Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 001-16767
Westfield Financial, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Massachusetts 73-1627673
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
141 Elm Street, Westfield, Massachusetts 01085
(Address of Principal Executive Offices, including zip code)
(413) 568-1911
(Registrant's telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value per share AMEX
- -------------------------------------- ----------------------
(Title of Each Class) (Name of Each Exchange
on which Registered)
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or 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 files 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 or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ].
As of March 7, 2005, the registrant had 10,580,000 shares of common stock,
$.01 par value, issued and 9,954,512 shares outstanding. Of such shares
outstanding, 5,607,400 shares were held by Westfield Mutual Holding
Company, the registrant's mutual holding company, and 4,347,112 were held
by the public and directors, officers and employees of the registrant.
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of June 30, 2004, was $80,280,882. This figure was based
on the closing price as of June 30, 2004 on The American Stock Exchange for
a share of the registrant's common stock, which was $20.34 on June 30,
2004.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III of Form 10-K - Portions of the Proxy Statement for the 2005 Annual
Meeting of Stockholders.
WESTFIELD FINANCIAL, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2004
TABLE OF CONTENTS
ITEM PART I PAGE
1 BUSINESS 2
2 PROPERTIES 40
3 LEGAL PROCEEDINGS 41
4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 41
PART II
5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 41
6 SELECTED FINANCIAL DATA 42
7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 43
7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 69
8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 69
9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 70
9A CONTROLS AND PROCEDURES 70
9B OTHER INFORMATION 71
PART III
10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 71
11 EXECUTIVE COMPENSATION 72
12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 72
13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 73
14 PRINCIPAL ACCOUNTING FEES AND SERVICES 73
PART IV
15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES 73
SIGNATURES 76
FORWARD - LOOKING STATEMENTS
This Annual Report on Form 10-K contains "forward-looking statements"
which may be identified by the use of such words as "believe," "expect,"
"anticipate," "should," "planned," "estimated," and "potential." Examples
of forward-looking statements include, but are not limited to, estimates
with respect to our financial condition and results of operation and
business that are subject to various factors which could cause actual
results to differ materially from these estimates. These factors include,
but are not limited to:
* general and local economic conditions;
* changes in interest rates, deposit flows, demand for mortgages
and other loans, real estate values, and competition;
* changes in accounting principles, policies, or guidelines;
* changes in legislation or regulation; and
* other economic, competitive, governmental, regulatory, and
technological factors affecting our operations, pricing,
products, and services.
Any or all of our forward-looking statements in this Annual Report on
Form 10-K and in any other public statements we make may turn out to be
wrong. They can be affected by inaccurate assumptions we might make or
known or unknown risks and uncertainties. Consequently, no forward-looking
statements can be guaranteed. We disclaim any obligation to subsequently
revise any forward-looking statements to reflect events or circumstances
after the date of such statements, or to reflect the occurrence of
anticipated or unanticipated events.
1
PART I
ITEM 1. BUSINESS
General. Westfield Financial, Inc. ("Westfield Financial," "us,"
"our," or "we") is a Massachusetts-chartered stock holding company
organized in November 2001 in connection with the reorganization of
Westfield Mutual Holding Company, a federally-chartered mutual holding
company which owns 56.3% of the outstanding common stock of Westfield
Financial. Westfield Financial serves as the bank holding company for
Westfield Bank, a federally-chartered stock savings bank. Unless the
context otherwise requires, all references herein to Westfield Bank or
Westfield Financial include Westfield Financial and Westfield Bank on a
consolidated basis. In connection with our reorganizing, Westfield
Financial sold 4,972,600 shares of its common stock to eligible depositors
of Westfield Bank. Net proceeds of the stock offering were $47.7 million.
The reorganization of Westfield Mutual Holding Company and the related
stock offering by Westfield Financial were completed on December 27, 2001.
The common stock of Westfield Financial commenced trading on The American
Stock Exchange under the symbol "WFD" on December 28, 2001.
On July 23, 2004 Westfield Bank and Westfield Mutual Holding Company
completed their conversions from Massachusetts-chartered companies
regulated by the Massachusetts Division of Banks or the Federal Reserve
Board to federally-chartered companies regulated by the Office of Thrift
Supervision (the "OTS").
Westfield Securities Corp., a Massachusetts chartered security
corporation, and Westfield Bank are the only operating subsidiaries of
Westfield Financial. Westfield Securities Corp. was formed in December 2001
by Westfield Financial for the primary purpose of holding qualified
investment securities.
Westfield Bank was formed in 1853 and reorganized into a mutual
holding company structure without a stock offering in 1995. Historically,
Westfield Bank has been a community-oriented provider of banking products
and services to businesses and individuals, including traditional products
such as residential and commercial real estate loans, consumer loans and a
variety of deposit products. In recent years, however, Westfield Bank has
developed and implemented a lending strategy that focuses less on
residential real estate lending and more on servicing commercial customers,
including increased emphasis on commercial and industrial and consumer
lending and deposit relationships, extending its branch network and
broadening its product lines and services. Westfield Bank believes that
this business strategy is best for its long term success and viability, and
complements its existing commitment to high quality customer service.
Beginning on September 1, 2001, Westfield Bank began referring its
residential real estate loan customers to a third party mortgage company.
Under the program, substantially all of Westfield Bank's residential real
estate loans are underwritten and originated by a third party mortgage
company. In connection with this referral program, Westfield Bank receives
fee income for each of the loans originated by the third party mortgage
company. Westfield Bank may purchase residential real estate loans from
the third party mortgage company depending on market conditions. To date,
Westfield Bank has not purchased a significant amount of loans
2
from the third party mortgage company. Westfield Bank believes that this
program diversifies its loan portfolio and reduces interest rate risk.
Westfield Bank operates through 10 banking offices in Agawam, East
Longmeadow, Holyoke, Southwick, Springfield, West Springfield and
Westfield, Massachusetts. It also has four free-standing ATM locations in
Agawam, Feeding Hills and Springfield, Massachusetts. Westfield Bank's
primary deposit gathering area is concentrated in the communities
surrounding these locations and its primary lending area includes all of
Hampden County in Western Massachusetts. In addition, Westfield Bank
provides online banking services through its web site
http://www.westfieldbank.com.
Westfield Bank's revenues are derived principally from interest on
its loans and interest and dividends on its investment securities. Its
primary sources of funds are deposits, scheduled amortization and
prepayments of loan principal and mortgage-backed securities, maturities
and calls of investment securities, and funds provided by operations.
Market Area. Westfield Bank conducts its operations out of the
Bank's main office in Westfield, Massachusetts. It also operates through
nine other banking offices located in Westfield and in the communities of
Agawam, East Longmeadow, Holyoke, Southwick, Springfield and West
Springfield, Massachusetts. Its deposits are gathered from the general
public in these towns and surrounding communities, and its lending
activities are concentrated primarily in Hampden County, Massachusetts.
The City of Westfield is largely suburban and is located in the
Pioneer Valley near the intersection of U.S. Interstates 90 (the
Massachusetts Turnpike) and 91. Interstate 90 is the major east-west
highway that crosses Massachusetts. Interstate 91 is the major north-south
highway that runs directly through the heart of New England. Westfield is
located approximately 90 miles west of Boston, Massachusetts, 70 miles
southeast of Albany, New York and 30 miles north of Hartford, Connecticut.
Westfield's 2004 population was approximately 41,000 and the estimated 2004
population for Hampden County was approximately 456,200.
The economy of Westfield Bank's market area historically has been
supported by a variety of industries. Its primary market area has
benefited from the presence of large employers centered in insurance,
health care, warehouse, manufacturing and education. Among the largest
employers currently in its market area are Bay State Health Systems, Big Y
Foods, Friendly Ice Cream Corporation, Hasbro, Mass Mutual Life Insurance
Company, Mestek, Noble Hospital, the University of Massachusetts, Westfield
State College, American International College, and the Sullivan Paper
Company. In addition, other employment and economic activity is provided by
a substantial number of small and medium size businesses in the area.
Westfield Bank's future growth opportunities will be influenced by
the growth and stability of the statewide and regional economies, other
demographic population trends and the competitive environment. Westfield
Bank believes that it has developed lending products and marketing
strategies to address the diverse credit-related needs of the residents in
its market area.
3
As of December 2004, the unemployment rate of Westfield Bank's
primary market area and Massachusetts was 5.9% and 5.6%, respectively,
compared to 6.5% and 5.4%, respectively, in December 2003. From June 2003
to June 2004, the median household income in Westfield Bank's market area
increased by 2.2% to $55,624, compared to $54,387 as of June 2003. Despite
the increase, the median household income in Westfield Bank's market area
is below state and national averages.
Competition. Westfield Bank faces intense competition both in making
loans and attracting deposits. Its primary market area is highly
competitive and it faces direct competition from approximately 24 financial
institutions, many with a local, state-wide or regional presence and, in
some cases, a national presence. Many of these financial institutions are
significantly larger than and have greater financial resources than
Westfield Bank. Westfield Bank's competition for loans comes principally
from commercial banks, savings institutions, mortgage banking firms, credit
unions, finance companies, mutual funds, insurance companies and brokerage
and investment banking firms. Historically, Westfield Bank's most direct
competition for deposits has come from savings, co-operative and commercial
banks. Westfield Bank faces additional competition for deposits from short-
term money market funds and other corporate and government securities funds
and from brokerage firms and insurance companies. In Westfield Bank's
market area, there were approximately eight of the foregoing institutions
at December 31, 2004.
Lending Activities
Loan Portfolio Composition. Westfield Bank's loan portfolio
primarily consists of residential real estate loans, home equity loans,
commercial real estate loans, commercial and industrial loans and consumer
loans.
At December 31, 2004, Westfield Bank had total loans of $373.4
million, of which 71.7% were adjustable-rate loans and 28.3% were fixed-
rate loans. Commercial real estate loans and commercial and industrial
loans totaled $144.3 million and $94.7 million respectively. The remainder
of its loans at December 31, 2004 consisted of residential mortgage loans,
home equity loans and consumer loans. Residential mortgage and home equity
loans outstanding at December 31, 2004 totaled $122.8 million. Consumer
loans outstanding at December 31, 2004 were $11.6 million.
Westfield Bank's loans are subject to federal law and regulations.
The interest rates Westfield Bank charges on loans are affected principally
by the demand for loans, the supply of money available for lending purposes
and the interest rates offered by its competitors. These factors are, in
turn, affected by general and local economic conditions, monetary policies
of the federal government, including the Federal Reserve Board, legislative
tax policies and governmental budgetary matters. The following table
presents the composition of Westfield Bank's loan portfolio in dollar
amounts and in percentages of the total portfolio at the dates indicated.
4
At December 31,
---------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------------- ------------------- ------------------- ------------------- -------------------
Percent of Percent of Percent of Percent of Percent of
Amount Total Amount Total Amount Total Amount Total Amount Total
------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ----------
(Dollars in thousands)
Real estate loans:
Commercial $144,336 38.65 $131,292 37.57 $100,903 27.92 $ 99,425 23.82 $ 92,826 19.84
Residential 111,646 29.90 100,728 28.83 146,664 40.59 199,710 47.86 250,945 53.64
Home equity 11,176 2.99 9,819 2.81 11,232 3.11 13,041 3.13 13,217 2.83
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 267,158 71.54% 241,839 69.21% 258,799 71.62% 312,176 74.81% 356,988 76.31%
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Other loans:
Commercial and industrial 94,726 25.36 85,292 24.41 61,494 17.01 47,012 11.27 37,510 8.02
Indirect auto 5,886 1.58 15,983 4.57 33,848 9.37 52,129 12.49 66,168 14.14
Consumer, other 5,679 1.52 6,327 1.81 7,216 2.00 5,955 1.43 7,171 1.53
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total other loans 106,291 28.46 107,602 30.79 102,558 28.38 105,096 25.19 110,849 23.69
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 373,449 100.00% 349,441 100.00% 361,357 100.00% 417,272 100.00% 467,837 100.00%
Net deferred loan
origination costs 429 181 123 197 128
Allowance for loan losses (5,277) (4,642) (4,325) (3,923) (3,434)
-------- -------- -------- -------- --------
Total loans, net $368,601 $344,980 $357,155 $413,546 $464,531
======== ======== ======== ======== ========
5
Loan Maturity and Repricing. The following table shows the repricing
dates or contractual maturity dates as of December 31, 2004. The table
does not reflect prepayments or scheduled principal amortization. Demand
loans, loans having no stated maturity, and overdrafts are shown as due in
within one year.
At December 31, 2004
-------------------------------------------------------------------------------
Commercial
Residential Commercial and
Real Estate Home Equity Real Estate Industrial Consumer
Loans Loans Loans Loans Loans Totals
----------- ----------- ----------- ---------- -------- ------
(In thousands)
Amounts due:
Within one year $ 15,693 $11,176 $ 32,176 $65,481 $ 1,441 $125,967
-------- ------- -------- ------- ------- --------
After one year:
One to three years 7,228 - 11,665 4,589 6,955 30,437
Three to five years 32,538 - 65,997 15,114 3,030 116,679
Five to ten years 19,661 - 31,279 9,532 139 60,611
Ten to twenty years 21,941 - 3,219 10 - 25,170
Over twenty years 14,585 - - - - 14,585
-------- ------- -------- ------- ------- --------
Total due after one year 95,953 - 112,160 29,245 10,124 247,482
-------- ------- -------- ------- ------- --------
Total amount due: 111,646 11,176 144,336 94,726 11,565 373,449
-------- ------- -------- ------- ------- --------
Less:
Net deferred loan origination
costs 374 - - - 55 429
Allowance for loan losses (383) (38) (2,361) (2,314) (181) (5,277)
-------- ------- -------- ------- ------- --------
Loans, net $111,637 $11,138 $141,975 $92,412 $11,439 $368,601
======== ======= ======== ======= ======= ========
The following table presents, as of December 31, 2004, the dollar
amount of all loans contractually due or scheduled to reprice after
December 31, 2005 and whether such loans have fixed interest rates or
adjustable interest rates.
Due After December 31, 2005
---------------------------------
Fixed Adjustable Total
----- ---------- -----
(In thousands)
Real Estate Loans
Residential $58,840 $ 37,113 $ 95,953
Commercial real estate 6,085 106,075 112,160
------- -------- --------
Total real estate loans 64,925 143,188 208,113
------- -------- --------
Other Loans
Commercial and industrial 23,985 5,260 29,245
Consumer 10,124 - 10,124
------- -------- --------
Total other loans 34,109 5,260 39,369
------- -------- --------
Total loans $99,034 $148,448 $247,482
======= ======== ========
6
The following table presents our loan originations, purchases, sales
and principal payments for the years indicated:
For the Year Ended December 31,
--------------------------------
2004 2003 2002
---- ---- ----
(In thousands)
Loans:
Balance outstanding at beginning of years $349,441 $361,357 $417,272
Originations:
Real estate loans:
Residential 5,435 4,062 6,433
Home equity 6,390 5,694 2,247
Commercial 31,174 58,978 27,746
-------- -------- --------
Total mortgage originations 42,999 68,734 36,426
Commercial and industrial loans 50,349 67,558 47,844
Consumer loans 3,516 4,676 13,932
-------- -------- --------
Total originations 96,864 140,968 98,202
Purchases of one-to-four family mortgage loans 34,996 11,352 6,057
-------- -------- --------
131,860 152,320 104,259
-------- -------- --------
Less:
Principal repayments, unadvanced funds and
other, net 107,737 163,803 159,577
Loan charge-offs, net 115 433 532
Transfers to foreclosed real estate - - 65
-------- -------- --------
Total deductions 107,852 164,236 160,174
-------- -------- --------
Ending balance $373,449 $349,441 $361,357
======== ======== ========
7
Residential Mortgage Loans and Originations. Beginning in September,
2001, Westfield Bank began referring its residential real estate borrowers
to a third party mortgage company. Residential real estate borrowers
submit applications to Westfield Bank, but the loan is closed on the books
of the mortgage company. Westfield Bank receives a fee for each of these
loans originated by the third party mortgage company. Under the program,
substantially all of Westfield Bank's residential real estate loans are
underwritten and originated by the third party mortgage company. In
addition, depending on market conditions, Westfield Bank may purchase
residential real estate loans from the third party mortgage company. To
date, the Bank has not purchased a significant amount of loans from the
third party mortgage company. Westfield Bank believes that this program
diversifies its loan portfolio and reduces its interest rate risk.
Even though substantially all residential mortgages are referred to a
third party mortgage company, Westfield Bank still holds residential
mortgages in its loan portfolio. The mortgages held in portfolio consist
primarily of loans originated prior to the commencement of the third party
residential mortgage program. As of December 31, 2004, loans on one-to-
four family residential properties, including home equity lines, accounted
for $122.8 million, or 32.89%, of Westfield Bank's total loan portfolio.
Westfield Bank offers adjustable-rate mortgage loans with either a
one-year, three-year or five-year term to the initial repricing date.
After that initial period, the interest rate for each adjustable-rate
mortgage loan generally adjusts annually for the remainder of the term of
the loan. Westfield Bank uses a different number of indices to reprice its
adjustable-rate mortgage loans.
Westfield Bank's residential adjustable-rate mortgage loans generally
are fully amortizing loans with contractual maturities of up to 30 years,
payments due monthly. Its adjustable-rate mortgage loans generally provide
for specified minimum and maximum interest rates, with a lifetime cap and
floor, and a periodic adjustment on the interest rate over the rate in
effect on the date of origination. As a consequence of using caps, the
interest rates on these loans are not generally as rate sensitive as its
cost of funds. The adjustable-rate mortgage loans that Westfield Bank
originates generally are not convertible into fixed-rate loans.
Adjustable-rate mortgage loans generally pose different credit risks
than fixed-rate loans, primarily because as interest rates rise, the
borrower's payments rise, increasing the potential for default. To date,
Westfield Bank has not experienced difficulty with payments for these
loans. At December 31, 2004, its residential mortgage and home equity loan
portfolio included $63.9 million in adjustable-rate loans or, 52.0% of its
total loan portfolio, and $58.9 million in fixed-rate loans, or 48.0% of
its total loan portfolio.
8
Westfield Bank's home equity lines of credit totaled $11.2 million
and comprised 3.0% of its total loan portfolio at December 31, 2004. These
loans may be originated in amounts of the existing first mortgage, or up to
100% of the value of the property securing the loan. The term to maturity
on Westfield Bank's home equity and home improvement loans may be up to 15
years.
Commercial Real Estate Loans. Westfield Bank originates commercial
real estate loans to finance the purchase of real property, which generally
consists of apartment buildings, business properties, multi-family
investment properties and construction loans to developers of commercial
and residential properties. In underwriting commercial real estate loans,
consideration is given to the property's historic cash flow, current and
projected occupancy, location and physical condition. At December 31,
2004, Westfield Bank's commercial real estate loan portfolio consisted of
394 loans, totaling $144.3 million, or 38.6% of total loans. Since 2000,
commercial real estate loans have grown by $51.5 million, or 55.5%, from
$92.8 million at December 31, 2000 to $144.3 million at December 31, 2004.
Substantially all of the commercial real estate portfolio consists of
loans which are collateralized by properties in Westfield Bank's normal
lending area. Westfield Bank's commercial real estate loan portfolio is
diverse, and does not have any significant loan concentration by type of
property or borrower. Westfield Bank generally lends up to a maximum loan-
to-value ratio of 80% on commercial properties and generally requires a
minimum debt coverage ratio of 1.20 times. Its largest commercial real
estate loan relationship had an outstanding balance of $6.3 million at
December 31, 2004 which was secured by two commercial investment properties
located in Massachusetts and one property in Connecticut. The loans of
this borrower have performed to contractual terms.
Westfield Bank also offers construction loans to finance the
construction of commercial properties located in its primary market area.
Westfield Bank had $3.6 million in commercial construction loans and
commitments at December 31, 2004.
Commercial real estate lending involves additional risks compared
with one-to-four family residential lending. Payments on loans secured by
commercial real estate properties often depend on the successful management
of the properties, on the amount of rent from the properties, or on the
level of expenses needed to maintain the properties. Repayment of such
loans may therefore be adversely affected by conditions in the real estate
market or the general economy. Also, commercial real estate loans
typically involve large loan balances to single borrowers or groups of
related borrowers. In order to mitigate this risk, Westfield Bank monitors
its loan concentration on a quarterly basis and its loan policies generally
limit the amount of loans to a single borrower or group of borrowers.
Because of increased risks associated with commercial real estate
loans, Westfield Bank's commercial real estate loans generally have higher
rates and shorter maturities than residential mortgage loans. Westfield
Bank usually offers commercial real estate loans at adjustable rates tied
to the prime rate or to yields on U.S. Treasury securities. The terms of
such loans generally do not exceed 20 years.
9
Commercial and Industrial Loans. Westfield Bank offers commercial
and industrial loan products and services which are designed to give
business owners borrowing opportunities for modernization, inventory,
equipment, construction, consolidation, real estate, working capital,
vehicle purchases and the financing of existing corporate debt. Westfield
Bank offers business installment loans, vehicle and equipment financing,
lines of credit, equipment leasing and other commercial loans. At December
31, 2004, Westfield Bank's commercial and industrial loan portfolio
consisted of 765 loans, totaling $94.7 million or 25.4% of its total loans.
Since 2000, commercial and industrial loans have grown $57.2 million, or
153.0%, from $37.5 at December 31, 2000 to $94.7 million at December 31,
2004. Westfield Bank's commercial loan team includes six commercial loan
officers, one business development manager, and four credit analysts.
Westfield Bank may hire additional commercial loan officers on an as needed
basis.
As part of Westfield Bank's strategy of increasing its emphasis on
commercial lending, Westfield Bank seeks to attract its business customers'
entire banking relationship. Most commercial borrowers also maintain a
commercial deposit at Westfield Bank. Westfield Bank provides
complementary commercial products and services, including an equipment
leasing program with a third party vendor, a variety of commercial deposit
accounts, cash management services, internet banking, sweep accounts, a
broad ATM network and night deposit services. Commercial loan officers are
based in its main and branch offices, and Westfield Bank views its
potential branch expansion as a means of facilitating these commercial
relationships. Westfield Bank intends to continue to expand the volume of
its commercial business products and services within its current
underwriting standards.
Westfield Bank's commercial loan portfolio does not have any
significant loan concentration by type of property or borrower. The
largest concentration of loans was for testing laboratories, which comprise
approximately 3.4 % of the total loan portfolio as of December 31, 2004.
At December 31, 2004, Westfield Bank's largest commercial and industrial
loan relationship was $11.6 million to a company engaged in the wholesale
distribution of beer and wine products in western Massachusetts. The loans
of this borrower have performed to contractual terms.
Commercial and industrial loans generally have terms of five years or
less, however on an occasional basis, may have terms of up to ten years.
Although Westfield Bank does originate fixed-rate commercial loans,
substantially all of its commercial loans have variable interest rates tied
to the prime rate. Whenever possible, Westfield Bank also collateralizes
these commercial and industrial loans with a lien on commercial real
estate. Alternatively, Westfield Bank may collateralize these loans with a
lien on business assets and equipment. In some cases, both types of liens
are required. Westfield Bank also generally requires the personal
guarantee of the business owner. Interest rates on commercial loans
generally have higher yields than residential or commercial real estate
loans.
Commercial and industrial loans are generally considered to involve a
higher degree of risk than residential or commercial real estate loans
because the collateral may be in the form of intangible assets and/or
inventory subject to market obsolescence. Commercial and industrial loans
may also involve relatively large loan balances to single borrowers or
groups of related borrowers, with the repayment of such loans typically
dependent on the successful operation and income stream of the borrower.
These risks can be significantly affected by economic
10
conditions. In addition, business lending generally requires substantially
greater oversight efforts by Westfield Bank's staff compared to residential
or commercial real estate lending. In order to mitigate this risk,
Westfield Bank monitors its loan concentration and its loan policies
generally limit the amount of loans to a single borrower or group of
borrowers. Westfield Bank also utilizes the services of an outside
consultant to conduct on-site credit quality reviews of the commercial and
industrial loan portfolio.
Consumer Loans. Consumer loans are generally originated at higher
interest rates than residential and commercial mortgage loans, but they
also generally tend to have a higher credit risk than residential mortgage
loans because they are usually unsecured or secured by rapidly depreciable
assets. Management, however, believes that offering consumer loan products
helps to expand and create stronger ties to Westfield Bank's existing
customer base by increasing the number of customer relationships and
providing cross-marketing opportunities.
Westfield Bank offers a variety of consumer loans to retail customers
in the communities it serves. Examples of its consumer loans include:
* automobile loans;
* secured passbook loans;
* credit lines tied to deposit accounts to provide overdraft
protection; and
* unsecured personal loans.
At December 31, 2004, the consumer loan portfolio totaled $11.6
million or 3.1% of total loans. Westfield Bank's consumer lending will
allow it to diversify its loan portfolio while continuing to meet the needs
of the individuals and businesses that it serves.
