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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2004
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)
(Registrant's telephone number including area code)
(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 15, 2004, the aggregate market value of the voting and non-
voting common equity held by non-affiliates of the Registrant was
approximately $45,549,496.
As of September 15, 2004, 1,565,945 shares of Registrant's common stock
were outstanding.
Documents Incorporated by Reference:
Portions of the Registrant's Proxy Statement for its 2004 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, 2004
TABLE OF CONTENTS
PART I
ITEM 1. Business 1
ITEM 2. Properties 27
ITEM 3. Legal Proceedings 27
ITEM 4. Submission of Matters to a Vote of Security Holders 27
PART II
ITEM 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities 28
ITEM 6. Selected Financial Data 29
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 30
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk 41
ITEM 8. Financial Statements and Supplementary Data 42
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
ITEM 9A. Controls and Procedures 42
PART III
ITEM 10. Directors and Executive Officers of the Registrant 43
ITEM 11. Executive Compensation 43
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management 43
ITEM 13. Certain Relationships and Related Transactions 44
PART IV
ITEM 14. Principal Accounting Fees and Service 44
ITEM 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 44
SIGNATURES 48
PART I
Forward Looking Statements
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, not adjusted to reflect the Company's 5% stock dividend declared
on July 9, 2003. The
1
conversion of the Bank from mutual to stock form, the formation of the
Company as the 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 227,735 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.
Mystic Financial Capital Trust I issued $5.0 million of floating-rate trust
preferred securities on April 10, 2002. The trust preferred securities are
scheduled to mature in 2032, and are callable at the option of the Company
on April 22, 2007 with the prior approval of the Federal Reserve Board. As
of June 30, 2004, the floating-rate was 5.07%. Distributions on these
securities are payable semi-annually in arrears on April 22nd and October
22nd. In February 2003, Mystic Financial Capital Trust II issued $7.0
million of floating-rate trust preferred securities that are scheduled to
mature in 2033, and are callable at the option of the Company on February
15, 2008, with the prior approval of the Federal Reserve Board. As of June
30, 2004 the floating-rate was 4.50%. Distributions on these securities
are payable quarterly 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 an
additional four full-service offices in Lexington, Arlington, Bedford and
Malden, Massachusetts. The Bank's deposits are 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, 2004.
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
2
approximate or exceed interest-bearing liabilities, any positive interest
rate spread will generate net interest income.
The Bank has one active subsidiary, Mystic Securities Corporation,
which was established for the sole purpose of acquiring and holding
securities. All securities held by Mystic Securities Corporation are
investments which are permissible for banks to hold under Massachusetts
law.
On July 7, 2004, Mystic entered into an agreement and plan of merger
with Brookline Bancorp, Inc., ("Brookline") pursuant to which Brookline
will acquire Mystic in an exchange of cash and stock. Brookline is
headquartered in Brookline, Massachusetts, and operates Brookline Bank.
Under the terms of the agreement, stockholders of Mystic will be entitled
to receive either cash or shares of Brookline common stock, subject to
election and allocation procedures which are intended to ensure that, in
aggregate, 40% of the shares of Mystic are converted into the right to
receive cash of $39.00 per share and that 60% are converted into the right
to receive a fixed exchange of 2.6786 shares of Brookline common stock for
each share of Mystic. It is anticipated that the merger will close in the
first quarter of 2005, provided that regulatory and Mystic shareholder
approvals are obtained. In connection with the merger of Mystic and
Brookline, Medford Co-operative Bank will merge into Brookline Bank.
Market Area
The Bank's main office and two of its branch offices are located in
Medford, Massachusetts. The Bank has full-service offices in Lexington,
Arlington, Bedford and Malden, Massachusetts. The Bank's Malden office
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
towns of Arlington and Malden contain 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, Bedford, Woburn and
Reading, 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 4,000, 1,400, and 900 employees, 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
3
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 and non-mortgage loans. The primary
factors in competing for loans are interest rates, loan origination fees,
and the range of services offered.
While the Bank is subject to competition from other financial
institutions, which may have greater financial and marketing resources, the
Bank believes it benefits from its community bank orientation and from 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, Melrose, Woburn, and Reading 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 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.
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,
-------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Residential mortgage loans $167,701 53.8% $165,463 59.1% $153,915 63.1% $138,163 64.2% $127,862 67.6%
Commercial real estate loans 80,071 25.7 69,785 24.9 58,889 24.2 50,483 23.5 41,294 21.8
Commercial loans 21,580 6.9 20,250 7.2 16,215 6.7 13,514 6.3 10,881 5.8
Consumer loans 687 0.2 767 0.3 1,004 0.4 1,532 0.7 1,526 0.8
Home equity loans 18,171 5.8 9,385 3.4 4,965 2.0 3,880 1.8 3,470 1.8
Construction loans 26,069 8.4 16,557 5.9 11,015 4.5 9,282 4.3 5,686 3.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans 314,279 100.8 282,207 100.8 246,003 100.9 216,854 100.8 190,719 100.8
Deferred loan origination
(fees) costs 64 - 89 - (197) (0.1) (35) - 12 -
Allowance for loan losses (2,537) (0.8) (2,347) (0.8) (2,063) (0.8) (1,784) (0.8) (1,531) (0.8)
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Loans, net $311,806 100.0% $279,949 100.0% $243,743 100.0% $215,035 100.0% $189,200 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
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, 2004, loans on one- to four-
family residential properties accounted for 53.6% of the Bank's net loan
portfolio.
During the year ended June 30, 2004, the Bank originated $38.1
million in adjustable-rate mortgage loans and $50.2 million in fixed-rate
mortgage loans. Of the fixed-rate loans originated, the Bank sold $24.3
million fixed-rate loans with terms of greater than 15 years and retained
$25.9 million fixed-rate loans, which had terms of 15 to 30 years.
Approximately 26.5% of all loan originations during fiscal 2004 were
refinances of loans already in the Bank's loan portfolio. At June 30, 2004,
the Bank's loan portfolio included $71.5 million in adjustable-rate one- to
four-family residential mortgage loans or 22.9% of the Bank's net loan
portfolio, and $96.2 million in fixed-rate one- to four-family residential
mortgage loans, or 30.9% of the Bank's net loan portfolio.
Commercial Real Estate Loans. At June 30, 2004, the Bank's
commercial real estate loan portfolio consisted of 167 loans, totaling
$80.1 million, or 25.7% of net loans. The Bank's largest aggregate loan
relationship is a commercial borrower with an outstanding balance of $6.3
million at June 30, 2004 secured by various properties in Massachusetts.
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 lends to companies that have $500,000 to
$15.0 million in sales. At June 30, 2004, the Bank's commercial loan
portfolio consisted of 192 loans, totaling $21.6 million, or 6.9% of net
loans.
Consumer Loans. The Bank's consumer loans consist of passbook and
automobile loans. At June 30, 2004, the consumer loan portfolio totaled
$687,000 or 0.2% of net loans.
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 are
made for up to 90% 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, 2004, the Bank
had $18.2 million in home equity loans with unused credit available to
existing borrowers of $27.8 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
construction loans are for the construction or 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, 2004, the Bank's construction loan
portfolio totaled $58.0 million, offset by $31.9 million in unadvanced
principal.
Loan Commitments. The Bank generally makes loan commitments to
borrowers not exceeding 60 days. At June 30, 2004, the Bank had $28.7
million in loan commitments outstanding, all for the
6
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 $71.4 million on June 30, 2004.
Loan Maturities. The following table sets forth certain information
at June 30, 2004 regarding the dollar amount of loans maturing in the
Bank's commercial real estate, commercial construction and commercial loan
portfolio based on their contractual terms to maturity.
Commercial Commercial
Real Estate Construction Commercial
Loans Loans Loans Total
----------- ------------ ---------- -----
(In thousands)
Loan balance by type scheduled
to mature after 1 year:
Fixed-rate $ 1,553 $ - $3,062 $ 4,615
Adjustable-rate 78,501 5,658 6,813 90,972
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. The Bank continues to service all loans sold to Fannie Mae.
At June 30, 2004, the Bank was servicing $45.4 million in loans for Fannie
Mae and $354,000 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, 2004,
the Bank was servicing $237,000 of such loans.
Originations for the year ended June 30, 2004 decreased in all loan
categories except home equity loan originations that increased by $17.3
million. Loan sales decreased during the same period due to a higher
demand for an adjustable-rate product. 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.
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.
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The following table sets forth the Bank's problem assets and loans at
the dates indicated.
At June 30,
----------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Loans 30-89 days past due
(not included in non-performing loans) $1,335 $1,297 $1,191 $1,854 $ 540
Loans 90 days or more past due
(not included in non-performing loans) - - - 276 148
------ ------ ------ ------ ------
Total delinquent loans $1,335 $1,297 $1,191 $2,130 $ 688
====== ====== ====== ====== ======
Delinquent loans as a percentage of net loans 0.43% 0.46% 0.49% 0.99% 0.36%
====== ====== ====== ====== ======
Non-performing loans (over 90 days past due) $1,822 $ 223 $ 108 $ 15 $ 2
------ ------ ------ ------ ------
Total non-performing loans $1,822 $ 223 $ 108 $ 15 $ 2
====== ====== ====== ====== ======
Non-performing loans as a percent of total
loans 0.58% 0.08% 0.04% 0.01% 0.00%
At June 30, 2004, management was not aware of any loans not currently
classified as non-accrual, 90 days past due or restructured that 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 as 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, 2004, the Bank had loans in
the amount of $133,000 classified as doubtful or loss, and loans in the
amount of $3.2 million 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
8
the 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,
--------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Average loans, net $291,535 $257,519 $226,711 $205,837 $173,319
======== ======== ======== ======== ========
Year-end net loans $311,806 $279,949 $243,743 $215,035 $189,200
======== ======== ======== ======== ========
Allowance for loan losses at
beginning of year $ 2,347 $ 2,063 $ 1,784 $ 1,531 $ 1,348
Provision charged to operations 584 300 305 275 200
Recoveries:
Real estate mortgage:
Residential - - - - -
Commercial - - - - -
Commercial loans - 3 - 2 -
Consumer and home equity 15 21 4 3 6
Construction - - - - -
-------- -------- -------- -------- --------
Total recoveries 15 24 4 5 6
-------- -------- -------- -------- --------
Charge-offs:
Real estate mortgage:
Residential - - - - -
Commercial - - - - -
Commercial loans (400) - (12) - -
Consumer and home equity (9) (40) (18) (27) (23)
Construction - - - - -
-------- -------- -------- -------- --------
Total charge-offs (409) (40) (30) (27) (23)
-------- -------- -------- -------- --------
Net charge-offs (394) (16) (26) (22) (17)
-------- -------- -------- -------- --------
Allowance for loan losses at end of year $ 2,537 $ 2,347 $ 2,063 $ 1,784 $ 1,531
======== ======== ======== ======== ========
Ratios:
Allowance for loan losses to year-end net loans 0.81% 0.84% 0.85% 0.83% 0.81%
Net charge-offs to average loans, net 0.14% 0.01% 0.01% 0.01% 0.01%
Net charge-offs to allowance for loan losses 15.53% 0.68% 1.26% 1.23% 1.11%
9
Allowance for Loan Losses
The allowance for loan losses is an estimate of the amount necessary
to absorb probable losses in the loan portfolio. The allowance consists of
specific, general and unallocated components. Commercial real estate and
commercial business loans are evaluated individually for allowance
purposes. Other categories of loans are generally evaluated as a group.
