10-K 1 d444905d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)   
þ   

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

   For the fiscal year ended December 31, 2012
¨   

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 0-15752

CENTURY BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

COMMONWEALTH OF MASSACHUSETTS   04-2498617

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification number)

400 MYSTIC AVENUE, MEDFORD, MA   02155
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number including area code:

(781) 391-4000

Securities registered pursuant to Section 12(b) of the Act:

 

Class A Common Stock, $1.00 par value   Nasdaq Global Market
(Title of class)   (Name of Exchange)

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ

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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    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 or any amendment to this Form 10-K    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨

   Accelerated filer    þ    Non-accelerated filer    ¨    Smaller reporting company    ¨
      (Do not check if a smaller reporting company)   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  þ

State the aggregate market value of the registrant’s voting and nonvoting stock held by nonaffiliates, computed using the closing price as reported on Nasdaq as of June 30, 2012 was $106,506,833.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of February 28, 2013:

Class A Common Stock, $1.00 par value 3,569,679 Shares

Class B Common Stock, $1.00 par value 1,986,880 Shares

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).

 

(1) Portions of the Registrant’s Annual Report to Stockholders for the fiscal year ended December 31, 2012 are incorporated into Part II, Items 5-8 of this Form 10-K.

 

 

 

 


Table of Contents

CENTURY BANCORP INC.

FORM 10-K

TABLE OF CONTENTS

 

          Page  
  

PART I

  
ITEM 1   

BUSINESS

     1-5   
ITEM 1A   

RISK FACTORS

     5-6   
ITEM 1B   

UNRESOLVED STAFF COMMENTS

     6   
ITEM 2   

PROPERTIES

     6-7   
ITEM 3   

LEGAL PROCEEDINGS

     7   
ITEM 4   

MINE SAFETY DISCLOSURES

     7   
  

PART II

  
ITEM 5   

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     8-9   
ITEM 6   

SELECTED FINANCIAL DATA

     9   
ITEM 7   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

     9   
ITEM 7a   

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     9   
ITEM 8   

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     9   
ITEM 9   

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     9   
ITEM 9A   

CONTROLS AND PROCEDURES

     9-10   
ITEM 9B   

OTHER INFORMATION

     10   
  

PART III

  
ITEM 10   

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     90-94   
ITEM 11   

EXECUTIVE COMPENSATION

     95-105   
ITEM 12   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     106-107   
ITEM 13   

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

     107   
ITEM 14   

PRINCIPAL ACCOUNTING FEES AND SERVICES

     107-108   
  

PART IV

  
ITEM 15   

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

     108-110   
SIGNATURES      111   

 

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PART I

 

ITEM 1.    BUSINESS

The Company

Century Bancorp, Inc. (together with its bank subsidiary, unless the context otherwise requires, the “Company”) is a Massachusetts state-chartered bank holding company headquartered in Medford, Massachusetts. The Company is a Massachusetts corporation formed in 1972 and has one banking subsidiary (the “Bank”): Century Bank and Trust Company formed in 1969. At December 31, 2012, the Company had total assets of $3.1 billion. Currently, the Company operates 25 banking offices in 19 cities and towns in Massachusetts, ranging from Braintree in the south to Andover in the north. The Bank’s customers consist primarily of small and medium-sized businesses and retail customers in these communities and surrounding areas, as well as local governments and institutions throughout Massachusetts.

The Company’s results of operations are largely dependent on net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. The results of operations are also affected by the level of income/fees from loans and deposits, as well as operating expenses, the provision for loan losses, the impact of federal and state income taxes and the relative levels of interest rates and economic activity.

The Company offers a wide range of services to commercial enterprises, state and local governments and agencies, nonprofit organizations, and individuals. It emphasizes service to small and medium-sized businesses and retail customers in its market area. The Company makes commercial loans, real estate and construction loans, and consumer loans and accepts savings, time and demand deposits. In addition, the Company offers to its corporate and institutional customers automated lockbox collection services, cash management services and account reconciliation services, and it actively promotes the marketing of these services to the municipal market. Also, the Company provides full-service securities brokerage services through a program called Investment Services at Century Bank, which is supported by LPL Financial, a full-service third-party securities brokerage business.

The Company is also a provider of financial services, including cash management, transaction processing and short-term financing, to municipalities in Massachusetts and Rhode Island. The Company has deposit relationships with 192 (55%) of the 351 cities and towns in Massachusetts.

Availability of Company Filings

Under the Securities Exchange Act of 1934, Sections 13 and 15(d), periodic and current reports must be filed with the Securities and Exchange Commission (the “SEC”). The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0030. The Company electronically files with the SEC its periodic and current reports, as well as other filings it makes with the SEC from time to time. The SEC maintains an Internet site that contains reports and other information regarding issuers, including the Company, that file electronically with the SEC, at www.sec.gov, in which all forms filed electronically may be accessed. Additionally, our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and additional shareholder information are available free of charge on the Company’s website: www.centurybank.com.

Employees

As of December 31, 2012, the Company had 336 full-time and 82 part-time employees. The Company’s employees are not represented by any collective bargaining unit. The Company believes that its employee relations are good.

 

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Financial Services Modernization

On November 12, 1999, President Clinton signed into law The Gramm-Leach-Bliley Act (“Gramm-Leach”) which significantly altered banking laws in the United States. Gramm Leach enables combinations among banks, securities firms and insurance companies beginning March 11, 2000. As a result of Gramm Leach, many of the depression-era laws that restricted these affiliations and other activities that may be engaged in by banks and bank holding companies were repealed. Under Gramm-Leach, bank holding companies are permitted to offer their customers virtually any type of financial service that is financial in nature or incidental thereto, including banking, securities underwriting, insurance (both underwriting and agency) and merchant banking.

In order to engage in these financial activities, a bank holding company must qualify and register with the Federal Reserve Board as a “financial holding company” by demonstrating that each of its bank subsidiaries is “well capitalized,” “well managed,” and has at least a “satisfactory” rating under the Community Reinvestment Act of 1977 (the “CRA”). The Company has not elected to become a financial holding company under Gramm-Leach.

These financial activities authorized by Gramm-Leach may also be engaged in by a “financial subsidiary” of a national or state bank, except for insurance or annuity underwriting, insurance company portfolio investments, real estate investment and development and merchant banking, which must be conducted in a financial holding company. In order for the new financial activities to be engaged in by a financial subsidiary of a national or state bank, Gramm-Leach requires each of the parent bank (and any bank affiliates) to be “well capitalized” and “well managed;” the aggregate consolidated assets of all of that bank’s financial subsidiaries may not exceed the lesser of 45% of its consolidated total assets or $50 billion; the bank must have at least a satisfactory CRA rating; and, if the bank is one of the 100 largest banks, it must meet certain financial rating or other comparable requirements. The Company does not currently conduct activities through a financial subsidiary.

Gramm-Leach establishes a system of functional regulation, under which the federal banking agencies will regulate the banking activities of financial holding companies and banks’ financial subsidiaries, the SEC will regulate their securities activities, and state insurance regulators will regulate their insurance activities. Gramm-Leach also provides new protections against the transfer and use by financial institutions of consumers’ nonpublic, personal information.

Holding Company Regulation

The Company is a bank holding company as defined by the Bank Holding Company Act of 1956, as amended (the “Holding Company Act”), and is registered as such with the Board of Governors of the Federal Reserve Bank (the “FRB”), which is responsible for administration of the Holding Company Act. Although the Company may meet the qualifications for electing to become a financial holding company under Gramm-Leach, the Company has elected to retain its pre-Gramm-Leach status for the present time under the Holding Company Act. As required by the Holding Company Act, the Company files with the FRB an annual report regarding its financial condition and operations, management and intercompany relationships of the Company and the Bank. It is also subject to examination by the FRB and must obtain FRB approval before (i) acquiring direct or indirect ownership or control of more than 5% of the voting stock of any bank, unless it already owns or controls a majority of the voting stock of that bank, (ii) acquiring all or substantially all of the assets of a bank, except through a subsidiary which is a bank, or (iii) merging or consolidating with any other bank holding company. A bank holding company must also give the FRB prior written notice before purchasing or redeeming its equity securities, if the gross consideration for the purchase or redemption, when aggregated with the net consideration paid by the company for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth.

The Holding Company Act prohibits a bank holding company, with certain exceptions, from (i) acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any company which is not a bank or a bank holding company, or (ii) engaging in any activity other than managing or controlling banks, or furnishing services to or performing services for its subsidiaries. A bank holding company may own, however, shares of a company engaged in activities which the FRB has determined are so closely related to banking or managing or controlling banks as to be a proper incident thereto.

 

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The Company and its subsidiaries are examined by federal and state regulators. The FRB has responsibility for holding company activities and performed a review of the Company and its subsidiaries as of June 2012.

Federal Deposit Insurance Corporation Improvement Act of 1991

On December 19, 1991, the FDIC Improvement Act of 1991 (the “1991 Act”) was enacted. This legislation provides for, among other things: enhanced federal supervision of depository institutions, including greater authority for the appointment of a conservator or receiver for undercapitalized institutions; the establishment of risk-based deposit insurance premiums; a requirement that the federal banking agencies amend their risk-based capital requirements to include components for interest-rate risk, concentration of credit risk, and the risk of nontraditional activities; expanded authority for cross-industry mergers and acquisitions; mandated consumer protection disclosures with respect to deposit accounts; and imposed restrictions on the activities of state-chartered banks, including the Bank.

Provisions of the 1991 Act relating to the activities of state-chartered banks significantly impact the way the Company conducts its business. In this regard, the 1991 Act provides that insured state banks, such as the Bank, may not engage as principal in any activity that is not permissible for a national bank, unless the FDIC has determined that the activity would pose no significant risk to the Bank Insurance Fund (“BIF”) and the state bank is in compliance with applicable capital standards. Activities of subsidiaries of insured state banks are similarly restricted to those activities permissible for subsidiaries of national banks, unless the FDIC has determined that the activity would pose no significant risk to the BIF and the state bank is in compliance with applicable capital standards.

Interstate Banking

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the “Interstate Banking Act”), generally permits bank holding companies to acquire banks in any state and preempts all state laws restricting the ownership by a bank holding company of banks in more than one state. The Interstate Banking Act also permits a bank to merge with an out-of-state bank and convert any offices into branches of the resulting bank if both states have not opted out of interstate branching; permits a bank to acquire branches from an out-of-state bank if the law of the state where the branches are located permits the interstate branch acquisition; and operated de novo interstate branches whenever the host state opts-in to de novo branching. Bank holding companies and banks seeking to engage in transactions authorized by the Interstate Banking Act must be adequately capitalized and managed.

USA PATRIOT Act

Under Title III of the USA PATRIOT Act, also known as the “International Money Laundering Abatement and Anti-Terrorism Act of 2001”, all financial institutions are required in general to identify their customers, adopt formal and comprehensive anti-money laundering programs, scrutinize or prohibit altogether certain transactions of special concern, and be prepared to respond to inquiries from U.S. law enforcement agencies concerning their customers and their transactions. Additional information-sharing among financial institutions, regulators, and law enforcement authorities is encouraged by the presence of an exemption from the privacy provisions of the Gramm-Leach Act for financial institutions that comply with this provision and the authorization of the Secretary of the Treasurer to adopt rules to further encourage cooperation and information-sharing. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act.

Sarbanes-Oxley Act

The Sarbanes-Oxley Act, signed into law July 30, 2002, addresses, among other issues, corporate governance, auditor independence and accounting standards, executive compensation, insider loans, whistleblower protection and enhanced and timely disclosure of corporate information. The SEC has adopted a substantial number of implementing rules and the Financial Industry Regulatory Authority (FINRA) has adopted corporate governance rules that have been approved by the SEC and are applicable to the Company. The changes

 

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are intended to allow stockholders to monitor more effectively the performance of companies and management. As directed by Section 302(a) of the Sarbanes-Oxley Act, the Company’s Chief Executive Officer and Chief Financial Officer are each required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. This requirement has several parts, including certification that these officers are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s disclosure controls and procedures and internal controls over financial reporting; that they have made certain disclosures to the Company’s auditors and the Board of Directors about the Company’s disclosure controls and procedures and internal control over financial reporting, and that they have included information in the Company’s quarterly and annual reports about their evaluation of the Company’s disclosure controls and procedures and internal control over financial reporting, and whether there have been significant changes in the Company’s internal disclosure controls and procedures or in other factors that could significantly affect such controls and procedures subsequent to the evaluation and whether there have been any significant changes in the Company’s internal control over financial reporting that have materially affected or reasonably likely to materially affect the Company’s internal control over financial reporting, and compliance with certain other disclosure objectives. Section 906 of the Sarbanes-Oxley Act requires an additional certification that each periodic report containing financial statements fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934 and that the information in the report fairly presents, in all material respects, the financial conditions and results of operations of the Company.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act became law. The Act was intended to address many issues arising in the recent financial crisis and is exceedingly broad in scope affecting many aspects of bank and financial market regulation. The Act requires, or permits by implementing regulation, enhanced prudential standards for banks and bank holding companies inclusive of capital, leverage, liquidity, concentration and exposure measures. In addition, traditional bank regulatory principles such as restrictions on transactions with affiliates and insiders were enhanced. The Act also contains reforms of consumer mortgage lending practices and creates a Bureau of Consumer Financial Protection which is granted broad authority over consumer financial practices of banks and others. It is expected as the specific new or incremental requirements applicable to the company become effective that the costs and difficulties of remaining compliant with all such requirements will increase. The Act broadens the base for FDIC assessments to average consolidated assets less tangible equity of financial institutions and also permanently raises the current standard maximum FDIC deposit insurance amount to $250,000. The Act extended unlimited deposit insurance on non-interest bearing transaction accounts through December 31, 2012.

