-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EQWA/R0E4eA3MKQih3kqDRV21iaK1nZPM+ZmJIoXu4HNCwFbIgxGSCABF7bE3P5h vFi9zTIBoVC+Kb8PawrWxA== 0000950135-97-001560.txt : 19970401 0000950135-97-001560.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950135-97-001560 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: BOSTONFED BANCORP INC CENTRAL INDEX KEY: 0000948515 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 521940834 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 001-13936 FILM NUMBER: 97570292 BUSINESS ADDRESS: STREET 1: 17 NEW ENGLAND EXECUTIVE OFFICE PARK CITY: BURLINGTON STATE: MA ZIP: 01803 BUSINESS PHONE: 6172730300 MAIL ADDRESS: STREET 1: 17 NEW ENGLAND EXECUTIVE OFFICE PK CITY: BURLINGTON STATE: MA ZIP: 01803 10-K405 1 BOSTONFED BANCORP, INC. ANNUAL REPORT ON FORM 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K Annual report pursuant to Section 13 of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1996 Commission File No.: 1-13936 BOSTONFED BANCORP, INC. (exact name of registrant as specified in its charter) DELAWARE 52-1940834 (State or other jurisdiction (IRS Employer Identification) of incorporation or organization) 17 New England Executive Park, Burlington, Massachusetts 01803 (Address of principal executive offices) Registrant's telephone number, including area code: (617) 273-0300 Securities registered pursuant to Section 12(b) of the Act: Common Stock par value $0.01 per share (Title of class) Securities registered pursuant to Section 12(g) of the Act: None The American Stock Exchange (Name of exchange on which registered) The registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, i.e., persons other than directors and executive officers of the registrant is $83.2 million and is based upon the last sales price as quoted on the American Stock Exchange for March 7, 1997. The number of shares of Common Stock outstanding as of March 7, 1997 is 5,962,502. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Stockholders for the year ended December 31, 1996 are incorporated by reference into Part II of this Form 10-K. Portions of the Proxy Statement for the 1997 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. 53296 2 INDEX PART I PAGE ---- Item 1. Business................................................... 1 Item 2. Properties................................................. 39 Item 3. Legal Proceedings.......................................... 39 Item 4. Submission of Matters to a Vote Security Holders........... 40 PART II Item 5. Market for Registrant's Common Equity and Related Stockholders Matters....................................... 40 Item 6. Selected Financial Data.................................... 40 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........................ 40 Item 8. Financial Statements and Supplementary Data ............... 40 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.................. 40 PART III Item 10. Directors and Executive Officers of the Registrant......... 41 Item 11. Executive Compensation..................................... 41 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................. 41 Item 13. Certain Relationships and Related Transactions............. 41 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................. 41 SIGNATURES ..................................................... 43 3 PART I Item 1. Business. General BostonFed Bancorp, Inc. (also referred to as the "Company" or "Registrant") was incorporated under Delaware law on July 11, 1995, and subsequently became the holding company for Boston Federal Savings Bank (the "Bank"). On October 24, 1995, the Bank completed its conversion from a mutual savings bank to a stock form of ownership, while simultaneously, the Company issued 6,589,617 shares of common stock utilizing a portion of the proceeds to acquire all of the stock of the Bank. The Company's business has been conducted primarily through its ownership of the Bank which operates its administrative branch office located in Burlington, Massachusetts and its seven other branch offices located in Arlington, Bedford, Billerica, Boston, Lexington, Peabody and Wellesley, all of which are located in the greater Boston metropolitan area. As the result of its acquisition on February 7, 1997, of Broadway Capital Corp. and its commercial bank, Broadway National Bank, ("Broadway National Bank") the Company added two banking offices (Chelsea and Revere) to its franchise in the greater Boston metropolitan area. On February 7, 1997, the Company acquired Broadway National Bank, a nationally chartered commercial bank. As a result of the acquisition, the Company became a multi-bank holding company subject to regulation by the Federal Reserve Bank ("FRB"). Prior to its acquisition of Broadway National Bank, the Company was a savings and loan holding company regulated by the Office of Thrift Supervision ("OTS") and, as a result, was not subject to any significant restrictions on the types of business activities in which it could engage. As a bank holding company, the Company is subject to certain restrictions and requirements imposed by the FRB on the activities in which the Company may engage and the assets in which the Company may invest. See "Regulation and Supervision - Holding Company Regulation." Since the acquisition was consummated after December 31, 1996, the financial statements of the Company and the following discussion regarding the Company's financial condition and results of operations at and for the years ended December 31, 1996 and 1995, do not include information and data related to Broadway National Bank. The Company's principal business has been and continues to be attracting retail deposits from the general public in the areas surrounding its branch offices and investing those deposits, together with funds generated from operations and borrowings, primarily in one- to four-family residential mortgage loans. To a lesser extent, the Company invests in multi-family mortgage, commercial real estate, construction and land and consumer loans. The Company originates loans for investment and loans for sale in the secondary market, generally retaining the servicing rights for loans sold. Loan sales are made from loans held in the Company's portfolio designated as being held for sale or originated for sale during the period. The Company's revenues are derived principally from interest on its mortgage loans, and to a lesser extent, interest and dividends on its investment and mortgage-backed securities, fees and loan servicing income. The Company's primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, FHLB advances, repurchase agreements and proceeds from the sale of loans. Market Area and Competition The Company has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial products and services to meet the needs of the communities it serves. The Company currently operates out of its main office located in Burlington and its branch offices located in Arlington, Bedford, Billerica, Boston, Lexington, Peabody and Wellesley, all of which are located in the 1 4 greater Boston metropolitan area. The Company's deposit gathering is concentrated in the communities surrounding its offices while its lending base extends throughout eastern Massachusetts and, to a lesser extent, other areas of New England. The Company faces significant competition both in generating loans and in attracting deposits. The Boston metropolitan area is a highly competitive market. The Company's share of deposits and loan originations in eastern Massachusetts amounts to less than one percent. The Company faces direct competition from a significant number of financial institutions operating in its market area, many with a state-wide or regional presence and, in some cases, a national presence. Many of these financial institutions are significantly larger and have greater financial resources than the Company. The Company's competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, credit unions and insurance companies. Its most direct competition for deposits has historically come from savings and commercial banks. In addition, the Company faces increasing competition for deposits from non-bank institutions such as brokerage firms and insurance companies in such instruments as short-term money market funds, corporate and government securities funds, mutual funds and annuities. Competition may also increase as a result of the lifting of restrictions on the interstate operations of financial institutions. Lending Activities Loan Portfolio Composition. The Company's loan portfolio consists primarily of first mortgage loans secured by one- to four-family residences. At December 31, 1996, the Company had total loans outstanding, including mortgage loans held for sale, of $690.7 million, of which $607.8 million were one- to four-family, residential mortgage loans, or 88.0% of the Company's total loans. At such date, the remainder of the loan portfolio consisted of: $21.4 million of multi-family residential loans, or 3.1% of total loans; $28.1 million of commercial real estate loans, or 4.1% of total loans; $12.5 million of construction and land loans, or 1.8% of total loans; and other loans, primarily home equity lines of credit, of $20.9 million or 3.0% of total loans. The Company had $4.0 million of mortgage loans held for sale at December 31, 1996 consisting of one- to four-family fixed-rate mortgage loans. At that same date, 77.9% of the Company's total mortgage loans had adjustable interest rates, most of which are indexed to the one-year Constant Maturity Treasury ("CMT") Index. The types of loans that the Company may originate are subject to federal and state laws and regulations. Interest rates charged by the Company on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal government, including the Federal Reserve Board, and legislative tax policies. 2 5 The following table sets forth the composition of the Company's loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.
At December 31, ---------------------------------------------------------------------------------- 1996 1995 1994 -------------------------- ------------------------- --------------------------- Percent Percent Percent Amount of Total Amount of Total Amount of Total ------------- ------------ ------------- ----------- ------------- ------------- (Dollars in thousands) Mortgage Loans: Residential: One- to four-family(1)....... $607,792 88.00% $447,033 85.44% $427,716 84.77% Multi-family................. 21,381 3.10 27,986 5.35 29,212 5.79 Commercial real estate......... 28,136 4.07 26,412 5.05 28,714 5.69 Construction and land.......... 12,532 1.81 3,435 .66 3,450 0.68 Other loans(2)................... 20,850 3.02 18,343 3.50 15,504 3.07 -------- ------ -------- ------ -------- ------ Total loans................ 690,691 100.00% 523,209 100.00% 504,596 100.00% ====== ====== ====== Less: Allowance for loan losses...... (4,400) (4,275) (3,700) Construction loans in process...................... (6,936) (805) (1,078) Net unearned discount on loans purchased.............. (163) (262) (525) Deferred loan origination (fees) costs................. 1,448 560 96 -------- -------- -------- Loans, net and mortgage loans held for sale....... $680,640 $518,427 $499,389 ======== ======== ========
At December 31, ----------------------------------------------------- 1993 1992 -------------------------- ------------------------- Percent Percent Amount of Total Amount of Total ------------- ------------ ------------- ----------- Mortgage Loans: Residential: One- to four-family(1)....... $340,584 81.57% $315,894 78.46% Multi-family................. 30,418 7.28 32,150 7.99 Commercial real estate......... 24,548 5.88 30,734 7.63 Construction and land.......... 4,704 1.13 4,922 1.22 Other loans(2)................... 17,276 4.14 18,934 4.70 ------- ------ -------- ------ Total loans................ 417,530 100.00% 402,634 100.00% ====== ====== Less: Allowance for loan losses...... (4,450) (4,381) Construction loans in process...................... (1,175) (149) Net unearned discount on loans purchased.............. (489) (742) Deferred loan origination (fees) costs................. 150 (858) -------- -------- Loans, net and mortgage loans held for sale....... $411,566 $396,504 ======== ========
- ---------- (1) Includes mortgage loans held for sale of $4.0 million, $8.9 million, $316,000, $25.9 million and $29.7 million at December 31, 1996, 1995, 1994, 1993 and 1992, respectively. (2) These loans primarily consist of home equity and improvement lines of credit secured by mostly second mortgages which amounted to $17.4 million $14.9 million, $12.8 million, $12.0 million and $13.9 million at December 31, 1996, 1995, 1994, 1993 and 1992, respectively. 3 6 Loan Maturity. The following table shows the remaining contractual maturity of the Company's loans at December 31, 1996. There were $4.0 million of mortgage loans held for sale at December 31, 1996. The table does not include the effect of future principal prepayments. Principal prepayments on total loans were $95.4 million, $57.8 million and $44.3 million for the years ended December 31, 1996, 1995 and 1994, respectively.
At December 31, 1996 ------------------------------------------------------------------------------ One- to Four- Multi- Commercial Construction Other Total Family Family Real Estate and Land Loans Loans ------------- ----------- ------------- ------------- ----------- -------- (In thousands) Amounts due: One year or less................................. $ 697 $ 1,534 $ 61 $11,408 $ 578 $14,278 -------- -------- -------- ------- -------- ------- After one year: More than one year to three years............. 4,869 41 2,697 1,124 378 9,109 More than three years to five years........... 12,509 183 117 -- 323 13,132 More than five years to 10 years.............. 58,126 6,601 14,029 -- 13,570 92,326 More than 10 years to 20 years................ 71,184 3,839 5,980 -- 2,289 83,292 More than 20 years............................ 460,407 9,183 5,252 -- 3,712 478,554 ------- ----- ------ ------- ------ ------- Total due after one year...................... 607,095 19,847 28,075 1,124 20,272 676,413 ------- ------ ------ ------ ------ ------- Total amount due.............................. $607,792 $21,381 $28,136 $12,532 $20,850 690,691 ======== ======= ======= ======= ======= Less: Allowance for loan losses.............. (4,400) Construction loans in process.......... (6,936) Net unearned discount on loans purchased.......................... (163) Deferred loan origination costs........ 1,448 --------- Loans, net, and mortgage loans held for sale.. $680,640 Mortgage loans held for sale.................. (3,970) ---------- Loans, net.................................... $676,670 ========
4 7 The following table sets forth at December 31, 1996 the dollar amount of loans contractually due after December 31, 1997, and whether such loans have fixed interest rates or adjustable interest rates. Due After December 31, 1997 -------------------------------------- Fixed Adjustable Total ----------- ------------- -------- (In thousands) Mortgage loans: Residential: One- to four-family............. $142,377 $464,718 $607,095 Multi-family.................... 1,574 18,273 19,847 Commercial real estate............ 1,891 26,184 28,075 Construction and land............. 65 1,059 1,124 Other loans.......................... 1,599 18,673 20,272 -------- -------- -------- Total loans .................. $147,506 $528,907 $676,413 ======== ======== ======== Origination, Sale, Servicing and Purchase of Loans. The Company's mortgage lending activities are conducted primarily by its commissioned loan personnel, through its eight branch offices, and through wholesale brokers and other financial institutions approved by the Company. All loans originated by the Company, either through internal sources or through wholesale brokers or other correspondent financial institutions are underwritten by the Company pursuant to the Company's policies and procedures. The Company originates both adjustable-rate and fixed-rate mortgage loans. The Company's ability to originate loans is dependent upon the relative customer demand for fixed-rate or adjustable-rate loans, which is affected by the current and expected future level of interest rates. While the Company has in the past, from time to time, sold adjustable-rate one-to four-family loans, it is currently the general policy of the Company to sell substantially all of the one- to four-family fixed-rate mortgage loans with maturities over ten years that it originates and to retain substantially all adjustable-rate and loans with maturities of under ten years, one- to four-family mortgage loans which it originates. The Company retains the servicing of loans sold in most cases. At December 31, 1996, the Company serviced $540.4 million of loans for others. The Company recognizes, at the time of sale, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold. See "- Lending Activities - Loan Servicing." At December 31, 1996, the Company had $4.0 million of mortgage loans held for sale consisting of fixed-rate one- to four-family loans. The Company has, in the past, from time to time, purchased loans or participations of loans, primarily one- to four-family mortgage loans, and had $9.0 million of purchased loans at December 31, 1996. With the exception of purchases of loans from correspondent financial institutions, which are underwritten pursuant to the Company's policies and closed in the name of the correspondent financial institution but immediately purchased by the Company for its mortgage banking activities, the Company currently does not purchase loans or participations in loans. The Company engages in certain hedging activities to facilitate the sale of its originated and purchased mortgage loans in an attempt to minimize interest rate risk from the time the loan commitments are made to the time until the loans are securitized or packaged and sold. The Company currently utilizes forward loan sale commitment contracts with FNMA, FHLMC, and other approved investors as its method 5 8 of hedging loan sales in an attempt to protect the Company from fluctuations in market interest rates. Generally, the Company will enter into contracts to deliver loans or agency mortgage-backed securities to purchasers at a future date for a specified price while the Company simultaneously processes and closes loans, thereby protecting the price of currently processed loans from interest rate fluctuations that may occur from the time the interest rate on the loan is fixed to the time of sale. As loans are closed and funded, they may also be pooled to create mortgage-backed securities which will be delivered to fulfill the forward commitment contracts. For the year ended December 31, 1996, the Company had $668,000 in net gains attributable to the sale of loans. These gains were primarily the result of implementation of FASB 122, "Accounting for Mortgage Servicing Rights." The following table sets forth the Company's loan originations, purchases, sales and principal repayments for the periods indicated: For the Year Ended December 31, ------------------------------------ 1996 1995 1994 --------- --------- --------- (In thousands) Net loans: Beginning balance........................ $509,496 $499,073 $411,566 Loans originated: One- to four-family............... 362,534 146,303 246,272 Multi-family...................... 4,204 440 1,068 Commercial real estate............ 5,942 906 2,659 Construction and land............. 11,638 5,728 3,375 Other(1).......................... 16,124 11,356 8,632 --------- --------- --------- Total loans originated............ 400,442 164,733 262,006 Loans purchased(2)................... 46,208 6,356 1,877 --------- --------- --------- Total......................... 956,146 670,162 675,449 Less: Principal repayments and other, net........................ (122,346) (77,937) (71,220) Loan charge-offs, net................ (1,169) (3,039) (1,033) Sale of mortgage loans............... (148,025) (69,426) (103,097) Transfer of mortgage loans to REO.... (3,966) (1,333) (710) --------- --------- --------- Loans, net and mortgage loans held for sale............................. 680,640 518,427 499,389 Mortgage loans held for sale......... (3,970) (8,931) (316) --------- --------- --------- Loans, net .............................. $676,670 $509,496 $499,073 ========= ========= ========= - ---------- (1) Other loans primarily consist of one- to four-family lines of credit secured by mortgages. The amounts indicated primarily include new amounts drawn on such home-equity lines of credit during the periods presented. (2) Includes loans purchased from correspondent financial institutions which are underwritten pursuant to the Company's policies and closed in the name of the financial institution but immediately purchased by the Company for its mortgage banking activities. 6 9 One- to Four-Family Mortgage Lending. The Company offers both fixed-rate and adjustable-rate mortgage loans secured by one- to four-family residences located in the Company's primary market area, with maturities of up to thirty years. Substantially all of such loans are secured by property located in the Company's primary market area. Loan originations are generally obtained from the Company's commissioned loan representatives, correspondent banking relationships and wholesale brokers and their contacts with the local real estate industry, existing or past customers, and members of the local communities. At December 31, 1996, the Company's total loans outstanding were $690.7 million, of which $607.8 million, or 88.0%, were one- to four-family residential mortgage loans, most of which were primarily owner-occupied properties. Of the one- to four-family residential mortgage loans outstanding at that date, 23.5% were fixed-rate loans, and 76.5% were adjustable-rate mortgage loans. The interest rates for the majority of the Company's adjustable-rate mortgage loans are indexed to the CMT Index. The Company currently offers fixed-rate mortgage loans with amortization periods of five to thirty years. The Company currently offers a number of adjustable-rate mortgage loan programs with interest rates which adjust annually with amortization schedules of ten to thirty years. The Company's adjustable-rate mortgage loans are originated with interest rates which are fixed for an initial period of one, three, five or seven years and at the end of such period will adjust thereafter either annually or a greater period according to their terms. The Company's one- to four-family adjustable-rate loan products generally reprice based on a margin, currently 275 to 325 basis points, over the CMT Index for the Treasury security of a maturity which is comparable to the interest adjustment period for the loan. Generally, all of the Company's adjustable-rate mortgage loans provide for periodic and overall caps on the increase or decrease in interest rate at any adjustment date and over the life of the loan. Included in the Company's adjustable-rate mortgage loan portfolio is a type of adjustable-rate loan which is originated at an interest rate below the fully-indexed rate and which limits the adjustment of the interest rate to 1% annually and 6% over the life of the loan. The Company also offers a single-family loan product which has been popular with its customers consisting of a fixed-rate loan up to the conforming FNMA/FHLMC limit of $214,000 coupled with a second mortgage adjustable-rate loan for the amount of the loan in excess of the FNMA/FHLMC limit. After origination, the Company will typically sell the fixed-rate portion of the loan (to FNMA/FHLMC) and retain the adjustable-rate second mortgage portion of the loan for its portfolio. During 1996, the Company's retained portion of this loan product was $18.0 million, or 4.4% of total originations. The Company generally originates one- to four-family residential mortgage loans in amounts up to 80% of the lower of the appraised value or the selling price of the property securing the loan and up to 95% of the appraised value or selling price if private mortgage insurance is obtained on the portion of the loan in excess of 75% of the lesser of the appraised value or selling price. However, the Company may originate single-family owner-occupied mortgage loans in amounts up to 85% of the lesser of the appraised value or selling price without private mortgage insurance. Mortgage loans originated by the Company generally include due-on-sale clauses which provide the Company with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Company's consent. Due-on-sale clauses are an important means of adjusting the rates on the Company's fixed-rate mortgage loan portfolio and the Company has generally exercised its rights under these clauses. Multi-Family Mortgage Lending. The Company originates multi-family mortgage loans generally secured by 5 to 120 unit apartment buildings located in the Company's primary market area. As a result of uncertain market conditions in its primary market area, the Company currently originates multi-family loans on a limited and highly selective basis. In reaching its decision on whether to make a multi-family loan, the Company considers the value of the underlying property as well as the qualifications of the 7 10 borrower. Other factors relating to the property to be considered are: the net operating income of the mortgaged premises before debt service and depreciation; the debt service ratio (the ratio of earnings before debt service to debt service); and the ratio of loan amount to appraised value. The Company generally requires a debt service ratio of 115% or greater. Pursuant to the Company's current underwriting policies, a multi-family mortgage loan may only be made in an amount up to 85% of the appraised value of the underlying property to a maximum amount of $4.0 million. However, generally loans are not granted which exceed 80% of the appraised value. Generally, all multi-family loans made to corporations, partnerships and other business entities require personal guarantees by the principal borrowers. On an exception basis, the Company may not require a personal guarantee on such loans depending on the creditworthiness of the borrower and amount of the downpayment. Subsequent declines in the real estate values in the Company's primary market area have resulted in some increase in the loan-to-value ("LTV") ratio on some mortgage loans. When evaluating the qualifications of the borrower for a multi-family loan, the Company considers the financial resources and income level of the borrower, the borrower's experience in owning or managing similar property, and the Company's lending experience with the borrower. The Company's underwriting guidelines require that the borrower be able to demonstrate strong management skills and the ability to maintain the property from current rental income. The borrower is required to present evidence of the ability to repay the mortgage and a history of making mortgage payments on a timely basis. In making its assessment of the creditworthiness of the borrower, the Company generally reviews the financial statements, employment and credit history of the borrower, as well as other related documentation. The Company's multi-family loan portfolio at December 31, 1996, totalled $21.4 million or 3.1% of total loans. The Company's largest multi-family loan at December 31, 1996, was a $3.8 million performing loan secured by a 118 unit apartment complex located in Malden, Massachusetts. Loans secured by apartment buildings and other multi-family residential properties are generally larger and involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to the then prevailing conditions in the real estate market or the economy. The Company seeks to minimize these risks through its underwriting policies. Commercial Real Estate Lending. The Company originates commercial real estate loans that are secured by properties generally used for business purposes such as small office buildings or retail facilities located in the Company's primary market area. The Company's underwriting procedures provide that commercial real estate loans may be made in amounts up to the lesser of 85% of the appraised value of the property, or the Company's current loan limit which is $4.0 million. However, generally loans are not granted which exceed 80% of the appraised value. The Company currently originates commercial real estate loans with terms of up to thirty years only with adjustable-rates which are indexed to the CMT Index. The Company's underwriting standards and procedures are similar to those applicable to its multi-family loans, whereby the Company considers the net operating income of the property and the borrower's expertise, credit history and profitability. The Company has generally required that the properties securing commercial real estate loans have debt service coverage ratios of at least 115%. Generally, all commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principal borrowers. On an exception basis, the Company may not require a personal guarantee on such loans depending on the creditworthiness of the borrowers and the amount of the downpayment. The Company's commercial real estate loan portfolio at December 31, 1996 was $28.1 million, or 4.1% of total loans. The largest commercial real estate loan in the Company's portfolio at December 31, 1996 was a performing loan which had an outstanding carrying balance of $2.3 million and is secured by an office building located in Watertown, Massachusetts. 