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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
COMMISSION FILE NUMBER 0-23533
MYSTIC FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3401049
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
60 High Street, Medford, Massachusetts 02155
(Address of principal executive office-zip code)
Telephone (781) 395-2800
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K [ X ]
As of August 28, 1998, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the Registrant was
approximately $27,528,992.
As of August 28, 1998, 2,573,555 shares of Registrant's common stock were
outstanding.
Documents Incorporated by Reference:
Portions of the Registrant's Proxy Statement for its 1998 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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MYSTIC FINANCIAL, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
JUNE 30, 1998
TABLE OF CONTENTS
PART I
ITEM 1. Business ................................................................. 1
ITEM 2. Properties ............................................................... 28
ITEM 3. Legal Proceedings ........................................................ 28
ITEM 4. Submission of Matters to a Vote of Security Holders ...................... 28
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters .... 29
ITEM 6. Selected Financial Data................................................... 30
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations ........................................................... 32
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk................ 45
ITEM 8. Financial Statements and Supplementary Data .............................. 46
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .................................................... 46
PART III
ITEM 10. Directors and Executive Officers of the Registrant ....................... 47
ITEM 11. Executive Compensation ................................................... 47
ITEM 12. Security Ownership of Certain Beneficial Owners and Management............ 47
ITEM 13. Certain Relationships and Related Transactions ........................... 47
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K .......... 48
PART I
ITEM 1. BUSINESS
General
On January 8, 1998, Medford Co-operative Bank (the "Bank") completed its
conversion from mutual to stock form and became a wholly-owned subsidiary of
Mystic Financial, Inc. ("Mystic" or the "Company"). On such date, the Company
sold 2,711,125 shares of its common stock, par value $0.01 per share (the
"Common Stock"), to the public, at a per share price of $10.00. The conversion
of the Bank from mutual to stock form, the formation of the Company as the
holding company for the Bank and the issuance and sale of the Common Stock are
herein referred to collectively as the "Conversion." The Conversion raised
$25.7 million in net proceeds. Mystic used $3.2 million of retained net
proceeds to fund a loan to its Employee Stock Ownership Plan ("ESOP") to
purchase 216,890 shares of the Common Stock in open-market purchases following
completion of the Conversion.
The Company's principal business activity consists of the ownership of
the Bank. The Company also invests in short-term investment grade marketable
securities and other liquid investments. The Company has no significant
liabilities (other than those of the Bank). The Company neither owns nor leases
any property but instead uses the premises and equipment of the Bank. At the
present time, the Company does not employ any persons other than certain
officers of the Bank who do not receive any extra compensation as officers of
the Company. The Company utilizes the support staff of the Bank from time to
time, as needed. Additional employees may be hired as deemed appropriate by the
management of the Company. Unless otherwise disclosed, the information
presented in this Annual Report on Form 10-K represents the activity of the
Bank for the period prior to January 8, 1998 and the consolidated activity of
Mystic and the Bank thereafter.
The Bank is a Massachusetts chartered stock co-operative bank founded in
1886 with three full-service offices and one educational branch office in
Medford, Massachusetts. The Bank's deposits have been federally insured since
1986 and are currently insured by the Bank Insurance Fund ("BIF") of the
Federal Deposit Insurance Corporation ("FDIC") and the Share Insurance Fund of
the Co-operative Central Bank. The Bank has been a member of the Co-operative
Central Bank since 1932 and a member of the Federal Home Loan Bank ("FHLB")
since 1988. The Bank is subject to comprehensive examination, supervision and
regulation by the Commissioner of Banks of the Commonwealth of Massachusetts
(the "Commissioner") and the FDIC. This regulation is intended primarily for
the protection of depositors and borrowers. The Bank exceeded all of its
regulatory capital requirements at June 30, 1998.
The business of the Bank consists of attracting deposits from the general
public and using these funds to originate various types of loans primarily in
eastern Middlesex County, Massachusetts, including mortgage loans secured by
one- to four-family residences, commercial loans secured by general business
assets and commercial real estate loans secured by commercial property, and to
invest in U.S. Government and Federal Agency and other securities. To a lesser
extent, the Bank engages in various forms of consumer and home equity lending.
The Bank's profitability depends primarily on its net interest income, which is
the difference between the interest income it earns on its loans and investment
portfolio and its cost of funds, which consists mainly of interest paid on
deposits and on borrowings from the FHLB. Net interest income is affected by
the relative amounts of interest-earning assets and interest-bearing
liabilities and the interest rates earned or paid on these balances. When
interest-earning assets approximate or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income.
The Bank has one active subsidiary, Mystic Securities Corporation, which
was established for the sole purpose of acquiring and holding investment
securities. All securities held by Mystic Securities Corporation are
investments which are permissible for banks to hold under Massachusetts law.
Market Area
The Bank's main office and three branch offices are located in Medford,
Middlesex County, Massachusetts. The city of Medford, containing approximately
60,000 residents, is located approximately seven miles from downtown Boston in
the northern suburbs of Boston, bounded by the towns of Malden, Everett,
Somerville, Stoneham, Winchester and Arlington. The City of Medford is easily
accessible from downtown Boston via Interstate 93 and is accessible via other
state roads connecting the communities within the Route 128 corridor
surrounding Boston. As an established metropolitan suburb, Medford consists
mostly of developed single- and multi-family properties within a network of
well-maintained neighborhoods. The city of Medford represents the primary
market area for deposit and loan generation as most of the Bank's depositors
and loan customers live in the areas surrounding the Bank's office locations.
The Bank considers its primary market area to be the communities of Medford,
Malden, Everett, Stoneham, Arlington, Winchester, Somerville, Melrose,
Lexington and Bedford, Massachusetts. The economic base of the Bank's market
area is diversified and includes a number of financial service institutions,
industrial and manufacturing companies, hospitals and other health care
facilities and educational institutions. The major employers in the Medford
area are Tufts University, Lawrence Memorial Hospital, the City of Medford and
Meadow Glen Mall, with approximately 1,600, 1,300, 1,200 and 1,000 employees
each, respectively. Management believes that the housing vacancy rate in
Medford is very low. The majority of the Bank's lending and deposit activity
has historically been in Medford, although the commercial loan department has
been largely responsible for expanded business throughout eastern Middlesex
County. Middlesex County, located in eastern Massachusetts to the north and
west of the city of Boston, is part of the Boston metropolitan area. Based on
1997 Bureau of Labor Statistics, the median household income for Middlesex
County was $49,414.
Management believes that the Bank's success as a home lender has been
due, in part, to the favorable income, population and housing demographics in
Medford and in the Bank's market area. At the same time, the growth of the
market area and delineated lending area and their proximity to Boston has
resulted in a highly competitive environment among the many financial
institutions competing for deposits and loans.
Competition
The Bank experiences competition both in attracting and retaining savings
deposits and in the making of mortgage, commercial and other loans. Direct
competition for savings deposits primarily comes from larger commercial banks
and other savings institutions located in or near the Bank's primary market
area which often have significantly greater financial and technological
resources than the Bank. Additional significant competition for savings
deposits comes from credit unions, money market funds and brokerage firms.
With regard to lending competition in the local market area, the Bank
experiences the most significant competition from the same institutions
providing deposit services, most of whom have placed an emphasis on real estate
lending as a line of business. In addition, the Bank competes with local and
regional mortgage companies, independent mortgage brokers and credit unions in
originating mortgage and non-mortgage loans. The primary factors in competing
for loans are interest rates and loan origination fees and the range of
services offered by the various financial institutions.
Competition from other financial institutions operating in the Bank's
local community includes a number of both large and small commercial banks and
savings institutions. The Bank has experienced growth in deposits in recent
years primarily due to an increased emphasis on marketing products and
services. However, competition remains high in the marketplace.
Lending Activities
The Bank originates loans through its three offices located in Medford,
Massachusetts. The principal lending activities of the Bank are the origination
of conventional mortgage loans for the purpose of purchasing or refinancing
owner-occupied, one- to four-family residential properties in its designated
community reinvestment area, consisting of the Massachusetts communities of
Medford, Malden, Everett, Stoneham, Arlington, Winchester, Somerville and
Melrose, and the origination of commercial loans secured by commercial real
estate and commercial assets within eastern Middlesex County. To a lesser
extent, the Bank also originates consumer loans including home equity and
passbook loans.
In the past three years, the Bank has made a major commitment to small
business commercial lending. The Bank has expanded its commercial lending
department with the addition of two senior officers with considerable
commercial lending expertise and has developed a support staff to run the
commercial loan department.
The Bank's ten largest loans, outstanding as of June 30, 1998, ranged
from $733,000 to $2.2 million.
Loan Portfolio. The following table presents selected data relating to
the composition of the Bank's loan portfolio by type of loan on the dates
indicated.
At June 30,
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1998 1997 1996
------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Residential mortgage loans $106,412 76.8% $ 90,203 78.7% $ 82,459 87.0%
Commercial real estate loans 24,475 17.7 17,847 15.6 8,280 8.7
Commercial loans 4,579 3.3 3,677 3.2 1,715 1.8
Consumer loans 1,787 1.3 1,655 1.4 1,781 1.9
Home equity loans 1,716 1.2 1,564 1.4 1,176 1.2
Construction loans 1,260 0.9 976 0.9 285 0.4
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Total loans 140,229 101.2% 115,922 101.2% 95,696 101.0%
Less:
Deferred loan origination fees 17 --- 37 --- 60 0.1
Unadvanced principal 383 0.3 340 0.3 134 0.1
Allowance for loan losses 1,236 0.9 977 0.9 742 0.8
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Loans, net $138,593 100.0% $114,568 100.0% $ 94,760 100.0%
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One- to Four-Family Residential Real Estate Lending. The primary emphasis
of the Bank's lending activity is the origination of conventional mortgage
loans on one- to four-family residential dwellings located in the Bank's
primary market area. As of June 30, 1998, loans on one- to four-family
residential properties accounted for 76.8% of the Bank's loan portfolio.
The Bank's mortgage loan originations are for terms of up to 30 years,
amortized on a monthly basis with interest and principal due each month.
Residential real estate loans often remain outstanding for significantly
shorter periods than their contractual terms as borrowers may refinance or
prepay loans at their option, without penalty. Conventional residential
mortgage loans granted by the Bank customarily contain "due-on-sale" clauses
which permit the Bank to accelerate the indebtedness of the loan upon transfer
of ownership of the mortgaged property.
The Bank makes conventional mortgage loans and uses standard Federal
National Mortgage Association ("FNMA") documents, to allow for the sale of
qualifying loans in the secondary mortgage market. The Bank's lending policies
generally limit the maximum loan-to-value ratio on mortgage loans secured by
owner-occupied properties to 95% of the lesser of the appraised value or
purchase price of the property, with the condition that private mortgage
insurance is required on loans with a loan-to-value ratio in excess of 80%.
Since the early 1980s the Bank has offered adjustable-rate mortgage loans
with terms of up to 30 years. Adjustable-rate loans offered by the Bank include
loans which reprice every one or three years and provide for an interest rate
which is based on the interest rate paid on U.S. Treasury securities of a
corresponding term, plus a margin of up to 250 basis points, or 2.5%.
Additionally, the Bank offers an adjustable-rate loan product with an interest
rate fixed for seven years which then reprices annually for its remaining term
thereafter. The Bank currently offers adjustable-rate loans with initial rates
below those which would prevail under the foregoing computations, based upon
the Bank's determination of market factors and competitive rates for
adjustable-rate loans in its market area. For adjustable-rate loans, borrowers
are qualified at the initial rate.
Historically, the Bank has retained all adjustable-rate mortgages it
originates. However, in recent years, in order to generate liquidity, the Bank
has sold some of these loans. The Bank's adjustable-rate mortgages include
limits on increases or decreases of the interest rate of the loan. The interest
rate may increase or decrease by 2% per year and 5% over the life of the loan
for the Bank's one-year adjustable rate mortgages and by 3% per adjustment
period and 6% over the life of the loan for the Bank's three-year adjustable
rate mortgages. The Bank also offers an adjustable rate mortgage on which the
rate is fixed for the first seven years; thereafter, the loan converts to a
one-year adjustable-rate mortgage. The retention of adjustable-rate mortgage
loans in the Bank's loan portfolio helps reduce the Bank's exposure to
increases in interest rates. However, there are unquantifiable credit risks
resulting from potential increased costs to the borrower as a result of the
repricing of adjustable-rate mortgage loans. During periods of rising interest
rates, the risk of default on adjustable-rate mortgage loans may increase due
to the upward adjustment of interest cost to the borrower.
During the year ended June 30, 1998, the Bank originated $15.2 million in
adjustable-rate mortgage loans and $27.9 million in fixed-rate mortgage loans.
Of the fixed-rate loans originated, the Bank sold $5.3 million of fixed-rate
loans with terms of greater than 15 years and retained $22.6 million of
fixed-rate loans, substantially all of which had terms of 15 years or less.
Approximately 24% of all loan originations during fiscal 1998 were refinancings
of loans already in the Bank's loan portfolio. At June 30, 1998, the Bank's
loan portfolio included $59.0 million in adjustable-rate one- to four-family
residential mortgage loans or 42.6% of the Bank's net loan portfolio, and $47.4
million in fixed-rate one- to four-family residential mortgage loans, or 34.2%
of the Bank's net loan portfolio.
The Bank engages in a limited amount of construction lending usually for
the construction of single family residences. Most are construction/permanent
loans to the future occupants, structured to become permanent loans upon the
completion of construction. All construction loans are secured by first liens
on the property. Loan proceeds are disbursed as construction progresses and
inspections warrant. Loans involving construction financing present a greater
risk than loans for the purchase of existing homes, since collateral values and
construction costs can only be estimated at the time the loan is approved. Due
to the small amount of construction loans in the Bank's portfolio, the risk in
this area is limited.
Commercial Real Estate Loans. At June 30, 1998, the Bank's commercial
real estate loan portfolio consisted of 93 loans, totaling $24.5 million, or
17.7% of net loans. The Bank's largest loan is a commercial real estate loan
with an outstanding balance of $2.2 million at June 30, 1998 secured by 78
residential apartment units in Medford and Malden, Massachusetts. Commercial
real estate loans are administered by the commercial loan department as
described below under "Commercial Loans."
In May 1995, the Bank hired a commercial loan officer with over 20 years
of experience in commercial lending in the Boston market area for the purpose
of expanding the commercial lending program of the Bank. In 1996, the Bank
added a second commercial loan officer with over 15 years of experience with
commercial lending in the Bedford/Lexington area. With the help of these two
officers, the Bank is originating commercial real estate loans and commercial
loans to satisfy the working capital and short-term financing needs of
established local businesses.
Commercial real estate lending entails additional risks compared with
one- to four-family residential lending. Because payments on loans secured by
commercial real estate properties are often dependent on the successful
operation or management of the properties, repayment of such loans may be
subject, to a greater extent, to adverse conditions in the real estate market
or the economy. Also, commercial real estate loans typically involve large loan
balances to single borrowers or groups of related borrowers and the payment
experience on such loans is typically dependent on the successful operation of
a real estate project and/or the collateral value of the commercial real estate
securing the loan.
Commercial Loans. In the past three years, the Bank has made a major
commitment to small business commercial lending. The Bank has worked to develop
a niche of making commercial loans to companies which have from $500,000 to $15
million in sales and has recently become an approved lender of the Small
Business Administration. At June 30, 1998, the Bank's commercial loan portfolio
consisted of 123 loans, totaling $4.6 million, or 3.3% of net loans.
Commercial loans are expected to comprise a growing portion of the Bank's
loan portfolio in the future. Unless otherwise structured as a mortgage on
commercial real estate, such loans generally are limited to terms of five years
or less. Substantially all such commercial loans have variable interest rates
tied to the prime rate as reported in the Wall Street Journal. Whenever
possible, the Bank collateralizes these loans with a lien on commercial real
estate, or alternatively, with a lien on business assets and equipment and the
personal guarantees from principals of the borrower.
Commercial business loans are generally considered to involve a higher
degree of risk than residential mortgage loans because the collateral may be in
the form of intangible assets and/or inventory subject to market obsolescence.
Commercial loans may also involve relatively large loan balances to single
borrowers or groups of related borrowers, with the repayment of such loans
typically dependent on the successful operation and income stream of the
borrower. Such risks can be significantly affected by economic conditions. In
addition, commercial business lending generally requires substantially greater
oversight efforts compared to residential real estate lending.
Home Equity Loans. The Bank also originates home equity loans which are
loans secured by available equity based on the appraised value of
owner-occupied one- to four-family residential property. Home equity loans will
be made for up to 75% of the appraised value of the property (less the amount
of the first mortgage). Home equity loans are offered at adjustable rates and
fixed rates. The adjustable interest rate is prime minus 1% for the first year
and prime plus 1% thereafter above the prime rate as reported in the Wall
Street Journal and have terms of ten years or less. At June 30, 1998, the Bank
had $1.7 million in home equity loans with unused credit available to existing
borrowers of $1.7 million.
Consumer Loans. The Bank's consumer loans consist of share secured loans,
and other consumer loans, including automobile loans and credit card loans. At
June 30,1998, the consumer loan portfolio totaled $1.8 million or 1.3% of total
loans. Consumer loans are generally offered for terms of up to five years at
fixed interest rates. Consumer loans generally do not exceed $25,000
individually.
The Bank makes share secured loans up to 90% of the amount of the
depositor's savings account balance. The interest rate on the loan is 4% higher
than the rate being paid on the account. The Bank also makes other consumer
loans, which may or may not be secured. The terms of such loans usually depend
on the collateral.
The Bank makes loans for automobiles, both new and used, directly to the
borrowers. The loans are generally limited to 90% of the purchase price or the
retail value listed by the National Automobile Dealers Book. The terms of the
loans are determined by the age and condition of the collateral. Collision
insurance policies are required on all these loans.
The Bank makes unsecured credit card loans up to $5,000 at fixed rates of
interest. At June 30, 1998, the Bank had 625 unsecured credit card loans
totaling $356,000.
Consumer loans are generally originated at higher interest rates than
residential mortgage loans but also tend to have a higher credit risk than
residential loans due to the loan being unsecured or secured by rapidly
depreciable assets. Despite these risks, the Bank's level of consumer loan
delinquencies generally has been low. No assurance can be given, however, that
the Bank's delinquency rate on consumer loans will continue to remain low in
the future, or that the Bank will not incur future losses on these activities.
Loan Commitments. The Bank generally makes loan commitments to borrowers
not exceeding 60 days. At June 30, 1998, the Bank had $6.4 million in loan
commitments outstanding, all for the origination of one- to four-family
residential real estate loans, home equity loans, commercial loans and
commercial real estate loans. In addition, unadvanced funds on lines of credit
and credit card loans were $5.9 million.
Loan Solicitation and Loan Fees. Loan originations are derived from a
number of sources, including the Bank's existing customers, referrals,
realtors, advertising and "walk-in" customers at the Bank's office.
Additionally, the Bank has two residential loan originators, both of whom
actively cover the local community, working with local real estate brokers and
agents to identify and contact potential new customers.
Upon receipt of a loan application from a prospective borrower, a credit
report and verifications are ordered to verify specific information relating to
the loan applicant's employment, income and credit standing. For all mortgage
loans, an appraisal of real estate intended to secure the proposed loan is
obtained from an independent appraiser who has been approved by the Bank's
board of directors. Fire and casualty insurance are required on all loans
secured by improved real estate. Insurance on other collateral is required
unless waived by the loan committee. The board of directors of the Bank has the
responsibility and authority for the general supervision over the loan policies
of the Bank. The Board has established written lending policies for the Bank.
All residential and commercial real estate mortgages and commercial business
loans must be ratified by the Bank's board of directors. In addition, certain
designated officers of the Bank have authority to approve loans not exceeding
specified levels, while the board of directors must approve loans in excess of
(a) $300,000 for commercial real estate loans; (b) $100,000 for commercial
loans; (c) loans over the current FNMA limit for residential mortgage loans;
and (d) $20,000 for consumer loans.
Interest rates charged by the Bank on all loans are primarily determined
by competitive loan rates offered in its market area and interest rate costs of
the source of funding for the loan. The Bank may charge an origination fee on
new mortgage loans. The origination fees, net of direct origination costs, are
deferred and amortized into income over the life of the loan. At June 30, 1998,
the amount of net deferred loan origination fees was $17,000.
Loan Maturities. The following table sets forth certain information at
June 30, 1998 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal. Demand loans and loans having no stated schedule of
repayments and no stated maturity are reported as due in one year or less.