Deposit Insurance Premiums

The Bank’s deposits have the benefit of FDIC insurance up to applicable limits. The FDIC’s Deposit Insurance Fund is funded by assessments on insured depository institutions, which depend on the risk category of an institution and the amount of assets that it holds. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis.

The Bank was also a participant in the FDIC’s Temporary Liquidity Guarantee Program.

On May 22, 2009, the FDIC announced a special assessment on insured institutions as part of its efforts to rebuild the Deposit Insurance Fund and help maintain public confidence in the banking system. The special assessment is five basis points of each FDIC-insured depository institution’s assets minus Tier 1 capital, as of June 30, 2009. The Company recorded a pre-tax charge of approximately $1.0 million in the second quarter of 2009 in connection with the special assessment.

On September 29, 2009, the FDIC adopted a Notice of Proposed Rulemaking (NPR) that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC Board voted to adopt a uniform three-basis point increase in assessment rates effective on January 1, 2011, and extend the restoration period from seven to eight years. This rule was finalized on November 2, 2009. As a result, the Company is carrying a prepaid asset of $2.8 million as of December 31, 2012.

 

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The Company’s quarterly risk-based deposit insurance assessments will be paid from this amount until the amount is exhausted or until December 30, 2014, when any amount remaining would be returned to the Company.

In February 2011, the FDIC approved a rule to change the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity. The rule should keep the overall amount collected from the industry very close to the amount collected prior to the new calculation.

Competition

The Company experiences substantial competition in attracting deposits and making loans from commercial banks, thrift institutions and other enterprises such as insurance companies and mutual funds. These competitors include several major commercial banks whose greater resources may afford them a competitive advantage by enabling them to maintain numerous branch offices and mount extensive advertising campaigns. A number of these competitors are not subject to the regulatory oversight that the Company is subject to, which increases these competitors’ flexibility.

Forward-Looking Statements

Certain statements contained herein are not based on historical facts and are “forward-looking statements” within the meaning of Section 21A of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions (some of which are beyond the Company’s control), may be identified by a reference to a “estimate,” “anticipate” “continue” or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities market and the availability of and costs associated with sources of liquidity.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

 

ITEM 1A.    RISK FACTORS

The risk factors that may affect the Company’s performance and results of operations include the following:

(i)  the Company’s business is dependent upon general economic conditions in Massachusetts. The national and local economies may adversely affect the Company’s performance and results of operations;

(ii)  the Company’s earnings depend to a great extent upon the level of net interest income generated by the Company, and therefore the Company’s results of operations may be adversely affected by increases or decreases in interest rates or by the shape of the yield curve;

(iii)  the banking business is highly competitive and the profitability of the Company depends upon the Company’s ability to attract loans and deposits in Massachusetts, where the Company competes with a variety of traditional banking companies, some of which have vastly greater resources, and nontraditional institutions such as credit unions and finance companies;

(iv)  at December 31, 2012, approximately 59.8% of the Company’s loan portfolio was comprised of commercial and commercial real estate loans, exposing the Company to the risks inherent in financings based upon analyses of credit risk, the value of underlying collateral, including real estate, and other more intangible factors, which are considered in making commercial loans;

(v)  at December 31, 2012, approximately 36.0% of the Company’s loan portfolio was comprised of residential real estate loans, exposing the Company to the risks inherent in financings based upon analyses of credit risk and the value of underlying collateral. Accordingly, the Company’s profitability may be

 

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negatively impacted by errors in risk analyses, by loan defaults and the ability of certain borrowers to repay such loans may be adversely affected by any downturn in general economic conditions;

(vi)  economic conditions and interest rate risk could adversely impact the fair value and the ultimate collectability of the Company’s investments. Should an investment be deemed “other than temporarily impaired”, the Company would be required to writedown the carrying value of the investment through earnings. Such writedown(s) may have a material adverse effect on the Company’s financial condition and results of operations;

(vii)  writedown of goodwill and other identifiable intangible assets would negatively impact our financial condition and results of operations. At December 31, 2012, our goodwill and other identifiable intangible assets were approximately $2.7 million;

(viii)  acts or threats of terrorism and actions taken by the United States or other governments as a result of such acts or threats, including possible military action, could further adversely affect business and economic conditions in the United States of America generally and in the Company’s markets, which could adversely affect the Company’s financial performance and that of the Company’s borrowers and on the financial markets and the price of the Company’s Class A common stock;

(ix)  changes in the extensive laws, regulations and policies governing bank holding companies and their subsidiaries could alter the Company’s business environment or affect the Company’s operations; 

(x)  the potential need to adapt to industry changes in information technology systems, on which the Company is highly dependent to secure bank and customer financial information, could present operational issues, require significant capital spending or impact the Company’s reputation; and

(xi)  the Governor of Massachusetts has proposed a tax plan that would modify existing income tax rules. The Governor’s plan is part of his budget recommendations for fiscal year 2014, and will subject security corporations to the same tax base and rate as regular business corporations. The proposed tax changes would take effect as of January 1, 2014. The Company is currently analyzing the financial impact of the proposed changes.

These factors, as well as general economic and market conditions in the United States of America, may materially and adversely affect the Company’s performance, results of operations and the market price of shares of the Company’s Class A common stock.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

No written comments received by the Company from the SEC regarding the Company’s periodic or current reports remain unresolved.

 

ITEM 2. PROPERTIES

The Company owns its main banking office, headquarters, and operations center in Medford, Massachusetts, which were expanded in 2004, and 11 of the 24 other facilities in which its branch offices are located. The remaining offices are occupied under leases expiring on various dates from 2013 to 2026. The Company believes that its banking offices are in good condition.

During July 2010, the Company entered into a lease agreement to open a branch located at Newton Centre in Newton, Massachusetts. The branch opened on June 20, 2011.

During September 2010, the Company entered into a lease agreement to open a branch located in Andover, Massachusetts. The branch opened on July 16, 2012.

During June 2012, the Company entered into a lease agreement to open a branch located in Wellesley, Massachusetts. The branch opened on November 26, 2012.

 

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During July 2012, the Company received state regulatory approval to close a branch at Chestnut Hill in Newton, Massachusetts. The branch closed on September 21, 2012 and the accounts were temporarily moved to the Brookline, Massachusetts branch. During July 2012, the Company entered into a lease agreement and received regulatory approval to open a branch at a new location at Chestnut Hill in Newton, Massachusetts. The branch is scheduled to open during the fourth quarter of 2013 and the accounts that were temporarily moved to the Brookline, Massachusetts branch will be moved to the new branch at Chestnut Hill in Newton, Massachusetts.

 

ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are parties to various claims and lawsuits arising in the course of their normal business activities. Although the ultimate outcome of these suits cannot be ascertained at this time, it is the opinion of management that none of these matters, even if it resolved adversely to the Company, will have a material adverse effect on the Company’s consolidated financial position.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

(a)  The Class A Common Stock of the Company is traded on the NASDAQ National Global Market under the symbol “CNBKA.” The price range of the Company’s Class A common stock since January 1, 2011 is shown on page 12. The Company’s Class B Common Stock is not traded on any national securities exchange or other public trading market.

 

     Issuer Purchases of Equity Securities  

Period

   Total Number
of Shares
Purchased
     Weighted
Average
Price Paid
per Share
     Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
     Maximum Number of
Shares That May Yet be
Purchased Under the
Plans or Programs(1)
 

October 1 — October 31, 2012

                             300,000   

November 1 — November 30, 2012

                             300,000   

December 1 — December 31, 2012

                             300,000   

 

 

 

(1) On July 10, 2012, the Company announced a reauthorization of the Class A common stock repurchase program to repurchase up to 300,000 shares. The Company placed no deadline on the repurchase program. There were no shares purchased other than through a publicly announced plan or program.

The shares of Class A Common Stock are generally not entitled to vote on any matter, including in the election of Company Directors, but, in limited circumstances, may be entitled to vote as a class on certain extraordinary transactions, including any merger or consolidation (other than one in which the Company is the surviving corporation or one which by law may be approved by the directors without any stockholder vote) or the sale, lease, or exchange of all or substantially all of the property and assets of the Company. Since the vote of a majority of the shares of the Company’s Class B Common Stock, voting as a separate class, is required to approve certain extraordinary corporate transactions, the holders of Class B Common Stock have the power to prevent any takeover of the Company not approved by them.

(b)  Approximate number of equity security holders as of December 31, 2012:

 

Title of Class

   Approximate Number
of Record Holders
 

Class A Common Stock

     1,130   

Class B Common Stock

     49   

(c)  Under the Company’s Articles of Organization, the holders of Class A Common Stock are entitled to receive dividends per share equal to at least 200% of dividends paid, if any, from time to time, on each share of Class B Common Stock.

The following table shows the dividends paid by the Company on the Class A and Class B Common Stock for the periods indicated.

 

     Dividends per
Share
 
     Class A      Class B  

2011

     

First quarter

   $ .12       $ .06   

Second quarter

     .12         .06   

Third quarter

     .12         .06   

Fourth quarter

     .12         .06   

2012

     

First quarter

   $ .12       $ .06   

Second quarter

     .12         .06   

Third quarter

     .12         .06   

Fourth quarter

     .12         .06   

 

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As a bank holding company, the Company’s ability to pay dividends is dependent in part upon the receipt of dividends from the Bank, which is subject to certain restrictions on the payment of dividends. A Massachusetts trust company may pay dividends out of net profits from time to time, provided that either (i) the trust company’s capital stock and surplus account equal an aggregate of at least 10% of its deposit liabilities, or (ii) the amount of its surplus account is equal to at least the amount of its capital account.

(d)  The following schedule provides information with respect to the Company’s equity compensation plans under which shares of Class A Common Stock are authorized for issuance as of December 31, 2012:

 

     Equity Compensation Plan Information  

Plan Category

   Number of Shares
to be Issued
Upon Exercise of
Outstanding Options
(a)
     Weighted-Average
Exercise Price of
Outstanding Options
(b)
     Number of Shares
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding
Shares Reflected in
Column (a))
(c)
 

Equity compensation plans approved by security holders

     23,350       $ 31.17         223,534   

Equity compensation plans not approved by security holders

                       
  

 

 

    

 

 

    

 

 

 

Total

     23,350       $ 31.17         223,534   

(e)  The performance graph information required herein is shown on page 12.

 

ITEM 6. SELECTED FINANCIAL DATA

The information required herein is shown on pages 11 and 12.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

The information required herein is shown on pages 13 through 36.

 

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required herein is shown on page 33.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required herein is shown on pages 37 through 86.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

The Company’s principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures as of December 31, 2012. Based on this evaluation, the principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures effectively ensure that information required to be disclosed in the Company’s filings and submissions with the Securities and Exchange Commission under the Exchange Act is accumulated and reported to Company management (including the principal executive officer and principal financial officer) and is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission. In addition, the Company has reviewed its internal control over financial reporting and there have been no

 

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significant changes in its internal control over financial reporting or in other factors that could significantly affect its internal control over financial reporting. Management’s report on internal control over financial reporting is shown on page 89. The audit report of the registered public accounting firm is shown on page 88.

 

ITEM 9B. OTHER INFORMATION

None.