8 11 Loans secured by commercial real estate properties are generally larger and involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a great extent to the then prevailing conditions in the real estate market or the economy. The Company seeks to minimize these risks through its underwriting standards. Construction and Land Lending. The Company originates loans for the acquisition and development of property to licensed and experienced contractors in its primary market area. The Company's construction loans primarily have been made to finance the construction of one- to four-family, owner-occupied residential properties. While the Company originates loans secured by raw land, the Company generally does not originate such loans unless the borrower has also secured financing with the Company for the construction of structures on the property. These loans are primarily adjustable-rate loans with maturities of less than two years. Construction and land mortgage loans are originated in amounts up to 75% of the lesser of the appraised value of the property, as improved, or sales price, unless such loan is for the construction of a residential property which cannot exceed an 80% loan to value ("LTV") ratio. Proceeds of such loans are dispersed as phases of the construction are completed. Generally, if the borrower is a corporation, partnership or other business entity, personal guarantees by the principal borrowers are required. However, personal guarantees may not be required on such loans depending on the creditworthiness of the borrower and amount of the downpayment. The Company's current loan limit is $4 million. The Company's largest construction and land loan at December 31, 1996 was a performing loan with a revolving $4.5 million line of credit with a carrying balance of $941,000 and secured by a 70 unit residential subdivision in Southborough, Massachusetts. However, at no time will the loan exceed $4 million At December 31, 1996, the Company had $12.5 million of construction and land loans which amounted to 1.8% of the Company's total loan portfolio. Working with experienced land developers in the local community, the Company will continue to expand this area of its lending business. Construction and land financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development compared to the estimated cost (including interest) of construction. If the estimate of value proves to be inaccurate, the Company may be confronted with a project, when completed, having a value which is insufficient to assure full repayment. Other Lending. Other loans at December 31, 1996, amounting to $20.9 million or 3.0% of the Company's total loan portfolio, consisted primarily of home equity and improvement loans, and, to a significantly lesser extent, new and used automobile loans originated by the Company, personal loans, student loans, business loans and loans secured by savings accounts. Such loans are generally originated in the Company's primary market area and generally are secured by real estate, personal property, savings accounts and automobiles. These loans are shorter term and generally contain higher interest rates than residential mortgage loans. Substantially all of the Company's home equity lines of credit are primarily secured by second mortgages on one- to two-family residences located in the Company's primary market area. At December 31, 1996, these loans totalled $17.4 million, or 2.5% of the Company's total loans and 83.3% of other loans. Generally, under the terms of the Company's home-equity lines of credit, borrowers have the ability to draw on such lines and repay outstanding principal and interest on a monthly basis on a certain percentage of the outstanding principal over a period of up to ten years and, thereafter, the outstanding balance drawn on such lines is converted to an adjustable-rate loan with terms of up to ten years. The 9 12 underwriting standards employed by the Company for these loans include a determination of the applicant's credit history and an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment and, additionally, from any verifiable secondary income. Creditworthiness of the applicant is of primary consideration. Loans secured by rapidly depreciable assets such as automobiles or that are unsecured entail greater risks than one- to four-family residential mortgage loans. In such cases, repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance, since there is a greater likelihood of damage, loss or depreciation of the underlying collateral. Further, consumer loan collections on these loans are dependent on the borrower's continuing financial stability and, therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Finally, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the event of a default. At December 31, 1996, there were three consumer or other loans, totalling $14,000, 90 days or more delinquent. Loan Approval Procedures and Authority. The Board of Directors establishes the lending policies and loan approval limits of the Company. In connection with one- to four-family mortgage loans, the Board of Directors has authorized the following persons and committees to approve loans up to the amounts indicated: loans in amounts up to $750,000 must be approved by two designated members of the Company's management; mortgage loans in excess of $750,000 and up to $1.0 million require, in addition to the foregoing, the approval of the Loan Committee and ratification by the Investment Committee; loans in excess of $1.0 million and up to $1.5 million require, in addition to the foregoing approvals, the approval of the Investment Committee; and loans in excess of $1.5 million require, in addition to the foregoing approvals, the approval of the Board of Directors. In connection with commercial real estate loans, multi-family and construction (non-owner occupied) real estate lending, the Board of Directors has authorized the following persons and committees to approve loans up to the amounts indicated: loans in amounts up to $750,000 must be approved by two designated members of the Company's management, one of whom must be a member of the Loan Committee; mortgage loans in excess of $750,000 and up to $1.0 million require, in addition to the foregoing, the approval of the Loan Committee; loans in excess of $1.0 million and up to $2.0 million require, in addition to the foregoing approvals, the approval of the Investment Committee; and loans in excess of $2.0 million require, in addition to the foregoing approvals, the approval of the Board of Directors. Loans over $500,000 and $1.5 million require ratification of the Investment Committee and Board of Directors, respectively Pursuant to OTS regulations, loans to one borrower cannot, subject to certain exceptions, exceed 15% of the Bank's unimpaired capital and surplus. At December 31, 1996, the loans to one borrower limit was $10.0 million. Loan Servicing. The Company also services mortgage loans for others. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, making inspections as required of mortgaged premises, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. The Company has recognized gains from excess servicing, which is the present value of any difference between the interest rate charged to the borrower and the interest rate paid to the purchaser after deducting a normal servicing fee, and is recognizable as 10 13 an adjustment to the cash gain or loss. The excess servicing gain or loss is dependent on prepayment estimates and discount rate assumptions. All of the loans currently being serviced for others are loans which have been sold by the Company. At December 31, 1996, the Company was servicing $540.4 million of loans for others. The gross servicing fee income from loans originated and purchased is generally .25% to .38% of the total balance of the loan serviced. The Company currently does not purchase servicing rights related to mortgage loans originated by other institutions. The Company recognizes the present value of the servicing income, net of servicing expenses, attributable to servicing rights upon sale of the loan. The Company amortizes the capitalized mortgage servicing rights using a method which approximates the level yield method in proportion to, and over the period of, estimated net servicing income. The Company reviews prepayment activity on its serviced loans at least semi-annually and adjusts its capitalized mortgage servicing rights amortization schedule accordingly. As of December 31, 1996, the Company had $988,000 of capitalized mortgage servicing rights. Nonperforming and Problem Assets. Classified Assets. Federal regulations and the Company's Asset Classification Policy require that the Company utilize an internal asset classification system as a means of reporting problem and potential problem assets. The Company has incorporated the OTS internal asset classifications as a part of its credit monitoring system. The Company currently classifies problem and potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is considered "Substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "Doubtful" have all of the weaknesses inherent in those classified "Substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "Loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated "Special Mention." When an insured institution classifies one or more assets, or portions thereof, as "Substandard" or "Doubtful," it is required to establish a general valuation allowance for loan losses in an amount deemed prudent by management. General valuation allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies one or more assets, or portions thereof, as "Loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS which can order the establishment of additional general or specific loss allowances. The OTS, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectibility of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. As a result of the declines in local and regional 11 14 real estate market values and the significant losses experienced by many financial institutions, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions undertaken as part of the examination of institutions by the OTS and the FDIC. While the Company believes that it has established an adequate allowance for loan losses, there can be no assurance that regulators, in reviewing the Company's loan portfolio, will not request the Company to materially increase at that time its allowance for loan losses, thereby negatively affecting the Company's financial condition and earnings at that time. Although management believes that, based on information currently available to it at this time, its allowance for loan losses is adequate, actual losses are dependent upon future events and, as such, further additions to the level of allowances for loan losses may become necessary. The Company's Asset Classification Committee reviews and classifies the Company's assets on a quarterly basis and reports the results of its review to the Board of Directors. The Company classifies assets in accordance with the management guidelines described above. At December 31, 1996, the Company had $7.7 million of loans designated as "Special Mention," $3.8 million of loans designated as "Substandard," and $2.4 million of loans designated as "Loss." All loans classified as "Loss" have been charged off for financial statement purposes. There were no loans classified as "Doubtful." Included in these amounts was $1.5 million in non-performing loans at December 31, 1996. In the opinion of management, the remaining special mention and "Substandard" loans of $10.0 million evidence one or more weaknesses or potential weaknesses and, depending on the regional economy and other factors, may become non-performing loans in future periods. 12 15 The following table sets forth delinquencies in the Company's loan portfolio as of the dates indicated: At December 31, 1996 ----------------------------------------------- 60-89 Days 90 Days or More ----------------------- -------------------- Principal Principal Number Balance Number Balance of Loans of Loans of Loans of Loans --------- ---------- --------- --------- (Dollars in thousands) One- to four-family.......... 15 $1,481 24 $1,463 Multi-family................. 1 60 -- -- Commercial real estate....... -- -- -- -- Construction and land........ -- -- -- -- Other loans.................. 4 56 3 14 --- ------ --- ------ Total........................ 20 $1,597 27 $1,477 === ====== === ====== Delinquent loans to loans, net and mortgage loans held for sale........... 0.23% 0.22% At December 31, 1995 ----------------------------------------------- 60-89 Days 90 Days or More ----------------------- -------------------- Principal Principal Number Balance Number Balance of Loans of Loans of Loans of Loans --------- ---------- --------- --------- One- to four-family.......... 11 $ 923 23 $1,178 Multi-family................. -- -- 1 720 Commercial real estate....... 1 202 4 2,693 Construction and land........ -- -- -- -- Other loans.................. -- -- -- -- --- ------ --- ------ Total........................ 12 $1,125 28 $4,591 === ====== === ====== Delinquent loans to loans, net and mortgage loans held for sale........... 0.22% 0.89% At December 31, 1994 ----------------------------------------------- 60-89 Days 90 Days or More ----------------------- -------------------- Principal Principal Number Balance Number Balance of Loans of Loans of Loans of Loans --------- ---------- --------- --------- (Dollars in thousands) One- to four-family.......... 16 $1,206 27 $848 Multi-family................. 3 732 3 546 Commercial real estate....... 1 1,232 3 2,126 Construction and land........ -- - - - Other loans.................. -- - 4 51 --- -------- --- -------- Total........................ 20 $3,170 37 $3,571 === ====== === ====== Delinquent loans to loans, net and mortgage loans held for sale................ 0.63% 0.72% 13 16 Non-Performing Assets and Restructured Loans. The following table sets forth information regarding non-accrual loans, restructured loans and real estate owned ("REO"). A restructured loan is one for which the Bank has modified the terms to provide a temporary reduction in the rate of interest below the current market rate and, in certain instances, an extension of payments of principal or interest or both due to the deterioration in the financial position of the borrower. At December 31, 1996, restructured loans totalled $2.5 million, consisting of six loans, and REO totalled $2.7 million, consisting of 10 properties. It is the policy of the Company to cease accruing interest on loans 90 days or more past due and charging off all accrued interest. For the years ended December 31, 1996, 1995, 1994, 1993 and 1992, the amount of additional interest income that would have been recognized on non-accrual loans if such loans had continued to perform in accordance with their contractual terms was $103,000, $303,000, $281,000, $421,000 and $922,000, respectively. For the same periods, the difference between the amount of interest income which would have been recognized on restructured loans if such loans were performing in accordance with their regular terms and amounts recognized was $73,000, $77,000, $294,000, $461,000 and $443,000, respectively.
At December 31, ----------------------------------------------------------------------- 1996 1995 1994 1993 1992 ------------- ------------- ------------- ------------- ----------- (Dollars in thousands) Non-accrual loans: Residential real estate: One- to four-family.................... $1,463 $1,195 $ 848 $2,088 $3,794 Multi-family........................... -- 745 546 -- 6,005 Construction and land.................... -- -- -- 738 246 Commercial real estate................... 25 3,312 2,126 -- 100 Other loans.............................. 14 -- 51 14 35 ------ ------ ------ ------- ------- Total.................................. 1,502 5,252 3,571 2,840 10,180 Real estate owned, net(3).................. 2,668 971 387 3,103 8,834 ------ ------ ------ ------- ------- Total non-performing assets............ 4,170 6,223 3,958 5,943 19,014 Restructured loans......................... 2,489 2,941 4,834 4,668 12,112 ------ ------ ------ ------- ------- Total risk elements........................ $6,659 $9,164 $8,792 $10,611 $31,126 ====== ====== ====== ======= ======= Allowance for loan losses as a percent of loans(1).............................. 0.64% 0.82% 0.74% 1.07% 1.09% Allowance for loan losses as a percent of non-performing loans(2)............... 293.02 81.40 103.61 156.69 43.04 Non-performing loans as a percent of loans(1)(2)........................... 0.22 1.00 0.71 0.68 2.54 Non-performing assets as a percent of total assets(4)....................... 0.51 0.97 0.68 1.19 3.73
- ---------- (1) Loans includes loans, net and mortgage loans held for sale, excluding allowance for loan losses. (2) Non-performing loans consist of all 90 days or more past due and other loans which have been identified by the Company as presenting uncertainty with respect to the collectability of interest or principal. (3) REO balances are shown net of related valuation allowances. (4) Non-performing assets consist of non-performing loans and real estate owned (REO). 14 17 The Company adopted a new accounting method for measuring loan impairment on January 1, 1995. Adoption of this accounting standard did not have a material effect on the comparability of the above tables. See "Impact of New Accounting Standards." At December 31, 1996, loans which were characterized as impaired pursuant to SFAS 114 and 118 totalled $4.4 million. All of the $4.4 million in impaired loans have been measured using the fair value of the collateral method. During the year ended December 31, 1996, the average recorded value of impaired loans was $5.4 million, $321,000 of interest income was recognized, all of which was recorded on a cash basis, and $497,000 of interest income would have been recognized under original terms. For a discussion of SFAS 114, see "Impact of New Accounting Standards." At December 31, 1996 --------------------------- 1996 1995 ------- ------- (In thousands) Impaired loans: Residential real estate: One-to four-family $1,763 $2,828 Multi-family 2,271 1,367 Commercial real estate 246 4,062 Other loans 112 99 Impaired loan valuation allowance -- (618) ------- ------- Total $4,392 $7,738 ====== ====== Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. Amounts provided for the years 1996, 1995 and 1994 were $1.3 million, $3.6 million, and $283,000, respectively. During the year ended 1996, there were recoveries of $343,000 and charge-offs of $1.5 million made against this allowance. The allowance is based upon a number of factors, including current economic conditions, actual loss experience and industry trends. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management. As of December 31, 1996, the Company's allowance for loan losses was 0.64% of total loans as compared to 0.82% as of December 31, 1995. The Company had non-accrual loans of $1.5 million and $5.3 million at December 31, 1996 and December 31, 1995, respectively. The Company will continue to monitor and modify its allowance for loan losses as conditions dictate. While management believes the Company's allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Company's level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Company or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses. 15 18 The following table sets forth activity in the Company's allowance for loan losses for the periods set forth in the following table.
At or For the Year Ended December 31, ---------------------------------------------------------------------- 1996 1995 1994 1993 1992 ------------ ------------- ------------- ------------- ------------- (In thousands) Balance at beginning of period ............. $4,275 $3,700 $4,450 $4,381 $5,000 Provision for loan losses................... 1,294 3,614 283 3,918 5,487 Charge-offs: Real estate loans: One -to-four-family...................... 387 550 711 2,114 2,330 Multi-family............................. 263 483 251 1,114 1,288 Commercial............................... 664 2,297 200 805 1,241 Construction and land.................... -- -- -- 4 1,268 Other..................................... 198 194 56 17 3 ------ ------ ------ ------ ------ Total.................................. 1,512 3,524 1,218 4,054 6,130 Recoveries.................................. 343 485 185 205 24 ------ ------ ------ ------ ------ Balance at end of period.................... $4,400 $4,275 $3,700 $4,450 $4,381 ====== ====== ====== ====== ====== Ratio of net charge-offs during the period to average loans outstanding during the period............. 0.19% 0.60% 0.23% 0.94% 1.54% ==== ==== ==== ==== ====
16 19 The following tables set forth the Company's percent of allowance for loan losses to total allowance for loan losses and the percent of loans to total loans in each of the categories listed at the dates indicated.
At December 31, ------------------------------------------------------------------------------------------- 1996 1995 ------------------------------------------- -------------------------------------------- Percent of Percent of Percent of Percent of Allowance Loans in Allowance Loans in to Total Each Category to Total Each Category Amount Allowance to Total Loans Amount Allowance to Total Loans ------------ ------------ --------------- ------------ -------------- ------------- (Dollars in thousands) One- to four-family.... $1,899 43.16% 88.00% $1,974 46.18% 85.44% Multi-family........... 274 6.23 3.10 373 8.72 5.35 Commercial real estate. 451 10.25 4.07 1,285 30.06 5.05 Construction and land.. 463 10.52 1.81 580 13.57 0.66 Other loans............ 61 1.39 3.02 47 1.10 3.50 Unallocated............ 1,252 28.45 -- 16 0.37 -- ------ ------ ------ ------ ------ ------ Total allowance for loan losses.. $4,400 100.00% 100.00% $4,275 100.00% 100.00% ====== ====== ====== ====== ====== ======
At December 31, ----------------------------------------------------------------------------------------------- 1994 1993 1992 ------------------------------ ------------------------------ ----------------------------- Percent Percent Percent of of Loans of Loans of Loans Percent of in Each Percent of in Each Percent in Each Allowance Category Allowance Category Allowance Category to Total to Total to Total to Total to Total to Total Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans -------- --------- -------- ------- --------- -------- ------- -------- --------- (Dollars in thousands) One-to four-family....... $1,309 35.38% 84.77% $1,467 32.97% 81.57% $1,564 35.70% 78.46% Multi-family......... 393 10.62 5.79 369 8.29 7.28 334 7.63 7.99 Commercial real estate............ 655 17.70 5.69 646 14.52 5.88 691 15.77 7.63 Construction and land 416 11.24 0.68 594 13.35 1.13 252 5.75 1.22 Other loans.......... 92 2.49 3.07 98 2.20 4.14 128 2.92 4.70 Unallocated.......... 835 22.57 -- 1,276 28.67 -- 1,412 32.23 -- ------ ------ -------- ------ ------ -------- ------ ------ ------ Total allowance for loan losses $3,700 100.00% 100.00% $4,450 100.00% 100.00% $4,381 100.00% 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ======
17 20 Real Estate Owned At December 31, 1996, the Company had $2.7 million of real estate owned, net of valuation allowances. When the Company acquires property through foreclosure or deed in lieu of foreclosure, it is initially recorded at the lower of the recorded investment in the corresponding loan or the fair value of the related assets at the date of foreclosure, less costs to sell. Thereafter, if there is a further deterioration in value, the Company provides for a specific valuation allowance and charges operations for the diminution in value. It is the policy of the Company to have obtained an appraisal on all real estate subject to foreclosure proceedings prior to the time of foreclosure. It is the Company's policy to require appraisals on a periodic basis on foreclosed properties and conduct periodic inspections on foreclosed properties. Investment Activities The investment policy of the Company, as approved by the Board of Directors, requires management to maintain adequate liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk and to complement the Company's lending activities. Generally, the Company's investment policy is more restrictive than the OTS regulations allow and, accordingly, the Company has invested primarily in U.S. Government and Agency securities, FDIC insured certificates of deposit, mutual funds which qualify as liquid assets under the OTS regulations, federal funds and U.S. government sponsored agency issued mortgage-backed securities. As required by SFAS 115, the Company has established an investment portfolio of securities that are categorized as held to maturity, available for sale or held for trading. The Company does not currently maintain a portfolio of securities categorized as held for trading. The substantial majority of the Company's investment and mortgage-backed securities are purchased for the held to maturity portfolio which such portfolio totalled $62.2 million, or 7.6% of assets. The Company's current policies restrict the amount of securities classified as available for sale to 5% of the Company's assets. At December 31, 1996, the available for sale portfolio totalled $24.7 million or 3.0% of the Company's assets. The investment policy provides different management levels of approval, from the investment officer up to and including the Board of Directors, depending on the size of purchase or sale and monthly cumulative purchase or sale amounts. Generally, pursuant to the Company's policies, the Board must provide prior approval for all individual securities investments over $10.0 million and approval for all monthly purchases which aggregate $25.0 million or more. The Investment Committee of the Board is provided a detail of the held to maturity and available for sale investment portfolio on a quarterly basis. The Board of Directors ratifies all of the activity in the investment portfolio on a monthly basis. At December 31, 1996, the Company had invested $66.6 million in mortgage-backed securities, or 8.1% of total assets, which were guaranteed by GNMA, insured by either FNMA or FHLMC or privately issued. Of the $66.6 million, $40.3 million were GNMA securities, of which $36.0 million were adjustable-rate with 1% maximum annual rate adjustments and lifetime maximum interest rates of 10% to 13%. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby reducing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates. At December 31, 1996, mortgage-backed securities available for sale and held to maturity amounted to $23.6 million and $43.0 million, respectively. 18 21 The following table sets forth the composition of the Company's mortgage-backed securities portfolio in dollar amounts and in percentages of the respective portfolios at the dates indicated.