The specific component relates to loans that are classified as doubtful,
substandard or special mention. Loans classified as doubtful are
considered impaired in accordance with SFAS No. 114, and an allowance is
determined using the fair value of existing collateral. Loss factors for
loans are based on the Company's historical loss experience with similar
loans of similar quality as determined by the Company's internal rating
system. Loss factors are then adjusted for additional points that consider
qualitative factors such as current economic trends (both local and
national), concentrations, growth and performance trends and the results of
risk management assessments. Accordingly, increases or decreases in the
amount of each loan category as well as the ratings of the loans within
each category are considered in calculating the overall allowance. The
allowance is an estimate, and ultimate losses may vary from current
estimates. As adjustments become necessary, they are reported in earnings
of the periods in which they become known.
For the each of the years in the preceding table, the provision was
principally impacted by growth in the portfolio, as credit quality remained
strong. In fiscal year 2004, the increased provision was necessary due to
a specific reserve allocated to one impaired loan.
10
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,
--------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------------- -------------------- -------------------- -------------------- --------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each Loans in Each Loans in Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
------ ------------- ------ ------------- ------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
Real estate-mortgage:
Residential and
home equity $ 489 59.1% $ 628 58.6% $ 588 62.6% $ 578 63.7% $ 563 67.0%
Commercial 1,083 25.5 947 24.7 827 23.9 767 23.3 687 21.7
Commercial loans 463 6.9 466 7.2 373 6.6 240 6.2 172 5.7
Consumer 12 0.2 11 3.6 30 2.4 34 2.5 19 2.6
Construction 490 8.3 295 5.9 245 4.5 165 4.3 90 3.0
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total allowance for
loan losses $2,537 100.0% $2,347 100.0% $2,063 100.0% $1,784 100.0% $1,531 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
11
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,
2004, 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,
---------------------------------------------------------------------
2004 2003 2002
------------------- ------------------- -------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ----- --------- ----- --------- -----
(Dollars in thousands)
Securities available for sale:
Marketable equity securities $ 3,022 $ 3,376 $ 3,009 $ 3,033 $ 2,698 $ 2,586
U.S. Government and federal
agency obligations 2,444 2,394 41,468 42,002 25,198 25,517
Corporate 8,549 8,566 7,565 7,655 8,668 8,685
Mortgage-backed securities 67,622 65,839 58,414 59,016 28,759 29,112
Other 8,775 8,549 6,171 6,165 - -
------- ------- -------- -------- ------- -------
Total $90,412 $88,724 $116,627 $117,871 $65,323 $65,900
======= ======= ======== ======== ======= =======
Securities held to maturity:
U.S. Government and federal
agency obligations $11,287 $11,032 $ - $ - $ - $ -
------- ------- -------- -------- ------- -------
Total $11,287 $11,032 $ - $ - $ - $ -
======= ======= ======== ======== ======= =======
12
The following table sets forth the final maturity dates, carrying values
and average yields for the Bank's debt securities at June 30, 2004.
At June 30, 2004
--------------------------------------------------------------------------------------------------
One Year One to Over Five through Over
or Less Five Years Ten Years Ten Years Totals
------------------ ------------------ ------------------ ------------------ ------------------
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
--------- ------- --------- ------- --------- ------- --------- ------- --------- -------
(Dollars in thousands)
Securities available for sale:
U.S. Government and federal
agency obligations $ - -% $ 2,444 2.72% $ - -% $ - -% $ 2,444 2.72%
Other bonds and obligations 4,019 6.39 11,056 3.24 - - 2,249 2.37 17,324 3.86
Mortgage-backed securities - - 14,321 3.82 21,683 3.76 31,618 4.13 67,622 4.25
------ ------- ------- ------- -------
Total $4,019 6.39% $27,821 3.49% $21,683 3.76% $33,867 4.01% $87,390 4.13%
====== ======= ======= ======= =======
Securities held to maturity:
U.S. Government and federal
agency obligations $ - -% $ 2,500 3.61% $ - -% $ 8,787 4.13% $11,287 4.06%
------ ------- ------- ------- -------
Total $ - -% $ 2,500 3.61% $ - -% $ 8,787 4.13% $11,287 4.06%
====== ======= ======= ======= =======
13
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.
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,
------------------------------------------------------------------------
2004 2003 2002
-------------------- -------------------- --------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Savings deposit $ 83,001 23.6% $ 69,015 20.1% $ 52,762 19.7%
NOW accounts 26,292 7.5 26,342 7.7 26,971 10.1
IOLTA accounts 12,505 3.6 28,659 8.4 22,397 8.4
Money market deposits 54,968 15.6 51,719 15.1 21,466 8.0
Demand deposits 36,066 10.3 25,871 7.5 19,856 7.4
Certificate of deposits 138,575 39.4 141,958 41.2 123,986 46.4
-------- ----- -------- ----- -------- -----
Total deposits $351,407 100.0% $343,564 100.0% $267,438 100.0%
======== ===== ======== ===== ======== =====
For more information on the Bank's deposit accounts, see Note 7 of
Notes to Consolidated Financial Statements.
14
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,
2004.
Weighted
Average
Maturity Period Certificates of Deposit Rate
--------------- ----------------------- --------
(Dollars in thousands)
0-3 months $ 9,146 1.85%
3-6 months 6,218 1.90
6-12 months 7,030 1.92
1-2 years 17,825 3.30
2-3 years 10,105 3.27
> 3 years 4,719 3.98
-------
Total $55,043 2.78%
=======
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 $47.9 million
outstanding at June 30, 2004.
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.
Personnel
As of June 30, 2004, the Bank had 82 full-time employees and 21 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.
15
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.
State and Local Taxation
Massachusetts. 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.
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.
16
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.
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
17
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 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
18
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.
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, 2004. 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 $42,499 16.3% $20,842 8.0% N/A N/A
Bank 39,302 15.1 20,779 8.0 $25,973 10.0%
Tier 1 Capital to Risk Weighted Assets
Consolidated 36,964 14.2 10,421 4.0 N/A N/A
Bank 36,596 14.1 10,389 4.0 15,584 6.0
Tier 1 Capital to Average Assets
Consolidated 36,964 8.6 17,192 4.0 N/A N/A
Bank 36,596 8.6 17,095 4.0 21,368 5.0
As the preceding table shows, the Company and the Bank exceeded the
minimum capital adequacy requirements at June 30, 2004.
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.
19
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.
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 that 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
20
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, rescinded
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 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
21
procedures and documentation, approval and reporting requirements. The real
estate lending policies must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies that have been adopted by the
federal bank regulators.
Safety and Soundness Standards. Pursuant to the requirements of
FDICIA, as amended by the Riegle Community Development and Regulatory
Improvement Act of 1994, each federal banking agency, including the FDIC,
has adopted guidelines establishing general standards relating to internal
controls, information and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, asset quality,
earnings, and compensation, fees and benefits. In general, the guidelines
require, among other things, appropriate systems and practices to identify
and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound
practice and describe compensation as excessive when the amounts paid are
unreasonable or disproportionate to the services performed by an executive
officer, employee, director, or principal shareholder. In addition, the
FDIC adopted regulations to require a bank that is given notice by the FDIC
that it is not satisfying any of such safety and soundness standards to
submit a compliance plan to the FDIC. If, after being so notified, a bank
fails to submit an acceptable compliance plan or fails in any material
respect to implement an accepted compliance plan, the FDIC may issue an
order directing corrective and other actions of the types to which a
significantly undercapitalized institution is subject under the "prompt
corrective action" provisions of FDICIA. If a bank fails to comply with
such an order, the FDIC may seek to enforce such an order in judicial
proceedings and to impose civil monetary penalties.
Prompt Corrective Action. FDICIA also established a system of prompt
corrective action to resolve the problems of undercapitalized institutions.
The FDIC, as well as the other federal banking regulators, adopted
regulations governing the supervisory actions that may be taken against
undercapitalized institutions. The regulations establish five categories,
consisting of "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." At June 30, 2004, 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 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
22
basis substantially similar to those of the FDIC for the Bank. As of June
30, 2004, the Company's total capital and Tier 1 capital ratios exceeded
these minimum capital requirements.
The Company will be required to obtain the prior approval of the FRB
to acquire all, or substantially all, of the assets of any bank or bank
holding company. Prior FRB approval will be required for the Company to
acquire direct or indirect ownership or control of any voting securities of
any bank or bank holding company if, after giving effect to such
acquisition, it would, directly or indirectly, own or control more than 5%
of any class of voting shares of such bank or bank holding company.
The Company will be required to give the FRB prior written notice of
any purchase or redemption of its outstanding equity securities if the
gross consideration for the purchase or redemption, when combined with the
net consideration paid for all such purchases or redemptions during the
preceding 12 months, will be equal to 10% or more of the Company's
consolidated net worth. The FRB may disapprove such a purchase or
redemption if it determines that the proposal would constitute an unsafe
and unsound practice, or would violate any law, regulation, FRB order or
directive, or any condition imposed by, or written agreement with, the FRB.
Such notice and approval is not required for a bank holding company that
would be treated as "well capitalized" under applicable regulations of the
FRB, that has received a composite "1" or "2" rating at its most recent
bank holding company inspection by the FRB, and that is not the subject of
any unresolved supervisory issues.
The status of the Company as a registered bank holding company under
the BHCA does not exempt it from certain federal and state laws and
regulations applicable to corporations generally, including, without
limitation, certain provisions of the federal securities laws.
In addition, a bank holding company which does not qualify as a
financial holding company under the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 (the "GLBA") is generally prohibited from
engaging in, or acquiring direct or indirect control of any company engaged
in non-banking activities. One of the principal exceptions to this
prohibition is for activities found by the Federal Reserve Board to be so
closely related to banking or managing or controlling banks as to be
permissible. Some of the principal activities that the Federal Reserve
Board has determined by regulation to be so closely related to banking as
to be permissible are:
* 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 that 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.
23
As of June 30, 2004, 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.
The Company is subject to capital adequacy guidelines for bank
holding companies (on a consolidated basis) that are substantially similar
to those of the FDIC for the Bank. The Company's stockholders' equity
exceeds these requirements. The FRB in May 2004 proposed to continue to
permit trust preferred securities to qualify as an element of bank holding
companies Tier 1 capital but on a more limited basis. The proposal in
general would continue to limit the aggregate amount of trust preferred
securities and certain other restricted core capital elements to 25% of
Tier 1 capital, net of goodwill. Previously, however, goodwill was not
deducted when calculating the 25% limit. The amount of trust preferred
securities and other restricted core capital elements in excess of the
limit could be included in Tier 2 capital, subject to certain limits. The
new limits would become fully effective on March 31, 2007. Before then,
bank holding companies with outstanding trust preferred securities and
other restricted core capital elements that do not conform to the new
limits would be asked to consult with their Federal Reserve Banks on plans
to ensure that the companies are not placing undue reliance on these
instruments and, where appropriate, to reduce such reliance.