At June 30, 1998
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Residential Commercial
Mortgage Real Estate Commercial Consumer Total
Loans(1) Loans Loans Loans Loans
----------- ----------- ---------- -------- --------
(In thousands)
Total loans scheduled to mature:
In one year or less $ 1,589 $ 334 $1,878 $ 71 $ 3,872
After 1 year through 5 years 1,567 356 2,257 1,603 5,783
Beyond five years 106,232 23,785 444 113 130,574
------------------------------------------------------------
Total $109,388 $24,475 $4,579 $1,787 $140,229
============================================================
Loan balance by type scheduled to
mature after one year:
Fixed-rate $ 45,927 $ 2,055 $1,461 $1,716 $ 51,159
Adjustable-rate 61,872 22,086 1,240 --- 85,198
- --------------------
For purposes of this schedule, home equity loans and construction loans
have been included in residential mortgage loans.
Originations and Sales of Loans. The Bank is a qualified seller/servicer
for FNMA. Beginning in 1987, the Bank began to sell a portion of its fixed-rate
loans with terms in excess of 15 years to FNMA. All of the Bank's sales to FNMA
have been made with servicing retained on the loans. At June 30, 1998, the Bank
was servicing $13.1 million in loans for FNMA. Depending upon market
conditions, the Bank retains a portion of its fixed rate loans from time to
time. In addition, the Bank has also sold loans to other private investors. At
June 30, 1998, the Bank was servicing $3.7 million of such loans.
Originations for the year ended June 30, 1998 have continued to increase
due to the addition of a mortgage loan originator and a second commercial
lending officer. Loan sales were reduced during the same period as the Bank
borrowed from the FHLB to fund loan originations. Historically, the Bank has
not purchased loans. However, the Bank may in the future consider making
limited loan purchases, including purchases of commercial loans and commercial
real estate loans. The following table sets forth information with respect to
originations and sales of loans during the periods indicated.
Years Ended June 30,
--------------------------------
1998 1997 1996
-------- -------- --------
(In thousands)
Beginning balance $114,568 $ 94,760 $ 80,217
--------------------------------
Mortgage originations 43,141 28,423 24,712
Consumer loan originations 2,218 959 1,033
Commercial real estate loan originations 6,338 10,573 5,357
Commercial loan originations 3,680 4,771 2,908
Loan participations repurchased 1,914 -- --
--------------------------------
Total loans originated and purchased 57,291 44,726 34,010
--------------------------------
Less:
Amortization and payoffs 27,675 15,055 16,561
Provision for loan losses 245 272 100
Transfers to foreclosed real estate -- -- 83
Total loans sold 5,346 8,750 1,598
Loan participations sold -- 841 1,125
--------------------------------
Ending balance $138,593 $114,568 $ 94,760
================================
Non-Performing Assets, Asset Classification and Allowances for Losses.
Management and the Security Committee of the board of directors perform a
monthly review of all delinquent loans and loans are placed on a non-accrual
status when loans are 90 days past due or, in the opinion of management, the
collection of principal and interest are doubtful. One of the primary tools
used to manage and control problem loans is the Bank's "Watch-List," a listing
of all loans or commitments larger than $25,000, that are considered to have
characteristics that could result in loss to the Bank if not properly
supervised. The list is managed by the Senior Lending Officer for Commercial
Loans, Senior Loan Officer for Mortgage Lending, Chief Financial Officer, Chief
Executive Officer, and Mortgage Servicing Officer (the "Watch-List Committee"),
who meet periodically to discuss the status of the loans on the Watch List and
to add or delete loans from the list. The Directors can request that a loan
relationship be placed on Watch-List status.
Real estate acquired by the Bank as a result of foreclosure is classified
as real estate owned until such time as it is sold. When such property is
acquired, it is recorded at the lower of the unpaid principal balance or its
fair value. Any required write-down of the loan to its fair value is charged to
the allowance for loan losses.
The following table sets forth the Bank's problem assets and loans at the
dates indicated.
At June 30,
-----------------------------
1998 1997 1996
------- ------- -------
(Dollars in thousands)
Loans 30-89 days past due
(not included in non-performing loans) $1,374 $1,708 $1,265
============================
Loans 30-89 days past due as a percent of net loans 0.99% 1.49% 1.33%
Non-performing loans (90 days past due) $ 150 $ 365 622
Foreclosed real estate -- -- --
----------------------------
Total non-performing assets $ 150 $ 365 $ 622
============================
Non-performing loans as a percent of net loans 0.11% 0.32% 0.66%
Non-performing assets as a percent of total assets 0.08% 0.24% 0.47%
During the year ended June 30, 1998, gross interest income of $24,000,
would have been recorded on loans accounted for on a non-accrual basis if the
loans had been current throughout the period. No interest on such loans was
included in income during the respective period. At June 30, 1998, management
was not aware of any loans not currently classified as non-accrual, 90 days
past due or restructured but which may be so classified in the near future
because of concerns over the borrower's ability to comply with repayment terms.
Federal regulations require each banking institution to classify its
asset quality on a regular basis. In addition, in connection with examinations
of such banking institutions, federal and state examiners have authority to
identify problem assets and, if appropriate, classify them. An asset is
classified substandard if it is determined to be inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. As a general rule, the Bank will classify a loan as
substandard if the Bank can no longer rely on the borrower's income as the
primary source for repayment of the indebtedness and must look to secondary
sources such as guarantors or collateral. An asset is classified as doubtful if
full collection is highly questionable or improbable. An asset is classified as
loss if it is considered uncollectible, even if a partial recovery could be
expected in the future. The regulations also provide for a special mention
designation, described as assets which do not currently expose a banking
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's
close attention. Assets classified as substandard or doubtful require a banking
institution to establish general allowances for loan losses. If an asset or
portion thereof is classified as a loss, a banking institution must either
establish specific allowances for loan losses in the amount of the portion of
the asset classified as a loss, or charge off such amount. Examiners may
disagree with a banking institution's classifications and amounts reserved. If
a banking institution does not agree with an examiner's classification of an
asset, it may appeal this determination to the Regional Director of the FDIC.
At June 30, 1998, the Bank had no assets classified as doubtful or loss, and
$150,000 in assets designated as substandard.
In originating loans, the Bank recognizes that credit losses will occur
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. It is management's policy to maintain an adequate
general allowance for loan losses based on, among other things, evaluation of
economic conditions and regular reviews of delinquencies and loan portfolio
quality. Further, after properties are acquired following loan defaults,
additional losses may occur with respect to such properties while the Bank is
holding them for sale. The Bank increases its allowances for loan losses and
losses on real estate owned by charging provisions for losses against the
Bank's income. Specific reserves are also recognized against specific assets
when management believes it is warranted.
While the Bank believes it has established its existing allowances for
loan losses in accordance with GAAP there can be no assurance that regulators,
in reviewing the Bank's loan portfolio, will not request the Bank to increase
its allowance for loan losses, thereby negatively affecting the Bank's
financial condition and earnings. Alternately, there can be no assurance that
increases in the Bank's allowance for loan losses will occur.
The FDIC has adopted a policy statement regarding maintenance of an
adequate allowance for loan and lease losses and an effective loan review
system. This policy includes an arithmetic formula for checking the
reasonableness of an institution's allowance for loan loss estimate compared to
the average loss experience of the industry as a whole. Examiners will review
an institution's allowance for loan losses and compare it against the sum of
(i) 50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio
that is classified as substandard; and (iii) estimated credit losses for the
portions of the portfolio that have not been classified (including those loans
designated as special mention). This amount is considered neither a "floor" nor
a "safe harbor" of the level of allowance for loan losses an institution should
maintain, but examiners will view a shortfall relative to the amount as an
indication that they should review management's policy on allocating these
allowances to determine whether it is reasonable based on all relevant factors.
The following table analyzes activity in the Bank's allowance for loan
losses for the periods indicated.
Years Ended June 30,
----------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in thousands)
Average loans, net $124,971 $103,223 $ 86,651
==================================
Period-end total loans $138,593 $114,568 $ 94,760
==================================
Allowance for loan losses at beginning of period $ 977 $ 742 $ 757
Provision charged to operations 245 272 100
Recoveries:
Real estate mortgage:
Residential --- --- 10
Commercial --- --- ---
Commercial loans 16 --- ---
Consumer and home equity --- 20 13
Construction --- --- ---
----------------------------------
Total recoveries 16 20 23
----------------------------------
Loans charged-off:
Real estate-mortgage:
Residential --- --- (100)
Commercial --- (24) ---
Commercial loans --- --- ---
Consumer and home equity (2) (33) (38)
Construction --- --- ---
----------------------------------
Loans charged-off (2) (57) (138)
----------------------------------
Allowance for loan losses at end of period $ 1,236 $ 977 $ 742
==================================
Ratios:
Allowance for loan losses to period end net loans 0.89% 0.85% 0.78%
Allowance for loan losses to non-performing loans 824.00% 267.67% 119.29%
Net charge-offs (recoveries) to average loans, net (0.01)% 0.04% 0.13%
Net charge-offs (recoveries) to allowance for loan losses (1.13)% 3.79% 15.50%
The following table sets forth a breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. These
allocations are not necessarily indicative of future losses and do not restrict
the use of the allowance to absorb losses in any other loan category.
At June 30,
------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
Real estate - mortgage:
Residential $ 559 75.8% $542 77.8% $542 86.2%
Commercial 531 17.5 338 15.4 120 8.7
Commercial loans 100 3.3 75 3.2 50 1.8
Consumer and home equity 46 2.5 22 2.8 30 3.1
Construction -- 0.9 -- 0.8 -- 0.2
----------------------------------------------------------------------
Total allowance for loan losses $1,236 100.0% $977 100.0% $742 100.0%
======================================================================
Investment Activities
General. The Bank is required to maintain an amount of liquid assets
appropriate for its level of net savings withdrawals and current borrowings. It
has generally been the Bank's policy to maintain a liquidity portfolio in
excess of regulatory requirements. At June 30, 1998, the Bank's liquidity ratio
was 25.4%. Liquidity levels may be increased or decreased depending upon the
yields on investment alternatives, management's judgment as to the
attractiveness of the yields then available in relation to other opportunities,
management's expectations of the level of yield that will be available in the
future and management's projections as to the short-term demand for funds to be
used in the Bank's loan origination and other activities.
Interest income from investments in various types of liquid assets
provides a significant source of revenue for the Bank. As the New England
economy experienced a severe downturn in the late 1980's, the Bank chose to
invest excess liquidity in its investment portfolio. The Bank invests in U.S.
Treasury and Federal Agency securities, bank certificates of deposits, equity
securities, corporate debt securities and overnight federal funds. The balance
of investment securities maintained by the Bank in excess of regulatory
requirements reflects management's historical objective of maintaining
liquidity at a level that assures the availability of adequate funds, taking
into account anticipated cash flows and available sources of credit, for
meeting withdrawal requests and loan commitments and making other investments.
The Bank purchases securities through a primary dealer of U.S. Government
obligations or such other securities dealers authorized by the board of
directors and requires that the securities be delivered to a safekeeping agent
before the funds are transferred to the broker or dealer. The Bank purchases
investment securities pursuant to an investment policy established by the board
of directors.
Available for sale securities are reported at fair value with unrealized
gains or losses reported as a separate component of stockholders' equity, net
of tax effects. Held-to-maturity securities are carried at amortized cost.
Substantially all purchases of investment securities conform to the Company's
interest rate risk policy. The following table sets forth the Company's
investment securities at the dates indicated.
At June 30,
---------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ------- --------- ------- --------- -------
(Dollars in thousands)
Securities available for sale:
Marketable equity securities $ 2,544 $ 3,222 $ 3,543 $ 3,819 $ 1,639 $ 1,568
U.S. Government and Federal Agency
obligations 11,540 11,527 --- --- --- ---
--------------------------------------------------------------
Total 14,084 14,749 3,543 3,819 1,639 1,568
--------------------------------------------------------------
Securities held to maturity:
U.S. Government and Federal Agency
obligations 9,498 9,510 14,976 14,908 16,899 16,767
Other bonds and obligations 2,508 2,520 2,528 2,523 27 27
--------------------------------------------------------------
Total 12,006 12,030 17,504 17,431 16,926 16,794
--------------------------------------------------------------
Total $26,090 $26,779 $21,047 $21,250 $18,565 $18,362
==============================================================
The following table sets forth the scheduled maturities, carrying values
and average yields for the Company's debt securities at June 30, 1998.
June 30, 1998
---------------------------------------------------------------
One Year or Less One to Five Years Total
------------------- ------------------- -------------------
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
--------- ------- --------- ------- --------- -------
(Dollars in thousands)
Securities available for sale:
U.S. Government and Federal Agency
obligations $1,499 5.38% $10,041 5.98% $11,540 5.90%
============================================================
Securities held to maturity:
U.S. Government and Federal Agency
obligations $5,996 5.97% $ 3,502 6.07% $ 9,498 6.01%
Other bonds and obligations 1,505 6.25% 1,003 6.16% 2,508 6.24%
------------------------------------------------------------
Total $7,501 6.03% $ 4,505 6.09% $12,006 6.06%
============================================================
Deposit Activity and Other Sources Of Funds
General. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. In addition to deposits, the Bank derives funds
from principal repayments and interest payments on loans and investments as
well as other sources arising from operations in the production of net
earnings. Loan repayments and interest payments are a relatively stable source
of funds, while deposit inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds from
other sources, or on a longer term basis for general business purposes.
Deposits. Deposits are attracted principally from within the Bank's
primary market area through the offering of a broad selection of deposit
instruments, including checking accounts, passbook savings, NOW accounts,
demand deposits, money market accounts and certificates of deposit. Deposit
account terms vary, with the principal differences being the minimum balance
required, the time periods the funds must remain on deposit and the interest
rate.
The Bank's policies are designed primarily to attract deposits from local
residents and businesses rather than to solicit deposits from areas outside its
primary market. The Bank does not accept deposits from brokers due to the
volatility and rate sensitivity of such deposits. Interest rates paid, maturity
terms, service fees and withdrawal penalties are established by the Bank on a
periodic basis. Determination of rates and terms are predicated upon funds
acquisition and liquidity requirements, rates paid by competitors, growth goals
and federal regulations.
During the past two years, there has been a significant increase in
demand deposit and NOW accounts, resulting from the increase in commercial
customers during this time period.
The following table sets forth the various types of deposit accounts at
the Bank and the balances in these accounts at the dates indicated.
At June 30,
-----------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Savings deposits $ 40,460 27.9% $ 40,794 31.6% $ 40,019 33.5%
NOW accounts 34,208 23.6 17,975 13.9 15,480 12.9
Money market deposits 6,256 4.3 6,489 5.0 6,366 5.3
Demand deposits 6,603 4.6 4,910 3.8 4,103 3.4
Certificates of deposit 57,239 39.6 59,135 45.7 53,666 44.9
-----------------------------------------------------------------
Total deposits $144,766 100.0% $129,303 100.0% $119,634 100.0%
=================================================================
For more information on the Bank's deposit accounts, see Note 6 of Notes
to Consolidated Financial Statements.
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity at June 30, 1998.
Maturity Period Certificates of Deposit Rate
--------------- ----------------------- -----
(Dollars in thousands)
0-3 months $ 2,568 5.22%
3-6 months 2,794 5.26
6-12 months 2,206 5.59
1-2 years 1,660 5.71
2-3 years 420 6.07
over 3 years 120 6.25
-------
Total $ 9,768 5.45%
=======
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB to supplement its supply of lendable funds and to meet liquidity
requirements. Due to recent lending activity and demand for liquidity, the Bank
has utilized this borrowing power, and has received advances from the FHLB.
Advances from the FHLB are secured by the Bank's stock in the FHLB, the Bank's
deposits at the FHLB and a portion of the Bank's mortgage loans and investment
securities. The Bank had FHLB advances of $16.5 million outstanding at June 30,
1998.
The FHLB functions as a central reserve bank providing credit for savings
institutions and certain other financial institutions. As a member, the Bank is
required to own capital stock in the FHLB and is authorized to apply for
advances on the security of such stock and certain of its home mortgages and
other assets (principally, securities which are obligations of, or guaranteed
by the United States) provided certain standards related to creditworthiness
have been met.
Personnel
As of June 30, 1998, the Bank had 48 full-time employees and 21 part-time
employees. The employees are not represented by a collective bargaining unit
and the Bank considers its relationship with its employees to be good.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The following is intended only as a discussion of material tax
matters and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company. The Bank has not been audited by the IRS
during the last five years. For federal income tax purposes, the Company and
the Bank will file consolidated income tax returns and report their income on a
fiscal year basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's tax reserve for bad debts,
discussed below.
Bad Debt Reserves. The Bank, as a "small bank" (one with assets having an
adjusted tax basis of $500 million or less) is permitted to maintain a reserve
for bad debts with respect to its loans and to make, within specified formula
limits, annual additions to the reserve which are deductible for purposes of
computing the Bank's taxable income. Pursuant to the Small Business Job
Protection Act of 1996, the Bank is now recapturing (taking into income) over a
multi-year period a portion of the balance of its bad debt reserve as of June
30, 1997.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to shareholders, such distributions will be considered to result
in distributions from the Bank's "base year reserve," i.e., its reserve as of
April 30, 1988, to the extent thereof and then from its supplemental reserve
for losses on loans, and an amount based on the amount distributed will be
included in the Bank's taxable income. Non-dividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not constitute non-dividend distributions and, therefore, will
not be included in the Bank's income.
The amount of additional taxable income created from a non-dividend
distribution is equal to the lesser of the Bank's base year reserve and
supplemental reserve for losses on loans; or an amount that, when reduced by
the tax attributable to the income, is equal to the amount of the distribution.
Thus, in certain situations approximately one and one-half times the
non-dividend distribution would be includable in gross income for federal
income tax purposes, assuming a 34% federal corporate income tax rate.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended (the "Code"), imposes a tax ("AMT") on alternative minimum taxable
income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net
operating loss carryovers of which the Bank currently has none. AMTI is also
adjusted by determining the tax treatment of certain items in a manner that
negates the deferral of income resulting from the regular tax treatment of
those items. Thus, the Bank's AMTI is increased by an amount equal to 75% of
the amount by which the Bank's adjusted current earnings exceeds its AMTI
(determined without regard to this adjustment and prior to reduction for net
operating losses). The Bank does not expect to be subject to the AMT.
Although the corporate environmental tax of 0.12% of the excess of AMTI
(with certain modifications) over $2.0 million has expired, under current
Administration proposals, such tax will be retroactively reinstated for taxable
years beginning after December 31, 1997 and before January 2009.
Elimination of Dividends; Dividends Received Deduction. The Company may
exclude from its income 100% of dividends received from the Bank as a member of
the same affiliated group of corporations. A 70% dividends received deduction
generally applies with respect to dividends received from domestic corporations
that are not members of such affiliated group, except that an 80% dividends
received deduction applies if the Company and the Bank own more than 20% of the
stock of a corporation paying a dividend.
State and Local Taxation
Prior to July, 1995, the Bank was subject to an annual Massachusetts
excise (income) tax equal to 12.54% of its pre-tax income. In 1995, legislation
was enacted to reduce the Massachusetts bank excise (income) tax rate and to
allow Massachusetts-based financial institutions to apportion income earned in
other states. Further, this legislation expands the applicability of the tax to
non-bank entities and out-of-state financial institutions. The Massachusetts
excise tax rate for co-operative banks is currently 11.32% of federal taxable
income, adjusted for certain items. It is anticipated that this rate will be
gradually reduced over the next few years so that the Bank's tax rate will
become 10.5% by June 30, 2000. Taxable income includes gross income as defined
under the Code, plus interest from bonds, notes and evidences of indebtedness
of any state, including Massachusetts, less deductions, but not the credits,
allowable under the provisions of the Code. No deductions, however, are allowed
for dividends received until July 1, 1999. In addition, carryforwards and
carrybacks of net operating losses are not allowed.
The Bank's active subsidiary, Mystic Securities Corporation, was
established solely for the purpose of acquiring and holding investments which
are permissible for banks to hold under Massachusetts law. Mystic Securities
Corporation is classified with the Massachusetts Department of Revenue as a
"security corporation" under Massachusetts law, qualifying it to take advantage
of the low 1.32% income tax rate on gross income applicable to companies that
are so classified.
State of Delaware. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and has paid an annual franchise tax to
the State of Delaware.
For additional information regarding taxation, see Note 8 of the Notes to
Consolidated Financial Statements.
REGULATION
General
As a co-operative bank chartered by the Commonwealth of Massachusetts,
the Bank is subject to extensive regulation under state law with respect to
many aspects of its banking activities; this state regulation is administered
by the Commissioner. In addition, as a bank whose deposits are insured by the
FDIC under the BIF, the Bank is subject to deposit insurance assessments by the
FDIC, and the FDIC has examination and supervisory authority over the Bank,
with a broad range of enforcement powers. Finally, the Bank is required to
maintain reserves against deposits according to a schedule established by the
Federal Reserve System. These laws and regulations have been established
primarily for the protection of depositors and the deposit insurance funds, not
bank stockholders.