At December 31, ------------------------------------------------------------------------- 1996 1995 1994 --------------------- ---------------------- ---------------------- Percent Percent Percent Amount of Total Amount of Total Amount of Total ---------- --------- -------- ---------- ---------- --------- (Dollars in thousands) Mortgage-backed securities: GNMA(1)(3)............................. $40,321 60.53% $44,385 75.24% $35,671 89.62% FHLMC(2)(4)............................ 11,239 16.87 13,092 22.20 2,349 5.90 FNMA................................... 1,147 1.72 1,512 2.56 1,781 4.48 Privately issued collateralized mortgage obligations................. 13,905 20.88 -- -- -- -- ------ ------ ------ ------ ------ ------ Total mortgage-backed securities..... 66,612 100.00% 58,989 100.00% 39,801 100.00% ====== ====== ====== Less: Mortgage-backed securities available for sale - GNMA(3)................... 13,710 12,605 -- Mortgage-backed securities available for sale - FHLMC(4).................. 9,883 11,268 -- ----- ------ ------- held to maturity....................... $43,019 $35,116 $39,801 ======= ======= =======
- ---------- (1) Includes $341,000, $527,000 and $305,000 of unamortized premiums related to GNMA securities as of December 31, 1996, 1995 and 1994, respectively. Also includes $77,000 of unamortized discounts related to GNMA securities as of December 31, 1996. (2) Includes $187,000 and $234,000 of unamortized premiums related to FHLMC securities as of December 31, 1996 and 1995, respectively. (3) Is net of unrealized loss of $169,000 at December 31, 1996. (4) Is net of unrealized loss of $153,000 at December 31, 1996. 19 22 The following tables set forth the Company's mortgage-backed securities activities for the periods indicated: For the Year Ended December 31, --------------------------- 1996 1995 1994 ------- ------- ------- (In thousands) Beginning balance ............................. $58,989 $39,801 $45,232 Mortgage-backed securities purchased - available for sale........................ 10,666 23,873 -- held to maturity.......................... 13,891 -- -- Less: Sale of mortgage-backed securities available for sale ..................... 10,614) -- -- Principal repayments ..................... (5,934) (4,586) (5,307) Change in unrealized losses............... (322) -- -- Accretion of premium, net of discount..... (64) (99) (124) ------- -------- ------- Ending balance ................................ $66,612 $58,989 $39,801 ======= ======= ======= The following table sets forth certain information regarding the carrying amounts and fair values of the Company's mortgage-backed securities at the dates indicated:
At December 31, --------------------------------------------------------------------------- 1996 1995 1994 ---------------------- ---------------------- ------------------------- Carrying Fair Carrying Fair Carrying Fair Amount Value Amount Value Amount Value ---------- --------- ---------- --------- ---------- ------------ (In thousands) Mortgage-backed securities: Held to maturity: FNMA.......................... $1,147 $1,129 $1,512 $1,531 $ 1,781 $ 1,630 FHLMC......................... 1,356 1,330 1,824 1,830 2,349 2,136 GNMA.......................... 26,611 26,696 31,780 32,286 35,671 32,855 Privately issued collateralized mortgage obligations........ 13,905 13,878 -- -- -- -- ------ ------ ------ ------ -------- -------- Total held to maturity...... 43,019 43,033 35,116 35,647 39,801 36,621 ------ ------ ------ ------ -------- -------- Available for sale: GNMA.......................... 13,710 13,710 12,605 12,605 -- -- FHLMC......................... 9,883 9,883 11,268 11,268 -- -- ------ ------ ------- ------- -------- -------- Total available for sale.... 23,593 23,593 23,873 23,873 -- -- ------ ------ ------ ------- -------- -------- Total mortgage-backed securities.................. $66,612 $66,626 $58,989 $59,520 $39,801 $36,621 ======= ======= ======= ======= ======= =======
20 23 The following table sets forth certain information regarding the carrying amount and fair values of the Company's short-term investments and investment securities at the dates indicated:
At December 31, -------------------------------------------------------------------------- 1996 1995 1994 ---------------------- ---------------------- ------------------------ Carrying Fair Carrying Fair Carrying Fair Amount Value Amount Value Amount Value ---------- --------- ---------- ---------- ----------- ----------- (In thousands) Daily federal funds sold and short-term investments.............. $ 2,943 $ 2,943 $10,460 $10,460 $ 448 $ 448 ------- ------ ------ ------ ------ ------ Investment securities: Held to maturity: Certificates of deposit......... 250 250 495 495 198 198 U.S. Government obligations, federal agency obligations, and other obligations................... 18,920 18,795 16,309 16,411 14,586 13,697 ------- ------ ------ ------ ------ ------ Total held to maturity.......... 19,170 19,045 16,804 16,906 14,784 13,895 ------- ------ ------ ------ ------ ------ Available for sale: U.S. Government obligations, federal agency obligations, and other obligations.................. -- -- -- -- -- -- ------- ------ ------ ------ ------ ------ Cash management fund(1)......... 1,085 1,085 1,022 1,022 -- -- ------- ------- ------- ------- ------- ------- Total available for sale..... 1,085 1,085 1,022 1,022 -- -- ------- ------- ------- ------- ------- ------- Total investment securities......... $23,198 $23,073 $28,286 $28,388 $15,232 $14,343 ======= ======= ======= ======= ======= =======
- ---------- (1) Consists of securities issued by an institutional mutual fund which primarily invests in short-term U.S. Government securities. 21 24 The table below sets forth certain information regarding the carrying amount, weighted average yields and contractual maturities of the Company's short-term investments, investment securities and mortgage-backed securities as of December 31, 1996.
At December 31, 1996 --------------------------------------------------------------------------- More than One More than Five One Year or Less Year to Five Years Years to Ten Years ------------------------ ---------------------- ------------------------- Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Amount Yield Amount Yield Amount Yield ---------- ----------- ---------- ---------- ----------- ----------- (Dollars in thousands) Daily federal funds sold and short-term FP investments.......................... $2,943 5.75% $ -- --% $ -- --% Investment securities: Held to maturity: Certificates of deposit......... -- -- 250 5.17 -- -- U.S. Government obligations, federal agency obligations, and other obligations........ 2,004 5.64 15,916 6.03 1,000 7.00 ------ ---------- ------- Total held to maturity...... 2,004 5.64 16,166 6.02 1,000 7.00 ------ ---------- ---- ------- Available for sale: U.S. Government obligations, federal agency obligations, and other obligations...... -- -- -- -- -- -- Cash management fund(1)......... 1,085 5.98 -- -- -- -- ------ ---------- ------- Total available for sale...... 1,085 5.98 -- -- -- -- ------ ---------- ------- Total investment securities.......... $6,032 5.75% $ 16,166 6.02% $1,000 7.00% ====== ===== ========== ==== ======= ==== Mortgage-backed securities: Held to maturity: FNMA............................ $ -- --% $ -- --% $1,063 7.00% GNMA............................ -- -- 51 6.50 3,066 8.19 FHLMC........................... -- -- -- -- 1,356 7.00 Privately issued collateralized mortgage obligation........... -- -- -- -- -- -- ------ ---------- ---- Total held to maturity........ $ -- -- $ 51 6.50 $5,485 7.67 ------ ---------- ------ Held for sale: GNMA............................ $ -- -- $ -- -- $ -- -- FHLMC........................... -- -- -- -- 9,883 6.98 ------ ---------- ------ Total held for sale........... -- -- -- -- 9,883 6.98 ------ ---------- ------ Total mortgage-backed securities..... $ -- --% $ 51 6.50% $15,368 7.23% ====== ===== ========== ==== ======= ==== At December 31, 1996 -------------------------------------------------------- More than Ten Years Total -------------------------- ---------------------------- Weighted Weighted Carrying Average Carrying Average Amount Yield Amount Yield ----------- ------------ ------------ ------------- (Dollars in thousands) Daily federal funds sold and short-term investments.......................... $ -- --% $ 2,943 5.75% Investment securities: Held to maturity: Certificates of deposit......... -- -- 250 5.17 U.S. Government obligations, federal agency obligations, and other obligations........ -- -- 18,920 6.04 ----- ------- Total held to maturity...... -- -- 19,170 6.03 ----- ------- Available for sale: U.S. Government obligations, federal agency obligations, and other obligations...... -- -- -- -- Cash management fund(1)......... -- -- 1,085 5.98 ----- ------- Total available for sale...... -- -- 1,085 5.98 ----- ------- Total investment securities.......... $ -- --% $23,198 5.99% ===== ==== ======= ==== Mortgage-backed securities: Held to maturity: FNMA............................ $ 83 6.98% $ 1,146 7.00% GNMA............................ 23,495 7.09 26,612 7.22 FHLMC........................... -- -- 1,356 7.00 Privately issued collateralized mortgage obligation........... 13,905 7.16 13,905 7.16 ------- ------- Total held to maturity........ $37,483 7.12 $43,019 7.19 ------- ------- Held for sale: GNMA............................ $13,710 5.98 $13,710 5.98 FHLMC........................... -- -- 9,883 6.98 ------- ------- Total held for sale........... 13,710 5.98 23,593 6.40 ------- ------- Total mortgage-backed securities..... $51,193 6.81% $66,612 6.91% ======= ==== ======= ====
- ---------- (1) Consists of securities issued by an institutional mutual fund which primarily invests in short-term U.S. Government securities. 22 25 Sources of Funds General. Deposits, loan repayments and prepayments, proceeds from sales of loans, cash flows generated from operations and FHLB advances are the primary sources of the Company's funds for use in lending, investing and for other general purposes. Deposits. The Company offers a variety of deposit accounts with a range of interest rates and terms. The Company's deposits consist of savings, NOW accounts, checking accounts, money market accounts and certificate accounts. For the year ended December 31, 1996, core deposits represented 49.3% of total average deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Company's deposits are obtained predominantly from the areas in which its branch offices are located. The Company relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Company's ability to attract and retain deposits. The Company uses traditional means of advertising its deposit products, including radio and print media and generally does not solicit deposits from outside its market area. Certificate accounts in excess of $100,000 are not actively solicited by the Company and the Company did not use brokers to obtain deposits during 1996. The following table presents the deposit activity of the Company for the periods indicated: For the Year Ended December 31, ---------------------------------------- 1996 1995 1994 ---------- ----------- ----------- (In thousands) Net withdrawals..................... $(6,425) $(9,179) $(36,430) Interest credited on deposit accounts.................. 16,139 15,119 12,696 ------ ------ -------- Total increase (decrease) in deposit accounts............... $9,714 $ 5,940 $(23,734) ====== ======= ======== At December 31, 1996, the Company had $15.3 million in certificate accounts in amounts of $100,000 or more maturing as follows: Weighted Maturity Period Amount Average Rate - -------------------------------------------- ----------- -------------- (Dollars in thousands) Three months or less........................ $ 4,376 5.38% Over 3 through 6 months..................... 3,705 5.48 Over 6 through 12 months.................... 2,663 5.47 Over 12 months.............................. 4,512 5.78 ------ Total....................................... $15,256 5.54% ======= ===== 23 26 The following table sets forth the distribution of the Company's average deposit accounts for the periods indicated and the weighted average nominal interest rates on each category of deposits presented. Averages for the periods presented utilize average month-end balances.
For the Year Ended December 31, ------------------------------------------------------------------------------------------------- 1996 1995 1994 ------------------------------- --------------------------------- ------------------------------- Percent Weighted Percent Weighted Percent Weighted of Total Average of Total Average of Total Average Average Average Nominal Average Average Nominal Average Average Nominal Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate --------- --------- ----------- --------- ----------- ----------- ---------- ---------- -------- (Dollars in thousands) Money market deposit accounts.. $46,540 11.01% 3.01% $49,693 11.89% 2.99% $ 59,699 14.08% 2.46% Savings accounts............... 90,763 21.47 2.49 99,498 23.81 2.49 119,253 28.13 2.50 NOW accounts................... 66,336 15.69 1.36 65,661 15.71 1.49 64,875 15.30 1.50 Non-interest-bearing accounts.. 19,542 4.62 14,016 3.35 11,589 2.73 -------- ------ -------- ------ -------- ------ Total..................... 223,181 52.79 228,868 54.76 255,416 60.24 -------- ------ -------- ------ -------- ------ Certificate accounts: Less than six months........ 23,748 5.62 4.96 16,682 3.99 4.81 17,161 4.05 2.92 Over six through 12 months.. 49,259 11.65 5.48 41,343 9.89 5.57 28,278 6.67 3.69 Over 12 through 36 months... 70,849 16.75 5.77 75,445 18.05 5.44 64,941 15.32 4.67 Over 36 months.............. 6,973 1.65 5.40 6,670 1.60 5.44 7,277 1.72 5.67 IRA/KEOGH................... 48,769 11.54 5.81 48,940 11.71 5.68 50,915 12.00 4.68 -------- ------ -------- ------ -------- ------ Total certificate accounts 199,598 47.21 189,080 45.24 168,572 39.76 -------- ------ -------- ------ -------- ------ Total average deposits.. $422,779 100.00% $417,948 100.00% $423,988 100.00% ======== ====== ======== ====== ======== ======
24 27 The following table presents, by various rate categories, the amount of certificate accounts outstanding at the dates indicated and the periods to maturity of the certificate accounts outstanding at December 31, 1996.
Period to Maturity from December 31, 1996 At December 31, ---------------------------------------------------------------- ------------------------------------ Less than One to Two to Three to Four to One Year Two years Three years Four years Five years 1996 1995 1994 ---------- ----------- ------------ ---------- ---------- ----------- ----------- ---------- (In thousands) Certificate accounts: 0 to 4.00%............... $ 1,480 $ -- $ 2 $ -- $ 4 $ 1,486 $ 1,977 $ 49,119 4.01 to 5.00%............ 1,086 163 381 -- -- 1,630 16,130 73,328 5.01 to 6.00%............ 110,990 33,969 3,482 2,448 1,004 151,893 101,060 43,179 6.01 to 7.00%............ 21,470 3,817 12,587 5,927 1,220 45,021 76,878 6,656 7.01 to 8.00%............ -- -- 94 -- -- 94 129 278 8.01 to 9.00%............ -- -- -- -- -- -- -- 449 Over 9.01%............... -- -- -- -- -- -- -- 29 -------- ------- ------- ------ ------ -------- -------- -------- Total................. $135,026 $37,949 $16,546 $8,375 $2,228 $200,124 $196,174 $173,038 ======== ======= ======= ====== ====== ======== ======== ========
Borrowings. The Company utilizes advances from the FHLB as an alternative to retail deposits to fund its operations and may do so in the future as part of its operating strategy. During 1996, the Company increasingly utilized FHLB borrowings to fund its asset growth, primarily its origination of adjustable-rate one- to four-family loans. These FHLB advances are collateralized primarily by certain of the Company's mortgage loans and mortgage-backed securities and secondarily by the Company's investment in capital stock of the FHLB. FHLB advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB will advance to member institutions, including the Company, fluctuates from time to time in accordance with the policies of the OTS and the FHLB. See "Regulation - Federal Home Loan Bank System." During the year ended December 31, 1996, the Company borrowed, net of repayments, $176.6 million from the FHLB. At December 31, 1996, the Company had $296.5 million in outstanding advances from the FHLB and $3.5 million in repurchase agreements. 25 28 The following tables set forth certain information regarding the Company's borrowed funds and repurchase agreements at or for the periods ended on the dates indicated: At or For the Year Ended December 31, -------------------------------- 1996 1995 1994 ---- ---- ---- (Dollars in thousands) FHLB advances: Average balance outstanding............. $217,628 $133,268 $ 77,645 ======== ======== ========= Maximum amount outstanding at any month-end during the period...... $303,374 $148,274 $141,390 ======== ======== ======== Balance outstanding at end of period.... $296,500 $119,909 $135,031 ======== ======== ======== Weighted average interest rate during the period.................... 5.86% 6.30% 5.46% ==== ==== ==== Weighted average interest rate at end of period........................... 5.88% 5.95% 5.99% ==== ==== ==== At or For the Year Ended December 31, ------------------------ 1996 1995 --------- -------- (Dollars in thousands) Securities sold under agreements to repurchase: Average balance outstanding..................... $7,496 $ 96 Maximum amount outstanding at any month-end during the period.............. $9.973 $7,000 ====== ====== Balance outstanding at end of period............ $3,500 $7,000 ====== ====== Weighted average interest rate during the period............................ 5.86% 5.43% ==== ==== Weighted average interest rate at end of period................................... 5.45% 5.43% ==== ==== Subsidiary Activities Leader Corporation ("Leader Corp.") and BFS Service Corp. ("BFS") are wholly-owned subsidiaries of the Company. BFS is not currently conducting any activities. In 1986 and 1987, Leader Corp. entered into four real estate limited partnerships and invested in one other real estate project. With the subsequent downturn in the local real estate market, all of the entities experienced significant operating losses. One partnership and the wholly owned real estate project was terminated in 1991. Two other partnerships substantially concluded their business in 1993 and are in the process of being dissolved. The 26 29 fourth partnership, Connelly Hill Limited Partnership ("Connelly Hill"), sold its only parcel of land to a developer on January 31, 1997. In 1994, the Company, through Leader Corp., permitted Liberty Financial, a third party securities broker, to offer various uninsured investment products to the Company's customers. Leader Corp. entered into a contract with such third party brokerage concern to perform brokerage services in segregated areas of the Company's branches. Under this contract, Liberty Financial leases space from the Company at three of the Company's branch locations, pays rent and a percentage of sales to Leader Corp. At December 31, 1996, Leader Corp. had a retained deficit of $2.4 million and for the years ended December 31, 1996 and 1995 had a net loss of $38,000 and $94,000, respectively. Personnel As of December 31, 1996, the Company had 169 authorized full-time employee positions and 71 authorized part-time employee positions, for a total of approximately 200 full time equivalents. The employees are not represented by a collective bargaining unit and the Company considers its relationship with its employees to be good. REGULATION AND SUPERVISION General As a result of the Company's acquisition of Broadway National Bank in February 1997, the Company became a bank holding company. The Company, as a bank holding company, is required to file certain reports with, and otherwise comply with the rules and regulations of the Federal Reserve Board ("FRB") under the Bank Holding Company Act of 1956, as amended ("BHCA"). In addition, the activities of savings institutions, such as the Bank, are governed by the HOLA and the Federal Deposit Insurance Act ("FDI Act"). The activities of national banks are generally governed by the National Bank Act and the FDI Act. The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of other institutions. Broadway National Bank is subject to extensive regulation examination and supervision and reporting with the OCC, as its primary federal regulator, and the FDIC, as the deposit insurer. Broadway National Bank is a member of the Bank Insurance Fund ("BIF") managed by the FDIC. The OTS and/or the FDIC conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the OCC, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank, Broadway National Bank and their operations. Certain of the regulatory requirements applicable to the 27 30 Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank, Broadway National Bank and the Company. Holding Company Regulation Federal Regulation. Due to its control of Broadway National Bank, the Company is subject to examination, regulation, and periodic reporting under the BHCA, as administered by the FRB. The Company is required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company or merge with another bank holding company. Prior FRB approval will also be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of such bank or bank holding company. Bank holding companies may acquire additional banks in any state, subject to certain restrictions such as deposit concentration. In addition to the approval of the FRB, before any bank acquisition can be completed, prior approval may also be required to be obtained from other agencies having supervisory jurisdiction over the bank to be acquired. A bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting securities of any company engaged in, non-banking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) finance leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings association, like the Bank, provided that the savings association only engages in activities permitted bank holding companies. The FRB has adopted capital adequacy guidelines for bank holding companies (on a consolidated basis) substantially similar to those of the OTS for the Bank and the OCC for Broadway National Bank. See "Capital Requirements." The Company's total and Tier 1 capital exceeds these requirements. Bank holding companies are generally required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Company's consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. The FRB has now adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain other conditions. The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB's policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization's capital needs, asset quality, and overall financial condition. The FRB's policies also require that a bank holding company serve as a source of financial strength to it subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising 28 31 capacity to obtain additional resources for assisting its subsidiary banks where necessary. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions. The status of the Company as a registered bank holding company under the BHCA does not exempt it from certain Federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the Federal securities laws. Under the FDI Act, depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This applies to depository institutions controlled by the same bank holding company. The Company and its subsidiaries will be affected by the monetary and fiscal policies of various agencies of the United States Government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is impossible for the management of the Company to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of the Company, the Bank or Broadway National Bank. State Regulation. The Company is also a "bank holding company" within the meaning of the Massachusetts bank holding company laws. The prior approval of the Massachusetts Board of Bank Incorporation is required before the Company may acquire all or substantially all of the assets of any depository institution (or holding company thereof) merge with a holding company of a depository institution or acquire more than 5% of the voting stock of a depository institution or holding company thereof. Acquisition of the Holding Company Federal Regulation. Under the Federal Change in Bank Control Act ("CIBCA"), a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company's outstanding voting stock, unless the FRB has found that the acquisition will not result in a change in control of the Company. Under the CIBCA, the FRB has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer, the convenience and needs of the communities served by the Company and the Bank, and the anti-trust effects of the acquisition. Under the BHCA, any company would be required to obtain prior approval from the FRB before it may obtain "control" of the Company within the meaning of the BHCA. Control generally is defined to mean the ownership or power to vote 25 percent or more of any class of voting securities of the Company or the ability to control in any manner the election of a majority of the Company's directors. An existing bank holding company would be required to obtain the FRB's prior approval under the BHCA before acquiring more than 5% of the Company's voting stock. See "Holding Company Regulation." Approval of the Board of Bank Incorporation may also be required for acquisition of the Company under some circumstances. Federal Banking Regulations Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, 29 32 in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital ratio (3% for institutions receiving the highest rating on the CAMEL financial institution examination rating system), and, together with the risk-based capital standard itself, a 4% Tier I risk-based capital standard. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain purchased mortgage servicing rights and credit card relationships. The OTS regulations also require that, in meeting the tangible, leverage (core) and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as a principle not permissible for a national bank. The risk-based capital standard for savings institutions requires the maintenance of Tier I (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. The components of Tier I (core) capital are equivalent to those discussed earlier. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. National Banks are required by OCC regulation to maintain leverage (core) capital at least equal to 4% (3% for institutions receiving the highest rating on the CAMEL financial institution examination rating system) and an 8% risk-based capital ratio. National banks are subject to identical requirements under the prompt corrective action standards. The OCC's regulations do not establish a separate interest rate risk component for national bank capital requirements. 30 33 The following table presents the Bank's capital position at December 31, 1996 relative to fully phased-in regulatory requirements.