The Company's wholly-owned subsidiaries, Mystic Financial Capital
Trust I ("Trust I") and Mystic Financial Trust II ("Trust II"), have
participated in pooled offerings of trust preferred securities. In
connection with the offerings, Trust I and Trust II, respectively, issued
$5.0 million in April 2002 and $7.0 million in February 2003 of trust
preferred securities and reinvested the proceeds in 30-year, subordinated
debenture issued by the Company. Approximately $9.2 million of the
proceeds of the offerings qualified as an element of the Company's Tier 1
capital under both the current and proposed FRB capital adequacy
guidelines, representing the maximum allowed under the 25.0% limitation as
of June 30, 2004. The Company currently does not have any goodwill.
Federal Home Loan Bank System
The Bank is a member of the FHLB of Boston, which is one of the
regional FHLBs composing the FHLB System. Each FHLB provides a central
credit facility primarily for its member institutions. The Bank, as a
member of the FHLB of Boston, must 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. The Bank was in compliance with this requirement with an
investment in FHLB of Boston stock at June 30, 2004 of $3.2 million. Any
advances from a FHLB must be secured by specified types of collateral, and
all long-term advances may be obtained only for the purpose of providing
funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of
insolvent thrifts and to contribute funds for affordable housing programs.
These requirements could reduce the amount of earnings that the FHLBs can
pay as dividends to their members and could also result in the FHLBs
imposing a higher rate of interest on advances to their members. If
dividends were reduced, or interest on future FHLB advances increased, the
Bank's net interest income would be affected.
Under the Gramm-Leach Bliley Financial Services Modernization Act,
membership in the FHLB is now voluntary for all state chartered banks, such
as the Bank. The Gramm-Leach Bliley Act also
24
replaces the existing redeemable stock structure of the FHLB System with a
capital structure that requires each FHLB to meet a leverage limit and a
risk-based permanent capital requirement. Two classes of stock are
authorized: Class A (redeemable on 6-months notice) and Class B (redeemable
on 5-years notice).
Federal Reserve System
Under Federal Reserve Board regulations, the Bank is required to
maintain noninterest-earning reserves against its transaction accounts.
The Federal Reserve Board regulations generally require that reserves of 3%
must be maintained against aggregate transaction accounts of $38.8 million
or less, subject to adjustment by the Federal Reserve Board. Total
transaction accounts in excess of $38.8 million are required to have a
reserve of 10% held against them, which are also subject to adjustment by
the Federal Reserve Board. The first $6.6 million of otherwise reservable
balances, subject to adjustments by the Federal Reserve Board, are exempted
from the reserve requirements. The Bank is in compliance with these
requirements. Because required reserves must be maintained in the form of
either vault cash, a noninterest-bearing account at a Federal Reserve Bank
or a pass-through account as defined by the Federal Reserve Board, the
effect of this reserve requirement is to reduce the Bank's interest-earning
assets.
Other Federal Regulation
The USA PATRIOT Act
In response to the events of September 11th, 2001, 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.
* Pursuant to Section 326, on May 9, 2003, the Secretary of the
Department of Treasury, in conjunction with other bank
regulators issued Joint Final Rules that provide for minimum
standards with respect to customer identification and
verification. These rules became effective on October 1, 2003.
* 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
25
States) to establish appropriate, specific, and, where
necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering.
* Effective December 25, 2001, financial institutions are
prohibited from establishing, maintaining, administering or
managing correspondent accounts for foreign shell banks
(foreign banks that do not have a physical presence in any
country), and will be subject to certain record keeping
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.
The 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. 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 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.
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.
26
Federal Securities Law
Our common stock is registered with the Securities and Exchange
Commission under Section 12(g) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). We are subject to information, proxy
solicitation, insider trading restrictions, and other requirements under
the Exchange Act.
ITEM 2. PROPERTIES
The following table sets forth certain information at June 30, 2004
regarding the Bank's Medford office facilities, which are owned by the
Bank, the Lexington, Arlington, Bedford and Malden offices, which are
leased, and certain other information relating to its property at that
date.
Year Square
Acquired Footage
-------- -------
Main Office 60 High Street 1931 7,000
Medford, MA 02155
West Medford Office 430 High Street 1970 2,500
Medford, MA 02155
Salem Street Office 201 Salem Street 1995 3,500
Medford, MA 02155
Lexington Office 1793 Massachusetts Avenue 1998 3,000
Lexington, MA 02420
Arlington Office 856 Massachusetts Avenue 2000 3,000
Arlington, MA 02476
Bedford Office 168 Great Road 2002 2,500
Bedford, MA 01730
Malden Office 280 Medford Street 2003 3,000
Malden, MA 02148
The Bank also owns an office building adjacent to its main office,
located at 66 High Street, Medford, MA 02155. 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.
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, 2004.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
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, 2004, the last trading date in the Company's fiscal
year, the Company's common stock closed at $32.15. On September 15, 2004,
there were 1,565,945 shares of the Company's common stock outstanding,
which were held of record by approximately 850 stockholders, not including
persons or entities that hold the stock in nominee or "street" name through
various brokerage firms.
The Board of Directors considers paying dividends, dependent on the
results of operations and financial condition of the Company, tax
considerations, industry standards, economic conditions, regulatory
restrictions and other factors. There are significant regulatory
limitations on the Company's ability to pay dividends depending on the
dividends it receives from its subsidiary, Medford Co-operative Bank, which
are subject to regulations and the Bank's continued compliance with all
regulatory capital requirements and the overall health of the institution.
Share amounts for the fiscal year ended June 30, 2003 have been
restated to reflect the Company's 5% stock dividend declared on July 9,
2003.
Quarter Ended High Low Dividends
- ------------- ---- --- ---------
Fiscal year ended June 30, 2004:
Fourth Quarter ended June 30, 2004 $32.750 $28.100 $0.115
Third Quarter ended March 31, 2004 33.470 29.500 0.100
Second Quarter ended December 31, 2003 30.230 24.000 0.100
First Quarter ended September 30, 2003 25.220 20.476 0.100
Fiscal year ended June 30, 2003:
Fourth Quarter ended June 30, 2003 $21.981 $16.867 $0.086
Third Quarter ended March 31, 2003 17.638 16.705 0.086
Second Quarter ended December 31, 2002 17.619 15.429 0.086
First Quarter ended September 30, 2002 17.286 15.457 0.086
28
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. All share amounts
have been restated to reflect the Company's 5% stock dividend declared on
July 9, 2003.
At or For the Years Ended June 30,
-----------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Balance sheet data:
Total assets $ 441,192 $ 429,689 $ 356,733 $ 300,402 $ 263,888
Loans, net 311,806 279,949 243,743 215,035 189,200
Securities:
Available for sale 88,724 117,871 65,900 28,820 32,452
Held to maturity 11,287 - - - -
Deposits 351,407 343,564 267,438 224,750 194,135
Borrowings 47,861 41,200 58,135 44,618 38,750
Subordinated debt 12,373 12,373 5,155 - -
Total stockholders' equity 26,740 26,244 23,923 29,015 29,189
Asset quality data:
Non-performing loans 1,822 223 108 15 2
Allowance for loan losses 2,537 2,347 2,063 1,784 1,531
Number of employees:
Full-time 82 75 66 55 62
Part-time 21 20 25 25 28
Statement of income data:
Interest and dividend income $ 21,377 $ 21,388 $ 19,868 $ 19,422 $ 16,177
Interest expense 8,238 10,342 10,171 9,967 7,446
--------- --------- --------- --------- ---------
Net interest income 13,139 11,046 9,697 9,455 8,731
Provision for loan losses 584 300 305 275 200
--------- --------- --------- --------- ---------
Net interest income after
provision for loan losses 12,555 10,746 9,392 9,180 8,531
Non-interest income 1,718 2,165 1,137 1,196 945
Non-interest expense 11,432 10,081 7,871 8,470 6,715
--------- --------- --------- --------- ---------
Income before income taxes 2,841 2,830 2,658 1,906 2,761
Provision for income taxes 966 1,114 1,031 721 1,072
--------- --------- --------- --------- ---------
Net income $ 1,875 $ 1,716 $ 1,627 $ 1,185 $ 1,689
========= ========= ========= ========= =========
Per share data:
Weighted average shares
outstanding - basic 1,448,850 1,399,407 1,535,424 1,818,468 2,024,201
Basic earnings per share $ 1.29 $ 1.23 $ 1.06 $ 0.65 $ 0.79
Weighted average shares
outstanding - diluted 1,538,673 1,460,347 1,579,461 1,856,297 2,125,411
Diluted earnings per share $ 1.22 $ 1.18 $ 1.03 $ 0.64 $ 0.79
Cash dividends paid per share $ 0.42 $ 0.34 $ 0.31 $ 0.27 $ 0.25
Dividend pay-out ratio (basic) 0.32% 0.28% 0.29% 0.42% 0.30%
Book value per share $ 18.14 $ 18.46 $ 16.72 $ 15.61 $ 15.65
29
At or For the Years Ended June 30,
-----------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Selected operating ratios:
Interest rate spread (1) 2.96% 2.70% 2.88% 3.11% 3.43%
Net interest margin (2) 3.18 2.96 3.29 3.70 4.04
Return on average assets 0.44 0.44 0.53 0.44 0.74
Return on average equity 7.13 6.86 6.27 4.04 5.37
Non-interest expense as a
percent of average total assets 2.66 2.58 2.54 3.15 2.95
Efficiency ratio (3) 76.95 76.31 72.65 79.52 69.40
Asset quality ratios:
Non-performing loans as a
percent of total loans 0.58 0.08 0.04 0.01 0.00
Non-performing loans as a
percent of total assets 0.41 0.05 0.04 0.01 0.00
Net charge-offs to average loans 0.14 0.01 0.01 0.01 0.01
Regulatory Capital ratios:
Regulatory Tier 1 leverage
capital ratio 7.97 8.16 8.69 10.12 11.35
Total risk-based capital 15.65 13.74 13.92 16.39 19.22
___________________
Interest rate spread represents the difference between weighted
average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
Net interest margin represents net interest income divided by average
interest-earning assets.
Operating expenses divided by the sum of net interest income and
other income.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Medford Co-operative Bank (the "Bank") completed its conversion from
a mutual to a stock institution and was simultaneously acquired by Mystic
Financial, Inc. ("Mystic" or the "Company") on January 8, 1998. The
following discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes thereto included within
this report.
The business of the Bank consists of attracting deposits from the
general public and using these funds to originate various types of loans
primarily in eastern Middlesex County, Massachusetts, including mortgage
loans secured by one-to four-family residences, commercial loans secured by
general business assets, commercial real estate loans secured by commercial
property, and to invest in U.S. Government and federal agency and other
securities. To a lesser extent, the Bank engages in various forms of
consumer and home equity lending.
The Company's profitability depends primarily on its net interest
income, which is the difference between the interest income it earns on its
loans and investment portfolio and its cost of funds, which consists mainly
of interest paid on deposits and on borrowings from the FHLB. Net interest
income is affected by the relative amounts of interest-earning assets and
interest-bearing liabilities and the interest rates earned or paid on these
balances. When interest-earning assets approximate or exceed interest-
bearing liabilities, any positive interest rate spread will generate net
interest income.