 

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Financial Highlights

 

     2012     2011     2010     2009     2008  
     (dollars in thousands, except share data)  

FOR THE YEAR

          

Interest income

   $ 81,494      $ 78,065      $ 76,583      $ 79,600      $ 80,693   

Interest expense

     19,540        22,766        24,817        31,723        35,914   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     61,954        55,299        51,766        47,877        44,779   

Provision for loan losses

     4,150        4,550        5,575        6,625        4,425   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     57,804        50,749        46,191        41,252        40,354   

Other operating income

     15,865        16,240        15,999        16,470        13,975   

Operating expenses

     53,238        48,742        47,372        46,379        43,028   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     20,431        18,247        14,818        11,343        11,301   

Provision for income taxes

     1,392        1,554        1,244        1,183        2,255   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 19,039      $ 16,693      $ 13,574      $ 10,160      $ 9,046   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average shares outstanding Class A, basic

     3,557,693        3,543,233        3,521,179        3,509,931        3,514,883   

Average shares outstanding Class B, basic

     1,990,474        1,997,411        2,012,327        2,022,318        2,027,100   

Average shares outstanding Class A, diluted

     5,549,191        5,541,794        5,535,742        5,534,340        5,543,702   

Average shares outstanding Class B, diluted

     1,990,474        1,997,411        2,012,327        2,022,318        2,027,100   

Total shares outstanding at year-end

     5,554,959        5,542,697        5,540,247        5,530,297        5,538,407   

Earnings per share:

          

Basic, Class A

   $ 4.18      $ 3.68      $ 3.00      $ 2.25      $ 2.00   

Basic, Class B

   $ 2.09      $ 1.84      $ 1.50      $ 1.12      $ 1.00   

Diluted, Class A

   $ 3.43      $ 3.01      $ 2.45      $ 1.84      $ 1.63   

Diluted, Class B

   $ 2.09      $ 1.84      $ 1.50      $ 1.12      $ 1.00   

Dividend payout ratio

     11.5     13.1     16.0     21.4     24.0

AT YEAR-END

          

Assets

   $ 3,086,209      $ 2,743,225      $ 2,441,684      $ 2,254,035      $ 1,801,566   

Loans

     1,111,788        984,492        906,164        877,125        836,065   

Deposits

     2,445,073        2,124,584        1,902,023        1,701,987        1,265,527   

Stockholders’ equity

     179,990        160,649        145,025        132,730        120,503   

Book value per share

   $ 32.40      $ 28.98      $ 26.18      $ 24.00      $ 21.76   

SELECTED FINANCIAL PERCENTAGES

          

Return on average assets

     0.65     0.63     0.56     0.50     0.54

Return on average stockholders’ equity

     11.06     10.72     9.52     7.98     7.43

Net interest margin, taxable equivalent

     2.51     2.48     2.52     2.69     3.00

Net charge-offs as a percent of average loans

     0.15     0.21     0.44     0.63     0.38

Average stockholders’ equity to average assets

     5.85     5.88     5.93     6.26     7.23

Efficiency ratio

     62.1     62.2     65.0     68.5     70.6

 

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Financial Highlights — (Continued)

 

     2012, Quarter Ended  

Per Share Data

   December 31,      September 30,      June 30,      March 31,  

Market price range (Class A)

           

High

   $ 34.00       $ 33.00       $ 30.24       $ 29.50   

Low

     28.02         28.46         25.00         23.51   

Dividends Class A

     0.12         0.12         0.12         0.12   

Dividends Class B

     0.06         0.06         0.06         0.06   
     2011, Quarter Ended  
     December 31,      September 30,      June 30,      March 31,  

Market price range (Class A)

           

High

   $ 28.80       $ 28.91       $ 27.80       $ 28.38   

Low

     20.50         21.96         23.25         24.75   

Dividends Class A

     0.12         0.12         0.12         0.12   

Dividends Class B

     0.06         0.06         0.06         0.06   

The stock performance graph below compares the cumulative total shareholder return of the Company’s Class A Common Stock from December 31, 2007 to December 31, 2012 with the cumulative total return of the NASDAQ Market Index (U.S. Companies) and the NASDAQ Bank Stock Index. The lines in the graph represent monthly index levels derived from compounded daily returns that include all dividends. If the monthly interval, based on the fiscal year-end, was not a trading day, the preceding trading day was used.

Comparison of Five-Year

Cumulative Total Return*

 

LOGO

 

Value of $100 Invested on December 31, 2007 at:    2008      2009      2010      2011      2012  

Century Bancorp, Inc.

   $ 80.32       $ 115.35       $ 143.27       $ 153.83       $ 182.35   

NASDAQ Banks

     72.91         60.66         72.13         64.51         77.18   

NASDAQ U.S.

     61.17         87.93         104.35         104.92         123.85   

 

* Assumes that the value of the investment in the Company’s Common Stock and each index was $100 on December 31, 2007 and that all dividends were reinvested.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition

FORWARD-LOOKING STATEMENTS

Certain statements contained herein are not based on historical facts and are “forward-looking statements” within the meaning of Section 21A of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions (some of which are beyond the Company’s control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “estimate,” “anticipate,” “continue” or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets, and the availability of and costs associated with sources of liquidity.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

RECENT MARKET DEVELOPMENTS

The financial services industry continues to face unprecedented challenges in the aftermath of the recent national and global economic crisis. Since June 2009, the U.S. economy has been recovering from the most severe recession and financial crisis since the Great Depression. There have been some improvements in private-sector employment, industrial production and U.S. exports; nevertheless, the pace of economic recovery has been extremely slow. The housing markets continue to be depressed. Financial markets have improved since the depths of the crisis but are still unsettled and volatile. Investors have pulled back from risky assets. There is continued concern about the U.S. economic outlook and the potential effects of the continued crisis in the European financial markets.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) became law. The Act was intended to address many issues arising in the recent financial crisis and is exceedingly broad in scope, affecting many aspects of bank and financial market regulation. The Act requires, or permits by implementing regulation, enhanced prudential standards for banks and bank holding companies inclusive of capital, leverage, liquidity, concentration and exposure measures. In addition, traditional bank regulatory principles such as restrictions on transactions with affiliates and insiders were enhanced. The Act also contains reforms of consumer mortgage lending practices and creates a Bureau of Consumer Financial Protection, which is granted broad authority over consumer financial practices of banks and others. It is expected as the specific new or incremental requirements applicable to the Company become effective that the costs and difficulties of remaining compliant with all such requirements will increase. The Act broadens the base for FDIC assessments to average consolidated assets less tangible equity of financial institutions and also permanently raises the current standard maximum FDIC deposit insurance amount to $250,000. The Act extended unlimited deposit insurance on non-interest bearing transaction accounts through December 31, 2012.

On September 29, 2009, the FDIC adopted a Notice of Proposed Rulemaking (NPR) that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC Board voted to adopt a uniform three-basis point increase in assessment rates effective on January 1, 2011, and extend the restoration period from seven to eight years. This rule was finalized on November 2, 2009. As a result, the Company is carrying a prepaid asset of $2.8 million as of December 31, 2012. The Company’s quarterly risk-based deposit insurance assessments will be paid from this amount until the amount is exhausted or until December 30, 2014, when any amount remaining would be returned to the Company.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

On September 30, 2011, the Massachusetts Department of Revenue issued a draft directive prohibiting a corporation from pledging more than 50 percent of security corporation stock it owns to secure a borrowing, effective for tax years beginning on or after October, 2012. Century Bank currently utilizes the stock of two of its security corporations to secure Federal Home Loan Bank of Boston (“FHLBB”) advances. Should this draft directive have become effective, Century Bank would have had fewer assets available to secure FHLBB advances, or would have had a higher tax rate if it chose to utilize security corporations to a lesser extent. On April 6, 2012, the Massachusetts Department of Revenue issued an updated draft directive allowing a corporation to pledge up to 100% of security corporation stock it owns to secure a borrowing. This revised draft directive would allow Century Bank to continue to utilize existing assets to secure FHLBB advances without pledging limitations. On May 24, 2012, the Massachusetts Department of Revenue issued Directive 12-2. The directive states that the pledge by a shareholder of shares of stock of a corporation as security or collateral for a loan to the shareholder, in and of itself, will not preclude classification of the corporation as a security corporation or result in revocation of a corporation’s existing security corporation classification.

Federal banking regulators have issued risk-based capital guidelines, which assign risk factors to asset categories and off-balance-sheet items. Also, the Basel Committee has issued capital standards entitled “Basel III: A global regulatory framework for more resilient banks and banking systems” (“Basel III”). Although the Company is not currently subject to these requirements, if adopted in their current form by U.S. banking regulators, the Basel III rules could increase the capital requirements of the Company. If enacted, the new Basel III requirements would be phased-in over a ten year timeframe, resulting in an increase in capital requirements along with the restriction of certain items in Tier 1 capital. Restricted items from Tier 1 capital would include trust preferred securities along with certain levels of deferred tax assets and mortgage servicing assets. Federal banking regulators then issued a notice of proposed rulemaking (NPR, proposal, or proposed rule) to revise the general risk-based capital rules to incorporate certain revisions by the Basel Committee on Banking Supervision to the Basel capital framework (Basel III). The Company is currently analyzing the proposed rules and the impact on the Company’s capital requirements.

The Governor of Massachusetts has proposed a tax plan that would modify existing income tax rules. The governor’s plan is part of his budget recommendations for fiscal year 2014, and will subject security corporations to the same tax base and rate as regular business corporations. The proposed tax changes would take effect as of January 1, 2014. The Company is currently analyzing the financial impact of the proposed changes.

OVERVIEW

Century Bancorp, Inc. (together with its bank subsidiary, unless the context otherwise requires, the “Company”) is a Massachusetts state-chartered bank holding company headquartered in Medford, Massachusetts. The Company is a Massachusetts corporation formed in 1972 and has one banking subsidiary (the “Bank”): Century Bank and Trust Company formed in 1969. At December 31, 2012, the Company had total assets of $3.1 billion. Currently, the Company operates 25 banking offices in 19 cities and towns in Massachusetts, ranging from Braintree in the south to Andover in the north. The Bank’s customers consist primarily of small and medium-sized businesses and retail customers in these communities and surrounding areas, as well as local governments and institutions throughout Massachusetts.

The Company’s results of operations are largely dependent on net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. The results of operations are also affected by the level of income/fees from loans and deposits, as well as operating expenses, the provision for loan losses, the impact of federal and state income taxes and the relative levels of interest rates and economic activity.

The Company offers a wide range of services to commercial enterprises, state and local governments and agencies, nonprofit organizations and individuals. It emphasizes service to small and medium-sized businesses and retail customers in its market area. The Company makes commercial loans, real estate and construction loans, and consumer loans and accepts savings, time and demand deposits. In addition, the Company offers to its

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

corporate and institutional customers automated lockbox collection services, cash management services and account reconciliation services, and it actively promotes the marketing of these services to the municipal market. Also, the Company provides full-service securities brokerage services through a program called Investment Services at Century Bank, which is supported by LPL Financial, a third party full-service securities brokerage business.

The Company is also a provider of financial services, including cash management, transaction processing and short-term financing, to municipalities in Massachusetts and Rhode Island. The Company has deposit relationships with 192 (55%) of the 351 cities and towns in Massachusetts.

The Company had net income of $19,039,000 for the year ended December 31, 2012, compared with net income of $16,693,000 for the year ended December 31, 2011, and net income of $13,574,000 for the year ended December 31, 2010. Class A diluted earnings per share were $3.43 in 2012, compared to $3.01 in 2011 and $2.45 in 2010.

Earnings per share (EPS) for each class of stock and for each year ended December 31, is as follows:

 

     2012      2011      2010  

Basic EPS – Class A common

   $ 4.18       $ 3.68       $ 3.00   

Basic EPS – Class B common

   $ 2.09       $ 1.84       $ 1.50   

Diluted EPS – Class A common

   $ 3.43       $ 3.01       $ 2.45   

Diluted EPS – Class B common

   $ 2.09       $ 1.84       $ 1.50   

The trends in the net interest margin are illustrated in the graph below:

Net Interest Margin

 

 

LOGO

The primary factor accounting for the general level of the net interest margin for 2010 was a large influx of deposits, primarily from municipalities, and a corresponding increase in short-term investments. The net interest margin fell somewhat during the second quarter of 2011 mainly as a result of increased deposits and corresponding lower-yield short-term investments. During the third quarter of 2011 through the third quarter of 2012, management stabilized the net interest margin by continuing to lower cost of funds and by deploying excess liquidity through expansion of the investment portfolio. Also, the Company collected approximately $3,000,000 of prepayment penalties during the first three quarters of 2012. The primary factor accounting for the decrease in the net interest margin for the fourth quarter of 2012 was an additional large influx of deposits, primarily from municipalities. Management invested the funds in shorter term securities.

While management will continue its efforts to improve the net interest margin, there can be no assurance that certain factors beyond its control, such as the prepayment of loans and changes in market interest rates, will continue to positively impact the net interest margin.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Historical U.S. Treasury Yield Curve

LOGO

A yield curve is a line that typically plots the interest rates of U.S. Treasury Debt, which have different maturity dates but the same credit quality, at a specific point in time. The three main types of yield curve shapes are normal, inverted and flat. Over the past three years, the U.S. economy has experienced low short-term rates. Since December 31, 2010, longer-term rates have declined resulting in a flatter yield curve.

During 2012, the Company’s earnings were positively impacted primarily by an increase in net interest income. This increase was primarily due to an increase in earning assets. During 2012, 2011 and 2010, the U.S. economy experienced a lower short-term rate environment. The lower short-term rates negatively impacted the net interest margin for 2011 and 2010 as the rate at which short-term deposits could be invested declined more than the rates offered on those deposits. The net interest margin also increased in 2012 as a result of prepayment penalties that were collected during the year.