The following references to the laws and regulations under which the Bank
is regulated are brief summaries thereof, do not purport to be complete, and
are qualified in their entirety by reference to such laws and regulations.
Massachusetts Banking Laws and Supervision
Massachusetts co-operative banks such as the Bank are regulated and
supervised by the Commissioner. The Commissioner is required to regularly
examine each state-chartered bank. The approval of the Commissioner is required
to establish or close branches, to merge with another bank, to form a bank
holding company, to issue stock or to undertake many other activities. Any
Massachusetts bank that does not operate in accordance with the regulations,
policies and directives of the Commissioner is subject to sanctions. The
Commissioner may under certain circumstances suspend or remove directors or
officers of a bank who have violated the law, conducted a bank's business in a
manner which is unsafe, unsound or contrary to the depositors' interests, or
been negligent in the performance of their duties.
All Massachusetts-chartered co-operative banks are required to be members
of the Co-operative Central Bank and are subject to its assessments. The
Co-operative Central Bank maintains the Share Insurance Fund, a private deposit
insurer, which insures all deposits in member banks in excess of FDIC deposit
insurance limits. In addition, the Co-operative Central Bank acts as a source
of liquidity to its members in supplying them with low-cost funds, and
purchasing certain qualifying obligations from them.
Major changes in Massachusetts law in 1982 and 1983 substantially
expanded the powers of co-operative banks, and made their powers virtually
identical to those of state-chartered commercial banks. The powers which
Massachusetts-chartered co-operative banks can exercise under these laws are
summarized below.
Lending Activities. A Massachusetts chartered co-operative bank may make
a wide variety of mortgage loans. Fixed-rate loans, adjustable-rate loans,
variable-rate loans, participation loans, graduated payment loans, construction
loans, condominium and co-operative loans, second mortgage loans and other
types of loans may be made in accordance with applicable regulations. Mortgage
loans may be made on real estate in Massachusetts or in another New England
state if the bank making the loan has an office there or under certain other
circumstances. In addition, certain mortgage loans may be made on improved real
estate located anywhere in the United States. Commercial loans may be made to
corporations and other commercial enterprises with or without security. With
certain exceptions, such loans may be made without geographic limitation.
Consumer and personal loans may be made with or without security and without
geographic limitation. Loans to individual borrowers generally will be limited
to 20% of the total of the Bank's capital accounts and stockholders' equity.
Investments Authorized. Massachusetts-chartered co-operative banks have
broad investment powers under Massachusetts law, including so-called "leeway"
authority for investments that are not otherwise specifically authorized. The
investment powers authorized under Massachusetts law are restricted by federal
law to permit, in general, only investments of the kinds that would be
permitted for national banks. The Bank has authority to invest in all of the
classes of loans and investments that are permitted by its existing loan and
investment policies.
Payment of Dividends. A co-operative bank may only pay dividends on its
capital stock if such payment would not impair the bank's capital stock and
surplus account. No dividends may be paid to stockholders of a bank if such
dividends would reduce stockholders' equity of the bank below the amount of the
liquidation account required by Massachusetts conversion regulations.
Branches. With the approval of the Commissioner, bank branches may be
established in any city or town in Massachusetts; in addition, co-operative
banks may operate automated teller machines at any of their offices or, with
the Commissioner's approval, anywhere in Massachusetts. Sharing of ATMs or
"networking" is also permitted with the Commissioner's approval. Massachusetts
chartered co-operative banks may also operate ATMs outside of Massachusetts if
permitted to do so by the law of the jurisdiction in which the ATM is located.
Interstate Acquisitions. In 1996, the Massachusetts legislature passed a
new interstate banking statute in anticipation of the June 1, 1997 effective
date of the federal interstate banking law. Pursuant to this statute, an
out-of-state bank may (subject to various regulatory approvals and to
reciprocity in its home state) establish and maintain bank branches in
Massachusetts by (i) merging with a Massachusetts bank that has been in
existence for at least three years, (ii) acquiring a branch or branches of a
Massachusetts bank without acquiring the entire bank, or (iii) opening such
branches de novo. Massachusetts banks' ability to exercise similar interstate
banking powers in other states depends upon the laws of the other states. For
example, according to the law of the bordering state of New Hampshire,
out-of-state banks may acquire New Hampshire banks by merger, but may not
establish de novo branches in New Hampshire.
Other Powers. Massachusetts-chartered co-operative banks may also lease
machinery and equipment, act as trustee or custodian for tax qualified
retirement plans, establish trust departments and act as professional trustee
or fiduciary, provide payroll services for their customers, issue or
participate with others in the issuance of mortgage-backed securities and
establish mortgage banking companies and discount securities brokerage
operations. Some of these activities require the prior approval of the
Commissioner.
Post-conversion Oversight. The Commissioner continues to oversee the Bank
following the Conversion on a number of matters specifically relating to the
Conversion. For example, the Bank has agreed to submit written quarterly
progress reports to the Division for three years following the Conversion which
detail the implementation of the Bank's conversion business plan's objectives
and goals.
Federal Banking Regulations
Capital Requirements. Under FDIC regulations, state-chartered banks that
are not members of the Federal Reserve System ("state non-member banks"), such
as the Bank, are required to comply with minimum leverage capital requirements.
For an institution determined by the FDIC to not be anticipating or
experiencing significant growth and to have well diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high liquidity,
good earnings and to be in general a strong banking organization, rated
composite 1 under the Uniform Financial Institutions Ranking System (the CAMELS
rating system) established by the Federal Financial Institutions Examination
Council, the minimum capital leverage requirement is a ratio of Tier 1 capital
to total assets of 3%. For all other institutions, the minimum leverage capital
ratio is 3% plus an additional "cushion" amount of at least 100 to 200 basis
points. The FDIC and the other federal banking regulators have proposed
amendments to their minimum capital regulations to provide that the minimum
leverage capital ratio for a depository institution that has been assigned the
highest composite rating of 1 under the Uniform Financial Institutions Rating
System will be 3% and that the minimum leverage capital ratio for any other
depository institution will be 4%, unless a higher leverage capital ratio is
warranted by the particular circumstances or risk profile of the depository
institution. Tier 1 capital is the sum of common stockholders' equity,
non-cumulative perpetual preferred stock (including any related surplus) and
minority investments in certain subsidiaries, less most intangible assets.
The FDIC has also adopted risk-based capital guidelines to which the Bank
is subject. The guidelines establish a systematic analytical framework designed
to make regulatory capital requirements sensitive to differences in risk
profiles among banking organizations. The FDIC guidelines require state
non-member banks to maintain certain levels of regulatory capital in relation
to regulatory risk-weighted assets. The ratio of such regulatory capital to
regulatory risk-weighted assets is referred to as the Bank's "risk-based
capital ratio." Risk-based capital ratios are determined by allocating assets
and specified off-balance sheet items to four risk-weighted categories ranging
from 0% to 100%, with higher levels of capital being required for the
categories perceived as representing greater risk. Under the FDIC's
risk-weighting system, cash and securities backed by the full faith and credit
of the U.S. government are given a 0% risk weight. Mortgage-backed securities
that qualify under the Secondary Mortgage Enhancement Act, including those
issued, or fully guaranteed as to principal and interest, by the FNMA or the
Federal Home Loan Mortgage Corporation ("FHLMC"), are assigned a 20% risk
weight. Single-family first mortgages not more than 90 days past due with
loan-to-value ratios under 80%, multi-family mortgages (maximum 36 dwelling
units) with loan-to-value ratios under 80% and average annual occupancy rates
over 80%, and certain qualifying loans for the construction of one- to
four-family residences pre-sold to home purchasers, are assigned a risk weight
of 50%. Consumer loans and commercial real estate loans, repossessed assets and
assets more than 90 days past due, as well as all other assets not specifically
categorized, are assigned a risk weight of 100%.
State non-member banks must maintain a minimum ratio of qualifying total
capital to risk-weighted assets of at least 8%, of which at least one-half must
be Tier 1 capital. Qualifying total capital consists of Tier 1 capital plus
Tier 2 or supplementary capital items, which include allowances for loan losses
in an amount of up to 1.25% of risk-weighted assets, cumulative preferred
stock, preferred stock with a maturity of over 20 years, and certain other
capital instruments. The includable amount of Tier 2 capital cannot exceed the
amount of the institution's Tier 1 capital. Qualifying total capital is further
reduced by the amount of the bank's investments in banking and finance
subsidiaries that are not consolidated for regulatory capital purposes,
reciprocal cross-holdings of capital securities issued by other banks and
certain other deductions.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
required each federal banking agency to revise its risk-based capital standards
for insured institutions to ensure that those standards take adequate account
of interest-rate risk ("IRR"), concentration of credit risk, and the risk of
nontraditional activities, as well as to reflect the actual performance and
expected risk of loss on multi-family residential loans. In August 1995, the
FDIC, along with the other federal banking agencies, adopted a regulation
providing that the agencies will take account of the exposure of a bank's
capital and economic value to the risks of changes in interest rates in
assessing a bank's capital adequacy. According to the agencies, applicable
considerations include the quality of the bank's interest rate risk management
process, the overall financial condition of the bank, and the level of other
risks at the bank for which capital is needed. Institutions with significant
interest rate risk may be required to hold additional capital. The agencies
also issued a joint policy statement providing guidance on interest rate risk
management, including a discussion of the critical factors affecting the
agencies' evaluation of interest rate risk in connection with capital adequacy.
The agencies have determined not to proceed with a previously issued proposal
to develop a supervisory framework for measuring interest rate risk and to
require an explicit capital component for interest rate risk.
The following table shows the Company's and the Bank's leverage ratio,
its Tier 1 risk-based capital ratio, and its total risk-based capital ratio, at
June 30, 1998.
Minimum
To Be Well
Capitalized Under
Minimum Prompt Corrective
Actual Capital Requirement Action Provisions
---------------- ----------------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------------ ------- ------- ------
(Dollars in thousands)
Total Risk-Based Capital Ratio
Consolidated $36,931 34.1% $8,670 8.0% N/A N/A
Bank 25,653 24.4 8,412 8.0 $10,515 10.0%
Tier I Risk-Based Capital Ratio
Consolidated 35,695 32.9 4,335 4.0 N/A N/A
Bank 24,417 23.2 4,206 4.0 6,309 6.0
Regulatory Tier I Leverage Capital Ratio (1)
Consolidated 35,695 19.1 7,486-9,357 4.0-5.0 N/A N/A
Bank 24,417 13.9 7,032-8,790 4.0-5.0 8,790 5.0
- --------------------
For the purpose of calculating Regulatory Tier 1 leverage capital, assets
are based on adjusted total average assets. In calculating Tier 1
risk-based capital and total risk-based capital, assets are based on
total risk-weighted assets.
As the preceding table shows, the Company and the Bank exceeded the
minimum capital adequacy requirements at the date indicated.
Enforcement. The FDIC has extensive enforcement authority over insured
co-operative banks, including the Bank. This enforcement authority includes,
among other things, the ability to assess civil money penalties, to issue cease
and desist orders and to remove directors and officers. In general, these
enforcement actions may be initiated in response to violations of laws and
regulations and to unsafe or unsound practices.
The FDIC has authority under federal law to appoint a conservator or
receiver for an insured bank under certain circumstances. The FDIC is required,
with certain exceptions, to appoint a receiver or conservator for an insured
state bank if that bank was "critically undercapitalized" on average during the
calendar quarter beginning 270 days after the date on which the bank became
"critically undercapitalized." For this purpose, "critically undercapitalized"
means having a ratio of tangible capital to total assets of less than 2%. See
"--Prompt Corrective Action." The FDIC may also appoint a conservator or
receiver for a state bank on the basis of the institution's financial condition
or upon the occurrence of certain events, including: (i) insolvency (whereby
the assets of the bank are less than its liabilities to depositors and others);
(ii) substantial dissipation of assets or earnings through violations of law or
unsafe or unsound practices; (iii) existence of an unsafe or unsound condition
to transact business; (iv) likelihood that the bank will be unable to meet the
demands of its depositors or to pay its obligations in the normal course of
business; and (v) insufficient capital, or the incurring or likely incurring of
losses that will deplete substantially all of the institution's capital with no
reasonable prospect of replenishment of capital without federal assistance.
Deposit Insurance. The FDIC has adopted a risk-based deposit insurance
assessment system. The FDIC assigns an institution to one of three capital
categories based on the institution's financial information, as of the
reporting period ending seven months before the assessment period, consisting
of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized,
and one of three supervisory subcategories within each capital group. The
supervisory subgroup to which an institution is assigned is based on a
supervisory evaluation provided to the FDIC by the institution's primary
federal regulator and information that the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance funds. An institution's assessment rate depends on the capital
category and supervisory category to which it is assigned. Assessment rates for
BIF deposits currently range from 0 basis points to 27 basis points. The Bank's
assessment rate is currently 0 basis points. The FDIC is authorized to raise
the assessment rates in certain circumstances, including to maintain or achieve
the designated reserve ratio of 1.25%, which requirement the BIF currently
meets. The FDIC has exercised its authority to raise rates in the past and may
raise insurance premiums in the future. If such action is taken by the FDIC, it
could have an adverse effect on the earnings of the Bank. In addition, recent
legislation requires BIF-insured institutions like the Bank to assist in the
payment of FICO bonds.
Under the Deposit Insurance Funds Act of 1996 (the "Funds Act"), the
assessment base for the payments on the FICO bonds was expanded to add,
beginning January 1, 1997, the deposits of BIF-insured institutions, such as
the Bank. Until December 31, 1999, or such earlier date on which the last
savings association ceases to exist, the rate of assessment for BIF-assessable
deposits shall be one-fifth of the rate imposed on SAIF-assessable deposits.
The annual rate of assessments for the payments on the FICO bonds for the
semi-annual period beginning on July 1, 1997 was 0.0126% for BIF-assessable
deposits and 0.0630% for SAIF-assessable deposits. For the semi-annual period
beginning July 1, 1998, the rates of assessment for the FICO bonds is 0.0122%
for BIF-assessable deposits and 0.0610% for SAIF-assessable deposits.
Under the Federal Deposit Insurance Act (the "FDI Act"), insurance of
deposits may be terminated by the FDIC upon a finding that the institution has
engaged in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law, regulation, rule, order
or condition imposed by the FDIC or the Division. The management of the Bank
does not know of any practice, condition or violation that might lead to
termination of deposit insurance.
Transactions with Affiliates and Insiders of the Bank. Transactions
between an insured bank, such as the Bank, and any of its affiliates is
governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a
bank is any company or entity which controls, is controlled by or is under
common control with the bank. Currently, a subsidiary of a bank that is not
also a depository institution is not treated as an affiliate of the bank for
purposes of Sections 23A and 23B, but the FRB has proposed treating any
subsidiary of a bank that is engaged in activities not permissible for bank
holding companies under the BHCA as an affiliate for purposes of Sections 23A
and 23B. Generally, Sections 23A and 23B (i) limit the extent to which the bank
or its subsidiaries may engage in "covered transactions" with any one affiliate
to an amount equal to 10% of such institution's capital stock and surplus, and
limit all such transactions with all affiliates to an amount equal to 20% of
such capital stock and surplus and (ii) require that all such transactions be
on terms that are consistent with safe and sound banking practices. The term
"covered transaction" includes the making of loans, purchase of assets,
issuance of guarantees and similar other types of transactions. In addition,
any covered transaction and certain other transactions, including the sale of
assets or purchase of services, between a bank and any of its affiliates must
be on terms that are substantially the same, or at least as favorable, to the
bank as those that would be provided to a non-affiliate. Further, most loans by
a bank to its affiliate must be supported by collateral in amounts ranging from
100 to 130 percent of the loan amounts.
A bank's loans to its executive officers, directors, any owner of 10% or
more of its stock and any of certain entities affiliated to any such person
(each an "insider") are subject to the conditions and limitations imposed by
Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder. Under Section 22(h), loans to an insider may not
exceed, together with all other outstanding loans to such person and affiliated
interests, the loans-to-one-borrower limit applicable to national banks
(generally 15% of the institution's unimpaired capital and surplus), and all
loans to all such persons in the aggregate may not exceed the institution's
unimpaired capital and unimpaired surplus. Regulation O also prohibits the
making of loans in an amount greater than either (a) $500,000 or (b) the
greater of $25,000 or 5% of the bank's unimpaired capital and surplus, unless
such loans are approved in advance by a majority of the board of directors of
the bank, with any "interested" director not participating in the voting.
Further, Regulation O requires that loans to insiders be made on terms
substantially the same as those that are offered in comparable transactions to
other persons. Regulation O also prohibits a depository institution from paying
the overdrafts over $1,000 of any of its executive officers or directors unless
they are paid pursuant to written pre-authorized extension of credit or
transfer of funds plans. Also, loans to an executive officer, other than loans
for the education of the officer's children and certain loans secured by the
officer's residence, may not exceed the lesser of (a) $100,000 or (b) the
greater of $25,000 or 2.5% of the bank's capital stock, surplus fund and
undivided profits.
State chartered non-member banks are further subject to the requirements
and restrictions of 12 U.S.C. ss. 1972 on certain tying arrangements and
extensions of credit by correspondent banks. Specifically, this statute (i)
prohibits a depository institution from extending credit to or offering any
other service, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain
services of a competitor of the institution, subject to certain exceptions, and
(ii) also prohibits extensions of credit to executive officers, directors, and
greater than 10% stockholders of a depository institution by any other
institution which has a correspondent banking relationship with the
institution, unless such extension of credit is on substantially the same terms
as those prevailing at the time for comparable transactions with other persons
and does not involve more than the normal risk of repayment or present other
unfavorable features.
Real Estate Lending Policies. FDIC regulations require that
state-chartered nonmember banks must adopt and maintain written policies that
establish appropriate limits and standards for extensions of credit that are
secured by liens or interest in real estate or are made for the purpose of
financing permanent improvements to real estate. These policies must establish
loan portfolio diversification standards, prudent underwriting standards,
including loan-to-value limits, that are clear and measurable, loan
administration procedures and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration of
the Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") that have been adopted by the federal bank regulators.
The Interagency Guidelines, among other things, call upon a depository
institution to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multi-family or other nonresidential property, the supervisory limit is 80%;
(iv) for loans for the construction of one- to four-family properties, the
supervisory limit is 85%; and (v) for loans secured by other improved property
(e.g., farmland, completed commercial property and other income-producing
property including non owner occupied, one- to four-family property), the limit
is 85%. Although no supervisory loan-to-value limit has been established for
owner-occupied, one to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
Safety and Soundness Standards. Pursuant to the requirements of FDICIA,
as amended by the Riegle Community Development and Regulatory Improvement Act
of 1994, each federal banking agency, including the FDIC, has adopted
guidelines establishing general standards relating to internal controls,
information and internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, asset quality, earnings,
and compensation, fees and benefits. In general, the guidelines require, among
other things, appropriate systems and practices to identify and manage the
risks and exposures specified in the guidelines. The guidelines prohibit
excessive compensation as an unsafe and unsound practice and describe
compensation as excessive when the amounts paid are unreasonable or
disproportionate to the services performed by an executive officer, employee,
director, or principal shareholder. In addition, the FDIC adopted regulations
to require a bank that is given notice by the FDIC that it is not satisfying
any of such safety and soundness standards to submit a compliance plan to the
FDIC. If, after being so notified, a bank fails to submit an acceptable
compliance plan or fails in any material respect to implement an accepted
compliance plan, the FDIC may issue an order directing corrective and other
actions of the types to which a significantly undercapitalized institution is
subject under the "prompt corrective action" provisions of FDICIA. If a bank
fails to comply with such an order, the FDIC may seek to enforce such an order
in judicial proceedings and to impose civil monetary penalties.
Prompt Corrective Action. FDICIA also established a system of prompt
corrective action to resolve the problems of undercapitalized institutions. The
FDIC, as well as the other federal banking regulators, adopted regulations
governing the supervisory actions that may be taken against undercapitalized
institutions. The regulations establish five categories, consisting of "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." The FDIC's regulations
defines the five capital categories as follows: Generally, an institution will
be treated as "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of core capital to risk-weighted assets is at
least 6%, its ratio of core capital to total assets is at least 5%, and it is
not subject to any order or directive by the FDIC to meet a specific capital
level. An institution will be treated as "adequately capitalized" if its ratio
of total capital to risk-weighted assets is at least 8%, its ratio of core
capital to risk-weighted assets is at least 4%, and its ratio of core capital
to total assets is at least 4% (3% if the bank receives the highest rating on
the CAMELS financial institutions rating system) and it is not a
well-capitalized institution. An institution that has total risk-based capital
of less than 8%, Tier 1 risk-based-capital of less than 4% or a leverage ratio
that is less than 4% (or less than 3% if the institution is rated a composite
"1" under the CAMELS rating system) would be considered to be
"undercapitalized." An institution that has total risk-based capital of less
than 6%, core capital of less than 3% or a leverage ratio that is less than 3%
would be considered to be "significantly undercapitalized," and an institution
that has a tangible capital to assets ratio equal to or less than 2% would be
deemed to be "critically undercapitalized." At June 30, 1998 and June 30, 1997,
the Bank was categorized as "well capitalized."