Indirect automobile loans currently represent the largest portion of
its consumer loan portfolio, totaling $5.9 million, or 1.6% of its total
loan portfolio and 50.9% of its consumer loan portfolio, at December 31,
2004. Management curtailed its indirect lending beginning in fiscal year
2000 and in fourth quarter of 2003 the Bank ceased writing new loans under
this program.
When the indirect lending program was in operation, Westfield Bank
maintained contractual relationships with approximately 40 new and used car
dealers located throughout western Massachusetts and northern Connecticut.
Westfield Bank had maintained a contractual arrangement and outsourced a
portion of the origination function and all of the servicing function to a
nationally recognized service provider. As of the fourth quarter of 2003,
the Bank no longer originates indirect loans and in the first quarter of
2004, transferred servicing of the indirect loans from the service provider
to Westfield Bank. The collection and liquidation functions had been, and
continue to be, handled in-house by Westfield Bank personnel.
Loans collateralized by rapidly depreciable assets such as
automobiles or that are unsecured entail greater risks than residential
mortgage loans. In such cases, repossessed collateral for a defaulted loan
may not provide an adequate source of repayment of the outstanding loan
balance, since there is a greater likelihood of damage, loss or
depreciation of the underlying collateral. The remaining deficiency often
does not warrant further substantial
11
collection efforts against the borrower beyond obtaining a deficiency
judgment. Further, collections on these loans are dependent on the
borrower's continuing financial stability and, therefore, are more likely
to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Repossessed collateral relating to consumer loans at December
31, 2004 approximated $18,000. Finally, the application of various federal
and state laws, including federal and state bankruptcy and insolvency laws,
may limit the amount which can be recovered on such loans if a borrower
defaults.
Loan Approval Procedures and Authority. As established by the
Executive Committee of the Board of Directors, Westfield Bank's lending
policies provide that its mortgage underwriting department may review and
approve mortgage loans up to $500,000. Westfield Bank's underwriting
department also may review and approve home equity loans up to $100,000.
Any loan applications, including mortgage loans, that exceed $500,000 or
$100,000 for home equity loans require approval of the Executive Committee.
For loans requiring board approval, management is responsible for
presenting to the board information about the creditworthiness of a
borrower and the estimated value of the subject property. Generally, the
estimated value of the property must be supported by an independent
appraisal report prepared in accordance with Westfield Bank's appraisal
policy.
The following generally describes Westfield Bank's current lending
procedures. Upon receipt of a completed loan application from a
prospective borrower, Westfield Bank must order a credit report and verify
other information. If necessary, Westfield Bank obtains additional
financial or credit related information. Westfield Bank requires an
appraisal for all mortgage loans. Appraisals for mortgage loans are
performed by licensed or certified third-party appraisal firms and are
reviewed by Westfield Bank's lending department. Appraisals for second
mortgages or home equity loans are not required. Rather, a designated
employee of Westfield Bank conducts an inspection of the property.
Westfield Bank requires title insurance on all mortgage loans and certain
other loans. Westfield Bank requires borrowers to obtain hazard insurance.
Westfield Bank also requires borrowers to obtain flood insurance, if
applicable, prior to closing. In addition, Westfield Bank makes available
to borrowers the option to advance funds on a monthly basis together with
each payment of principal and interest to a mortgage escrow account from
which it makes disbursements for items such as real estate taxes, flood
insurance, and private mortgage insurance premiums. Beginning on September
1, 2001, Westfield Bank began referring its residential real estate loans
to a third-party mortgage company. Residential real estate borrowers
submit applications to Westfield Bank, but the loan is closed on the books
of the mortgage company.
Asset Quality. One of Westfield Bank's key operating objectives has
been and continues to be the achievement of a high level of asset quality.
Westfield Bank maintains a large proportion of loans secured by residential
and commercial properties, sets sound credit standards for new loan
originations and follows careful loan administration procedures. Westfield
Bank also utilizes the services of an outside consultant to conduct on-site
credit quality reviews of Westfield Bank's commercial and industrial loan
portfolio on an annual basis. These practices and relatively favorable
economic and real estate market conditions have resulted in historically
low delinquency ratios and, in recent years, a low level of nonaccrual
loans.
12
Delinquent Loans and Foreclosed Assets. Westfield Bank's policies
require that management continuously monitor the status of the loan
portfolio and report to the Board of Directors on a monthly basis. These
reports include information on delinquent loans and foreclosed real estate,
as well as Westfield Bank's actions and plans to cure the delinquent status
of the loans and to dispose of the foreclosed property.
The following table presents information regarding nonperforming
mortgage, consumer and other loans, and foreclosed real estate as of the
dates indicated. All loans where the interest payment is 90 days or more
in arrears as of the closing date of each month are placed on non-accrual
status. At December 31, 2004, 2003, and 2002, Westfield Bank had $2.2
million, $1.8 million, and $2.4 million, respectively, of non-accrual
loans. If all non-accrual loans had been performing in accordance with
their terms, Westfield Bank would have earned additional interest income of
$176,000, $134,000 and $146,000 for the years ended December 31, 2004,
2003, and 2002, respectively.
At December 31,
--------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Non-accrual real estate loans:
Residential $ 631 $ 995 $1,323 $1,866 $1,180
Home equity - 32 30 14 113
Commercial real estate 1,341 342 374 536 247
------ ------ ------ ------ ------
Total non-accrual real estate loans 1,972 1,369 1,727 2,416 1,540
Other loans:
Commercial and industrial 170 289 530 183 392
Consumer 29 110 126 85 376
------ ------ ------ ------ ------
Total non-accrual consumer and other loans $ 199 $ 399 $ 656 $ 268 $ 768
====== ====== ====== ====== ======
Total nonperforming loans $2,171 $1,768 $2,383 $2,684 $2,308
Foreclosed real estate, net - - - 176 -
------ ------ ------ ------ ------
Total nonperforming assets $2,171 $1,768 $2,383 $2,860 $2,308
====== ====== ====== ====== ======
Nonperforming loans to total loans 0.58% 0.51% 0.66% 0.64% 0.49%
Nonperforming assets to total assets 0.27 0.22 0.29 0.37 0.33
13
Allowance for Loan Losses. The following table presents the activity
in Westfield Bank's allowance for loan losses and other ratios at or for
the dates indicated.
At or for Years Ended December 31,
------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Balance at beginning of years $ 4,642 $ 4,325 $ 3,923 $ 3,434 $ 3,118
Charge-offs:
Residential - (3) (36) (16) (12)
Commercial real estate - - (29) (17) (20)
Home equity loans - (31) - - -
Commercial and industrial (14) (124) (241) (26) (42)
Consumer (390) (567) (622) (1,784) (985)
-------- -------- -------- -------- --------
Total charge-offs (404) (725) (928) (1,843) (1,059)
-------- -------- -------- -------- --------
Recoveries:
Residential - 10 17 - -
Commercial real estate - - - - -
Home equity loans 4 3 - - -
Commercial and industrial 65 73 16 14 8
Consumer 220 206 363 688 278
-------- -------- -------- -------- --------
Total recoveries 289 292 396 702 286
-------- -------- -------- -------- --------
Net charge-offs (115) (433) (532) (1,141) (773)
Provision for loan losses 750 750 934 1,630 1,089
-------- -------- -------- -------- --------
Balance at end of years $ 5,277 $ 4,642 $ 4,325 $ 3,923 $ 3,434
======== ======== ======== ======== ========
Total loans receivable(1) $373,449 $349,441 $361,357 $417,272 $467,837
======== ======== ======== ======== ========
Average loans outstanding $366,677 $354,134 $398,555 $443,652 $464,917
======== ======== ======== ======== ========
Allowance for loan losses as a
percent of total loans receivable 1.41% 1.33% 1.20% 0.94% 0.73%
Net loans charged off as a percent
of average loans outstanding 0.03% 0.12% 0.13% 0.26% 0.17%
- --------------------
Does not include deferred fees.
Westfield Bank maintains an allowance for loan losses to absorb
losses inherent in the loan portfolio based on ongoing quarterly
assessments of the estimated losses. Westfield Bank's methodology for
assessing the appropriateness of the allowance consists of a review of the
components, which include a specific valuation allowance for identified
problem loans and a formula allowance for current performing loans.
Fluctuations in the balances of impaired loans affect the specific
valuation allowance while fluctuations in volume and concentrations of
loans affects the formula reserve and the allocation of the allowance of
the loan losses among loan types.
14
The specific valuation allowance incorporates the results of
measuring impairment for specifically identified non-homogenous problem
loans in accordance with Statement of Financial Accounting Standards (SFAS)
No. 114, "Accounting By Creditors for Impairment of a Loan," and SFAS No.
118, "Accounting by Creditors for Impairment of a Loan - Income Recognition
and Disclosures." In accordance with SFAS No. 114 and No. 118 the specific
allowance reduces the carrying amount of the impaired loans to their
estimated fair value. A loan is recognized as impaired when it is probable
that principal and/or interest are not collectible in accordance with the
loan's contractual terms. A loan is not deemed to be impaired if there is
a short delay in receipt of payment or if, during a longer period of delay,
the Westfield Bank expects to collect all amounts due including interest
accrued at the contractual rate during the period of delay. Measurement of
impairment can be based on the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's observable
market price or the fair value of the collateral, if the loan is collateral
dependent. Measurement of impairment does not apply to large groups of
smaller balance homogenous loans that are collectively evaluated for
impairment such as the Westfield Bank portfolios of home equity loans, real
estate mortgages, installment and other loans.
The formula allowance is calculated by applying loss factors to
outstanding loans by type, excluding loans for which a specific allowance
has been determined. As part of this analysis, each quarter Westfield Bank
prepares an allowance for loan losses worksheet which categorizes the loan
portfolio by risk characteristics such as loan type and loan grade. The
formula allowance is inherently subjective as it requires material
estimates that may be susceptible to significant change. There are a number
of factors that are considered when evaluating the appropriate level of the
allowance. These factors include current economic and business conditions
that affect key lending areas of the company, new loan products, collateral
values, loan volumes and concentrations, credit quality trends such as
nonperformance loans, delinquency and loan losses, and specific industry
connections within the portfolio segments that may impact the
collectibility of the loan portfolio. Loss factors are described as
follows:
* Classified loan loss factors are derived from loss percentages
utilized by banking regulators for similarly graded loans. Loss
factors of 3% to 5%, 10% to 15% and 50% to 75% are applied to the
outstanding balance of loans internally classified special mention,
substandard and doubtful, respectively.
* Pass graded loan loss factors are based on actual losses for the
previous twelve quarters adjusted for qualitative factors, such as
new loan products, credit quality trends (including trends in
nonperforming loans expected to result from existing conditions),
collateral values, loan volumes and concentrations and specific
industry conditions within portfolio segments that exist at the
balance sheet date. The loss factors are applied to outstanding
loans by loan type.
In addition, management employs an independent third party to perform
an annual review of all of Westfield Bank's commercial and industrial loans
and owner occupied commercial real estate loans with balances or
commitments equal or greater than $600,000. The third party also reviews
all commercial investment real estate loans in excess of $1 million, watch
list loans with aggregate balances greater than $100,000, and all 30 day or
longer past due commercial loans with balances in excess of $50,000.
15
Westfield Bank's methodologies include several factors that are
intended to reduce the difference between estimated and actual losses. The
loss factors that are used to establish the allowance for pass graded loans
are designated to be self-correcting by taking into account changes in loan
classification, loan concentrations and loan volumes and by permitting
adjustments based on management's judgments of qualitative factors as of
the evaluation date. Similarly, by basing the pass graded loan loss
factors on loss experience over the prior three years, the methodology is
designed to take Westfield Bank's recent loss experience into account.
Westfield Bank's allowance methodology has been applied on a
consistent basis. Based on this methodology, Westfield Bank believes that
it has established and maintained the allowance for loan losses at adequate
levels. Future adjustments to the allowance for loan losses, however, may
be necessary if economic, real estate and other conditions differ
substantially from the current operating environment resulting in estimated
and actual losses differing substantially. Adjustments to the allowance
for loan losses are charged to income through the provision for loan
losses.
A summary of the components of the allowance for loan losses is as
follows:
December 31, 2004 December 31, 2003 December 31, 2002
----------------------------- ----------------------------- -----------------------------
Specific Formula Total Specific Formula Total Specific Formula Total
-------- ------- ----- -------- ------- ----- -------- ------- -----
(In Thousands)
Real estate mortgage
Residential $ - $ 421 $ 421 $ - $ 517 $ 517 $ - $ 713 $ 713
Commercial 264 2,097 2,361 17 1,994 2,011 17 1,618 1,635
Commercial and
Industrial 236 2,078 2,314 53 1,660 1,713 53 1,408 1,461
Consumer - 181 181 - 401 401 - 516 516
---- ------ ------ --- ------ ------ --- ------ ------
Total $500 $4,777 $5,277 $70 $4,572 $4,642 $70 $4,255 $4,325
t ==== ====== ====== === ====== ====== === ====== ======
December 31, 2001 December 31, 2002
----------------------------- -----------------------------
Specific Formula Total Specific Formula Total
-------- ------- ----- -------- ------- -----
Real estate mortgage
Residential $ - $ 839 $ 839 $ - $ 859 $ 859
Commercial 32 1,435 1,467 49 1,187 1,236
Commercial and
Industrial 53 946 999 28 551 579
Consumer - 618 618 - 760 760
---- ------ ------ --- ------ ------
Total $ 85 $3,838 $3,923 $77 $3,357 $3,434
==== ====== ====== === ====== ======
16
In addition, the OTS, as an integral part of its examination process,
periodically reviews Westfield Bank's loan and foreclosed real estate
portfolios and the related allowance for loan losses and valuation
allowance for foreclosed real estate. The OTS may require Westfield Bank
to adjust the allowance for loan losses or the valuation allowance for
foreclosed real estate based on their judgments of information available to
them at the time of their examination, thereby adversely affecting
Westfield Bank's results of operations.
For the year ended December 31, 2004, Westfield Bank provided
$750,000 to the allowance for loan losses based on its evaluation of the
items discussed above. Westfield Bank believes that the allowance for loan
losses accurately reflects the level of risk in the current loan portfolio
as of December 31, 2004.
17
Allocation of Allowance for Loan Losses. The following tables set
forth the allowance for loan losses allocated by loan category, the total
loan balances by category, and the percent of loans in each category to
total loans indicated.
At December 31,
------------------------------------------------------------------------------------------------------
2004 2003 2002
-------------------------------- -------------------------------- --------------------------------
Percent of Percent of Percent of
Loan Loans in Loan Loans in Loan Loans in
Amount Balances Each Amount Balances Each Amount Balances Each
of Loan by Category to of Loan by Category to of Loan by Category to
Loan Category Loss Category Total Loans Loss Category Total Loans Loss Category Total Loans
- ------------- ------- -------- ----------- ------- -------- ----------- ------- -------- -----------
(Dollars in thousands)
Real estate - mortgage:
Residential(1) $ 421 $122,822 32.89% $ 517 $110,547 31.64% $ 713 $157,896 43.70%
Commercial 2,361 144,336 38.65 2,011 131,292 37.57 1,635 100,903 27.92
Commercial loans 2,314 94,726 25.36 1,713 85,292 24.41 1,461 61,494 17.01
Consumer loans 181 11,565 3.10 401 22,310 6.38 516 41,064 11.37
------ -------- ------ ------ -------- ------ ------ -------- ------
Total allowance
for loan losses $5,277 $373,449 100.00% $4,642 $349,441 100.00% $4,325 $361,357 100.00%
====== ======== ====== ====== ======== ====== ====== ======== ======
At December 31,
-------------------------------------------------------------------
2001 2000
-------------------------------- --------------------------------
Percent of Percent of
Loan Loans in Loan Loans in
Amount Balances Each Amount Balances Each
of Loan by Category to of Loan by Category to
Loan Category Loss Category Total Loans Loss Category Total Loans
- ------------- ------- -------- ----------- ------- -------- -----------
(Dollars in thousands)
Real estate - mortgage:
Residential(1) $ 839 $212,751 50.98% $ 859 $264,162 56.47%
Commercial 1,467 99,425 23.83 1,236 92,826 19.84
Commercial loans 999 47,012 11.27 579 37,510 8.02
Consumer loans(2) 618 58,084 13.92 760 73,339 15.67
------ -------- ------ ------ -------- ------
Total allowance
for loan losses $3,923 $417,272 100.00% $3,434 $467,837 100.00%
====== ======== ====== ====== ======== ======
- --------------------
Includes home equity loans.
18
Investment Activities. The Board of Directors reviews and approves
Westfield Bank's investment policy on an annual basis. The President and
Treasurer, as authorized by the Board of Directors, implement this policy
based on the established guidelines within the written policy.
Westfield Bank's investment policy is designed primarily to manage
the interest rate sensitivity of its assets and liabilities, to generate a
favorable return without incurring undue interest rate and credit risk, to
complement its lending activities and to provide and maintain liquidity
within the range established by policy. In determining Westfield Bank's
investment strategies, it considers its interest rate sensitivity, yield,
credit risk factors, maturity and amortization schedules, and other
characteristics of the securities to be held.
Federally chartered savings banks have authority to invest in various
types of assets, including U.S. Treasury obligations, securities of various
federal agencies, mortgage-backed securities, certain certificates of
deposit of insured financial institutions, repurchase agreements, overnight
and short term loans to other banks and corporate debt instruments.
Securities Portfolio. Westfield Financial classifies securities as
held to maturity or available for sale at the date of purchase. Westfield
Financial does not have any securities classified as trading. Held to
maturity securities are reported at cost, adjusted for amortization of
premium and accretion of discount. Available for sale securities are
reported at fair market value. At December 31, 2004, held to maturity
securities totaled $246.6 million, or 73.6% of the total securities
portfolio, and available for sale investments totaled $88.3 million, or
26.4% of Westfield Financial's total securities portfolio. Westfield
Financial classifies U.S. Government securities and U.S. Government Agency
securities as available for sale and held to maturity. These securities
predominately have maturities of less than five years, although Westfield
Financial also invests in adjustable rate securities with maturities of up
to 15 years. Westfield Financial's mortgage-backed securities, which are
directly or indirectly insured or guaranteed by Freddie Mac, Ginnie Mae or
Fannie Mae or are rated AAA, consist of both fixed rate and adjustable rate
securities primarily with average lives of less than five years. Westfield
Financial also invests in municipal bonds issued by cities and towns in
Massachusetts and are AAA rated by Moody's, Standard and Poor's, or Fitch.
These securities generally have maturities between 7 and 20 years, however,
many have earlier call dates. In addition, Westfield Financial has
investments in Federal Home Loan Bank stock and mutual funds that invest
only in securities allowed by the Office of Thrift Supervision.
19
The following table sets forth the composition of Westfield Bank's
securities portfolio at the dates indicated.
At December 31,
-----------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- ------ --------- ------ --------- ------
(In thousands)
Securities:
Federal agency obligations $ 45,151 $ 45,061 $ 49,737 $ 50,296 $ 70,525 $ 71,376
Municipal bonds 29,147 29,597 21,687 22,041 -- --
Corporate debt securities 4,909 4,978 8,735 9,017 26,764 27,314
-------- -------- -------- -------- -------- --------
Total securities 79,207 79,636 80,159 81,354 97,289 98,690
-------- -------- -------- -------- -------- --------
Mortgage-backed and mortgage-
related securities:
Fannie Mae 153,271 152,292 163,435 163,557 99,231 100,944
Freddie Mac 62,614 62,501 69,362 69,275 88,918 90,302
Ginnie Mae 29,811 29,718 29,437 29,446 39,682 40,323
Collateralized mortgage
obligations 2,848 2,856 5,413 5,410 20,153 20,396
-------- -------- -------- -------- -------- --------
Total mortgage-backed and
mortgage-related securities 248,544 247,367 267,647 267,688 247,984 251,965
-------- -------- -------- -------- -------- --------
Marketable equity securities 7,301 6,986 14,594 15,455 28,432 27,734
-------- -------- -------- -------- -------- --------
Total securities $335,052 $333,989 $362,400 $364,497 $373,705 $378,389
======== ======== ======== ======== ======== ========
20
Mortgage-Backed Securities and Mortgage-Related Securities. The
following table sets forth the amortized cost and fair value of Westfield
Bank's mortgage-backed and mortgage-related securities, which are
classified as available for sale or held to maturity at the dates
indicated.
At December 31,
---------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------- ------------------------------- -------------------------------
Amortized Percent of Market Amortized Percent of Market Amortized Percent of Market
Cost Total Value Cost Total Value Cost Total Value
--------- ---------- ------ --------- ---------- ------ --------- ---------- ------
(Dollars in thousands)
Mortgage-backed and mortgage-
related securities available
for sale:
Fannie Mae $ 32,676 13.15% $ 32,713 $ 31,627 11.82% $ 31,872 $ 22,182 8.95% $ 22,879
Freddie Mac 22,842 9.19 22,838 18,611 6.95 18,586 29,930 12.07 30,481
Ginnie Mae 15,036 6.05 15,069 20,854 7.79 20,857 25,762 10.39 26,200
Collateralized mortgage
obligations 2,688 1.08 2,696 4,872 1.82 4,862 10,771 4.34 10,908
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed and
mortgage related securities
available for sale 73,242 29.47 73,316 75,964 28.38 76,177 88,645 35.75 90,468
-------- ------ -------- -------- ------ -------- -------- ------ --------
Mortgage-backed and mortgage
related securities held
to maturity:
Fannie Mae 120,595 48.52 119,579 131,808 49.25 131,685 77,049 31.07 78,065
Freddie Mac 39,772 16.00 39,663 50,751 18.96 50,689 58,988 23.79 59,821
Ginnie Mae 14,775 5.95 14,649 8,583 3.21 8,589 13,920 5.61 14,123
Collateralized mortgage
obligations 160 0.06 160 541 0.20 548 9,382 3.78 9,488
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed and
mortgage related securities
held to maturity 175,302 70.53 174,051 191,683 71.62 191,511 159,339 64.25 161,497
-------- ------ -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed and
mortgage related securities $248,544 100.00% $247,367 $267,647 100.00% $267,688 $247,984 100.00% $251,965
======== ====== ======== ======== ====== ======== ======== ====== ========
21
Securities Portfolio Maturities. The composition and maturities of
the securities portfolio (debt securities) and the mortgage-backed
securities portfolio at December 31, 2004 are summarized in the following
table. Maturities are based on the final contractual payment dates, and do
not reflect the impact of prepayments or redemptions that may occur.
More than One Year More than Five Years
One Year or Less Through Five Years Through Ten Years More than Ten Years Total Securities
------------------- ------------------- -------------------- ------------------- ---------------------------
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Market Average
Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield
--------- -------- --------- -------- --------- -------- --------- -------- --------- ------ --------
(Dollars in thousands)
Securities available
for sale:
Federal agency
securities $ -- --% $ -- --% $ 6,043 4.78% $ 948 1.97% $ 6,991 $ 7,050 4.40%
Corporate debt
securities -- -- -- -- -- -- 918 2.38 918 932 2.38
------ ------- ------- -------- -------- --------
Total securities -- -- -- -- 6,043 4.78 1,866 2.17 7,909 7,982 4.16
------ ------- ------- -------- -------- --------
Mortgage-backed
securities available
for sale:
Ginnie Mae -- -- -- -- -- -- 15,036 3.29 15,036 15,069 3.29
Fannie Mae -- -- -- -- 4,671 4.63 28,005 3.91 32,676 32,713 4.01
Freddie Mac -- -- -- -- 4,548 4.34 18,294 3.44 22,842 22,838 3.62
Collateralized
mortgage
obligations -- -- -- -- -- -- 2,688 6.04 2,688 2,696 6.05
------ ------- ------- -------- -------- --------
Total mortgage-backed
securities -- -- -- -- 9,219 4.49 64,023 3.72 73,242 73,316 3.82
------ ------- ------- -------- -------- --------
Total $ -- -- $ -- -- $15,262 4.60 $ 65,889 3.68 $ 81,151 $ 81,298 3.85
====== ======= ======= ======== ======== ========
Securities held to
maturity:
Federal agency
securities $ -- -- $18,179 2.97 $ 9,981 4.92 $ 10,000 5.94 $ 38,160 $ 38,011 4.26
Municipal bonds -- -- -- -- 7,408 3.59 21,739 4.31 29,147 29,597 4.13
Corporate debt
securities 3,991 7.19 -- -- -- -- -- -- 3,991 4,046 7.20
------ ------- ------- -------- -------- --------
Total investment
securities 3,991 7.19 18,179 2.97 17,389 4.35 31,739 4.82 71,298 71,654 4.37
------ ------- ------- -------- -------- --------
Mortgage-backed
securities held
to maturity:
Ginnie Mae 2 8.00 260 5.44 921 5.22 13,592 3.49 14,775 14,649 3.63
Fannie Mae -- -- 3,134 3.84 21,098 3.84 96,363 4.32 120,595 119,579 4.22
Freddie Mac -- -- 1,116 4.30 5,403 3.31 33,253 4.12 39,772 39,663 4.01
Collateralized
mortgage
obligations -- -- -- -- -- -- 160 6.07 160 160 6.07
------ ------- ------- -------- -------- --------
Total mortgage-
backed securities 2 8.00 4,510 4.05 27,422 3.78 143,368 4.20 175,302 174,051 4.12
------ ------- ------- -------- -------- --------
Total $3,993 7.45% $22,689 3.18% $44,811 4.00% $175,107 4.31% $246,600 $245,705 4.19%
====== ======= ======= ======== ======== ========
22
Sources of Funds
General. Deposits, scheduled amortization and prepayments of loan
principal, maturities and calls of investments securities and funds
provided by operations are Westfield Bank's primary sources of funds for
use in lending, investing and for other general purposes. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
Deposits. Westfield Bank offers a variety of deposit accounts having
a range of interest rates and terms. Westfield Bank currently offers
regular savings deposits (consisting of passbook and statement savings
accounts), NOW accounts, noninterest-bearing demand accounts, money market
accounts and time deposits. Westfield Bank has expanded the types of
deposit products that it offers to include jumbo certificates of deposit,
tiered money market accounts and customer repurchase agreements to
compliment its increased emphasis on attracting commercial banking
relationships.