Total assets were $3,086,209,000 at December 31, 2012, an increase of 12.5% from total assets of $2,743,225,000 on December 31, 2011.

On December 31, 2012, stockholders’ equity totaled $179,990,000, compared with $160,649,000 on December 31, 2011. Book value per share increased to $32.40 at December 31, 2012, from $28.98 on December 31, 2011.

During July 2010, the Company entered into a lease agreement to open a branch located at Newton Centre in Newton, Massachusetts. The branch opened on June 20, 2011.

During September 2010, the Company entered into a lease agreement to open a branch located in Andover, Massachusetts. The branch opened on July 16, 2012.

During June 2012, the Company entered into a lease agreement to open a branch located in Wellesley, Massachusetts. The branch opened on November 26, 2012.

During July 2012, the Company received state regulatory approval to close a branch at Chestnut Hill in Newton, Massachusetts. The branch closed on September 21, 2012 and the accounts were temporarily moved to the Brookline, Massachusetts branch. During July 2012, the Company entered into a lease agreement and received regulatory approval to open a branch at a new location at Chestnut Hill in Newton, Massachusetts. The branch is scheduled to open during the fourth quarter of 2013 and the majority of the accounts that were temporarily moved to the Brookline, Massachusetts branch will be moved to the new branch at Chestnut Hill in Newton, Massachusetts.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

CRITICAL ACCOUNTING POLICIES

Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets and impact income, are considered critical accounting policies.

The Company considers impairment of investment securities and allowance for loan losses to be its critical accounting policies. There have been no significant changes in the methods or assumptions used in the accounting policies that require material estimates and assumptions.

Impaired Investment Securities

If a decline in fair value below the amortized cost basis of an investment security is judged to be “other-than-temporary,” the cost basis of the investment is written down to fair value. The amount of the writedown is included as a charge to earnings. The amount of the impairment charge is recognized in earnings with an offset for the noncredit component which is recognized through other comprehensive income. Some factors considered for other-than-temporary impairment related to a debt security include an analysis of yield which results in a decrease in expected cash flows, whether an unrealized loss is issuer specific, whether the issuer has defaulted on scheduled interest and principal payments, whether the issuer’s current financial condition hinders its ability to make future scheduled interest and principal payments on a timely basis or whether there was a downgrade in ratings by rating agencies.

The Company does not intend to sell any of its debt securities with an unrealized loss, and it is not likely that it will be required to sell the debt securities before the anticipated recovery of their remaining amortized cost, which may be maturity.

Allowance for Loan Losses

Arriving at an appropriate level of allowance for loan losses necessarily involves a high degree of judgment. Management maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on assessments of the probable estimated losses inherent in the loan portfolio. Management’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance and specific allowances for identified problem loans.

The formula allowance evaluates groups of loans to determine the allocation appropriate within each portfolio segment. Specific allowances for loan losses entail the assignment of allowance amounts to individual loans on the basis of loan impairment. The formula allowance and specific allowances also include management’s evaluation of various conditions, including business and economic conditions, delinquency trends, charge-off experience and other quality factors. Further information regarding the Company’s methodology for assessing the appropriateness of the allowance is contained within Note 1 of the “Notes to Consolidated Financial Statements.”

Management believes that the allowance for loan losses is adequate. In addition, various regulatory agencies, as part of the examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

FINANCIAL CONDITION

Investment Securities

The Company’s securities portfolio consists of securities available-for-sale (“AFS”) and securities held-to-maturity (“HTM”).

Securities available-for-sale consist of certain U.S. Treasury and U.S. Government Sponsored Enterprise mortgage-backed securities; state, county and municipal securities; privately issued mortgage-backed securities; other debt securities; and other marketable equities.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

These securities are carried at fair value, and unrealized gains and losses, net of applicable income taxes, are recognized as a separate component of stockholders’ equity. The fair value of securities available-for-sale at December 31, 2012 totaled $1,434,801,000 and included gross unrealized gains of $21,477,000 and gross unrealized losses of $1,271,000. A year earlier, the fair value of securities available-for-sale was $1,258,676,000 including gross unrealized gains of $16,842,000 and gross unrealized losses of $3,138,000. In 2012, the Company recognized gains of $1,843,000 on the sale of available-for-sale securities. In 2011 and 2010, the Company recognized gains of $1,940,000 and $1,851,000, respectively.

Securities which management intends to hold until maturity consist of U.S. Government Sponsored Enterprises and mortgage-backed securities. Securities held-to-maturity as of December 31, 2012 are carried at their amortized cost of $275,507,000 and exclude gross unrealized gains of $6,499,000 and gross unrealized losses of $82,000. A year earlier, securities held-to-maturity totaled $179,368,000, excluding gross unrealized gains of $5,471,000 and gross unrealized losses of $17,000.

The following table sets forth the fair value and percentage distribution of securities available-for-sale at the dates indicated.

Fair Value of Securities Available-for-Sale

 

      2012     2011     2010  

At December 31,

   Amount      Percent     Amount      Percent     Amount      Percent  
     (dollars in thousands)  

U.S. Treasury

   $ 2,004         0.1   $ 2,012         0.2   $ 2,005         0.2

U.S. Government Sponsored Enterprises

     130,340         9.1     174,957         13.9     175,663         19.3

SBA Backed Securities

     8,156         0.6     8,801         0.7     9,732         1.1

U.S. Government Agency and Sponsored Enterprises Mortgage-Backed Securities

     1,233,357         86.0     1,035,838         82.3     680,898         74.9

Privately Issued Residential Mortgage-Backed Securities

     2,947         0.2     3,198         0.3     3,968         0.4

Obligations Issued by States and Political Subdivisions

     55,174         3.8     20,642         1.6     34,074         3.7

Other Debt Securities

     2,253         0.2     12,610         1.0     2,253         0.2

Equity Securities

     570         0.0     618         0.0     798         0.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,434,801         100.0   $ 1,258,676         100.0   $ 909,391         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Included in Obligations Issued by States and Political Subdivisions as of December 31, 2012, is $3,963,000 of an auction rate municipal obligation (“ARS”) with an unrealized loss of $722,000. This debt security was issued by a governmental entity but is not a debt obligation of the issuing entity. This ARS is the obligation of a large nonprofit entity. This obligation is a variable rate security with long-term maturity whose interest rate is set periodically through an auction process for ARS. As the auctions have not attracted sufficient bidders, i.e., failed, the interest rate adjusts to the default rate defined in the obligation’s underlying documents. Although many of these issuers have bond insurance, the Company purchased the security based on the creditworthiness of the underlying obligor.

In the case of a failed auction, the Company may not have access to funds as only a limited market exists for the failed ARS. As of December 31, 2012, the Company’s ARS was purchased subsequent to its failure with a fair value of $3,963,000 and an amortized cost of $4,685,000. As of December 31, 2012, the taxable equivalent yield on this security was 0.36%.

The majority of the Company’s securities AFS are classified as Level 2, as defined in Note 1 of the “Notes to Consolidated Financial Statements.” The fair values of these securities are obtained from a pricing service, which provides the Company with a description of the inputs generally utilized for each type of security. These

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Management’s understanding of a pricing service’s pricing methodologies includes obtaining an understanding of the valuation risks, assessing its qualification, verification of sources of information and processes used to develop prices and identifying, documenting, and testing controls. Management’s validation of a vendor’s pricing methodology includes establishing internal controls to determine that the pricing information received by a pricing service and used by management in the valuation process is relevant and reliable. Market indicators and industry and economic events are also monitored. The decline in fair value from amortized cost for individual available-for-sale securities that are temporarily impaired is not attributable to changes in credit quality. Because the Company does not intend to sell any of its debt securities and it is not likely that it will be required to sell the debt securities before the anticipated recovery of their remaining amortized cost, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2012.

Securities available-for-sale totaling $53,782,000, or 1.74% of assets, are classified as Level 3, as defined in Note 1 of the “Notes to Consolidated Financial Statements.” These securities are generally equity investments or municipal securities with no readily determinable fair value. The securities are carried at fair value with periodic review of underlying financial statements and credit ratings to assess the appropriateness of these valuations.

Debt securities of Government Sponsored Enterprises refer primarily to debt securities of Fannie Mae and Freddie Mac. Control of these enterprises was directly taken over by the U.S. Government in the third quarter of 2008.

The following table sets forth the amortized cost and percentage distribution of securities held-to-maturity at the dates indicated.

Amortized Cost of Securities Held-to-Maturity

 

     2012     2011     2010  

At December 31,

   Amount      Percent     Amount      Percent     Amount      Percent  
     (dollars in thousands)  

U.S. Government Sponsored Enterprises

   $ 17,747         6.4   $ 26,979         15.0   $ 84,534       36.7%   

U.S. Government Sponsored Enterprise Mortgage-Backed Securities

     257,760         93.6     152,389         85.0     145,582       63.3%   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

  

 

 

 

Total

   $ 275,507         100.0   $ 179,368         100.0   $ 230,116            100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

  

 

 

 

The following two tables set forth contractual maturities of the Bank’s securities portfolio at December 31, 2012. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Fair Value of Securities Available-for-Sale Amounts Maturing

 

    Within
One
Year
    % of
Total
    Weighted
Average
Yield
    One Year
to Five
Years
    % of
Total
    Weighted
Average
Yield
    Five Years
to Ten
Years
    % of
Total
    Weighted
Average
Yield
    Over
Ten
Years
    % of
Total
    Weighted
Average
Yield
 
    (dollars in thousands)  

U.S. Treasury

  $ 2,004        0.1     0.63   $        0.0     0.00   $        0.0     0.00   $        0.0     0.00

U.S. Government Sponsored Enterprises

           0.0     0.00     30,077        2.1     0.92     100,263        7.0     1.63            0.0     0.00

SBA Backed Securities

           0.0     0.00            0.0     0.00     4,548        0.3     0.81     3,608        0.3     0.93

U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities

    17,027        1.2     3.36     1,057,605        73.7     1.76     155,757        10.8     1.66     2,968        0.2     4.14

Privately Issued Residential Mortgage-Backed Securities

           0.0     0.00     2,144        0.1     2.56     803        0.1     3.14            0.0     0.00

Obligations of States and Political Subdivisions

    50,083        3.4     0.98     1,128        0.1     3.82            0.0     0.00     3,963        0.3     0.36

Other Debt Securities

    200        0.0     1.32     600        0.1     1.71            0.0     0.00            0.0     0.00

Equity Securities

           0.0     0.00            0.0     0.00            0.0     0.00            0.0     0.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 69,314        4.7     1.55   $ 1,091,554        76.1     1.74   $ 261,371        18.2     1.64   $ 10,539        0.8     1.72
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Non-
Maturing
     % of
Total
    Weighted
Average
Yield
    Total      % of
Total
    Weighted
Average
Yield
 
     (dollars in thousands)  

U.S. Treasury

   $         0.0     0.00   $ 2,004         0.1     0.63

U.S. Government Sponsored Enterprises

             0.0     0.00     130,340         9.1     1.46

SBA Backed Securities

             0.0     0.00     8,156         0.6     0.86

U.S. Government Agency and Sponsored Enterprise Mortgage-Backed Securities

             0.0     0.00     1,233,357         85.9     1.78

Privately Issued Residential Mortgage-Backed Securities

             0.0     0.00     2,947         0.2     2.72

Obligations of States and Political Subdivisions

             0.0     0.00     55,174         3.8     0.98

Other Debt Securities

     1,453         0.1     4.16     2,253         0.2     3.27

Equity Securities

     570         0.1     1.47     570         0.1     1.47
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 2,023         0.2     3.40   $ 1,434,801         100.0     1.72
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Amortized Cost of Securities Held-to-Maturity Amounts Maturing

 

    Within
One
Year
    % of
Total
    Weighted
Average
Yield
    One Year
to Five
Years
    % of
Total
    Weighted
Average
Yield
    Five Years
to Ten
Years
    % of
Total
    Weighted
Average
Yield
    Over
Ten
Years
    % of
Total
    Weighted
Average
Yield
    Total     % of
Total
    Weighted
Average
Yield
 
    (dollars in thousands)   

U.S. Government Sponsored Enterprises

  $        0.0     0.00   $        0.0     0.00   $ 17,747        6.4     2.13   $        0.0     0.00   $ 17,747        6.4     2.13

U.S. Government Sponsored Enterprise Mortgage-Backed Securities

    6,780        2.5     3.80     205,981        74.8     2.44     44,725        16.2     2.38     274        0.1     2.60     257,760        93.6     2.47
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 6,780        2.5     3.80   $ 205,981        74.8     2.44   $ 62,472        22.6     2.31   $ 274        0.1     2.60   $ 275,507        100.0     2.44
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

20


Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

At December 31, 2012 and 2011, the Bank had no investments in obligations of individual states, counties, municipalities or nongovernment corporate entities which exceeded 10% of stockholders’ equity. In 2012, sales of securities totaling $294,881,000 in gross proceeds resulted in a net realized gain of $1,843,000. There were no sales of state, county or municipal securities during 2012 and 2011. In 2011, sales of securities totaling $75,615,000 in gross proceeds resulted in net realized gains of $1,940,000. In 2010, sales of securities totaling $41,251,000 in gross proceeds resulted in net realized gains of $1,851,000.