30
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, 2004 included in our Annual Report on Form 10-K for the year ended
June 30, 2004 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.
31
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 of Directors 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 of
Directors that will enhance income while managing the Bank's vulnerability
to changes in interest rates and report to the Board of Directors 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, 2004,
the Bank's loan portfolio included $71.5 million of adjustable-rate one- to
four-family mortgage loans, $80.1 million of adjustable-rate commercial
real estate loans, $11.1 million of adjustable-rate or short-term
commercial loans, and $18.2 million of adjustable-rate home equity loans.
Together, these loans represent 58.0% of the Bank's net loans at June 30,
2004.
Recent Developments
On July 7, 2004, Mystic entered into an agreement and plan of merger
with Brookline Bancorp, Inc., ("Brookline") pursuant to which Brookline
will acquire Mystic in an exchange of cash and stock. Brookline is
headquartered in Brookline, Massachusetts, and operates Brookline Bank.
Under the terms of the agreement, stockholders of Mystic will be entitled
to receive either cash or shares of Brookline common stock, subject to
election and allocation procedures which are intended to ensure that, in
aggregate, 40% of the shares of Mystic are converted into the right to
receive cash of $39.00 per share and that 60% are converted into the right
to receive a fixed exchange of 2.6786 shares of Brookline common stock for
each share of Mystic. It is anticipated that the merger will close in the
first quarter of 2005, provided that regulatory and Mystic shareholder
approvals are obtained. In connection with the merger of Mystic and
Brookline, Medford Co-operative Bank will merge into Brookline Bank.
32
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,
---------------------------------------------------------------------------------------------
2004 2003 2002
----------------------------- ----------------------------- -----------------------------
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 $291,535 $17,351 5.95% $257,519 $17,542 6.81% $226,711 $16,972 7.49%
Securities 113,724 3,942 3.47% 90,206 3,467 3.84% 50,765 2,405 4.74%
Other earning assets (1) 8,340 84 1.01% 25,310 379 1.50% 17,564 491 2.80%
-------- ------- -------- ------- -------- -------
Total interest-earning
assets 413,599 21,377 5.17% 373,035 21,388 5.73% 295,040 19,868 6.73%
------- ------- -------
Cash and due from banks 7,660 9,109 7,558
Other assets 8,666 8,178 6,981
-------- -------- --------
Total assets $429,925 $390,322 $309,579
======== ======== ========
Interest-bearing liabilities:
Regular and other deposits $ 78,646 583 0.74% $ 60,695 843 1.39% $ 47,710 990 2.08%
NOW and IOLTA accounts 37,942 54 0.14% 39,821 277 0.70% 34,384 344 1.00%
Money market deposits 55,203 856 1.55% 45,521 1,036 2.28% 19,952 469 2.35%
Certificates of deposit 140,864 4,230 3.00% 134,408 4,967 3.70% 111,193 5,510 4.96%
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits 312,655 5,723 1.83% 280,445 7,123 2.54% 213,239 7,313 3.43%
FHLB borrowings 47,566 1,948 4.10% 53,321 2,820 5.29% 49,854 2,789 5.59%
Subordinated debt 12,373 567 4.73% 7,627 399 5.23% 1,250 69 5.52%
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 372,594 8,238 2.21% 341,393 10,342 3.03% 264,343 10,171 3.85%
------- ------- -------
Demand deposit accounts 28,995 22,073 17,837
Other liabilities 2,038 1,846 1,458
-------- -------- --------
Total liabilities 403,627 365,312 283,638
Stockholders' equity 26,298 25,010 25,941
-------- -------- --------
Total liabilities and
stockholders' equity $429,925 $390,322 $309,579
======== ======== ========
Net interest income $13,139 $11,046 $ 9,697
======= ======= =======
Interest rate spread 2.96% 2.70% 2.88%
Net interest margin 3.18% 2.96% 3.29%
Interest-earning assets/
interest-bearing Liabilities 1.11x 1.09x 1.12x
___________________
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.
33
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,
2004 vs 2003 2003 vs 2002
Due to Increase Due to Increase
(Decrease) (Decrease)
------------------------------- -------------------------------
Rate Volume Total Rate Volume Total
---- ------ ----- ---- ------ -----
(In thousands)
Interest and dividend income:
Loans, net $(2,359) $2,168 $ (191) $(1,611) $2,181 $ 570
Securities (364) 839 475 (523) 1,585 1,062
Other earning assets (97) (198) (295) (280) 168 (112)
------- ------ ------- ------- ------ ------
Total (2,820) 2,809 (11) (2,414) 3,934 1,520
------- ------ ------- ------- ------ ------
Interest expense:
Regular and other deposits (464) 204 (260) (376) 229 (147)
NOW accounts (211) (12) (223) (116) 49 (67)
Money market deposits (372) 192 (180) (15) 582 567
Certificates of deposit (966) 229 (737) (1,562) 1,019 (543)
Borrowed funds (590) (282) (872) (157) 188 31
Subordinated debt (42) 210 168 (4) 334 330
------- ------ ------- ------- ------ ------
Total (2,645) 541 (2,104) (2,230) 2,401 171
------- ------ ------- ------- ------ ------
Change in net interest income $ (175) $2,268 $ 2,093 $ (184) $1,533 $1,349
======= ====== ======= ======= ====== ======
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, 2004 and 2003
The Company's total assets amounted to $441.2 million at June 30,
2004 compared to $429.7 million at June 30, 2003, an increase of $11.5
million or 2.7%. The increase in total assets is primarily attributable to
an increase in net loans of $31.9 million or 11.4% offset in part by a
decrease in securities available for sale and securities held to maturity
of $17.9 million or 15.2%.
Cash and cash equivalents totaled $15.7 million at June 30, 2004
compared to $19.8 million at June 30, 2003, a decrease of $4.1 million or
20.7%. The $3.3 million decrease in short-term investments and federal
funds sold was due to the increased loan demand in both the residential and
commercial real estate areas.
34
Net loans increased by $31.9 million or 11.4% to $311.8 million or
70.7% of total assets at June 30, 2004 as compared to $279.9 million or
65.2% of total assets at June 30, 2003, 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 decreased by
$17.6 million or 14.5% to $103.2 million at June 30, 2004 from $120.8
million at June 30, 2003. The proceeds from the sales were used to fund
growth in commercial real estate loans, construction loans and home equity
loans.
Total deposits increased by $7.8 million or 2.3% to $351.4 million at
June 30, 2004 from $343.6 million at June 30, 2003. Money market deposits
increased to $55.0 million at June 30, 2004 from $51.7 million at June 30,
2003, an increase of $3.5 million or 6.3%. Certificates of deposit
decreased to $138.6 million at June 30, 2004 from $142.0 million at June
30, 2003, a decrease of $3.4 million or 2.4%. Demand deposits and IOLTA
accounts decreased to $48.6 million at June 30, 2004 from $54.5 million at
June 30, 2003, a decrease of $5.6 million or 10.9%. Savings accounts
increased by $14.0 million or 20.3% to $83.0 million at June 20, 2004 from
$69.0 million at June 30, 2003.
During the year ended June 30, 2004, total borrowings increased by
$6.7 million to $47.9 million at June 30, 2004 from $41.2 million at June
30, 2003. The increase of $6.7 million reflects additional funding needed
to support growth in net loans.
Stockholders' equity increased by $0.5 million to $26.7 million at
June 30, 2004 from $26.2 million at June 30, 2003 as a result of dividends
paid of $599,000, a net unrealized loss on securities available for sale of
$1.8 million, offset by net income of $1.9 million, proceeds from exercise
of stock options of $342,000, a reduction in unearned Recognition and
Retention Plan ("RRP") stock of $99,000, and a reduction in unearned
Employee Stock Ownership Plan ("ESOP") shares of $606,000.
Book value per share of common stock was $18.14 as of June 30, 2004
as compared to $18.46 as of June 30, 2003. 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 committed
to be released to participants' individual accounts, unearned RRP shares
and treasury stock. There were 1,473,696 and 1,421,879 shares of common
stock outstanding as of June 30, 2004 and June 30, 2003, respectively, for
purposes of calculating the Company's book value per share.
Comparison of the Operating Results for the Years Ended June 30, 2004
and 2003
Net Income. Net income was $1.9 million for the year ended June 30,
2004 as compared to $1.7 million for the year ended June 30, 2003. This
$159,000 increase in net income during the year was the result of an
increase in net interest income of $2.1 million offset by a decrease in
non-interest income of $446,000, an increase in non-interest expense of
$1.4 million and an increase in provision for loan losses of $284,000. The
return on average assets for each of the years ended June 30, 2004 and June
30, 2003 was .44%. The return on average equity for the year ended June
30, 2004 was 7.13% compared to 6.86% for the year ended June 30, 2003.
Earnings per share on a basic and diluted basis were $1.29 and $1.22,
respectively, for the year ended June 30, 2004 compared to $1.23 and $1.18,
respectively, on a basic and diluted basis for the year ended June 30,
2003.
Interest Income. Total interest and dividend income remained
relatively unchanged at $21.4 million for the years ended June 30, 2004 and
2003. The average balance of net loans for the year ended June 30, 2004
was $291.5 million compared to $257.5 million for the year ended June 30,
2003. The
35
average yield on net loans was 5.95% for the year ended June 30, 2004
compared to 6.81% for the year ended June 30, 2003. The average balance of
securities for the year ended June 30, 2004 was $113.7 million compared to
$90.2 million for the year ended June 30, 2003. The average yield on
securities was 3.47% for the year ended June 30, 2004 compared to 3.84% for
the year ended June 30, 2003. The average balance of other earning assets
for the year ended June 30, 2004 was $8.3 million compared to $25.3 million
for the year ended June 30, 2003. The average yield on other earning
assets was 1.01% for the year ended June 30, 2004 compared to 1.50% for the
year ended June 30, 2003.
Interest Expense. Total interest expense decreased by $2.1 million
or 20.3% to $8.2 million for the year ended June 30, 2004 from $10.3
million for the year ended June 30, 2003. Interest expense continued to
decline during 2004 mainly attributable to the reduction of all deposit and
borrowing rates. Average interest-bearing deposits increased by $32.2
million or 11.5% to $312.7 million for the year ended June 30, 2004 from
$280.4 million for the year ended June 30, 2003. Average borrowings
decreased by $5.8 million to $47.6 million for the year ended June 30, 2004
from $53.3 million for the year ended June 30, 2003. Average subordinated
debt increased by $4.8 million to $12.4 million for the year ended June 30,
2004 from $7.6 million for the year ended June 30, 2003. The average rate
on interest-bearing deposits decreased 71 basis points to 1.83% for the
year ended June 30, 2004 from 2.54% for the year ended June 30, 2003, the
average rate on borrowed funds decreased 119 basis points to 4.10% for the
year ended June 30, 2004 from 5.29% for the year ended June 30, 2003 and
the average rate on subordinated debt decreased 50 basis points to 4.73%
for the year ended June 30, 2004 from 5.23% for the year ended June 30,
2003.