Deposit flows are influenced significantly by general and local
economic conditions, changes in prevailing interest rates, pricing of
deposits and competition. Westfield Bank's deposits are primarily obtained
from areas surrounding our offices. Westfield Bank relies primarily on
paying competitive rates, service and long-standing relationships with
customers to attract and retain these deposits. Westfield Bank does not
use brokers to obtain deposits.
When Westfield Bank determines its deposit rates, it considers local
competition, U.S. Treasury securities offerings and the rates charged on
other sources of funds. Core deposits (defined as regular accounts, money
market accounts, NOW accounts and demand accounts) represented 48.9% of
total deposits on December 31, 2004 and 47.2% on December 31, 2003. The
strategic plan calls for a greater reliance on core deposits and a
decreased reliance on time deposits. At December 31, 2004 and December 31,
2003, time deposits with remaining terms to maturity of less than one year
amounted to $184.5 million and $234.7 million, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Net Interest and Dividend Income" for information relating to
the average balances and costs of Westfield Bank's deposit accounts for the
years ended December 31, 2004, 2003 and 2002.
23
Deposit Distribution Weighted Average. The following table sets
forth the distribution of Westfield Bank's deposit accounts, by account
type, at the dates indicated.
At December 31,
------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------ ------------------------------ ------------------------------
Weighted Weighted Weighted
Average Average Average
Amount Percent Rates Amount Percent Rates Amount Percent Rates
------ ------- -------- ------ ------- -------- ------ ------- --------
(Dollars in thousands)
Demand deposits $ 48,305 7.88% 0.00% $ 54,620 8.64% 0.00% $ 54,736 8.34% 0.00%
NOW accounts 57,050 9.31 0.51 42,465 6.71 0.54 41,907 6.39 1.07
Regular accounts 44,882 7.33 0.50 46,331 7.33 0.50 44,876 6.84 1.05
Money market accounts 149,288 24.37 0.93 154,825 24.48 0.98 139,543 21.27 1.49
-------- ------ -------- ------ -------- ------
Total non-certificated
accounts 299,525 48.89 0.64 298,241 47.16 0.81 281,062 42.84 1.32
-------- ------ -------- ------ -------- ------
Time certificates of deposit
Due within 1 year 184,500 30.12 2.14 234,694 37.11 2.35 265,760 40.51 3.33
Over 1 year through 3 years 103,856 16.95 2.88 90,934 14.38 3.13 98,418 15.00 3.91
Over 3 years 24,740 4.04 3.71 8,562 1.35 3.24 10,825 1.65 4.28
-------- ------ -------- ------ -------- ------
Total certificated accounts 313,096 51.11 2.51 334,190 52.84 2.58 375,003 57.16 3.51
-------- ------ -------- ------ -------- ------
Total $612,621 100.00% 1.59% $632,431 100.00% 1.75% $656,065 100.00% 2.57%
======== ====== ======== ====== ======== ======
C.D. Maturities. At December 31, 2004, Westfield Bank had $63.9
million in time certificates of deposit with balances of $100,000 and over
maturing as follows:
Weighted
Average
Maturity Period Amount Rate
- ------------------------------------- ---------------------- --------
(Dollars in thousands)
Three months or less $13,839 1.98%
Over three months through six months 5,237 2.37
Over six months through twelve months 13,755 2.60
Over twelve months 31,097 3.22
-------
Total $63,928 2.75%
=======
C.D. Balances by Rates. The following table sets forth, by interest
rate ranges, information concerning Westfield Bank's time certificates of
deposit at the dates indicated.
At December 31, 2004
-------------------------------------------------------------------------------
Period to Maturity
-------------------------------------------------------------------------------
Less than One to Two Two to More than Percent of
One Year Years Three Years Three Years Total Total
--------- ---------- ----------- ----------- ----- ----------
(Dollars in thousands)
2.00% and under $114,290 $ 4,108 $ - $ - $118,398 38%
2.01% to 3.00% 42,693 55,098 13,145 1 110,937 35
3.01% to 4.00% 13,149 11,752 11,284 15,967 52,152 17
4.01% to 5.00% 14,368 8,469 - 8,772 31,609 10
======== ======= ======= ====== ======== ===
Total $184,500 $79,427 $24,429 $24,740 $313,096 100%
======== ======= ======= ====== ======== ===
24
Borrowings. In addition to deposits, borrowings from the Federal
Home Loan Bank of Boston are available as an additional source of funds to
finance Westfield Bank's lending and investing activities. Westfield Bank
traditionally has not relied upon borrowings from the Federal Home Loan
Bank. However, Westfield Bank borrowed $25.0 million in 2004 and $5.0
million in 2003 from the Federal Home Loan Bank to take advantage of the
low interest rate environment.
Westfield Bank offers repurchase agreements to commercial customers
and higher balance retail customers. These agreements are direct
obligations of Westfield Bank to repay at maturity or on demand the
purchase price of an undivided interest in a U.S. Government or agency
security owned by Westfield Bank. Since these agreements are not deposits,
they are not insured by the Federal Deposit Insurance Corporation. At
December 31, 2004, such repurchase agreement borrowings totaled $14.6
million.
Personnel
As of December 31, 2004, Westfield Bank had 129 full-time employees
and 29 part-time employees. The employees are not represented by a
collective bargaining unit, and we consider our relationship with our
employees to be excellent.
Federal And State Taxation
Federal
General. For federal income tax purposes, we report income on the
basis of a taxable year ending December 31, using the accrual method of
accounting, and we are generally subject to federal income taxation in the
same manner as other corporations. Westfield Bank and Westfield Financial
constitute an affiliated group of corporations and, therefore, are eligible
to report their income on a consolidated basis. Because Westfield Mutual
Holding Company owns less than 80% of the common stock of Westfield
Financial, it is not a member of such affiliated group and therefore, must
report its income on a separate return. Westfield Bank and Westfield Mutual
Holding Company are not currently under audit by the IRS.
Distributions. To the extent that Westfield Bank makes "non-dividend
distributions" to Westfield Financial, such distributions will be
considered to result in distributions from unrecaptured tax bad debt
reserve as of December 31, 1987 (our "base year reserve"), to the extent
thereof and then from supplemental reserve for losses on loans, and an
amount based on the amount distributed will be included in income. Non-
dividend distributions include distributions in excess of current and
accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. Dividends paid out of
current or accumulated earnings and profits will not be included in income.
25
The amount of additional income created from a non-dividend
distribution is equal to the lesser of the 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 some situations, approximately one and one-half
times the non-dividend distribution would be includible in gross income for
federal income tax purposes, assuming a 34% federal corporate income tax
rate. Westfield Bank does not intend to pay dividends that would result in
the recapture of any portion of the bad debt reserves.
Corporate Alternative Minimum Tax. The alternative minimum tax
("AMT") rules have been devised to ensure that at least a minimum amount of
income tax is paid by high-income corporate taxpayers who take advantage of
substantial tax savings due to the use of certain tax deductions and
exemptions. In essence, the AMT functions as a recapture mechanism,
reclaiming some of the tax deductions and credits utilized by these
taxpayers when calculating their regular federal income tax liability. In
general, a corporation's alternative minimum taxable income ("AMTI") is
equal to its regular taxable income, increased by its preference items for
the year and adjusted by computing certain items under special rules that
negate the acceleration of certain tax benefits which are available under
the regular tax rules. The AMT rate is 20%. Such preference items include
adjustments for tax exempt interest, inside build-up of life insurance
policies and accelerated depreciation deductions. During the past five
years, Westfield Financial has not been the subject of the AMT and
therefore has no AMT net operating losses or credit to utilize.
Elimination of Dividends; Dividends Received Deduction. Westfield
Financial may exclude from its income 100% of dividends received from
Westfield Bank as a member of the same affiliated group of corporations.
Because Westfield Mutual Holding Company is not a member of such affiliated
group, it does not qualify for such 100% dividends exclusion, but is
entitled to deduct 80% of the dividends it receives from Westfield
Financial so long as it owns more than 20% of the common stock.
State
Westfield Bank files Massachusetts Financial Institution excise tax
returns. Generally, the income of financial institutions in Massachusetts,
which is calculated based on federal taxable income, subject to certain
adjustments, is subject to Massachusetts tax. Westfield Bank is not
currently under audit with respect to its Massachusetts income tax returns
and its state tax returns have not been audited for the past five years.
Westfield Financial is also required to file a Massachusetts income
tax return and is generally subject to a state income tax rate that is the
same tax rate as the tax rate for financial institutions in Massachusetts.
However, Westfield Securities Corp. and Elm Street Securities Corp. are
taxed at a rate that is currently lower than income tax rates for savings
institutions in Massachusetts.
26
Massachusetts legislation was signed on March 5, 2003 amending the
corporate tax law affecting the treatment of dividends received from Real
Estate Investment Trusts (REITs). Dividends from the REIT subsidiary are
no longer eligible for a dividends-received deduction. As a result of the
enactment of this legislation, Westfield Financial ceased recording the tax
benefits associated with the dividend received deduction effective for the
2003 tax year.
In addition to the effect on 2003, the legislation was retroactive to
1999. Westfield Financial's 2003 results include a charge of $1.45 million
representing the additional state tax liability, including interest,
relating to the deduction for dividends received from the REIT for 2002 and
prior years.
REGULATION
General
Westfield Bank is a federal savings bank subject to regulation,
examination, and supervision by the OTS and is subject to the examination
and supervision of the Federal Deposit Insurance Corporation ("FDIC") as
its deposit insurer. Westfield Bank is a member of the Bank Insurance Fund
("BIF"), and its deposit accounts are insured up to applicable limits by
the FDIC. All of the deposit premiums paid by Westfield Bank to the FDIC
for deposit insurance are currently paid to the BIF. Westfield Bank is
also a member of the Federal Home Loan Bank ("FHLB") of Boston, which is
one of the twelve regional FHLBs. Westfield Bank must file reports with
the OTS concerning its activities and financial condition, and it must
obtain regulatory approvals prior to entering into certain transactions,
such as mergers with, or acquisitions of, other depository institutions.
The OTS conducts periodic examinations to assess Westfield Bank's
compliance with various regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which a
savings association can engage and is intended primarily for the protection
of the insurance fund and depositors. As a savings and loan holding
company, we must file certain reports with, and otherwise comply with, the
rules and regulations of the OTS and of the Securities and Exchange
Commission ("SEC") under the federal securities laws.
The OTS and the FDIC have significant discretion in connection with
their supervisory and enforcement activities and examination policies,
including policies with respect to the classification of assets and the
establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC, SEC or the United
States Congress, could have a material adverse impact on us, Westfield
Bank, and our operations and stockholders.
On July 23, 2004, Westfield Bank converted to its federal charter
from a Massachusetts state banking charter. At this time, Westfield Mutual
Holding Company also converted its charter to that of a federal mutual
holding company. Westfield Financial became a savings and loan holding
company, rather than a bank holding company, and its federal regulator
became the OTS rather than the Board of Governors of the Federal Reserve
Board (the "FRB").
27
The following discussion is intended to be a summary of the material
statutes and regulations applicable to savings associations and their
holding companies, and it does not purport to be a comprehensive
description of all such statutes and regulations.
Regulation Of Federal Savings Associations
Business Activities. Westfield Bank derives its lending and
investment powers from the Home Owners' Loan Act, as amended ("HOLA"), and
OTS regulations. Under these laws and regulations, Westfield Bank may
invest in mortgage loans secured by residential and commercial real estate,
commercial and consumer loans, certain types of debt securities, and
certain other assets. Westfield Bank may also establish service
corporations that may engage in activities not otherwise permissible for
Westfield Bank, including certain real estate equity investments and
securities and insurance brokerage. Westfield Bank's authority to invest
in certain types of loans or other investments is limited by federal law.
Loans to One Borrower. Westfield Bank is generally subject to the
same limits on loans to one borrower as is a national bank. With specified
exceptions, Westfield Bank's total loans or extensions of credit to a
single borrower cannot exceed 15% of Westfield Bank's unimpaired capital
and surplus, which does not include accumulated other comprehensive income.
Westfield Bank may lend additional amounts up to 10% of its unimpaired
capital and surplus which does not include accumulated other comprehensive
income, if the loans or extensions of credit are fully-secured by readily-
marketable collateral. Westfield Bank currently complies with applicable
loans-to-one borrower limitations.
QTL Test. The HOLA requires that Westfield Bank, as a savings
association, to comply with the qualified thrift lender ("QTL") test.
Under the QTL test, Westfield Bank is required to maintain at least 65% of
its portfolio assets in certain "qualified thrift investments" for at least
nine months of the most recent twelve-month period. "Portfolio assets"
means, in general, Westfield Bank's total assets less the sum of:
* specified liquid assets up to 20% of total assets;
* goodwill and other intangible assets; and
* the value of property used to conduct Westfield Bank's
business.
Westfield Bank may also satisfy the QTL test by qualifying as a
domestic building and loan association as defined in the Internal Revenue
Code of 1986, as amended (the "Code"). Westfield Bank met the QTL test at
December 31, 2004 and in each of the prior 12 months, and, therefore,
qualified as a thrift lender. If Westfield Bank fails the QTL test, it
must either operate under certain restrictions on its activities or convert
to a national charter.
28
Capital Requirements. The OTS regulations require savings
associations to meet three minimum capital standards: (i) a tangible
capital ratio requirement of 1.5% of total assets as adjusted under the OTS
regulations; (ii) a leverage ratio requirement of 3.0% of core capital to
such adjusted total assets, if a savings association has been assigned the
highest composite rating of 1 under the Uniform Financial Institutions
Rating System; and (iii) a risk-based capital ratio requirement of 8.0% of
core and supplementary capital to total risk-based assets. The minimum
leverage capital ratio for any other depository institution that does not
have a composite rating of 1 will be 4.0%, unless a higher leverage capital
ratio is warranted by the particular circumstances or risk profile of the
depository institution. In determining the amount of risk-weighted assets
for purposes of the risk-based capital requirement, a savings association
must compute its risk-based assets by multiplying its assets and certain
off-balance sheet items by risk-weights, which range from 0.0% for cash and
obligations issued by the United States Government or its agencies to
100.0% for consumer and commercial loans, as assigned by the OTS capital
regulation based on the risks found by the OTS to be inherent in the type
of asset.
Tangible capital is defined, generally, as common stockholders'
equity (including retained earnings), certain non-cumulative perpetual
preferred stock and related earnings, minority interests in equity accounts
of fully consolidated subsidiaries, less intangibles (other than certain
mortgage servicing rights), and investments in and loans to subsidiaries
engaged in activities not permissible for a national bank. Core capital is
defined similarly to tangible capital, but core capital also includes
certain qualifying supervisory goodwill and certain purchased credit card
relationships. Supplementary capital currently includes cumulative and
other preferred stock, mandatory convertible debt securities, subordinated
debt and intermediate preferred stock and the allowance for loan and lease
losses. In addition, up to 45.0% of unrealized gains on available-for-sale
equity securities with a readily determinable fair value may be included in
tier 2 capital. The allowance for loan and lease losses includable in
supplementary capital is limited to a maximum of 1.25% of risk-weighted
assets, and the amount of supplementary capital that may be included as
total capital cannot exceed the amount of core capital.
At December 31, 2004, Westfield Bank met each of its capital
requirements, in each case on a fully phased-in basis.
Capital Distributions. The OTS imposes various restrictions or
requirements on Westfield Bank's ability to make capital distributions,
including cash dividends. A savings institution that is the subsidiary of
a savings and loan holding company must file a notice with the OTS at least
30 days before making a capital distribution. Westfield Bank must file an
application for prior approval if the total amount of its capital
distributions, including the proposed distribution, for the applicable
calendar year would exceed an amount equal to Westfield Bank's net income
for that year plus Westfield Bank's retained net income for the previous
two years.
The OTS may disapprove of a notice of application if:
* Westfield Bank would be undercapitalized following the
distribution;
* the proposed capital distribution raises safety and soundness
concerns;
29
* the capital distribution would violate a prohibition contained
in any statute, regulation, or agreement; or
* our ability to pay dividends, service our debt obligations, and
repurchase our common stock is dependent upon receipt of
dividend payments from Westfield Bank.
Branching. Subject to certain limitations, HOLA and OTS regulations
permit federally-chartered savings associations to establish branches in
any state of the United States. The authority to establish such a branch
is available: (i) in states that expressly authorize branches of savings
associations located in another state; and (ii) to an association that
qualifies as a "domestic building and loan association" under the Code,
which imposes qualification requirements similar to those for a qualified
thrift lender under HOLA. The authority for a federal savings association
to establish an interstate branch network would facilitate a geographic
diversification of the association's activities. This authority under HOLA
and OTS regulations preempts any state law purporting to regulate branching
by federal savings associations.
Community Reinvestment. Under the Community Reinvestment Act (the
"CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including
low and moderate income neighborhoods. The CRA does not establish specific
lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and
services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the Office of Thrift
Supervision, in connection with its examination of a savings association,
to assess the association's record of meeting the credit needs of its
community and to take such record into account in its evaluation of certain
applications by such association. The CRA also requires all institutions
to publicly disclose their CRA ratings. Westfield Bank received a
"Satisfactory" CRA rating in its most recent examination.
The CRA regulations establish an assessment system that bases an
association's rating on its actual performance in meeting community needs.
In particular, the assessment system focuses on three tests: (i) a lending
test, to evaluate the institution's record of making loans in its
assessment areas; (ii) an investment test, to evaluate the institution's
record of investing in community development projects, affordable housing,
and programs benefiting low or moderate income individuals and businesses;
and (iii) a service test, to evaluate the institution's delivery of
services through its branches, ATMs, and other offices.
Transactions with Related Parties. Westfield Bank's authority to
engage in transactions with its affiliates is limited by the OTS
regulations and by Sections 23A and 23B of the Federal Reserve Act (the
"FRA"). In general, these transactions must be on terms that are as
favorable to Westfield Bank as comparable transactions with non-affiliates.
In addition, certain types of these transactions are restricted to an
aggregate percentage of Westfield Bank's capital. Collateral in specified
amounts must usually be provided by affiliates in order to receive loans
from Westfield Bank. In addition, OTS regulations prohibit a savings
association from lending to any of its affiliates that engage in activities
not permissible for bank holding companies and from purchasing the
securities of any affiliate (other than a subsidiary).
30
Effective April 1, 2003, the FRB rescinded its interpretations of
Sections 23A and 23B of the FRA and replaced 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, became 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.
Westfield Bank's authority to extend credit to its directors,
executive officers and 10% stockholders, as well as to entities controlled
by such persons, is currently governed by the requirements of Sections
22(g) and 22(h) of the FRA and Regulation O of the FRB. Among other
things, these provisions require that extensions of credit to insiders: (i)
be made on terms that are substantially the same as, and follow credit
underwriting procedures that are not less stringent than, those prevailing
for comparable transactions with unaffiliated persons and that do not
involve more than the normal risk of repayment or present other unfavorable
features; and (ii) not exceed certain limitations on the amount of credit
extended to such persons, individually and in the aggregate, which limits
are based, in part, on the amount of Westfield Bank capital. The
regulations allow small discounts on fees on residential mortgages for
directors, officers and employees. In addition, extensions for credit in
excess of certain limits must be approved by Westfield Bank's Board of
Directors.
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 Westfield
Bank, that are subject to the insider lending restrictions of Section 22(h)
of the FRA.
Enforcement. The OTS has primary enforcement responsibility over
savings associations, including Westfield 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.
Standards for Safety and Soundness. Under federal law, the OTS has
adopted a set of guidelines prescribing safety and soundness standards.
These guidelines establish general standards relating to internal controls
and information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, asset quality, earnings
standards, compensation, fees and benefits. In general, the guidelines
require appropriate systems and practices to identify and manage the risks
and exposures specified in the guidelines. In addition, the OTS adopted
regulations that authorize, but do not require, the OTS to order an
institution that has been given notice that it is not satisfying these
safety and soundness standards to submit a compliance plan. If, after
being notified, an institution fails to submit an acceptable plan of
compliance or fails in any material respect to implement an accepted plan,
the OTS must
31
issue an order directing action to correct the deficiency and may issue an
order directing other actions of the types to which an undercapitalized
association is subject under the "prompt corrective action" provisions of
federal law. If an institution fails to comply with such an order, the OTS
may seek to enforce such order in judicial proceedings and to impose civil
money penalties.
Real Estate Lending Standards. The OTS and the other federal banking
agencies adopted regulations to prescribe standards for extensions of
credit that are either secured by real estate or made for the purpose of
financing the construction of improvements on real estate. The OTS
regulations require each savings association to establish and maintain
written internal real estate lending standards that are consistent with
safe and sound banking practices and appropriate to the size of the
association and the nature and scope of its real estate lending activities.
The standards also must be consistent with accompanying OTS guidelines,
which include loan-to-value ratios for the different types of real estate
loans. Associations are also permitted to make a limited amount of loans
that do not conform to the proposed loan-to-value limitations so long as
such exceptions are reviewed and justified appropriately. The guidelines
also list a number of lending situations in which exceptions to the loan-
to-value standards are justified.
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain, and is authorized
to take other, supervisory actions against undercapitalized savings
associations. For this purpose, a savings association would be placed in
one of the following four categories based on the association's capital:
* well-capitalized;
* adequately capitalized;
* undercapitalized; or
* critically undercapitalized.
At December 31, 2004, Westfield Bank met the criteria for being
considered well-capitalized. When appropriate, the OTS can require
corrective action by a savings association holding company under the prompt
corrective action provision of federal law.
Insurance of Deposit Accounts. Westfield Bank is a member of the
BIF, and Westfield Bank pays its deposit insurance assessments to the BIF,
as prior to July 23, 2004, Westfield Bank was a Massachusetts-chartered
bank. The FDIC also maintains another insurance fund, the Savings
Association Insurance Fund, which ordinarily insures the deposits of
federal savings association and state-chartered savings banks.
Under federal law, the FDIC established a risk based assessment
system for determining the deposit insurance assessments to be paid by
insured depository institutions. Under the assessment system, the FDIC
assigns an institution to one of three capital categories based on the
institution's financial information as of the quarter ending three months
before the beginning of the assessment period. An institution's assessment
rate depends on the capital category and
32
supervisory category to which it is assigned. Under the regulation, there
are nine risk assessment classifications (i.e., combinations of capital
groups and supervisory subgroups) to which different assessment rates are
applied. Assessment rates currently range from 0.0% of deposits for an
institution in the highest category (i.e., well-capitalized and financially
sound, with no more than a few minor weaknesses) to 0.27% of deposits for
an institution in the lowest category (i.e., undercapitalized and
substantial supervisory concern). The FDIC is authorized to raise the
assessment rates as necessary to maintain the required reserve ratio of
1.25%.
In addition, all FDIC-insured institutions are required to pay
assessments to the FDIC at an annual rate of approximately 0.0168% of
insured deposits to fund interest payments on bonds issued by the Financing
Corporation, an agency of the federal government established to
recapitalize the predecessor to the BIF. These assessments will continue
until the Financing Corporation bonds mature in 2017.
Federal Home Loan Bank System. Westfield 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: (i) the greater of $1,000 or 0.20% of the member's
mortgage-related assets; and (ii) 4.50% of the dollar amount of any
outstanding advances under such member's advances, collateral pledge and
security agreement with the FHLB of Boston. Westfield Bank, as a member of
the FHLB of Boston, is required to acquire and hold shares of capital stock
in the FHLB of Boston in an amount at least equal to 0.12% of the total
assets of Westfield Bank. Westfield Bank is also required to own activity
based stock, which is based on 4.45% of Westfield Bank's outstanding
advances. These percentages are subject to change by the FHLB. Westfield
Bank was in compliance with this requirement with an investment in FHLB of
Boston stock at December 31, 2004 of $4.2 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,
Westfield Bank's net interest income would be affected.
