock, at cost - 1,253,682 shares and
1,253,322 shares, respectively (17,131) (17,124)
Accumulated other comprehensive income 767 350
Unearned ESOP shares (1,293) (1,622)
Unearned RRP shares (283) (506)
-------- --------
Total stockholders' equity 26,244 23,923
-------- --------
$429,316 $356,733
======== ========
See accompanying notes to consolidated financial statements.
F-3
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
---------------------------------------------
2003 2002 2001
---- ---- ----
(Dollars In Thousands, Except Per Share Data)
Interest and dividend income:
Interest and fees on loans $ 17,542 $ 16,972 $ 16,597
Interest and dividends on securities 3,467 2,405 1,785
Other interest 379 491 1,040
---------- ---------- ----------
Total interest and dividend income 21,388 19,868 19,422
---------- ---------- ----------
Interest expense:
Deposits 7,123 7,313 7,196
Federal Home Loan Bank borrowings 2,820 2,789 2,771
Subordinated debt 399 69 -
---------- ---------- ----------
Total interest expense 10,342 10,171 9,967
---------- ---------- ----------
Net interest income 11,046 9,697 9,455
Provision for loan losses 300 305 275
---------- ---------- ----------
Net interest income, after provision for loan losses 10,746 9,392 9,180
---------- ---------- ----------
Other income:
Customer service fees 992 890 809
Gain on sales of securities available for sale, net 95 45 174
Gain on sales of loans 1,021 111 8
Miscellaneous 57 91 205
---------- ---------- ----------
Total other income 2,165 1,137 1,196
---------- ---------- ----------
Operating expenses:
Salaries and employee benefits 5,714 4,680 5,437
Occupancy and equipment expenses 1,291 1,001 907
Data processing expenses 358 335 345
Penalty on prepayment of Federal Home Loan Bank borrowings 468 - -
Other general and administrative expenses 2,250 1,855 1,781
---------- ---------- ----------
Total operating expenses 10,081 7,871 8,470
---------- ---------- ----------
Income before income taxes 2,830 2,658 1,906
Provision for income taxes 1,114 1,031 721
---------- ---------- ----------
Net income $ 1,716 $ 1,627 $ 1,185
========== ========== ==========
Earnings per share - basic $ 1.29 $ 1.11 $ 0.68
========== ========== ==========
Weighted average shares outstanding - basic 1,332,769 1,462,309 1,731,874
========== ========== ==========
Earnings per share - diluted $ 1.23 $ 1.08 $ 0.67
========== ========== ==========
Weighted average shares outstanding - diluted 1,390,807 1,504,249 1,767,902
========== ========== ==========
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, 2003, 2002 and 2001
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, 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
-------
Comprehensive income:
Net income - - 1,716 - - - - 1,716
Change in net unrealized
gains/losses on securities
available for sale, net of
reclassification adjustment
and tax effects - - - - 417 - - 417
-------
Total comprehensive income 2,133
-------
Cash dividends paid
($0.36 per share) - - (477) - - - - (477)
Purchase of treasury stock
(360 shares) - - - (7) - - - (7)
Stock options exercised
(3,900 shares) - 49 - - - - - 49
Decrease in unearned
ESOP shares - 71 - - - 329 - 400
Decrease in unearned
RRP shares - - - - - - 223 223
--- ------- ------- -------- ----- ------- ----- -------
Balance at June 30, 2003 $27 $25,819 $18,338 $(17,131) $ 767 $(1,293) $(283) $26,244
=== ======= ======= ======== ===== ======= ===== =======
See accompanying notes to consolidated financial statements.