Net Interest Income. Net interest income for the year ended June 30,
2004 was $13.1 million as compared to $11.0 million for the year ended June
30, 2003. The $2.1 million or 18.9% increase is attributed to the $2.1
million decrease in interest expense on deposits, borrowed funds and
subordinated debt. The average yield on interest earning assets decreased
56 basis points to 5.17% for the year ended June 30, 2004 from 5.73% for
the year ended June 30, 2003, while the average cost on interest-bearing
liabilities decreased by 82 basis points to 2.21% for the year ended June
30, 2004 from 3.03% for the year ended June 30, 2003. As a result, the
interest rate spread increased by 26 basis points to 2.96% for the year
ended June 30, 2004 from 2.70% for the year ended June 30, 2003.
Provision for Loan Losses. The provision for loan losses was
$584,000 for the year ended June 30, 2004 as compared to $300,000 for the
year ended June 30, 2003. At June 30, 2004, the balance of the allowance
for loan losses was $2.5 million or .81% of total loans. During the year
ended June 30, 2004, $409,000 was charged against the allowance for loan
losses while $15,000 in recoveries was credited to the allowance for loan
losses. 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. There were three
non-performing loans with an aggregate balance of $1.8 million at June 30,
2004. At June 30, 2003, there were two non-performing loans with an
aggregate balance of $223,000.
Non-interest Income. Non-interest income decreased by $447,000 or
20.6% to $1.7 million for the year ended June 30, 2004 as compared to $2.2
million for the year ended June 30, 2003. This decrease was caused by
increased net security gains of $424,000 offset by a decrease in loan sale
gains of $737,000 and decrease in other income of $134,000.
Non-interest Expense. Non-interest expense increased by $1.4 million
or 13.4% to $11.4 million for the year ended June 30, 2004 as compared to
$10.1 million for the year ended June 30, 2003. This increase was caused by
higher personnel costs associated with the asset growth of the Bank,
increased benefit costs, expenses to operate the branch office that opened
in Malden, MA in September 2003, a prepayment penalty expense of $298,000
relating to the early retirement of various FHLB advances and
36
$174,000 of legal and consulting expenses relating to the Company's merger
agreement with Brookline Bancorp, Inc.
Provision for Income Taxes. The provision for income taxes was
$966,000 for the year ended June 30, 2004 as compared to $1.1 million for
the year ended June 30, 2003. The effective tax rate declined from 39.4%
for the year ended June 30, 2003 to 34.0% for the year ended June 30, 2004,
as a higher percentage of taxable income was included in the Bank's
security corporation that has a lower state tax rate.
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 $1.23 and $1.18,
respectively, for the year ended June 30, 2003 compared to $1.06 and $1.03
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.
37
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.
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.
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, 2004 was 49.1%, using the short-term
38
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, 2004, the Bank had borrowings of $47.9
million from the FHLB and the capacity to borrow approximately $108 million
more based on the Bank's level of qualified collateral.
At June 30, 2004, the Bank had $28.7 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 $62.8 million at June 30, 2004. Based upon
historical experience, management believes that a significant portion of
such deposits will remain with the Bank.
In April 2002, Mystic Financial Capital Trust I (the "Trust") 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. Using interest payments made by the
Company on the debentures, the Trust pays semi-annual dividends to
preferred security holders. The interest payable on the subordinated
debentures and the cumulative dividends payable on the preferred securities
is equal to a floating rate of 5.07% at June 30, 2004. Interest payments
on these securities are payable semi-annually in arrears on April 22nd and
October 22nd. The Company has the option to defer interest payments on the
subordinated debentures for up to five years and, accordingly, the Trust
may defer dividend distributions for up to five years.
In February 2003, Mystic Financial Capital Trust II (the "Trust") 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. Using interest payments made by the
Company on the debentures, the Trust pays quarterly dividends to preferred
security holders. The interest payable on the subordinated debentures and
the cumulative dividends payable on the preferred securities is equal to a
floating rate of 4.50% at June 30, 2004. Interest payments on these
securities are payable every three months in arrears on February 15th, May
15th, August 15th and November 15th. The Company has the option to defer
interest payments on the subordinated debentures for up to five years and,
accordingly, the Trust may defer dividend distributions for up to five
years.
At June 30, 2004, 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, 2004, see Notes to
Consolidated Financial Statements.
39
Contractual Obligations
The table below contains information on the Company's contractual
obligations as of the fiscal year ended June 30, 2004.
Payment Due By Period
--------------------------------------------------------
Less More
Than 1 Than 5
Total Year 1-3 Years 3-5 Years Years
----- ------ --------- --------- ------
(In thousands)
Contractual Obligations:
Federal Home Loan Bank borrowings $47,861 $28,300 $4,361 $3,200 $12,000
Subordinated debt 12,373 - - - 12,373
Operating leases 1,739 380 596 451 312
Purchase obligations - - - - -
Other long-term liabilities - - - - -
------- ------- ------ ------ -------
Total $61,973 $28,680 $4,957 $3,651 $24,685
======= ======= ====== ====== =======
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 a Statement of Financial Accounting
Standards ("FASB") 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.
40
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 ALCO, which is composed of
members of management and the Board of Directors. 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 monitors the difference between the Company's maturing and
repricing assets and liabilities and develops and implements 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 of Directors that will enhance income while managing the Company's
vulnerability to changes in interest rates and report to the Board of
Directors 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, 2004, 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 of Directors 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,
2004, its most recent analysis.
41
Estimated NII Sensitivity
-------------------------
Rate Change Year One Year Two
----------- -------- --------
+200 basis points (2.71%) 1.85%
-100 basis points 1.41% 7.28%
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 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'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 files and
submits under the Exchange Act is recorded, processed, summarized and
reported as and when required.
There have been no changes in Mystic's internal control over
financial reporting identified in connection with the evaluation that
occurred during Mystic's last fiscal quarter that has materially affected,
or that is reasonably likely to materially affect, Mystic's internal
control over financial reporting.
42
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included on pages 97 through 98, page
104 and page 115 of the Company's Proxy Statement for the 2004 Annual
Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference: "Information as to Nominees and Continuing Directors," "Nominees
for Election as Directors," "Executive Officers" and "Section 16(a)
Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
The following information included on pages 105 through 106 and pages
110 through 115 of the Proxy Statement is incorporated herein by reference:
"Directors' Compensation," "Executive Compensation," "Certain Employee
Benefits and Employment Agreements," and "Benefits."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included on pages 38 through 40 of the
Proxy Statement is incorporated herein by reference: "Security Ownership of
Certain Beneficial Owners of Mystic Financial" and "Beneficial Stock
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, 2004.
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 151,580 $12.96 86,662
Equity compensation plans not
approved by security holders - - -
------- ------ ------
Total 151,580 $12.96 86,662
======= ====== ======
43
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included on pages 105 and 106 of the Proxy
Statement is incorporated herein by reference: "Directors' Compensation"
and "Executive Compensation."
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding principal accountant fees and services is
presented under the heading "Audit Committee Report" in Mystic's definitive
Proxy Statement for the 2004 Annual Meeting of Stockholders to be held on
November 17, 2004, 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, 2004 and 2003 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, 2004, together
with the related notes and the independent auditors'
report of Wolf & Company, P.C., independent registered
public accounting firm.
(2) Schedules omitted, as they are not applicable.
(3) Exhibits
44
Exhibit No. Exhibit 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 by and between Mystic Financial, Inc.
and Ralph W. Dunham.****
10.3 Employment Agreement by and between Mystic Financial, Inc.
and John M. O'Donnell.****
10.4 Employment Agreement by and between Mystic Financial, Inc.
and Anthony J. Patti.*****
10.5 Employment Agreement by and between Medford Co-operative Bank
and Thomas G. Burke.*
10.6 Employment Agreement by and between Medford Co-operative Bank
and Robert Kaminer.**
10.7 Amendment No. 1 to the Employment Agreement by and between
Mystic Financial, Inc. and Ralph W. Dunham.
10.8 Amendment No. 1 to the Employment Agreement by and between
Mystic Financial, Inc. and John M. O'Donnell.
10.9 Amendment No. 1 to the Employment Agreement by and between
Mystic Financial, Inc. and Anthony J. Patti.
10.10 Severance Pay Plan of Medford Co-operative Bank.**
10.11 Amendment No. 1 to Severance Pay Plan of Medford Co-operative
Bank.
10.12 Mystic Financial, Inc. Retirement Plan for Non-Employee
Directors.***
10.13 Amendment No. 1 to the Mystic Financial, Inc. Retirement Plan
for Non-Employee Directors.
10.14 Amendment No. 2 to the Mystic Financial, Inc. Retirement Plan
for Non-Employee Directors.
10.15 Guarantee Agreement dated as of April 10, 2002 by Mystic
Financial, Inc. and Wilmington Trust Company. *****
10.16 Indenture Agreement dated as of April 10, 2002 by Mystic
Financial, Inc. and Wilmington Trust Company. *****
45
10.17 Amendment No. 1 to the Mystic Financial, Inc. Employee Stock
Ownership Plan.
10.18 Amendment No. 2 to the Mystic Financial, Inc. Employee Stock
Ownership Plan.*****
10.19 Amendment No. 3 to the Mystic Financial, Inc. Employee Stock
Ownership Plan.
10.20 Amendment No. 4 to the Mystic Financial, Inc. Employee Stock
Ownership Plan.
10.21 Guarantee Agreement dated as of February 14, 2003 by Mystic
Financial, Inc. and Wilmington Trust Company.******
10.22 Indenture Agreement dated as February 14, 2003 by Mystic
Financial, Inc. and Wilmington Trust Company. ******
10.23 Change of Control Agreement by and among Medford Co-operative
Bank, Mystic Financial, Inc. and Todd A. Goldstein.
10.24 Change of Control Agreement by and among Medford Co-operative
Bank, Mystic Financial, Inc. and Nancy P. Graham.
10.25 Change of Control Agreement by and among Medford Co-operative
Bank, Mystic Financial, Inc. and Annette J. Hunt.
10.26 Change of Control Agreement by and among Medford Co-operative
Bank, Mystic Financial, Inc. and Robert W. Kershaw.
14.1 Code of Ethics and Conflict of Interest Policy.
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.
___________________
* 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.
46
**** Incorporated herein by reference to the Quarterly Report on Form
10-Q of Mystic Financial, Inc. filed with the Securities and
Exchange Commission on February 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.
****** Incorporated herein by reference to the Annual Report on Form 10-K
of Mystic Financial, Inc. filed with the Securities and Exchange
Commission on September 29, 2003.
(b) Reports on Form 8-K.
The Company filed no current reports on Form 8-K during the quarter
ended June 30, 2004.
47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant certifies that it has duly caused this
report to be signed on its behalf by the undersigned, hereunto duly
authorized, in the City of Medford, Commonwealth of Massachusetts, on
September 15, 2004.