The severity of the action authorized or required to be taken under the
prompt corrective action regulations increases as a bank's capital deteriorates
within the three undercapitalized categories. All banks are prohibited from
paying dividends or other capital distributions or paying management fees to
any controlling person if, following such distribution, the bank would be
undercapitalized. The FDIC is required to monitor closely the condition of an
undercapitalized bank and to restrict the growth of its assets. An
undercapitalized bank is required to file a capital restoration plan within 45
days of the date the bank receives notice that it is within any of the three
undercapitalized categories, and the plan must be guaranteed by any parent
holding company. The aggregate liability of a parent holding company is limited
to the lesser of: (i) an amount equal to the five percent of the bank's total
assets at the time it became "undercapitalized," and (ii) the amount which is
necessary (or would have been necessary) to bring the bank into compliance with
all capital standards applicable with respect to such bank as of the time it
fails to comply with the plan. If a bank fails to submit an acceptable plan, it
is treated as if it were "significantly undercapitalized." Banks that are
significantly or critically undercapitalized are subject to a wider range of
regulatory requirements and restrictions.
The FDIC has a broad range of grounds under which it may appoint a
receiver or conservator for an insured depositary bank. If one or more grounds
exist for appointing a conservator or receiver for a bank, the FDIC may require
the bank to issue additional debt or stock, sell assets, be acquired by a
depository bank holding company or combine with another depository bank. Under
FDICIA, the FDIC is required to appoint a receiver or a conservator for a
critically undercapitalized bank within 90 days after the bank becomes
critically undercapitalized or to take such other action that would better
achieve the purposes of the prompt corrective action provisions. Such
alternative action can be renewed for successive 90-day periods. However, if
the bank continues to be critically undercapitalized on average during the
quarter that begins 270 days after it first became critically undercapitalized,
a receiver must be appointed, unless the FDIC makes certain findings that the
bank is viable.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"), as
implemented by FDIC regulations, a bank savings association has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate
income neighborhoods. The CRA does not establish specific lending requirements
or programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the FDIC, in connection with its examination of a bank, to assess the
bank's record of meeting the credit needs of its community and to take such
record into account in its evaluation of certain applications by such bank. The
CRA also requires all institutions to make public disclosure of their CRA
ratings. The Bank received an "Outstanding" CRA rating in its most recent
examinations from both the FDIC and Commonwealth of Massachusetts.
In April 1995, the FDIC and the other federal banking agencies adopted
amendments revising their CRA regulations. Among other things, the amended CRA
regulations substitute for the prior process-based assessment factors a new
evaluation system that would rate an institution based on its actual
performance in meeting community needs. In particular, the proposed system
would focus on three tests: (a) a lending test, to evaluate the institution's
record of making loans in its service areas; (b) an investment test, to
evaluate the institution's record of investing in community development
projects, affordable housing, and programs benefitting low or moderate income
individuals and businesses; and (c) a service test, to evaluate the
institution's delivery of services through its branches, ATMs, and other
offices. Small banks would be assessed pursuant to a streamlined approach
focusing on a lesser range of information and performance standards. The term
"small bank" is defined as including banks with less than $250 million in
assets or an affiliate of a holding company with banking and thrift assets of
less than $1 billion, which would include the Bank.
Holding Company Regulation
Federal Regulation. The Company is subject to examination, regulation and
periodic reporting under the Bank Holding Company Act (the "BHCA"), as
administered by the Federal Reserve Board (the "FRB"). The FRB has adopted
capital adequacy guidelines for bank holding companies on a consolidated basis
substantially similar to those of the FDIC for the Bank. As of June 30, 1998,
the Company's total capital and Tier 1 capital ratios exceeded these minimum
capital requirements.
The Company will be required to obtain the prior approval of the FRB to
acquire all, or substantially all, of the assets of any bank or bank holding
company. Prior FRB approval will be required for the Company to acquire direct
or indirect ownership or control of any voting securities of any bank or bank
holding company if, after giving effect to such acquisition, it would, directly
or indirectly, own or control more than 5% of any class of voting shares of
such bank or bank holding company.
The Company will be required to give the FRB prior written notice of any
purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding
12 months, will be equal to 10% or more of the Company's consolidated net
worth. The FRB may disapprove such a purchase or redemption if it determines
that the proposal would constitute an unsafe and unsound practice, or would
violate any law, regulation, FRB order or directive, or any condition imposed
by, or written agreement with, the FRB. Such notice and approval is not
required for a bank holding company that would be treated as "well capitalized"
under applicable regulations of the FRB, that has received a composite "1" or
"2" rating at its most recent bank holding company inspection by the FRB, and
that is not the subject of any unresolved supervisory issues.
The status of the Company as a registered bank holding company under the
BHCA does not exempt it from certain federal and state laws and regulations
applicable to corporations generally, including, without limitation, certain
provisions of the federal securities laws.
In addition, a bank holding company is generally prohibited from engaging
in, or acquiring direct or indirect control of any company engaged in,
non-banking activities. One of the principal exceptions to this prohibition is
for activities found by the FRB to be so closely related to banking or managing
or controlling banks as to be a proper incident thereto. Some of the principal
activities that the FRB has determined by regulation to be so closely related
to banking as to be a proper incident thereto are: (i) making or servicing
loans; (ii) performing certain data processing services; (iii) providing
discount brokerage services; (iv) acting as fiduciary, investment or financial
advisor, (v) leasing personal or real property; (vi) making investments in
corporations or projects designed primarily to promote community welfare; and
(vii) acquiring a savings and loan association.
Under FIRREA, depository institutions are liable to the FDIC for losses
suffered or anticipated by the FDIC in connection with the default of a
commonly controlled depository institution or any assistance provided by the
FDIC to such an institution in danger of default. This law would have potential
applicability if the Company ever acquired as a separate subsidiary a
depository institution in addition to the Bank. There are no current plans for
such an acquisition.
Subsidiary banks of a bank holding company are subject to certain
quantitative and qualitative restrictions imposed by the Federal Reserve Act on
any extension of credit to, or purchase of assets from, or letter of credit on
behalf of, the bank holding company or its subsidiaries, and on the investment
in or acceptance of stocks or securities of such holding company or its
subsidiaries as collateral for loans. In addition, provisions of the Federal
Reserve Act and FRB regulations limit the amounts of, and establish required
procedures and credit standards with respect to, loans and other extensions of
credit to officers, directors and principal shareholders of the Bank, the
Company, any subsidiary of the Company and related interests of such persons.
Moreover, banks are prohibited from engaging in certain tie-in arrangements
(with the bank's parent holding company or any of the holding company's
subsidiaries) in connection with any extension of credit, lease or sale of
property or furnishing of services.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
Federal Home Loan Banks subject to supervision and regulation by the Federal
Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide a central
credit facility primarily for member institution. As a member of the FHLB, the
Bank is required to acquire and hold shares of capital stock in the FHLB in an
amount at least equal to 1% of the aggregate unpaid principal of its home
mortgage loans, home purchase contracts, and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB,
whichever is greater. The Bank was in compliance with this requirement with an
investment in FHLB stock at June 30, 1998, of $997,000.
The FHLB serves as a reserve or central bank for its member institutions
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It offers advances to
members in accordance with policies and procedures established by the FHFB and
the board of directors of the FHLB. Long-term advances may only be made for the
purpose of providing funds for residential housing finance.
Federal Reserve System
Pursuant to regulations of the FRB, a bank must maintain average daily
reserves equal to 3% on the first $47.8 million of net transaction accounts
(subject to an exemption for the first $4.7 million), plus 10% on the
remainder. This percentage is subject to adjustment by the FRB. Because
required reserves must be maintained in the form of vault cash or in a
non-interest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's
interest-earning assets. As of June 30, 1998, the Bank met its reserve
requirements.
Federal Securities Laws
The Company's Common Stock is registered with the SEC under Section 12(g)
of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Accordingly, the Company is subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the Exchange Act.
ITEM 2. PROPERTIES
The following table sets forth certain information at June 30, 1998
regarding the Bank's office facilities, which are owned by the Bank, with the
exception of the High School Educational Branch, which is leased at no cost,
and certain other information relating to its property at that date.
Year Square Net Book
Completed Footage Value
--------- ------- --------
(Dollars in thousands)
Main Office: 60 High Street 1931 7,000 $1,138
Medford, MA 02155
West Medford Office: 430 High Street 1970 2,500 $ 34
Medford, MA 02155
Salem Street Office: 201 Salem Street 1995 3,500 $ 940
Medford, MA 02155
High School Educational Branch: 489 Winthrop Street 1986 500 $ ---
Medford, MA 02155
The Bank also owns an office building adjacent to its main office,
located at 66 High Street, Medford, MA 02155, which had a net book value of
$1.8 million at June 30, 1998. The Bank uses a portion of the top floor of this
building to house some of its administrative and clerical services and leases
the remaining space to third-party tenants.
At June 30, 1998, the net book value of the Bank's computer equipment and
other furniture, fixtures and equipment at its existing offices totaled
$447,000. For more information, see Note 4 of the Notes to Consolidated
Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings in the aggregate are believed by management to be
immaterial to the Company's financial condition and 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
The Company's common stock is traded on the Nasdaq National Market under
the symbol "MYST." The table below shows the high and low sales price during
the periods indicated. The Bank's common stock began trading on January 8,
1998, the date of the Conversion and initial public offering. At June 30, 1998,
the last trading date in the Company's fiscal year, the Company's common stock
closed at $14 1/2. At August 28, 1998, there were 2,573,555 shares of the
Company's common stock outstanding, which were held of record by approximately
1,078 stockholders, not including persons or entities who hold the stock in
nominee or "street" name through various brokerage firms.
On April 8, 1998, the Board of Directors of the Company declared a
quarterly cash dividend of $0.05 per share of common stock, which was paid on
May 15, 1998 to shareholders of record on April 30, 1998. On July 8, 1998, the
Board of Directors of the Company declared a quarterly cash dividend of $0.05
per share of common stock, which was paid on August 14, 1998 to stockholders of
record on July 30, 1998.
The Board of Directors considers paying dividends, dependent on the
results of operations and financial condition of the Company, tax
considerations, industry standards, economic conditions, regulatory
restrictions and other factors. There are significant regulatory limitations on
the Company's ability to pay dividends depending on the dividends it receives
from its subsidiary, Medford Co-operative Bank, which are subject to
regulations and the Bank's continued compliance with all regulatory capital
requirements and the overall health of the institution.
Price Range
------------------
Quarter Ended High Low Dividends
- --------------------------------------- ------- ------- ---------
Fiscal year ended June 30, 1998:
Third Quarter ended March 31, 1998(1) $18 5/8 $14 1/2 $ ---
Fourth Quarter ended June 30, 1998 18 3/4 13 7/8 0.05
- -------------------
Third quarter data is for the period of January 8, 1998 to March 31,
1998.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data concerning the
Company at the dates and for the years indicated. The following data is
qualified in its entirety by the detailed information and consolidated
financial statements appearing elsewhere in this Annual Report on Form 10-K.
At or for the Years Ended June 30,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------- ----
(Dollars in thousands)
Balance sheet data:
Total assets $199,049 $149,653 $131,366 $124,966 $121,063
Loans, net 138,593 114,568 94,760 80,217 77,988
Investment securities:
Available for sale 14,749 3,819 1,568 1,463 1,422
Held to maturity 12,006 17,504 16,926 25,051 25,152
Deposits 144,766 129,303 119,634 113,825 110,665
Borrowings 16,505 7,532 -- -- --
Total stockholders' equity 36,127 11,940 10,949 10,366 9,683
Asset quality data:
Non-performing loans 150 365 622 868 839
Allowance for loan losses 1,236 977 742 757 749
Foreclosed real estate --- --- --- 104 270
Number of:
Mortgage loans outstanding 1,548 1,384 1,329 1,236 1,290
Deposit accounts 18,920 18,809 18,465 17,753 17,016
Full-service offices 3 3 3 2 2
Number of employees:
Full-time 48 44 42 40 38
Part-time 21 22 22 15 14
Statement of income data:
Interest and dividend income $ 12,210 $ 9,899 $ 8,928 $ 8,165 $ 7,784
Interest expense 5,648 4,911 4,569 3,885 3,474
--------------------------------------------------------
Net interest income 6,562 4,988 4,359 4,280 4,310
Provision for loan losses 245 272 100 100 152
--------------------------------------------------------
Net interest income after provision
for loan losses 6,317 4,716 4,259 4,180 4,158
Other income 1,035 882 658 536 543
Operating expenses 4,774 4,330 3,878 3,576 3,144
--------------------------------------------------------
Income before income taxes 2,578 1,268 1,039 1,140 1,557
Provision for income taxes 1,031 527 440 480 658
--------------------------------------------------------
Net income $ 1,547 $ 741 $ 599 $ 660 $ 899
========================================================
At or for the Years Ended June 30,
-------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------ ------
Selected operating ratios:
Interest rate spread(1) 3.54% 3.63% 3.48% 3.57% 3.67%
Net interest margin(2) 4.05 3.84 3.67 3.73 3.81
Return on average assets 0.90 0.54 0.48 0.55 0.75
Return on average equity 6.70 6.40 5.53 6.46 9.61
Operating expenses as a percentage of
average total assets 2.79 3.15 3.08 2.97 2.62
Efficiency ratio(3) 62.84 73.76 77.30 74.25 64.78
Asset quality ratios:
Non-performing loans as a percent of
net loans 0.11 0.32 0.66 1.08 1.08
Non-performing assets as a percent of
total assets 0.08 0.24 0.47 0.78 0.92
Allowance for loan losses as a percent
of non-performing loans 824.00 267.67 119.29 87.21 89.27
Net charge-offs (recoveries) to average
loans, net (0.01) 0.04 0.13 0.12 0.19
Capital ratios:
Average equity to average assets 13.48 8.42 8.60 8.47 7.81
Regulatory Tier I leverage capital ratio 19.07 8.08 8.51 8.45 8.09
Total equity to total assets 18.15 7.98 8.33 8.30 8.00
- ----------------------------
Interest rate spread represents the difference between weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
Net interest margin represents net interest income divided by average
interest-earning assets.
Operating expenses divided by the sum of net interest income and other
income.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
Medford Co-operative Bank (the "Bank") completed its conversion from a
mutual to a stock institution and was simultaneously acquired by Mystic
Financial, Inc. ("Mystic" or the "Company") on January 8, 1998. The following
discussion and analysis should be read in conjunction with the consolidated
financial statements and related notes thereto included within this report.
The Private Securities Litigation Reform Act of 1995 contains safe harbor
provisions regarding forward-looking statements. When used in this discussion,
the words "believes", "anticipates", "contemplates", "expects", and similar
expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. Those risks and
uncertainties include changes in interest rates generally and changes in real
estate values and other economic conditions in eastern Massachusetts, the
Bank's principal market area. The Company undertakes no obligation to publicly
release the results of any revisions to those forward-looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
The business of the Bank consists of attracting deposits from the general
public and using these funds to originate various types of loans primarily in
eastern Middlesex County, Massachusetts, including mortgage loans secured by
one- to four-family residences, commercial loans secured by general business
assets, commercial real estate loans secured by commercial property, and to
invest in U.S. Government and Federal Agency and other securities. To a lesser
extent, the Bank engages in various forms of consumer and home equity lending.
The Company's profitability depends primarily on its net interest income,
which is the difference between the interest income it earns on its loans and
investment portfolio and its cost of funds, which consists mainly of interest
paid on deposits and on borrowings from the Federal Home Loan Bank of Boston.
Net interest income is affected by the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rates earned or paid
on these balances. When interest-earning assets approximate or exceed
interest-bearing liabilities, any positive interest rate spread will generate
net interest income.
The Company's profitability is also affected by the level of other
(noninterest) income and operating expenses. Other income consists primarily of
service fees, loan servicing and other loan fees and gains on sales of
investment securities. Operating expenses consist of salaries and benefits,
occupancy related expenses, and other general operating expenses.
The operations of the Bank, and banking institutions in general, are
significantly influenced by general economic conditions and related monetary
and fiscal policies of financial institution's regulatory agencies. Deposit
flows and the cost of funds are influenced by interest rates on competing
investments and general market rates of interest. Lending activities are
affected by the demand for financing real estate and other types of loans,
which in turn are affected by the interest rates at which such financing may be
offered and other factors affecting loan demand and the availability of funds.
Business Strategy
The Bank's business strategy is to operate as a well-capitalized,
profitable and independent community bank dedicated to financing home
ownership, small business and consumer needs in its market area and providing
quality service to its customers. The Bank has implemented this strategy by:
(i) monitoring the needs of customers and providing quality service; (ii)
emphasizing consumer-oriented banking by originating residential mortgage loans
and consumer loans, and by offering various deposit accounts and other
financial services and products; (iii) recently increasing its emphasis on
commercial banking and lending by originating loans for small businesses and
providing greater services in its commercial and commercial real estate loan
department; (iv) maintaining high asset quality through conservative
underwriting; and (v) producing stable earnings.
Asset/Liability Management
A principal operating objective of the Bank is to produce stable earnings
by achieving a favorable interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Since the Bank's principal
interest-earning assets have longer terms to maturity than its primary source
of funds, i.e., deposit liabilities, increases in general interest rates will
generally result in an increase in the Bank's cost of funds before the yield on
its asset portfolio adjusts upward. The Bank has sought to reduce its exposure
to adverse changes in interest rates by attempting to achieve a closer match
between the periods in which its interest-bearing liabilities and
interest-earning assets can be expected to reprice through the origination of
adjustable-rate mortgages and loans with shorter terms and the purchase of
other shorter term interest-earning assets.
The term "interest rate sensitivity" refers to those assets and
liabilities which mature and reprice periodically in response to fluctuations
in market rates and yields. As noted above, one of the principal goals of the
Bank's asset/liability program is to maintain and match the interest rate
sensitivity characteristics of the asset and liability portfolios.
In order to properly manage interest rate risk, the Bank's board of
directors has established an Asset/Liability Management Committee ("ALCO") made
up of members of management to monitor the difference between the Bank's
maturing and repricing assets and liabilities and to develop and implement
strategies to decrease the "negative gap" between the two. The primary
responsibilities of the committee are to assess the Bank's asset/liability mix,
recommend strategies to the Board that will enhance income while managing the
Bank's vulnerability to changes in interest rates and report to the Board the
results of the strategies used.
Since the early 1980s, the Bank has stressed the origination of
adjustable-rate residential mortgage loans and adjustable-rate home equity
loans. The Bank regularly sells fixed rate loans with terms in excess of 15
years. Since 1995, the Bank has also emphasized commercial loans with
short-term maturities or repricing intervals as well as commercial real estate
mortgages with short-term repricing intervals. In addition, the Bank has used
borrowings from the FHLB to match-fund the maturity or repricing interval of
several larger commercial real estate mortgages. At June 30, 1998, the Bank's
loan portfolio included $59.0 million of adjustable-rate one-to four-family
mortgage loans, $22.1 million of adjustable-rate commercial real estate loans,
$1.2 million of adjustable-rate or short-term commercial loans, and $1.7
million of adjustable-rate home equity loans. Together, these loans represent
60.7% of the Bank's net loans at June 30, 1998. See "Business-Lending
Activities."
In the future, in managing its interest rate sensitivity, the Bank
intends to continue to stress the origination of adjustable-rate mortgages when
possible and loans with shorter maturities and the maintenance of a consistent
level of short-term securities.
Interest Rate Sensitivity Analysis
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and
by monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period
if it will mature or reprice within that period. The interest rate sensitivity
gap is defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that same time
period. A gap is considered positive when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities, and is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. Generally, during a
period of rising interest rates, a negative gap would adversely affect net
interest income while a positive gap would result in an increase in net
interest income, while conversely, during a period of falling interest rates, a
negative gap would result in an increase in net interest income and a positive
gap would negatively affect net interest income.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1998 which are expected to
mature or reprice in each of the time periods shown. In the table, investment
securities held to maturity are presented at amortized cost; other
interest-earning assets include marketable equity securities, FHLB stock, due
from Co-operative Central Bank, federal funds sold and other short-term
investments; fixed rate one-to four-family loans are assumed to have an average
life of 12 years; adjustable rate one-to four-family loans, commercial real
estate loans, and commercial loans do not include any amortization or
prepayment amounts. Money market accounts, NOW accounts, regular and other
deposits are allocated in accordance with FDIC guidelines for interest rate
risk management.