Management reviews the investment portfolio for other-than-temporary impairment of individual securities on a regular basis. The results of such analysis are dependent upon general market conditions and specific conditions related to the issuers of our securities.

Loans

The Company’s lending activities are conducted principally in Massachusetts. The Company grants single-family and multi-family residential loans, commercial and commercial real estate loans, and a variety of consumer loans. To a lesser extent, the Company grants loans for the construction of residential homes, multi-family properties, commercial real estate properties and land development. Most loans granted by the Company are secured by real estate collateral. The ability and willingness of commercial real estate, commercial, construction, residential and consumer loan borrowers to honor their repayment commitments are generally dependent on the health of the real estate market in the borrowers’ geographic areas and of the general economy.

The following summary shows the composition of the loan portfolio at the dates indicated.

 

    2012     2011     2010     2009     2008  

December 31,

  Amount     Percent
of Total
    Amount     Percent
of Total
    Amount     Percent
of Total
    Amount     Percent
of Total
    Amount     Percent
of Total
 
    (dollars in thousands)  

Construction and land development

  $ 38,618        3.5   $ 56,819        5.7   $ 53,583        5.9   $ 60,349        6.9   $ 59,511        7.1

Commercial andindustrial

    88,475        8.0     82,404        8.4     90,654        10.0     141,061        16.1     141,373        16.9

Commercial real estate

    576,465        51.8     487,495        49.5     433,337        47.8     361,823        41.2     332,325        39.8

Residential real estate

    281,857        25.3     239,307        24.3     207,787        22.9     188,096        21.4     194,644        23.3

Consumer

    6,823        0.6     6,197        0.6     5,957        0.7     7,105        0.8     8,246        1.0

Home equity

    118,923        10.7     110,786        11.3     114,209        12.6     118,076        13.5     98,954        11.8

Overdrafts

    627        0.1     1,484        0.2     637        0.1     615        0.1     1,012        0.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,111,788        100.0   $ 984,492        100.0   $ 906,164        100.0   $ 877,125        100.0   $ 836,065        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At December 31, 2012, 2011, 2010, 2009 and 2008, loans were carried net of discounts of $498,000, $550,000, $598,000, $645,000 and $692,000, respectively. Net deferred loan fees of $369,000, $666,000, $186,000, $71,000 and $81,000 were carried in 2012, 2011, 2010, 2009 and 2008, respectively.

The following table summarizes the remaining maturity distribution of certain components of the Company’s loan portfolio on December 31, 2012. The table excludes loans secured by 1–4 family residential real estate and loans for household and family personal expenditures. Maturities are presented as if scheduled principal amortization payments are due on the last contractual payment date.

 

21


Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Remaining Maturities of Selected Loans at December 31, 2012

 

        
     One Year
or Less
     One to Five
Years
     Over
Five Years
     Total  
     (dollars in thousands)  

Construction and land development

   $ 8,899       $ 4,786       $ 24,933       $ 38,618   

Commercial and industrial

     16,098         24,872         47,505         88,475   

Commercial real estate

     23,935         127,480         425,050         576,465   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 48,932       $ 157,138       $ 497,488       $ 703,558   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table indicates the rate variability of the above loans due after one year.

 

December 31, 2012

   One to Five
Years
     Over
Five Years
     Total  
     (dollars in thousands)  

Predetermined interest rates

   $ 92,616       $ 125,554       $ 218,170   

Floating or adjustable interest rates

     64,522         371,934         436,456   
  

 

 

    

 

 

    

 

 

 

Total

   $ 157,138       $ 497,488       $ 654,626   
  

 

 

    

 

 

    

 

 

 

The Company’s commercial and industrial (“C&I”) loan customers represent various small and middle-market established businesses involved in manufacturing, distribution, retailing and services. Most clients are privately owned with markets that range from local to national in scope. Many of the loans to this segment are secured by liens on corporate assets and the personal guarantees of the principals. The regional economic strength or weakness impacts the relative risks in this loan category. There is little concentration in any one business sector, and loan risks are generally diversified among many borrowers.

Commercial real estate loans are extended to finance various manufacturing, warehouse, light industrial, office, retail and residential properties in the Bank’s market area, which generally includes Eastern Massachusetts, Southern New Hampshire, and Rhode Island. Also included are loans to educational institutions, hospitals and other non-profit organizations. Loans are normally extended in amounts up to a maximum of 80% of appraised value and normally for terms between three and ten years. Amortization schedules are long term and thus a balloon payment is generally due at maturity. Under most circumstances, the Bank will offer to rewrite or otherwise extend the loan at prevailing interest rates. During recent years, the Bank has emphasized nonresidential-type owner-occupied properties. This complements our C&I emphasis placed on the operating business entities and will continue. The regional economic environment affects the risk of both nonresidential and residential mortgages.

Residential real estate (1–4 family) includes two categories of loans. Included in residential real estate are approximately $12,460,000 of C&I type loans secured by 1–4 family real estate. Primarily, these are small businesses with modest capital or shorter operating histories where the collateral mitigates some risk. This category of loans shares similar risk characteristics with the C&I loans, notwithstanding the collateral position.

The other category of residential real estate loans is mostly 1–4 family residential properties located in the Bank’s market area. General underwriting criteria are largely the same as those used by Fannie Mae. The Bank utilizes mortgage insurance to provide lower down payment products and has provided a “First Time Homebuyer” product to encourage new home ownership. Residential real estate loan volume has increased and remains a core consumer product. The economic environment impacts the risks associated with this category.

Home equity loans are extended as both first and second mortgages on owner-occupied residential properties in the Bank’s market area. Loans are underwritten to a maximum loan to property value of 75%.

 

22


Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Bank officers evaluate the feasibility of construction projects based on independent appraisals of the project, architects’ or engineers’ evaluations of the cost of construction and other relevant data. As of December 31, 2012, the Company was obligated to advance a total of $17,609,000 to complete projects under construction.

The composition of nonperforming assets is as follows:

 

December 31,

   2012     2011     2010     2009     2008  
     (dollars in thousands)  

Total nonperforming loans

   $ 4,471      $ 5,827      $ 8,068      $ 12,311      $ 3,661   

Other real estate owned

            1,182                        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 4,471      $ 7,009      $ 8,068      $ 12,311      $ 3,661   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accruing troubled debt restructured loans

   $ 3,048      $ 4,634      $ 1,248      $ 521      $   

Loans past due 90 and still accruing

            18        50               89   

Nonperforming loans as a percent of gross loans

     0.40     0.59     0.89     1.40     0.44
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming assets as a percent of total assets

     0.14     0.26     0.33     0.55     0.20
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The composition of impaired loans at December 31, is as follows:

 

     2012      2011      2010      2009      2008  

Residential real estate, multi-family

   $ 862       $ 516       $       $       $ 194   

Commercial real estate

     2,281         4,561         2,492         4,260         1,175   

Construction and land development

     1,500         1,500         4,000         4,900           

Commercial and industrial

     1,282         1,525         1,471         1,356         1,329   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 5,925       $ 8,102       $ 7,963       $ 10,516       $ 2,698   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2012, 2011, 2010, 2009 and 2008, impaired loans had specific reserves of $1,732,000, $741,000, $317,000, $745,000 and $600,000 respectively.

The Company was servicing mortgage loans sold to others without recourse of approximately $26,786,000, $18,196,000, $983,000, $1,127,000 and $768,000 at December 31, 2012, 2011, 2010, 2009, and 2008, respectively. The Company had $9,378,000 of loans held for sale at December 31, 2012, $3,389,000 at December 31, 2011, and $0 for December 31, 2008, through December 31, 2010.

Servicing assets are recorded at fair value and recognized as separate assets when rights are acquired through sale of loans with servicing rights retained. Mortgage servicing assets (“MSA”) are amortized into non-interest income in proportion to, and over the period of, the estimated net servicing income. Upon sale, the mortgage servicing asset is established, which represents the then-current estimated fair value based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing rights are recorded in other assets and are amortized in proportion to, and over the period of estimated net servicing income and are assessed for impairment based on fair value at each reporting date. MSAs are reported in other assets in the consolidated balance sheets. MSAs totaled $137,000 at December 31, 2012, $123,000 for December 31, 2011, and $0 for December 31, 2008, through December 31, 2010.

Directors and officers of the Company and their associates are customers of, and have other transactions with, the Company in the normal course of business. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time

 

23


Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

for comparable transactions with other persons and do not involve more than normal risk of collection or present other unfavorable features.

Loans are placed on nonaccrual status when any payment of principal and/or interest is 90 days or more past due, unless the collateral is sufficient to cover both principal and interest and the loan is in the process of collection. The Company monitors closely the performance of its loan portfolio. In addition to internal loan review, the Company has contracted with an independent organization to review the Company’s commercial and commercial real estate loan portfolios. This independent review was performed in each of the past five years. The status of delinquent loans, as well as situations identified as potential problems, is reviewed on a regular basis by senior management and monthly by the Board of Directors of the Bank.

Nonaccrual loans decreased during 2012, primarily as a result of a decrease in home equity and residential real estate nonperforming loans.

Nonaccrual loans decreased during 2011, primarily as a result of $1,200,000 in charge-offs from two construction loans as well as the subsequent foreclosure of $1,300,000 of one of the construction loans. Nonaccrual loans decreased during 2010, primarily as a result of resolution of a $2,479,000 commercial real estate loan as well as $900,000 in charge-offs from two construction loans during 2010. Nonaccrual loans increased from 2008 to 2009, primarily as a result of three loan relationships, one primarily commercial real estate and two construction totaling $7,379,000.

The Company continues to monitor closely $18,645,000 and $20,906,000 at December 31, 2012 and 2011, respectively, of loans for which management has concerns regarding the ability of the borrowers to perform. The majority of the loans are secured by real estate and are considered to have adequate collateral value to cover the loan balances at December 31, 2012, although such values may fluctuate with changes in the economy and the real estate market.

 

24


Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Allowance for Loan Losses

The Company maintains an allowance for loan losses in an amount determined by management on the basis of the character of the loans, loan performance, financial condition of borrowers, the value of collateral securing loans and other relevant factors. The following table summarizes the changes in the Company’s allowance for loan losses for the years indicated.

 

Year Ended December 31,

  2012     2011     2010     2009     2008  
    (dollars in thousands)  

Year-end loans outstanding (net of unearned discount and deferred loan fees)

  $ 1,111,788      $ 984,492      $ 906,164      $ 877,125      $ 836,065   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average loans outstanding (net of unearned discount and deferred loan fees)

  $ 1,036,296      $ 948,883      $ 877,858      $ 853,422      $ 775,337   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance of allowance for loan losses at the beginning of year

  $ 16,574      $ 14,053      $ 12,373      $ 11,119      $ 9,633   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans charged-off:

         

Commercial

    1,253        676        1,559        1,498        2,869   

Construction

           1,200        900        3,639        15   

Commercial real estate

                  922                 

Residential real estate

    351        341        515        490          

Consumer

    697        607        547        443        489   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

    2,301        2,824        4,443        6,070        3,373   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recovery of loans previously charged-off:

         

Commercial

    307        293        172        352        159   

Construction

                         25          

Real estate

    45        35        8        4        5   

Consumer

    422        467        368        318        270   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries of loans previously charged-off:

    774        795        548        699        434   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loan charge-offs

    1,527        2,029        3,895        5,371        2,939   

Provision charged to operating expense

    4,150        4,550        5,575        6,625        4,425   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

  $ 19,197      $ 16,574      $ 14,053      $ 12,373      $ 11,119   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs during the year to average loans outstanding

    0.15     0.21     0.44     0.63     0.38
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of allowance for loan losses to loans outstanding

    1.73     1.68     1.55     1.41     1.33
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The amount of the allowance for loan losses results from management’s evaluation of the quality of the loan portfolio considering such factors as loan status, specific reserves on impaired loans, collateral values, financial condition of the borrower, the state of the economy and other relevant information. The pace of the charge-offs depends on many factors, including the national and regional economy. Cyclical lagging factors may result in charge-offs being higher than historical levels. Charge-offs increased during 2009 due to an increase in commercial loan charge-offs and construction loan charge-offs as a result of the weakening of the overall economy and real estate market. Charge-offs declined in 2010, 2011, and 2012 as a result of the overall decrease in the level of nonaccrual loans. The dollar amount of the allowance for loan losses and the level of the allowance for loan losses to total loans increased primarily as a result of a lower level of charge-off activity combined with changes in the portfolio composition.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

In evaluating the allowance for loan losses, the Company considered the following categories to be higher risk:

Construction loans — The outstanding loan balance of construction loans at December 31, 2012 is $38,618,000. A major portion in nonaccrual loans is one construction loan. Based on this fact, and the general local construction conditions, management closely monitors all construction loans and considers this type of loan to be higher risk.