F-5
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
-----------------------------------
2003 2002 2001
---- ---- ----
(In Thousands)
Cash flows from operating activities:
Net income $ 1,716 $ 1,627 $ 1,185
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 300 305 275
Net amortization (accretion) of securities 320 164 (51)
Amortization of unearned ESOP shares 400 365 339
Amortization of unearned RRP stock 223 201 224
Gain on sales of securities available for sale, net (95) (45) (174)
Depreciation and amortization expense 542 386 418
Deferred income tax provision (benefit) 17 (247) (75)
Net change in:
Loans held for sale 1,231 (957) 269
Accrued interest receivable 4 (374) (86)
Other assets (602) 71 58
Accrued interest payable (43) 53 77
Accrued expenses and other liabilities 90 129 44
--------- -------- --------
Net cash provided by operating activities 4,103 1,678 2,503
--------- -------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales 30,848 1,967 20,388
Maturities, prepayments and calls 31,365 11,637 14,769
Purchases (109,850) (50,395) (31,048)
Purchase of Federal Home Loan Bank stock - (400) (94)
Loans originated, net of payments received (36,506) (29,013) (26,110)
Purchases of banking premises and equipment (661) (715) (45)
Additions to real estate held for investment - - (37)
--------- -------- --------
Net cash used by investing activities (84,804) (66,919) (22,177)
--------- -------- --------
(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,
-----------------------------------
2003 2002 2001
---- ---- ----
(In Thousands)
Cash flows from financing activities:
Net increase in deposits 76,126 42,688 30,615
Proceeds from borrowings 18,096 22,500 17,900
Repayment of borrowings (35,031) (8,983) (12,032)
Proceeds from issuance of subordinated debt 7,000 5,000 -
Net increase in mortgagors' escrow accounts 133 36 84
Purchase of treasury stock (7) (7,069) (1,631)
Proceeds from exercise of stock options 49 36 60
Cash dividends paid (477) (484) (524)
--------- -------- --------
Net cash provided by financing activities 65,889 53,724 34,472
--------- -------- --------
Net change in cash and cash equivalents (14,812) (11,517) 14,798
Cash and cash equivalents at beginning of year 34,612 46,129 31,331
--------- -------- --------
Cash and cash equivalents at end of year $ 19,800 $ 34,612 $ 46,129
========= ======== ========
Supplemental information:
Interest paid $ 10,385 $ 10,118 $ 9,890
Income taxes paid, net 1,247 962 969
Due to broker 3,891 - -
See accompanying notes to consolidated financial statements.
F-7
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended June 30, 2003, 2002 and 2001
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 subsidiaries, Medford
Co-operative Bank (the "Bank") and Mystic Financial Capital Trust I and II
(the "Trusts"). 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 Trusts, (Mystic Financial
Capital Trust I formed in April 2002 and Mystic Financial Capital Trust II
formed in February 2003) were formed for the purpose of issuing trust
preferred securities and investing the proceeds from 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. A material estimate that is particularly
susceptible to significant change in the near term relates 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 interest-bearing deposits in the Bank Investment Fund-
Liquidity Fund and money market funds.
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 Bank is required to maintain average balances on hand or with the
Federal Reserve Bank. At June 30, 2003 and 2002, these reserve balances
amounted to $3,726,000 and $1,747,000, respectively.
Securities
Securities, 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 past due. Past due status is based on the contractual terms of
the loan. Loans are placed on non-accrual 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 non-
accrual 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 of imprecision inherent in the underlying assumptions used in the
methodologies for estimating losses in the portfolio.
Servicing
Effective July 1, 2002, the Company applied the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities."
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Capitalized servicing
rights are reported in other assets and are amortized into non-interest
income in proportion to, and over the period of, the estimated future net
servicing income of the underlying financial assets. Servicing assets are
evaluated for impairment based upon the fair value of the rights as compared
to amortized cost. Impairment is determined by stratifying rights by
predominant characteristics, such as interest rates and terms. Fair value is
determined using prices for similar assets with similar characteristics,
when available, or based upon discounted cash flows using market-based
assumptions. Impairment is recognized through a valuation allowance for an
individual stratum, to the extent that fair value is less than the
capitalized amount for the stratum.
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.
F-11
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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.
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
At June 30, 2003, the Company has one stock-based employee compensation
plan, which is described more fully in Note 14. The Company accounts for its
stock option plan under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in
net income, as all options granted under this plan had an exercise price
equal to the fair value of the underlying common stock on the date of the
grant. The following table illustrates the effect on net income and earnings
per share for the years ending June 30, if the Company had applied the fair
value recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, to the stock option plan.