At June 30, 1998
----------------------------------------------------------------------------------
Over Six
Three Over Three Months Over One Over Three Over
Months Through Six Through Through Through Seven
or Less Months One Year Three Years Seven Years Years Total
------- ----------- --------- ----------- ----------- ------- --------
(Dollars in thousands)
Interest-earning assets:
Investment securities held to maturity $ 1,499 $ 1,998 $ 4,005 $ 1,503 $ 3,001 $ --- $ 12,006
Investment securities available for sale,
at fair value 500 500 498 10,029 --- --- 11,527
Other interest-earning assets 23,501 --- --- --- --- --- 23,501
Adjustable-rate one- to four- family
loans 1,663 2,837 3,674 16,709 34,125 --- 59,008
Fixed rate one- to four- family loans 235 76 18 225 1,941 44,909 47,404
Commercial real estate loans 884 1,153 4,410 6,876 10,142 1,010 24,475
Commercial loans 3,229 316 813 221 --- --- 4,579
Home equity loans 1,716 --- --- --- --- --- 1,716
Consumer loans 404 57 266 664 396 --- 1,787
Construction loans --- --- 1,260 --- --- --- 1,260
----------------------------------------------------------------------------------
Total interest-earning assets 33,631 6,937 14,944 36,227 49,605 45,919 187,263
----------------------------------------------------------------------------------
Interest-bearing liabilities:
Certificates of deposit 18,591 12,267 13,112 12,846 423 --- 57,239
Money market accounts 6,256 --- --- --- --- --- 6,256
NOW accounts --- --- 20,708 6,750 6,750 --- 34,208
Regular and other deposits 2,072 2,023 4,046 16,184 8,043 8,092 40,460
FHLB borrowings --- --- 1,100 2,400 6,250 6,755 16,505
----------------------------------------------------------------------------------
Total interest-bearing liabilities 26,919 14,290 38,966 38,180 21,466 14,847 154,668
----------------------------------------------------------------------------------
Interest rate sensitivity gap $ 6,712 $(7,353) $(24,022) $ (1,953) $28,139 $31,072 $ 32,595
==================================================================================
Cumulative interest rate sensitivity gap $ 6,712 $(641) $(24,663) $(26,616) $ 1,523 $32,595 $ 32,595
==================================================================================
Cumulative ratio of interest-earning assets
to interest-bearing liabilities 124.9% 98.4% 69.2% 77.5% 101.1% 121.1% 121.1%
Ratio of cumulative interest rate sensitivity
gap to total interest-earning assets 3.6% (0.3)% (13.2)% (14.2)% 0.8% 17.4% 17.4%
Ratio of cumulative interest rate sensitivity
gap to total assets 3.4% (0.3)% (12.4)% (13.4)% 0.8% 16.4% 16.4%
Management believes the current one-year gap of negative 13.2% presents a
risk to the net interest income should a sustained increase occur in the
current level of interest rates. If interest rates increase, the Bank's
negative one-year gap should cause the net interest margin to decrease. A
conservative interest rate risk-gap policy provides a stable net interest
income margin. Accordingly, management emphasizes a structured schedule of
investment securities with greater emphasis on maturities and repricings within
one year. It is possible that the actual interest rate sensitivity of the
Bank's assets and liabilities could vary significantly from the information set
forth in the table due to market and other factors.
Certain shortcomings are inherent in the method of analysis presented
above. Although certain assets and liabilities may have similar maturity or
periods of repricing, they may react in different degrees to changes in the
market interest rates. The interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
rates on other types of assets and liabilities may lag behind changes in market
interest rates. Certain assets, such as adjustable-rate mortgages, generally
have features which restrict changes in interest rates on a short-term basis
and over the life of the asset. In the event of a change in interest rates,
prepayments and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Additionally, an interest rate increase
may make it more difficult for borrowers to service their debt, thereby
increasing the credit risk in the Bank's loan portfolio.
Average Balances, Interest and Average Yields
The following tables set forth certain information relating to the
Company's average balance sheet and reflect the average yield on assets and
average cost of liabilities for the periods indicated and the average yields
earned and rates paid for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average monthly balances of assets
and liabilities, respectively, for the periods presented. Average balances are
derived from daily balances. Loans on nonaccrual status are included in the
average balances of loans shown in the table. Interest earned on loan
portfolios is net of reserves for uncollected interest. The investment
securities in the following table are presented at amortized cost.
Years Ended June 30,
--------------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- ----------------------------
Interest Average Interest Average Interest Average
Average Earned Yield/ Average Earned Yield/ Average Earned Yield/
Balance or Paid Rate Balance or Paid Rate Balance or Paid Rate
-------- -------- ------- -------- -------- ------- -------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Total loans, net $124,971 $10,183 8.15% $103,223 $8,397 8.13% $ 86,651 $7,115 8.21%
Investments 22,318 1,248 5.59% 20,686 1,208 5.84% 23,306 1,364 5.85%
Other earning assets(1) 14,886 779 5.23% 5,896 294 4.99% 8,836 449 5.08%
-------- ------- -------- ------ -------- ------
Total interest-earning assets 162,175 12,210 7.53% 129,805 9,899 7.63% 118,793 8,928 7.52%
------- ------ ------
Cash and due from banks 2,908 2,188 1,627
Other assets 6,151 5,638 5,445
-------- -------- -------
Total assets $171,234 $137,631 $125,865
======== ======== ========
Interest-bearing liabilities:
Regular and other deposits $ 43,108 1,118 2.59% $ 40,419 1,114 2.76% $ 39,818 1,121 2.82%
Now accounts 21,608 349 1.62% 15,710 281 1.79% 14,681 286 1.95%
Money market deposits 6,577 173 2.63% 6,070 157 2.59% 6,154 157 2.55%
Certificates of deposit 57,990 3,258 5.62% 57,223 3,148 5.50% 52,340 3,005 5.74%
-------- ------- -------- ------ -------- ------
Total interest-bearing deposits 129,283 4,898 3.79% 119,422 4,700 3.94% 112,993 4,569 4.04%
FHLB borrowings 12,231 750 6.13% 3,289 211 6.42% -- -- --
-------- ------- -------- ------ -------- ------
Total interest-bearing liabilities 141,514 5,648 3.99% 122,711 4,911 4.00% 112,993 4,569 4.04%
------- ------ ------
Demand deposit accounts 5,763 3,056 1,756
Other liabilities 871 277 288
-------- -------- -------
Total liabilities 148,148 126,044 115,037
Stockholders' equity 23,086 11,587 10,828
-------- -------- -------
Total liabilities and stockholders'
equity $171,234 $137,631 $125,865
======== ======== =======
Net interest income $ 6,562 $4,988 $4,359
======= ====== =======
Interest rate spread 3.54% 3.63% 3.48%
Net interest margin 4.05% 3.84% 3.67%
Interest-earning assets/interest-bearing
liabilities 1.15x 1.06x 1.05x
- -------------------
At June 30, 1998, other earning assets included Bank Investment Fund
Liquidity Fund, FHLB overnight deposits, federal funds sold, the
Co-operative Central Reserve Fund and money market accounts.
Rate/Volume Analysis
The following table sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rates (change
in rate multiplied by old volume). Changes in rate-volume (changes in rate
multiplied by the changes in volume) are allocated between changes in rate and
changes in volume.
Year Ended June 30, Year Ended June 30,
1998 vs 1997 1997 vs 1996
Increase (decrease) Increase (decrease)
------------------------- -------------------------
Due to Due to
--------------- ---------------
Rate Volume Total Rate Volume Total
----- ------ ------ ----- ------ ------
(In thousands)
Interest and dividend income:
Loans, net $ 21 $1,765 $1,786 $ (69) $1,351 $1,282
Investments (53) 93 40 (2) (154) (156)
Other earning assets 15 470 485 (8) (147) (155)
------------------------- -------------------------
Total (17) 2,328 2,311 (79) 1,050 971
------------------------- -------------------------
Interest expense:
Deposits (183) 381 198 (119) 250 131
Borrowed funds (9) 548 539 --- 211 211
------------------------- -------------------------
Total (192) 929 737 (119) 461 342
------------------------- -------------------------
Change in net interest income $ 175 $1,399 $1,574 $ 40 $ 589 $ 629
========================= =========================
Results of Operations
The Company's operating results depend primarily upon its net interest
income, which is the difference between the interest income earned on its
interest-bearing assets (loans and investment securities), and the interest
expense paid on its interest-bearing liabilities (deposits and FHLB
borrowings). Operating results are also significantly affected by provisions
for loan losses, other income and operating expenses. Each of these factors is
significantly affected not only by the Company's policies, but, to varying
degrees, by general economic and competitive conditions and by policies of
state and federal regulatory authorities.
Financial Condition and Results of Operations
Comparison of Financial Condition at June 30, 1998 and June 30, 1997
The Company's total assets amounted to $199.0 million at June 30, 1998
compared to $149.7 million at June 30, 1997, an increase of $49.4 million or
33.0%. The increase in total assets is primarily attributable to a $3.7 million
increase in cash and due from banks, a $14.7 million increase in federal funds
sold, a $1.4 million increase in short-term investments, a $5.4 million
increase in investment securities, and an increase in net loans of $24.0
million.
Cash and due from banks was $7.6 million at June 30, 1998 compared to
$4.0 million at June 30, 1997. Federal funds sold were $16.8 million at June
30, 1998 compared to $2.1 million at June 30, 1997. Short-term investments were
$1.6 million at June 30, 1998 compared to $197,000 at June 30, 1997. Cash and
due from banks, federal funds sold and short-term investments increased at June
30, 1998 due to proceeds from the stock offering and the Company's need to
maintain liquidity for a large deposit relationship with a law firm which
maintains short-term deposits in real estate conveyancing accounts and has
significant fluctuations in its deposit account balances.
Net loans increased by $24.0 million or 21.0% to $138.6 million or 69.6%
of total assets at June 30, 1998 as compared to $114.6 million or 76.6% of
total assets at June 30, 1997 as the Bank continued its emphasis on originating
and retaining residential mortgage loans and commercial and commercial real
estate loans. The percentage of net loans to total assets declined at June 30,
1998 despite the increase in net loans because of the increase in the Company's
total assets. Investment securities held by the Company increased by $5.4
million or 25.5% to $26.8 million at June 30, 1998 from $21.3 million at June
30, 1997. The increase in the Company's investment portfolio reflects the
Company's decision to invest a portion of the offering proceeds in short and
medium term investment securities.
Total deposits increased by $15.5 million or 12.0% to $144.8 million at
June 30, 1998 from $129.3 million at June 30, 1997 as a result of a general
increase in deposit balances. A significant portion of the increase in total
deposits was due to a large deposit relationship with a law firm which
maintains short-term deposits in real estate conveyancing accounts.
Total borrowings increased by $9.0 million to $16.5 million at June 30,
1998 from $7.5 million at June 30, 1997. The Company's continued use of
borrowed funds reflects additional funding needed to support its growth in net
loans. Net loan growth exceeded the increase in total deposits by $8.6 million
from June 30, 1997 through June 30, 1998. The Company and the Bank each
received approximately one-half of the net proceeds from the stock offering and
the Bank's portion of such proceeds was applied towards funding the growth in
net loans and improving the Bank's liquidity. In addition, the Bank has secured
longer-term borrowed funds with original maturities ranging up to 15 years in
order to fund longer-term assets and improve its interest rate risk.
Stockholders' equity increased by $24.2 million to $36.1 million at June
30, 1998 from $11.9 million at June 30, 1997 as a result of net proceeds from
the issuance of common stock of $25.7 million, net income of $1,547,000 and an
increase in the net unrealized gain on securities available for sale of
$253,000. These increases were partially offset by the Company's $3.2 million
loan to the Employee Stock Ownership Plan ("ESOP") and dividend payment of
$135,000.
Comparison of the Operating Results for the Years Ended June 30, 1998 and 1997
Net Income. Net income was $1,547,000 for the year ended June 30, 1998 as
compared to $741,000 for the year ended June 30, 1997. This $806,000 increase
in net income during the period was the result of an increase of $1.6 million
in net interest income after provision for loan losses and an increase in other
income of $153,000, partially offset by an increase in operating expenses of
$444,000 and an increase in income taxes of $504,000. The return on average
assets for the year ended June 30, 1998 was .90% compared to .54% for the year
ended June 30, 1997. The return on average equity for the year ended June 30,
1998 was 6.70% compared to 6.40% for the year ended June 30, 1997.
Interest Income. Total interest and dividend income increased by $2.3
million or 23.3% to $12.2 million for the year ended June 30, 1998 from $9.9
million for the year ended June 30, 1997. The increase in interest income was
primarily the result of a higher level of loans. The average balance of net
loans for the year ended June 30, 1998 was $125.0 million compared to $103.2
million for the year ended June 30, 1997. The average yield on net loans was
8.15% for the year ended June 30, 1998 compared to 8.13% for the year ended
June 30, 1997.
Interest Expense. Total interest expense increased by $737,000 or 15.0%
to $5.6 million for the year ended June 30, 1998 from $4.9 million for the year
ended June 30, 1997. The reason for the increase in interest expense was the
increase in the overall deposit balances as well as an increase in Federal Home
Loan Bank of Boston borrowings. Average interest-bearing deposits increased by
$9.9 million or 8.3% to $129.3 million for the year ended June 30, 1998.
Average borrowings increased by $8.9 million to $12.2 million for the year
ended June 30, 1998 from $3.3 million for the year ended June 30, 1997. The
average rate on interest bearing deposits decreased 15 basis points to 3.79%
for the year ended June 30, 1998 from 3.94% for the year ended June 30, 1997,
while the average rate on borrowed funds decreased 29 basis points to 6.13%
from 6.42% during the same period.
Net Interest Income. Net interest income for the year ended June 30, 1998
was $6.6 million as compared to $5.0 million for the year ended June 30, 1997.
The $1.6 million or 31.6% increase is attributed to $2.3 million increase in
interest and dividend income partially offset by the $737,000 increase in
interest expense on deposits and borrowed funds. The average yield on interest
earning assets decreased 10 basis points to 7.53% for the year ended June 30,
1998 from 7.63% for the year ended June 30, 1997, while the average cost on
interest-bearing liabilities decreased by 1 basis point to 3.99% for the year
ended June 30, 1998 from 4.00% for the year ended June 30, 1997. As a result,
the interest rate spread decreased to 3.54% for the year ended June 30, 1998
from 3.63% for the year ended June 30, 1997. The interest rate spread declined
due to the receipt of net conversion proceeds which have been invested in
federal funds sold, short-term investments and investment securities at
interest rates lower than the Company's average yield on loans. The Company's
net loans to total assets ratio declined to 69.6% at June 30, 1998 from 76.6%
at June 30, 1997 as a result of the conversion proceeds being invested in
federal funds sold, short-term investments and investment securities and the
growth in total assets.
Provision for Loan Losses. The provision for loan losses was $245,000 for
the year ended June 30, 1998 as compared to $272,000 for the year ended June
30, 1997. The decrease reflects the low amount of delinquent and non-performing
loans. At June 30, 1998, the balance of the allowance for loan losses was
$1,236,000 or .88% of total loans. During the year ended June 30, 1998, $2,000
was charged against allowance for loan losses while $16,000 in recoveries was
credited to the allowance for loan losses. At June 30, 1997, the balance of the
allowance for loan losses was $977,000 or .85% of total loans. During the year
ended June 30, 1997, $57,000 was charged against allowance for loan losses
while $20,000 in recoveries was credited to the allowance for loan losses.
Non-performing loans at June 30, 1998 and 1997 were $150,000 and $365,000,
respectively.
Other Income. Other income was $1.0 million for the year ended June 30,
1998 compared to $882,000 for the year ended June 30, 1997. The $153,000 or
17.3% increase was primarily the result of an increase in the gain on the sale
of mortgage loans of $27,000, an increase in the gain on the sale of investment
securities of $59,000, and an increase in miscellaneous income of $31,000.
Operating Expenses. Operating expenses increased by $444,000 or 10.3% to
$4.8 million for the year ended June 30, 1998 from $4.3 million for the year
ended June 30, 1997. Salaries and employee benefits increased by $214,000, of
which $163,000 was attributable to the Company's adoption of an Employee Stock
Ownership Plan ("ESOP"). Occupancy and equipment expense increased by $67,000
due to higher equipment depreciation costs. Data processing expense increased
by $50,000 due to higher loan and deposit activity as well as Year 2000 costs.
Other general and administrative expenses increased by $113,000 as a result of
higher professional fees and liability insurance costs from operating as a
public company. Annual operating expenses are expected to increase in future
periods due to the increased cost of operating as a publicly held stock
institution.
Comparison of Financial Condition at June 30, 1997 and 1996.
The Bank's total assets increased by $18.3 million or 13.9% to $149.7
million at June 30, 1997 from $131.4 million at June 30, 1996. The Bank's asset
growth reflected the increased emphasis on the origination and retention of
residential mortgage loans, commercial real estate loans and commercial loans
during 1997. Net loans were $114.6 million or 76.6% of total assets at June 30,
1997 as compared to $94.8 million or 72.1% of total assets at June 30, 1996,
representing an increase of $19.8 million or 20.9%. The increase in loans was
funded through FHLB borrowings and increased deposits. Investment securities
held by the Bank increased by $2.8 million or 15.3% to $21.3 million in 1997
from $18.5 million in 1996. Total deposits increased by $9.7 million or 8.1% to
$129.3 million at June 30, 1997 from $119.6 million at June 30, 1996. Deposits
increased due to new accounts established at the Bank's new branch opened in
November 1995 as well as increases in commercial deposits resulting from the
Bank's emphasis on expanding its commercial banking services. Total borrowings
were $7.5 million at June 30, 1997 compared to no borrowings at June 30, 1996.
Total surplus increased by $1.0 million or 9.1% to $11.9 million at June 30,
1997 from $10.9 million at June 30, 1996 as a result of net income of $741,000
and an increase in the net unrealized gain on securities available for sale of
$250,000.
Comparison of the Operating Results for the Years Ended June 30, 1997 and 1996.
Net Income. The Bank's net income for the year ended June 30, 1997 was
$741,000 as compared to $599,000 for the year ended June 30, 1996. This
$142,000 or 23.7% increase in net income during the period was the result of an
increase of $457,000 in net interest income after provision for loan losses and
an increase of $224,000 in other income, partially offset by an increase of
$452,000 in operating expenses. The Bank's expansion of its lending activities
accounted for the increase in net interest income, while its operating expenses
increased due to the opening of a new branch in November 1995 and the expansion
of its commercial loan and commercial real estate departments during 1997. The
return on average assets for the year ended June 30, 1997 was 0.54% compared to
0.48% for the year ended June 30, 1996.
Interest Income. Total interest and dividend income increased by $971,000
or 10.9% to $9.9 million for the year ended June 30, 1997 from $8.9 million for
the year ended June 30, 1996. The increase in interest income was a result of a
higher level of loan originations and a greater mix of higher yielding
commercial and commercial real estate loans funded by FHLB borrowings and
increased deposits.
Interest Expense. Interest expense increased by $342,000 or 7.5% to $4.9
million for the year ended June 30, 1997 from $4.6 million for the year ended
June 30, 1996. The reason for the increase in interest expense was the increase
in the overall deposit balances as well as the increase in FHLB borrowings.
Net Interest Income. Net interest income for the year ended June 30, 1997
was $5.0 million as compared to $4.4 million for the year ended June 30, 1996.
The $629,000 or 14.4% increase can be attributed to a combination of the
$971,000 increase in interest and dividend income and the $342,000 increase in
interest expense on deposits and FHLB borrowings. The average yield on
interest-earning assets increased 11 basis points to 7.63% for the year ended
June 30, 1997 from 7.52% for the year ended June 30, 1996, while the average
cost of interest-bearing liabilities decreased by 4 basis points to 4.00% for
the year ended June 30, 1997 from 4.04% for the year ended June 30, 1996. As a
result, the net interest spread increased to 3.63% for the year ended June 30,
1997 from 3.48% for the year ended June 30, 1996.
Provision for Loan Losses. The provision for loan losses was $272,000 for
the year ended June 30, 1997 as compared to $100,000 for the year ended June
30, 1996. The provision was increased in part because of the larger number of
high-balance commercial loans. At June 30, 1997, the balance of the allowance
for loan losses was $977,000 or 0.9% of total loans. During the year ended June
30, 1997, $57,000 was charged against the allowance for loan losses while
$20,000 in recoveries was credited to the allowance for loan losses. At June
30, 1996, the balance of the allowance for loan losses was $742,000 or 0.8% of
total loans. During the year ended June 30, 1996, $138,000 was charged against
the allowance for loan losses while $23,000 in recoveries was credited to the
allowance for loan losses.