Higher-balance loans — Loans greater than $1.0 million are considered “high-balance loans.” The balance of these loans is $567,306,000 at December 31, 2012, as compared to $489,114,000 at December 31, 2011. These loans are considered higher risk due to the concentration in individual loans. Additional allowance allocations are made based upon the level of high-balance loans. Included in high-balance loans are loans greater than $10.0 million. The balance of these loans is $245,198,000 at December 31, 2012, as compared to $189,222,000 at December 31, 2011. Additional allowance allocations are made based upon the level of this type of high balance loans that is separate and greater than the $1.0 million allocation.

Small business loans — The outstanding loan balances of small business loans is $42,032,000 at December 31, 2012. These are considered higher risk loans because small businesses have been negatively impacted by the current economic conditions. In a liquidation scenario, the collateral, if any, is often not sufficient to fully recover the outstanding balance of the loan. As a result, the Company often seeks additional collateral prior to renewing maturing small business loans. In addition, the payment status of the loans is monitored closely in order to initiate collection efforts in a timely fashion.

The allowance for loan losses is an estimate of the amount needed for an adequate reserve to absorb losses in the existing loan portfolio. This amount is determined by an evaluation of the loan portfolio, including input from an independent organization engaged to review selected larger loans, a review of loan experience and current economic conditions. Although the allowance is allocated between categories, the entire allowance is available to absorb losses attributable to all loan categories. At December 31 of each year listed below, the allowance is comprised of the following:

 

    2012     2011     2010     2009     2008  
    Amount     Percent
of Loans
in Each
Category
to Total
Loans
    Amount     Percent
of Loans
in Each
Category
to Total
Loans
    Amount     Percent
of Loans
in Each
Category
to Total
Loans
    Amount     Percent
of Loans
in Each
Category
to Total
Loans
    Amount     Percent
of Loans
in Each
Category
to Total
Loans
 
    (dollars in thousands)  

Construction and land development

  $ 3,041        3.5   $ 2,893        5.7   $ 1,752        5.9   $ 362        6.9   $ 677        7.1

Commercial and industrial

    3,118        8.0        3,139        8.4        3,163        10.0        4,972        16.1        5,125        16.9   

Commercial real estate

    9,065        51.8        6,566        49.5        5,671        47.8        2,983        41.2        2,620        39.8   

Residential real estate

    1,994        25.3        1,886        24.3        1,718        22.9        1,304        21.4        778        23.3   

Consumer and other

    333        0.7        356        0.8        298        0.8        1,753        0.9        342        1.1   

Home equity

    886        10.7        704        11.3        725        12.6        761        13.5        1,527        11.8   

Unallocated

    760          1,030          726          238          50     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 19,197        100.0   $ 16,574        100.0   $ 14,053        100.0   $ 12,373        100.0   $ 11,119        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Management believes that the allowance for loan losses is adequate. In addition, various regulatory agencies, as part of the examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Further information regarding the allocation of the allowance is contained within Note 6 of the “Notes to Consolidated Financial Statements.”

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Deposits

The Company offers savings accounts, NOW accounts, demand deposits, time deposits and money market accounts. Additionally, the Company offers cash management accounts which provide either automatic transfer of funds above a specified level from the customer’s checking account to a money market account or short-term borrowings. Also, an account reconciliation service is offered whereby the Company provides a computerized report balancing the customer’s checking account.

Interest rates on deposits are set bi-monthly by the Bank’s rate-setting committee, based on factors including loan demand, maturities and a review of competing interest rates offered. Interest rate policies are reviewed periodically by the Executive Management Committee.

The following table sets forth the average balances of the Bank’s deposits for the periods indicated.

 

     2012     2011     2010  
     Amount      Percent     Amount      Percent     Amount      Percent  
     (dollars in thousands)  

Demand Deposits

   $ 386,863         16.5   $ 326,102         15.3   $ 298,825         15.8

Savings and Interest Checking

     870,046         37.1     735,022         34.6     696,232         36.7

Money Market

     666,949         28.5     584,059         27.4     543,432         28.7

Time Certificates of Deposit

     418,789         17.9     484,142         22.7     356,457         18.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,342,647         100.0   $ 2,129,325         100.0   $ 1,894,946         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Time Deposits of $100,000 or more as of December 31, are as follows:

 

     2012  
     (dollars in thousands)  

Three months or less

   $ 99,957   

Three months through six months

     57,643   

Six months through twelve months

     59,972   

Over twelve months

     69,476   
  

 

 

 

Total

   $ 287,048   
  

 

 

 

Borrowings

The Bank’s borrowings consisted primarily of Federal Home Loan Bank of Boston (“FHLBB”) borrowings collateralized by a blanket pledge agreement on the Bank’s FHLBB stock, certain qualified investment securities, deposits at the FHLBB and residential mortgages held in the Bank’s portfolios. The Bank’s borrowings from the FHLBB totaled $195,000,000, a decrease of $49,000,000 from the prior year. The Bank’s remaining term borrowing capacity at the FHLBB at December 31, 2012, was approximately $280,598,000. In addition, the Bank has a $14,500,000 line of credit with the FHLBB. See Note 12, “Other Borrowed Funds and Subordinated Debentures,” for a schedule, their interest rates and other information.

Subordinated Debentures

In December 2004, the Company consummated the sale of a Trust Preferred Securities offering, in which it issued $36,083,000 of subordinated debt securities due 2034 to its newly formed unconsolidated subsidiary, Century Bancorp Capital Trust II.

Century Bancorp Capital Trust II then issued 35,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $1,000 per share. These securities pay dividends at an annualized rate of 6.65% for the first

 

27


Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

ten years and then convert to the three-month LIBOR rate plus 1.87% for the remaining 20 years. The Company is using the proceeds primarily for general business purposes.

Securities Sold Under Agreements to Repurchase

The Bank’s remaining borrowings consist primarily of securities sold under agreements to repurchase. Securities sold under agreements to repurchase totaled $191,390,000, an increase of $48,070,000 from the prior year. See Note 11, “Securities Sold Under Agreements to Repurchase,” for a schedule, including their interest rates and other information.

RESULTS OF OPERATIONS

Net Interest Income

The Company’s operating results depend primarily on net interest income and fees received for providing services. Net interest income on a fully taxable equivalent basis increased 12.6% in 2012 to $69,918,000, compared with $62,081,000 in 2011. The increase in net interest income for 2012 was mainly due to an 11.5% increase in the average balances of earning assets, combined with a similar increase in deposits. The level of interest rates, the ability of the Company’s earning assets and liabilities to adjust to changes in interest rates and the mix of the Company’s earning assets and liabilities affect net interest income. The net interest margin on a fully taxable equivalent basis increased to 2.51% in 2012 from 2.48% in 2011 and decreased from 2.52% in 2010. The Company collected approximately $3,253,000, $158,000, and $102,000, respectively, of prepayment penalties, which are included in interest income on loans, for 2012, 2011, and 2010, respectively.

Additional information about the net interest margin is contained in the “Overview” section of this report. Also, there can be no assurance that certain factors beyond its control, such as the prepayment of loans and changes in market interest rates, will continue to positively impact the net interest margin. Management believes that the current yield curve environment will continue to present challenges as deposit and borrowing costs may have the potential to increase at a faster rate than corresponding asset categories.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

The following table sets forth the distribution of the Company’s average assets, liabilities and stockholders’ equity, and average rates earned or paid on a fully taxable equivalent basis for each of the years indicated.

 

Year Ended December 31,

  Average
Balance
    2012
Interest
Income/
Expense(1)
    Rate
Earned/
Paid(1)
    Average
Balance
    2011
Interest
Income/
Expense(1)
    Rate
Earned/
Paid(1)
    Average
Balance
    2010
Interest
Income/
Expense(1)
    Rate
Earned/
Paid(1)
 
    (dollars in thousands)  
        ASSETS               

Interest-earning assets:

                 

Loans(2)

                 

Taxable

  $ 715,553      $ 34,983        4.89   $ 703,491      $ 36,772        5.23   $ 711,422      $ 40,163        5.65

Tax-exempt

    320,743        24,220        7.55        245,392        17,996        7.33        166,436        13,193        7.93   

Securities available-for-sale:(3)

                 

Taxable

    1,214,352        22,363        1.84        1,076,689        22,828        2.12        756,544        18,958        2.51   

Tax-exempt

    49,023        516        1.05        22,410        321        1.43        32,407        596        1.84   

Securities held-to-maturity:

                 

Taxable

    270,525        6,746        2.49        178,659        5,816        3.26        222,154        7,158        3.22   

Interest-bearing deposits in other banks

    219,540        630        0.29        276,413        1,114        0.40        371,665        1,642        0.44   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    2,789,736      $ 89,458        3.21     2,503,054      $ 84,847        3.39     2,260,628      $ 81,710        3.61

Noninterest-earning assets

    172,748            158,297            155,956       

Allowance for loan losses

    (18,039         (15,767         (13,686    
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 2,944,445          $ 2,645,584          $ 2,402,898       
 

 

 

       

 

 

       

 

 

     
                 
 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

  

       
                 

Interest-bearing deposits:

                 

NOW accounts

  $ 588,500      $ 1,561        0.27   $ 476,807      $ 1,715        0.36   $ 423,693      $ 2,504        0.59

Savings accounts

    281,546        689        0.24        258,215        824        0.32        272,539        1,568        0.58   

Money market accounts

    666,949        2,373        0.36        584,059        2,706        0.46        543,432        3,942        0.73   

Time deposits

    418,789        6,250        1.49        484,142        9,356        1.93        356,457        7,914        2.22   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    1,955,784        10,873        0.56        1,803,223        14,601        0.81        1,596,121        15,928        1.00   

Securities sold under agreements to repurchase

    174,624        367        0.21        129,137        379        0.29        133,080        573        0.43   

Other borrowed funds and subordinated debentures

    217,542        8,300        3.82        202,209        7,786        3.85        201,273        8,316        4.13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    2,347,950      $ 19,540        0.83     2,134,569      $ 22,766        1.07     1,930,474      $ 24,817        1.29

Noninterest-bearing liabilities

                 

Demand deposits

    386,863            326,102            298,825       

Other liabilities

    37,497            29,253            31,074       
 

 

 

       

 

 

       

 

 

     

Total liabilities

    2,772,310            2,489,924            2,260,373       
 

 

 

       

 

 

       

 

 

     

Stockholders’ equity

    172,135            155,660            142,525       

Total liabilities and stockholders’ equity

  $ 2,944,445          $ 2,645,584          $ 2,402,898       
 

 

 

       

 

 

       

 

 

     

Net interest income on a fully taxable equivalent basis

    $ 69,918          $ 62,081          $ 56,893     
   

 

 

       

 

 

       

 

 

   

Less taxable equivalent adjustment

      (7,964         (6,782         (5,127  
   

 

 

       

 

 

       

 

 

   

Net interest income

    $ 61,954          $ 55,299          $ 51,766     
   

 

 

       

 

 

       

 

 

   

Net interest spread

        2.38         2.32         2.32
     

 

 

       

 

 

       

 

 

 

Net interest margin

        2.51         2.48         2.52
     

 

 

       

 

 

       

 

 

 

 

 

(1) On a fully taxable equivalent basis calculated using a federal tax rate of 34%.

 

(2) Nonaccrual loans are included in average amounts outstanding.

 

(3) At amortized cost.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

The following table summarizes the year-to-year changes in the Company’s net interest income resulting from fluctuations in interest rates and volume changes in earning assets and interest-bearing liabilities. Changes due to rate are computed by multiplying the change in rate by the prior year’s volume. Changes due to volume are computed by multiplying the change in volume by the prior year’s rate. Changes in volume and rate that cannot be separately identified have been allocated in proportion to the relationship of the absolute dollar amounts of each change.