Capital Excess --------------------------------- Required (Deficiency) Actual Required Capital Capital Amount Percent Percent ----------------- ------------- ----------------- -------------- --------------- (Dollars in thousands) Tangible............ $53,910 $11,934 $41,976 6.8% 1.5% Core (Leverage)..... 53,910 23,868 30,042 6.8 3.0% Risk-based.......... 58,310 35,301 23,009 13.2 8.0%
Prompt Corrective Regulatory Action. Under the prompt corrective action regulations, the OTS with respect to savings associations and the OCC with respect to National Banks, are required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a depository institution is considered "well capitalized" if its ratio of total capital to risk-weighted assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted assets is at least 6%, its ratio of core capital to total assets is at least 5%, and it is not subject to any order or directive by the appropriate regulator to meet a specific capital level. An institution generally is considered "adequately capitalized" if its ratio of total capital to risk-weighted assets is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%, and its ratio of core capital to total assets is at least 4% (3% if the institution receives the highest CAMEL rating). An institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." An institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date an institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The appropriate agency could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Insurance of Deposit Accounts. Deposits of the Bank are presently insured by the SAIF and Broadway National Bank is a member of the BIF. Both the SAIF and the BIF (the deposit insurance fund that covers most commercial bank deposits), are statutorily required to be capitalized to a 1.25% of insured reserve deposits ratio. Until recently, members of the SAIF and BIF were paying average deposit insurance premiums of between 24 and 25 basis points. The BIF met the required reserve in 1995, whereas the SAIF was not expected to meet or exceed the required level until 2002 at the earliest. This situation was primarily due to the statutory requirement that SAIF members make payments on bonds 31 34 issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF. In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted a new assessment rate schedule of from 0 to 27 basis points under which 92% of BIF members paid an annual administration fee of only $2,000. With respect to SAIF member institutions, the FDIC adopted a final rule retaining the previously existing assessment rate schedule applicable to SAIF member institutions of 23 to 31 basis points. As long as the premium differential continued, it may have had adverse consequences for SAIF members, including reduced earnings and an impaired ability to raise funds in the capital markets. In addition, SAIF members, such as the Bank were placed at a substantial competitive disadvantage to BIF members with respect to pricing of loans and deposits and the ability to achieve lower operating costs. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed a special one-time assessment on SAIF member institutions, including the Bank, to recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a special assessment of 65.7 basis points on SAIF assessable deposits held as of March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The SAIF Special Assessment was recognized by the Bank as an expense in the quarter ended September 30, 1996 and is generally tax deductible. The SAIF Special Assessment recorded by the Bank amounted to $2.7 million on a pre-tax basis and $1.6 million on an after-tax basis. The Funds Act also spreads the obligations for payment of the FICO bonds across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits, including those held by the National Bank, will be assessed for a FICO payment of 1.3 basis points, while SAIF deposits will pay 6.48 basis points. Full pro rata sharing of the FICO payments between BIF and SAIF members will occur on the earlier of January 1, 2000 or the date the BIF and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be merged on January 1, 1999, provided no savings associations remain as of that time. As a result of the Funds Act, the FDIC recently voted to effectively lower SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to that of BIF members. SAIF members will also continue to make the FICO payments described above. The FDIC also lowered the SAIF assessment schedule for the fourth quarter of 1996 to 18 to 27 basis points. Management cannot predict the level of FDIC insurance assessments on an on-going basis, whether the savings association charter will be eliminated or whether the BIF and SAIF will eventually be merged. The Bank's assessment rate for fiscal 1996 ranged from 18 to 23 basis points and the premium paid for this period was $916,000. Broadway National Bank paid an administrative fee of $2,000 to the FDIC for 1996. A significant increase in FDIC insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank and/or Broadway National Bank. Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the regulators. The management of the Bank and Broadway National Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. Thrift Rechartering Legislation. The Funds Act provides that the BIF and SAIF will merge on January 1, 1999 if there are no more savings associations as of that date. That legislation also requires 32 35 that the Department of Treasury submit a report to Congress by March 31, 1997 that makes recommendations regarding a common financial institutions charter, including whether the separate charters for thrifts and banks should be abolished. Various proposals to eliminate the federal thrift charter, create a uniform financial institutions charter and abolish the OTS have been introduced in Congress. The bills would require federal savings institutions to convert to a national bank or some type of state charter by a specified date (January 1, 1998 in one bill, June 30, 1998 in the other) or they would automatically become national banks. Converted federal thrifts would generally be required to conform their activities to those permitted for the charter selected and divestiture of nonconforming assets would be required over a two year period, subject to two possible one year extensions. State chartered thrifts would become subject to the same federal regulation as applies to state commercial banks. The Company is unable to predict whether such legislation would be enacted, the extent to which the legislation would restrict or disrupt its operations or those of its subsidiary or whether the BIF and SAIF funds will eventually merge. Loans to One Borrower. Under the HOLA, savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital, surplus, and allowable general valuation allowance. An additional amount may be lent, equal to 10% of unimpaired capital, surplus and allowable general valuation allowance, if such loan is secured by readily-marketable collateral, which is defined to include certain financial instruments and bullion. National banks are generally subject to similar loan to one borrower limits. At December 31, 1996, the Bank's limit on loans to one borrower was $10.0 million and Broadway National Bank's limit was $2.4 million. At December 31, 1996, the Bank's largest aggregate outstanding balance of loans to one borrower was $3.8 million and Broadway National Bank's largest aggregate outstanding balance of loans to one borrower was $1.9 million. QTL Test. The HOLA requires savings institutions to meet a QTL test. Under the QTL test, a savings and loan association is required to maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. A savings institution that fails the QTL test is subject to certain operating restrictions and may be required to convert to a bank charter. As of December 31, 1996, the Bank maintained 93.1% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test. National banks are not subject to the QTL test. Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without obtaining approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year or (ii) 75% of its net income for the previous four quarters. Any additional capital distributions would require prior regulatory approval. In the event the Bank's capital fell below its regulatory requirements or the 33 36 OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. In December 1994, the OTS proposed amendments to its capital distribution regulation that would generally authorize the payment of capital distributions without OTS approval provided that the payment does not cause the institution to be undercapitalized within the meaning of the prompt corrective action regulation. However, institutions in a holding company structure would still have a prior notice requirement. At December 31, 1996, the Bank was a Tier 1 Bank. National banks may not pay dividends out of its permanent capital and may not, without OCC approval, pay dividends in excess of the total of the bank's retained net income for the year combined with retained net income for the prior two years. A national bank may not pay a dividend that would cause it to fall below regulatory capital standards. Liquidity. The Bank is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement is currently 5% but may be changed from time to time by the OTS to any amount within the range of 4% to 10% depending upon economic conditions and the savings flows of member institutions. OTS regulations also require each member savings institution to maintain an average daily balance of short-term liquid assets at a specified percentage (currently 1%) of the total of its net withdrawable deposit accounts and borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Bank's liquidity and short-term liquidity ratios for December 31, 1996 were 8.0% and 4.8% respectively, which exceeded the applicable requirements. The Bank has never been subjected to monetary penalties for failure to meet its liquidity requirements. Broadway National Bank, under OCC regulations, is not subject to regulatory liquidity requirements. Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended December 31, 1996 totalled $136,000. National banks pay assessments to the OCC to fund its operations. Such assessments for Broadway National Bank amounted to $32,000 for the year ended December 31, 1996. Branching. OTS regulations permit nationwide branching by federally chartered savings institutions to the extent allowed by federal statute. This permits federal savings institutions to establish interstate networks and to geographically diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions. National banks are authorized to establish branches within the state in which they are headquartered but only to the extent state law allows branching by state banks. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Act") provides for interstate branching for national banks, effective June 1, 1997. Under the Act, interstate branching by merger is authorized on June 1, 1997 unless the state in which the bank is to branch has enacted a law opting out of interstate branching or expedites the effective date by passing legislation. De novo interstate branching will be permitted by 34 37 the Act to the extent the state into which the bank is to branch has enacted a law authorizing out-of-state banks to establish de novo branches. Transactions with Related Parties. The authority of a depository institution to engage in transactions with related parties or "affiliates" (e.g., any company that controls or is under common control with an institution, including the Company) is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of covered transactions with any individual affiliate to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B generally provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions like the Bank are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. The authority of the Bank and Broadway National Bank to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder. Among other things, such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and to not involve more than the normal risk of repayment. Recent legislation created an exception to this requirement for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Regulation O also places individual and aggregate limits on the amount of loans that institutions may make to insiders based, in part, on the institution's capital position and requires certain board approval procedures to be followed. Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions, the OCC has primary enforcement authority over national banks and both agencies have the authority to bring actions against the respective institutions and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. Under the FDI Act, the FDIC has the authority to recommend to OTS that enforcement action be taken with respect to a particular savings institution or the OCC with respect to a national bank. If action is not taken by the agency, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. The FRB has similar enforcement authority with respect to the Company. Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") and a final rule to implement safety and soundness standards required under the FDI Act. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Guidelines address 35 38 internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; and compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans when such plans are required. Federal Reserve System The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). During fiscal 1996, the Federal Reserve Board regulations generally required that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $52.0 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts aggregating greater than $52.0 million, the reserve requirement is $1.6 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $52.0 million. The first $4.3 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) were exempted from the reserve requirements. The Bank and Broadway National Bank maintained compliance with the foregoing requirements during fiscal 1996. Federal Securities Laws The Company's common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to the information and proxy solicitation requirements, insider trading restrictions, and other requirements under the Exchange Act. Shares of the common stock purchased by persons who are not affiliates of the Company may be resold without registration. Shares purchased by an affiliate of the Company will be subject to the resale restrictions of Rule 144 under the Securities Act. If the Company meets the current public information requirements of Rule 144 under the Securities Act, each affiliate of the Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed in any three-month period the greater of (i) 1% of the outstanding shares of the Company or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks. Provision may be made in the future by the Company to permit affiliates to have their shares registered for sale under the Securities Act under certain circumstances. FEDERAL AND STATE TAXATION Federal Taxation General. The Company and the Bank report their federal income on a consolidated basis and the accrual method of accounting, and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. Broadway National Bank will also report its income on a consolidated basis with the Company and Bank effective February 8, 1997. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Bank was audited by the IRS during 1996, and covered the tax years 1991, 1992 and 1993. For its 1996 taxable year, the Bank is subject to a maximum federal income tax rate of 34%. Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995, thrift institutions which qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans (generally secured by interests in real property improved or to be improved) under (i) the Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience Method. The reserve for nonqualifying loans was computed using the Experience Method. The Small Business Job Protection Act of 1996 (the "1996 Act"), which was enacted on August 20, 1996, requires savings institutions to recapture (i.e., take into income) certain portions of their accumulated bad debt reserves. The 1996 Act repeals the reserve method of accounting for bad debts effective for tax years beginning after 1995. Thrift institutions that would be treated as small banks are allowed to utilize the Experience Method applicable to such institutions, while thrift institutions that are treated as large banks (those generally exceeding $500 million in assets) are required to use only the 36 39 specific charge-off method. Thus, the PTI Method of accounting for bad debts is no longer available for any financial institution. A thrift institution required to change its method of computing reserves for bad debts will treat such change as a change in method of accounting, initiated by the taxpayer, and having been made with the consent of the IRS. Any Section 481(a) adjustment required to be taken into income with respect to such change generally will be taken into income ratably over a six-taxable year period, beginning with the first taxable year beginning after 1995, subject to the residential loan requirement. Under the residential loan requirement provision, the recapture required by the 1996 Act will be suspended for each of two successive taxable years, beginning with the Bank's current taxable year, in which the Bank originates a minimum of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding its current taxable year. Under the 1996 Act, for its current and future taxable years, the Bank is not permitted to make additions to its tax bad debt reserves. In addition, the Bank is required to recapture (i.e., take into income) over a six year period the excess of the balance of its tax bad debt reserves as of December 31, 1995 other than its supplemental reserve for losses on loans, if any over the balance of such reserves as of December 31, 1987. The Company has previously recorded a deferred tax liability equal to the bad debt recapture and as such, the new rules will have no effect on net income or income tax expense. Distributions. Under the 1996 Act, if the Bank makes "non-dividend distributions" to the Company, such distributions will be considered to have been made from the Bank's unrecaptured tax bad debt reserves (including the balance of its reserves as of December 31, 1987) to the extent thereof, and then from the Bank's supplemental reserve for losses on loans, to the extent thereof, and an amount based on the amount distributed (but not in excess of the amount of such reserves) will be included in the Bank's income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank's current or accumulated earnings and profits will not be so included in the Bank's income. The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a non-dividend distribution to the Company, approximately one and one-half times the amount of such distribution (but not in excess of the amount of such reserves) would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves. SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee on every $100 of thrift deposits held on March 31, 1995. For financial statement purposes, this assessment was reported as an expense for the quarter ended September 30, 1996. The Funds Act includes a provision which states that the amount of any special assessment paid to capitalize SAIF under this legislation is deductible under Section 162 of the Code in the year of payment. State and Local Taxation Commonwealth of Massachusetts. On July 27, 1995, the Governor of Massachusetts approved legislation to reduce the tax rate applicable to financial institutions, including savings banks, from 12.54% on their net income to 10.50% on their net income apportioned to Massachusetts. The reduced rate is to 37 40 be phased-in over a five year period whereby the rates are 12.13% for 1995, 11.72% for 1996, 11.32% for 1997, 10.91% for 1998 and 10.50% for 1999. Net income for years beginning before January 1, 1999 includes gross income as defined under the provisions of the Internal Revenue Code, plus interest from bonds, notes and evidences of indebtedness of any state, including Massachusetts, less the deductions, excluding the deductions for dividends received, state taxes, and losses sustained in other taxable years, as defined under the provisions of the Internal Revenue Code. For taxable years beginning on or after January 1, 1999, the definition of state taxable income is modified to allow a deduction for ninety-five percent of dividends received from stock where the Bank owns fifteen percent or more of the voting stock of the institution paying the dividend and to allow deductions from certain expenses allocated to federally tax exempt obligations. Subsidiary corporations of the Bank conducting business in Massachusetts must file separate Massachusetts state tax returns and are taxed as financial institutions, with certain modifications and grandfathering for taxable years before 1995. The net worth or tangible property of such subsidiaries is taxed at a rate of 0.26%. Such subsidiaries may file consolidated tax returns on the net earnings portion of the corporate tax. Corporations which qualify as "securities corporations," as defined by the Massachusetts tax code, are taxed at a special rate of 0.33% of their gross income if they qualify as a "bank-holding company" under the Massachusetts tax code. The Company has applied for and received approval to be taxed at this reduced tax rate as long as it is exclusively engaged in activities of a "securities corporation." The Company believes it will continue to qualify as a securities corporation because a separate subsidiary was formed to make the loan to the Bank's Employee Stock Ownership Plan and the Company's other activities qualify as activities permissible for a securities corporation. If the Company fails to so qualify, however, it will be taxed as a financial institution at a rate of 10.50%, rather than at the phased-in rates, beginning with fiscal 1995. Delaware Taxation. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. IMPACT OF NEW ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities ("SFAS 125"). SFAS 125 establishes, among other things, new criteria for determining whether a transfer of financial assets in exchange for cash or other consideration should be accounted for as a sale or as a pledge of collateral in a secured borrowing. SFAS 125 also establishes new accounting requirements for pledged collateral. SFAS 125 is effective for most transactions occurring after December 31, 1996 and must be applied prospectively. However, SFAS 127, Deferral of the Effective Date of Certain Provisions of SFAS 125, requires the deferral of implementation as it relates to repurchase agreements, dollar-rolls, securities lending and similar transactions in the years beginning after December 31, 1997. The Company has determined that the adoption of SFAS 125 will not have a material impact on its consolidated financial statements. 38 41 Item 2. Properties. The Company conducts its business through an administrative and full service office located in Burlington and seven other full service branch offices. The Company believes it's current facilities are adequate to meet the present and immediately foreseeable needs of the Company.