Other Income. Non-interest income or other income was $882,000 for the
year ended June 30, 1997 compared to $658,000 for the year ended June 30, 1996.
The $224,000 or 34% increase was primarily the result of a $164,000 increase in
gain on sales of investment securities and a decrease in the writedown of
mortgage loans held for sale of $41,000.
Operating Expenses. Non-interest expense or operating expense increased
to $4.3 million for the year ended June 30, 1997 from $3.9 million for the year
ended June 30, 1996. The increase of $452,000 or 11.7% mainly resulted from an
increase of $248,000 in salaries and employee benefits and an increase of
$91,000 in occupancy and equipment expenses, resulting from the opening of a
new branch office in November 1995 and the expansion of the commercial and
commercial real estate loan department. Other general and administrative
expenses increased by $79,000 over the prior year.
Liquidity and Capital Resources
The Bank's primary sources of funds consist of deposits, borrowings,
repayment and prepayment of loans, sales and participations of loans,
maturities of investments and interest-bearing deposits, and funds provided
from operations. While scheduled repayments of loans and maturities of
investment securities are predictable sources of funds, deposit flows and loan
prepayments are greatly influenced by the general level of interest rates,
economic conditions, and competition. The Bank uses its liquidity resources
primarily to fund existing and future loan commitments, to fund net deposit
outflows, to invest in other interest-earning assets, to maintain liquidity and
to meet operating expenses.
The Bank is required to maintain adequate levels of liquid assets. This
guideline, which may be varied depending upon economic conditions and deposit
flows, is based upon a percentage of deposits and short-term borrowings. The
Bank has historically maintained a level of liquid assets in excess of
regulatory requirements. The Bank's liquidity ratio at June 30, 1998 was 25.4%.
The Bank began using FHLB borrowings in 1997 to augment its liquidity as its
loan originations increased from 1996.
A major portion of the Bank's liquidity consists of cash and cash
equivalents, short-term U.S. Government and Federal Agency obligations, and
corporate bonds. The level of these assets is dependent upon the Bank's
operating, investing, lending and financing activities during any given period.
The primary investing activities of the Bank include origination of loans
and purchase of investment securities. During the year ended June 30, 1998,
loan originations and purchases totaled $57.3 million while purchases of
investment securities and FHLB stock totaled $14.9 million. These investments
were funded primarily from loan repayments of $27.7 million, investment
security maturities of $7.0 million, net deposit increases of $15.5 million, a
net increase in borrowings of $9.0 million and net proceeds of $25.7 million
from the issuance of common stock.
Liquidity management is both a daily and long-term function of
management. If the Bank requires funds beyond its ability to generate them
internally, the Bank believes it could borrow additional funds from the FHLB.
At June 30, 1998, the Bank had borrowings of $16.5 million from the FHLB.
At June 30, 1998, the Bank had $12.3 million in outstanding commitments
to originate loans and unadvanced funds on lines of credit and credit card
loans. The Bank anticipates that it will have sufficient funds available to
meet its current loan commitments. Certificates of deposit which are scheduled
to mature in one year or less totaled $44.0 million at June 30, 1998. Based
upon historical experience, management believes that a significant portion of
such deposits will remain with the Bank.
At June 30, 1998, the Company and the Bank exceeded all of their
regulatory capital requirements. For further information regarding the
Company's and the Bank's regulatory capital at June 30, 1998, see
"Regulation--Federal Banking Regulations--Capital Requirements."
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and results of operations
in terms of historical dollars without considering changes in the relative
purchasing power of money over time because of inflation. Unlike most
industrial companies, virtually all of the assets and liabilities of the Bank
are monetary in nature. As a result, interest rates have a more significant
impact on the Bank's performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services.
Impact of New Accounting Standards
In June of 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). SFAS 130 is effective for fiscal years beginning after
December 15, 1997. Accounting principles generally require all recognized
revenue, expenses, gains and losses to be included in net income. Various FASB
statements, however, require companies to report certain changes in assets and
liabilities as a separate component of the equity section of the balance sheet
such as unrealized gains and losses on available for sale securities. This such
item, along with net income, is a component of comprehensive income.
It is required under SFAS 130 that all items of comprehensive income are
to be reported in a "financial statement" that is displayed with the same
prominence as other financial statements. Additionally, SFAS 130 requires the
classification of items comprising other comprehensive income by their nature,
and the accumulated balance of other comprehensive income must be displayed
separately from retained earnings and additional paid-in capital in the equity
section of the balance sheet. Management will adopt this new disclosure
requirement beginning in fiscal year 1999.
Also, in June of 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information," ("SFAS 131"). SFAS 131 is effective for financial statements for
periods beginning after December 15, 1997. SFAS 131 establishes standards for
the way that public companies report information about operating segments in
annual financial statements and selected information about operating segments
in interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments.
SFAS 131 also requires companies to report information about the way that
the operating segments were determined, the product and services provided by
the operating segments, differences between the measurements used in reporting
segment information and those used by the company in its general purpose
financial statements, and changes in the measurement of segment amounts from
period to period. Management has not yet determined the impact that adoption of
SFAS 131 will have on its financial statement presentation.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
Statement requires that all derivatives be recognized at fair value as either
assets or liabilities on the consolidated balance sheet. If certain conditions
are met, a derivative may be specifically designated as (a) a hedge of the
exposure to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security or a foreign-currency-denominated
forecasted transaction. The accounting for changes in fair value of a
derivative depends on the intended use of the derivative and the resulting
designation. This Statement generally provides for matching the timing of a
gain or loss recognition on the hedging instrument with the recognition of (a)
the changes in the fair value of the hedged asset or liability that are
attributable to the hedged risk or (b) the earnings effect of the hedged
forecasted transaction. This Statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999, with earlier application
encouraged. Retroactive application to prior periods is prohibited. The Bank
does not generally use derivative instruments and therefore the adoption of the
Statement is not expected to have a material impact on the financial statements
of the Company.
Year 2000
The "Year 2000 Problem" centers on the inability of computer systems to
recognize the Year 2000. Many existing computer programs and systems were
originally programmed with six digit dates that provided only two digits to
identify the calendar year in the date field, without considering the upcoming
change in the century. With the impending millennium, these programs and
computers will recognize "00" as the year 1900 rather than the year 2000. Like
most financial service providers, the Bank and its operations may be
significantly affected by the Year 2000 Problem due to the nature of financial
information. Software, hardware, and equipment both within and outside the
Bank's direct control and with whom the Bank electronically or operationally
interfaces (e.g. third party vendors providing data processing, information
system management, maintenance of computer systems, and credit bureau
information) are likely to be affected. Furthermore, if computer systems are
not adequately changed to identify the Year 2000, many computer applications
could fail or create erroneous results. As a result, many calculations which
rely on the date field information, such as interest, payment or due dates and
other operating functions, will generate results which could be significantly
misstated, and the Bank could experience a temporary inability to process
transactions, send invoices or engage in similar normal business activities. In
addition, under certain circumstances, failure to adequately address the Year
2000 Problem could adversely affect the viability of the Bank's suppliers and
creditors and the creditworthiness of its borrowers. Thus, if not adequately
addressed, the Year 2000 Problem could result in a significant adverse impact
on the Bank's products, services and competitive condition.
In order to address the Year 2000 issue and to minimize its potential
adverse impact, in 1997 management began a process to identify areas that will
be affected by the Year 2000 Problem, assess its potential impact on the
operations of the Bank, monitor the progress of third party software vendors in
addressing the matter, test changes provided by these vendors, and develop
contingency plans for any critical systems which are not effectively
reprogrammed. The Bank's plan is divided into the five phases: (1) awareness;
(2) assessment; (3) renovation; (4) testing; and (5) implementation.
The Bank has substantially completed the first two phases of the plan and
is currently working internally and with external vendors on the final three
phases. Because the Bank outsources its data processing and item processing
operations, a significant component of the Year 2000 plan is working with
external vendors to test and certify their systems as Year 2000 compliant.
The Bank's external vendors have surveyed its programs to inventory the
necessary changes and have begun correcting the applicable computer programs
and replacing equipment so that the Bank's information systems will be Year
2000 compliant prior to the end of 1998. This will enable the Bank to devote
substantial time to the testing of the upgraded systems prior to the arrival of
the millennium in order to comply with all applicable regulations. The Bank
expects to complete its timetable for carrying out its plans to address year
2000 issues by December 31, 1998. The Company presently believes that with
modifications to existing software and conversions to new software, the Year
2000 Problem will be mitigated without causing a material adverse impact on the
operations of the Company. However, if such modifications and conversions are
not made, or are not completed timely, the Year 2000 Problem could have an
impact on the operations of the Company.
In addition, monitoring and managing the Year 2000 project will result in
additional direct and indirect costs to the Company and the Bank. Direct costs
include potential charges by third party software vendors for product
enhancements, costs involved in testing software products for Year 2000
compliance, and any resulting costs for developing and implementing contingency
plans for critical software products which are not enhanced. Indirect costs
will principally consist of the time devoted by existing employees in
monitoring software vendor progress, testing enhanced software products and
implementing any necessary contingency plans. The Company currently estimates
that the aggregate direct and indirect costs will be between $25,000 and
$50,000 and does not believe that such costs will have a material effect on the
results of operations. Both direct and indirect costs of addressing the Year
2000 Problem will be charged to earnings as incurred. Such costs have not been
material to date.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including
the continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from those plans.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct all relevant computer codes, and similar
uncertainties. The Company has not developed a contingency plan which would be
implemented in the unlikely event that it was not Year 2000 compliant. The
Company will continue to closely monitor the progress of its Year 2000
compliance plan and will determine by December 31, 1998 if the need for a
contingency plan exists.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates/prices such as interest rates, foreign currency
exchange rates, commodity prices, and equity prices. The Company's primary
market risk exposure is interest rate risk. The ongoing monitoring and
management of this risk is an important component of the Company's
asset/liability management process which is governed by policies established by
its Board of Directors that are reviewed and approved annually. The Board of
Directors delegates responsibility for carrying out the asset/liability
management policies to the Asset/Liability Management Committee ("ALCO"). In
this capacity, ALCO develops guidelines and strategies affecting the Company's
asset/liability management related activities based upon estimated market risk
sensitivity, policy limits and overall market interest rate levels and trends.
The ALCO Committee is composed of members of management to monitor the
difference between the Company's maturing and repricing assets and liabilities
and to develop and implement strategies to decrease the "negative gap" between
the two. The primary responsibilities of the committee are to assess the
Company's asset/liability mix, recommend strategies to the Board that will
enhance income while managing the Company's vulnerability to changes in
interest rates and report to the Board the results of the strategies used.
Interest rate risk represents the sensitivity of earnings to changes in
market interest rates. As interest rates change the interest income and expense
streams associated with the Company's financial instruments also change thereby
affecting net interest income ("NII"), the primary component of the Company's
earnings. ALCO utilizes the results of a detailed and dynamic simulation model
to quantify the estimated exposure of NII to sustained interest rate changes.
While ALCO routinely monitors simulated NII sensitivity over a rolling one-year
horizon, it also utilizes additional tools to monitor potential longer-term
risk.
The simulation model captures the impact of changing interest rates on
the interest income received and interest expense paid on all assets and
liabilities reflected on the Company's balance sheet. This sensitivity analysis
is compared to Board and ALCO policy limits which specify a maximum tolerance
level for NII exposure over a one year horizon, assuming no balance sheet
growth, given both a 200 basis point upward and downward shift in interest
rates. A parallel and pro rata shift in rates over a 12 month period is
assumed. The Company uses various other assumptions in its sensitivity
analysis. For investment securities, in the event of a call provision, if the
interest rate is lower than the contractual rate, reinvestment is assumed at
the lower rate. For residential mortgage loans, the Company uses the PSA method
to generate different prepayment assumptions. Commercial loans and commercial
real estate loans do not include any amortization or prepayment amounts. For
money market accounts, NOW accounts, regular savings deposits, not all deposits
within these categories are assumed to increase by the full extent of the
interest rate shift based upon management's judgment as to deposit elasticity.
The following reflects the Company's NII sensitivity analysis as of June 30,
1998.
Estimated
Rate Change NII Sensitivity
----------------- ---------------
+200 basis points (2.06)%
-200 basis points (14.58)%
The preceding sensitivity analysis does not represent a Company forecast
and should not be relied upon as being indicative of expected operating
results. These hypothetical estimates are based upon numerous assumptions
including: the nature and timing of interest rate levels including yield curve
shape, prepayments on loans and securities, changes in deposit levels, pricing
decisions on loans and deposits, reinvestment of asset and liability cash
flows, and others. While assumptions are developed based upon current economic
and local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change.
In addition, as market conditions vary from those assumed in the
sensitivity analysis, actual results will also differ due to: prepayment and
refinancing levels likely deviating from those assumed, the varying impact of
interest rate changes caps or floors on adjustable rate assets, the potential
effect of changing debt service levels on customers with adjustable rate loans,
depositor early withdrawals and product preference changes, and other internal
and external variables. Furthermore, the sensitivity analysis does not reflect
actions that ALCO might take in responding to or anticipating changes in
interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Mystic Financial, Inc. and
subsidiary as of June 30, 1998 and 1997 are included in pages F-1 through F-37
of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included on pages 5 through 8, and page 16 of
the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders (the
"Proxy Statement") is incorporated herein by reference: "Election of
Directors," "Information as to Nominees and Continuing Directors," "Nominees
for Election as Director," "Executive Officers," and " -- Section 16(a)
Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
The following information included on pages 8 through 15 of the Proxy
Statement is incorporated herein by reference: "Compensation of Directors and
Executive Officers--Directors' Compensation," "--Executive Compensation,"
"--Employment Agreements," and "--Benefits."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included on pages 3 and 4 of the Proxy
Statement is incorporated herein by reference: "Security Ownership of Certain
Beneficial Owners and Management--Principal Stockholders of the Company" and
"--Security Ownership of Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included on page 15 of the Proxy Statement is
incorporated herein by reference: "Compensation of Directors and Executive
Officers--Transactions with Certain Related Persons."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Listed below are all financial statements and exhibits filed as
part of this report:
(1) The consolidated balance sheets of Mystic Financial, Inc. and
subsidiary as of June 30, 1998 and 1997 and the related
consolidated statements of income, changes in stockholders'
equity and cash flows for each of the years in the three-year
period ended June 30, 1998, together with the related notes
and the independent auditors' report of Wolf & Company, P.C.
independent certified public accountants.
(2) Schedules omitted as they are not applicable.
(3) Exhibits
Exhibit No. Description
- ----------- -----------
3.1 Certificate of Incorporation of Mystic Financial, Inc.*
3.2 Bylaws of Mystic Financial, Inc.*
4.3 Specimen of Stock Certificate of Mystic Financial, Inc.*
10.1 Employee Stock Ownership Plan and Trust Agreement of Mystic
Financial, Inc.*
10.2 Employment Agreement between Medford Co-operative Bank and
Robert H. Surabian.*
10.3 Employment Agreement between Medford Co-operative Bank and
Ralph W. Dunham.*
10.4 Employment Agreement between Medford Co-operative Bank and
John O'Donnell.*
10.5 Employment Agreement between Medford Co-operative Bank and
Thomas G. Burke.*
21.1 Subsidiaries of the Registrant.*
27.1 Financial Data Schedule (Submitted only with filing in
electronic format).
99.1 Proxy Statement for the 1998 Annual Meeting of Stockholders
of Mystic Financial, Inc. (previously filed with the
Securities and Exchange Commission on September 23, 1998).
* Incorporated herein by reference to Registration Statement No. 333-34447
on Form S-1 of Mystic Financial, Inc. filed with the Securities and
Exchange Commission on August 27, 1997, as amended.
(b) The Company filed no reports on Form 8-K during the fourth quarter of the
fiscal year ended June 30, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant certifies that it has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Medford, Commonwealth of Massachusetts, on September
9, 1998.
Mystic Financial, Inc.
By: /s/ Robert H. Surabian
-------------------------------------
Robert H. Surabian
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons in the capacities
and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Robert H. Surabian Director, President and Chief Executive September 9, 1998
- ---------------------------- Officer (Principal executive officer)
Robert H. Surabian
/s/ Ralph W. Dunham Executive Vice President, Treasurer September 9, 1998
- ---------------------------- and Chief Financial Officer
Ralph W. Dunham (Principal financial and accounting
officer)
/s/ Julie Bernardin Director September 9, 1998
- ----------------------------
Julie Bernardin
/s/ John A. Hackett Director September 9, 1998
- ----------------------------
John A. Hackett
/s/ Richard M. Kazanjian Director September 9, 1998
- ----------------------------
Richard M. Kazanjian
/s/ John W. Maloney Director September 9, 1998
- ----------------------------
John W. Maloney
/s/ John J. McGlynn Director, Chairman of the Board September 9, 1998
- ----------------------------
John J. McGlynn
/s/ Lorraine P. Silva Director September 9, 1998
- ----------------------------
Lorraine P. Silva
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report F-2
Consolidated Balance Sheets as of June 30, 1998 and 1997 F-3
Consolidated Statements of Income for each of the years
in the three-year period ended June 30, 1998 F-4
Consolidated Statements of Changes in Stockholders'
Equity for each of the years in the three-year period
ended June 30, 1998 F-5
Consolidated Statements of Cash Flows for
each of the years in the three-year period ended
June 30, 1998 F-6
Notes to Consolidated Financial Statements F-8
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of Mystic Financial, Inc.
We have audited the consolidated balance sheets of Mystic Financial, Inc.
and subsidiary as of June 30, 1998 and 1997, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for
each of the years in the three-year period ended June 30, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mystic
Financial, Inc. and subsidiary as of June 30, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three-
year period ended June 30, 1998 in conformity with generally accepted
accounting principles.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts
July 24, 1998, except for Note 15 as to which
the date is August 6, 1998
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
-----------------------
1998 1997
--------- ---------
(In Thousands)
Cash and due from banks $ 7,626 $ 3,953
Federal funds sold 16,773 2,075
Short-term investments 1,580 197
-----------------------
Total cash and cash equivalents 25,979 6,225
Securities available for sale, at fair value (Note 2) 14,749 3,819
Securities held to maturity, at amortized cost (Note 2) 12,006 17,504
Federal Home Loan Bank stock, at cost 997 858
Loans, net of allowance for loan losses of $1,236 and $977,
respectively (Note 3) 138,593 114,568
Mortgage loans held for sale 80 210
Banking premises and equipment, net (Note 4) 2,559 2,697
Real estate held for investment, net (Note 5) 1,785 1,840
Accrued interest receivable 1,099 870
Due from Co-operative Central Bank 929 669
Other assets (Note 8) 273 393
-----------------------
$ 199,049 $ 149,653
=======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 6) $ 144,766 $ 129,303
Federal Home Loan Bank borrowings (Note 7) 16,505 7,532
Mortgagors' escrow accounts 481 386
Accrued interest payable 288 249
Accrued expenses and other liabilities 882 243
-----------------------
Total liabilities 162,922 137,713
-----------------------
Commitments and contingencies (Notes 9 and 15)
Stockholders' equity (Notes 10, 12, 13 and 15):
Preferred stock, $.01 par value, 1,000,000 shares authorized;
none issued - -
Common stock, $.01 par value, 5,000,000 shares authorized;
2,711,125 issued and outstanding at June 30, 1998 27 -
Additional paid-in capital 25,710 -
Retained earnings 13,173 11,761
-----------------------
38,910 11,761
Treasury stock, at cost - 2,120 shares (21) -
Net unrealized gain on securities available for sale, net of
tax effects (Notes 2 and 8) 432 179
Loan due from ESOP (Note 12) (3,194) -
-----------------------
Total stockholders' equity 36,127 11,940
-----------------------
$ 199,049 $ 149,653
=======================
See accompanying notes to consolidated financial statements.