 

     2012 Compared with 2011     2011 Compared with 2010  
           Increase/(Decrease)                 Increase/(Decrease)        
     Due to Change in     Due to Change in  

Year Ended December 31,

   Volume     Rate     Total     Volume     Rate     Total  
     (dollars in thousands)  

Interest income:

            

Loans

            

Taxable

   $ 622      $ (2,411   $ (1,789   $ (443   $ (2,948   $ (3,391

Tax-exempt

     5,675        549        6,224        5,854        (1,051     4,803   

Securities available-for-sale:

            

Taxable

     2,730        (3,195     (465     7,117        (3,247     3,870   

Tax-exempt

     299        (104     195        (160     (115     (275

Securities held-to-maturity:

            

Taxable

     2,510        (1,580     930        (1,415     73        (1,342

Interest-bearing deposits in other banks

     (202     (282     (484     (393     (135     (528
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     11,634        (7,023     4,611        10,560        (7,423     3,137   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

            

Deposits:

            

NOW accounts

     352        (506     (154     284        (1,073     (789

Savings accounts

     70        (205     (135     (79     (665     (744

Money market accounts

     350        (683     (333     276        (1,512     (1,236

Time deposits

     (1,156     (1,950     (3,106     2,565        (1,123     1,442   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

     (384     (3,344     (3,728     3,046        (4,373     (1,327

Securities sold under agreements to repurchase

     113        (125     (12     (17     (177     (194

Other borrowed funds and subordinated debentures

     586        (72     514        40        (570     (530
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     315        (3,541     (3,226     3,069        (5,120     (2,051
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net interest income

   $ 11,319      $ (3,482   $ 7,837      $ 7,491      $ (2,303   $ 5,188   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average earning assets were $2,789,736,000 in 2012, an increase of $286,682,000 or 11.5% from the average in 2011, which was 10.7% higher than the average in 2010. Total average securities, including securities available-for-sale and securities held-to-maturity, were $1,533,900,000, an increase of 20.0% from the average in 2011. The increase in securities volume was mainly attributable to an increase in taxable securities. An increase in securities balances offset, somewhat, by lower securities returns resulted in higher securities income, which increased 2.3% to $29,625,000 on a fully tax equivalent basis. Total average loans increased 9.2% to $1,036,296,000 after increasing $71,025,000 in 2011. The primary reason for the increase in loans was due in large part to an increase in tax-exempt commercial real estate lending as well as residential first mortgage

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

lending. The increase in loan volume was offset, somewhat, by a decrease in loan rates resulted in higher loan income, which increased by 8.1% or $4,435,000 to $59,203,000. Total loan income was $53,356,000 in 2010.

The Company’s sources of funds include deposits and borrowed funds. On average, deposits increased 10.0%, or $213,322,000, in 2012 after increasing by 12.4%, or $234,379,000, in 2011. Deposits increased in 2012, primarily as a result of increases in demand deposits, savings, money market, NOW and time deposit accounts. Deposits increased in 2011, primarily as a result of increases in demand deposits, money market savings and NOW accounts. Borrowed funds and subordinated debentures increased by 18.4% in 2012, following a decrease of 0.9% in 2011. The majority of the Company’s borrowed funds are borrowings from the FHLBB and retail repurchase agreements. Average borrowings from the FHLBB increased by approximately $15,633,000, and average retail repurchase agreements increased by $45,487,000 in 2012. Interest expense totaled $19,540,000 in 2012, a decrease of $3,226,000, or 14.2%, from 2011 when interest expense decreased 8.3% from 2010. The decrease in interest expense is primarily due to market decreases in deposit rates and continued deposit pricing discipline. Interest expense on time deposits accounted for a majority of this decrease.

Provision for Loan Losses

The provision for loan losses was $4,150,000 in 2012, compared with $4,550,000 in 2011 and $5,575,000 in 2010. These provisions are the result of management’s evaluation of the amounts and quality of the loan portfolio considering such factors as loan status, collateral values, financial condition of the borrower, the state of the economy and other relevant information. The provision for loan losses decreased during 2012 and 2011, primarily as a result of decreased provisions related to nonaccrual loans as well as management’s quantitative analysis of the loan portfolio.

The allowance for loan losses was $19,197,000 at December 31, 2012, compared with $16,574,000 at December 31, 2011. Expressed as a percentage of outstanding loans at year-end, the allowance was 1.73% in 2012 and 1.68% in 2011. The allowance for loan losses increased despite a decrease in the provision for loan losses due to a lower level of charge-off activity combined with changes in the portfolio composition.

Nonperforming loans, which include all non-accruing loans, totaled $4,471,000 on December 31, 2012, compared with $5,827,000 on December 31, 2011. Nonperforming loans decreased primarily as a result of a decrease in home equity and residential real estate nonperforming loans.

Other Operating Income

During 2012, the Company continued to experience positive results in its fee-based services, including fees derived from traditional banking activities such as deposit-related services, its automated lockbox collection system and full-service securities brokerage supported by LPL Financial, a full-service securities brokerage business.

Under the lockbox program, which is not tied to extensions of credit by the Company, the Company’s customers arrange for payments of their accounts receivable to be made directly to the Company. The Company records the amounts paid to its customers, deposits the funds to the customer’s account and provides automated records of the transactions to customers. Typical customers for the lockbox service are municipalities that use it to automate tax collections, cable TV companies and other commercial enterprises.

Through a program called Investment Services at Century Bank, the Bank provides full-service securities brokerage services supported by LPL Financial, a full-service securities brokerage business. Registered representatives employed by Century Bank offer limited investment advice, execute transactions and assist customers in financial and retirement planning. LPL Financial provides research to the Bank’s representatives. The Bank receives a share in the commission revenues.

Total other operating income in 2012 was $15,865,000, a decrease of $375,000, or 2.3%, compared to 2011. This decrease followed an increase of $241,000, or 1.5%, in 2011, compared to 2010. Included in other operating income are net gains on sales of securities of $1,843,000, $1,940,000 and $1,851,000 in 2012, 2011 and 2010,

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

respectively. Service charge income, which continues to be a major area of other operating income, totaling $7,880,000 in 2012, decreased $5,000 compared to 2011. This followed an increase of $9,000 compared to 2010. The decrease in fees was mainly attributable to a decrease in overdraft fees, which was offset, somewhat, by an increase in debit card fees and fees collected from processing activities. Service charges on deposit accounts increased during 2011. The increase in fees was mainly attributable to an increase in overdraft fees and debit card fees, which was offset, somewhat, by a decrease in fees collected from processing activities. Lockbox revenues totaled $2,930,000, up $160,000 in 2012 following a decrease of $141,000 in 2011. Other income totaled $3,212,000, down $433,000 in 2012 following an increase of $284,000 in 2011. The decrease in 2012 was mainly attributable to a decrease in net gains on sales of loans of $363,000 as well as a decrease in brokerage commissions. The increase in 2011 was mainly attributable to net gains on sales of loans of $660,000 and an increase in brokerage commissions. This was offset, somewhat, by a decrease of $514,000 in the growth of cash surrender values on life insurance policies, which was attributable to lower returns on life insurance policies.

Operating Expenses

Total operating expenses were $53,238,000 in 2012, compared to $48,742,000 in 2011 and $47,372,000 in 2010.

Salaries and employee benefits expenses increased by $3,313,000 or 11.2% in 2012, after increasing by 4.3% in 2011. The increase in 2012 was mainly attributable to increases in pension costs, staff levels, merit increases in salaries and increases in health insurance costs. The increase in pension costs was mainly attributable to a decrease in the discount rate. The increase in 2011 was mainly attributable to increases in staff levels, merit increases in salaries and increases health insurance costs.

Occupancy expense increased by $284,000, or 6.4%, in 2012, following an increase of $374,000, or 9.3%, in 2011. The increase in 2012 was primarily attributable to an increase in rent expense and depreciation expense associated with branch expansion. The increase in 2011 was primarily attributable to an increase in rent expense, depreciation expense and building maintenance costs associated with branch expansion.

Equipment expense increased by $20,000, or 0.9%, in 2012, following an increase of $103,000, or 4.8%, in 2011. The increase in 2012 was primarily attributable to an increase in service contracts. The increase in 2011 was primarily attributable to an increase in service contracts and depreciation expense.

FDIC assessments decreased by $288,000, or 14.2%, in 2012, following a decrease of $940,000, or 31.7%, in 2011. FDIC assessments decreased in 2012 and 2011 mainly as a result of a decrease in the assessment rate.

Other operating expenses increased by $1,167,000 in 2012, which followed a $601,000 increase in 2011. The increase in 2012 was primarily attributable to an increase in contributions, software maintenance and marketing expense offset somewhat by a decrease in core deposit intangible amortization. The increase in 2011 was primarily attributable to an increase in customer expenses, other real estate owned expense and contributions offset somewhat by decreases in marketing expense.

Provision for Income Taxes

Income tax expense was $1,392,000 in 2012, $1,554,000 in 2011 and $1,244,000 in 2010. The effective tax rate was 6.8% in 2012, 8.5% in 2011 and 8.4% in 2010. The decrease in the effective tax rate for 2012 was mainly attributable to an increase in tax-exempt interest income and tax credits as a percentage of taxable income. The federal tax rate was 34% in 2012, 2011 and 2010.

Market Risk and Asset Liability Management

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. To that end, management actively monitors and manages its interest rate risk exposure.

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using several tools. One measure of the Company’s exposure to differential changes in interest rates between assets and liabilities is an interest rate risk management test.

This test measures the impact on net interest income of an immediate change in interest rates in 100-basis point increments as set forth in the following table:

 

Change in Interest Rates

(in Basis Points)

  

Percentage Change in
Net Interest Income(1)

+400    (17.0)%
+300    (12.4)%
+200    (8.4)%
+100    (4.1)%
–100    1.0%
–200    4.4%

 

(1) The percentage change in this column represents net interest income for 12 months in various rate scenarios versus the net interest income in a stable interest rate environment.

The Company’s primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Company’s net interest income and capital, while structuring the Company’s asset-liability structure to obtain the maximum yield-cost spread on that structure. The Company relies primarily on its asset-liability structure to control interest rate risk.

Liquidity and Capital Resources

Liquidity is provided by maintaining an adequate level of liquid assets that include cash and due from banks, federal funds sold and other temporary investments. Liquid assets totaled $169,650,000 on December 31, 2012, compared with $226,117,000 on December 31, 2011. In each of these two years, deposit and borrowing activity has generally been adequate to support asset activity.

The sources of funds for dividends paid by the Company are dividends received from the Bank and liquid funds held by the Company. The Company and the Bank are regulated enterprises and their abilities to pay dividends are subject to regulatory review and restriction. Certain regulatory and statutory restrictions exist regarding dividends, loans and advances from the Bank to the Company. Generally, the Bank has the ability to pay dividends to the Company subject to minimum regulatory capital requirements.

Capital Adequacy

Total stockholders’ equity was $179,990,000 at December 31, 2012, compared with $160,649,000 at December 31, 2011. The increase in 2012 was primarily the result of earnings and a decrease in accumulated other comprehensive loss, net of taxes, offset by dividends paid. The decrease in accumulated other comprehensive loss was mainly attributable to an increase of $4,011,000 in the net unrealized gains on the Company’s available-for-sale portfolio, net of taxes, offset by an increase of $1,839,000 in the additional pension liability, net of taxes.

Federal banking regulators have issued risk-based capital guidelines, which assign risk factors to asset categories and off-balance-sheet items. The current guidelines require a Tier 1 capital-to-risk assets ratio of at least 4.00% and a total capital-to-risk assets ratio of at least 8.00%. The Company and the Bank exceeded these requirements with a Tier 1 capital-to-risk assets ratio of 14.34% and 12.90%, respectively, and total capital-to-risk assets ratio of 15.59% and 14.15%, respectively, at December 31, 2012. Additionally, federal banking

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

regulators have issued leverage ratio guidelines, which supplement the risk-based capital guidelines. The minimum leverage ratio requirement applicable to the Company is 4.00%; and at December 31, 2012, the Company and the Bank exceeded this requirement with leverage ratios of 6.80% and 6.11%, respectively.

Contractual Obligations, Commitments, and Contingencies

The Company has entered into contractual obligations and commitments. The following tables summarize the Company’s contractual cash obligations and other commitments at December 31, 2012.

Contractual Obligations and Commitments by Maturity (dollars in thousands)

 

     Payments Due — By Period  
            Less Than      One to      Three to      After Five  

CONTRACTUAL OBLIGATIONS

   Total      One Year      Three Years      Five Years      Years  

FHLBB advances

   $ 195,000       $ 46,000       $ 37,000       $ 90,000       $ 22,000   

Subordinated debentures

     36,083                                 36,083   

Retirement benefit obligations

     29,238         2,089         4,315         5,836         16,998   

Lease obligations

     12,340         1,858         3,606         2,645         4,231   

Customer repurchase agreements

     191,390         191,390                           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual cash obligations

   $ 464,051       $ 241,337       $ 44,921       $ 98,481       $ 79,312   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Amount of Commitment Expiring — By Period  
            Less Than      One to      Three to      After Five  

OTHER COMMITMENTS

   Total      One Year      Three Years      Five Years      Years  

Lines of credit

   $ 217,246       $ 123,324       $ 4,159       $ 4,705       $ 85,058   

Standby and commercial letters of credit

     8,411         7,120         1,011         75         205   

Other commitments

     36,061         14,793         2,920         1,244         17,104   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commitments

   $ 261,718       $ 145,237       $ 8,090       $ 6,024       $ 102,367   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financial Instruments with Off-Balance-Sheet Risk

The Company is 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 primarily include commitments to originate and sell loans, standby letters of credit, unused lines of credit and unadvanced portions of construction loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in these particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments, standby letters of credit and unadvanced portions of construction loans is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Financial instruments with off-balance-sheet risk at December 31 are as follows:

 

Contract or Notional Amount

   2012      2011  
     (dollars in thousands)  

Financial instruments whose contract amount represents credit risk:

     

Commitments to originate 1–4 family mortgages

   $ 13,580       $ 12,638   

Standby and commercial letters of credit

     8,411         4,645   

Unused lines of credit

     217,246         195,181   

Unadvanced portions of construction loans

     17,609         16,819   

Unadvanced portions of other loans

     4,872         4,605   

 

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Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Commitments to originate loans, unadvanced portions of construction loans and unused letters of credit are generally agreements to lend to a customer, provided 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The fair value of standby letters of credit was $36,000 and $39,000 for 2012 and 2011, respectively.