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 Chief Executive September 15, 2004
- ---------------------------- Officer (Principal executive officer)
Ralph W. Dunham
/s/ Anthony J. Patti Senior Vice-President, Chief Financial Officer September 15, 2004
- ---------------------------- and Treasurer (Principal financial officer)
Anthony J. Patti
/s/ Julie Bernardin Director September 15, 2004
- ----------------------------
Julie Bernardin
/s/ Frederick N. Dello Russo Director September 15, 2004
- ----------------------------
Frederick N. Dello Russo
/s/ John A. Hackett Director September 15, 2004
- ----------------------------
John A. Hackett
/s/ Richard M. Kazanjian Director September 15, 2004
- ----------------------------
Richard M. Kazanjian
/s/ John W. Maloney Director September 15, 2004
- ----------------------------
John W. Maloney
/s/ John J. McGlynn Director, Chairman of the Board September 15, 2004
- ----------------------------
John J. McGlynn
Director
- ----------------------------
William F. Rucci, Jr.
Director
- ----------------------------
Lorraine P. Silva
48
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Income F-4
Consolidated Statements of Changes in Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-8
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2004 and 2003, 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, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mystic
Financial, Inc. and subsidiaries as of June 30, 2004 and 2003, and the
results of their operations and their cash flows for each of the years in
the three-year period ended June 30, 2004 in conformity with U.S. generally
accepted accounting principles.
Boston, Massachusetts
July 23, 2004
F-2
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
----------------------
2004 2003
---- ----
(Dollars In Thousands)
Cash and due from banks $ 10,761 $ 11,548
Federal funds sold 3,214 6,734
Short-term investments 1,726 1,518
-------- --------
Total cash and cash equivalents 15,701 19,800
Securities available for sale, at fair value 88,724 117,871
Securities held to maturity (fair value
approximates $11,032 at June 30,2004) 11,287 -
Federal Home Loan Bank stock, at cost 3,234 2,932
Loans, net of allowance for loan losses of $2,537
and $2,347, respectively 311,806 279,949
Banking premises and equipment, net 3,294 3,049
Real estate held for investment, net 1,470 1,541
Accrued interest receivable 1,647 1,780
Due from Co-operative Central Bank 929 929
Other assets 3,100 1,838
-------- --------
$441,192 $429,689
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $351,407 $343,564
Federal Home Loan Bank borrowings 47,861 41,200
Subordinated debt 12,373 12,373
Mortgagors' escrow accounts 967 925
Accrued interest payable 421 568
Due to broker - 3,891
Accrued expenses and other liabilities 1,423 924
-------- --------
Total liabilities 414,452 403,445
-------- --------
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; 2,746,501 and 2,723,025
shares issued, respectively 27 27
Additional paid-in capital 27,071 25,819
Retained earnings 17,998 18,338
Treasury stock, at cost - 1,180,556 shares and
1,180,319 shares, respectively (16,136) (17,131)
Accumulated other comprehensive income (1,053) 767
Unearned ESOP shares, 71,659 shares and 93,530 shares, respectively (983) (1,293)
Unearned RRP shares, 18,589 and 27,297 shares, respectively (184) (283)
-------- --------
Total stockholders' equity 26,740 26,244
-------- --------
$441,192 $429,689
======== ========
See accompanying notes to consolidated financial statements.
F-3
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
---------------------------------------------
2004 2003 2002
---- ---- ----
(Dollars In Thousands, Except Per Share Data)
Interest and dividend income:
Interest and fees on loans $ 17,351 $ 17,542 $ 16,972
Interest and dividends on securities 3,942 3,467 2,405
Other interest 84 379 491
--------- --------- ---------
Total interest and dividend income 21,377 21,388 19,868
--------- --------- ---------
Interest expense:
Deposits 5,723 7,123 7,313
Federal Home Loan Bank borrowings 1,948 2,820 2,789
Subordinated debt 567 399 69
--------- --------- ---------
Total interest expense 8,238 10,342 10,171
--------- --------- ---------
Net interest income 13,139 11,046 9,697
Provision for loan losses 584 300 305
--------- --------- ---------
Net interest income, after provision for loan losses 12,555 10,746 9,392
--------- --------- ---------
Non-interest income:
Customer service fees 893 992 890
Gain on sales of securities available for sale, net 519 95 45
Gain on sales of loans 284 1,021 111
Miscellaneous 22 57 91
--------- --------- ---------
Total non-interest income 1,718 2,165 1,137
--------- --------- ---------
Non-interest expense:
Salaries and employee benefits 6,633 5,714 4,680
Occupancy and equipment expenses 1,422 1,291 1,001
Data processing expenses 459 358 335
Professional fees 947 700 542
Penalty on prepayment of Federal Home Loan Bank borrowings 298 468 -
Other general and administrative expenses 1,673 1,550 1,313
--------- --------- ---------
Total non-interest expense 11,432 10,081 7,871
--------- --------- ---------
Income before income taxes 2,841 2,830 2,658
Provision for income taxes 966 1,114 1,031
--------- --------- ---------
Net income $ 1,875 $ 1,716 $ 1,627
========= ========= =========
Earnings per share - basic $ 1.29 $ 1.23 $ 1.06
========= ========= =========
Weighted average shares outstanding - basic 1,448,850 1,399,407 1,535,424
========= ========= =========
Earnings per share - diluted $ 1.22 $ 1.18 $ 1.03
========= ========= =========
Weighted average shares outstanding - diluted 1,538,673 1,460,347 1,579,461
========= ========= =========
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, 2004, 2003 and 2002
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, 2001 $27 $25,643 $15,956 $(10,055) $ 118 $(1,967) $(707) $29,015
-------
Comprehensive income:
Net income - - 1,627 - - - - 1,627
Net unrealized gain on
securities available for
sale, net of tax effects - - - - 232 - - 232
-------
Total comprehensive income 1,859
-------
Dividends declared and paid
($0.31 per share) - - (484) - - - - (484)
Stock options exercised
(3,150 shares) - 36 - - - - - 36
Decrease in unearned ESOP shares - 20 - - - 345 - 365
Purchase of treasury stock
(454,945 shares) - - - (7,069) - - - (7,069)
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
Net unrealized gain on
securities available for
sale, net of tax effects - - - - 417 - - 417
-------
Total comprehensive income 2,133
-------
Dividends declared and paid
($0.34 per share) - - (477) - - - - (477)
Stock options exercised
(4,095 shares) - 49 - - - - - 49
Decrease in unearned ESOP shares - 71 - - - 329 - 400
Purchase of treasury stock
(378 shares) - - - (7) - - - (7)
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
-------
Comprehensive income:
Net income - - 1,875 - - - - 1,875
Net unrealized loss on
securities available for
sale, net of tax effects - - - - (1,820) - - (1,820)
-------
Total comprehensive income - - - - - - - 55
-------
Stock dividend - 5% - 614 (1,616) 1,002 - - - -
Dividends declared and paid
($0.42 per share) - - (599) - - - - (599)
Stock options exercised,
net of tax effect of
$62,000 (23,476 shares) - 342 - - - - - 342
Decrease in unearned ESOP shares - 296 - - - 310 - 606
Purchase of treasury stock
(237 shares) - - - (7) - - - (7)
Decrease in unearned RRP stock - - - - - - 99 99
--- ------- ------- -------- ------- ------- ----- -------
Balance at June 30, 2004 $27 $27,071 $17,998 $(16,136) $(1,053) $ (983) $(184) $26,740
=== ======= ======= ======== ======= ======= ===== =======
See accompanying notes to consolidated financial statements.
F-5
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
------------------------------------
2004 2003 2002
---- ---- ----
(In Thousands)
Cash flows from operating activities:
Net income $ 1,875 $ 1,716 $ 1,627
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 584 300 305
Net amortization of securities 41 320 164
Amortization of unearned ESOP shares 606 400 365
Amortization of unearned RRP stock 99 223 201
Net gain on sales of securities available for sale (519) (95) (45)
Gain on sales of loans, net (284) (1,021) (111)
Depreciation and amortization of servicing rights 783 570 386
Deferred income tax provision (benefit) (99) 17 (247)
Net change in mortgage loans held for sale - 1,231 (957)
(Increase) decrease in accrued interest receivable 133 4 (374)
(Increase) decrease in other assets (101) (658) 71
Increase in accrued expenses and other liabilities 352 47 182
--------- --------- --------
Net cash provided by operating activities 3,470 3,054 1,567
--------- --------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales 60,308 30,848 1,967
Maturities, prepayments and calls 32,745 31,365 11,637
Purchases (70,253) (109,850) (50,395)
Purchase of securities held to maturity (11,285) - -
Purchase of Federal Home Loan Bank stock (302) - (400)
Proceeds from sales of loans 24,535 37,831 10,579
Loans originated, net of payments received (56,692) (73,266) (39,515)
Purchases of banking premises and equipment (845) (683) (681)
--------- --------- --------
Net cash used by investing activities (21,789) (83,755) (66,808)
--------- --------- --------
(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,
------------------------------------
2004 2003 2002
---- ---- ----
(In Thousands)
Cash flows from financing activities:
Net increase in deposits 7,843 76,126 42,688
Proceeds from FHLB advances 432,850 18,096 22,500
Repayment of FHLB advances (426,189) (35,031) (8,983)
Proceeds from issuance of subordinated debt - 7,000 5,000
Net increase in mortgagors' escrow accounts 42 133 36
Dividends paid (599) (477) (484)
Purchase of treasury stock (7) (7) (7,069)
Proceeds from exercise of stock options 280 49 36
--------- --------- --------
Net cash provided by financing activities 14,220 65,889 53,724
--------- --------- --------
Net change in cash and cash equivalents (4,099) (14,812) (11,517)
Cash and cash equivalents at beginning of year 19,800 34,612 46,129
--------- --------- --------
Cash and cash equivalents at end of year $ 15,701 $ 19,800 $ 34,612
========= ========= ========
Supplemental information:
Interest paid $ 8,385 $ 10,385 $ 10,118
Income taxes paid, net 980 1,247 962
Due to broker (3,891) 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, 2004, 2003 and 2002
l. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and business
The consolidated financial statements include the accounts of Mystic
Financial, Inc. (the "Company" or "Mystic") and its wholly-owned subsidiary,
Medford Co-operative Bank (the "Bank"). 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. All
significant inter-company accounts have been eliminated in consolidation.
The Company's wholly-owned subsidiaries, Mystic Financial Capital Trust I
and Mystic Financial Capital Trust II 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. These
subsidiaries are accounted for on the equity method (see Note 9).
The Bank provides a variety of financial services to individuals and
businesses through its seven offices in Medford, Arlington, Lexington,
Bedford and Malden, 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.
Merger
On July 7, 2004, the Company announced the execution of a definitive
agreement in which Brookline Bancorp, Inc. ("Brookline") will acquire the
Company in an exchange of cash and stock.
The merger is subject to regulatory and the Company's shareholder approvals.
In connection with the merger of the Company and Brookline, Medford
Co-operative Bank will merge into Brookline Bank, a subsidiary of Brookline.
Under the terms of the agreement, stockholders of the Company will be
entitled to receive either cash or shares of Brookline common stock, subject
to election and allocation procedures which are intended to ensure that, in
aggregate, 40% of the shares of the Company are converted into the right to
receive cash of $39.00 per share, and that 60% are converted into the right
to receive a fixed exchange of 2.6786 shares of Brookline common stock for
each share of the Company.