Under the Gramm-Leach-Bliley Act (the "GLB Act"), membership in the
FHLB is now voluntary for all federally-chartered savings associations,
such as Westfield Bank. The GLB Act also 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
six-months notice) and Class B (redeemable on five-years notice).
Federal Reserve System. Westfield Bank is subject to provisions of
the FRA and the FRB's regulations pursuant to which depositary institutions
may be required to maintain non-interest-earning reserves against their
deposit accounts and certain other liabilities. Currently, reserves must
be maintained against transaction accounts (primarily NOW and regular
checking accounts). The FRB regulations generally require that reserves be
maintained in the
33
amount of 3.0% of the aggregate of transaction accounts up to $42.1
million. The amount of aggregate transaction accounts in excess of $42.1
million are currently subject to a reserve ratio of 10.0%. The FRB
regulations currently exempt $6.0 million of otherwise reservable balances
from the reserve requirements, which exemption is adjusted by the FRB at
the end of each year. Westfield Bank is in compliance with the foregoing
reserve requirements. Because required reserves must be maintained in the
form of either vault cash, a non-interest-bearing account at a Federal
Reserve Bank, or a pass-through account as defined by the FRB, the effect
of this reserve requirement is to reduce Westfield Bank's interest-earning
assets. The balances maintained to meet the reserve requirements imposed
by the FRB may be used to satisfy liquidity requirements imposed by the
OTS. FHLB System members are also authorized to borrow from the Federal
Reserve discount window, but FRB regulations require such institutions to
exhaust all FHLB sources before borrowing from a Federal Reserve Bank.
Privacy Regulations. Pursuant to the GLB Act, the OTS has published
final regulations implementing the privacy protection provisions of the GLB
Act. The new regulations generally require that Westfield Bank disclose
its privacy policy, including identifying with whom it shares a customer's
"non-public personal information," to customers at the time of establishing
the customer relationship and annually thereafter. In addition, Westfield
Bank is required to provide its customers with the ability to "opt-out" of
having their personal information shared with unaffiliated third parties
and not to disclose account numbers or access codes to non-affiliated third
parties for marketing purposes. Westfield Bank currently has a privacy
protection policy in place and believes that such policy is in compliance
with the regulations.
The USA PATRIOT Act. Westfield Bank is subject to the USA PATRIOT
Act, which 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.
34
* 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, which became effective on October
1, 2003, require each financial institution to implement a
written customer identification program appropriate for its
size, location and type of business that includes certain
minimum requirements.
* Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United
States persons or their representatives (including foreign
individuals visiting the United States) to establish
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to detect
and report instances of money laundering through those
accounts.
* Section 318, which became effective December 25, 2001,
prohibits financial institutions 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 requires financial
institutions to take reasonable steps to ensure that
correspondent accounted provided to foreign banks are not being
used to indirectly provide banking services to foreign shell
banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Bank
Holding Company Act and Bank Merger Act applications.
Holding Company Regulation
Westfield Financial and Westfield Mutual Holding Company are savings
and loan holding companies regulated by the Office of Thrift Supervision.
As such, Westfield Financial and Westfield Mutual Holding Company are
registered with and are subject to OTS examination and supervision, as well
as certain reporting requirements. In addition, the OTS has enforcement
authority over Westfield Financial and Westfield Mutual Holding Company and
any of their non-savings institution subsidiaries. Among other things,
this authority permits the OTS to restrict or prohibit activities that are
determined to be a serious risk to the financial safety, soundness or
stability of a subsidiary savings institution. Unlike bank holding
companies, federal savings and loan holding companies are not subject to
any regulatory capital requirements or to supervision by the Federal
Reserve System.
Restrictions Applicable to Westfield Financial. Because Westfield
Financial was acquired after May 4, 1999, under the GLB Act it is
prohibited from engaging in non-financial activities. Unitary savings and
loan associations acquired before this date are "grandfathered" under the
GLB Act and generally have no restrictions on their business activities.
Westfield Financial's activities, however, will be restricted to:
35
* furnishing or performing management services for a savings
institution subsidiary of such holding company;
* conducting an insurance agency or escrow business;
* holding, managing, or liquidating assets owned or acquired from
a savings institution subsidiary of such company;
* holding or managing properties used or occupied by a savings
institution subsidiary of such company;
* acting as trustee under a deed of trust;
* any other activity (i) that the FRB, by regulation, has
determined to be permissible for bank holding companies under
Section 4(c) of the Bank Holding Company Act of 1956 (the "BHC
Act"), unless the Director of the OTS, by regulation, prohibits
or limits any such activity for savings and loan holding
companies, or (ii) in which multiple savings and loan holding
companies were authorized by regulation to directly engage in
on March 5, 1987;
* purchasing, holding, or disposing of stock acquired in
connection with a qualified stock issuance if the purchase of
such stock by such holding company is approved by the Director
of the OTS; and
* any activity permissible for financial holding companies under
section 4(k) of the BHC Act.
Permissible activities which are deemed to be financial in nature or
incidental thereto under section 4(k) of the BHC Act include:
* lending, exchanging, transferring, investing for others, or
safeguarding money or securities;
* insurance activities or providing and issuing annuities, and
acting as principal, agent, or broker;
* financial, investment, or economic advisory services;
* issuing or selling instruments representing interests in pools
of assets that a bank is permitted to hold directly;
* underwriting, dealing in, or making a market in securities;
* activities previously determined by the FRB to be closely
related to banking;
* activities that bank holding companies are permitted to engage
in outside of the U.S.; and
* portfolio investments made by an insurance company.
In addition, Westfield Financial cannot be acquired or acquire a
company unless the acquirer is engaged solely in financial activities.
Restrictions Applicable to Activities of Mutual Holding Companies.
Under federal law, a mutual holding company may engage only in the
following activities:
* investing in the stock of a savings institution;
* acquiring a mutual association through the merger of such
association into a savings institution subsidiary of such
holding company or an interim savings institution subsidiary of
such holding company;
36
* merging with or acquiring another holding company, one of whose
subsidiaries is a savings institution;
* investing in a corporation the capital stock of which is
available for purchase by a savings institution under federal
law or under the law of any state where the subsidiary savings
institution or association is located; and
* the permissible activities described above for non-
grandfathered savings and loan holding companies.
If a mutual holding company acquires or merges with another holding
company, the holding company acquired or the holding company resulting from
such merger or acquisition may only invest in assets and engage in the
activities listed above, and it has a period of two years to cease any non-
conforming activities and divest any non-conforming investments.
Restrictions Applicable to All Savings and Loan Holding Companies.
Federal law prohibits a savings and loan holding company, including
Westfield Financial and Westfield Mutual Holding Company, directly or
indirectly, from acquiring:
* control (as defined under HOLA) of another savings institution
(or a holding company parent) without prior OTS approval;
* through merger, consolidation, or purchase of assets, another
savings institution or a holding company thereof, or acquiring
all or substantially all of the assets of such institution (or
a holding company) without prior OTS approval; or
* control of any depository institution not insured by the FDIC
(except through a merger with and into the holding company's
savings institution subsidiary that is approved by the OTS).
A savings and loan holding company may not acquire as a separate
subsidiary an insured institution that has a principal office outside of
the state where the principal office of its subsidiary institution is
located, except:
* in the case of certain emergency acquisitions approved by the
FDIC;
* if such holding company controls a savings institution
subsidiary that operated a home or branch office in such
additional state as of March 5, 1987; or
* if the laws of the state in which the savings institution to be
acquired is located specifically authorize a savings
institution chartered by that state to be acquired by a savings
institution chartered by the state where the acquiring savings
institution or savings and loan holding company is located or
by a holding company that controls such a state-chartered
association.
If the savings institution subsidiary of a federal mutual holding
company fails to meet the QTL test set forth in Section 10(m) of the HOLA
and regulations of the Office of Thrift Supervision, the holding company
must register with the FRB as a bank holding company under the BHC Act
within one year of the savings institution's failure to so qualify.
37
Prohibitions Against Tying Arrangements. Federal savings banks are
subject to the prohibitions of 12 U.S.C. [SECTION] 1972 on certain tying
arrangements. A depository institution is prohibited, subject to some
exceptions, 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 its affiliates or not obtain services of a
competitor of the institution.
Federal Securities Laws. Our common stock is registered with the SEC
under Section 12(b) 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.
The Sarbanes-Oxley Act. As a public company, we are subject to the
Sarbanes-Oxley Act, which 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
corporate wrongdoing. The Sarbanes-Oxley Act's principal legislation and
the derivative regulation and rule making promulgated by the SEC includes:
* the creation of an independent accounting oversight board;
* auditor independence provisions that 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;
* a requirement that companies establish and maintain a system of
internal control over financial reporting and that a company's
management provide an annual report regarding its assessment of
the effectiveness of such internal control over financial
reporting to the company's independent accountants and that
such accountants provide an attestation report with respect to
management's assessment of the effectiveness of the company's
internal control over financial reporting;
* the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by
directors and senior officers in the twelve month period
following initial publication of any financial statements that
later require restatement;
* an increase in the oversight of, and enhancement of certain
requirements relating to audit committees of public companies
and how they interact with the company's independent auditors;
* the requirement that audit committee members must be
independent and are absolutely barred from accepting
consulting, advisory or other compensatory fees from the
issuer;
38
* the requirement that companies disclose whether at least one
member of the committee is a "financial expert" (as such term
is defined by the SEC) 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 the requirement of filing of
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.
Quotation on AMEX. Our common stock is quoted on the American Stock
Exchange ("AMEX"). In order to maintain such quotation, we are subject to
certain corporate governance requirements, including:
* a majority of our board must be composed of independent
directors;
* we are required to have an audit committee composed of at least
three directors, each of whom is an independent director, as
such term is defined by both AMEX rules as set forth in its
Company Guide and by Exchange Act regulations;
* our nominating committee and compensation committee must also
be composed entirely of independent directors; and
* each of our audit committee and nominating committee must have
a publicly available written charter.
39
ITEM 2. PROPERTIES
Properties
Westfield Bank currently conducts its business through its ten
banking offices and four off-site ATMs. As of December 31, 2004, the
properties and leasehold improvements owned by us had an aggregate net book
value of $11.5 million.
Year of Lease
or License
Location Ownership Year Opened Expiration
- ----------------------------------------------------------------------
Main Office:
141 Elm St.
Westfield, MA Owned 1964 N/A
Branch Offices:
206 Park St.
W. Springfield, MA Owned 1957 N/A
655 Main St.
Agawam, MA Owned 1968 N/A
26 Arnold St.
Westfield, MA Owned 1976 N/A
300 Southampton Rd.
Westfield, MA Owned 1987 N/A
462 College Highway
Southwick, MA Owned 1990 N/A
382 N. Main St.
E. Longmeadow, MA Leased 1997 2007(1)
1341 Main St.
Springfield, MA Leased 1999 2009(2)
1642 Northampton St.
Holyoke, MA Owned 2001 N/A
1342 Liberty St.
Springfield, MA Owned 2001 N/A
ATMs:
337 N. Westfield St.
Feeding Hills, MA Leased 1988 2013
830 Suffield St.
Agawam, MA Tenant at will 1997 N/A
516 Carew St.
Springfield, MA Tenant at will 2002 N/A
1000 State St.
Springfield, MA Tenant at will 2003 N/A
- --------------------
Does not include one additional five-year option.
Does not include two additional five-year options.
40
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any pending legal proceeding other than
routine legal proceedings occurring in the ordinary course of business. In
the opinion of management, no legal proceedings will have a material effect
on the company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is listed on The American Stock Exchange under the
symbol "WFD." Westfield Mutual Holding Company owns 5,607,400 shares, or
53% of our outstanding common stock. At December 31, 2004, there were
9,954,512 shares of common stock issued and outstanding, and there were
approximately 1,384 holders of record.
The table below shows the high and low sales price during the periods
indicated as well as dividends declared per share. The information set
forth in the table below was provided by the American Stock Exchange.
Price Range Dividends
---------------- ---------
For the Year Ended December 31, 2004 High Low
---- ---
Fourth Quarter ended December 31, 2004 $26.00 $23.50 $0.10
Third Quarter ended September 30, 2004 23.60 19.76 0.10
Second Quarter ended June 30, 2004 24.87 19.45 0.05
First Quarter ended March 31, 2004 25.07 23.15 0.05
Price Range Dividends
---------------- ---------
For the Year Ended December 31, 2003 High Low
---- ---
Fourth Quarter ended December 31, 2003 $24.80 $22.70 $0.05
Third Quarter ended September 30, 2003 22.32 18.60 0.05
Second Quarter ended June 30, 2003 18.90 15.47 0.05
First Quarter ended March 31, 2003 15.90 15.15 0.05
A quarterly cash dividend of $0.05 per share was declared on January
27, and April 26, and $0.10 per share was declared on July 27 and October
26, 2004 by the Board of Directors. The continued payment of dividends
also depend upon our debt and equity structure, earnings, financial
condition, need for capital in connection with possible future acquisitions
and other factors, including economic conditions, regulatory restrictions
and tax considerations. We cannot guarantee that we will pay dividends or
that, if paid, that we will not reduce or eliminate dividends in the
future.
41
The only funds available for the payment of dividends on the capital
stock of Westfield Financial will be cash and cash equivalents held by
Westfield Financial, dividends paid by Westfield Bank to Westfield
Financial, and borrowings. Westfield Bank will be prohibited from paying
cash dividends to Westfield Financial to the extent that any such payment
would reduce Westfield Bank's capital below required capital levels or
would impair the liquidation account to be established for the benefit of
the Westfield Bank's eligible account holders and supplemental eligible
account holders at the time of the reorganization and stock offering.
ITEM 6. SELECTED FINANCIAL DATA
The summary information presented below at or for each of the years
presented is derived in part from the consolidated financial statements of
Westfield Financial. The following information is only a summary, and you
should read it in conjunction with our consolidated financial statements
and notes beginning on page F-1.
At December 31,
--------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In thousands)
Selected Financial Condition Data:
Total assets $796,903 $795,216 $812,980 $782,732 $694,791
Loans, net(1) 368,601 344,980 357,155 413,546 464,531
Securities available for sale 14,968 25,806 79,842 74,184 75,709
Securities held to maturity 71,298 69,927 45,960 45,614 39,461
Mortgage backed securities
available for sale 73,316 76,177 90,468 87,150 52,580
Mortgage backed securities
held to maturity 175,302 191,683 159,339 81,007 6,806
Deposits 612,621 632,431 656,065 637,109 601,896
Customer repurchase agreements 14,615 12,135 8,724 6,061 7,686
Federal Home Loan Bank advances 45,000 20,000 15,000 - -
Total equity 118,051 124,804 126,699 131,317 77,755
Allowance for loan losses 5,277 4,642 4,325 3,923 3,434
Nonperforming loans 2,171 1,768 2,383 2,684 2,308
For the Years Ended
December 31,
--------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In thousands, except per share data)
Selected Operating Data:
Interest and dividend income $34,428 $35,635 $43,013 $47,543 $46,718
Interest expense 10,913 13,858 18,775 25,002 24,535
------- ------- ------- ------- -------
Net interest and dividend income 23,515 21,777 24,238 22,541 22,183
Provision for loan losses 750 750 934 1,630 1,089
------- ------- ------- ------- -------
Net interest and dividend income
after provision for loan losses 22,765 21,027 23,304 20,911 21,094
Total noninterest income (loss) 3,896 3,074 (362) 2,517 2,855
Total noninterest expense 17,776 17,630 16,659 15,899 14,684
------- ------- ------- ------- -------
Income before income taxes 8,885 6,471 6,283 7,529 9,265
Income taxes 2,562 2,820 2,239 2,512 3,185
------- ------- ------- ------- -------
Net income $ 6,323 $ 3,651 $ 4,044 $ 5,017 $ 6,080
======= ======= ======= ======= =======
Basic earnings per share $ 0.65 $ 0.36 $ 0.39 N/A N/A
Diluted earnings per share $ 0.64 $ 0.36 $ 0.38 N/A N/A
Dividends per share paid $ 0.30 $ 0.20 $ 0.15 N/A N/A
- --------------------
Loans are shown net of deferred loan fees, allowance for loan losses
and unadvanced loan funds.
42
At or for the Years Ended December 31,
---------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Selected Financial Ratios and
Other Data(1)
Performance Ratios:
Return on average assets 0.79% 0.45% 0.51% 0.70% 0.92%
Return on average equity 5.24 2.94 3.14 6.16 8.04
Average equity to average assets 15.14 15.33 16.23 11.32 11.45
Equity to total assets at end of year 14.83 15.69 15.58 16.78 11.19
Average interest rate spread 2.83 2.47 2.54 2.75 2.91
Net interest margin(2) 3.13 2.86 3.18 3.33 3.51
Average interest earning assets to
average interest earning liabilities 121.47 121.49 125.76 115.77 115.40
Total noninterest expense to
average assets 2.24 2.18 2.10 2.21 2.22
Efficiency ratio(3) 66.99 72.13 65.01 65.62 62.48
Regulatory Capital Ratios:
Regulatory tier 1 leverage capital 14.69 15.31 15.65 17.27 11.51
Tier 1 risk-based capital 25.75 28.46 28.77 28.09 16.33
Total risk-based capital 26.90 29.63 29.78 28.98 17.24
Asset Quality Ratios:
Nonperforming loans as a percent of
total loans 0.58 0.51 0.66 0.64 0.49
Nonperforming assets as a percent of
total assets 0.27 0.22 0.29 0.37 0.33
Allowance for loan losses as a percent of
total loans 1.41 1.33 1.20 0.94 0.73
Allowance for loan losses as a percent of
nonperforming assets 243 263 181 137 149
Number of:
Banking offices 10 10 10 10 8
Full-time equivalent employees 144 152 146 159 151
- --------------------
Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios.
Net interest margin represents net interest and dividend income as a
percentage of average interest earning assets.
The efficiency ratio represents the ratio of operating expenses
divided by the sum of net interest and dividend income and
noninterest income less gain on sale of securities.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Westfield Financial strives to remain a leader in meeting the
financial service needs of the local community and to provide quality
service to the individuals and businesses in the market areas that it has
served since 1853. Historically, Westfield Bank has been a community-
oriented provider of traditional banking products and services to business
organizations and individuals, including products such as residential and
commercial real estate loans, consumer loans and a variety of deposit
products. Westfield Bank meets the needs of its local community through a
community-based and service-oriented approach to banking.
In recent years, in addition to real estate lending, we have adopted
a growth-oriented strategy that has focused on increased emphasis on
commercial lending. Our strategy also calls for increasing deposit
relationships and broadening our product lines and services. We believe
that this business strategy is best for our long term success and
viability, and complements our existing commitment to high quality customer
service. In connection with our overall growth strategy, Westfield Bank
seeks to:
43
* continue to grow its commercial loan portfolio as a means to
increase the yield on and diversify its loan portfolio and
build transactional deposit account relationships;
* focus on expanding its retail banking franchise, and increasing
the number of households served within its market area; and
* depending on market conditions, refer substantially all of the
fixed-rate residential real estate loans to a third party
mortgage company which underwrites, originates and services
these loans in order to diversify its loan portfolio, increase
fee income and reduce interest rate risk.
You should read our financial results for the year ended December 31,
2004 in the context of this strategy.
* Net income increased $2.6 million, or 70.3%, to $6.3 million or
$0.64 per diluted share for the year ended December 31, 2004
from $3.7 million or $0.36 per diluted share for 2003. This
was due to a $1.7 million increase in net interest income, a
$822,000 increase in noninterest income, and a decrease in
income tax expense of $258,000.
* The 2003 results were affected by an agreement with the
Massachusetts Department of Revenue to settle the issue related
to taxes owed on dividends received from Westfield Bank's REIT
subsidiary in 2002 and prior tax years. Under the agreement,
Westfield Financial paid 50% of the amount owed including
interest. This resulted in a charge of approximately $1.45
million for state taxes, interest and penalties, net of federal
benefit.
* Net interest and dividend income increased primarily as a
result of lower funding costs. The net interest margin was
3.13% for the year ended December 31, 2004, as a compared to
2.86% for the same period in 2003. The cost of interest-
bearing liabilities decreased 44 basis points to 1.77% for the
year ended December 31, 2004 from 2.21% in the same period in
2003. This was achieved by the use of a pricing strategy
whereby less emphasis was placed on attracting term deposits,
which generally have higher interest rates than core deposits.
Westfield Financial expects net interest and dividend income to
increase in future periods as it continues to emphasize higher
yielding commercial real estate loans and commercial and
industrial loans, while referring residential mortgage loans to
a third party mortgage company.
* Commercial real estate and commercial and industrial loans
increased $22.5 million, or 10.4%, to $239.1 million at
December 31, 2004. This is consistent with Westfield Bank's
strategic plan, which emphasizes commercial lending. The
continued success of Westfield Bank's commercial lending is
primarily dependent on the local and national economy.
44
* Residential real estate loans increased $12.7 million to $123.2
million at December 31, 2004 from $110.5 million at December
31, 2003. Westfield Bank purchased $35.3 million in adjustable
rate mortgage loans, which are serviced by the originating
institutions. This was offset by principal payments and
payoffs of other residential real estate loans. Westfield Bank
refers its residential real estate borrowers to a third party
mortgage company and substantially all of Westfield Bank's
residential real estate loans are underwritten, originated and
serviced by a third party mortgage company. Westfield Bank
receives a fee from each of these loans originated. Westfield
Bank believes that this program has diversified its loan
portfolio and continues to reduce interest rate risk.
* Indirect automobile loans decreased $10.1 million, or 63.1%,
from $16.0 million at December 31, 2003 to $5.9 million at
December 31, 2004. Management curtailed its indirect
automobile lending beginning in fiscal year 2000 due to credit
quality concerns, and in the fourth quarter of 2003, Westfield
Bank ceased writing indirect automobile loans. Although
indirect auto loans had higher yields, they also had higher
costs, therefore Westfield Bank expects minimal impact on
earnings as a result of the discontinuation of the program.
* Total deposits decreased $19.8 million from $632.4 million at
December 31, 2003 to $612.6 million at December 31, 2004. The
decrease in deposits was primarily due to a decrease of $21.1
million in time deposits for the year ended December 31, 2004.
Management believes that the decrease in time deposits was a
result of a pricing strategy whereby less emphasis was placed
on attracting term deposits, which generally have higher
interest rates than core deposits. This led to an increase in
net interest income. Core deposits, which include checking,
NOW, savings, and money market accounts, increased $1.3 million
to $299.5 million at December 31, 2004. Westfield Bank's
strategy is to emphasize core deposits in order to maintain
long-term relationships with customers and to reduce the cost
of funds. Management believes, however, that a percentage of
the growth in core deposits over the last three years was due
to the low rate environment, i.e. no incentive for customers to
lock up funds in time deposits. In a period of rising interest
rates, the more rate sensitive customers may shift funds back
into time deposits, resulting in a higher cost of funds.
* The decrease in deposits was offset by increases in Federal
Home Loan Bank borrowings and customer repurchase agreements.
Federal Home Loan Bank borrowings increased $25.0 million to
$45.0 million at December 31, 2004 to take advantage of the
current interest rate environment. Customer repurchase
agreements increased $2.5 million to $14.6 million at December
31, 2004.
* Fees received from the third party mortgage company were
$100,000 for the year ended December 31, 2004 as compared to
$340,000 for the same period in 2003. Higher interest rates
resulted in fewer referrals to the third party mortgage
company. Fee income from the third party mortgage company in
the future may be affected by borrower activity, which
generally decreases in a rising interest rate environment.
45
* Checking account processing fees increased $617,000 for the
twelve months ended December 31, 2004 as compared to the same
period in 2003. This was as a result of new products and
services provided by Westfield Bank to its checking account
customers commencing in the second quarter of 2004.
* Nonperforming loans increased $403,000 to $2.2 million at
December 31, 2004 from $1.8 million at December 31, 2003. This
was primarily due to single commercial real estate loan
relationship of $1.4 million. The loan is fully collateralized
based on the estimated fair market value of the property. This
was offset primarily by payments in full received on other
nonperforming loans.
* Gross charge-offs decreased by 44.3% for the twelve months
ended December 31, 2004 as compared to the same period in 2003,
primarily as a result of the curtailment of indirect auto loans
and the improved local and national economy.
* The allowance for loans as a percent of total loans receivable
increased. Westfield Bank has steadily increased this ratio
over the last five years to compensate for growth in commercial
loans, which typically have higher risks than residential
loans. As Westfield Bank emphasizes the origination of
commercial real estate loans and commercial and industrial
loans for its loan portfolio, increased allowance requirements
may continue. Due to Westfield Bank's discontinuation of its
indirect automobile lending, the balance of consumer loans is
expected to decrease. Decreased allowances for consumer loans
in the future may result.
* Stockholders' equity at December 31, 2004 and December 31, 2003
was $118.1 million and $124.8 million, respectively,
representing 14.8% and 15.7% of total assets. The change is
comprised of net income of $6.3 million for the year ended
December 31, 2004, the net repurchase of 567,788 shares of
common stock for $12.0 million, and the declaration by the
Board of Directors of quarterly cash dividends aggregating $1.7
million.