Original Net Book Value Year of Property or Leased Leased Date of Leasehold or or Lease Improvements at Location Owned Acquired Expiration December 31, 1996 - --------------------------------------- ---------- ------------ ----------------------- ------------------------ (In thousands) Administrative/Branch/Home Office: 17 New England Executive Park Leased 1988 November 1998 (1) $1,496 Burlington, MA 01803 Branch Offices: 980 Massachusetts Avenue Owned 1976 -- 482 Arlington, MA 02174 60 The Great Road Owned 1971 -- 450 Bedford, MA 01730 459 Boston Road Owned 1972 -- 427 Billerica, MA 01821 75 Federal Street Leased 1988 September 1998 (1) 185 Boston, MA 02110 1840 Massachusetts Avenue Owned 1960 -- 1,164 Lexington, MA 02173 31 Cross Street Owned 1971 -- 563 Peabody, MA 01960 200 Linden Street Leased 1973 November 1998 (1) 212 ----- Wellesley, MA 02181 Total............................ $4,979 ======
- ---------- (1) The Company has options to renew these leases which range from 5 to 15 years. Item 3. Legal Proceedings. The Company is not involved in any pending material legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition or results of operations. 39 42 In 1993, the Company foreclosed on and took possession of a 35 unit multi-family residential complex located in Lowell, Massachusetts. Subsequent thereto, the Company instituted an action in the Superior Court for Middlesex County (C.A. No. 94-4127) to recover a $735,000 deficiency against the borrower whereafter the borrower countersued the Company and two of its officers. The borrower sought damages against the Company and the two members of management claiming, among other things, $2.9 million in damages for a breach of an oral agreement to forbear. On February 24, 1996, the court granted summary judgment for the Company and its two officers. The defendant has appealed the summary judgment. The Company has been advised by its counsel that there is little possibility that the borrower will prevail on his counterclaims against the Company. Item 4. Submission of Matters to a Vote of Security Holders. None. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. Information relating to the market for Registrant's common equity and related stockholder matters appears under "Shareholder Information" in the Registrant's 1996 Annual Report to Stockholders on page 64 and is incorporated herein by reference. Item 6. Selected Financial Data. The above-captioned information appears under "Selected Financial Data" of the Corporation in the Registrant's 1996 Annual Report to Stockholders on pages 6 and 7 is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The above-captioned information appears under Management Discussion and Analysis of Financial Condition and Results of Operation in the Registrant's 1996 Annual Report to Stockholders on pages 9 through 22 and is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data. The Consolidated Financial Statements of BostonFed Bancorp, Inc. and its subsidiaries, together with the report thereon by KPMG Peat Marwick LLP appears in the Registrant's 1996 Annual Report to Stockholders on pages 23 through 62 and are incorporated herein by reference. Item 9. Change In and Disagreements with Accountants on Accounting and Financial Disclosure. None. 40 43 PART III Item 10. Directors and Executive Officers of the Registrant. The information relating to Directors and Executive Officers of the Registrant is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 28, 1997 at pages 5 through 7. Item 11. Executive Compensation. The information relating to executive compensation is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 28, 1997 at pages 13 through 18. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 28, 1997, at pages 3 through 7. Item 13. Certain Relationships and Related Transactions. The information relating to certain relationships and related transactions is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on April 28, 1997, at page 19. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) The following documents are filed as a part of this report: (1) Consolidated Financial Statements of the Company are incorporated by reference to the following indicated pages of the 1996 Annual Report to Stockholders: PAGE Independent Auditors' Report.......................................... 23 Consolidated Balance Sheets as of December 31, 1996 and 1995.......................................... 24 Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994.................................... 26 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994.................... 27 41 44 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994.............................. 29 Notes to Consolidated Financial Statements............................ 31 The remaining information appearing in the Annual Report to Stockholder is not deemed to be filed as part of this report, except as expressly provided herein. (2) All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto. (3) Exhibits (a) The following exhibits are filed as part of this report. 3.1 Restated Certificate of Incorporation of BostonFed Bancorp, Inc.* 3.2 Bylaws of BostonFed Bancorp, Inc.* 4.0 Stock Certificate of BostonFed Bancorp, Inc.* 10.1 Employment Agreement between the Bank and David F. Holland and Employment Agreement between the Company and David F. Holland* 10.2 Employment Agreement between Bank and David P. Conley and Employment Agreement between the Company and David P. Conley* 10.3 Employment Agreement between Bank and John A. Simas and Employment Agreement between the Company and John A. Simas* 10.4 Form of Change in Control Agreement between the Bank and Executive and between the Company and Executive* 10.5 Boston Federal Savings Bank Employee Severance Compensation Plan* 10.6 Employee Stock Ownership Plan and Trust* 10.7 BostonFed Bancorp, Inc. 1996 Stock-Based Incentive Plan** 10.8 BostonFed Bancorp, Inc. 1997 Stock Incentive Plan*** 13.0 1996 Annual Report to Stockholders (filed herewith) 21.0 Subsidiary information is incorporated herein by reference to "Part I - Subsidiaries" 23.0 Consent of KPMG Peat Marwick LLP 27.0 Financial Data Schedule (filed herewith) ---------- * Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, and any amendments thereto, filed on July 21, 1995, Registration No. 33-94860 ** Incorporated herein by reference into this document from the Proxy Statement for the 1996 Annual Meeting of Stockholders dated March 20, 1996. *** Incorporated herein by reference into this document from the Proxy Statement for the 1997 Annual Meeting of Stockholders dated March 28, 1997. (b) Reports on Form 8-K. None. 42 45 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BOSTONFED BANCORP, INC. By: /s/ David F. Holland ----------------------------- David F. Holland President and Chief Executive Officer DATED: 3/31/97 ---------------------- Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. Name Title Date ---- ----- ---- /s/ David F. Holland President and Chief 3/31/97 - ---------------------- Executive Officer David F. Holland and Chairman of the Board /s/ David P. Conley Director, Executive 3/31/97 - ---------------------- Vice President, David P. Conley Assistant Treasurer and Assistant Secretary /s/ John A. Simas Senior Vice President, 3/31/97 - ---------------------- Treasurer, Corporate John A. Simas Secretary and Chief Financial Officer (Principal Accounting Officer) /s/ Edward P. Callahan Director 3/31/97 - ---------------------- Edward P. Callahan /s/ Richard J. Dennis, Sr. Director 3/31/97 - ---------------------- Richard J. Dennis, Sr. /s/ Charles R. Kent Director 3/31/97 - ---------------------- Charles R. Kent /s/ W. Robert Mill Director 3/31/97 - ---------------------- W. Robert Mill /s/ Irwin W. Sizer Director 3/31/97 - ---------------------- Irwin W. Sizer 43 EX-13.0 2 ANNUAL REPORT TO SHAREHOLDERS 1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS GENERAL BostonFed Bancorp, Inc. (the "Company") was incorporated on July 11, 1995, and at such time became the holding company for Boston Federal Savings Bank (the "Bank"). On October 24, 1995, the Bank completed its conversion from a mutual savings bank to a stock form of ownership, while simultaneously the Company issued 6,589,617 shares of common stock, utilizing a portion of the proceeds to acquire all of the outstanding stock of the Bank. The Company's business has been conducted primarily through its ownership of the Bank which operates its administrative/branch office located in Burlington, Massachusetts and its seven other branch offices located in Arlington, Bedford, Billerica, Boston, Lexington, Peabody and Wellesley, all of which are located in the greater Boston metropolitan area. As a result of its acquisition of Broadway Capital Corp. and its subsidiary, Broadway National Bank, (collectively "Broadway National Bank") the Company added two banking offices (Chelsea and Revere) to its franchise in the greater Boston metropolitan area. The Company's primary business is attracting retail deposits from the general public and investing those deposits and other borrowed funds in loans, mortgage-backed securities, U.S. Government and federal agency securities and other securities. The Company originates loans for investment and loans for sale in the secondary market, generally retaining the servicing rights for loans sold. Loan sales are made from loans held in the Company's portfolio designated as being held for sale or originated for sale during the period. The Company's revenues are derived principally from interest on its mortgage loans, and to a lesser extent, interest and dividends on its investment and mortgage-backed securities, fees and loan servicing income. The Company's primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, Federal Home Loan Bank of Boston ("FHLB") advances, repurchase agreements and proceeds from the sale of loans. The Company's results of operations are primarily dependent on net interest income, which is the difference between the income earned on its loan and investment portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the Company's provision for loan losses, real estate operations expense, investment and loan sale activities and loan servicing. The Company's non-interest expense principally consists of compensation and benefits, occupancy and equipment expense, deposit insurance premiums, advertising, data processing expense, real estate operations and other expenses. Results of operations of the Company are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. On February 7, 1997, the Company acquired Broadway National Bank, a national bank chartered commercial bank. As a result of the acquisition the Company became a bank holding company subject to regulation by the Federal Reserve Bank ("FRB"). Since the acquisition was consummated after December 31, 1996, the financial statements of the Company and the following discussion regarding the Company's financial condition and results of operations at and for the years ended December 31, 1996 and 1995, do not include information and data related to Broadway National Bank. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds are deposits, principal and interest payments on loans, mortgage-backed and related securities FHLB advances and repurchase agreements. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. However, the Bank has maintained the required minimum levels of liquid assets as defined by Office of Thrift Supervision ("OTS") regulations. This requirement, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of the Bank's deposits and short-term borrowings. The Bank's currently required liquidity ratio is 5%. At December 31, 1996 and 1995, the Bank's liquidity ratio was 8.0% and 5.3% respectively. Management has maintained liquidity close to the minimum requirement so that it may invest any excess liquidity in higher yielding interest-earning assets or use such 9 2 funds to repay higher cost FHLB advances or repurchase agreements. The Company's most liquid assets are cash, daily fed funds sold, short-term investments and investments available for sale. The levels of these assets are dependent on the Company's operating, financing, lending and investing activities during any given period. At December 31, 1996, cash, short-term investments and investment securities available for sale totaled $19.4 million or 2.4% of total assets. Additional investments were available which qualified for regulatory liquidity requirements. The Company has other sources of liquidity if a need for additional funds arises, including FHLB advances. At December 31, 1996, the Bank had $296.5 million in advances outstanding from the FHLB and had an additional $133.6 million in overall borrowing capacity from the FHLB. The Company also borrowed $3.5 million through a repurchase agreement (collateralized borrowing). The Company generally avoids paying the highest deposit rates in its market and accordingly utilizes alternative sources of funds such as FHLB advances and repurchase agreements to supplement cash flow needs. At December 31, 1996, the Company had commitments to originate loans and unused outstanding lines of credit totaling $60.9 million. The Company anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificate accounts which are scheduled to mature in less than one year from December 31, 1996, totaled $135.0 million. The Company expects that a substantial majority of the maturing certificate accounts will be retained by the Company at maturity. At the time of conversion, the Bank was required to establish a liquidation account in an amount equal to its retained earnings as of June 30, 1995. The liquidation account will be reduced to the extent that eligible account holders reduce their qualifying deposits. In the unlikely event of a complete liquidation of the Bank, each eligible account holder will be entitled to receive a distribution from the liquidation account. The Bank is not permitted to declare or pay dividends on its capital stock, or repurchase any of its outstanding stock, if the effect thereof would cause its stockholders' equity to be reduced below the amount required for the liquidation account or applicable regulatory capital requirements. The balance of the liquidation account at December 31, 1996 was approximately $13.4 million. Prior to the Company's acquisition of Broadway National Bank, the Company as a savings and loan holding company was not required to maintain a minimum level of capital for regulatory purposes. As a result of the Company's status as a bank holding company, the Company is required to maintain a ratio of capital to assets, on a consolidated basis, which is substantially equal to that required to be maintained by the Bank. At December 31, 1996, the consolidated capital to assets ratio of the Company was 10.5% which would have exceeded the minimum regulatory capital requirements for the Company. As of December 31, 1996, the Bank exceeded all of its regulatory capital requirements with tangible, core and risk-based capital ratios of 6.8%, 6.8% and 13.2%, respectively, as compared to the minimum regulatory requirements of 1.5%, 3.0% and 8.0%, respectively. On August 20, 1996, the provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996". The new rules eliminate the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts beginning after December 31, 1995. These rules also require that all thrift institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Company has previously recorded a deferred tax liability equal to the bad debt recapture and as such, the new rules will have no effect on net income or federal income tax expense. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provision of present law that require recapture in the case of certain excess distributions to shareholders. The tax effect of pre-1988 bad debt reserves subject to recapture in the case of certain excess distributions is approximately $5.5 million. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and Notes thereto presented herein have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP"), which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates 10 3 have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. MANAGEMENT OF INTEREST RATE RISK The principal objective of the Company's interest rate risk management function is to evaluate the interest rate risk included in certain balance sheet accounts, determine the level of risk appropriate given the Company's business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with Board of Directors' approved guidelines. Through such management, the Company seeks to reduce the vulnerability of its operations to changes in interest rates. The Company monitors its interest rate risk as such risk relates to its operating strategies. The Company's Board of Directors has established a management Asset/Liability Committee which is responsible for reviewing the Company's asset/liability policies and interest rate risk position. The Committee meets at least quarterly and reports trends and interest rate risk position to the Board of Directors on a quarterly basis. The extent of the movement of interest rates is an uncertainty that could have a negative impact on the earnings of the Company. In recent years, the Company has utilized the following strategies to manage interest rate risk: (1) emphasizing the origination and retention of adjustable-rate, one- to four-family mortgage loans; (2) generally selling in the secondary market substantially all fixed-rate mortgage loans originated with terms greater than 10 years while generally retaining the servicing rights thereof; (3) primarily investing in short-term investment securities or mortgage-backed securities with adjustable interest rates; and (4) attempting to reduce the overall interest rate sensitivity of liabilities by emphasizing longer-term deposits and utilizing FHLB advances to replace rate sensitive deposits. The volatile and generally rising rate environment of 1996 allowed the Bank to originate record loan volume, the majority of loans originated were adjustable-rate loans which were primarily retained for the Bank's portfolio. Many of these loans, however, do not reprice until the third or fifth year of their term. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring the Company's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Accordingly, during a period of rising interest rates, an institution with a positive gap position would be in a better position to invest in higher yielding assets which, consequently, may result in the yield on its assets increasing at a pace more closely matching the increase in the cost of its interest-bearing liabilities than if it had a negative gap. During a period of falling interest rates, an institution with a positive gap would tend to have its assets repricing at a faster rate than one with a negative gap which, consequently, may tend to restrain the growth of, or reduce, its net interest income. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1996, which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the "GAP Table"). Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The Gap Table sets forth an approximation of the projected repricing of assets and liabilities at December 31, 1996, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. Annual prepayment rates for adjustable-rate and fixed-rate residential loans are assumed to be 11.0% and 13.8%, respectively. Annual prepayment rates for adjustable-rate and fixed-rate mortgage-backed securities are assumed to be 10.5% and 13.8%, respectively. Money market deposit accounts are assumed to be immediately rate-sensitive, while passbook accounts and negotiable order of withdrawal ("NOW") accounts are assumed to have decay rates of 12% annually. These assumptions may or may not be indicative of actual prepayment and withdrawals experienced by the Company. The table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the actual repricing dates of various 11 4 assets and liabilities is subject to customer discretion and competitive and other pressures and, therefore, actual experience may vary from that indicated. The following table shows the gap position of the Company at December 31, 1996:
MORE THAN 3 MORE THAN MORE THAN MORE THAN 3 YEARS MORE MONTHS 3 MONTHS 6 MONTHS 1 YEAR TO TO THAN TOTAL OR LESS TO 6 MONTHS TO 1 YEAR 3 YEARS 5 YEARS 5 YEARS AMOUNT -------- ----------- --------- --------- --------- -------- -------- (DOLLARS IN THOUSANDS) INTEREST-EARNING ASSETS Short-term investments............. $ 2,930 $ 13 $ 0 $ 0 $ 0 $ 0 $ 2,943 Investment securities.............. 5,339 250 0 3,670 9,996 1,000 20,255 Loans(1)........................... 87,546 88,292 177,295 179,066 117,480 33,859 683,538 Mortgage-backed securities......... 27,051 1,432 9,827 4,442 3,695 20,165 66,612 Stock in FHLB-Boston............... 16,295 0 0 0 0 0 16,295 -------- ------- -------- -------- -------- -------- -------- Total Interest-earning assets.................. $139,161 $ 89,987 $187,122 $187,178 $131,171 $ 55,024 $789,643 -------- ------- -------- -------- -------- -------- -------- INTEREST-BEARING LIABILITIES Money market deposit accounts...... 45,788 0 0 0 0 0 43,787 Savings accounts................... 2,643 2,643 5,286 24,668 28,192 24,668 88,100 NOW accounts....................... 2,356 2,356 4,711 14,918 10,207 43,969 78,517 Certificate accounts............... 84,920 24,684 29,305 42,000 19,215 0 202,125 FHLB Advances...................... 39,000 34,000 92,000 114,000 16,500 1,000 296,500 Securities sold under agreement to repurchase....................... 0 0 3,500 0 0 0 3,500 -------- ------- -------- -------- -------- -------- -------- Total interest-bearing liabilities............. 174,707 63,683 134,802 195,586 74,114 69,637 712,529 -------- ------- -------- -------- -------- -------- -------- Interest-earning assets less interest-bearing liabilities..... $(35,546) $ 26,304 $ 52,320 $ (8,408) $ 57,057 $(14,613) $ 77,114 ======== ======= ======== ======== ======== ======== ======== Cumulative interest rate sensitivity gap.................. $(35,546) $ (9,242) $ 43,078 $ 34,670 $ 91,727 $ 77,114 ======== ======= ======== ======== ======== ======== Cumulative interest rate gap as a percentage of total assets at December 31, 1996................ (4.33)% (1.13)% 5.25% 4.23% 11.18% 9.40% Cumulative interest rate gap as a percentage of total interest- earning assets at December 31, 1996............................. (4.50)% (1.17)% 5.46% 4.39% 11.62% 9.77% Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at December 31, 1996................ 79.65% 96.12% 111.54% 106.10% 114.27% 110.82%
- --------------- (1) Includes totals loans net of non-performing loans. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase. The Company's interest rate sensitivity is also monitored by management through the use of a model which internally generates estimates of the change in net portfolio value ("NPV") over a range of interest rate change scenarios. NPV is the present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The OTS also produces a similar analysis using its own model, based upon 12 5 data submitted on the Company's quarterly Thrift Financial Reports, the results of which may vary from the Company's internal model primarily due to differences in assumptions utilized between the Company's internal model and the OTS model, including estimated loan prepayment rates, reinvestment rates and deposit decay rates. For purposes of the NPV table, prepayment speeds similar to those used in the Gap table were used, reinvestment rates were those in effect for similar products currently being offered and rates on core deposits were modified to reflect recent trends. The following table sets forth the Company's NPV as of December 31, 1996, as calculated by the Company.
PORTFOLIO RATES NET PORTFOLIO VALUE VALUE OF ASSETS IN BASIS -------------------------- ----------------- POINTS $ $ % NPV % (RATE SHOCK) AMOUNT CHANGE CHANGE RATIO CHANGE(1) - -------------- ------- ------- ------ ----- --------- (DOLLAR IN THOUSANDS) 400........... 76,445 (33,413) (30.4)% 9.3 (30.6) 300........... 84,133 (25,725) (23.4) 10.3 (23.1) 200........... 91,864 (17,994) (16.4) 11.2 (16.4) 100........... 99,915 (9,943) (9.1) 12.2 (9.0) Static........ 109,858 13.4 (100)......... 113,504 3,646 3.3 13.8 3.0 (200)......... 119,621 9,763 8.9 14.6 9.0 (300)......... 125,090 15,232 13.9 15.2 13.4 (400)......... 137,278 27,420 25.0 16.7 24.6
- --------------- (1) Based on the portfolio value of the Company's assets assuming no change in interest rates. As in the case with the Gap Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV model presented assumes that the composition of the Company's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of the Company's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Company's net interest income and will differ from actual results. ANALYSIS OF NET INTEREST INCOME Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following table sets forth certain information relating to the Company for the years ended December 31, 1996, 1995 and 1994. The average yields and costs are derived by dividing income or expense by the average balance of interest earning assets or interest bearing liabilities, respectively, for the periods shown. For 1996, the average balance data is derived from daily balances and for 1995 and 1994, average balance data is derived from average month-end balances. Management does not believe that the use of average monthly balances instead of average daily balances has caused any material differences in the information presented. The yields and costs include fees, premiums and discounts which are considered adjustments to yields. 13 6
AT FOR THE YEAR ENDED DECEMBER 31, DECEMBER 31, ------------------------------------------------------------ 1996 1996 1995 ---------------- --------------------------- ----------------------------- AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE COST BALANCE INTEREST COST BALANCE INTEREST COST -------- ------ -------- -------- ------- -------- -------- ------- (DOLLARS IN THOUSANDS) ASSETS: Interest-earning assets: Investment securities(1)...................... $ 39,493 6.14% $ 36,678 $ 2,167 5.91% $ 33,558 $ 1,945 5.80% Loan, net and mortgage loans held for sale(2)..................................... 680,640 7.67 603,585 45,513 7.54 503,920 38,079 7.56 Mortgage-backed securities(3)................. 66,612 6.83 72,287 4,998 6.91 39,454 2,430 6.16 -------- ----- -------- ------- ---- -------- ------- ---- Total interest-earning assets............... 786,745 7.52 712,550 52,678 7.39 576,932 42,454 7.36 ----- ------- ---- ------- ---- Non-interest-earning assets.................... 33,822 28,354 23,590 -------- -------- -------- Total assets................................ $820,567 $740,904 $600,522 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing liabilities: Money market deposit accounts.................. $ 45,788 3.00 $ 46,540 1,395 3.00 $ 49,693 1,472 2.96 Savings accounts............................... 88,100 2.50 90,763 2,258 2.49 99,498 2,485 2.50 NOW accounts................................... 72,503 1.25 66,336 890 1.34 65,661 931 1.42 Certificate accounts........................... 200,124 5.54 199,598 11,155 5.59 189,080 10,235 5.41 -------- ----- -------- ------- ---- -------- ------- ---- Total....................................... 406,515 3.83 403,237 15,698 3.89 403,932 15,123 3.74 Borrowed Funds(4).............................. 300,000 5.97 225,124 13,193 5.86 133,268 8,429 6.32 -------- ----- -------- ------- ---- -------- ------- ---- Total interest-bearing liabilities.......... 706,515 4.74 628,361 28,891 4.60 537,200 23,552 4.38 ----- ------- ---- ------- ---- Non-interest-bearing liabilities............... 27,697 21,030 19,145 -------- -------- -------- Total liabilities........................... 734,212 649,391 556,345 -------- -------- -------- Stockholders' equity........................... 86,355 91,513 44,177 -------- -------- -------- Total liabilities and stockholders' equity.................................... $820,567 $740,904 $600,522 ======== ======== ======== Net interest rate spread(5).................... 2.78% $23,787 2.79% $18,902 2.98% ===== ======= ==== ====== ==== Net interest margin(6)......................... 3.34% 3.28% ==== ==== Ratio of interest-earning assets to interest-bearing liabilities.................. 111.36% 113.40% 107.40% ======== ======== ======== 1994 --------------------------- AVERAGE AVERAGE YIELD/ BALANCE INTEREST COST -------- -------- ------- ASSETS: Interest-earning assets: Investment securities(1)...................... $ 26,157 $ 1,522 5.82% Loan, net and mortgage loans held for sale(2)..................................... 441,959 32,578 7.37 Mortgage-backed securities(3)................. 42,306 2,427 5.74 -------- ------- ---- Total interest-earning assets............... 510,422 36,527 7.16 ------- ---- Non-interest-earning assets.................... 24,864 -------- Total assets................................ $535,286 ======== LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing liabilities: Money market deposit accounts.................. 59,699 1,442 2.42 Savings accounts............................... 119,253 3,185 2.67 NOW accounts................................... 64,875 1,017 1.57 Certificate accounts........................... 168,572 7,043 4.18 -------- ------- ---- Total....................................... 412,399 12,687 3.08 Borrowed Funds(4).............................. 77,645 4,335 5.58 -------- ------- ---- Total interest-bearing liabilities.......... 490,044 17,022 3.47 ------- ---- Non-interest-bearing liabilities............... 17,630 -------- Total liabilities........................... 507,674 -------- Stockholders' equity........................... 27,612 -------- Total liabilities and stockholders' equity.................................... $535,286 ======== Net interest rate spread(5).................... $19,505 3.69% ======= ==== Net interest margin(6)......................... 3.82% ==== Ratio of interest-earning assets to interest-bearing liabilities.................. 104.16% ========
- --------------- (1) Includes investment securities available for sale and held to maturity, short-term investments, stock in FHLB-Boston and daily federal funds sold. (2) Amount is net of deferred loan origination costs, construction loans in process, net unearned discount on loans purchased and allowance for loan losses and includes non-performing loans. (3) Includes mortgage-backed securities available for sale and held to maturity. (4) Interest paid on borrowed funds for the periods presented includes interest expense on FNMA deposits held in escrow accounts with the Company related to the Company's FNMA servicing, which, if such interest expense was excluded, would result in an average cost of borrowed funds of 5.81%, 6.31%, and 5.46% for the years ended December 31, 1996, 1995 and 1994, respectively. (5) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (6) Net interest margin represents net interest income as a percentage of average interest-earning assets. Note: Average balances for 1996 are calculated on a daily basis, while for 1995 and 1994 average balances are based on average monthly balances. 14 7 RATE/VOLUME ANALYSIS The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated to changes due to rate.