F-12
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Years Ended June 30,
-------------------------------------
2003 2002 2001
---- ---- ----
(In Thousands, except per share data)
Net income as reported $1,716 $1,627 $1,185
Additional expense had the Company
adopted SFAS No. 123 (83) (85) (112)
Related tax benefit 33 34 45
------ ------ ------
Pro-forma net income $1,666 $1,576 $1,118
====== ====== ======
Basic earnings per share, as reported $ 1.29 $ 1.11 $ 0.68
Pro-forma basic earnings per share $ 1.25 $ 1.08 $ 0.65
Diluted earnings per share, as reported $ 1.23 $ 1.08 $ 0.67
Pro-forma diluted earnings per share $ 1.20 $ 1.05 $ 0.63
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 (continued)
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,
-------------------------
2003 2002 2001
---- ---- ----
(In Thousands)
Change in unrealized holding gains/losses
on available-for-sale securities $ 763 $ 453 $ 427
Reclassification adjustment for gains
realized in income (95) (45) (174)
----- ----- -----
Change in net unrealized gains/losses 668 408 253
Tax effect (251) (176) (80)
----- ----- -----
Net-of-tax amount $ 417 $ 232 $ 173
===== ===== =====
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; 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.
Recent accounting pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." This Statement amends SFAS No. 123,
"Accounting for Stock-Based Compensation," and provides three alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123. The transition guidance
and annual disclosure provisions of this Statement are effective for fiscal
years ending after December 15, 2002 and the interim period disclosure
provisions are effective for interim periods beginning after December 31,
2002. This Statement did not have any effect on the Company's consolidated
financial statements.
F-14
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Recent accounting pronouncements (concluded)
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
This Statement provides new rules on the accounting for certain financial
instruments that, under previous guidance, issuers could account for as
equity. Most of the guidance in SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June
30, 2003. This Statement is not expected to have material effect on the
Company's consolidated financial statements.
F-15
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, 2003
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In Thousands)
U.S. Government and
federal agency obligations $ 41,468 $ 534 $ - $ 42,002
Mortgage-backed securities 58,414 634 (32) 59,016
Other bonds and obligations 13,736 250 (166) 13,820
Marketable equity securities 3,009 238 (214) 3,033
-------- ------ ----- --------
Total $116,627 $1,656 $(412) $117,871
======== ====== ===== ========
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-16
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SECURITIES AVAILABLE FOR SALE (concluded)
The amortized cost and estimated fair value of debt securities by
contractual maturity at June 30, 2003 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 $ 9,019 $ 9,081
Over 1 year to 5 years 38,958 39,649
Over 5 years 7,227 7,092
-------- --------
55,204 55,822
Mortgage-backed securities 58,414 59,016
-------- --------
Total $113,618 $114,838
======== ========
During the years ended June 30, 2003, 2002 and 2001, proceeds from sales of
securities available for sale amounted to $30,848,000, $1,967,000 and
$20,388,000, respectively. Gross realized gains for 2003, 2002 and 2001
amounted to $581,000, $457,000 and $637,000, respectively, and gross
realized losses were $486,000, $412,000 and $463,000, respectively.
F-17
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. LOANS
A summary of the balances of loans follows:
June 30,
---------------------
2003 2002
(In Thousands)
Mortgage loans on real estate:
Fixed residential $ 97,477 $ 81,423
Adjustable residential 67,986 72,492
Commercial 69,785 58,889
Construction 16,557 11,015
Home equity lines of credit 9,385 4,965
-------- --------
261,190 228,784
-------- --------
Other loans:
Commercial 10,332 8,051
Commercial lines of credit 9,918 8,164
Personal 767 1,004
-------- --------
21,017 17,219
-------- --------
Total loans 282,207 246,003
Net deferred loan costs(fees) 89 (197)
Allowance for loan losses (2,347) (2,063)
-------- --------
Loans, net $279,949 $243,743
======== ========
An analysis of the allowance for loan losses follows:
Years Ended June 30,
----------------------------
2003 2002 2001
---- ---- ----
(In Thousands)
Balance at beginning of year $2,063 $1,784 $1,531
Provision for loan losses 300 305 275
Recoveries 24 4 5
Charge-offs (40) (30) (27)
------ ------ ------
Balance at end of year $2,347 $2,063 $1,784
====== ====== ======
F-18
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
LOANS (concluded)
At June 30, 2003 and 2002, the recorded investment in impaired loans
amounted to $209,000 and $103,000, 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, 2003, 2002, and
2001 amounted to $365,000, $28,000 and $19,000, respectively, and interest
income recognized on a cash basis on impaired loans amounted to $1,000,
$1,000 and $0, respectively. Non-accrual loans amounted to $223,000 and
$108,000 at June 30, 2003 and 2002, respectively.
4. SERVICING
Loans serviced for others are not included in the accompanying consolidated
balance sheets. The unpaid principal balances of loans serviced for others
were $38,924,000 and $23,873,000 at June 30, 2003 and 2002, respectively.