Recent Accounting Developments

In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements. This update revises the criteria for assessing effective control for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The determination of whether the transfer of a financial asset subject to a repurchase agreement is a sale is based, in part, on whether the entity maintains effective control over the financial asset. This update removes from the assessment of effective control: the criterion requiring the transferor to have the ability to repurchase or redeem the financial asset on substantially the agreed terms, even in the event of default by the transferee, and the related requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The amendments in this update were effective for interim and annual reporting periods beginning on or after December 15, 2011. The amendments were applied prospectively to transactions or modifications of existing transactions that occurred on or after the effective date and early adoption was permitted. The adoption of this guidance did not have a material impact on the Company’s financial condition or results of operations.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The guidance clarifies and expands the disclosures pertaining to unobservable inputs used in Level 3 fair value measurements, including the disclosure of quantitative information related to (1) the valuation processes used, (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, and (3) use of a nonfinancial asset in a way that differs from the asset’s highest and best use. The guidance also requires, for public entities, disclosure of the level within the fair value hierarchy for assets and liabilities not measured at fair value in the statement of financial position but for which the fair value is disclosed. The amendments in this update are to be applied prospectively. The amendments are effective during interim and annual periods beginning after December 15, 2011. Early application was permitted. The Company has presented the requirements for this amendment in Note 9.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income. This ASU amends the disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the consolidated statement of changes in stockholders’ equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes were effective for fiscal years, and interim periods within those years, ending after December 15, 2011, with retrospective application required. Early application was permitted. There was no impact on the Company’s consolidated financial results as the amendments relate only to changes in financial statement presentation. In December 2011, the FASB elected to defer the effective date of those changes in ASU 2011-05 that relate only to the presentation of reclassification adjustments in the statement of income by issuing ASU 2011-12, Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive

 

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Table of Contents

Management’s Discussion and Analysis of Results of Operations and Financial Condition — (Continued)

 

Income in Accounting Standards Update No. 2011-05. The Company has presented a separate financial statement as a result of this pronouncement.

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350), Testing Goodwill for Impairment. This ASU is intended to reduce the complexity and cost of performing an evaluation of impairment of goodwill. Under the new guidance, an entity will have the option of first assessing qualitative factors (events and circumstances) to determine whether it is more likely than not (meaning a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If, after considering all relevant events and circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test will be unnecessary. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption was permitted. The Company implemented the provisions of ASU 2011-08 as of January 1, 2012. The adoption of this pronouncement did not have a material effect on the consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210), Disclosures About Offsetting Assets and Liabilities. ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on its financial position, and to allow investors to better compare financial statements prepared under U.S. GAAP with financial statements prepared under IFRS. The new standards are effective for annual periods beginning January 1, 2013, and interim periods within those annual periods. Retrospective application is required. The Company is currently assessing the impact on the Company’s financial statements and will implement the provisions of ASU 2011-11 as of January 1, 2013.

In July 2012, the FASB issued ASU No. 2012-02, Intangibles — Goodwill and Other (Topic 350), Testing Indefinite-Lived Intangible Assets for Impairment. This ASU permits an entity to make a qualitative assessment to determine whether it is more likely than not than an indefinite-lived intangible asset, other than goodwill, is impaired. Entities are required to test indefinite-lived intangible assets for impairment at least annually and more frequently if indicators of impairment exist. If an entity concludes, based on an evaluation of all relevant qualitative factors, that it is not more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, it is not required to perform the quantitative impairment test for that asset. The ASU applies to both public and nonpublic entities and is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company evaluated for goodwill impairment under this standard as of December 31, 2012, and determined no impairment existed.

 

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Table of Contents

Consolidated Balance Sheets

 

     December 31,  
      2012     2011  
    

(dollars in thousands

except share data)

 

ASSETS

  

Cash and due from banks (Note 2)

   $ 53,646      $ 50,187   

Federal funds sold and interest-bearing deposits in other banks

     98,637        157,579   
  

 

 

   

 

 

 

Total cash and cash equivalents

     152,283        207,766   

Short-term investments

     17,367        18,351   

Securities available-for-sale, amortized cost $1,414,595 in 2012 and $1,244,972 in 2011 (Notes 3, 9 and 11)

     1,434,801        1,258,676   

Securities held-to-maturity, fair value $281,924 in 2012 and $184,822 in 2011 (Notes 4 and 11)

     275,507        179,368   

Federal Home Loan Bank of Boston, stock at cost

     15,146        15,531   

Loans, net (Note 5)

     1,111,788        984,492   

Less: allowance for loan losses (Note 6)

     19,197        16,574   
  

 

 

   

 

 

 

Net loans

     1,092,591        967,918   

Bank premises and equipment (Note 7)

     23,899        21,757   

Accrued interest receivable

     5,811        6,022   

Prepaid FDIC assessments

     2,773        4,335   

Other assets (Notes 5, 8 and 15)

     66,031        63,501   
  

 

 

   

 

 

 

Total assets

   $ 3,086,209      $ 2,743,225   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

  

Demand deposits

   $ 438,429      $ 365,854   

Savings and NOW deposits

     933,316        708,988   

Money market accounts

     653,345        616,241   

Time deposits (Note 10)

     419,983        433,501   
  

 

 

   

 

 

 

Total deposits

     2,445,073        2,124,584   

Securities sold under agreements to repurchase (Note 11)

     191,390        143,320   

Other borrowed funds (Note 12)

     195,144        244,143   

Subordinated debentures (Note 12)

     36,083        36,083   

Other liabilities

     38,529        34,446   
  

 

 

   

 

 

 

Total liabilities

     2,906,219        2,582,576   

Commitments and contingencies (Notes 7, 17 and 18)

    

Stockholders’ equity (Note 14):

    

Preferred Stock – $1.00 par value; 100,000 shares authorized; no shares issued and outstanding

              

Common stock, Class A,

    

$1.00 par value per share; authorized 10,000,000 shares; issued 3,568,079 shares in 2012 and 3,548,317 shares in 2011

     3,568        3,548   

Common stock, Class B,

    

$1.00 par value per share; authorized 5,000,000 shares; issued 1,986,880 shares in 2012 and 1,994,380 shares in 2011

     1,986        1,994   

Additional paid-in capital

     11,891        11,587   

Retained earnings

     162,892        146,039   
  

 

 

   

 

 

 
     180,337        163,168   

Unrealized gains on securities available-for-sale, net of taxes

     12,330        8,319   

Pension liability, net of taxes

     (12,677     (10,838
  

 

 

   

 

 

 

Total accumulated other comprehensive loss, net of taxes (Notes 3 and 14)

     (347     (2,519
  

 

 

   

 

 

 

Total stockholders’ equity

     179,990        160,649   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 3,086,209      $ 2,743,225   
  

 

 

   

 

 

 

See accompanying “Notes to Consolidated Financial Statements.”

 

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Table of Contents

Consolidated Statements of Income

 

     Year Ended December 31,  
      2012      2011      2010  
     (dollars in thousands except share data)  

INTEREST INCOME

        

Loans, taxable

   $ 34,983       $ 36,772       $ 40,163   

Loans, non-taxable

     16,432         11,324         8,271   

Securities available-for-sale, taxable

     22,286         22,782         18,958   

Securities available-for-sale, non-taxable

     340         211         391   

Federal Home Loan Bank of Boston dividends

     77         46           

Securities held-to-maturity

     6,746         5,816         7,158   

Federal funds sold, interest-bearing deposits in other banks and short-term investments

     630         1,114         1,642   
  

 

 

    

 

 

    

 

 

 

Total interest income

     81,494         78,065         76,583   

INTEREST EXPENSE

        

Savings and NOW deposits

     2,250         2,539         4,072   

Money market accounts

     2,373         2,706         3,942   

Time deposits

     6,250         9,356         7,914   

Securities sold under agreements to repurchase

     367         379         573   

Other borrowed funds and subordinated debentures

     8,300         7,786         8,316   
  

 

 

    

 

 

    

 

 

 

Total interest expense

     19,540         22,766         24,817   
  

 

 

    

 

 

    

 

 

 

Net interest income

     61,954         55,299         51,766   

Provision for loan losses (Note 6)

     4,150         4,550         5,575   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     57,804         50,749         46,191   

OTHER OPERATING INCOME

        

Service charges on deposit accounts

     7,880         7,885         7,876   

Lockbox fees

     2,930         2,770         2,911   

Brokerage commissions

     364         441         230   

Net gains on sales of securities

     1,843         1,940         1,851   

Other income

     2,848         3,204         3,131   
  

 

 

    

 

 

    

 

 

 

Total other operating income

     15,865         16,240         15,999   

OPERATING EXPENSES

        

Salaries and employee benefits (Note 16)

     32,943         29,630         28,398   

Occupancy

     4,695         4,411         4,037   

Equipment

     2,255         2,235         2,132   

FDIC assessments

     1,737         2,025         2,965   

Other (Note 19)

     11,608         10,441         9,840   
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     53,238         48,742         47,372   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     20,431         18,247         14,818   

Provision for income taxes (Note 15)

     1,392         1,554         1,244   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 19,039       $ 16,693       $ 13,574   
  

 

 

    

 

 

    

 

 

 

SHARE DATA (Note 13)

        

Weighted average number of shares outstanding, basic

        

Class A

     3,557,693         3,543,233         3,521,179   

Class B

     1,990,474         1,997,411         2,012,327   

Weighted average number of shares outstanding, diluted

        

Class A

     5,549,191         5,541,794         5,535,742   

Class B

     1,990,474         1,997,411         2,012,327   

Basic earnings per share

        

Class A

   $ 4.18       $ 3.68       $ 3.00   

Class B

   $ 2.09       $ 1.84       $ 1.50   

Diluted earnings per share

        

Class A

   $ 3.43       $ 3.01       $ 2.45   

Class B

   $ 2.09       $ 1.84       $ 1.50   

See accompanying “Notes to Consolidated Financial Statements.”

 

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Table of Contents

Consolidated Statements of Comprehensive Income

 

     Year Ended December 31,  
      2012     2011     2010  
     (dollars in thousands)  

NET INCOME

   $ 19,039      $ 16,693      $ 13,574   

Other comprehensive income, net of tax:

      

Unrealized gains on securities:

      

Unrealized holding gains arising during period

     5,854        6,666        1,315   

Less: reclassification adjustment for gains included in net income

     (1,843     (1,940     (1,851
  

 

 

   

 

 

   

 

 

 

Total unrealized gains on securities

     4,011        4,726        (536

Defined benefit pension plans:

      

Pension liability adjustment:

      

Net gain (loss)

     (2,488     (4,047     771   

Amortization of prior service cost and loss included in net periodic benefit cost

     649        380        488   
  

 

 

   

 

 

   

 

 

 

Total pension liability adjustment

     (1,839     (3,667     1,259   

Other comprehensive income

     2,172        1,059        723   
  

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 21,211      $ 17,752      $ 14,297   
  

 

 

   

 

 

   

 

 

 

See accompanying “Notes to Consolidated Financial Statements.”

 

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Table of Contents

Consolidated Statements of Changes in Stockholders’ Equity

 

     Class A
Common
Stock
     Class B
Common
Stock
    Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Total
Stockholders’
Equity
 
     (dollars in thousands except share data)  

BALANCE, DECEMBER 31, 2009

   $ 3,516       $ 2,014      $ 11,376       $ 120,125      $ (4,301   $ 132,730   

Net income

                            13,574               13,574   

Other comprehensive income, net of tax:

              

Unrealized holding losses arising during period, net of $415 in taxes and $1,851 in realized net gains

                                   (536     (536

Pension liability adjustment, net of $836 in taxes

                                   1,259        1,259   

Conversion of Class B Common Stock to Class A Common Stock, 3,150 shares

     3         (3                             

Stock options exercised, 9,950 shares

     10                140                       150   

Tax benefit of stock option exercises

                    21                       21   

Cash dividends, Class A Common Stock, $0.48 per share

                            (1,690