YEAR ENDED YEAR ENDED DECEMBER 31, 1996 DECEMBER 31, 1995 COMPARED TO COMPARED TO YEAR ENDED YEAR ENDED DECEMBER 31, 1995 DECEMBER 31, 1994 ---------------------------- --------------------------- INCREASE INCREASE (DECREASE) (DECREASE) DUE TO DUE TO ----------------- ----------------- VOLUME RATE NET VOLUME RATE NET ------- ------- ------- ------ ------- ------ (IN THOUSANDS) INTEREST-EARNING ASSETS: Investment securities.. $ 181 $ 41 $ 222 $ 431 $ (8) $ 423 Loan, net and mortgage loans held for sale...... 7,535 (101) 7,434 4,567 934 5,501 Mortgage- backed securities.. 2,023 545 2,568 (164) 167 3 ------ ------- ------- ----- ------- ------ Total interest- earning assets.. 9,739 485 10,224 4,834 1,093 5,927 ------ ------- ------- ----- ------- ------ INTEREST-BEARING LIABILITIES: Money market deposit accounts.. (93) 16 (77) (242) 272 30 Savings accounts.. (218) (9) (227) (527) (173) (700) NOW accounts.. 10 (51) (41) 12 (98) (86) Certificate accounts.. 569 351 920 857 2,335 3,192 ------ ------- ------- ----- ------- ------ Total..... 268 307 575 100 2,336 2,436 Borrowed funds..... 5,805 (1,041) 4,764 3,104 990 4,094 ------ ------- ------- ----- ------- ------ Total interest- bearing liabilities.. 6,073 (734) 5,339 3,204 3,326 6,530 ------ ------- ------- ----- ------- ------ Net change in net interest income...... $3,666 $ 1,219 $ 4,885 $1,630 $(2,233) $ (603) ====== ======= ======= ====== ======= ======
ASSET QUALITY The following table sets forth information regarding non-performing assets which consist of: non-performing loans and real estate owned ("REO"). In addition to identifying non-performing loans, as discussed below, the Company identifies loans which are characterized as "impaired" pursuant to Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan and SFAS No. 118, Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosure. Accordingly, loans categorized as "impaired" include non-performing loans as well as other identified loans. At December 31, 1996, non-performing loans totaled $1.5 million, (all of which are included in the balance of impaired loans) impaired loans totaled $4.4 million, consisting of 40 loans, and REO totaled $2.7 million, consisting of ten properties. It is the policy of the Company to cease accruing interest on loans 90 days or more past due and to charge-off all accrued interest. For the years ended December 31, 1996, 1995, and 1994, the amount of additional interest income that would have been recognized on non-accrual loans if such loans had continued to perform in accordance with their contractual terms was $103,000, $303,000, and $281,000, respectively. For the same periods, the difference between the amount of interest income which would have been recognized on other impaired loans if such loans were performing in accordance with their regular terms and actual amounts recognized was $73,000, $77,000, and $294,000, respectively.
AT DECEMBER 31, ------------------------ 1996 1995 1994 ------ ------ ------ (DOLLARS IN THOUSANDS) NON-PERFORMING LOANS: Residential real estate: One- to four-family............. $1,463 $1,195 $ 848 Multi-family.................... -- 745 546 Commercial real estate............ 25 3,312 2,126 Other Loans....................... 14 -- 51 ------ ------ ------ Total......................... 1,502 5,252 3,571 Real estate owned, net(3)........... 2,668 971 387 ------ ------ ------ Total non-performing assets... 4,170 6,223 3,958 Restructured loans.................. 2,489 2,941 4,834 ------ ------ ------ Total risk elements................. $6,659 $9,164 $8,792 ====== ====== ====== Allowance for loan losses as a percent of loans(1)............... 0.64% 0.82% 0.74% Allowance for loan losses as a percent of non-performing loans(2).......................... 293.02 81.40 103.61 Non-performing loans as a percent of loans(1)(2)....................... 0.22 1.00 0.71 Non-performing assets as a percent of total assets(4)................ 0.51 0.97 0.68
- --------------- (1) Loans includes loans, net and mortgage loans held for sale, excluding allowance for loan losses. (2) Non-performing loans consist of all 90 days or more past due and other loans which have been identified by the Company as presenting uncertainty with respect to the collectability of interest or principal. (3) REO balances are shown net of related valuation allowances. (4) Non-performing assets consist of non-performing loans and real estate owned (REO). 15 8 At December 31, 1996, loans which were characterized as impaired totaled $4.4 million. All of the impaired loans have been measured using the fair value of the collateral method. During the year ended December 31, 1996, the average recorded value of impaired loans was $5.4 million, $321,000 of interest income was recognized and $497,000 of interest income would have been recognized under original terms. The composition of impaired loans by type is shown below:
DECEMBER 31, --------------- 1996 1995 ------ ------ (IN THOUSANDS) Impaired loans: Residential real estate One- to four-family........ $1,763 $2,828 Multi-family............... 2,271 1,367 Commercial real estate........ 246 4,062 Other loans................... 112 99 ------ ------ Sub total............. 4,392 8,356 Specific valuation allowance.................. -- (618) ------ ------ Total impaired loans............... $4,392 $7,738 ====== ======
The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the national and regional economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses in loans which are deemed probable and estimable based on information currently known to management. Management's analysis of the adequacy of the allowance is based upon consideration of a number of factors, including current economic conditions, actual loss experience and industry trends. In addition various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management. Amounts provided for the years 1996, 1995 and 1994 were $1.3 million, $3.6 million and $283,000, respectively. During the year ended December 31, 1996, there were recoveries of $343,000 credited to, and charge-offs of $1.5 million taken against this allowance. As of December 31, 1996, the Company's allowance for loan losses was .64% of total loans compared to .82% as of December 31, 1995. The Company had non-performing loans of $1.5 million and $5.3 million at December 31, 1996 and December 31, 1995, respectively. The decrease in the non-performing loans occurred principally due to the transfer of certain commercial real estate loans to real estate owned. The Company will continue to monitor and modify its allowance for loan losses as conditions dictate. While management believes the Company's allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Company's level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Company or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of allowance for loan losses. The following table sets forth activity in the Company's allowance for loan losses for the periods indicated.
AT OR FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------ 1996 1995 1994 1993 1992 ------ ------ ------ ------ ------ (IN THOUSANDS) Balance at begin- ning of period.... $4,275 $3,700 $4,450 $4,381 $5,000 Provision for loan losses............ 1,294 3,614 283 3,918 5,487 Charge offs: One-to-four-family.. 387 550 711 2,114 2,330 Multi-family...... 263 483 251 1,114 1,288 Commercial........ 664 2,297 200 805 1,241 Construction and land............ -- -- -- 4 1,268 Other............... 198 194 56 17 3 ------ ------ ------ ------ ------ Total....... 1,512 3,524 1,218 4,054 6,130 Recoveries.......... 343 485 185 205 24 ------ ------ ------ ------ ------ Balance at end of period............ $4,400 $4,275 $3,700 $4,450 $4,381 ====== ====== ====== ====== ====== Ratio of net charge- offs during the period to average loans outstanding during the period............ 0.19% 0.60% 0.23% 0.94% 1.54% ====== ====== ====== ====== ======
The Company has developed an internal asset classification system which classifies assets depending on risk of loss characteristics. The most severe classification before a charge-off is required is "sub-standard." At December 31, 1996, 1995 and 1994, the Company classified (excluding REO) $3.8 million, $8.3 million and $9.8 million of sub-standard assets, respectively. Included in these amounts were $4.2 million, $6.2 million and $4.0 million in non-performing assets, respectively. In the opinion of management, the performing sub-standard loans evidence one or more weaknesses or potential weaknesses and, depending on the regional economy and other factors, may become non-performing assets in future periods. 16 9 COMPARISON OF FINANCIAL CONDITION AND OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995. CHANGES IN FINANCIAL CONDITION Assets at December 31, 1996 totaled $820.6 million, an increase of $179.8 million, or 28.1%, compared to $640.8 million at December 31, 1995. This growth was primarily due to increased originations of adjustable-rate one- to four-family mortgage loans which caused loans, net, to increase by $167.2 million to a balance of $676.7 million at December 31, 1996, compared to a balance of $509.5 million at December 31, 1995. Volatility in market interest rates and a generally rising interest rate environment in 1996 caused customer preference to shift to adjustable-rate loan products and the demand for fixed-rate products declined. Deposits increased $9.7 million to $428.8 million at December 31, 1996 compared to $419.1 million as of December 31, 1995, due primarily to interest credited to accounts during the year. The Company funded the increase in loans, net, primarily by borrowing short- and long-term funds from the FHLB. Mortgage-backed securities increased by $7.6 million, or 12.9%, from a balance of $59.0 million at December 31, 1995 to a balance of $66.6 million at December 31, 1996. Mortgage loans held for sale totaled $4.0 million at December 31, 1996, compared to $8.9 million at December 31, 1995. FHLB advances increased $176.6 million to a balance of $296.5 million at December 31, 1996, compared to $119.9 million at December 31, 1995. Total stockholders' equity at December 31, 1996 totaled $86.4 million, or $14.75 book value per share and 10.5% of total assets, compared to $90.7 million, or $14.78 book value per share and 14.2% of total assets at December 31, 1995. The decrease in total stockholders' equity is due to the combined effects of the contribution to the Company's 1995 Stock-Based Incentive Plan Trust (the "SIP") to fund the SIP's purchase of 4% of the Company's common stock (net of amortization), the completion of a 5% stock repurchase program, the change in market valuation (net of taxes), of the available-for-sale securities portfolio and dividends paid, offset by net income. RESULTS OF OPERATIONS General Net income for the year ended December 31, 1996 was $2.9 million, or $.48 per share, an increase of $1.8 million or 164%, from the $1.1 million (with earnings per share not applicable) for the year ended December 31, 1995. The increase was primarily attributable to higher net interest income, due to increased balances of interest earning assets and a lower provision for loan losses, which were partially offset by the one-time $2.7 million (approximately $1.6 million after tax) special assessment for the recapitalization of the Savings Association Insurance Fund (the "SAIF") as a result of federal legislation enacted in late 1996. Excluding such non-recurring SAIF special assessment, net income for the year would have been $4.5 million or $.73 per share, a 309% increase over 1995's net income of $1.1 million, with earnings per share not meaningful. The net interest margin in 1996 increased to 3.34% from 3.28% during 1995. The improvement in the net interest margin in 1996 was primarily due to the impact of the Company's utilization of net conversion proceeds for a full year in 1996 compared to approximately two months in 1995. Interest Income Total interest income for the year ended December 31, 1996 increased by $10.2 million to $52.7 million compared to $42.5 million for the year ended December 31, 1995. Interest on loans increased by $7.4 million, or 19.4%, to $45.5 million, during 1996 compared to $38.1 million during 1995. The increase in interest income in 1996 was attributable to increased average balances of interest earning assets, primarily due to an increase in the average balance of loans, from $503.9 million for 1995 to $603.9 million for 1996. The increased average loan balances generated an additional $7.5 million of interest earned which was partially offset by reduced earnings of $101,000 due to increased origination of the Company's discounted adjustable-rate loans which resulted in an overall decline in yields for the loan portfolio whereby the average loan yield was reduced to 7.54% for 1996 compared to an average of 7.56% for 1995. Interest income on mortgage-backed securities increased by $2.6 million for the year ended December 31, 1996 due primarily to an increase in average balances compared to the prior year. Average balances increased by $32.8 million from an average of $39.5 million during 1995 to an average $72.3 million during 1996. The majority of the mortgage-backed securities held in 1996 were adjustable GNMA securities. The yields on mortgage-backed securities increased from an average yield of 6.16% in 1995 to 6.91% in 1996, resulting in an increase in interest earned on such securities in 1996 of $545,000, compared to 1995. 17 10 Interest Expense Interest expense increased by $5.3 million, or 22.5%, for the year ended December 31, 1996 to $28.9 million compared to $23.6 million for the year ended December 31, 1995. The primary cause of the increase in interest expense for the year ended December 31, 1996 was interest expense on borrowed funds consisting primarily of FHLB advances and to a lesser extent, repurchase agreements which were used primarily to fund adjustable-rate loans originated for portfolio during 1996. Interest expense on deposit accounts increased by $575,000 for the year ended December 31, 1996 due primarily to the effects of higher deposit rates during the year, caused by a shift of regular savings deposits into higher yielding certificates of deposit. Average deposit balances were $403.2 million during the year ended December 31, 1996, compared to $403.9 million for the prior year, a decrease of $695,000. For the year ended December 31, 1996, interest expense on borrowed funds was $13.2 million compared to $8.4 million the prior year, an increase of $4.8 million, or 57.1% While the average cost of borrowed funds declined by 46 basis points, from an average of 6.32% for the year ended December 31, 1995 to 5.86% for 1996, causing interest expense on FHLB advances to decrease by $1.0 million, the average balances increased from an average borrowed money balance of $133.3 million in 1995 to an average of $225.1 million in 1995. The higher average balances increased interest expense on borrowed funds by $5.8 million in 1996 compared to 1995. Provision for Loan Losses During 1996, the provision for loan losses was reduced to $1.3 million from the prior year's provision of $3.6 million. The lower provision was based on management's evaluation of existing real estate market conditions, improvement in the level of charge-offs and classified assets as well as a stabilization of general economic conditions in the Company's market area. Total non-performing loans decreased to $1.5 million, or .22% of loans at December 31, 1996 from $5.3 million, or 1.00% at December 31, 1995. Net charge-offs also decreased, amounting to $1.2 million, or .19% of average loans outstanding during 1996 compared with 1995's total of $3.0 million or .60% of average loans outstanding. The allowance for loan losses as a percentage of total loans was 0.64% at December 31, 1996 compared to 0.82% at December 31, 1995. As a percentage of total non-performing loans, the allowance for loan losses was 293.0% at December 31, 1996, compared to 81.4% a year earlier. See "Asset Quality" included elsewhere herein. Non-Interest Income Total non-interest income increased to $3.6 million for the year ended December 31, 1996 from $2.7 million for the year ended December 31, 1995. The primary contributing factors were increased gains on the sale of loans and higher transaction account service fees. The $668,000 gain on sale of loans during the current year exceeded the $214,000 for the prior year due mostly to the implementation of Statement of Financial Accounting Standards ("SFAS") No. 122 Accounting for Mortgage Servicing Rights, as of January 1, 1996. Deposit service fees improved to $1.1 million for the year ended December 31, 1996, compared to $668,000 for the prior year due to continued growth in transaction accounts and service fees collected thereon during 1996. Non-Interest Expense Total non-interest expense for the year ended December 31, 1996 was $21.0 million, compared to $16.0 million for 1995. The increase of $5.0 million, or 31.3%, was primarily attributable to the SAIF special assessment of $2.7 million, increased compensation and benefits expense, occupancy and equipment expense and other expenses. Compensation and benefits expense for the year ended December 31, 1996 amounted to $9.8 million, compared to $8.4 million for the prior year. The primary reason for the increase is the SIP expense, which amounted to $1.1 million, (including $187,000 in market value appreciation). Office occupancy and equipment expense increased from $2.2 million for the year ended December 31, 1995 to $2.5 million for the year ended December 31, 1996, due to higher costs incurred for the new data processing service and the costs of new automation equipment placed in service during the current year. While the Company's Federal Deposit Insurance Premiums were slightly lower this year, the Company paid a non-recurring special assessment of $2.7 million. Other non-interest expense increased to $3.4 million for the year ended December 31, 1996 from $2.6 million for the prior year due to increased costs of temporary help and supplies (both due to high lending volumes), advertising and other operating expenses. 18 11 Income Taxes Income tax expense was $2.1 million for the year ended December 31, 1996 (resulting in an effective tax rate of 41.5%), compared to a tax expense of $815,000 for the year ended December 31, 1995 (resulting in an effective tax rate of 41.8%). The increase in income tax expense is primarily attributable to an increase in pre-tax earnings. COMPARISON OF FINANCIAL CONDITION AND OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994. CHANGES IN FINANCIAL CONDITION Assets at December 31, 1995 totaled $640.8 million, an increase of $57.2 million or 9.8%, compared to $583.6 million at December 31, 1994. Most of the growth in assets was in cash and cash equivalents, which increased from $8.3 million to $21.2 million, mortgage-backed securities available for sale, which increased from zero to $23.9 million, and mortgage loans held for sale, which increased from $316,000 to $8.9 million. Loans, net, increased by $10.4 million or 2.1% from a balance of $499.1 million at December 31, 1994 to a balance of $509.5 million at December 31, 1995. The relatively minor growth in loans, net, was due to a market shift from adjustable rate loans towards fixed-rate products in 1995, which the Bank generally sells in the secondary market. These increases were funded by a portion of the $63.9 million net conversion proceeds. Mortgage-backed securities held to maturity declined by $4.7 million to a balance of $35.1 million at December 31, 1995, compared to a balance of $39.8 million at December 31, 1994 due to amortization and pre-payments. Deposit accounts increased from $413.2 million at December 31, 1994 to $419.1 million at December 31, 1995, an increase of 1.4%. Certificate account balances increased by $23.2 million from $173.0 million at December 31, 1994 to $196.2 million at December 31, 1995, an increase of 13.4%. The growth in certificate accounts was offset, somewhat by decreases in non-certificate accounts which declined by $17.2 million during the same period. This shift was caused in part by depositors seeking higher rates during a generally falling interest rate environment. FHLB advances declined from $135.0 million at December 31, 1994 to $119.9 million at December 31, 1995 due to the utilization of net conversion proceeds used to reduce borrowings. Other borrowed money increased by $7.0 million as the Company entered into a repurchase agreement to fund some of the purchases of mortgage-backed securities. Total stockholders' equity at December 31, 1995 was $90.7 or 14.2% of assets compared to $30.0 million or 5.1% of assets at December 31, 1994. The increase is due to the addition of conversion proceeds of $63.9 million, less the unearned portion of the Employee Stock Ownership Plan ("ESOP") shares, amounting to $4.5 million, net income of $1.1 million and a $132,000 increase in additional paid-in capital related to the appreciation in the fair value of allocated ESOP shares. Non-performing assets increased to $6.2 million or .97% of total assets at December 31, 1995, compared to $4.0 million or .68% of total assets at December 31, 1994. The allowance for loan losses was increased from $3.7 million at December 31, 1994 to $4.3 million at December 31, 1995 partly in response to the higher balance in non-performing assets at December 31, 1995, compared to the previous year end. The allowance for loan losses amounted to .82% of loans at December 31, 1995, compared to .74% of loans at December 31, 1994. RESULTS OF OPERATIONS General Net income for the year ended December 31, 1995, amounted to $1.1 million, compared to net income of $4.0 million for the year ended December 31, 1994. The reduction in net income was primarily attributable to a $3.3 million increase in the provision for loan losses. A majority of this provision was for non-performing multi-family and commercial real estate loans and increased charge-offs related to such loans during the current year. Net interest income was also lower for the year ended December 31, 1995, compared to the year ended December 31, 1994 as an increase in the cost of funds, although partially offset by rising yields on assets, resulted in a decline in the net interest margin from 3.82% to 3.28%. The net conversion proceeds, used to repay maturing FHLB advances mitigated the reduction of the net interest margin. The net interest spread, which is not impacted by the conversion proceeds, declined from 3.69% for the year ended December 31, 1994 to 2.98% for the year ended December 31, 1995. Despite the reduction of the net interest margin, net interest income remained relatively stable at $18.9 million for the year ended December 31, 1995, compared to $19.5 million for the year ended December 31, 1994. 19 12 INTEREST INCOME Total interest income for the year ended December 31, 1995 was $42.5 million. This is an increase of $6.0 million from the $36.5 million total interest income for the year ended December 31, 1994. Most of the increase in interest income was due to higher average balances of interest earning assets which averaged $576.9 million during 1995, compared to average balances of $510.4 million during 1994. Interest income from loans, net, increased $5.5 million or 16.9%, to $38.1 million for the year ended December 31, 1995. This increase resulted from the combined effect of a $62.0 million increase in the average balance of loans, net, and an improvement of 19 basis points in yield. Although interest rates generally fell during 1995, the yield of loans, net, improved as the discounted adjustable mortgages originated in 1994 were adjusted to higher contractual rates as per the terms of the loans. Interest income on mortgage-backed securities remained the same at $2.4 million despite a reduction in the average balance of $2.8 million, from an average balance of $42.3 million during the year ended December 31, 1994 to an average balance of $39.5 million for the year ended December 31, 1995. The 42 basis point improvement in the average yield during 1995 was sufficient to offset the reduction in average balances caused by amortization and repayments during the year ended December 31, 1995. The Company also purchased $23.9 million of mortgage-backed securities in late December 1995, however, because of the timing, such purchase did not significantly increase the average balance of interest earning assets for the year. INTEREST EXPENSE Interest expense for the year ended December 31, 1995 amounted to $23.6 million, an increase of $6.6 million, or 38.8% from the prior year's total of $17.0 million. The primary reason for this increase was due to higher average balances of borrowed funds totaling $133.3 million during the year ended December 31, 1995, compared to average borrowed funds of $77.6 million during the year ended December 31, 1994. The Company increased its borrowed funds balance in the latter part of 1994 to fund the growth of its adjustable rate portfolio lending. Additionally, the average cost of borrowed funds increased from 5.58% during 1994 to 6.32% during 1995. The borrowed funds balance did not increase substantially until the latter part of 1994 when interest rates had risen substantially. These higher cost borrowings were outstanding for a longer period of time in 1995 and the borrowing rates on these borrowings did not decline until the latter half of 1995. Because of the lag effect of maturing advances, the average cost was higher in 1995 than 1994. Interest expense increased by $3.1 million because of higher average borrowed funds balance and $1.0 million because of higher average cost during the year ended December 31, 1995. Interest expense on deposits increased $2.4 million from $12.7 million for the year ended December 31, 1994 to $15.1 million for the year ended December 31, 1995, reflecting the net of an increase in the average cost of deposits from 3.08% to 3.74%, as depositors shifted funds from lower yielding savings accounts to higher yielding certificate accounts in the declining rate environment of 1995. This increase was offset somewhat by a decrease in the average balance of total deposits of $8.5 million. Although the average cost of savings and NOW accounts declined from 2.67% and 1.57% to 2.50% and 1.42%, respectively, during the year ended December 31, 1995, these reductions were more than offset by increased costs of money market deposit and certificate accounts which increased from 2.42% and 4.18%, respectively, to 2.96% and 5.41%, respectively. The Company has generally held rates paid on savings and NOW accounts stable, while money market and certificate accounts are heavily influenced by market rates. While interest rates were generally falling throughout 1995, the Company's overall cost of funds of market sensitive accounts lag the current market. 