All loans serviced for others were sold without recourse provisions.
The balance of capitalized servicing rights included in other assets at June
30, 2003 was $248,000, and the fair value of these rights was $259,000. The
fair value of servicing rights was determined using a discount rate of 4.5%
and a prepayment rate of 18.0%.
Mortgage servicing rights capitalized and amortized during the year ended
June 30, 2003 amounted to $276,000 and $28,000, respectively. There was no
valuation allowance on capitalized servicing rights for the year ended June
30, 2003.
5. BANKING PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization of
banking premises and equipment is as follows:
June 30,
-------------------
2003 2002
---- ----
(In Thousands)
Banking premises:
Land $ 242 $ 242
Buildings and improvements 2,539 2,452
Leasehold improvements 568 564
Equipment 3,227 2,687
------- -------
6,576 5,945
Less accumulated depreciation and amortization (3,527) (3,060)
------- -------
$ 3,049 $ 2,885
======= =======
F-19
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
BANKING PREMISES AND EQUIPMENT (concluded)
Depreciation and amortization expense for the years ended June 30, 2003,
2002 and 2001 amounted to $467,000, $323,000 and $357,000, respectively.
6. 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,
-----------------
2003 2002
---- ----
(In Thousands)
Land $ 34 $ 34
Building 2,297 2,266
------ ------
2,331 2,300
Less accumulated depreciation (790) (714)
------ ------
$1,541 $1,586
====== ======
Depreciation expense for the years ended June 30, 2003, 2002 and 2001
amounted to $75,000, $63,000 and $61,000, respectively.
The following is a schedule of minimum future rental income on noncancelable
leases:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
2004 $ 92
2005 38
2006 11
----
$141
====
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, 2003, 2002 and 2001 amounted to
$124,000, $136,000 and $124,000, respectively.
F-20
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. DEPOSITS
A summary of deposit balances by type is as follows:
June 30,
--------------------
2003 2002
---- ----
(In Thousands)
NOW accounts $ 26,342 $ 26,971
IOLTA accounts 28,659 22,397
Demand deposits 25,871 19,856
Regular and other deposits 69,015 52,762
Money market deposits 51,719 21,466
-------- --------
Total non-certificate accounts 201,606 143,452
-------- --------
Term certificates less than $100,000 85,306 72,875
Term certificates of $100,000 or more 56,652 51,111
-------- --------
Total certificate accounts 141,958 123,986
-------- --------
Total deposits $343,564 $267,438
======== ========
A summary of certificate accounts, by maturity, is as follows:
June 30, 2003 June 30, 2002
-------------------- --------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ -------- ------ --------
(Dollars In Thousands)
Within 1 year $102,616 3.22% $ 63,938 3.97%
Over 1 year to 3 years 30,982 3.58 53,669 3.98
Over 3 years to 5 years 8,360 4.22 6,379 5.79
-------- --------
$141,958 3.36% $123,986 4.07%
======== ========
F-21
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. FEDERAL HOME LOAN BANK BORROWINGS
Federal Home Loan Bank borrowings consist of the following at June 30, 2003
and 2002:
Amount Weighted Average Rate
------------------ ---------------------
Maturity 2003 2002 2003 2002
- --------------------------- ---- ---- ---- ----
(In Thousands)
Year Ending June 30,
- --------------------
2003 $ - $11,500 -% 3.55%
2004 10,600 10,600 4.71 4.71
2005 (1) 7,000 12,400 6.85 6.83
2006 600 600 6.05 6.05
2007 (2) 7,000 7,000 5.37 5.37
2008 (3) 1,200 1,200 5.59 5.59
Thereafter (4) 14,000 14,000 4.88 4.88
Amortizing advance, due on
August 14, 2006, requiring
monthly payments of $7,793
including interest 800 835 6.97 6.97
------- -------
$41,200 $58,135 5.33% 5.12%
======= =======
Includes advances aggregating $6,000,000, callable on September 2,
2003.
Includes advances aggregating $3,000,00, callable on July 24, 2003.
Advance callable on August 11, 2003.
Includes advances aggregating $2,000,000, $2,000,000, $2,000,000,
$5,000,000 and $3,000,000, callable on July 8, 2003, July 25, 2003,
August 11, 2003, August 12, 2003 and September 22, 2003, respectively.
During the year ended, June 30, 2003, several advances amounting to
$16,600,000 were prepaid resulting in prepayment penalties of $468,000,
which were included in operating expense when incurred.