General
Westfield Financial's consolidated results of operations are
comprised of earnings on investments and the net income recorded by its
principal operating subsidiary, Westfield Bank. Westfield Bank's
consolidated results of operations depend primarily on net interest and
dividend income. Net interest and dividend income is the difference
between the interest income earned on interest-earning assets and the
interest paid on interest-bearing liabilities. Interest-earning assets
consist primarily of residential mortgage loans, commercial mortgage loans,
commercial loans, consumer loans, mortgage-backed securities and investment
securities. Interest-bearing liabilities consist primarily of certificates
of deposit, savings, money market and NOW account deposits, and borrowings
from the Federal Home Loan Bank of Boston. The consolidated results of
operations also depend on provision for loan losses, noninterest income,
and noninterest expense. Noninterest expense includes salaries and
employee benefits, occupancy expenses and other general and administrative
expenses. Noninterest income includes service fees and charges, income on
bank owned life insurance, and gains (losses) on sales of securities and
securities writedowns.
46
The consolidated results of operations may also be affected
significantly by economic and competitive conditions in the market area and
elsewhere, including those conditions that influence market interest rates,
government policies and the actions of regulatory authorities. Future
changes in applicable laws, regulations or government policies may
materially affect the results of operations. Furthermore, because
Westfield Bank's lending activity is concentrated in loans secured by
residential and commercial real estate located in Hampden County,
Massachusetts, downturns in this regional economy could have a negative
impact on its earnings.
Critical Accounting Policies
Westfield Financial's accounting policies are disclosed in Note 1 to
the Consolidated Financial Statements. The more critical policies given
Westfield Financial's current business strategy and asset/liability
structure are accounting for non performing loans, the allowance for loan
losses and provision for credit loans, the classification of securities as
either held to maturity or available for sale, other than temporary
impairment of securities, and discount rate assumptions used for benefit
liabilities. In addition to the information disclosure in the Notes to the
Consolidated Financial Statements, Westfield Financial's policy on each of
these accounting policies is described in detail in the applicable sections
of Management's Discussion and Analysis of Financial Condition and results
of Operations. Senior management has discussed the development and
selection of these accounting estimates and the related disclosures with
the Audit Committee of the Company's Board of Directors.
On a quarterly basis, the Company reviews available for sale
investment securities with unrealized depreciation on a judgmental basis to
assess whether the decline in fair value is temporary or other than
temporary. Declines in the fair value of held to maturity and available
for sale securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses. In estimating
other than temporary impairment losses, management considers (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 corporation to retain its investment in the
issuer for a period of time sufficient to allow for any anticipated
recovery in fair value.
Securities, including mortgage-backed securities, which management
has the positive intent and ability to hold until maturity are classified
as held to maturity and are carried at amortized cost. Securities,
including mortgage-backed securities, which have been identified as assets
for which there is not a positive intent to hold to maturity are classified
as available for sale and are carried at fair value with unrealized gains
and losses, net of income taxes, reported as a separate component of
equity. Accordingly, a misclassification would have a direct effect on
stockholders' equity. Sales or reclassification as available for sale
(except for certain permitted reasons) of held to maturity securities may
result in the reclassification of all such securities to available for
sale. The Company has never sold held to maturity securities or
reclassified such securities to available for sale other than in
specifically permitted circumstances. Westfield Financial does not acquire
securities or mortgage-backed securities for purposes of engaging in
trading activities.
47
Westfield Financial's general policy is to discontinue the accrual of
interest when principal or interest payments are delinquent 90 days or
more, or earlier if the loan is considered impaired. Any unpaid amounts
previously accrued on these loans are reversed from income. Subsequent cash
receipts are applied to the outstanding principal balance or to interest
income if, in the judgment of management, collection of principal balance
is not in question. Loans are returned to accrual status when they become
current as to both principal and interest and when subsequent performance
reduces the concern as to the collectibility of principal and interest.
Loan fees and certain direct loan origination costs are deferred, and the
net fee or cost is recognized as an adjustment to interest income over the
estimated average lives of the related loans. Compensation to an auto
dealer is normally based upon a spread that a dealer adds on the loan base
rate set by Westfield Financial. The compensation is paid to an automobile
dealer shortly after the loan is originated. Westfield Financial records
the amount as a deferred cost that is amortized over the life of the loans
in relation to the interest paid by the consumer.
The process of evaluating the loan portfolio, classifying loans and
determining the allowance and provision is described in detail on pages 16-
20. Westfield Financial's methodology for assessing the appropriations of
the allowance consists of two key components, which are a specific
allowance for identified problems or impaired loans and a formula allowance
for the remainder of the portfolio. Measurement of impairment can be based
on present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's observable market price or the fair
value of the collateral, if the loan is collateral dependent. This
evaluation is inherently subjective as it requires material estimates that
may be susceptible to significant change. The appropriations of the
allowance is also reviewed by management based upon its evaluation of then-
existing economic and business conditions affecting the key lending areas
of Westfield Financial and other conditions, such as new loan products,
credit quality trends (including trends in nonperforming loans expected to
result from existing conditions,) collateral values, loan volumes and
concentrations, specific industry conditions within portfolio segments that
existed as of the balance sheet date and the impact that such conditions
were believed to have had on the collectibility of the loan portfolio.
Although management believes it has established and maintained the
allowance for loan losses at adequate levels, future adjustments may be
necessary if economic, real estate and other conditions differ
substantially from the current operating environment.
48
AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST AND DIVIDEND INCOME
The following tables set forth information relating to our financial
condition and net interest and dividend income for the years ended December
31, 2004, 2003 and 2002 and reflect the average yield on assets and average
cost of liabilities for the periods indicated. The yields and costs were
derived by dividing income or expense by the average balance of interest-
earning assets or interest-bearing liabilities, respectively, for the
periods shown. Average balances were derived from actual daily balances
over the periods indicated. Interest income includes fees earned from
making changes in loan rates or terms, and fees earned when commercial real
estate loans were prepaid or refinanced.
For the Year Ended December 31,
---------------------------------------------------------------------------------------------
2004 2003 2002
----------------------------- ----------------------------- -----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- -------- ------- ------- -------- -------
(Dollars in thousands)
ASSETS:
Interest-earning assets:
Short term investments(1) $ 20,866 $ 290 1.39% $ 17,648 $ 170 0.96% $ 27,162 $ 416 1.53%
Securities 361,253 13,195 3.65 389,333 13,189 3.39 337,646 14,562 4.31
Loans(2) 366,677 20,943 5.71 354,134 22,276 6.29 398,555 28,035 7.03
-------- ------- -------- ------- -------- -------
Total interest-earning
assets 748,796 34,428 4.60 761,115 35,635 4.68 763,363 43,013 5.63
------- ------- -------
Total noninterest-earning
assets 46,135 48,693 28,971
-------- -------- --------
Total assets $794,931 $809,808 $792,334
======== ======== ========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
NOW accounts 48,004 249 0.52% 42,783 347 0.81% 40,636 589 1.45%
Savings accounts 47,728 232 0.49 46,771 371 0.79 44,026 474 1.08
Money market deposit accounts 152,855 1,419 0.93 152,863 1,860 1.22 133,622 2,541 1.90
Time certificates of deposit 317,563 7,724 2.43 353,967 10,544 2.98 380,385 14,957 3.93
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits 566,150 9,624 596,384 13,122 598,669 18,561
Customer repurchase agreements
and other borrowings 50,309 1,289 2.56 30,123 736 2.44 8,332 214 2.57
-------- ------- -------- ------- -------- -------
Interest-bearing liabilities 616,459 10,913 1.77 626,507 13,858 2.21 607,001 18,775 3.09
-------- ------- -------- ------- -------- -------
Noninterest-bearing deposits 52,631 54,119 48,856
Other noninterest-bearing
liabilities 5,488 5,020 7,883
-------- -------- --------
Total noninterest-bearing
liabilities 58,119 59,139 56,739
-------- -------- --------
Total liabilities 674,578 685,646 663,740
Total equity 120,353 124,162 128,594
-------- -------- --------
Total liabilities and equity $794,931 $809,808 $792,334
======== ======== ========
Net interest and dividend
income $23,515 $21,777 $24,238
======= ======= =======
Net interest rate spread(3) 2.83 2.47 2.54
Net interest margin(4) 3.13% 2.86% 3.18%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 121.5x 121.5x 125.8x
- --------------------
Short term investments include Federal funds sold.
Loans, including non-accrual loans, are net of deferred loan
origination costs (fees), and unadvanced funds.
Net interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted
average cost of interest-bearing liabilities.
Net interest margin represents net interest and dividend income as a
percentage of average interest earning assets.
49
Rate/Volume Analysis. The following table shows how changes in
interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected our interest and dividend income
and interest expense during the periods indicated. Information is provided
in each category with respect to:
(1) interest income changes attributable to changes in volume
(changes in volume multiplied by prior rate);
(2) interest income changes attributable to changes in rate
(changes in rate multiplied by prior volume); and
(3) the net change.
The changes attributable to the combined impact of volume and rate
have been allocated proportionately to the changes due to volume and the
changes due to rate.
Year Ended December 31, 2004 Year Ended December 31, 2003
Compared to Year Ended Compared to Year Ended
December 31, 2003 December 31, 2002
Increase/(Decrease) Increase/(Decrease)
-------------------------------- --------------------------------
Due to Due to
-------------------- --------------------
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
(In thousands)
Interest earning assets:
Short term investments $ 31 $ 89 $ 120 $ (146) $ (100) $ (246)
Investment securities (951) 957 6 2,229 (3,602) (1,373)
Loans 789 (2,122) (1,333) (3,125) (2,634) (5,759)
------- ------- ------- ------- ------- -------
Total interest-earning assets $ (131) $(1,076) $(1,207) $(1,042) $(6,336) $(7,378)
======= ======= ======= ======= ======= =======
Interest bearing liabilities:
NOW accounts $ 42 $ (140) $ (98) $ 31 $ (273) $ (242)
Savings accounts 8 (147) (139) 30 (133) (103)
Money market deposit accounts 0 (441) (441) 366 (1,047) (681)
Time certificates of deposit (1,084) (1,736) (2,820) (1,039) (3,374) (4,413)
Customer repurchase agreements
and other borrowings 493 60 553 560 (38) 522
------- ------- ------- ------- ------- -------
Total interest bearing
liabilities (541) (2,404) (2,945) (52) (4,865) (4,917)
------- ------- ------- ------- ------- -------
Change in net interest and
dividend income $ 410 $ 1,328 $ 1,738 $ (990) $(1,471) $(2,461)
======= ======= ======= ======= ======= =======
50
Comparison of Financial Condition at December 31, 2004 and December 31, 2003
Consolidated assets increased $1.7 million, or 0.2%, to $796.9
million at December 31, 2004 from $795.2 million at December 31, 2003.
Securities decreased $28.7 million, or 7.9%, to $334.9 million at
December 31, 2004 from $363.6 million at December 31, 2003. Cash received
from maturities, calls, and paydowns of securities was primarily used to
fund loan demand. Cash and cash equivalents increased $5.4 million to
$51.0 million at December 31, 2004 from $45.7 million at December 31, 2003.
Net loans during this period increased by $23.6 million, or 6.8%, to
$368.6 million at December 31, 2004, from $345.0 million at December 31,
2003.
Commercial real estate loans increased $13.0 million, or 9.9%, to
$144.3 million at December 31, 2004 from $131.3 million at December 31,
2003. Commercial and industrial loans increased $9.5 million, or 11.1%, to
$94.8 million at December 31, 2004 from $85.3 million at December 31, 2003.
Westfield Bank's strategic plan calls for emphasis on commercial lending.
The success of the plan to grow commercial loans is primarily dependent
upon the improvement of the local and national economy.
Residential real estate loans increased $12.7 million to $123.2
million at December 31, 2004 from $110.5 million at December 31, 2003. The
increase was primarily the result of Westfield Bank's purchase of $35.3
million in adjustable rate mortgage loans, which are serviced by the
originating institutions. This was offset by principal payments and
payoffs of other residential real estate loans. Westfield Bank refers its
residential real estate borrowers to a third party mortgage company and
substantially all of Westfield Bank's residential real estate loans are
underwritten, originated and serviced by a third party mortgage company.
Westfield Bank receives a fee from each of these loans originated.
Westfield Bank believes that this program has diversified its loan
portfolio and continues to reduce interest rate risk.
Indirect automobile loans decreased $10.1 million, or 63.1%, to $5.9
million on December 31, 2004 as compared to $16.0 million on December 31,
2003. Management curtailed its indirect lending beginning in fiscal year
2000 and in the fourth quarter of 2003, the Bank ceased writing loans under
this program.
Total deposits decreased $19.8 million to $612.6 million at December
31, 2004. The decrease in deposits was primarily due to a decrease of
$21.1 million in time deposits for the year ended December 31, 2004.
Management believes that the decrease in time deposits was a result of a
pricing strategy whereby less emphasis was placed on attracting term
deposits, which generally have higher interest rates than core deposits.
This led to an increase in net interest income.
Core deposits, which include checking, NOW, savings and money market
accounts, increased $1.3 million to $299.5 million at December 31, 2004.
Westfield Bank's strategy is to emphasize core deposits in order to
maintain long-term relationships with customers and to reduce the cost of
funds. Management believes, however, that a percentage of the growth in
core deposits over the last three years was due to the low rate
environment, i.e. no incentive for
51
customers to lock up funds in time deposits. In a period of rising
interest rates, the more rate sensitive customers may shift funds back into
time deposits, resulting in a higher cost of funds.
The decrease in deposits was offset by increases in Federal Home Loan
Bank borrowings and customer repurchase agreements. Federal Home Loan Bank
borrowings increased $25.0 million to $45.0 million at December 31, 2004 to
take advantage of the current interest rate environment. Customer
repurchase agreements increased $2.5 million to $14.6 million at December
31, 2004. A customer repurchase agreement is an agreement by Westfield
Bank to sell to and repurchase from the customer an interest in specific
securities issued by or guaranteed by the United States Government. This
transaction settles immediately on a same day basis in immediately
available funds. Interest paid is commensurate with other products of
equal interest and credit risk. All the customer repurchase agreements are
held by Westfield Bank's commercial loan customers. The increase customer
repurchase agreements is consistent with Westfield Bank's strategy to
emphasize commercial customer relationships.
Stockholders' equity at December 31, 2004 and December 31, 2003 was
$118.1 million and $124.8 million, respectively. The change is comprised
of net income of $6.3 million for the year ended December 31, 2004, the net
repurchase of 567,788 shares of common stock for $12.0 million, and the
declaration by the Board of Directors of quarterly cash dividends
aggregating $1.7 million.
Comparison of Operating Results for Years Ended December 31, 2004 and 2003
General
Westfield Financial reported net income of $6.3 million or $0.64 per
diluted share for the year ended December 31, 2004 compared to net income
of $3.7 million or $0.36 per diluted share for the same period in 2003.
Interest and dividend income increased by $1.2 million and interest expense
decreased by $2.9 million resulting in an increase in net interest income
of $1.7 million. Noninterest income increased by $822,000 and income tax
expense decreased by $258,000.
Westfield Financial 2003 results included a charge of $1.45 million
representing the additional state tax liability, including interest,
relating to the deduction for dividends received from Westfield Bank's real
estate investment trust subsidiary for 2002 and prior years. Total income
taxes were $2.6 million for the year ended December 31, 2004 as compared to
$2.8 million for the same period in 2003.
Interest and Dividend Income
Total interest and dividend income decreased $1.2 million or 3.4% to
$34.4 million for the year ended December 31, 2004 compared to $35.6
million for the same period in 2003.
The decrease in interest income was primarily the result of a $1.3
million decrease in interest income on loans. Interest income from
residential real estate loans decreased $1.6 million to $7.8 million for
the year ended December 31, 2004 as compared to the same period in 2003.
The average balance of residential real estate loans decreased to $119.6
million for the
52
year ended December 31, 2004 from $131.4 million for the year ended
December 31, 2003 due to our residential real estate loan program with a
third party mortgage company. In addition, interest on consumer loans
decreased $1.2 million to $1.2 million for the year ended December 31, 2004
as compared to $2.4 million for the same period in 2003. This was
primarily the result of a decrease in average balance of consumer loans
from $31.2 million for 2003 to $16.0 million for 2004 due to management's
decision to discontinue indirect automobile loan originations.
The decrease is interest income from residential real estate loans
and consumer loans was partially offset by increases in income from
commercial real estate loans and commercial and industrial loans. Interest
income from commercial real estate loans and commercial and industrial
loans increased $1.5 million for the year ended December 31, 2004 from the
year ended December 31, 2003. In accordance with Westfield Bank's
strategic plan, the average balance of commercial real estate loans and
commercial industrial loans increased $39.6 million to $231.1 million for
the year ended December 31, 2004 as compared to $191.5 million for the same
period in 2003
Interest and dividends on securities was $13.2 million for both the
years ended December 31, 2004 and 2003. The average yield on securities
increased from 3.39% for the year 2003 to 3.65% for the same period in
2004. This change was offset by a $28.0 million decrease in the average
balance of securities from $389.3 million for 2003 to $361.3 million for
2004. Market interest rates increased during 2004. As lower yielding
investments purchased in a higher rate environment matured, were called, or
paid down in 2004, the funds were reinvested at higher rates. In addition,
the interest rate on adjustable rate securities repriced upward in the
rising interest rate environment.
Interest Expense
Interest expense for the year ended December 31, 2004 decreased $3.0
million to $10.9 million from the comparable 2003 period. This was
attributable to a decrease in the average cost of interest-bearing
liabilities of 44 basis points to 1.77% for the year ended December 31,
2004 from 2.21% for the same period in 2003. In addition, the average
balance of total interest-bearing liabilities decreased $10.0 million to
$616.5 million for the year ended December 31, 2004 from $626.5 million for
the same period in 2003.
The decrease in both the average balance and average cost of
interest-bearing liabilities was the result of a pricing strategy whereby
less emphasis was place on attracting term deposits, which generally have
higher interest rates than core deposits.
Net Interest and Dividend Income
Net interest and dividend income increased $1.7 million to $23.5
million for the twelve months ended December 31, 2004 as compared to $21.8
million for the same period in 2003. The net interest margin was 3.13% for
the twelve months ended December 31, 2004 as compared to 2.86% for the same
period in 2003.
53
The increase in the net interest margin was primarily the result of
lower funding costs. The average cost of interest-bearing liabilities
decreased 44 basis points to 1.77% for the twelve months ended December 31,
2004 from 2.21% for same period in 2003. The yield on interest-earning
assets decreased only 8 basis points to 4.60% for the twelve months ended
December 31, 2004 from 4.68% for same period in 2003. Westfield Financial
expects net interest and dividend income to generally increase in future
periods as it continues to emphasize higher yielding commercial real estate
loans and commercial and industrial loans, while referring residential
mortgage loans to a third party mortgage company.
In addition, Westfield Bank continues to emphasize core deposits over
time deposits. The average balance of core deposits, which are checking,
NOW, savings and money market accounts, increased $4.7 million to $301.2
million for the twelve months ended December 31, 2004 from $296.5 million
for the same period in 2003. The average balance of time deposits
decreased $36.4 million to $317.6 million for the twelve months ended
December 31, 2004 from $354.0 million for the same period in 2003. The
decrease in time deposits was partially offset by an increase in Federal
Home Loan Bank borrowings. The average balance of Federal Home Loan Bank
borrowings increased $17.5 million to $34.4 million for the twelve months
ended December 31, 2004 from $16.9 million for the same period in 2003.
The use of a pricing strategy whereby less emphasis was placed on
attracting term deposits, which generally have higher interest rates than
core deposits, and the shift in Westfield Bank's funding mix contributed to
the decrease in funding costs. Management believes, however, that a
percentage of the growth in core deposits over the last three years is due
to the low rate environment, i.e. no incentive for customers to lock up
funds in time deposits. In a period of rising interest rates, the more
rate sensitive customers may shift funds back into time deposits, resulting
in a higher cost of deposits.
Provision for Loan Losses
During 2004, Westfield Bank provided $750,000 for loans losses,
during both 2004 and 2003. The provision for loan losses brings Westfield
Bank's allowance for loan losses to a level determined appropriate by
management based on the methodology discussed under "Allowance for Loan
Losses". The allocation of the provision for loan losses among loan types
and between the specific and formula components of the allowance for loan
losses is also determined based on the methodology discussed under
"Allowance for Loan Losses". The following factors were used to determine
the provision for 2004.
* Loan concentrations - Commercial real estate loans and
commercial and industrial loans increased $22.5 million or
10.4% during 2004 as compared to 2003. Westfield Bank
considers these types of loans to contain more risk than
conventional residential mortgages. These increases resulted
in an increase in the allowance requirements for commercial
real estate and commercial and industrial loans. As Westfield
Bank emphasizes increasing its commercial real estate loans and
commercial and industrial loans, increased allowance
requirements may continue.
54
Residential real estate loans increased $12.7 million to $123.2
million at December 31, 2004. This was the result of Westfield
Bank purchasing $35.0 million of adjustable rate mortgage loans
in 2004. The increases in residential real estate loans and
commercial loans were partially offset by a decrease in
consumer loans of $10.8 million to $11.6 million, resulting in
decreases in the allowance requirements for consumer loans,
respectively. Due to Westfield Bank's discontinuation of its
indirect auto lending, the balance of consumer loans is
expected to continue to decrease. Decreased future allowances
for consumer loans may result.
* Credit quality - Actual loss experience on loans decreased with
charge-offs totaling $404,000 in 2004 as compared to $725,000
in 2003. Net loans charged off as a percent of average loans
outstanding decreased from 0.12% in 2003 to 0.03% in 2004.
Nonperforming loans increased $403,000 from $1.8 million at
December 31, 2003 to $2.2 million at December 31, 2004. This
was primarily due to a single commercial real estate loan
relationship of $1.4 million. The loan is fully collateralized
based on the estimated fair market value of the property. This
was offset primarily by payments in full received on other
nonperforming loans.
As a result of the detailed allowance for loan loss methodology and
consideration of the above factors, management determined that a provision
of $750,000 was appropriate in 2004.
The allowance for loan losses at the end of 2004 was 1.41% of total
loans compared with 1.33% at the end of 2003. The increase in the coverage
ratio reflects the changes in the loan portfolio described above.
Noninterest Income
Noninterest income increased $822,000 to $3.9 million in 2004 from
$3.1 million for 2003. Fees received from the third party mortgage company
were $100,000 for the year ended December 31, 2004 as compared to $340,000
for the same period in 2003. Higher interest rates resulted in fewer
referrals to the third party mortgage company. Fee income from the third
party mortgage company in the future may be affected by borrower activity,
which generally decreases in a rising interest rate environment.
Checking account processing fees increased $617,000 for the year
ended December 31, 2004 as compared to the same period in 2003. This was a
result of new products and services provided by Westfield Bank to its
checking account customers commencing in the third quarter of 2004.
Net gains from sales and writedowns of securities were $877,000 for
the year ended December 31, 2004 as compared to $409,000 for the same
period in 2003. This is primarily the result of the company selling its
common stock portfolio in 2004 to comply with Office of Thrift Supervision
regulations. Income on bank owned life insurance was $741,000 for the
period ended December 31, 2004 as compared to $806,000 for the same period
in 2003.
55
Noninterest Expense
Noninterest expense for the twelve months ended December 31, 2004 was
$17.8 million as compared to $17.6 million for the same period in 2003.
The 2003 results included a net charge of $153,000 for tax-related interest
and penalties regarding the Commonwealth of Massachusetts' REIT
legislation. Salaries and benefits increased $1.1 million for the year
ended December 31, 2004 as compared to the same period in 2003. This was
primarily the result of normal increases in salaries and health care costs
along with an increase in stock base benefit plan expenses of $65,000.
Expenses associated with indirect auto loan processing decreased by
$153,000 for the year ended December 31, 2004 as compared to the same
period in 2003. This was a result of discontinuing the indirect auto loan
program.
Advertising and marketing expenses decreased $124,000 for the twelve
months ended December 31, 2004 as compared to the same period in 2003.
This was the result of additional expenses incurred in 2003 to promote the
150th anniversary of Westfield Bank.
Income Taxes
Income taxes decreased $258,000 to $2.6 million in 2004. The
effective tax rate was 28.8% in 2004 compared to 43.6% for 2003. The
effective tax rates for 2004 and 2003 also reflect the utilization of
Westfield Securities Corporation and Elm Street Securities Corporation,
both qualified securities corporations. The effective tax rate for 2003
also includes Elm Street Real Estate Investments, Inc., a wholly-owned
subsidiary of Westfield Bank, as a real estate investment trust.
The 2003 income taxes were affected by Massachusetts legislation
signed on March 5, 2003 amending the corporate tax law affecting the
treatment of dividends received from Real Estate Investment Trusts (REITs).
Dividends from the REIT subsidiary are no longer eligible for a dividends-
received deduction. As a result of the enactment of this legislation, the
Company ceased recording the tax benefits associated with the dividend
received deduction effective for the 2003 tax year.