F-8
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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 and cash equivalents
Cash and cash equivalents include amounts due from banks, federal funds sold
and short-term investments with original maturities of three months or less.
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, 2004 and 2003, these reserve balances
amounted to $3,304,000 and $3,726,000, respectively.
Short-term investments
Short-term investments are carried at cost, which approximates fair value,
and consist of interest-bearing deposits in the Bank Investment Liquidity
Fund and money market funds.
Reclassifications and restatements
Certain amounts in the 2003 consolidated financial statement have been
reclassified to conform to the 2004 presentation.
Prior period common share and per share data have been adjusted to reflect
the Company's 5% common stock dividend declared on July 9, 2003 and paid on
August 15, 2003 to shareholders of record on July 31, 2003.
Securities
Debt securities that management has the intent and ability to hold to
maturity are classified as "held to maturity" and reported at amortized
cost.
Securities, not classified as held to maturity or trading, including equity
securities with readily determinable fair values, are classified as
"available for sale" and recorded at fair value, with unrealized gains and
losses excluded from earnings and reported in other comprehensive
income/loss.
F-9
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Securities (continued)
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.
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 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.
All interest accrued but not collected for loans that are placed on non-
accrual status 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.
F-10
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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. For sales of mortgage
loans, a portion of the cost of originating the loan is allocated to the
servicing right based on relative fair value. Fair value is based on market
prices for comparable mortgage servicing contracts. 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.
F-11
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Banking premises and equipment and real estate held for investment
Land is carried at cost. Buildings, improvements, leasehold improvements and
equipment are stated at cost, less accumulated depreciation and
amortization, computed on the straight-line method over the estimated useful
lives of the assets, or the terms of the leases, if shorter.
Pension plan
It is the Company's policy to fund pension plan costs in the year of
accrual.
Transfers of financial assets
Transfers of financial assets are accounted for as sales when control over
the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when (1) the assets have been isolated from the Company,
(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 Company 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 Company'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.
F-12
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock option plan
The Company accounts for its stock option plan (see Note 14) 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.
Years Ended June 30,
-------------------------------------
2004 2003 2002
---- ---- ----
(In Thousands, except per share data)
Net income as reported $1,875 $1,716 $1,627
Additional expense had the Company
adopted SFAS No. 123 (94) (83) (85)
Related tax benefit 38 33 34
------ ------ ------
Pro-forma net income $1,819 $1,666 $1,576
====== ====== ======
Basic earnings per share, as reported $ 1.29 $ 1.23 $ 1.06
Pro-forma basic earnings per share $ 1.26 $ 1.19 $ 1.03
Diluted earnings per share, as reported $ 1.22 $ 1.18 $ 1.03
Pro-forma diluted earnings per share $ 1.18 $ 1.14 $ 1.00
Recognition and retention plan
The Company measures the unearned compensation cost of its Recognition and
Retention Plan (the "RRP"), which is reflected as a reduction of
stockholders' equity, by the fair value of the stock at the grant date.
Unearned compensation cost is recognized as compensation expense over the
vesting period.
Advertising costs
Advertising costs are expensed as incurred.
F-13
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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 to outstanding stock options and unearned RRP shares, and are
determined using the treasury stock method.
Years Ended June 30,
-------------------------------------
2004 2003 2002
---- ---- ----
(In Thousands, except per share data)
Net income applicable to common stock $1,875 $1,716 $1,627
====== ====== ======
Average number of common shares
outstanding 1,449 1,399 1,535
Effect of dilutive options 90 61 44
------ ------ ------
Average number of common shares
Outstanding used to calculate diluted
earning per common share 1,539 1,460 1,579
====== ====== ======
For the year ended June 30, 2004, an average of 6,229 stock options were
anti-dilutive and therefore excluded from the earnings per share
calculation. For the years ended June 30, 2003 and 2002, there were no anti-
dilutive stock options excluded from the earnings per share calculation.
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.
F-14
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Comprehensive income/loss (concluded)
The components of other comprehensive income/loss and related tax effects
are as follows:
Years Ended June 30,
---------------------------
2004 2003 2002
---- ---- ----
(In Thousands)
Unrealized holding gains (losses)
on available-for-sale securities $(2,413) $ 763 $ 453
Reclassification adjustment for gains
realized in income (519) (95) (45)
------- ----- -----
Net unrealized gains (losses) (2,932) 668 408
Tax effect 1,112 (251) (176)
------- ----- -----
Net-of-tax amount $(1,820) $ 417 $ 232
======= ===== =====
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 January 2003, the FASB issued interpretation No. 46, "Consolidated of
Variable Interest Entities," ("FIN 46") which establishes guidance for
determining when an entity should consolidate another entity that meets the
definition of a variable interest entity. FIN 46 requires a variable
interest entity to be consolidated by a company if that company will absorb
a majority of the expected losses, will receive a majority of the expected
residual returns, or both. In December 2003, the FASB deferred the effective
date of FIN 46 to no later than the end of the first reporting period that
ends after March 15, 2004. Application of FIN 46 resulted in Mystic
Financial Capital Trust I and II being presented on the equity method
instead of being consolidated, which had no material affect on the Company's
consolidated financial statements.
F-15
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. SECURITIES
The amortized cost and estimated fair value of securities with gross
unrealized gains and losses is as follows:
June 30, 2004
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In Thousands)
Securities Available for Sale
- -----------------------------
Debt Securities:
U.S. Government and
federal agency obligations $ 2,444 $ - $ (50) $ 2,394
Corporate 8,549 73 (56) 8,566
Mortgage-backed 67,622 11 (1,794) 65,839
Other 8,775 - (226) 8,549
------- ---- ------- -------
Total debt securities 87,390 84 (2,126) 85,348
Marketable equity securities 3,022 476 (122) 3,376
------- ---- ------- -------
Total $90,412 $560 $(2,248) $88,724
======= ==== ======= =======
June 30, 2004
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In Thousands)
Securities Held to Maturity
- ---------------------------
U.S. Government and
federal agency obligations $11,287 $ 2 $ (257) $11,032
------- ---- ------- -------
Total $11,287 $ 2 $ (257) $11,032
======= ==== ======= =======
F-16
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SECURITIES (continued)
June 30, 2003
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In Thousands)
Securities Available for Sale
- -----------------------------
Debt Securities:
U.S. Government and
federal agency obligations $ 41,468 $ 534 $ - $ 42,002
Corporate 7,565 245 (155) 7,655
Mortgage-backed 58,414 634 (32) 59,016
Other 6,171 5 (11) 6,165
-------- ------ ----- --------
Total debt securities 113,618 1,418 (198) 114,838
Marketable equity securities 3,009 238 (214) 3,033
-------- ------ ----- --------
Total $116,627 $1,656 $(412) $117,871
======== ====== ===== ========
The amortized cost and estimated fair value of debt securities by
contractual maturity at June 30, 2004 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.
June 30, 2004
--------------------------------------------
Available for Sale Held to Maturity
-------------------- --------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ----- --------- -----
(In Thousands)
Within 1 year $ 4,019 $ 4,055 $ - $ -
Over 1 year to 5 years 13,500 13,300 2,500 2,489
Over 10 years 2,249 2,154 8,787 8,543
Mortgage-backed securities 67,622 65,839 - -
------- ------- ------- -------
Total $87,390 $85,348 $11,287 $11,032
======= ======= ======= =======
During the years ended June 30, 2004, 2003 and 2002, proceeds from sales of
securities available for sale amounted to $60,308,000, $30,848,000 and
$1,967,000, respectively. Gross realized gains for 2004, 2003 and 2002
amounted to $742,000, $581,000 and $457,000, respectively, and gross
realized losses amounted to $223,000, $486,000 and $412,000, respectively.
F-17
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SECURITIES (continued)
Information pertaining to securities with gross unrealized losses at June
30, 2004, aggregated by investment and length of time that individual
securities have been in a continuous loss position follows:
June 30, 2004
------------------------------------------------
Less Than Twelve Months Over Twelve Months
----------------------- ---------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
(In Thousands)
Securities Available for Sale
- -----------------------------
Debt Securities:
U.S. Government and
federal agency obligations $ 50 $ 2,394 $ - $ -
Corporate - - 56 1,442
Mortgage-backed 1,165 48,360 629 14,763
Other 184 7,359 42 1,190
------ ------- ---- -------
Total debt securities 1,399 58,113 727 17,395
Marketable equity securities 98 807 24 171
------ ------- ---- -------
Total $1,497 $58,920 $751 $17,566
====== ======= ==== =======
Securities Held to Maturity
- ---------------------------
U.S. Government and
federal agency obligations $ 257 $ 9,530 $ - $ -
------ ------- ---- -------
Total $ 257 $ 9,530 $ - $ -
====== ======= ==== =======
F-18
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SECURITIES (concluded)
Management evaluates securities for other than temporary impairment at least
on a quarterly basis, and more frequently when economic or market concerns
warrant such evaluation. Consideration is given to: (1) the length of time
and the extent to which the fair value has been less than cost, (2) the
financial condition and near-term prospects of the issuer, and (3) the
intent and ability of the Company to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery in fair
value.
At June 30, 2004, fifty-eight (58) debt securities had unrealized losses
with aggregate depreciation of 3.0% from the Company's amortized cost basis.
In analyzing an issuer's financial condition, management considers whether
the securities are issued by the federal government or its agencies, whether
downgrades by bond rating agencies have occurred, and industry analysts'
reports. Unrealized losses on debt securities are generally attributable to
changes in interest rates. As management has the ability to hold debt
securities until maturity, or for the foreseeable future if classified as
available for sale, no declines are deemed to be other than temporary.
At June 30, 2004, twenty-three (23) marketable equity securities had
unrealized losses with aggregate depreciation of 11.0% from the Company's
cost basis. Two (2) equity securities with unrealized losses have existed
for twelve months or more, and twenty-one (21) equity securities with
unrealized losses have existed for an average of four months. No credit
issues have been identified that caused management to believe the declines
in market value are other than temporary.
F-19
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. LOANS
A summary of the balances of loans follows:
June 30,
---------------------
2004 2003
---- ----
(In Thousands)
Mortgage loans on real estate:
Fixed-rate residential $ 96,213 $ 97,477
Adjustable-rate residential 71,488 67,986
Commercial 80,071 69,785
Construction 26,069 16,557
Home equity lines of credit 18,171 9,385
-------- --------
292,012 261,190
-------- --------
Other loans:
Commercial 11,055 10,332
Commercial lines of credit 10,525 9,918
Personal 687 767
-------- --------
22,267 21,017
-------- --------
Total loans 314,279 282,207
Net deferred loan costs 64 89
Allowance for loan losses (2,537) (2,347)
-------- --------
Loans, net $311,806 $279,949
======== ========
An analysis of the allowance for loan losses follows:
Years Ended June 30,
----------------------------
2004 2003 2002
---- ---- ----
(In Thousands)
Balance at beginning of year $2,347 $2,063 $1,784
Provision for loan losses 584 300 305
Recoveries 15 24 4
Charge-offs (409) (40) (30)
------ ------ ------
Balance at end of year $2,537 $2,347 $2,063
====== ====== ======
F-20
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
LOANS (concluded)
At June 30, 2004 and 2003, the recorded investment in impaired loans
amounted to $2,222,000 and $209,000, 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, 2004, 2003, and
2002 amounted to $1,727,000, $365,000 and $28,000, respectively, and
interest income recognized on a cash basis on impaired loans amounted to
$21,000, $1,000 and $1,000, respectively. Non-accrual loans amounted to
$1,822,000 and $223,000 at June 30, 2004 and 2003, 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 $46,030,000 and $38,924,000 at June 30, 2004 and 2003, respectively.