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
------------------------------
1998 1997 1996
-------- ------- -------
(In Thousands)
Interest and dividend income:
Interest and fees on loans $ 10,183 $ 8,397 $ 7,115
Interest and dividends on investment securities 1,248 1,208 1,364
Other interest 779 294 449
------------------------------
Total interest and dividend income 12,210 9,899 8,928
------------------------------
Interest expense:
Deposits 4,898 4,700 4,569
Federal Home Loan Bank borrowings 750 211 -
------------------------------
Total interest expense 5,648 4,911 4,569
------------------------------
Net interest income 6,562 4,988 4,359
Provision for loan losses (Note 3) 245 272 100
------------------------------
Net interest income, after provision for loan losses 6,317 4,716 4,259
------------------------------
Other income:
Customer service fees 547 536 512
Loan servicing and other loan fees 59 56 52
Gain on sales of mortgage loans 35 8 8
Writedown of mortgage loans held for sale - - (41)
Gain on sales of securities available for sale,
net (Note 2) 227 168 4
Rental income, net of expenses (Note 5) 46 29 44
Co-operative Central Bank Share Insurance Fund
special dividend 49 44 44
Miscellaneous 72 41 35
------------------------------
Total other income 1,035 882 658
------------------------------
Operating expenses:
Salaries and employee benefits (Note 12) 2,948 2,734 2,486
Occupancy and equipment expenses (Note 4) 479 412 321
Data processing expenses 257 207 179
Other general and administrative expenses 1,090 977 892
------------------------------
Total operating expenses 4,774 4,330 3,878
------------------------------
Income before income taxes 2,578 1,268 1,039
Provision for income taxes (Note 8) 1,031 527 440
------------------------------
Net income $ 1,547 $ 741 $ 599
==============================
See accompanying notes to consolidated financial statements.
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended June 30, 1998, 1997 and 1996
Net
Unrealized
Gain (loss) Loan
Additional on Securities Due
Common Paid-in Retained Treasury Available From
Stock Capital Earnings Stock For Sale ESOP Total
------ ---------- -------- --------- ------------- -------- --------
(In Thousands)
Balance at June 30, 1995 $ - $ - $ 10,421 $ - $ (55) $ - $ 10,366
Net income - - 599 - - - 599
Increase in net unrealized loss
on securities available for sale - - - - (16) - (16)
-------------------------------------------------------------------------------
Balance at June 30, 1996 - - 11,020 - (71) - 10,949
Net income - - 741 - - - 741
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effects - - - - 250 - 250
-------------------------------------------------------------------------------
Balance at June 30, 1997 - - 11,761 - 179 - 11,940
Net proceeds from sale of common
stock (Note 10) 27 25,710 - - - - 25,737
Purchase of treasury stock
(Note 10) - - - (21) - - (21)
Loan to ESOP (Note 12) - - - - - (3,194) (3,194)
Net income - - 1,547 - - - 1,547
Cash dividends paid ($.05 per
share) - - (135) - - - (135)
Increase in net unrealized
gain on securities available
for sale, net of tax effects - - - - 253 - 253
-------------------------------------------------------------------------------
Balance at June 30, 1998 $ 27 $ 25,710 $ 13,173 $ (21) $ 432 $ (3,194) $ 36,127
===============================================================================
See accompanying notes to consolidated financial statements.
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
-------------------------------------
1998 1997 1996
--------- --------- ---------
(In Thousands)
Cash flows from operating activities:
Net income $ 1,547 $ 741 $ 599
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Provision for loan losses 245 272 100
Net amortization (accretion) of investment securities (2) (4) 8
Amortization of deferred loan fees (5) (14) (28)
Loss on sale of loans - 18 -
Net gain on sales of foreclosed real estate - - (7)
Gain on sales of securities available for sale (227) (168) (4)
Depreciation expense 335 266 213
Deferred income tax provision (benefit) (66) (87) 18
Mortgage loans originated for sale (5,216) (2,467) (2,772)
Principal balance of mortgage loans sold 5,346 3,389 1,598
Writedown of mortgage loans held for sale - - 41
(Increase) decrease in accrued interest receivable (229) (48) 26
Decrease in other assets 50 95 46
Increase in accrued interest payable 39 54 2
Increase (decrease) in accrued expenses and other
liabilities 639 (7) 34
-------------------------------------
Net cash provided (used) by operating activities 2,456 2,040 (126)
-------------------------------------
Cash flows from investing activities:
Net (increase) decrease in certificates of deposit - 1,000 (150)
Proceeds from maturities of securities held to maturity 7,006 12,916 16,017
Purchase of securities held to maturity (1,503) (13,490) (7,899)
Purchase of securities available for sale (13,241) (2,834) (137)
Proceeds from sales of securities available for sale 2,924 1,098 20
Purchase of Federal Home Loan Bank stock (139) (70) -
Loans originated, net of payments received (24,265) (25,427) (14,697)
Proceeds from sales of loans - 5,343 -
Proceeds from sales of foreclosed real estate - - 194
Purchases of banking premises and equipment (140) (369) (932)
Additions to real estate held for investment (2) (2) -
Increase in due from Co-operative Central Bank (260) - -
Loan to ESOP (3,194) - -
-------------------------------------
Net cash used by investing activities (32,814) (21,835) (7,584)
-------------------------------------
See accompanying notes to consolidated financial statements.
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
Years Ended June 30,
-------------------------------------
1998 1997 1996
--------- --------- ---------
(In Thousands)
Cash flows from financing activities:
Net increase in deposits 15,463 9,669 5,810
Proceeds from borrowings 33,100 7,550 -
Repayment of borrowings (24,127) (18) -
Net increase (decrease) in mortgagors' escrow accounts 95 48 (29)
Net proceeds from sale of common stock 25,737 - -
Purchase of treasury stock (21) - -
Cash dividends paid (135) - -
-------------------------------------
Net cash provided by financing activities 50,112 17,249 5,781
-------------------------------------
Net change in cash and cash equivalents 19,754 (2,546) (1,929)
Cash and cash equivalents at beginning of year 6,225 8,771 10,700
-------------------------------------
Cash and cash equivalents at end of year $ 25,979 $ 6,225 $ 8,771
=====================================
Supplemental information:
Interest paid $ 5,609 $ 4,857 $ 4,566
Income taxes paid 984 693 375
Transfer from loans to foreclosed real estate - - 83
See accompanying notes to consolidated financial statements.
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended June 30, 1998, 1997 and 1996
l. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and business
The consolidated financial statements include the accounts of Mystic
Financial, Inc. (the "Company") and its wholly-owned subsidiary,
Medford Co-operative Bank (the "Bank"). The Bank has two wholly-owned
subsidiaries, Mystic Securities Corp., which was organized during
1997, and engages in the purchase and sale of investment securities
and Mystic Investment Inc. which is inactive. Mystic Financial, Inc.
became the Bank's holding company on January 8, 1998 in connection
with the Bank's conversion from mutual to stock form. (See Note 10.)
All significant intercompany accounts have been eliminated in
consolidation.
The Bank provides a variety of financial services to individuals and
small businesses through its four offices in Medford, Massachusetts.
Its primary deposit products are checking, savings and term
certificate accounts, and its primary lending products are residential
and commercial mortgage, commercial and consumer loans.
Use of estimates
In preparing consolidated financial statements in conformity with
generally accepted accounting principles, management is required to
make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the balance sheet date and reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Material estimates that
are particularly susceptible to significant change in the near term
relate to the determination of the allowance for loan losses and the
valuation reserve for deferred tax assets.
Cash equivalents
Cash equivalents include amounts due from banks, federal funds sold
and short-term investments with original maturities of three months or
less.
Short-term investments
Short-term investments are carried at cost, which approximates fair
value, and consist of money market funds and interest-bearing deposits
in the Bank Investment Fund-Liquidity Fund.
Investment securities
Investments in debt securities that management has the positive intent
and ability to hold to maturity are classified as "held to maturity"
and carried at amortized cost. Investments classified as "available
for sale" are carried at fair value, with unrealized gains and losses
reported as a separate component of stockholders' equity, net of tax
effects.
Purchase premiums and discounts are recognized in interest income by a
method which approximates the interest method over the terms of the
investments. Gains and losses on the sale of securities are recorded
on the trade date using the specific identification method.
Loans
The Bank grants mortgage, commercial and consumer loans to customers.
A substantial portion of the loan portfolio consists of mortgage loans
in the Greater Boston area. The ability of the Bank's debtors to
honor their contracts is dependent upon the local real estate market
and economy in this area.
Loans, as reported, have been reduced by amounts due to borrowers on
incomplete loans, net deferred loan fees and the allowance for loan
losses.
Interest on loans is not accrued on loans which are identified as
impaired or loans which are ninety days or more past due. Interest
income previously accrued on such loans is reversed against current
period interest income. Interest income on all non-accrual loans is
recognized only to the extent of interest payments received.
Net deferred loan fees are amortized as an adjustment of the related
loan yields using the interest method.
Allowance for loan losses
The allowance for loan losses is established through a provision for
loan losses charged to earnings and is maintained at a level
considered adequate to provide for reasonably foreseeable loan losses.
The provision and the level of the allowance are evaluated on a
regular basis by management and are based upon management's periodic
review of the collectibility of the loans in light of known and
inherent risks in the nature and volume of the loan portfolio, adverse
situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions.
The allowance is an estimate and ultimate losses may vary from current
estimates and future additions to the allowance may be necessary. As
adjustments become necessary, they are reported in earnings for the
periods in which they become known. Loan losses are charged against
the allowance when management believes the collectibility of the loan
balance is unlikely. Subsequent recoveries, if any, are credited to
the allowance.
A loan is considered impaired when, based on current information and
events, it is probable that a creditor will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Impairment is measured on a
loan by loan basis by either the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's
obtainable market price, or the fair value of the collateral if the
loan is collateral dependent. All of the Bank's loans which have been
identified as impaired have been measured by the fair value of
existing collateral.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Company does not
separately identify individual consumer loans for impairment
disclosures.
Mortgage loans held for sale
Mortgage loans held for sale are carried at the lower of cost or
market.
Banking premises and equipment and real estate held for investment
Land is carried at cost. Buildings, equipment and improvements are
stated at cost, less accumulated depreciation, computed on the
straight-line method over the estimated useful lives of the assets.
It is general practice to charge the cost of maintenance and repairs
to earnings when incurred; major expenditures for improvements are
capitalized and depreciated.
Pension plan
It is the Company's policy to fund pension plan costs in the year of
accrual.
Income taxes
Deferred tax assets and liabilities are reflected at currently enacted
income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. As
changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted accordingly through the provision for income
taxes. The Bank's base amount of its federal income tax reserve for
loan losses is a permanent difference for which there is no
recognition of a deferred tax liability. However, the loan loss
allowance maintained for financial reporting purposes is a temporary
difference with allowable recognition of a related deferred tax asset,
if it is deemed realizable.
Employee stock ownership plan ("ESOP")
Compensation expense is recognized based on cash contributions paid or
committed to be paid to the ESOP. All shares held by the ESOP are
deemed outstanding for purposes of earnings per share calculations.
Dividends declared on all shares held by the ESOP are charged to
retained earnings. The loan due from the ESOP is reflected as a
reduction of stockholders' equity.
Earnings per share
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share" which requires that earnings per share be
calculated on a basic and a dilutive basis. Basic earnings per share
represents income available to common stock divided by the weighted-
average number of common shares outstanding during the period.
Diluted earnings per share reflects additional common shares that
would have been outstanding if dilutive potential common shares had
been issued, as well as any adjustment to income that would result
from the assumed conversion. At June 30, 1998, there were no
outstanding stock options or warrants. Except for certain quarterly
data included in Note 17, earnings per share data is not presented in
these financial statements since shares of common stock were not
issued until January 8, 1998.
Recent accounting pronouncements
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive
Income," effective for fiscal years beginning after December 15, 1997.
Accounting principles generally require that recognized revenue,
expenses, gains and losses be included in net income. Certain FASB
statements, however, require entities to report specific changes in
assets and liabilities, such as unrealized gains and losses on
available-for-sale securities, as a separate component of the equity
section of the consolidated balance sheet. Such items, along with net
income, are components of comprehensive income. SFAS No. 130 requires
that all items of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other
financial statements. Additionally, SFAS No. 130 requires that the
accumulated balance of other comprehensive income be displayed
separately from retained earnings and additional paid-in capital in
the equity section of the consolidated balance sheet. The Company
will adopt these disclosure requirements beginning in the first
quarter of the fiscal year ending June 30, 1999.
In June 1997, FASB issued SFAS No. 133, "Disclosures about Segments of
an Enterprise and Related Information," effective for fiscal years
beginning after December 15, 1997. SFAS No. 131 establishes standards
for the way that public business enterprises report information about
operating segments in annual and interim financial statements. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. Generally, financial
information is required to be reported on the basis that it is used
internally for evaluating segment performance and deciding how to
allocate resources to segments. The Statement also requires
descriptive information about the way that the operating segments were
determined, the products and services provided by the operating
segments, differences between the measurements used in reporting
segment information and those used by the enterprise in its general-
purpose financial statements, and changes in the measurement of
segment amounts from period to period. Management has not yet
determined how the adoption of SFAS No. 131 will impact the Company's
financial reporting.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This Statement requires that all
derivatives be recognized at fair value as either assets or
liabilities on the consolidated balance sheet. If certain conditions
are met, a derivative may be specifically designated as (a) a hedge of
the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (b) a hedge of the
exposure to variable cash flows of a forecasted transaction, or (c) a
hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available-for-
sale security or a foreign-currency-denominated forecasted
transaction. The accounting for changes in fair value of a derivative
depends on the intended use of the derivative and the resulting
designation. This Statement generally provides for matching the
timing of a gain or loss recognition on the hedging instrument with
the recognition of (a) the changes in the fair value of the hedged
asset or liability that are attributable to the hedged risk or (b) the
earnings effect of the hedged forecasted transaction. This Statement
is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999, with earlier application encouraged. Retroactive
application to prior periods is prohibited. The Bank does not
generally use derivative instruments and therefore the adoption of the
Statement is not expected to have a material impact on the
consolidated financial statements of the Company.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities
with gross unrealized gains and losses is as follows:
June 30, 1998
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
(In Thousands)
Available for Sale
- ------------------
U.S. Government and federal agency
obligations $ 11,540 $ 3 $ (16) $ 11,527
Marketable equity securities 2,544 717 (39) 3,222
----------------------------------------------
Total $ 14,084 $ 720 $ (55) $ 14,749
==============================================
Held to Maturity
- ----------------
U.S. Government and federal agency
obligations $ 9,498 $ 15 $ (3) $ 9,510
Other bonds 2,508 12 - 2,520
----------------------------------------------
Total $ 12,006 $ 27 $ (3) $ 12,030
==============================================
June 30, 1997
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
(In Thousands)
Available for Sale
- ------------------
Marketable equity securities:
Co-operative Bank Investment Fund One $ 1,500 $ - $ (78) $ 1,422
Other equity securities 2,043 403 (49) 2,397
----------------------------------------------
Total $ 3,543 $ 403 $ (127) $ 3,819
==============================================
Held to Maturity
- ----------------
U.S. Government and federal agency
obligations $ 14,976 $ 13 $ (81) $ 14,908
Other bonds 2,528 - (5) 2,523
----------------------------------------------
Total $ 17,504 $ 13 $ (86) $ 17,431
==============================================
The amortized cost and estimated fair value of debt securities by
contractual maturity at June 30, 1998 is as follows:
Available for Sale Held to Maturity
-------------------- ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ------- --------- --------
(In Thousands)
Within 1 year $ 1,499 $ 1,499 $ 7,502 $ 7,521
Over 1 year to 5 years 10,041 10,028 4,504 4,509
---------------------------------------------
Total $ 11,540 $ 11,527 $ 12,006 $ 12,030
=============================================
During the years ended June 30, 1998, 1997 and 1996, proceeds from
sales of securities available for sale amounted to $2,924,000,
$1,098,000 and $20,000, respectively. Gross realized gains for 1998,
1997 and 1996 amounted to $363,000, $172,000 and $4,000, respectively.
Gross realized losses for 1998 and 1997 were $136,000 and $4,000,
respectively.
3. LOANS
A summary of the balances of loans follows:
June 30,
-----------------------
1998 1997
--------- ---------
(In Thousands)
Mortgage loans on real estate:
Residential $ 106,412 $ 90,203
Commercial 24,475 17,847
Construction 1,260 976
Home equity lines of credit 1,716 1,564
-----------------------
133,863 110,590
Less: Due to borrowers on incomplete loans (383) (340)
Net deferred loan fees (17) (37)
-----------------------
133,463 110,213
-----------------------
Other loans:
Commercial 3,045 2,672
Commercial lines of credit 1,534 1,005
Personal 1,327 1,203
Share secured 246 244
Home improvement 214 208
-----------------------
6,366 5,332
-----------------------
Total loans 139,829 115,545
Less allowance for loan losses (1,236) (977)
-----------------------
Loans, net $ 138,593 $ 114,568
=======================
An analysis of the allowance for loan losses follows:
Years Ended June 30,
---------------------------
1998 1997 1996
------- ----- -----
(In Thousands)
Balance at beginning of year $ 977 $ 742 $ 757
Provision for loan losses 245 272 100
Recoveries 16 20 23
Charge-offs (2) (57) (138)
---------------------------
Balance at end of year $ 1,236 $ 977 $ 742
===========================
The following is a summary of information pertaining to impaired and
non-accrual loans:
June 30,
---------------
1998 1997
----- -----
(In Thousands)
Impaired loans without a valuation allowance $ 144 $ 365
===============
Non-accrual loans $ 150 $ 365
===============
Years Ended June 30,
-------------------------
1998 1997 1996
----- ----- -----
(In Thousands)
Average investment in impaired loans $ 371 $ 589 $ 867
=========================
Interest income recognized on a cash
basis on impaired loans $ 17 $ 31 $ 51
=========================
No additional funds are committed to be advanced in connection with
impaired loans.
On a fee basis, the Bank services loans it has originated and sold to
others. At June 30, 1998 and 1997, such loans amounted to
approximately $16,879,000 and $15,842,000, respectively. As of June
30, 1998 and 1997, the Bank has no capitalized mortgage servicing
rights. All loans serviced for others were sold without recourse
provisions.
4. BANKING PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of banking premises
and equipment and their estimated useful lives follows:
June 30,
---------------------- Estimated
1998 1997 Useful Lives
-------- --------- -------------
(In Thousands)
Banking premises:
Land $ 242 $ 242
Buildings and improvements 2,447 2,434 10 - 40 years
Equipment 1,625 1,498 3 - 10 years
---------------------
4,314 4,174
Less accumulated depreciation (1,755) (1,477)
---------------------
$ 2,559 $ 2,697
=====================
Depreciation expense for the years ended June 30, 1998, 1997 and 1996
amounted to $278,000, $210,000 and $157,000, respectively.
5. REAL ESTATE HELD FOR INVESTMENT
Real estate held for investment represents property adjacent to the
Bank's main office which is primarily leased as commercial retail and
office space. The Bank occupies a portion of the building for its own
activities. A summary of the cost and accumulated depreciation and
estimated useful life is as follows:
June 30,
------------------- Estimated
1998 1997 Useful Life
------- ------- -----------
(In Thousands)
Land $ 34 $ 34
Building 2,228 2,226 40 years
-------------------
2,262 2,260
Less accumulated depreciation (477) (420)
-------------------
$ 1,785 $ 1,840
===================
Depreciation expense for the years ended June 30, 1998, 1997 and 1996
amounted to $57,000, $56,000 and $56,000, respectively.
The following is a schedule of minimum future rental income on
noncancelable leases:
Year Ending
June 30, Amount
----------- ------
(In Thousands)
1999 $ 111
2000 32
-----
$ 143
=====
The provisions of the lease agreements provide that the tenants are
responsible for utilities and certain repairs. Certain of the leases
also contain provisions that the tenants are responsible for a
percentage of real estate taxes and certain other costs.
Rental income for the years ended June 30, 1998, 1997 and 1996
amounted to approximately $149,000, $135,000 and $148,000,
respectively.