In addition to the effect on 2003, the legislation was retroactive to
1999. The Company's 2003 results included a charge of $1.45 million
representing the additional state tax liability, including interest,
relating to the deduction for dividends received from the REIT for 2002 and
prior years.
56
Comparison of Financial Condition at December 31, 2003 and December 31,
2002
Consolidated assets decreased $17.8 million, or 2.2%, to $795.2
million at December 31, 2003 from $813.0 million at December 31, 2002.
Securities decreased $12.0 million, or 3.2%, to $363.6 million at December
31, 2003 from $375.6 million at December 31, 2002. Cash and cash
equivalents decreased $10.9 million to $45.7 million at December 31, 2003
from $56.6 million at December 31, 2002.
Net loans during this period decreased by $12.2 million, or 3.4%, to
$345.0 million at December 31, 2003, from $357.2 million at December 31,
2002. Decreases in residential and indirect automobile loans were
partially offset by increases in commercial real estate loans and
commercial and industrial loans.
Residential loans decreased $47.4 million to $110.5 million at
December 31, 2003 from $157.9 million at December 31, 2002. The decrease
is primarily the result of the current residential real estate loan program
with a third party mortgage company. Under this program, which commenced
on September 1, 2001, Westfield Bank refers its residential real estate
borrowers to a third party mortgage company and substantially all of the
Bank's residential real estate loans are underwritten, originated and
serviced by a third party mortgage company. The Bank receives a fee of 65
basis points for each of these loans originated. The Bank believes that
this program will diversify its loan portfolio and reduce interest risk.
The Bank may purchase residential real estate loans from the third party
mortgage company depending on market conditions. To date, the Bank has not
purchased a significant amount of loans from the third party mortgage
company.
Indirect automobile loans decreased $17.8 million, or 52.7% to $16.0
million on December 31, 2003 as compared to $33.8 million on December 31,
2002. Management curtailed its indirect lending beginning in fiscal year
2000 and in the fourth quarter of 2003, the Bank ceased writing loans under
this program.
Commercial real estate loans increased $30.4 million or 30.1% to
$131.3 million at December 31, 2003 from $100.9 million at December 31,
2002. Commercial and industrial loans increased $23.8 million or 38.7% to
$85.3 million at December 31, 2003 from $61.5 million at December 31, 2002.
The Bank's strategic plan calls for emphasis on commercial lending. The
success of the plan to grow commercial loans is primarily dependent upon
the improvement of the local and national economy.
During the twelve month period ended December 31, 2003, the Bank
invested $16.5 million in bank owned life insurance ("BOLI"). The Bank
purchased BOLI as a means to offset employee benefit costs. A substantial
number of employees are covered by BOLI policies.
57
Total deposits decreased $23.7 million, or 3.6%, to $632.4 million at
December 31, 2003 from $656.1 million at December 31, 2002. Noninterest-
bearing accounts decreased $116,000 to $54.6 million at December 31, 2003
from $54.7 million at December 31, 2002. This decrease was primarily the
result of a $2.7 million decrease in internal checking accounts to $3.4
million at December 31, 2003. The amount reported in internal checking
accounts represents checks outstanding that were issued by the Bank for
accounts payable purposes, loan proceeds, and official checks and money
orders purchased by Bank customers. The decrease in internal checking was
partially offset by an increase in customer demand deposits of $2.6
million, or 5.3%, to $51.2 million at December 31, 2003 from $48.6 million
at December 31, 2002.
NOW, regular savings, and money market accounts increased $17.3
million, or 7.6%, to $243.6 million at December 31, 2003 from $226.3
million at December 31, 2002. Time deposits decreased by $40.8 million, or
10.9% to $334.2 million at December 31, 2003 from $375.0 million at
December 31, 2002. The Bank's strategic plan calls for a lesser reliance
on time deposits accounts. This was facilitated by the low interest rate
environment of 2003, which gave little incentive for customers to lock up
funds in time deposits.
Customer repurchase agreements increased $3.4 million, or 39.1%, to
$12.1 million at December 31, 2003 from $8.7 million at December 31, 2002.
A customer repurchase agreement is an agreement by Westfield Bank to sell
to and repurchase from the customer an interest in specific securities
issued by or guaranteed by the United States Government. This transaction
settles immediately on a same day basis in immediately available funds.
Interest paid is commensurate with other products of equal interest and
credit risk. Substantially all the customer repurchase agreements are held
by the Bank's commercial loan customers. Federal Home Loan Bank ("FHLB")
borrowings increased $5.0 million from $15.0 million at December 31, 2002
to $20.0 million at December 31, 2003 to take advantage of the low interest
rate environment.
Stockholders' equity at December 31, 2003 and December 31, 2002 was
$124.8 million and $126.7 million, respectively. The change is comprised
of net income of $3.7 million for the year ended December 31, 2003, a
decrease in net unrealized gains on securities available for sale of
$430,000, net of income taxes, the net repurchase of 57,700 shares of
common stock for $1.1 million, the purchase of shares of common stock for
the management recognition and retention plan for $2.3 million and the
declaration by the Board of Directors of quarterly $0.05 per share cash
dividends aggregating $2.1 million.
Comparison of Operating Results for Years Ended December 31, 2003 and 2002
General
The Company reported net income of $3.7 million or $0.36 per diluted
share for the year ended December 31, 2003 compared to net income of $4.0
million or $0.38 per diluted share for the same period in 2002. Interest
and dividend income decreased by $7.4 million and interest expense
decreased by $4.9 million resulting in a decrease in net interest income of
$2.5 million. This was offset by an increase in noninterest income of $3.4
million.
58
The Company entered into an agreement with the Massachusetts
Department of Revenue to settle the issue related to taxes owed on
dividends received from the Bank's REIT subsidiary in 2002 and prior tax
years. Under the agreement, the Company paid 50% of the amount including
interest that would have been owed under legislation that was enacted in
March 2003. The legislation was retroactive to 2002 and prior years. The
payment is a deductible expense for federal tax purposes. This resulted in
a charge of approximately $1.45 million for state taxes, interest, and
penalties, net of federal tax benefit. Total income taxes were $2.8
million for the year ended December 31, 2003 as compared to $2.2 million
for the same period in 2002.
Interest and Dividend Income
Total interest and dividend income decreased $7.4 million, or 17.2%,
to $35.6 million for the year ended December 31, 2003 compared to $43.0
million for the same period in 2002. Interest and dividends on securities
decreased $1.2 million to $12.4 million, while interest income on loans
decreased $5.8 million to $22.3 million.
The decrease in interest and dividend income on securities was the
result of a decrease of 92 basis points in the average yield on securities
from 4.31% for the year 2002 to 3.39% for the same period in 2003. This
change was partially offset by a $51.7 million increase in the average
balance of securities from $337.6 million for 2002 to $389.3 million for
2003. Market interest rates have declined significantly since January 1,
2001. For example, the prime rate of interest decreased 550 basis points
from January of 2001 through December 31, 2003. As higher yielding
investments purchased in a higher rate environment have matured, been
called, or paid down in 2003, the funds were reinvested at lower rates. In
addition, the interest rate on adjustable rate securities repriced downward
in the declining interest rate environment.
The decrease in interest income on loans was primarily the result of
a $4.3 million decrease in interest on residential real estate loans. The
average balance of residential real estate loans decreased from $186.2
million for the year ended December 31, 2002 to $131.4 million for the year
ended December 31, 2003 due to our residential real estate loan program
with a third party mortgage company. However, Westfield Bank earned
$340,000 in fee income on the origination of these loans which is included
in noninterest income in 2003. In addition, as a result of the low
interest rate environment of 2003, the Bank experienced high levels of
payoffs of existing mortgages due to refinancing activity. Moreover,
interest on consumer loans decreased $1.7 million. This was primarily the
result of a decrease in average balance of consumer loans from $49.6
million for 2002 to $31.2 million for 2003 due to management's decision to
curtail indirect automobile loan originations.
Interest income from commercial real estate loans and commercial and
industrial loans increased $167,000 for the year ended December 31, 2003
from the year ended December 31, 2002. In accordance with Westfield Bank's
strategic plan, the average balance of commercial real estate loans and
commercial industrial loans increased $28.8 million to $191.5 million for
the year ended December 31, 2003 as compared to $162.7 million for the same
period in 2002. This change was offset by a decrease in the average yield
on these loans due to the significant
59
decline in market interest rates since December 31, 2000. Loans originated
in the current low interest rate environment have typically been at lower
rates than in previous years. In addition, some adjustable rate loans
repriced downward. This resulted in a lower yield for the commercial real
estate loan and commercial and industrial loan portfolios.
Interest Expense
Interest expense for the year ended December 31, 2003 decreased $4.9
million to $13.9 million from the comparable 2002 period. This was
attributable to a decrease in the average cost of interest-bearing
liabilities of 88 basis points to 2.21% for the year ended December 31,
2003 from 3.09% for the same period in 2002. This decrease was partially
offset by an increase of $19.5 million in the average balance of total
interest-bearing liabilities. The decrease in average cost of interest-
bearing liabilities was the result of the declining rate environment
discussed previously and Westfield Bank's emphasis on core deposits over
time deposits.
Net Interest and Dividend Income
Net interest and dividend income for the year ended December 31, 2003
decreased $2.5 million, or 10.3%, to $21.8 million in 2003 from $24.2
million in 2002. The net interest rate spread, the difference between the
average yield on average interest-earning assets and the average cost of
average total interest-bearing liabilities, decreased 7 basis points to
2.47% for 2003 from 2.54% for 2002. The net interest margin, which is net
interest and dividend income divided by average total interest earning
assets, decreased 32 basis points to 2.86% for 2003 from 3.18% for the
comparable prior year period. As discussed above, the decreases in net
interest and dividend income due to lower interest rates were partially
offset by the increase in the balance of interest-earning assets.
Provision for Loan Losses
During 2003, Westfield Bank provided $750,000 for loans losses,
compared to $934,000 for 2002. The provision for loan losses brings
Westfield Bank's allowance for loan losses to a level determined
appropriate by management based on the methodology discussed under
"Allowance for Loan Losses". The allocation of the provision for loan
losses among loan types and between the specific and formula components of
the allowance for loan losses is also determined based on the methodology
discussed under "Allowance for Loan Losses".
* Loan concentrations - Commercial real estate loans and
commercial and industrial loans increased $54.2 million or
33.4%. Westfield Bank considers these types of loans to
contain more risk than conventional residential mortgages.
These increases resulted in an increase in the allowance
requirements for commercial real estate and commercial and
industrial loans. As Westfield Bank emphasizes increasing its
commercial real estate loans and commercial and industrial
loans, increased allowance requirements may continue.
60
These increases were offset by a decrease in residential real
estate loans of $47.4 million to $110.5 million and a decrease
in consumer loans of $18.8 million to $22.3 million, resulting
in decreases in the allowance requirements for residential real
estate loans and consumer loans, respectively. Due to
Westfield Bank's residential real estate loan program with a
third party mortgage company and the discontinuation of its
indirect auto lending, the balance of residential mortgages and
consumer loans is expected to continue to decrease. Decreased
future allowances for these loans may result.
* Credit quality - Actual loss experience on loans decreased with
charge-offs totaling $725,000 in 2003 as compared to $928,000
in 2002. Net loans charged off as a percent of average loans
outstanding decreased from 0.13% in 2002 to 0.12% in 2003.
Non-accrual loans decreased $615,000 from $2.4 million at
December 31, 2002 to $1.8 million at December 31, 2003.
As a result of the detailed allowance for loan loss methodology and
consideration of the above factors, the provision for loan losses decreased
by $184,000 in 2003 as compared to 2002.
The allowance for loan losses at the end of 2003 was 1.33% of total
loans compared with 1.20% at the end of 2002. The increase in the coverage
ratio reflects the changes in the loan portfolio described above.
Noninterest Income
Noninterest income increased $3.4 million to $3.1 million in 2003
from ($362,000) for 2002. Included in noninterest income in the year 2002
were writedowns of certain equity securities of $2.5 million. Income on
bank owned life insurance ("BOLI") was $806,000 for the year ended December
31, 2003, compared to none for the same period in 2002. In addition, fees
received from our residential real estate loan program with a third party
mortgage company were $340,000 for the year ended December 31, 2003
compared with $196,000 for the same period in 2002. It is anticipated
that these fees will decrease as refinancing of residential loans
decreases, particularly if interest rates increase in future periods.
Noninterest Expense
Noninterest expense for the year ended December 31, 2003 was $17.6
million compared to $16.7 million for the same period in 2002. Employee
salary and benefits for the year ended December 31, 2003 were $9.7 million
compared to $8.9 million in 2002. The increase was the result of normal
salary increases, along with an increase in employee benefit expense of
$688,000 for the year ended December 31, 2003, primarily as a result of
increased expenses for the management recognition and retention plan and
supplemental employee retirement plan.
61
Income Taxes
Income taxes increased $581,000, or 26.0%, to $2.8 million in 2003.
The effective tax rate was 43.6% in 2003 compared to 35.6% for 2002. The
effective tax rate also reflects the utilization of Westfield Securities
Corporation and Elm Street Securities Corporation, both qualified
securities corporations, and Elm Street Real Estate Investments, Inc., a
wholly-owned subsidiary of Westfield Bank, as a real estate investment
trust.
Massachusetts legislation was signed on March 5, 2003 amending the
corporate tax law affecting the treatment of dividends received from Real
Estate Investment Trusts (REITs). Dividends from the REIT subsidiary are
no longer eligible for a dividends-received deduction. As a result of the
enactment of this legislation, the Company has ceased recording the tax
benefits associated with the dividend received deduction effective for the
2003 tax year.
In addition to the effect on 2003, the legislation is retroactive to
1999. The Company's 2003 results included a charge of $1.45 million
representing the additional state tax liability, including interest,
relating to the deduction for dividends received from the REIT for 2002 and
prior years.
Liquidity and Capital Resources
The term "liquidity" refers to our ability to generate adequate
amounts of cash to fund loan originations, loan purchases, deposit
withdrawals and operating expenses. Our primary sources of liquidity are
deposits, scheduled amortization and prepayments of loan principal and
mortgage-backed securities, maturities and calls of investment securities
and funds provided by our operations. Westfield Bank also can borrow funds
from the Federal Home Loan Bank based on eligible collateral of loans and
securities. Outstanding borrowings from the Federal Home Loan Bank at
December 31, 2004 and 2003 were $45.0 million and $20.0 million,
respectively. At December 31, 2004, Westfield Bank's maximum borrowing
capacity from the Federal Home Loan Bank was approximately $65.6 million,
net of any outstanding borrowings. In addition, we may enter into reverse
repurchase agreements with approved broker-dealers. Reverse repurchase
agreements are agreements that allow us to borrow money using our
securities as collateral.
Westfield Bank also has outstanding, at any time, a significant
number of commitments to extend credit and provide financial guarantees to
third parties. These arrangements are subject to strict credit control
assessments. Guarantees specify limits to Westfield Bank's obligations.
Because many commitments and almost all guarantees expire without being
funded in whole or in part, the contract amounts are not estimates of
future cash flows. Westfield Bank is also obligated under agreements with
the Federal Home Loan Bank to repay borrowed funds and is obligated under
leases for certain of its branches and equipment. A summary of lease
obligations, borrowings, and credit commitments at December 31, 2004
follows:
62
After 1 Year After 3 Years
Within but Within but Within After
1 Year 3 Years 5 Years 5 Years Total
------ ------------ ------------- ------- -----
(In thousands)
Lease Obligations
Operating lease obligations $ 199 $ 297 $ 150 $ 41 $ 687
======= ======= ======= ======== =======
Borrowings
Federal Home Loan Bank $ 5,000 $30,000 $10,000 $ - $ 45,000
======= ======= ======= ======== =======
Credit Commitments
Available lines of credit $46,599 $ - $ - $12,845 $ 59,444
Other loan commitments 34,767 - - 709 35,476
Letters of Credits 4,293 - - 1,004 5,297
------- ------- ------- ------- --------
Total $85,659 $ - $ - $14,558 $100,217
======= ======= ======= ======== =======
Maturing investment securities are a relatively predictable source of
funds. However, deposit flows, calls of securities and prepayments of
loans and mortgage-backed securities are strongly influenced by interest
rates, general and local economic conditions and competition in the
marketplace. These factors reduce the predictability of the timing of
these sources of funds.
Our primary investing activities are the origination of commercial
real estate, commercial and industrial and consumer loans, and the purchase
of mortgage-backed and other investment securities. During the year ended
December 31, 2004, Westfield Bank originated loans of approximately $96.9
million, and during the comparable period of 2003, Westfield Bank
originated loans of approximately $148.8 million. Under Westfield Bank's
residential real estate loan program, Westfield Bank refers its residential
real estate borrowers to a third party mortgage company and substantially
all of Westfield Bank's residential real estate loans are underwritten,
originated and serviced by a third party mortgage company. Purchases of
securities totaled $104.2 million for the year ended December 31, 2004 and
$252.9 million for the year ended December 31, 2003. At December 31, 2004,
Westfield Bank had loan commitments to borrowers of approximately $40.8
million, and available home equity and unadvanced lines of credit of
approximately $59.4 million.
Deposit flows are affected by the level of interest rates, by the
interest rates and products offered by competitors and by other factors.
Total deposits decreased $19.8 million during the year ended December 31,
2004 and decreased $23.7 million during the year ended December 31, 2003.
Time deposit accounts scheduled to mature within one year were $184.5
million at December 31, 2004. Based on Westfield Bank's deposit retention
experience and current pricing strategy, it anticipates that a significant
portion of these certificates of deposit will remain on deposit. Westfield
Bank monitors its liquidity position frequently and anticipates that it
will have sufficient funds to meet its current funding commitments.
63
At December 31, 2004, Westfield Bank exceeded each of the applicable
regulatory capital requirements. Westfield Bank's tier 1 leverage capital
was $118.0 million, or 14.7% to average assets. Westfield Bank's tier 1
capital to risk weighted assets was $118.0 million or 25.8%. Westfield Bank
had total capital to risk weighted assets of $123.2 or 26.9%.
We do not anticipate any material capital expenditures during
calendar year 2005, nor do we have any balloon or other payments due on any
long-term obligations or any off-balance sheet items other than the
commitments and unused lines of credit noted above.
Off-Balance Sheet Arrangement
We do not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that is
material to investors.
Management of Market Risk
As a financial institution, our primary market risk is interest rate
risk since substantially all transactions are denominated in U.S. dollars
with no direct foreign exchange or changes in commodity price exposure.
Fluctuations in interest rates will affect both our level of income and
expense on a large portion of our assets and liabilities. Fluctuations in
interest rates will also affect the market value of all interest-earning
assets.
The primary goal of our interest rate management strategy is to limit
fluctuations in net interest income as interest rates vary up or down and
control variations in the market value of assets, liabilities and net worth
as interest rates vary. We seek to coordinate asset and liability decisions
so that, under changing interest rate scenarios, net interest income will
remain within an acceptable range.
To achieve the objectives of managing interest rate risk, Westfield
Bank's Asset and Liability Management Committee meets monthly to discuss
and monitor the market interest rate environment relative to interest rates
that are offered on its products. The Asset and Liability Management
Committee presents periodic reports to the Board of Directors of Westfield
Bank and Westfield Financial, Inc. at their regular meetings.
In recent years, Westfield Bank's lending activities have emphasized
commercial real estate and commercial and industrial loans. Commercial
real estate loans have grown $43.4 million or 43.0% since December 31,
2002. Commercial and industrial loans have grown $33.2 million or 54.0%
since December 31, 2002. Consumer loans decreased $29.5 million, or 71.8%,
since December 31, 2002. Management curtailed its indirect lending
beginning in fiscal year 2000 and in the fourth quarter of 2003 the program
was discontinued. We believe that Westfield Bank's increased emphasis on
commercial lending will allow it to diversify its loan portfolio while
continuing to meet the needs of the businesses and individuals that it
serves.
64
Westfield Bank's primary source of funds has been deposits,
consisting primarily of time deposits, money market accounts, savings
accounts, demand accounts and NOW accounts, which have shorter terms to
maturity than the loan portfolio. Several strategies have been employed to
manage the interest rate risk inherent in the asset/liability mix,
including but not limited to:
* maintaining the diversity of our existing loan portfolio
through the origination of commercial loans and commercial real
estate loans which typically have variable rates and shorter
terms than residential mortgages; and
* emphasizing investments with an expected average duration of
five years or less.
In addition, emphasis on commercial loans has reduced the average
maturity of Westfield Bank's loan portfolio. Moreover, the actual amount
of time before loans are repaid can be significantly affected by changes in
market interest rates. Prepayment rates will also vary due to a number of
other factors, including the regional economy in the area where the loans
were originated, seasonal factors, demographic variables and the
assumability of the loans. However, the major factors affecting prepayment
rates are prevailing interest rates, related financing opportunities and
competition. We monitor interest rate sensitivity so that we can adjust
our asset and liability mix in a timely manner and minimize the negative
effects of changing rates.
Each of Westfield Bank's sources of liquidity is vulnerable to
various uncertainties beyond the control of Westfield Bank. Scheduled loan
and security payments are a relatively stable source of funds, while loan
and security prepayments and calls, and deposit flows vary widely in
reaction to market conditions, primarily prevailing interest rates. Asset
sales are influenced by pledging activities, general market interest rates
and unforeseen market conditions. Westfield Bank's financial condition is
affected by its ability to borrow at attractive rates, retain deposits at
market rates and other market conditions. Management considers Westfield
Bank's sources of liquidity to be adequate to meet expected funding needs
and also to be responsive to changing interest rate markets.
Net Interest and Dividend Income Simulation. We use a simulation
model to monitor interest rate risk. This model reports the net interest
income at risk primarily under seven different interest rate environments.
Specifically, net interest income is measured in one scenario that assumes
no change in interest rates, and six scenarios where interest rates
increase 100, 200, 300, and 400 basis points, and decrease 100 and 200
basis points, respectively, from current rates over the one year time
period following the current consolidated financial statements.
The changes in interest income and interest expense due to changes in
interest rates reflect the rate sensitivity of our interest earning assets
and interest bearing liabilities. For example, in a rising interest rate
environment, the interest income from an adjustable rate loan is likely to
increase depending on its repricing characteristics while the interest
income from a fixed rate loan would not increase until the funds were
repaid and loaned out at a higher interest rate.
65
The tables below set forth as of December 31, 2004 the estimated
changes in net interest and dividend income that would result from
incremental changes in interest rates over the applicable twelve-month
period.
For the Twelve Months Ending December 31, 2005
(Dollars in thousands)
----------------------------------------------
Changes in Net Interest
Interest Rates and Dividend
(Basis Points) Income % Change
-------------- ------------ --------
400 25,565 -0.8%
300 25,502 -1.1%
200 25,613 -0.6%
100 25,728 -0.2%
0 25,780 0.0%
-100 26,409 2.4%
-200 24,408 -5.3%
Market rates were assumed to increase 100, 200, 300 and 400 basis
points and decrease 100 and 200 basis points, in even increments over the
twelve month period. The repricing and/or new rates of assets and
liabilities moved in tandem with market rates. However, in certain deposit
products, the use of data from a historical analysis indicated that the
rates on these products would move only a fraction of the rate change
amount.
Management believes that a percentage of the growth in core deposits
over the last three years was due to the low rate environment, i.e. no
incentive for customers to lock up funds in time deposits. Management
believes that in a rising rate environment, Westfield Bank will experience
a shift, by some customers, out of core deposits and back into term
deposits. Based upon analysis, Management has estimated what is believed
to be the rate sensitive portion of the funds currently in core deposits.
In scenarios that assume a rising rate environment of 200 basis points or
more, this shift is incorporated into the balance sheet forecasts.
We have developed consolidated balance sheet growth projections for
the twelve month period. The same product mix and growth strategy was used
for all rate change simulations, except for the shift into term deposits in
certain scenarios as described in the previous paragraph. Income from tax-
exempt assets is calculated on a fully taxable equivalent basis.
Pertinent data from each loan account, deposit account and investment
security was used to calculate future cash flows. The data included such
items as maturity date, payment amount, next repricing date, repricing
frequency, repricing index and spread. Prepayment speed assumptions were
based upon the difference between the account rate and the current market
rate.
66
Another circumstance that affects the results is that interest rates
on some deposit products as of December 31, 2004 were near historical lows.
In the three declining rate scenarios, Westfield Bank forecasted that its
rates on some deposit products would not fall as sharply as market rates.
For example, because the rate on regular savings accounts is 0.50%, it is
not possible for the rate to decrease by 100 basis points or more.
Recent Accounting Pronouncements
In March 2004, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 105, "Application of Accounting
Principles to Loan Commitments," which provides guidance regarding loan
commitments that are accounted for as derivative instruments. In this SAB,
the SEC determined that an interest rate lock commitment should generally
be valued at zero at inception. The rate locks will continue to be
adjusted for changes in value resulting from changes in market interest
rates. This SAB did not have any effect on the Company's financial
position or results of operations.