All loans serviced for others were sold without recourse provisions.
The balance of capitalized servicing rights included in other assets at June
30, 2004 and 2003 amounted to $318,000 and $248,000, respectively. The fair
value of servicing rights approximates carrying value at June 30, 2004 and
2003.
Mortgage servicing rights capitalized during the year ended June 30, 2004
and June 30, 2003 amounted to $182,000 and $276,000, respectively. Mortgage
servicing rights amortized during the year ended June 30, 2004 and June 30,
2003 amounted to $112,000 and $28,000, respectively.
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,
-------------------
2004 2003
---- ----
(In Thousands)
Banking premises:
Land $ 242 $ 242
Buildings and improvements 2,471 2,539
Leasehold improvements 568 568
Equipment 4,174 3,227
------- -------
7,455 6,576
Less accumulated depreciation and amortization (4,161) (3,527)
------- -------
$ 3,294 $ 3,049
======= =======
F-21
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, 2004,
2003 and 2002 amounted to $600,000, $467,000 and $323,000, respectively.
6. REAL ESTATE HELD FOR INVESTMENT
Real estate held for investment represents property adjacent to the
Company's main office which is primarily leased as commercial retail and
office space. The Company occupies a portion of the building for its own
activities. A summary of the cost and accumulated depreciation is as
follows:
June 30,
-----------------
2004 2003
---- ----
(In Thousands)
Land $ 34 $ 34
Building 2,297 2,297
------ ------
2,331 2,331
Less accumulated depreciation (861) (790)
------ ------
$1,470 $1,541
====== ======
Depreciation expense for the years ended June 30, 2004, 2003 and 2002
amounted to $71,000, $75,000 and $63,000, respectively.
The following is a schedule of minimum future rental income on noncancelable
leases:
Year Ending
June 30, Amount
- ----------- ------
(In Thousands)
2005 $ 84
2006 42
2007 16
----
$142
====
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, 2004, 2003 and 2002 amounted to
$118,000, $124,000 and $136,000, respectively.
F-22
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,
--------------------
2004 2003
---- ----
(In Thousands)
NOW accounts $ 26,292 $ 26,342
IOLTA accounts 12,505 28,659
Demand deposits 36,066 25,871
Regular and other deposits 83,001 69,015
Money market deposits 54,968 51,719
-------- --------
Total non-certificate accounts 212,832 201,606
-------- --------
Term certificates less than $100,000 83,532 85,306
Term certificates of $100,000 or more 55,043 56,652
-------- --------
Total certificate accounts 138,575 141,958
-------- --------
Total deposits $351,407 $343,564
======== ========
A summary of certificate accounts, by maturity, is as follows:
June 30, 2004 June 30, 2003
-------------------- --------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ -------- ------ --------
(Dollars In Thousands)
Within 1 year $ 62,762 1.91% $102,616 3.22%
Over 1 year to 3 years 64,588 3.12 30,982 3.58
Over 3 years to 5 years 11,225 3.91 8,360 4.22
-------- --------
$138,575 2.64% $141,958 3.36%
======== ========
F-23
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, 2004
and 2003:
Amount Weighted Average Rate
------------------ ---------------------
Maturity 2004 2003 2004 2003
- --------------------------- ---- ---- ---- ----
(In Thousands)
Year Ending June 30,
- --------------------
2004 $ - $10,600 -% 4.71%
2005 (1) 28,300 7,000 2.60 6.85
2006 600 600 6.05 6.05
2007 (2) 3,000 7,000 6.16 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 761 800 6.97 6.97
------- -------
$47,861 $41,200 3.68% 5.33%
======= =======
Includes advances aggregating $6,000,000, callable on September 1,
2004.
Includes advances aggregating $3,000,000, callable on July 26, 2004.
Advance callable on August 11, 2004.
Includes advances aggregating $2,000,000, $2,000,000, $2,000,000,
$5,000,000 and $3,000,000, callable on July 8, 2004, July 26, 2004,
August 9, 2004, August 12, 2004 and September 20, 2004, respectively.
During the years ended, June 30, 2004 and 2003, advances aggregating
$5,000,000 and $5,400,000, respectively, were prepaid resulting in
prepayment penalties of $298,000 and $468,000, respectively, which were
included in operating expense when incurred.
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.
F-24
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. SUBORDINATED DEBT
In April 2002, Mystic Financial Capital Trust I (the "Trust") 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. Using interest payments made by the Company on the
debentures, the Trust pays semi-annual dividends to preferred security
holders. The interest payable on the subordinated debentures and the
cumulative dividends payable on the preferred securities is equal to a
floating rate of 5.07% at June 30, 2004. Interest payments on these
securities are payable semi-annually in arrears on April 22nd and October
22nd. The Company has the option to defer interest payments on the
subordinated debentures for up to five years and, accordingly, the Trust may
defer dividend distributions for up to five years.
In February 2003, Mystic Financial Capital Trust II (the "Trust") 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. Using interest payments made by the Company on the
debentures, the Trust pays quarterly dividends to preferred security
holders. The interest payable on the subordinated debentures and the
cumulative dividends payable on the preferred securities is equal to a
floating rate of 4.50% at June 30, 2004. Interest payments on these
securities are payable every three months in arrears on February 15th, May
15th, August 15th and November 15th. The Company has the option to defer
interest payments on the subordinated debentures for up to five years and,
accordingly, the Trust may defer dividend distributions for up to five
years.
F-25
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,
--------------------------
2004 2003 2002
---- ---- ----
(In Thousands)
Current tax provision:
Federal $ 962 $ 871 $ 967
State 103 226 311
------ ------ ------
Total current 1,065 1,097 1,278
------ ------ ------
Deferred tax provision (benefit):
Federal (74) 12 (189)
State (25) 5 (58)
------ ------ ------
Total deferred (99) 17 (247)
------ ------ ------
Total provision $ 966 $1,114 $1,031
====== ====== ======
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,
----------------------
2004 2003 2002
---- ---- ----
Statutory rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 1.8 5.4 6.3
Other, net (1.8) - (1.5)
---- ---- ----
Effective tax rate 34.0% 39.4% 38.8%
==== ==== ====
F-26
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,
-----------------
2004 2003
---- ----
(In Thousands)
Deferred tax asset:
Federal $1,470 $ 888
State 519 299
------ ------
1,989 1,187
Valuation reserve on asset (24) (24)
------ ------
1,965 1,163
------ ------
Deferred tax liability:
Federal (219) (547)
State (76) (157)
------ ------
(295) (704)
------ ------
Net deferred tax asset $1,670 $ 459
====== ======
The tax effects of each type of income and expense item that give rise to
deferred taxes are as follows:
June 30,
----------------
2004 2003
---- ----
(In Thousands)
Allowance for loan losses $1,038 $ 960
Net unrealized loss (gain) on securities available for sale 635 (477)
Other 21 -
------ -----
1,694 483
Valuation reserve (24) (24)
------ -----
Net deferred tax asset $1,670 $ 459
====== =====
F-27
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,
-------------------------
2004 2003 2002
---- ---- ----
(In Thousands)
Balance at beginning of year $ 459 $ 727 $ 656
Deferred tax benefit (provision) 99 (17) 247
Deferred tax (benefit) on net unrealized gain on
securities available for sale 1,112 (251) (176)
------ ----- -----
Balance at end of year $1,670 $ 459 $ 727
====== ===== =====
There was no change in the valuation reserve during the years ended June 30,
2004, 2003 and 2002.
The federal income tax reserve for loan losses at the Company'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 Company 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-28
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,
------------------
2004 2003
---- ----
(In Thousands)
Commitments to grant mortgage loans $ 7,655 $ 9,209
Commitments to grant commercial loans 21,032 9,370
Unadvanced funds on home equity lines of credit 27,843 11,555
Unadvanced funds on commercial lines of credit 11,055 9,920
Unadvanced funds on construction loans 31,859 14,016
Standby letters of credit 655 927
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, construction 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.
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, 2004 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-29
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
COMMITMENTS AND CONTINGENCIES (continued)
Directors' retirement plan
The Company has 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
$92,000, $158,000 and $34,000 for the years ended June 30, 2004, 2003 and
2002, 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 weeks of
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, 2004, the future minimum rent commitments for leased premises are
as follows:
Year Ending
June 30, Amount
- ----------- ------
(In Thousands)
2005 $ 380
2006 298
2007 298
2008 292
2009 159
Thereafter 312
------
Total $1,739
======
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 options and reimbursements are not included above.
Rent expense for the years ended June 30, 2004, 2003 and 2002 amounted to
$448,000, $385,000 and $333,000, respectively.
F-30
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-31
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, 2004 and 2003, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of June 30, 2004, 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, 2004:
Total Capital to Risk Weighted Assets
Consolidated $42,499 16.3% $20,842 8.0% N/A N/A
Bank 39,302 15.1 20,779 8.0 $25,973 10.0%
Tier I Capital to Risk Weighted Assets
Consolidated 36,964 14.2 10,421 4.0 N/A N/A
Bank 36,596 14.1 10,389 4.0 15,584 6.0
Tier I Capital to Average Assets
Consolidated 36,964 8.6 17,192 4.0 N/A N/A
Bank 36,596 8.6 17,095 4.0 21,368 5.0
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
F-32
MYSTIC FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
13. RELATED PARTY TRANSACTIONS
At June 30, 2004 and 2003, total loans to directors and officers of the Bank
which exceeded $60,000 in the aggregate to each related party, totaled
$4,237,000 and $4,128,000, respectively. During the years ended June 30,
2004 and 2003, total principal additions were $786,000 and $2,587,000,
respectively, and total principal payments were $677,000 and $2,074,000,
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, 2004, 2003 and 2002
amounted to $303,000, $167,000 and $127,000, 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, 2004, 2003
and 2002 amounted to $102,000, $87,000 and $72,000, respectively.
Employee stock ownership plan ("ESOP")
The Company has an ESOP for the benefit of eligible employees who have
attained age 21 and have completed one year of service.
F-33
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 227,735
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 through December 2007.
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. Upon the effective date of a Change
in Control, as defined, all benefits become fully vested. Forfeitures are
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,
------------------------
2004 2003
---- ----
Allocated 139,842 122,954
Committed to be Allocated 10,619 11,251
Unallocated 71,659 93,530
---------- ----------
Total 222,120 227,735
========== ==========
Fair value of unallocated ESOP shares $2,304,000 $1,960,000
========== ==========
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 $605,000, $400,000 and
$365,000 for the years ended June 30, 2004, 2003, and 2002, respectively.
F-34
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 270,223
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,
-----------------------------------------------------------------
2004 2003 2002
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------