The following is a summary of maturities of borrowings at June 30, 2003:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
2004 $10,635
2005 7,041
2006 644
2007 7,680
2008 1,200
Thereafter 14,000
-------
$41,200
=======
F-22
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.
9. TRUST PREFERRED SECURITIES
In April 2002, Mystic Financial Capital Trust I was formed for the purpose
of issuing Trust Preferred Securities and investing the proceeds from 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, 2003 was 4.99%. Distributions on these
securities are payable semi-annually in arrears on April 22nd and October
22nd.
In February 2003, Mystic Financial Capital Trust II was formed for the
purpose of issuing Trust Preferred Securities and investing the proceeds
from the sale of these securities in subordinated debentures issued by the
Company. A total of $7 million of floating rate Trust Preferred Securities
were issued and are scheduled to mature in 2033, callable at the option of
the Company on February 15, 2008, with the prior approval of the Federal
Reserve Board. The floating rate as of June 30, 2003 was 4.54%.
Distributions on these securities are payable every three months in arrears
on February 15th, May 15th, August 15th and November 15th.
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.
F-23
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
10. INCOME TAXES
Allocation of federal and state income taxes between current and deferred
portions is as follows:
Years Ended June 30,
-------------------------
2003 2002 2001
---- ---- ----
(In Thousands)
Current tax provision:
Federal $ 871 $ 967 $635
State 226 311 161
------ ------ ----
Total current 1,097 1,278 796
------ ------ ----
Deferred tax provision (benefit):
Federal 12 (189) (55)
State 5 (58) (20)
------ ------ ----
Total deferred 17 (247) (75)
------ ------ ----
Total provision $1,114 $1,031 $721
====== ====== ====
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,
----------------------
2003 2002 2001
---- ---- ----
Statutory rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 5.4 6.3 4.9
Other, net - (1.5) (1.1)
---- ---- ----
Effective tax rates 39.4% 38.8% 37.8%
==== ==== ====
F-24
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,
-----------------
2003 2002
---- ----
(In Thousands)
Deferred tax asset:
Federal $ 888 $ 793
State 299 267
------ ------
1,187 1,060
Valuation reserve on asset (24) (24)
------ ------
1,163 1,036
------ ------
Deferred tax liability:
Federal (547) (236)
State (157) (73)
------ ------
(704) (309)
------ ------
Net deferred tax asset $ 459 $ 727
====== ======
The tax effects of each type of income and expense item that give rise to
deferred taxes are as follows:
June 30,
--------------
2003 2002
---- ----
(In Thousands)
Allowance for loan losses $961 $845
Net unrealized gain on securities available for sale (478) (227)
Other - 133
---- ----
483 751
Valuation reserve (24) (24)
---- ----
Net deferred tax asset $459 $727
==== ====
F-25
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,
----------------------
2003 2002 2001
---- ---- ----
(In Thousands)
Balance at beginning of year $727 $656 $661
Deferred tax (provision) benefit (17) 247 75
Deferred tax on net unrealized gain on
securities available for sale (251) (176) (80)
---- ---- ----
Balance at end of year $459 $727 $656
==== ==== ====
There was no change in the valuation reserve during the years ended June 30,
2003, 2002 and 2001.
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.
11. 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-26
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,
------------------
2003 2002
---- ----
(In Thousands)
Commitments to grant mortgage loans $ 9,209 $ 5,246
Commitments to grant commercial loans 9,370 7,570
Unadvanced funds on home equity lines of credit 11,555 5,717
Unadvanced funds on credit card loans - 1,510
Unadvanced funds on commercial lines of credit 9,920 9,299
Unadvanced funds on construction loans 14,016 9,976
Standby letters of credit 927 526
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 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. During fiscal 2003, the Bank
sold its credit card portfolio at its approximate book value.
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, 2003 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-27
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 year
ended June 30, 2001, compensation expense under these agreements amounted to
$861,000.
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 through the Directors eligible retirement age. Total expense
under this Plan amounted to $158,000, $34,000 and $17,000 for the years
ended June 30, 2003, 2002 and 2001, respectively.
Severance pay plan
The Bank has established a severance pay plan which entitles eligible
employees to receive a lump sum benefit equal to a maximum of 26 week'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, 2003, the future minimum rent commitments for leased premises are
as follows:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
2004 $ 421
2005 364
2006 282
2007 282
2008 279
Thereafter 457
------
Total $2,085
======
The leases contain 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, 2003, 2002 and 2001 amounted to
$385,000, $333,000 and $260,000, respectively.