In December 2004, the Financial Accounting Standards Board ("FASB")
published FASB Statement No. 123 (revised 2004), "Share-Based Payment"
("FAS 123(R))" or the "Statement"). FAS 123(R) requires that the
compensation cost relating to share-based payment transactions, including
grants of employee stock options, be recognized in financial statements.
That cost will be measured based on the fair value of the equity or
liability instruments issued. FAS 123(R) covers a wide range of share-based
compensation arrangements including stock options, restricted share plans,
performance-based awards, share appreciation rights, and employee share
purchase plans. FAS 123(R) is a replacement of FASB Statement No. 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No.
25, "Accounting for Stock Issued to Employees," and its related
interpretive guidance.
The effect of the Statement will be to require entities to measure
the cost of employee services received in exchange for stock options based
on the grant-date fair value of the award, and to recognize the cost over
the period the employee is required to provide services for the award. FAS
123(R) permits entities to use any option-pricing model that meets the fair
value objective in the Statement.
The Company will be required to apply FAS 123(R) as of the beginning
of its first interim period that begins after June 15, 2005, which will be
the quarter ending September 30, 2005.
FAS 123(R) allows two methods for determining the effects of the
transition: the modified prospective transition method and the modified
retrospective method of transition. Under the modified prospective
transition method, an entity would use the fair value based accounting
method for all employee awards granted, modified, or settled after the
effective date. As of the effective date, compensation cost related to the
nonvested portion of awards outstanding as of that date would be based on
the grant-date fair value of those awards as calculated under the original
provisions of Statement No. 123; that is, an entity would not remeasure the
grant-date fair value estimate of the unvested portion of awards granted
prior to the effective date of FAS 123(R). An entity will have the further
option to either apply the Statement to only the quarters in the period of
adoption and subsequent periods, or apply the
67
Statement to all quarters in the fiscal year of adoption. Under the
modified retrospective method of transition, an entity would revise its
previously issued financial statements to recognize employee compensation
cost for prior periods presented in accordance with the original provisions
of Statement No. 123.
The Company has not yet completed its study of the transition methods
or made any decisions about how it will adopt FAS 123(R).
The changes in accounting will replace existing requirements under
SFAS No. 123, "Accounting for Stock-Based Compensation," and will eliminate
the ability to account for share-based compensation transactions using APB
Opinion No. 25, "Accounting for Stock Issued to Employees," which does not
require companies to expense options if the exercise price is equal to the
trading price at the date of grant. The accounting for similar
transactions involving parties other than employees or the accounting for
employee stock ownership plans that are subject to American Institute of
Certified Public Accountants ("AICPA") Statement of Position 93-6,
"Employers' Accounting for Employee Stock Ownership Plans," would remain
unchanged.
On September 30, 2004, the FASB issued FASB Staff Position ("FSP")
Emerging Issues Task Force ("EITF") Issue No. 03-1-1 delaying the effective
date of paragraphs 10-20 of EITF 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments", which provides
guidance for determining the meaning of "other-than-temporarily impaired"
and its application to certain debt and equity securities within the scope
of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", and investments accounted for under the cost method. The
guidance requires that investments which have declined in value due to
credit concerns or solely due to changes in interest rates must be recorded
as other-than-temporarily impaired unless the Company can assert and
demonstrate its intention to hold the security for a period of time
sufficient to allow for a recovery of fair value up to or beyond the cost
of the investment which might mean maturity. The delay of the effective
date of EITF 03-1 will be superceded concurrent with the final issuance of
proposed FSP Issue 03-1-a. Proposed FSP Issue 03-1-a is intended to
provide implementation guidance with respect to all securities analyzed for
impairment under paragraphs 10-20 of EITF 03-1. Management continues to
closely monitor and evaluate how the provisions of EITF 03-1 and proposed
FSP Issue 03-1-a will affect the Company.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and accompanying Notes of
Westfield Financial have been prepared in accordance with Accounting
Principles Generally Accepted in the United States of America ("GAAP").
GAAP generally requires the measurement of financial position and operating
results in terms of historical dollars without consideration for changes in
the relative purchasing power of money over time due to inflation. The
impact of inflation is reflected in the increased cost of our operations.
Unlike industrial companies, our assets and liabilities are primarily
monetary in nature. As a result, changes in market interest rates have a
greater impact on performance than do the effects of inflation.
68
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, Management of Market Risk, pages 64 -
67, for a discussion of Quantitative and Qualitative Disclosures About
Market Risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of Westfield Financial are
submitted on pages F-1 through F-40 of this report.
All schedules are omitted because they are not required or
applicable, or the required information is shown in the consolidated
financial statements or notes thereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Effective June 15, 2004, the Audit Committee of the Board of
Directors voted not to reengage Deloitte & Touche LLP as Westfield
Financial's Independent Registered Public Accounting Firm, effective
immediately. On the same date, the Audit Committee of the Board of
Directors recommended, approved and appointed Wolf & Company, P.C. as the
Westfield Financial's Independent Registered Public Accounting Firm for the
purpose of auditing Westfield Financial's consolidated financial statements
for the year ended December 31, 2004. Wolf & Company, P.C. will continue
to serve for the year ended December 31, 2005. A representative of Wolf &
Company, P.C. is expected to be present at the annual meeting to answer
questions concerning the consolidated financial statements presented and
will be permitted to make a statement at the meeting.
The audit reports of Deloitte & Touche LLP on the consolidated
financial statements of the Registrant as of and for the years ended
December 31, 2003 and 2002 did not contain an adverse opinion or disclaimer
of opinion and was not qualified or modified as to uncertainty, audit
scope, or accounting principles. During 2003 and 2002 and any subsequent
interim periods through June 15, 2004, there were no disagreements with
Deloitte & Touche LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedures, which
disagreements, if not resolved to Deloitte & Touche's satisfaction, would
have caused it to make reference in connection with its report to the
subject matter of the disagreement. We requested Deloitte & Touche LLP to
furnish a letter addressed to the Securities and Exchange Commission
stating whether it agrees with these statements made by us and, if not,
stating the respects in which it does not agree. A copy of this letter,
dated March 31, 2004, was attached as an exhibit to the Form 8-K filed with
the Securities and Exchange Commission on June 21, 2004 and is hereby
incorporated by reference.
69
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including Westfield Financial's President and Chief
Executive Officer and Chief Financial Officer and Treasurer, has evaluated
the effectiveness of Westfield Financial's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of
the end of the period covered by this report. Based upon that evaluation,
Westfield Financial's President and Chief Executive Officer and Chief
Financial Officer and Treasurer concluded that the disclosure controls and
procedures were effective, in all material respects, to ensure that
information required to be disclosed in the reports Westfield Financial
files and submits under the Exchange Act is recorded, processed, summarized
and reported as and when required.
There have been no changes in Westfield Financial's internal control
over financial reporting identified in connection with the evaluation that
occurred during Westfield Financial's last fiscal quarter that has
materially affected, or that is reasonably likely to materially affect,
Westfield Financial's internal control over financial reporting.
Management Report on Internal Control Over Financial Reporting
The management of Westfield Financial, Inc. is responsible for
establishing and maintaining adequate internal control over financial
reporting. Westfield Financial Inc.'s internal control system is a process
designed to provide reasonable assurance to the company's management and
board of directors regarding the preparation and fair presentation of
published financial statements.
Our internal control over financial reporting includes policies and
procedures that pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect transactions and dispositions of
assets; provide reasonable assurances that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
accounting principles generally accepted in the United States of America,
and that receipts and expenditures are being made only in accordance with
authorizations of management and the directors of Westfield Financial Inc.;
and provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of Westfield Financial
Inc.'s assets that could have a material effect on our financial
statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may
deteriorate.
70
Westfield Financial, Inc.'s management assessed the effectiveness of
the company's internal control over financial reporting as of December 31,
2004. In making this assessment, we used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control-Integrated Framework. Based on our assessment we believe
that, as of December 31, 2004, the company's internal control over
financial reporting is effective based on those criteria.
Westfield Financial Inc.'s Independent Registered Public Accounting
Firm has issued an audit report on our assessment of, and the effective
operation of, the company's internal control over financial reporting as of
December 31, 2004. This report appears on pages F-39 and F-40.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included in the Company's Proxy Statement
for the 2005 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference: "Election of Directors," Nominees for
Election as Director," "Continuing Directors", "Executive Officers," and
"Section 16(a) Beneficial Ownership Reporting Compliance.
Code of Ethics
Westfield Financial has adopted a Conflict of Interest Policy and
Code of Conduct, which applies to all employees and officers of Westfield
Financial and Westfield Bank. Westfield Financial has also adopted a Code
of Ethics for Senior Financial Officers of Westfield Financial, Inc., which
applies to Westfield Financial's principal executive officer, principal
financial officer, principal accounting officer or controller or person
performing similar functions for Westfield Financial and Westfield Bank,
and which requires compliance with the Conflict of Interest Policy and Code
of Conduct. The Code of Ethics for Senior Financial Officers of Westfield
Financial meets the requirements of a "code of ethics" as defined by Item
406 of Regulation S-K. The Code of Ethics for Senior Financial Officers
was filed as exhibit 14.1 to the Form 10-K filed with the SEC on March 15,
2003 and is hereby incorporated by reference. There have been no
amendments to the Code of Ethics since that time.
71
ITEM 11. EXECUTIVE COMPENSATION
The following information included in the Proxy Statement is
incorporated herein by reference: "Management Salary Compensation
Committee Report on Executive Compensation," "Compensation Committee
Interlocks and Insider Participation," "Performance Graph," "Directors'
Compensation," "Executive Compensation," "Employment Agreements," and
"Benefits."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included in the Proxy Statement is
incorporated herein by reference: "Security Ownership of Certain
Beneficial Owners and Management-Principal Shareholders of "Westfield
Financial", and "Security Ownership of Management."
Number of securities
Number of securities remaining available for
To be issued Weighted-average future issuance under
Upon exercise of exercise price of equity compensation plans
Outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
- -------------- -------------------- -------------------- -------------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders 445,200 $14.45 169,544
Equity compensation
plans not approved by
security holders - - -
------- ------ -------
Total 445,200 $14.45 169,544(1)
======= ====== =======
- --------------------
Reflects 46,760 shares reserved for future grant under the Westfield
Financial, Inc. 2002 Stock Option Plan, 114,680 shares subject to
current restricted stock awards under the Westfield Financial, Inc.
2002 Recognition and Retention Plan ("RRP") and 8,104 shares reserved
for future awards under the RRP.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included in the Proxy Statement is
incorporated herein by reference: "Compensation of Directors and Executive
Officers - Transactions with Certain Related Persons."
72
ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES
Information regarding the aggregate fees billed for each of the last
two fiscal years by Westfield Financial's principal accountants, Wolf &
Company, P.C. in 2004 and Deloitte & Touche LLP in 2003, is included under
the heading "Principal Accountants Fees and Services" in Westfield
Financial's Proxy Statement for its Annual Meeting of Shareholders to be
held on May 20, 2005, which will be filed with the SEC on or about April
15, 2005 and is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Listed below are all financial statements and exhibits filed as part
of this report:
a. Financial Statements, Schedules, and Exhibits
(1) Reference is made to the Consolidated Financial Statements
included in Item 8 of Part II hereof.
(2) Schedules omitted as they are not applicable.
(3) See Exhibit Index.
Exhibit Description
2.1 Plan of Reorganization and Minority Stock Issuance of
Westfield Mutual Holding Company, as amended. *
3.1 Articles of Organization of Westfield Financial, Inc.*
3.2 Bylaws of Westfield Financial, Inc. *
3.3 Amended and Restated Charter of Westfield Mutual Holding
Company*
3.4 Amended and Restated Bylaws of Westfield Mutual Holding
Company*
4.1 Articles of Organization of Westfield Financial, Inc. (See
Exhibit 3.1)*
4.2 Bylaws of Westfield Financial, Inc. (See Exhibit 3.2)*
4.3 Form of Stock Certificate of Westfield Financial, Inc.*
10.1 Form of Employee Stock Ownership Plan of Westfield
Financial, Inc.*
10.2 Form of the Benefit Restoration Plan of Westfield
Financial, Inc.*
10.3 Form of Employment Agreement between Donald A. Williams
and Westfield Financial, Inc.*
10.4 Form of Employment Agreement between Victor J. Carra and
Westfield Financial, Inc.*
10.5 Form of Employment Agreement between Michael J. Janosco,
Jr. and Westfield Financial, Inc.*
10.6 Form of One Year Change in Control Agreement by and among
certain officers and Westfield Financial, Inc. and
Westfield Bank*
10.7 Form of Directors' Deferred Compensation Plan*
10.8 The SBERA 401(k) Plan adopted by Westfield Bank**
10.9 Amendments to the Employee Stock Ownership Plan of
Westfield Financial, Inc.***
14.1 Code of Ethics
16.1 Letter regarding change on certifying accountants****
21.1 Subsidiaries of the Registrant*
23.1 Consent of Wolf & Company, PC
23.2 Consent of Deloitte & Touche LLP
31.1 Rule 13a - 14(a)/15d - 14(a) Certifications
32.1 Section 1350 Certifications
73
* Incorporated herein by reference to the Registration Statement No.
333-68550, on Form S-1 of Westfield Financial filed with the SEC on
August 28, 2001, as amended.
** Incorporated herein by reference to the Registration Statement No.
333-73132, on Form S-8, filed with the SEC on November 9, 2001, as
amended.
*** Incorporated by reference to the Annual Report on Form 10K for the
year ended December 31, 2002 as filed with the SEC on March 31, 2003.
**** Incorporated by reference to the Form 8-K filed with the SEC on June
21, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized, on
March 15, 2005.
Westfield Financial, Inc.
By: /s/ Donald A. Williams
--------------------------------
Donald A. Williams
President and Chief Executive
Officer
74
Pursuant to the requirements of the Securities Act of 1933, as
amended, and any rules and regulations promulgated thereunder, this Annual
Report on Form 10-K, has been signed by the following persons in the
capacities and on the dates indicated.
Name Title Date
/s/ Donald A. Williams President, Chief Executive Officer and Director March 15, 2005
- --------------------------- (Principal Executive Officer)
Donald A. Williams
/s/ Victor J. Carra Executive President and Director March 15, 2005
- ---------------------------
Victor J. Carra
/s/ Michael J. Janosco, Jr. Chief Financial Officer and Treasurer March 15, 2005
- --------------------------- (Principal Accounting Officer)
Michael J. Janosco, Jr.
/s/ David C. Colton, Jr. Director March 15, 2005
- ---------------------------
David C. Colton, Jr.
/s/ Robert T. Crowley, Jr. Director March 15, 2005
- ---------------------------
Robert T. Crowley, Jr.
/s/ Harry C. Lane Director March 15, 2005
- ---------------------------
Harry C. Lane
/s/ William H. McClure Director March 15, 2005
- ---------------------------
William H. McClure
/s/ Mary C. O'Neil Director March 15, 2005
- ---------------------------
Mary C. O'Neil
/s/ Richard C. Placek Director March 15, 2005
- ---------------------------
Richard C. Placek
/s/ Paul R. Pohl Director March 15, 2005
- ---------------------------
Paul R. Pohl
/s/ Charles E. Sullivan Director March 15, 2005
- ---------------------------
Charles E. Sullivan
/s/ Thomas C. Sullivan Director March 15, 2005
- ---------------------------
Thomas C. Sullivan
75
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Westfield Financial, Inc.
We have audited the accompanying consolidated balance sheet of Westfield
Financial, Inc. and subsidiaries as of December 31, 2004, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit. The consolidated financial statements for the year ended December
31, 2003 were audited by other auditors whose report, dated March 1, 2004,
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the 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 audit provides a reasonable basis for our
opinion.
In our opinion, the 2004 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Westfield Financial, Inc. and subsidiaries as of December 31, 2004, and the
results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United
States of America.
We also have audited, in accordance with the standards of the Public
Accounting Oversight Board (United States), the effectiveness of Westfield
Financial, Inc. and subsidiaries' internal control over financial reporting
as of December 31, 2004 based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) and our report dated March 8, 2005 expressed
an unqualified opinion on management's assessment of the effectiveness of
Westfield Financial, Inc.'s internal control over financial reporting and
an unqualified opinion on the effectiveness of Westfield Financial, Inc.'s
internal control over financial reporting.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts
March 8, 2005
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Westfield Financial, Inc.
Westfield, Massachusetts
We have audited the accompanying consolidated balance sheet of Westfield
Financial, Inc. and subsidiaries (the "Company") as of December 31, 2003
and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for each of the two years in the period ended
December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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, such consolidated financial statements present fairly, in
all material respects, the financial position of Westfield Financial, Inc.
and subsidiaries as of December 31, 2003, and the results of their
operations and their cash flows for each of the two years in the period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States of America.
/s/ Deloitte & Touche LLP
Hartford, Connecticut
March 11, 2004
F-2
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
December 31,
----------------------
2004 2003
---- ----
ASSETS
CASH AND DUE FROM BANKS $ 13,961 $ 11,740
FEDERAL FUNDS SOLD 31,964 15,930
INTEREST-BEARING DEPOSITS AND OTHER SHORT TERM INVESTMENTS 5,122 18,004
-------- --------
CASH AND CASH EQUIVALENTS 51,047 45,674
-------- --------
SECURITIES:
Available for Sale - at estimated fair value 14,968 25,806
Held to Maturity - at amortized cost (estimated fair
value of $71,654 in 2004 and $71,003 in 2003) 71,298 69,927
MORTGAGE BACKED SECURITIES:
Available for Sale - at estimated fair value 73,316 76,177
Held to Maturity - at amortized cost (estimated fair
value of $174,051 in 2004 and $191,511 in 2003) 175,302 191,683
FEDERAL HOME LOAN BANK OF BOSTON AND OTHER STOCK 4,237 4,237
LOANS - Net of allowance for loan losses of $5,277 in 2004
and $4,642 in 2003 368,601 344,960
PREMISES AND EQUIPMENT - Net 11,505 11,774
ACCRUED INTEREST AND DIVIDENDS 3,551 3,555
BANK-OWNED LIFE INSURANCE 17,248 16,507
OTHER ASSETS 5,830 4,896
-------- --------
TOTAL ASSETS $796,903 $795,216
======== ========
LIABILITIES AND EQUITY
LIABILITIES:
DEPOSITS:
Noninterest-bearing $ 48,305 $ 54,620
Interest-bearing 564,316 577,811
-------- --------
Total deposits 612,621 632,431
-------- --------
CUSTOMER REPURCHASE AGREEMENTS 14,615 12,135
FEDERAL HOME LOAN BANK OF BOSTON ADVANCES 45,000 20,000
OTHER LIABILITIES 6,616 5,846
-------- --------
TOTAL LIABILITIES 678,852 670,412
-------- --------
COMMITMENTS AND CONTINGENCIES (NOTE 16)
STOCKHOLDERS' EQUITY:
Preferred stock - $.01 par value, 5,000,000 shares authorized,
none outstanding at December 31, 2004 and 2003
Common stock - $.01 par value, 25,000,000 shares authorized,
10,580,000 shares issued, 9,954,512 and 10,522,300 shares
outstanding at December 31, 2004 and December 31, 2003,
respectively 106 106
Additional paid-in capital 47,659 47,143
Unallocated Common Stock of Employee Stock Ownership Plan (5,427) (5,837)
Restricted stock unearned compensation (1,543) (2,094)
Retained earnings 90,399 85,794
Accumulated other comprehensive (loss) income (122) 788
Treasury stock, at cost (625,488 shares at December 31, 2004
and 57,700 at December 31, 2003) (13,021) (1,096)
-------- --------
Total stockholders' equity 118,051 124,804
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $796,903 $795,216
======== ========
See notes to consolidated financial statements.
F-3
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
Years Ended December 31,
---------------------------------
2004 2003 2002
---- ---- ----
INTEREST AND DIVIDEND INCOME:
Residential and commercial real estate loans $14,644 $15,834 $20,166
Securities and mortgage backed securities 12,725 12,359 13,591
Consumer loans 1,212 2,440 4,113
Commercial and industrial loans 5,087 4,002 3,756
Federal funds sold 288 170 416
Marketable equity securities 355 526 603
Interest-bearing deposits and other short term investments 117 304 368
------- ------- -------
Total interest and dividend income 34,428 35,635 43,013
------- ------- -------
INTEREST EXPENSE:
Deposits 9,625 13,122 18,561
Customer repurchase agreements 195 211 213
Other borrowings 1,093 525 1
------- ------- -------
Total interest expense 10,913 13,858 18,775
------- ------- -------
Net interest and dividend income 23,515 21,777 24,238
PROVISION FOR LOAN LOSSES 750 750 934
------- ------- -------
Net interest and dividend income after
Provision for loan losses 22,765 21,027 23,304
------- ------- -------
NONINTEREST INCOME:
Income from bank-owned life insurance 741 806 -
Service charges and fees 2,278 1,859 1,388
Gains on sales and writedowns of securities, net 877 409 (1,750)
------- ------- -------
Total noninterest income 3,896 3,074 (362)
------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits 10,753 9,685 8,906
Occupancy 1,808 1,802 1,799
Computer operations 1,582 1,667 1,534
Stationery, supplies and postage 530 560 511
Other 3,103 3,916 3,909
------- ------- -------
Total noninterest expense 17,776 17,630 16,659
------- ------- -------
INCOME BEFORE INCOME TAXES 8,885 6,471 6,283
INCOME TAXES 2,562 2,820 2,239
------- ------- -------
NET INCOME $ 6,323 $ 3,651 $ 4,044
======= ======= =======
EARNINGS PER COMMON SHARE:
Basic $ 0.65 $ 0.36 $ 0.39
Diluted $ 0.64 $ 0.36 $ 0.38
See notes to consolidated financial statements.
F-4
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
Accumulated
Restricted Other
Stock Compre-
Additional Unallo- Unearned hensive
Common Stock Paid-In cated Compen- Retained (loss) Treasury Stock
Shares Amount Capital ESOP sation Earnings Income Shares Amount Total
------ ------ ---------- ------- ---------- -------- ----------- ------ ------ -----
BALANCE, JANUARY 1, 2002 10,580,000 $106 $47,623 $ - $ - $81,808 $ 1,780 - $ - $131,317
Comprehensive income:
Net income - - - - - 4,044 - - - 4,044
Unrealized losses on
securities arising
during the year, net
of tax benefit of $911 - - - - - - (1,689) - - (1,689)
Reclassification for
losses included in net
income, net of tax
benefit of $623 - - - - - - 1,127 - - 1,127
--------
Comprehensive income - - - - - - - - - 3,482
--------
Activity related to
common stock issued as
Employee incentives - - 2,052 (5,621) (2,731) - - - - (6,300)
Costs associated with
stock conversion - - (212) - - - - - - (212)
Cash dividends declared - - - - - (1,588) - - - (1,588)
---------- ---- ------- ------- ------- ------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2002 10,580,000 106 49,463 (5,621) (2,731) 84,264 1,218 - - 126,699
Comprehensive income:
Net income - - - - - 3,651 - - - 3,651
Unrealized losses on
securities arising
during the year, net
of tax benefit of $92 - - - - - - (167) - - (167)
Reclassification for
gains included in net
income, net of taxes
of $146 - - - - - - (263) - - (263)
--------
Comprehensive income - - - - - - - - - 3,221
--------
Activity related to
common stock issued
as employee incentives - - (2,320) (216) 637 - - - - (1,899)
Treasury stock purchased - - - - - - - (59,700) (1,134) (1,134)
Reissuance of treasury
shares in connection
with stock option
exercises - - - - - (8) - 2,000 38 30
Cash dividends declared - - - - - (2,113) - - - (2,113)
---------- ---- ------- ------- ------- ------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2003 10,580,000 106 47,143 (5,837) (2,094) 85,794 788 (57,700) (1,096) 124,804
Comprehensive income:
Net income - - - - - 6,323 - - - 6,323
Unrealized losses on
securities arising
during the year, net
of tax benefit of $128 - - - - - - (285) - - (285)
Reclassification for
gains included in net
income, net of taxes
of $252 - - - - - - (625) - - (625)
--------
Comprehensive income 5,413
--------
Activity related to
common stock issued
as employee incentives - - 516 410 551 - - - - 1,477
Treasury stock purchased - - - - - - - (569,588) (11,956) (11,956)
Reissuance of treasury
shares in connection
with stock option
exercises - - - - - (5) - 1,800 31 26
Cash dividends declared - - - - - (1,713) - - - (1,713)
---------- ---- ------- ------- ------- ------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2004 10,580,000 $106 $47,659 $(5,427) $(1,543) $90,399 $ (122) (625,488) $(13,021) $118,051
========== ==== ======= ======= ======= ======= ======= ======== ======== ========
See notes to consolidated financial statements.