6. DEPOSITS
A summary of deposit balances by type is as follows:
June 30,
-----------------------
1998 1997
--------- ---------
(In Thousands)
NOW accounts $ 34,208 $ 17,975
Demand deposits 6,603 4,910
Regular and other deposits 40,460 40,794
Money market deposits 6,256 6,489
-----------------------
Total non-certificate accounts 87,527 70,168
-----------------------
Term certificates less than $100,000 47,471 49,916
Term certificates of $100,000 or more 9,768 9,219
-----------------------
Total certificate accounts 57,239 59,135
-----------------------
Total deposits $ 144,766 $ 129,303
=======================
A summary of certificate accounts by maturity, is as follows:
June 30, 1998 June 30, 1997
--------------------- ---------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
-------- -------- -------- --------
(Dollars in Thousands)
Within 1 year $ 44,019 5.35% $ 48,316 5.46%
Over 1 year to 3 years 12,846 5.80 10,475 5.89
Over 3 years to 5 years 374 6.07 344 6.15
-------- --------
$ 57,239 5.45% $ 59,135 5.54%
======== ========
7. FEDERAL HOME LOAN BANK BORROWINGS
Federal Home Loan Bank borrowings consist of the following:
Weighted Average
Interest Rate Amount
----------------- --------------------
Maturity 1998 1997 1998 1997
- --------------------------- ------ ------ -------- --------
(In Thousands)
Year ending June 30, 1998 -% 5.92% $ - $ 2,100
Year ending June 30, 1999 5.70 - 1,100 -
Year ending June 30, 2000 6.30 6.32 2,400 2,300
Year ending June 30, 2002 6.31 6.46 2,950 2,150
Year ending June 30, 2003 5.85 - 2,300 -
Thereafter 5.54 - 6,800 -
Amortizing advance, due on
August 14, 2006, requiring
monthly payments of $7,793
including interest 6.97 6.97 955 982
--------------------
$ 16,505 $ 7,532
====================
The following is a summary of maturities of borrowings at June 30,
1998:
Year Ending
June 30, Amount
----------- --------
(In Thousands)
1999 $ 1,125
2000 2,428
2001 31
2002 2,983
2003 2,336
Thereafter 7,602
--------
$ 16,505
========
The Bank also has an available line of credit of $3,529,000 with the
Federal Home Loan Bank of Boston ("FHLB") at an interest rate that
adjusts daily. Borrowings under the line are limited to 2% of the
Bank's total assets. All borrowings from the Federal Home Loan Bank
of Boston are secured by a blanket lien on qualified collateral,
defined principally as 75% of the carrying value of first mortgage
loans on owner-occupied residential property and 90% of the market
value of U.S. Government and federal agency securities.
8. INCOME TAXES
Allocation of federal and state income taxes between current and
deferred portions is as follows:
Years Ended June 30,
-------------------------
1998 1997 1996
------- ----- -----
(In Thousands)
Current tax provision:
Federal $ 805 $ 444 $ 300
State 292 170 122
-------------------------
Total current 1,097 614 422
-------------------------
Deferred tax provision (benefit):
Federal (49) (65) 4
State (17) (22) 14
-------------------------
Total deferred (66) (87) 18
-------------------------
Total provision $ 1,031 $ 527 $ 440
=========================
The reasons for the differences between the statutory federal income
tax rate and the effective tax rates are summarized as follows:
Years Ended June 30,
-------------------------
1998 1997 1996
----- ----- -----
Statutory rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 7.0 7.7 8.6
Other, net (1.0) (0.1) (0.2)
-------------------------
Effective tax rates 40.0% 41.6% 42.4%
=========================
The components of the net deferred tax asset included in other assets
are as follows:
June 30,
--------------
1998 1997
----- -----
(In Thousands)
Deferred tax asset:
Federal $ 399 $ 350
State 138 121
--------------
537 471
Valuation reserve on asset (24) (24)
--------------
513 447
--------------
Deferred tax liability:
Federal (243) (111)
State (16) (12)
--------------
(259) (123)
--------------
Net deferred tax asset $ 254 $ 324
==============
The tax effects of each type of income and expense item that give rise
to deferred taxes are as follows:
June 30,
--------------
1998 1997
----- -----
(In Thousands)
Allowance for loan losses $ 505 $ 409
Net unrealized gain on securities available for sale (233) (97)
Other 6 36
--------------
278 348
Valuation reserve (24) (24)
--------------
Net deferred tax asset $ 254 $ 324
==============
A summary of the change in the net deferred tax asset is as follows:
Years Ended June 30,
-----------------------
1998 1997 1996
----- ----- -----
(In Thousands)
Balance at beginning of year $ 324 $ 334 $ 352
Deferred tax (provision) benefit 66 87 (18)
Deferred tax on net unrealized gain on
securities available for sale (136) (97) -
-----------------------
Balance at end of year $ 254 $ 324 $ 334
=======================
The change in the valuation reserve is as follows:
Years Ended June 30,
--------------------
1998 1997 1996
---- ---- ----
(In Thousands)
Balance at beginning of year $ 24 $ 24 $ 33
Recognition of prior years' benefits - - (9)
--------------------
Balance at end of year $ 24 $ 24 $ 24
====================
The federal income tax reserve for loan losses at the Bank's base year
amounted to approximately $2,663,000. If any portion of the reserve
is used for purposes other than to absorb the losses for which
established, approximately 150% of the amount actually used (limited
to the amount of the reserve) would be subject to taxation in the
fiscal year in which used. As the Bank intends to use the reserve
only to absorb loan losses, a deferred income tax liability of
approximately $1,090,000 has not been provided.
9. COMMITMENTS AND CONTINGENCIES
Loan commitments
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to
extend credit and advance funds under lines of credit and credit card
loans. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in
the accompanying consolidated financial statements.
The Bank's exposure to credit loss is represented by the contractual
amount of these instruments. The Bank uses the same credit policies
in making commitments as it does for on-balance-sheet instruments. A
summary of financial instruments outstanding whose contract amounts
represent credit risk is as follows:
June 30,
------------------
1998 1997
------- -------
(In Thousands)
Commitments to grant mortgage loans $ 3,501 $ 2,146
Commitments to grant commercial loans 2,898 2,267
Unadvanced funds on home equity lines of credit 1,749 1,649
Unadvanced funds on credit card loans 1,323 1,260
Unadvanced funds on commercial lines of credit 2,846 2,031
Standby letters of credit 210 -
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. The commitments
for lines of credit and credit card loans may expire without being
drawn upon; therefore, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The commitments
for mortgage loans and home equity lines of credit are collateralized
by real estate. Commercial loans and lines of credit are secured by
various assets of the borrowers. Credit card loans are generally
unsecured.
Standby letters-of-credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party.
Those letters-of-credit are primarily issued to support public and
private borrowing arrangements. Letters of credit outstanding as of
June 30, 1998 have expiration dates within six years. The credit risk
involved in issuing letters-of-credit is essentially the same as that
involved in extending loan facilities to customers.
Employment agreements
The Company and the Bank have entered into employment agreements with
the President and three other officers. The agreements provide for
base salaries, participation in employee benefit plans, and in the
event of termination of employment provide for certain lump-sum
severance payments and continuation of benefits. However, such
employment may be terminated for cause, as defined in the agreements,
without incurring any continuing obligations.
In June 1998, the Company amended the President's employment agreement
to provide him with a special benefit on his retirement. The
President would be entitled to receive a lump sum benefit upon
retirement equal to the dollar value of the shares of common stock
expected to be allocated to the President under the ESOP over the ten
year term of the ESOP loan reduced by the value of the shares of
common stock actually allocated to the President's ESOP account.
Contingencies
Various legal claims arise from time to time in the normal course of
business which, in the opinion of management, will have no material
effect on the Company's consolidated financial position or results of
operations.
10. STOCKHOLDERS' EQUITY
Stock conversion
On January 8, 1998, the Bank converted from a mutual to a stock
institution. Mystic Financial, Inc. became the Bank's holding company
in connection with the conversion and issued 2,711,125 shares of
common stock at $10.00 per share. Net proceeds were $25,737,000 after
conversion costs of approximately $1,374,000.
During the year ended June 30, 1998, the Company purchased 2,120
shares of common stock for approximately $21,000 from the original
stockholders.
At the time of the conversion, the Bank established a liquidation
account in the amount of $11,761,000. In accordance with
Massachusetts statute, the liquidation account will be maintained for
the benefit of eligible account holders who continue to maintain their
accounts in the Bank after the conversion. The liquidation account
will be reduced annually to the extent that eligible account holders
have reduced their qualifying deposits. Subsequent increases will not
restore an eligible account holder's interest in the liquidation
account. In the event of a complete liquidation, each eligible
account holder will be entitled to receive a distribution in an amount
equal to their current adjusted liquidation account balance, to the
extent that funds are available.
Minimum regulatory capital requirements
The Company (on a consolidated basis) and the Bank are subject to
various regulatory capital requirements administered by the federal
banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct
material effect on the Company's and the Bank's consolidated financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of
their assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts
and ratios (set forth in the following tables) of total and Tier I
capital (as defined) to average assets (as defined). Management
believes, as of June 30, 1998, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
As of June 30, 1998, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, the Bank must maintain minimum total
risk-based, Tier I risk-based and Tier I leverage ratios as set forth
in the following tables. There are no conditions or events that
management believes have changed the Bank's category. The Company's
and the Bank's actual capital amounts and ratios are also presented in
the tables.
Minimum
To Be Well
Capitalized Under
Prompt Corrective
Actual Minimum Capital Requirement Action Provisions
----------------- ---------------------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- --------------- --------- -------- -----
(Dollars in Thousands)
June 30, 1998:
Total Capital to Risk Weighted Assets
Consolidated $ 36,931 34.1% $ 8,670 8.0% N/A N/A
Bank 25,653 24.4 8,412 8.0 $ 10,515 10.0%
Tier I Capital to Risk Weighted Assets
Consolidated 35,695 32.9 4,335 4.0 N/A N/A
Bank 24,417 23.2 4,206 4.0 6,309 6.0
Tier I Capital to Average Assets
Consolidated 35,695 19.1 7,486 - 9,357 4.0 - 5.0 N/A N/A
Bank 24,417 13.9 7,032 - 8,790 4.0 - 5.0 8,790 5.0
June 30, 1997:
Total Capital to Risk Weighted Assets $ 12,738 14.4% $ 7,073 8.0% $ 8,842 10.0%
Tier I Capital to Risk Weighted Assets 11,761 13.3 3,537 4.0 5,305 6.0
Tier I Capital to Average Assets 11,761 8.1 5,820 - 7,274 4.0 - 5.0 7,274 5.0
11. RELATED PARTY TRANSACTIONS
At June 30, 1998 and 1997, total loans to directors and officers of
the Company greater than $60,000 on an individual basis amounted to
approximately $912,000 and $1,667,000, respectively. During the years
ended June 30, 1998 and 1997, total principal additions were $118,000
and $198,000, respectively, and total principal payments were $873,000
and $52,000, respectively.
12. EMPLOYEE BENEFIT PLANS
Pension plans
The Bank provides pension benefits for its employees through
membership in Plan C of the Defined Benefit Plan of the Co-operative
Banks Employees Retirement Association. The plan is a multi-employer
plan where the contributions by each bank are not restricted to
provide benefits to the employees of the contributing bank. Each
employee reaching the age of 21 and having completed 1,000 hours of
service in one consecutive twelve-month period beginning with such
employee's date of employment automatically becomes a participant in
the retirement plan. A participant in the plan is not vested until
they have performed two years of service, at which time they become
20% vested. Participants become 100% vested when credited with six
years of service.
Total pension expense for the years ended June 30, 1998, 1997 and 1996
amounted to approximately $132,000, $104,000 and $107,000,
respectively.
In addition to the defined benefit plan, the Bank has a savings and
retirement plan which qualifies under Section 401(k) of the Internal
Revenue Code. Each employee reaching the age of 21 and having
completed 1,000 hours of service in one consecutive twelve-month
period beginning with such employee's date of employment automatically
becomes a participant in the savings and retirement plan. The plan
provides for voluntary contributions by participating employees
ranging from one percent to ten percent of their compensation, subject
to certain limitations. The Bank matches 50% of an employee's
voluntary contribution up to ten percent of the employee's
compensation.
Total expense under the Section 401(k) plan for the years ended June
30, 1998, 1997 and 1996 amounted to approximately $68,000, $58,000 and
$49,000, respectively.
Employee stock ownership plan
The Company established and the Bank adopted an ESOP, for the benefit
of eligible employees, which became effective on January 8, 1998.
Employees who have attained age 21 and have completed one year of
service are eligible to become participants in the ESOP.
The Company loaned the ESOP approximately $3,194,000 to fund the
purchase of 216,890 shares of common stock of the Company in open-
market purchases following completion of the Bank's conversion from
mutual to stock form. The Bank intends to make annual contributions
to the ESOP in an aggregate amount at least equal to the principal and
interest requirements on the loan. The loan is for a term of 10
years, bears interest at 8% per annum and requires annual principal
payments of $319,386 plus interest.
Shares purchased by the ESOP are pledged as collateral for the loan,
and are held in a suspense account until released for allocation among
participants in the ESOP as the loan is repaid. The pledged shares
are released annually from the suspense account in an amount
proportional to the repayment of the ESOP loan for each plan year.
The released shares will be allocated among the accounts of
participants on the basis of the participant's compensation for the
year of allocation. Benefits generally become vested at the rate of
20% per year with vesting to begin after an employee's completion of
three years of service and full vesting to occur after seven years of
service. Participants also become immediately vested upon termination
of employment due to death, retirement at age 65 or older, permanent
disability or upon the occurrence of a change of control. Forfeitures
will be reallocated among remaining participating employees, in the
same proportion as contributions. Vested benefits may be paid in a
single sum or installment payments and are payable upon death,
retirement at age 65 or older, disability or separation from service.
At June 30, 1998, the ESOP held 216,890 shares of common stock of the
Company, all of which were unallocated. The fair value of the
unallocated shares at June 30, 1998 was approximately $3,145,000.
Cash dividends received on allocated shares will be allocated to
participants' accounts and dividends received on unallocated shares
are held to repay the outstanding debt of the ESOP.
Total expense applicable to the ESOP amounted to $163,000 for the year
ended June 30, 1998.
Benefit restoration plan
In June 1998, the Company adopted the Benefit Restoration Plan ("BRP")
in order to provide certain senior executives with the benefits that
would be due to such executives under the defined benefit pension
plan, the 401(k) Plan and the ESOP if such benefits were not limited
under the Internal Revenue Code.
The Company intends to establish an irrevocable grantor trust to hold
the assets of the BRP. This trust will be funded with contributions
of the Company for the purpose of providing the benefits under the
BRP. The assets of the trust will be considered to be part of the
general assets of the Company and will be subject to the claims of its
creditors. Earnings on the trust's assets will be taxable to the
Company.
13. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Company.
The total amount of dividends which may be paid at any date is
generally limited to the retained earnings of the Bank, and loans or
advances are limited to 10% of the Bank's capital stock and surplus on
a secured basis.
At June 30, 1998, the Bank's retained earnings available for the
payment of dividends was $13,083,000 and funds available for loans or
advances amounted to $1,133,000. Accordingly, $10,638,000 of the
Company's equity in the net assets of the Bank was restricted at June
30, 1998.
In addition, dividends paid by the Bank to the Company would be
prohibited if the effect thereof would cause the Bank's capital to be
reduced below applicable minimum capital requirements.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments"
requires disclosure of estimated fair values of all financial
instruments where it is practicable to estimate such values. In cases
where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows.
Accordingly, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be
realized in immediate settlement of the instrument. SFAS No. 107
excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying
value of the Company.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of cash,
federal funds sold and short-term investments approximate fair
values.
Investment securities: Fair values for investment securities,
excluding Federal Home Loan Bank stock, are based on quoted
market prices. The carrying value of Federal Home Loan Bank
stock approximates fair value based on the redemption provisions
of the Federal Home Loan Bank.
Loans receivable: For variable-rate loans that reprice
frequently and with no significant change in credit risk, fair
values are based on carrying values. Fair values for loans held
for sale are based on quoted market prices. Fair values for all
other loans are estimated using discounted cash flow analyses,
using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Fair
values for non-performing loans are estimated using underlying
collateral values.
Deposit liabilities: Fair values for interest and non-interest
checking, passbook savings, and certain types of money market
accounts are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts).
Fair values for term certificates of deposit are estimated using
a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of
aggregated expected monthly maturities.
Federal Home Loan Bank borrowings: Fair values for borrowings
are estimated using discounted cash flow analysis based on the
Bank's current incremental borrowing rates for similar types of
borrowing arrangements.
Accrued interest: The carrying amounts of accrued interest
approximate fair value.
Off-balance-sheet instruments: Fair values for off-balance-
sheet lending commitments are based on fees currently charged
to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties' credit
standing and are not material.
The estimated fair values, and related carrying amounts, of the
Company's financial instruments are as follows:
June 30,
--------------------------------------------
1998 1997
-------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
(In Thousands)
Financial assets:
Cash and cash equivalents $ 25,979 $ 25,979 $ 6,225 $ 6,225
Securities available for sale 14,749 14,749 3,819 3,819
Securities held to maturity 12,006 12,030 17,504 17,431
Federal Home Loan Bank stock 997 997 858 858
Loans, net 138,593 141,418 114,568 114,898
Mortgage loans held for sale 80 80 210 210
Accrued interest receivable 1,099 1,099 870 870
Financial liabilities:
Deposits 144,766 145,116 129,303 129,516
Federal Home Loan Bank borrowings 16,505 16,341 7,532 7,534
Accrued interest payable 288 288 249 249
15. SUBSEQUENT EVENT
On July 30, 1998, the Board of Directors adopted a stock repurchase
program authorizing the Company to repurchase up to 135,450 shares or
5% of its outstanding shares of common stock. On August 6, 1998, the
Company completed the repurchase program acquiring 135,450 shares at a
cost of approximately $1,967,000.
16. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Condensed financial information pertaining only to Mystic Financial,
Inc., is as follows:
BALANCE SHEET
June 30, 1998
(In Thousands)
Assets
- ------
Cash and due from banks $ 178
Federal funds sold 1,003
Short-term investments 1,522
--------
Total cash and cash equivalents 2,703
Securities available for sale, at fair value 8,511
Investment in common stock of Bank 24,854
Other assets 159
--------
Total assets $ 36,227
========
Liabilities and Stockholders' Equity
- ------------------------------------
Accrued expenses $ 100
--------
Stockholders' equity:
Preferred stock -
Common stock 27
Additional paid-in capital 25,710
Retained earnings 13,173
--------
38,910
Treasury stock, at cost (21)
Net unrealized gain on securities available for sale,
net of tax effects 432
Loan due from ESOP (3,194)
--------
Total stockholders' equity 36,127
--------
Total liabilities and stockholders' equity $ 36,227
========
STATEMENT OF INCOME
For the Period January 8, 1998 to June 30, 1998
(In Thousands)
Income:
Interest on investments $ 253
Interest on ESOP loan 126
Miscellaneous income 4
-----
Total income 383
Operating expenses 8
-----
Income before income taxes and equity in undistributed
income of Bank 375
Income tax provision 150
-----
225
Equity in undistributed income of Bank 731
-----
Net income $ 956
=====
STATEMENT OF CASH FLOWS
For the Period January 8, 1998 to June 30, 1998
(In Thousands)
Cash flows from operating activities:
Net income $ 956
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed income of Bank (731)
Amortization of investments 3
Increase in other assets (155)
Increase in accrued expenses 100
--------
Net cash provided by operating activities 173
--------
Cash flows from investing activities:
Purchase of Bank common stock (11,333)
Purchases of securities available for sale (8,524)
Loan to ESOP (3,194)
--------
Net cash used by investing activities (23,051)
--------
Cash flows from financing activities:
Net proceeds from sale of common stock 25,737
Purchase of treasury stock (21)
Cash dividends paid (135)
--------
Net cash provided by financing activities 25,581
--------
Net increase in cash and cash equivalents 2,703
Cash and cash equivalents, beginning of period -
--------
Cash and cash equivalents, end of period $ 2,703
========
17. QUARTERLY DATA (UNAUDITED)
MYSTIC FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
Years Ended June 30,
-----------------------------------------------------------------------------
1998 1997
------------------------------------- -------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(In thousands, except per share data)
Interest and dividend income $ 3,317 $ 3,171 $ 2,937 $ 2,785 $ 2,649 $ 2,481 $ 2,437 $ 2,332
Interest expense (1,435) (1,390) (1,432) (1,391) (1,317) (1,230) (1,202) (1,162)
------- ------- ------- ------- ------- ------- ------- -------
Net interest income 1,882 1,781 1,505 1,394 1,332 1,251 1,235 1,170
Provision for loan losses (30) (65) (80) (70) (150) (37) (60) (25)
------- ------- ------- ------- ------- ------- ------- -------
Net interest income, after provision for
loan losses 1,852 1,716 1,425 1,324 1,182 1,214 1,175 1,145
Other income 235 252 203 345 255 208 190 229
Operating expenses (1,278) (1,193) (1,233) (1,070) (1,146) (1,002) (1,146) (1,036)
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes 809 775 395 599 291 420 219 338
Provision for income taxes (320) (308) (159) (244) (132) (170) (86) (139)
------- ------- ------- ------- ------- ------- ------- -------
Net income $ 489 $ 467 $ 236 $ 355 $ 159 $ 250 $ 133 $ 199
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings per share $ 0.18 N/A N/A N/A N/A N/A N/A N/A
======= ======= ======= ======= ======= ======= ======= =======
Diluted earnings per share $ 0.18 N/A N/A N/A N/A N/A N/A N/A
======= ======= ======= ======= ======= ======= ======= =======
N/A - Shares of common stock were not issued until January 8, 1998.