F-28
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.
12. STOCKHOLDERS' EQUITY
Stock conversion
At the time of the conversion from mutual to stock form 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-29
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, 2003 and 2002, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of June 30, 2003, 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, 2003:
Total Capital to Risk Weighted Assets
Consolidated $36,326 14.7% $19,775 8.0% N/A N/A
Bank 37,730 15.4 19,583 8.0 $24,479 10.0%
Tier I Capital to Risk Weighted Assets
Consolidated 33,968 13.7 9,888 4.0 N/A N/A
Bank 35,372 14.5 9,792 4.0 14,688 6.0
Tier I Capital to Average Assets
Consolidated 33,968 8.2 16,657 4.0 N/A N/A
Bank 35,372 8.5 16,589 4.0 20,737 5.0
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 13,908 4.0 16,135 5.0
F-30
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
13. RELATED PARTY TRANSACTIONS
At June 30, 2003 and 2002, total loans to directors and officers of the Bank
greater than $60,000 on an individual basis amounted to $4,128,000 and
$3,615,000, respectively. During the years ended June 30, 2003 and 2002,
total principal additions were $2,587,000 and $1,611,000, respectively, and
total principal payments were $2,074,000 and $430,000, respectively.
14. 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, 2003, 2002 and 2001
amounted to $167,000, $127,000 and $137,000, 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 for the 401(k) plan for the years ended June 30, 2003, 2002
and 2001 amounted to $87,000, $72,000 and $69,000, 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-31
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,
------------------------
2003 2002
---- ----
Allocated 117,099 83,150
Committed to be allocated 10,715 11,316
Unallocated 89,076 122,424
---------- ----------
Total 216,890 216,890
========== ==========
Fair value of unallocated ESOP shares $1,960,000 $2,070,000
========== ==========
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 $400,000, $365,000 and
$339,000 for the years ended June 30, 2003, 2002, and 2001, respectively.
F-32
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.
A summary of the status of the Company's stock option plan is as follows:
Years Ended June 30,
-----------------------------------------------------------------
2003 2002 2001
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Fixed Options:
Outstanding at beginning of year 174,073 $12.06 184,691 $12.06 226,364 $12.06
Granted 8,700 17.38 - - - -
Exercised 3,900 12.61 3,000 12.06 5,000 12.06
Forfeited - - 7,618 12.06 36,673 12.06
------- ------- -------
Outstanding at end of year 178,873 $12.30 174,073 $12.06 184,691 $12.06
======= ======= =======
Options exercisable at year-end 142,160 $12.15 112,853 $12.06 85,546 $12.06
F-33
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
EMPLOYEE BENEFIT PLANS (concluded)
Stock option plan (concluded)
Information pertaining to options outstanding at June 30, 2003 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
- -------- ----------- ----------- -------- ----------- --------
$12.06 170,573 5.75 $12.06 139,660 $12.06
$17.38 8,300 9.50 $17.38 2,500 $17.38
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model. The assumptions used for grants
during the year ended June 30, 2003 were dividend yield of 1.96%, expected
life of 6.50 years, expected volatility of 20.58%, and a risk-free interest
rate of 4.03%. The fair value of options granted during the year ended June
30, 2003 was $4.01.
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, 2003, 2002, and 2001, awards were granted with respect to 3,900, 0, and
4,500 shares, respectively. Shares forfeited during the years ended June 30,
2003, 2002 and 2001 amounted to 360, 4,171 and 15,135 shares, respectively.
As of June 30, 2003, 69,000 vested shares had been distributed to eligible
participants. Compensation expense amounted to $230,000, $211,000 and
$254,000 for the years ended June 30, 2003, 2002 and 2001, 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 for the year
ended June 30, 2001.
F-34
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
15. 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, 2003, $15,341,000 of the Company's
equity in the Bank was restricted and funds available for loans and advances
amounted to $4,836,000.
16. 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 commitments
on hand from investors or prevailing 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.
F-35
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
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 fair value of subordinated debt is estimated
using discounted cash flow analysis based on current market rates for
similar types of debt agreements.
Accrued interest: The carrying amounts of accrued interest approximate
fair value.
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,
--------------------------------------------
2003 2002
-------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
(In Thousands)