F-5
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
--------------------------------------
2004 2003 2002
---- ---- ----
OPERATING ACTIVITIES:
Net Income $ 6,323 $ 3,651 $ 4,044
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses 750 750 934
Valuation adjustment of other real estate owned - - (77)
Other than temporary write-down of securities - 85 2,105
Depreciation and amortization of premises and equipment 1,003 1,080 1,052
Net amortization of premiums and discounts on securities,
mortgage Backed securities and mortgage loans 1,452 3,273 1,601
Amortization of unearned compensation 1,962 769 302
Gain on sale of other real estate owned - - (62)
Gain on sale of fixed assets - (50) -
Net realized securities gains (877) (494) (355)
Deferred income tax benefit (615) (992) (2,843)
Increase in cash surrender value of bank-owned life insurance (741) (806) -
Changes in assets and liabilities:
Accrued interest and dividends 4 382 264
Other assets 748 (708) 905
Other liabilities 155 (646) (428)
--------- --------- ---------
Net cash provided by operating activities 10,164 6,294 7,442
--------- --------- ---------
INVESTING ACTIVITIES:
Securities, held to maturity:
Purchases $ (18,473) $ (61,941) $ (42,389)
Proceeds from maturities and principal collections 17,000 37,980 42,053
Securities, available for sale:
Purchases (5,332) (19,883) (37,445)
Proceeds from sales 11,891 34,595 4,222
Proceeds from calls, maturities and principal collections 4,155 40,610 23,598
Mortgage backed securities, held to maturity:
Purchases (39,255) (127,681) (129,145)
Principal collections 54,687 93,000 49,839
Mortgage backed securities, available for sale:
Purchases (41,110) (43,383) (60,975)
Proceeds from sales 20,325 8,104 20,214
Principal collections 22,943 47,111 38,236
Purchase of Federal Home Loan Bank of Boston and other stock - (304) (299)
Purchase of residential mortgages (35,294) (11,462) (6,061)
Net other increase in loans 10,864 22,821 61,545
Proceeds from sale of other real estate owned - - 301
Purchases of premise and equipment (734) (452) (322)
Proceeds from sale of fixed assets - 499 -
Purchase of bank-owned life insurance - (15,701) -
--------- --------- ---------
Net cash provided by (used in) investing activities 1,667 3,913 (36,628)
--------- --------- ---------
FINANCING ACTIVITIES:
(Decrease) increase in deposits (19,810) (23,634) 18,956
Increase in customer repurchase agreements 2,480 3,411 2,663
Federal Home Loan Bank of Boston advances 25,000 5,000 15,000
Purchase of common stock in connection with employee
benefit program (485) (2,668) (6,301)
Cash dividends paid (1,713) (2,113) (1,588)
Treasury stock purchased (11,956) (1,134) -
Reissuance of treasury shares in connection with stock
option exercises 26 30 -
Stock issuance costs - - (4)
--------- --------- ---------
Net cash (used in) provided by financing activities (6,458) (21,108) 28,726
--------- --------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS: 5,373 (10,901) (460)
Beginning of year 45,674 56,575 57,035
--------- --------- ---------
End of year $ 51,047 $ 45,674 $ 56,575
========= ========= =========
See notes to consolidated financial statements
F-6
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Basis of Presentation - Westfield Financial,
Inc. is a Massachusetts corporation. The Company has a federally-
chartered stock savings bank subsidiary called Westfield Bank (the
"Bank"). The Bank's deposits are insured to the limits specified by
the Federal Deposit Insurance Corporation ("FDIC"). The Bank operates
10 branches in Western Massachusetts. The Bank's primary source of
revenue is earned from loans to small and middle-market businesses
and to residential property homeowners.
In 1998, the Bank formed a subsidiary, Elm Street Real Estate
Investments, Inc. (the "REIT"). The REIT was 99.9% owned by the Bank.
In December 2003, the Bank dissolved the REIT to streamline the
overall bank structure. Westfield Securities Corp., a Massachusetts
chartered security corporation, was formed in 2001 by the Company for
the primary purpose of holding qualified investment securities. In
2003, the Bank formed another wholly owned subsidiary, Elm Street
Securities Corporation, a Massachusetts chartered security
corporation for the primary purpose of holding quality investment
securities.
On July 23, 2004 Westfield Bank and Westfield Mutual Holding Company
completed their conversions from companies regulated by the
Massachusetts Division of Banks or the Federal Reserve Board to
federally-chartered companies regulated by the Office of Thrift
Supervision (the "OTS".
Principles of Consolidation - The consolidated financial statements
include the accounts of the Company, the Bank, Westfield Securities
Corp., Elm Street Securities Corporation, and the REIT prior to its
dissolution. All material intercompany balances and transactions have
been eliminated in consolidation.
Estimates - The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported
amounts of income and expenses for each. Actual results could differ
from those estimates. Estimates that are particularly susceptible to
significant change in the near-term relate to the determination of
the allowance for loan losses and other than temporary impairment of
investment securities.
Cash and Cash Equivalents - The Company defines cash on hand, cash
due from banks, federal funds sold and interest bearing deposits
having an original maturity of 90 days or less as cash and cash
equivalents. Cash and due from banks at December 31, 2004 and 2003
includes partially restricted cash of approximately $347,000, and
$154,000 respectively, for Federal Reserve Bank of Boston cash
reserve requirements.
F-7
Securities and Mortgage Backed Securities - Securities, including
mortgage backed securities, which management has the positive intent
and ability to hold until maturity are classified as held to maturity
and are carried at amortized cost. Securities, including mortgage
backed securities, which have been identified as assets for which
there is not a positive intent to hold to maturity are classified as
available for sale and are carried at fair value with unrealized
gains and losses, net of income taxes, reported as a separate
component of stockholders' equity. The Company does not acquire
securities and mortgage backed securities for purposes of engaging in
trading activities.
Realized gains and losses on sales of securities and mortgage backed
securities are computed using the specific identification method and
are included in noninterest income. The amortization of premiums and
accretion of discounts is determined by using the level yield method
to the maturity date.
Other than Temporary Impairment of Securities - On a quarterly basis,
the Company reviews available for sale investment securities with
unrealized depreciation on a judgmental basis to assess whether the
decline in fair value is temporary or other than temporary. Declines
in the fair value of held to maturity and available for sale
securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses. In estimating
other than temporary impairment losses, management considers (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 corporation to retain
its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Loans - Loans are recorded at the principal amount outstanding.
Interest on loans is calculated using the effective yield method on
daily balances of the principal amount outstanding and is credited to
income on the accrual basis to the extent it is deemed collectible.
The Company's general policy is to discontinue the accrual of
interest when principal or interest payments are delinquent 90 days
or more, or earlier if the loan is considered impaired. Any unpaid
amounts previously accrued on these loans are reversed from income.
Subsequent cash receipts are applied to the outstanding principal
balance or to interest income if, in the judgment of management,
collection of the principal balance is not in question. Loans are
returned to accrual status when they become current as to both
principal and interest and when subsequent performance reduces the
concern as to the collectibility of principal and interest. Loan fees
and certain direct loan origination costs are deferred, and the net
fee or cost is recognized as an adjustment to interest income over
the estimated average lives of the related loans. Compensation to an
auto dealer is normally based upon a spread that a dealer adds on the
loan base rate set by the Company. The compensation is paid to an
automobile dealer shortly after the loan is originated. The Company
records the amount as a deferred cost that is amortized over the life
of the loans in relation to the interest paid by the customer.
Allowance for Loan Losses - The allowance for loan losses is
established through provisions for loan losses charged to expense.
Loans are charged off against the allowance when management believes
that the collectibility of the principal is unlikely. Recoveries of
amounts previously charged-off are credited to the allowance.
The Bank maintains an allowance for loan losses to absorb losses
inherent in the loan portfolio based on ongoing quarterly assessments
of the estimated losses. The Bank's methodology for assessing the
appropriateness of the allowance consists of two key components,
which are a specific allowance for identified problem loans and a
formula allowance for the remainder of the portfolio. The specific
allowance incorporates the results of measuring impaired loans as
provided in Statement of Financial Accounting Standards ("SFAS") No.
114, "Accounting by Creditors for Impairment of a Loan," and SFAS No.
118, "Accounting by Creditors for Impairment of a Loan -
F-8
Income Recognition and Disclosures." These accounting standards
prescribe the measurement methods, income recognition and disclosures
related to impaired loans. The formula allowance is calculated by
applying loss factors to outstanding loans by type, excluding loans
for which a specific allowance has been determined. In determining
the loss factors to apply to each loan category, the Company
considers historical losses, peer group comparisons, industry data
and loss percentages used by banking regulators for similarly graded
loans. Loss factors may be adjusted for qualitative factors that, in
management's judgment, affect the collectibility of the portfolio as
of the evaluation date.
A loan is recognized as impaired when it is probable that principal
and/or interest are not collectible in accordance with the loan's
contractual terms. A loan is not deemed to be impaired if there is a
short delay in receipt of payment or if, during a longer period of
delay, the Company expects to collect all amounts due including
interest accrued at the contractual rate during the period of delay.
Measurement of impairment can be based on present value of expected
future cash flows discounted at the loan's effective interest rate,
the loan's observable market price or the fair value of the
collateral, if the loan is collateral dependent. This evaluation is
inherently subjective as it requires material estimates that may be
susceptible to significant change. If the fair value of the impaired
loan is less than the related recorded amount, a specific valuation
allowance is established within the allowance for loan losses or a
writedown is charged against the allowance for loan losses if the
impairment is considered to be permanent. Measurement of impairment
does not apply to large groups of smaller balance homogeneous loans
that are collectively evaluated for impairment such as the Company's
portfolios of home equity loans, real estate mortgages, installment
and other loans.
The Company's methodology for assessing the appropriateness of the
allowance consists of two key components, which are a specific
allowance for identified problem or impaired loans and a formula
allowance for the remainder of the portfolio. Measurement of
impairment can be based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's
observable market price or the fair value of the collateral, if the
loan is collateral dependent. This evaluation is inherently
subjective as it requires material estimates that may be susceptible
to significant change. The appropriateness of the allowance is also
reviewed by management based upon its evaluation of then-existing
economic and business conditions affecting the key lending areas of
the Company and other conditions, such as new loan products, credit
quality trends (including trends in nonperforming loans expected to
result from existing conditions), collateral values, loan volumes and
concentrations, specific industry conditions within portfolio
segments that existed as of the balance sheet date and the impact
that such conditions were believed to have had on the collectibility
of the loan portfolio. Although management believes it has
established and maintained the allowance for loan losses at
appropriate levels, future adjustments may be necessary if economic,
real estate and other conditions differ substantially from the
current operating environment.
In addition, the Office of Thrift Supervision, as an integral part of
its examination process, periodically review the loan and foreclosed
real estate portfolios and the related allowance for loan losses and
valuation allowance for foreclosed real estate. The Office of Thrift
Supervision may require adjustment to the allowance for loan losses
based on their judgments of information available to them at the time
of their examination, thereby adversely affecting results of
operations.
Management believes that the allowance for loan losses accurately
reflects estimated credit losses for specifically identified loans,
as well as probable credit losses inherent in the remainder of the
portfolio as of the end of the periods presented.
F-9
Transfers and Servicing 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.
Premises and Equipment - Land is carried at cost. Buildings and
equipment are stated at cost, less accumulated depreciation, computed
on either the straight-line or accelerated methods over the estimated
useful lives of the assets, or lease term, if shorter, as follows:
Years
-----
Buildings 39
Leasehold Improvements 20
Furniture and Equipment 3-7
The cost of maintenance and repairs is charged to expense when
incurred. Major expenditures for betterments are capitalized and
depreciated.
Other Real Estate Owned - Other real estate owned represents property
acquired through foreclosure or deeded to the Company in lieu of
foreclosure. Other real estate owned is recorded at the lower of the
carrying value of the related loan, or the estimated fair value of
the real estate acquired, net of estimated selling costs. Initial
write-downs are charged to the allowance for loan losses at the time
the loan is transferred to other real estate owned. Subsequent
valuations are periodically performed by management and the carrying
value is adjusted by a charge to expense to reflect any subsequent
declines in the estimated fair value. Operating costs associated with
other real estate owned are expensed as incurred.
Retirement Plans and Employee Benefits - The Company provides a
defined benefit pension plan for eligible employees through
membership in the Savings Banks Employees Retirement Association
("SBERA"). The Company's policy is to fund pension cost as accrued.
Employees are also eligible to participate in a 401(k) plan through
SBERA. The Company makes matching contributions to this plan at 50%
of up to 6% of the employees' eligible compensation.
The Company currently offers postretirement life insurance benefits
to retired employees. Such postretirement benefits represent a form
of deferred compensation which requires that the cost and obligations
of such benefits are recognized in the period in which services are
rendered.
Income Taxes - The Company uses the asset and liability method for
income tax accounting, whereby, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax
rates applied to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Earnings per Share - Basic earnings per share represents income
available to common stockholders 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 issuance. Potential common shares that may be issued by the
Company relate solely to outstanding stock awards and options, are
determined using the treasury stock method.
F-10
Earnings per common share for the years ended December 31, have been
computed based on the following (in thousands, except per share
data):
2004 2003 2002
---- ---- ----
Net income available to common stockholders $6,323 $ 3,651 $ 4,044
====== ======= =======
Weighted average number of common shares outstanding 9,706 10,037 10,336
Effect of dilutive stock awards 224 176 261
------ ------- -------
Adjusted weighted average number of common shares
outstanding used to calculate diluted earnings per
common shares 9,930 10,213 10,597
====== ======= =======
Basic earnings per share $ 0.65 $ 0.36 $ 0.39
Diluted earnings per share $ 0.64 $ 0.36 $ 0.38
Reclassifications - Certain amounts in the prior year financial
statements have been reclassified to conform to the current year
presentation.
Stock Options - The Company applies APB Opinion No. 25 and related
Interpretations in accounting for stock options. Accordingly, no
compensation cost has been recognized. Had compensation cost for the
Company's stock options been determined based on the fair value at
the grants dates for awards under the plan consistent with the method
prescribed by SFAS No. 123, the Company's net income (in thousands)
and earnings per share would have been adjusted to the pro forma
amounts indicated below:
For the years ended December 31,
2004 2003 2002
---- ---- ----
(In thousands, except per share data)
Net income as reported $6,323 $3,651 $4,044
Less: Compensation expense
determined under fair value
based method for all awards,
net of tax effects (272) (254) (129)
------ ------ ------
Pro forma net income $6,051 $3,397 $3,915
====== ====== ======
Net income per share
Basic as reported $ 0.65 $ 0.36 $ 0.39
Basic pro forma 0.62 0.34 0.38
Diluted as reported 0.64 0.36 0.38
Diluted pro forma 0.61 0.33 0.37
F-11
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted average assumptions:
Years Ended
December 31,
------------------------
2004 2002
---- ----
Dividend yield 1.02% 1.25%
Expected life in years 10 years 10 years
Expected volatility 17% 15%
Risk-free interest rate 4.16% 3.58%
No options were granted in 2003.
Recent accounting pronouncements
In March 2004, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 105, Application of Accounting
Principles to Loan Commitments, which provides guidance regarding
loan commitments that are accounted for as derivative instruments. In
this SAB, the SEC determined that an interest rate lock commitment
should generally be valued at zero at inception. The rate locks will
continue to be adjusted for changes in value resulting from changes
in market interest rates. This SAB did not have any effect on the
Company's financial position or results of operations.
In December 2004, the Financial Accounting Standards Board ("FASB")
published FASB Statement No. 123 (revised 2004), Share-Based Payment
("FAS 123(R)" or the "Statement"). FAS 123(R) requires that the
compensation cost relating to share-based payment transactions,
including grants of employee stock options, be recognized in
financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. FAS 123(R)
covers a wide range of share-based compensation arrangements
including stock options, restricted share plans, performance-based
awards, share appreciation rights, and employee share purchase plans.
FAS 123(R) is a replacement of FASB Statement No. 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related
interpretive guidance.
The effect of the Statement will be to require entities to measure
the cost of employee services received in exchange for stock options
based on the grant-date fair value of the award, and to recognize the
cost over the period the employee is required to provide services for
the award. FAS 123(R) permits entities to use any option-pricing
model that meets the fair value objective in the Statement.
The Company will be required to apply FAS 123(R) as of the beginning
of its first interim period that begins after June 15, 2005, which
will be the quarter ending September 30, 2005.
FAS 123(R) allows two methods for determining the effects of the
transition: the modified prospective transition method and the
modified retrospective method of transition. Under the modified
prospective transition method, an entity would use the fair value
based accounting method for all employee awards granted, modified, or
settled after the effective date. As of the effective date,
compensation cost related to the nonvested portion of awards
outstanding as of that date would be based on the grant-date fair
value of those awards as calculated under the original provisions of
Statement No. 123; that is, an entity would not remeasure the grant-
date fair value estimate of the unvested portion of awards granted
prior to the effective date of FAS 123(R). An entity will have the
further option to either apply the Statement to only the quarters in
the period of adoption and subsequent periods, or apply the Statement
to all quarters in the fiscal year of adoption. Under the modified
retrospective method of transition, an entity would revise its
previously issued financial statements to recognize employee
compensation cost for prior periods presented in accordance with the
original provisions of Statement No. 123.
F-12
The Company has not yet completed its study of the transition methods
or made any decisions about how it will adopt FAS 123(R).
The changes in accounting will replace existing requirements under
Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," and will eliminate the
ability to account for share-based compensation transactions using
APB Opinion No. 25, "Accounting for Stock Issued to Employees," which
does not require companies to expense options if the exercise price
is equal to the trading price at the date of grant. The accounting
for similar transactions involving parties other than employees or
the accounting for employee stock ownership plans that are subject to
American Institute of Certified Public Accountants ("AICPA")
Statement of Position 93-6, "Employers' Accounting for Employee Stock
Ownership Plans," would remain unchanged.
On September 30, 2004, the Financial Accounting Standards Board
("FASB") issued FASB Staff Position ("FSP") Emerging Issues Task
Force ("EITF") Issue No. 03-1-1 delaying the effective date of
paragraphs 10-20 of EITF 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments", which
provides guidance for determining the meaning of "other-than-
temporarily impaired" and its application to certain debt and equity
securities within the scope of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", and investments accounted
for under the cost method. The guidance requires that investments
which have declined in value due to credit concerns or solely due to
changes in interest rates must be recorded as other-than-temporarily
impaired unless the Company can assert and demonstrate its intention
to hold the security for a period of time sufficient to allow for a
recovery of fair value up to or beyond the cost of the investment
which might mean maturity. The delay of the effective date of EITF
03-1 will be superceded concurrent with the final issuance of
proposed FSP Issue 03-1-a. Proposed FSP Issue 03-1-a is intended to
provide implementation guidance with respect to all securities
analyzed for impairment under paragraphs 10-20 of EITF 03-1.
Management continues to closely monitor and evaluate how the
provisions of EITF 03-1 and proposed FSP Issue 03-1-a will affect the
Company.
F-13
2. SECURITIES
Securities are summarized as follows:
December 31, 2004
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
Held to maturity:
Federal agency obligations $38,160 $ 117 $266 $38,011
Municipal bonds 29,147 520 70 29,597
Corporate debt securities 3,991 55 - 4,046
------- ------ ---- -------
Total held to maturity 71,298 692 336 71,654
------- ------ ---- -------
Available for sale:
Equity securities 7,301 - 315 6,986
Federal agency obligations 6,991 63 4 7,050
Corporate debt securities 918 14 - 932
------- ------ ---- -------
Total available for sale 15,210 77 319 14,968
------- ------ ---- -------
Total Securities $86,508 $ 769 $655 $86,622
======= ====== ==== =======
December 31, 2003
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
Held to maturity:
Federal agency obligations $43,250 $ 501 $ 12 $43,739
Municipal bonds 21,687 369 15 22,041
Corporate debt securities 4,990 233 - 5,223
------- ------ ---- -------
Total held to maturity 69,927 1,103 27 71,003
------- ------ ---- -------
Available for sale:
Equity securities 14,594 1,004 143 15,455
Federal agency obligations 6,487 73 3 6,557
Corporate debt securities 3,745 49 - 3,794
------- ------- ---- -------
Total available for sale 24,826 1,126 146 25,806
------- ------- ---- -------
Total Securities $94,753 $2,229 $173 $96,809
======= ====== ==== =======
F-14
Information pertaining to securities with gross unrealized losses at
December 31, 2004 and 2003, aggregated by investment category and
length of time that individual securities have been in a continuous
loss position, follows:
December 31, 2004
--------------------------------------------
Less than Twelve Months Over Twelve Months
----------------------- ------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
(In Thousands)
Held to maturity:
Federal agency obligations $266 $22,894 $ - $ -
Municipal bonds 70 6,110 - -
---- ------- ---- -------
Total held to maturity 336 29,004 - -
---- ------- ---- -------
Available for sale:
Equity securities 75 4,330 240 760
Federal agency obligations 4 943 - -
---- ------- ---- -------
Total available for sale 79 5,273 240 760
---- ------- ---- -------
Total Temporarily Impaired Securities $415 $34,277 $240 $ 760
==== ======= ==== =======
December 31, 2003
--------------------------------------------
Less than Twelve Months Over Twelve Months
----------------------- ------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
(In Thousands)
Held to maturity:
Federal agency obligations $ 12 $ 5,267 $ - $ -
Municipal bonds 15 1,450 - -
---- ------- ---- -------
Total held to maturity 27 6,717 - -
---- ------- ---- -------
Available for sale:
Equity securities 124 7,043 19 1,352
Federal agency obligations - - 3 1,212
---- ------- ---- -------
Total available for sale 124 7,043 22 2,564
---- ------- ---- -------
Total Temporarily Impaired Securities $151 $13,760 $ 22 $ 2,564
==== ======= ==== =======
F-15
At December 31, 2004, twelve debt securities have gross unrealized
losses of 1.1% from the Bank's amortized cost basis of temporarily
impaired debt securities. Because these losses relate to federally-
sponsored agency obligations and highly rated municipal obligations,
are the result of fluctuations in interest rates, and management has
the intent and ability to hold these securities for the foreseeable
future, no declines are deemed to be other than temporary.
At December 31, 2004, three equity securities classified as available
for sale have an unrealized loss of 1.7% from the Bank's amortized
cost basis of temporarily impaired equity securities which existed
for less than twelve months and is principally related to
fluctuations in interest rates. These losses relate to mutual funds
which invest primarily in short term debt instruments and adjustable
rate mortgage-backed securities. Because these losses are the result
of fluctuations in interest rates, and management has the intent and
ability to hold these securities for the foreseeable future, no
declines are deemed to be other than temporary.
At December 31, 2004, one equity security classified as available for
sale has an unrealized loss of 2.4% from the Bank's amortized cost
basis of temporarily impaired equity securities which existed for
greater than twelve months. Because the security is an adjustable
rate preferred stock issued by a federally-sponsored agency, the
unrealized loss is principally related to fluctuations in interest
rates, and management has the intent and ability to hold these
securities for the foreseeable future, the decline is not deemed to
be other than temporary.
December 31, 2004
-----------------------
Amortized Estimated
Cost Fair Value
--------- ----------
(In Thousands)
Held to maturity:
Due in one year or less $ 3,991 $ 4,046
Due after one year through five years 18,179 18,033
Due after five years through ten years 17,389 17,337
Due after ten years 31,739 32,238
------- -------
Total held to maturity $71,298 $71,654
======= =======
Available for sale:
Due after five years through ten years $ 6,043 $ 6,106
Due after ten years 1,866 1,876
------- -------
Total available for sale $ 7,909 $ 7,982
======= =======
Gross gains of $1,130,000, $771,000, and $423,000, and gross losses
$39,000, $333,000, and $897,000 were recorded on securities during
the years ended December 31, 2004, 2003, and 2002, respectively.
During 2004, 2003, and 2002, the Company recorded losses of $ - 0 -,
85,000, and $2,105,000, respectively, for other than temporary
impairments in value.
Securities with a carrying value of $37 million and $35 million were
pledged as collateral to the Federal Reserve Bank of Boston at
December 31, 2004 and 2003, respectively.
Unrealized losses on securities available for sale, net of tax were
$176,000 and unrealized gains on securities available for sale were
$647,000 at December 31, 2004 and 2003, respectively.
F-16
3. MORTGAGE BACKED SECURITIES
Mortgage backed securities are summarized as follows:
December 31, 2004
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
Held to maturity:
Fannie Mae $120,595 $ 234 $1,250 $119,579
Freddie Mac 39,772 171 280 39,663
Ginnie Mae 14,775 33 159 14,649
Collateralized Mortgage Obligations 160 - - 160
-------- ------ ------ --------
Total held to maturity 175,302 438 1,689 174,051
-------- ------ ------ --------
Available for sale:
Fannie Mae 32,676 178 141 32,713
Freddie Mac 22,842 66 70 22,838
Ginnie Mae 15,036 58 25 15,069
Collateralized Mortgage Obligations 2,688 51 43 2,696
-------- ------ ------ --------
Total available for sale 73,242 353 279 73,316
-------- ------ ------ --------
Total Mortgage Backed Securities $248,544 $ 791 $1,968 $247,367
======== ====== ====== ========
December 31, 2003
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)