20 13 Provision for Loan Losses The Company's provision for loan losses amounted to $3.6 million for the year ended December 31, 1995, compared to a provision of $283,000 for the year ended December 31, 1994. The increase in the provision for loan losses was due primarily to multi-family and commercial real estate loan charge-offs of $2.8 million related to eight loans arising from four lending relationships, due to vacancies, environmental problems with a landfill located in close proximity to the properties securing two of such loans, bankruptcies of borrowers and repayment delinquencies. The events leading to such charge-offs associated with such loans were generally attributable to adverse events occurring in 1995 which resulted in the Company reevaluating such loans or obtaining updated appraisals on the properties. The increase in the provision for loan losses was also caused by management's assessment of the increase in non-accrual loans of $1.7 million to $5.3 million at December 31, 1995 from a balance of $3.6 million at December 31, 1994. The increase in non-accrual loans was also primarily attributable to increased delinquencies of one of the four lending relationships mentioned above involving multi-family and commercial real estate loans. The allowance for loan losses was also increased from $3.7 million or .74% of loans at December 31, 1994 to $4.3 million or .82% of loans at December 31, 1995. Although the balance of the allowance for loan losses was increased during the year 1995, the ratio of the allowance to non-performing loans declined from 103.6% at December 31, 1994 to 81.4% at December 31, 1995. The Company establishes provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level which is deemed to be appropriate based upon management's assessment of the risk inherent in its loan portfolio in light of current economic conditions, actual loss experience, industry trends and other factors which may affect the real estate values in the Company's market area. While management believes the current allowance for loan losses is adequate, actual losses are dependent upon future events, and as such, future provisions for loan losses may be necessary. Non-Interest Income Non-interest income increased to $2.7 million for the year ended December 31, 1995 compared to $1.6 million for the same period in 1994. The primary reason for the improvement in non-interest income was the recognition of a gain on the sale of loans of $214,000 during the year ended December 31, 1995, whereas a loss of $748,000 was incurred during the comparable period in 1994 consisting of a $536,000 loss on sale of loans due to the rapid increase in interest rates and its impact on the uncovered portion of the Company's mortgage pipeline and a $212,000 mark to market downward adjustment on loans previously contracted for a sale which was not completed. Deposit service fees increased by $165,000 or 32.8% to $668,000 for the year ended December 31, 1995 from the prior year's total of $503,000 primarily due to increased fee generation provided by the new checking account program. Additionally, a gain of $32,000 was recorded on the sale of investment securities available for sale during the year ended December 31, 1995 compared to a loss of $127,000 in the prior year due to the sale of investment securities available for sale. Non-Interest Expense Total non-interest expense increased $1.5 million, or 10.3% from $14.5 million for the prior year ended December 31, 1994 to $16.0 million for the year ended December 31, 1995. A primary contributing factor to this increase was an additional compensation and benefits expense of $887,000 during the year ended December 31, 1995 as the first year of the ESOP was implemented. The ESOP expense consisted of the first full year's contribution to the ESOP of $755,000 to enable the ESOP to make principal payments on a loan from BF Funding Corporation, a wholly-owned subsidiary of the Company. The ESOP expense also included $132,000 comprised of the increased market value of the ESOP shares compared to original cost on the shares allocated as a result of the loan repayment. In accordance with AICPA Statement of Position 93-6, the $132,000 was credited to additional paid-in capital. Excluding the ESOP expense, compensation for the year ended December 31, 1995 would have decreased to $7.5 million, compared to $7.6 million for the prior year. An increase in advertising expense from $351,000 for the year ended December 31, 1994 to $736,000 in the current year is another factor in the increase in non-interest expenses. The major reason for the increase in advertising was due to increased expenses incurred to promote a new line of checking account products. Other non-interest expense also increased from $2.3 million for the year ended December 31, 1994 to $2.6 million for the current year due to a variety of added costs associated with the growth of new checking account deposits and costs of operating in a public environment. Income Taxes Income tax expense was $815,000 for the year ended December 31, 1995 (resulting in an effective tax rate of 41.8%), compared to $2.3 million for the year ended December 31, 1994 (resulting in an 21 14 effective tax rate of 36.6%). The current year effective tax rate approximates the combined federal and state statutory rates, less a reduction of 5.4% due to a decrease in the valuation allowance, offset by a 2.8% increase due to a non-deductible expense for the appreciation in the fair value of the allocated ESOP shares. The effective tax rate for the year ended December 31, 1994 was lower than expected due to the impact of a lower effective state tax rate. Impact of New Accounting Standards In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities ("SFAS 125"). SFAS 125 establishes, among other things, new criteria for determining whether a transfer of financial assets in exchange for cash or other consideration should be accounted for as a sale or as a pledge of collateral in a secured borrowing. SFAS 125 also establishes new accounting requirements for pledged collateral. SFAS 125 is effective for most transactions occurring after December 31, 1996 and must be applied prospectively. However, SFAS 127, Deferral of the Effective Date of Certain Provisions of SFAS 125, requires the deferral of implementation as it relates to repurchase agreements, dollar-rolls, securities lending and similar transactions in the years beginning after December 31, 1997. The Company has determined that the adoption of SFAS 125 will not have a material impact on its consolidated financial statements. 22 15 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Burlington, Massachusetts Consolidated Financial Statements December 31, 1996, 1995 and 1994 (With Independent Auditors' Report Thereon) 16 Independent Auditors' Report The Board of Directors BostonFed Bancorp, Inc.: We have audited the accompanying consolidated balance sheets of BostonFed Bancorp, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BostonFed Bancorp, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. As discussed in note 1, the Company changed its method of accounting for mortgage servicing rights effective January 1, 1996. /s/ KPMG Peat Marwick LLP Boston, Massachusetts January 30, 1997 17 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in Thousands) December 31, 1996 and 1995
Assets 1996 1995 -------- ------- Cash and due from banks (note 1) $ 15,335 10,765 Daily federal funds sold 2,930 10,000 Short-term investments (note 1) 13 460 --------- --------- Total cash and cash equivalents 18,278 21,225 Investment securities available for sale (amortized cost of $1,085 at 1996 and $1,022 at 1995) (note 4) 1,085 1,022 Investment securities held to maturity (fair value of $19,045 at 1996 and $16,804 at 1995) (notes 5 and 14) 19,170 16,906 Mortgage-backed securities available for sale (amortized cost of $23,915 at 1996 and $23,873 at 1995) (notes 4, 13 and 14) 23,593 23,873 Mortgage-backed securities held to maturity (fair value of $43,033 at 1996 and $35,647 at 1995) (notes 5 and 14) 43,019 35,116 Mortgage loans held for sale 3,970 8,931 Loans, net of allowance for loan losses of $4,400 at 1996 and $4,275 at 1995 (notes 6, 7 and 14) 676,670 509,496 Accrued interest receivable (notes 8 and 13) 4,067 3,696 Stock in FHLB of Boston, at cost (note 14) 16,295 8,374 Premises and equipment, net (note 9) 4,979 5,246 Real estate held for sale or development (note 10) 874 874 Real estate owned (note 11) 2,668 971 Income tax receivable (note 15) 449 272 Deferred income tax asset, net (note 15) 1,537 2,112 Prepaid expenses and other assets (note 6) 3,913 2,638 --------- --------- Total assets $ 820,567 640,752 ========= ========= Liabilities and Stockholders' Equity Liabilities: Deposit accounts (note 12) $ 428,818 419,104 Securities sold under agreements to repurchase (note 13) 3,500 7,000 Federal Home Loan Bank advances (note 14) 296,500 119,909 Advance payments by borrowers for taxes and insurance 2,100 1,531 Accrued expenses and other liabilities 3,294 2,507 --------- --------- Total liabilities 734,212 550,051 --------- --------- Commitments and contingencies (notes 3, 4, 5, 7, 9, 16, 17, 18 and 19) Stockholders' equity (notes 2, 3 and 16): Preferred stock, $.01 par value; 1,000,000 shares authorized; none issued -- -- Common stock, $0.01 par value; 17,000,000 shares authorized; 6,589,617 issued at 1996 and 1995 66 66 Additional paid-in capital 64,461 63,987 Retained earnings 33,131 31,183 Net unrealized loss on investments available for sale (322) -- Treasury stock, at cost (329,300 shares at 1996) (4,739) -- Unallocated ESOP shares (3,929) (4,535) Unearned 1996 Stock-Based Incentive Plan (2,313) -- --------- --------- Total stockholders' equity 86,355 90,701 --------- --------- Total liabilities and stockholders' equity $ 820,567 640,752 ========= =========
See accompanying notes to consolidated financial statements. 18 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income (In Thousands, Except per Share Data) Years ended December 31, 1996, 1995 and 1994
1996 1995 1994 ------ ------ ------ Interest and dividend income: Loans (note 6) $ 45,513 38,079 32,578 Mortgage-backed securities 4,998 2,430 2,427 Investment securities 2,001 1,652 1,465 Federal funds sold 166 293 57 ------ ------ ------ Total interest and dividend income 52,678 42,454 36,527 ------ ------ ------ Interest expense: Deposit accounts (note 12) 15,698 15,123 12,687 Borrowed funds (notes 13 and 14) 13,193 8,429 4,335 ------ ------ ------ Total interest expense 28,891 23,552 17,022 ------ ------ ------ Net interest and dividend income 23,787 18,902 19,505 Provision for loan losses (note 7) 1,294 3,614 283 ------ ------ ------ Net interest and dividend income after provision for loan losses 22,493 15,288 19,222 ------ ------ ------ Non-interest income: Loan processing and servicing fees (note 6) 1,330 1,318 1,330 Deposit service fees 1,140 668 503 Gain (loss) on sale of loans 668 214 (748) Gain (loss) on sale of investments (note 4) (11) 32 (127) Other 440 440 682 ------ ------ ------ Total non-interest income 3,567 2,672 1,640 ------ ------ ------ Non-interest expense: Compensation and benefits (note 16) 9,841 8,423 7,575 Occupancy and equipment 2,479 2,231 2,174 Deposit insurance premiums 916 947 1,109 Advertising expense 588 736 351 Data processing 600 615 523 Real estate operations (notes 10 and 11) 561 448 466 SAIF special assessment (note 3) 2,670 -- -- Other 3,385 2,609 2,333 ------ ------ ------ Total non-interest expense 21,040 16,009 14,531 ------ ------ ------ Income before income taxes 5,020 1,951 6,331 Income tax expense (note 15) 2,083 815 2,320 ------ ------ ------ Net income $ 2,937 1,136 4,011 ====== ====== ====== Earnings per share (note 1) $ .48 NM NM ====== ====== ====== Weighted average shares outstanding 6,118 NM NM ====== ====== ======
See accompanying notes to consolidated financial statements. 19 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity (In Thousands, Except per Share Data) Years ended December 31, 1996, 1995 and 1994
Shares of Additional Preferred common Common paid-in Retained stock stock stock capital earnings ----- ----- ----- ------- -------- Balance at December 31, 1993 $ -- -- $ -- -- 26,036 Net income -- -- -- -- 4,011 Change in net unrealized loss on investments available for sale, net of taxes -- -- -- -- -- ----- ----- ----- ------ ------ Balance at December 31, 1994 -- -- -- -- 30,047 Stock issued pursuant to initial common stock offering -- 6,590 66 63,855 -- Common stock acquired by ESOP -- -- -- -- -- Reduction in unallocated ESOP shares charged to expense -- -- -- -- -- Appreciation in fair value of allocated ESOP shares charged to expense -- -- -- 132 -- Net income -- -- -- -- 1,136 ----- ----- ----- ------ ------ Balance at December 31, 1995 -- 6,590 66 63,987 31,183 Net unrealized gain (loss) on Unearned investments Unallocated Stock-Based Total Treasury available ESOP Incentive stockholders' stock for sale, net shares Plan ("SIP") equity ----- ------------- ------ ------------ ------ Balance at December 31, 1993 -- (19) -- -- 26,017 Net income -- -- -- -- 4,011 Change in net unrealized loss on investments available for sale, net of taxes -- 19 -- -- 19 ------ ------ ------- ------ ------ Balance at December 31, 1994 -- -- -- -- 30,047 Stock issued pursuant to initial common stock offering -- -- -- -- 63,921 Common stock acquired by ESOP -- -- (5,290) -- (5,290) Reduction in unallocated ESOP shares charged to expense -- -- 755 -- 755 Appreciation in fair value of allocated ESOP shares charged to expense -- -- -- -- 132 Net income -- -- -- -- 1,136 ------ ------ ------- ------ ------ Balance at December 31, 1995 -- -- (4,535) -- 90,701
(Continued) 20 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity (Continued) (In Thousands, Except per Share Data) Years ended December 31, 1996, 1995 and 1994
Shares of Additional Preferred common Common paid-in Retained stock stock stock capital earnings ----- ----- ----- ------- -------- Common stock repurchased (329,300 shares at an average price of $14.39 per share) $ -- $ -- -- -- (4,739) Cash dividends declared and paid (.15 per share) -- -- -- -- (989) Reduction in unallocated ESOP shares charged to expense -- -- -- -- -- Appreciation in fair value of allocated ESOP shares charged to expense -- -- -- 287 -- Common stock acquired for SIP -- -- -- -- -- Earned portion of SIP shares charged to expense -- -- -- -- -- Appreciation in fair value of SIP shares charged to expense -- -- -- 187 -- Changes in net unrealized loss in investments available for sale, net -- -- -- -- -- Net income -- -- -- -- 2,937 ----- ----- ------- ------ ------ Balance at December 31, 1996 $ -- 6,590 $ 66 64,461 33,131 ===== ===== ======= ====== ======
Net unrealized gain (loss) on Unearned investments Unallocated Stock-Based Total Treasury available ESOP Incentive stockholders' stock for sale, net shares Plan ("SIP") equity ----- ------------- ------ ------------ ------ Common stock repurchased (329,300 shares at an average price of $14.39 per share) -- -- -- (4,739) Cash dividends declared and paid (.15 per share) -- -- -- -- (989) Reduction in unallocated ESOP shares charged to expense -- -- 606 -- 606 Appreciation in fair value of allocated ESOP shares charged to expense -- -- -- -- 287 Common stock acquired for SIP -- -- -- (3,230) (3,230) Earned portion of SIP shares charged to expense -- -- -- 917 917 Appreciation in fair value of SIP shares charged to expense -- -- -- -- 187 Changes in net unrealized loss in investments available for sale, net -- (322) -- -- (322) Net income -- -- -- -- 2,937 ------ ---- ------ ------ ------ Balance at December 31, 1996 (4,739) (322) (3,929) (2,313) 86,355 ====== ==== ====== ====== ======
See accompanying notes to consolidated financial statements. 21 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (In Thousands) For the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 -------- ------- -------- Net cash flows from operating activities: Net income $ 2,937 1,136 4,011 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and accretion, net 1,034 1,109 1,125 Earned SIP shares 917 -- -- Appreciation in fair value of ESOP shares 287 132 -- Appreciation in fair value of SIP shares 187 -- -- Provision for loan losses 1,294 3,614 283 Provision for valuation allowance for real estate owned 335 246 322 Loans originated for sale (143,064) (78,041) (77,562) Proceeds from sale of loans 148,693 69,640 102,349 Write-downs (recovery) of real estate held for sale or development -- (54) 55 Net (gain) loss on sale of investment securities 11 (32) 127 Gain on sale of real estate held for sale or development -- (113) (201) Decrease (increase) in deferred income taxes 575 49 (39) Increase in income tax receivable (177) (272) -- Loss on sale of real estate acquired through foreclosure 44 -- 224 Loss (gain) on sale of loans (668) (214) 748 Increase in accrued interest receivable (371) (694) (498) Increase (decrease) in minority interest -- (226) 1 Decrease (increase) in prepaid expenses and other assets (1,275) 167 (708) Increase (decrease) in accrued expenses and other liabilities 787 (935) 135 -------- ------- -------- Net cash provided by (used in) operating activities 11,546 (4,488) 30,372 -------- ------- -------- Cash flows from investing activities: Proceeds from sales of investment securities available for sale -- 3,096 2,998 Proceeds from sale of mortgage-backed securities available for sale 10,614 -- -- Proceeds from maturities of investment securities available for sale -- -- 1,000 Proceeds from maturities of investment securities held to maturity 1,745 3,279 6,383 Purchase of investment securities available for sale (63) (4,088) (105) Purchase of investment securities held to maturity (9,992) (8,710) (10,129) Purchase of mortgage-backed securities available for sale (10,666) (23,873) -- Purchase of mortgage-backed securities held to maturity (13,891) -- -- Principal repayments on investment securities held to maturity 6,009 3,340 -- Principal repayments on mortgage-backed securities held to maturity 5,934 4,586 5,307 Increase in portfolio loans, net (172,557) (15,691) (114,722) Purchase of FHLB stock (7,921) (743) (3,268) Purchases of premises and equipment (617) (1,490) (367) Proceeds from sale of real estate held for sale or development -- 200 427 Additional investment in real estate held for sale or development -- (4) (82) Proceeds from sale of real estate owned 2,249 596 3,090 Additional investments in real estate owned (359) (93) (210) -------- ------- -------- Net cash used in investing activities (189,515) (39,595) (109,678) ======== ======= ========
(Continued) 22 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) (In Thousands)
1996 1995 1994 --------- -------- -------- Cash flows from financing activities: Increase (decrease) in deposits accounts $ 9,714 5,940 (23,734) Proceeds from securities sold under agreement to repurchase 2,973 7,000 -- Repayments of securities sold under agreement to repurchase (6,473) -- -- Proceeds from Federal Home Loan Bank advances 670,304 461,029 483,763 Repayments of Federal Home Loan Bank advances (493,713) (476,151) (379,613) Increase (decrease) in advance payments by borrowers for taxes and insurance 569 (204) 251 Net proceeds from common stock issued pursuant to initial public offering -- 63,921 -- Cash dividends paid (989) -- -- Common stock repurchased (4,739) -- -- Payments to acquire common stock for ESOP -- (5,290) -- Reduction in unallocated ESOP shares 606 755 -- Purchase of common stock for SIP (3,230) -- -- --------- -------- -------- Net cash provided by financing activities 175,022 57,000 80,667 --------- -------- -------- Net increase (decrease) in cash and cash equivalents (2,947) 12,917 1,361 Cash and cash equivalents at beginning of year 21,225 8,308 6,947 --------- -------- -------- Cash and cash equivalents at end of year $ 18,278 21,225 8,308 ========= ======== ======== Supplemental disclosure of cash flow information: Payments during the year for: Interest $ 27,889 23,803 16,489 ========= ======== ======== Taxes $ 1,664 1,293 2,141 ========= ======== ======== Supplemental schedule of noncash investing activities: Transfers of mortgage loans to real estate owned $ 3,966 1,333 710 ========= ======== ========
See accompanying notes to consolidated financial statements. 23 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies (Dollars in Thousands) As more fully described in note 2, Boston Federal Savings Bank (the "Bank") converted from a mutual savings bank to a capital stock savings bank on October 24, 1995. As part of the conversion, BostonFed Bancorp, Inc. (the "Company") was formed, acquired all of the Bank's conversion stock, and issued its common stock in a subscription offering. The Company provides a variety of loan and deposit services to its customers through a network of eight locations. The Company's deposit gathering is concentrated in the communities surrounding its eight offices located in the greater Boston metropolitan area, municipalities of Arlington, Bedford, Billerica, Boston, Burlington, Lexington, Peabody and Wellesley. The Company is subject to competition from other financial institutions including commercial banks, other savings banks, credit unions, mortgage banking companies and other financial service providers. The Bank is subject to the regulations of, and periodic examination by, the Office of Thrift Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The Bank's deposits are insured by the Savings Association Insurance Fund of the FDIC. In preparing these financial statements, management is required to make estimates that affect the reported amounts of assets and liabilities as of the dates of the balance sheets, and income and expense for the periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change relate to the valuation allowance for deferred tax assets and the determination of the allowance for loan losses and valuation of real estate owned. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: Boston Federal Savings Bank and B.F. Funding Corporation ("B.F. Funding"). Boston Federal Savings Bank includes its wholly-owned subsidiaries, Leader Corporation and BFS Service Corporation, including investments in various real estate joint ventures. Leader Corp. has an ownership interest in three real estate development partnerships, two of which became dormant in 1996 as operations have been completed. Additionally, Leader Corp. leases office space from the Bank which it sublets to Liberty Financial Securities. BFS Service Corp. is dormant and is not currently conducting any business. B.F. Funding is a business corporation formed at the direction of the Company under the laws of the Commonwealth of Massachusetts on August 25, 1995. B.F. Funding was established to lend funds to a Company sponsored employee stock ownership plan trust for the purchase of stock at the initial public offering. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain amounts previously reported have been reclassified to conform to the current year's presentation. Cash and Due from Banks The Bank is required to maintain cash and reserve balances with the Federal Reserve Bank. Such reserve is calculated based upon deposit levels and amounted to $3,394 at December 31, 1996. (Continued) 24 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Short-Term Investments Short-term investments represent certificates of deposit with original maturities of 90 days or less. These investments are stated at cost which approximates market value. Investment and Mortgage-backed Securities Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost; debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and reported at fair value, with unrealized gains and losses included in earnings; and debt and equity securities not classified as either held-to-maturity or trading are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of related income taxes. The Company's investment in mutual funds (Cash Management Funds) is classified as available for sale. Premiums and discounts on investment and mortgage-backed securities are amortized or accreted into income by use of the interest method adjusted for prepayments. If a decline in fair value below the amortized cost basis of an investment or mortgage-backed security is judged to be other than temporary, the cost basis of the investment is written down to fair value as a new cost basis and the amount of the write-down is included as a charge against gain on sale of investment and mortgage-backed securities. Gains and losses on the sale of investment and mortgage-backed securities are recognized at the time of sale on a specific identification basis. Loans Loans are reported at the principal amount outstanding, reduced by unamortized discounts and net deferred loan origination fees. Loans held for sale are carried at the lower of aggregate cost or market value, considering loan production and sales commitments and deferred fees. Generally, all longer term (typically mortgage loans with terms in excess of ten years) fixed-rate residential single-family mortgage loans are originated for sale and adjustable-rate loans are originated both for portfolio and for sale. Occasionally, the Company generates fixed-rate loans which are designated for portfolio at the time of origination. Discounts and premiums on loans are recognized as income using the interest method over the remaining contractual term to maturity of the loans adjusted for prepayments. Loan origination fees are offset with related direct incremental loan origination costs and the resulting net amount is deferred and amortized to interest income over the contractual life of the associated loan using the interest method. Net deferred amounts on loans sold are included in determining the gain or loss on the sale when the related loans are sold. The Company sells mortgage loans for cash proceeds approximately equal to the principal amount of loans sold, but with yields to investors which reflect current market rates. Gain or loss is recognized and premium or discount is recorded at the time of sale in an amount reflecting the difference between the contractual interest rates to the borrower on the loans sold and the yield to the investor, adjusted for a normal service fee (1/4 to 3/8 of 1%), any guarantee fees and buyups and buydowns. The resulting deferred premium, if any, is amortized to loan interest income using the interest method over the contractual term of the loans sold, adjusted for estimated prepayments. Actual prepayment experience is reviewed periodically and the deferred premium is adjusted, if necessary. (Continued) 25 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The Company adopted the provisions of SFAS No. 122, Accounting for Mortgage Servicing Rights, which amends SFAS No. 65, Accounting for Certain Mortgage Banking Activities, on January 1, 1996. The Statement requires that a mortgage banking enterprise recognize as separate assets, rights to service mortgage loans for others, regardless of how those servicing rights are acquired. As a result of adopting SFAS No. 122, the net gain on sale of loans increased $1,095 for the year ended December 31, 1996. Mortgage loan servicing rights are amortized to loan processing servicing fee income using a method which approximates the level yield method in proportion to, and over the period of, estimated net servicing income. Capitalized mortgage servicing rights are assessed for impairment based on the fair value of those rights. Prepayment experience on mortgage servicing rights is reviewed periodically and, when actual repayments exceed estimated prepayments, the balance of the mortgage servicing asset is adjusted by a charge to earnings. Any impairment in the fair value of those mortgage servicing assets is recognized by a charge to earnings through a valuation allowance. The risk characteristics of the underlying loans used to measure impairment include loan type, interest rate, loan origination date, and term to maturity. Accrual of interest on loans is discontinued when collectibility of principal or interest is uncertain or payments of principal or interest have become contractually past due 90 days or more. Interest received on non-accrual loans is applied against the principal balance and all amortization of deferred fees is discontinued. Accrual is generally not resumed until the loan is brought current, the loan becomes well secured and in the process of collection and, in either case, when concern no longer exists as to the collectibility of principal or interest. Impaired loans are commercial real estate, multi-family, and non-accrual mortgage and consumer and other loans for which it is probable that the Company will not be able to collect all amounts due in accordance with the contractual terms of the loan agreement. Impaired loans, except those loans that are accounted for at fair value or at lower of cost or fair value, are accounted for at the present value of the expected future cash flows discounted at the loan's effective interest rate or as a practical expedient in the case of collateralized loans, the lower of the fair value of the collateral or the recorded amount of the loan. These Statements apply to all creditors and all loans, uncollateralized as well as collateralized, except large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value and leases and debt securities. Management considers the payment status, net worth and earnings potential of the borrower, and the value and cash flow of the collateral as factors to determine if a loan will be paid in accordance with its contractual terms. Management does not set any minimum delay of payments as a factor in reviewing for impaired classification. Impaired loans are charged off when management believes that the collectibility of the loan's principal is remote. Classification of a loan as in-substance foreclosure is made only when a lender is in substantive possession of the collateral. Allowance for Loan Losses The allowance for loan losses is established through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management determines that the collectibility of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. (Continued) 26 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Management believes the allowance is adequate to absorb probable loan losses. Factors considered in evaluating the adequacy of the allowance include trends in loan delinquencies and charge-offs, current economic conditions and their effect on borrowers' ability to pay, underwriting standards by loan type, mix and balance of the portfolio, and the performance of individual loans in relation to contract terms. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for 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. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio is affected by changes in market conditions. Premises and Equipment Premises and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets (3 to 40 years). Amortization of leasehold improvements is provided over the life of the related leases by use of the straight-line method. Rental income on leased facilities is included as a reduction of occupancy and equipment expense. Real Estate Held for Sale or Development Real estate held for sale or development is carried at the lower of cost or estimated net realizable value. Acquisition and development costs, including interest, are capitalized. The Company's investments in real estate are usually made on a joint venture basis. For each project the Company maintains a controlling interest. Management believes that the net carrying value of real estate held for sale or development adequately reflects the lower of its cost basis or estimated current net realizable value. Factors similar to those considered in the evaluation of the allowance for loan losses, including regulatory agency requirements, are considered in the evaluation of the net realizable value of real estate held for sale or development. Real Estate Owned Real estate owned is acquired through foreclosure or by accepting a deed in lieu of foreclosure. Real estate owned is recorded at the lower of the carrying value of the loan or the fair value, less disposal costs, of the property constructively or actually received, thereby establishing a new cost basis. Subsequent write-downs are recorded if the cost basis exceeds current net fair value. Related operating costs, net of rental income, are reflected in operations when incurred. Management believes that the net carrying value of real estate owned reflects the lower of its cost basis or estimated current net fair value. Factors similar to those considered in the evaluation of the allowance for loan losses, including regulatory agency requirements, are considered in the evaluation of the net fair value of real estate owned. (Continued) 27 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the accounting basis and the tax basis of the Bank's assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The Bank's deferred tax asset is reviewed periodically and adjustments to such asset are recognized as deferred income tax expense or benefit based on management's judgments relating to the realizability of such asset. Pension Pension cost is recognized over the employees' approximate service period. Employee Benefits In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). The Statement encourages companies to adopt a new accounting method based on the estimated fair value of employee stock options and other stock awards under which compensation cost is measured at the grant date based on the value of the award and is recognized over the service period. The Company continues to follow APB Opinion No. 25, Accounting for Stock Issued to Employees. See footnote 16 for the expanded disclosures required by SFAS 123 regarding pro forma net income and earnings per share. Earnings Per Share Earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year, calculated using the treasury stock method, adjusted for the weighted average number of unallocated shares held by the Employee Stock Ownership Plan ("ESOP") and the 1996 Stock-Based Incentive Plan ("SIP"). Stock options did not have a material dilutive effect. Earnings per share is not presented for the period of October 24, 1995 (the date of conversion to a stock savings bank) through December 31, 1995 as the earnings per share calculation for the sixty-nine day period was not meaningful. Earnings per share is not presented for the periods prior to the conversion to stock form, as the Bank was a mutual savings bank and no stock was outstanding. Recent Accounting Developments In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities ("SFAS 125"). SFAS 125 establishes, among other things, new criteria for determining whether a transfer of financial assets in exchange for cash or other consideration should be accounted for as a sale or as a pledge of collateral in a secured borrowing. SFAS 125 also establishes new accounting requirements for pledged collateral. SFAS 125 is effective for most transactions occurring after December 31, 1996 and must be applied prospectively. However, SFAS 127, Deferral of the Effective Date of Certain Provisions of SFAS 125, requires the deferral of implementation as it relates to repurchase agreements, dollar-rolls, securities lending and similar transactions in the years beginning after December 31, 1997. The Company has determined that the adoption of SFAS 125 will not have a material impact on its consolidated financial statements. (Continued) 28 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (2) Conversion to Stock Form of Ownership (Dollars in Thousands, Except per Share Data) The Company is a business corporation formed at the direction of the Bank under the laws of Delaware on July 11, 1995. On October 24, 1995, (i) the Bank converted from a federally chartered mutual savings bank to a federally chartered stock savings bank, (ii) the Bank issued all of its outstanding capital stock to the Company and (iii) the Company consummated its initial public offering of common stock, par value $.01 per share (the "Common Stock"), by selling 6,589,617 shares of Common Stock at a price of $10.00 per share to the Bank's Employee Stock Ownership Plan ("ESOP") and to certain of the Bank's eligible account holders who had subscribed for such shares (collectively, the "Conversion"). The Conversion resulted in net proceeds of $63.9 million, after expenses of $2.0 million. Net proceeds of $31 million were invested in the Bank to increase the Bank's tangible capital to 10% of the Bank's total adjusted assets. Prior to the initial public offering and as a part of the subscription offering, in order to grant priority to eligible depositors, the Bank established a liquidation account at the time of conversion in an amount equal to the retained earnings of the Bank as of the date of its latest balance sheet date, June 30, 1995, contained in the final Prospectus used in connection with the Conversion. In the unlikely event of a complete liquidation of the Bank (and only in such an event), eligible depositors who continue to maintain accounts at the Bank shall be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account is decreased if the balances of eligible depositors decrease on the annual determination dates. The liquidation account approximated $13.4 million (unaudited) at December 31, 1996. The Company may not declare or pay dividends on its stock if such declaration and payment would violate statutory or regulatory requirements. In addition to the 17,000,000 authorized shares of common stock, the Company authorized 1,000,000 shares of preferred stock with a par value of $0.01 per share (the OPreferred StockO). The Board of Directors is authorized, subject to any limitations by law, to provide for the issuance of the shares of preferred stock in series, to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences, and rights of the shares of each such series and any qualifications, limitations or restrictions thereof. As of December 31, 1996 there were no shares of preferred stock issued. (3) Stockholders' Equity (Dollars in Thousands) The Bank is subject to various regulatory capital requirements administered by the federal banking services. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulations that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. (Continued) 29 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of risk-weighted, core and tangible capital (as defined). Management represents, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. As of April 22, 1996, the most recent notification from the OTS categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized" the Bank must maintain minimum risk-weighted capital, core capital and tangible ratios as set forth in the table. As of December 31, 1996, the Bank is categorized as "well capitalized" based on its ratios of risk-weighted core and tangible capital. The Bank's actual capital amounts and ratios are presented in the table. No deduction was taken from capital for interest-rate risk.
To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ---------------- ---------------- ----------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- As of December 31, 1996: Risk-weighted capital $ 58,310 13.2% $35,301 8.0% $44,060 10.0% Core capital 53,910 6.8 23,868 3.0 39,780 5.0 Tangible capital 53,910 6.8 11,934 1.5 39,780 5.0 As of December 31, 1995: Risk-weighted capital $ 65,809 19.5% $26,959 8.0% $33,632 10.0% Core capital 62,086 10.2 18,206 3.0 30,343 5.0 Tangible capital 62,086 10.2 9,103 1.5 30,343 5.0
During 1996, the Company's Board of Directors approved a program to repurchase up to 329,481 or approximately 5% of its outstanding common shares. The Company plans to hold the repurchased shares as treasury stock to be used for general company purposes. During the year ended December 31, 1996, 329,300 shares were repurchased under this program at a total cost of $4.7 million. The Company's deposits are insured by the Savings Association Insurance Fund ("SAIF") of the FDIC. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 (the "Act"). Among other provisions, the Act empowers the Board of Directors of the FDIC to impose a special assessment on "SAIF-assessable deposits" as of March 31, 1995 of depository institutions to recapitalize the SAIF. The Company was assessed a rate of 65.7 cents per $100 of SAIF-assessable deposits. The Company recorded a charge to SAIF special assessment expense of $2.7 million on September 30, 1996. (Continued) 30 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (4) Investment and Mortgage-Backed Securities Available for Sale (Dollars in Thousands) The amortized cost and fair values of investment and mortgage-backed securities available for sale are shown below by contractual maturity:
December 31, 1996 ----------------------------------------------------------- Weighted Amortized Unrealized Unrealized Fair average rate cost gains losses value ------------ --------- ---------- ---------- ------- Investment securities: Cash management funds 6.0% $ 1,085 -- -- 1,085 Mortgage-backed securities: Maturing after 5 years but within 10 years 7.0% $10,036 -- (153) 9,883 Maturing after 10 years 6.1% 13,879 -- (169) 13,710 Total mortgage-backed securities $23,915 -- (322) 23,593 ======= ===== ===== ======= December 31, 1995 ----------------------------------------------------------- Weighted Amortized Unrealized Unrealized Fair average rate cost gains losses value ------------ --------- ---------- ---------- ------- Investment securities: Cash management funds 6.3% $ 1,022 -- -- 1,022 Mortgage-backed securities: Maturing after 5 years but within 10 years 7.0% $11,268 -- -- 11,268 Maturing after 10 years 6.8% 12,605 -- -- 12,605 Total mortgage-backed securities $23,873 -- -- 23,873 ======= ===== ===== =======
Maturities of mortgage-backed securities are shown at final contractual maturity but are expected to have shorter lives because borrowers have the right to prepay obligations without prepayment penalties. At December 31, 1996, mortgage-backed securities with book value of $5,597 and fair value of $5,512 were pledged as collateral for securities sold under agreement to repurchase. At December 31, 1995, mortgage-backed securities with a book value and fair value of $7,407 were pledged as collateral for securities sold under agreement to repurchase. (Continued) 31 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The composition by issuer of mortgage-backed securities available for sale follows: December 31, ------------------------------------------------- 1996 1995 --------------------- ---------------------- Amortized Fair Amortized Fair cost value cost value ------- ------- ------- ------- FHLMC $10,036 9,883 11,268 11,268 GNMA 13,879 13,710 12,605 12,605 ------- ------- ------- ------- $23,915 23,593 23,873 23,873 ======= ======= ======= ======= Proceeds from the sale of investment securities available for sale amounted to $3,096 in 1995 and $2,998 in 1994. There were not such sales in 1996. Realized gains and losses on investment securities available for sale were $37 and $5, respectively, in 1995. There were $127 in realized losses on investment securities available for sale for the year ended 1994. Proceeds from the sale of mortgage-backed securities available for sale amounted to $10,614 in 1996. Realized gains and losses on mortgage-backed securities available for sale were $8 and $19, respectively, in 1996. There were no sales of mortgage-backed securities available for sale in 1995 and 1994. (5) Investment and Mortgage-Backed Securities Held to Maturity (Dollars in Thousands) The amortized cost and fair values of investment and mortgage-backed securities held to maturity are shown below by contractual maturity:
December 31, 1996 ----------------------------------------------------------- Weighted Amortized Unrealized Unrealized Fair average rate cost gains losses value ------------ --------- ---------- ---------- ------- Investment securities: U.S. government, federal agency and other obligations: Maturing within one year 5.6% $ 2,004 -- (3) 2,001 Maturing after 1 year but within 5 years 5.9% 15,916 43 (167) 15,792 Maturing after 5 years but within 10 years 7.0% 1,000 2 -- 1,002 -------- --- ---- ------ 18,920 45 (170) 18,795 -------- --- ---- ------ Certificates of deposit: Maturing after 1 year but within 5 years 5.1% 250 -- -- 250 -------- --- ---- ------ Total investment securities $ 19,170 45 (170) 19,045 ======== === ==== ====== Mortgage-backed securities: Maturing after 1 year but within 5 years 6.5% $ 51 -- (2) 49 Maturing after 5 years but within 10 years 7.7% 5,485 86 (51) 5,520 Maturing after 10 years 7.1% 37,483 113 (132) 37,464 -------- --- ---- ------ Total mortgage-backed securities $ 43,019 199 (185) 43,033 ======== === ==== ======
(Continued) 32 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
December 31, 1995 ----------------------------------------------------------- Weighted Amortized Unrealized Unrealized Fair average rate cost gains losses value ------------ --------- ---------- ---------- ------- Investment securities: U.S. government, federal agency and other obligations: Maturing within one year 5.2% $ 1,500 1 (6) 1,495 Maturing after 1 year but within 5 years 5.2% 13,911 58 (132) 13,837 Maturing after 5 years but within 10 years 5.5% 1,000 -- (23) 977 16,411 59 (161) 16,309 Certificates of deposit: Maturing after 1 year but within 5 years 5.7% 495 -- -- 495 Total investment securities $ 16,906 59 (161) 16,804 Mortgage-backed securities: Maturing after 5 years but within 10 years 7.4% $ 4,964 117 -- 5,081 Maturing after 10 years 6.5% 30,152 414 -- 30,566 Total mortgage-backed securities $ 35,116 531 -- 35,647
Maturities of mortgage-backed securities are shown at final contractual maturity but are expected to have shorter lives because borrowers have the right to prepay obligations without prepayment penalties. A U.S. Agency note with amortized cost of $500 at December 31, 1996 and 1995, and fair value of $491 and $490 at December 31, 1996 and 1995, respectively, was pledged to secure certain of the Bank's recourse liabilities relating to loans sold as described in note 6. A U.S. Agency note with an amortized cost of $1,000 and $500 at December 31, 1996 and 1995, respectively, and a fair value of $991 and $481 at December 31, 1996 and 1995, respectively was pledged to provide collateral for customer and the Bank's employee tax withholdings that are to be remitted to the federal government in excess of the $100 of withholdings insured by the FDIC. Included in U.S. government, federal agency and other obligations are investments with callable features that can be called prior to final maturity with an amortized cost of $10,996 and a fair value of $10,925 at December 31, 1996. (Continued) 33 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The composition by issuer of mortgage-backed securities held to maturity follows: December 31, ------------------------------------- 1996 1995 ------------------ ---------------- Amortized Fair Amortized Fair cost value cost value ---- ----- ---- ----- FHLMC $ 1,356 1,330 1,824 1,830 FNMA 1,147 1,129 1,512 1,531 GNMA 26,611 26,696 31,780 32,286 Privately issued collateralized mortgage obligation 13,905 13,878 -- -- $43,019 43,033 35,116 35,647 (6) Loans (Dollars in Thousands) The Company's lending activities are conducted principally in eastern Massachusetts. The Bank grants single-family and multifamily residential loans, commercial real estate loans, commercial loans and a variety of consumer loans. In addition, the Company grants loans for the construction of residential homes, multifamily properties, commercial real estate properties and for land development. Approximately 99% of the loans granted by the Company are secured by real estate collateral. The ability and willingness of the single-family residential and consumer borrowers to honor their repayment commitments is generally dependent, among other things, on the level of overall economic activity within the borrowers' geographic areas and real estate values. The ability and willingness of commercial real estate, commercial and construction loan borrowers to honor their repayment commitments is generally affected by the health of the real estate economic sector in the borrowers' geographic areas and the general economy. (Continued) 34 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The Company's loan portfolio was comprised of the following at December 31: 1996 1995 ---- ---- Mortgage loans: Residential 1-4 family $ 603,822 438,102 Multi-family 21,381 27,986 Construction and land 12,532 3,435 Commercial real estate 28,136 26,412 --------- ------- 665,871 495,935 --------- ------- Consumer and other loans: Home equity and improvement 17,417 14,914 Secured by deposits 979 1,092 Consumer 1,730 1,673 Business 724 664 --------- ------- 20,850 18,343 --------- ------- Total loans 686,721 514,278 Less: Allowance for loan losses (note 7) (4,400) (4,275) Construction loans in process (6,936) (805) Net unearned discount on loans purchased (163) (262) Deferred loan origination costs 1,448 560 --------- ------- Loans, net $ 676,670 509,496 ========= ======= Included in 1-4 family residential mortgage loans at December 31, 1996 and 1995, respectively, were $464,883 and $287,153 of loans at variable interest rates. Most other loans are also of a variable rate nature. The Company services mortgage loans for investors which are not included in the accompanying consolidated balance sheets totaling approximately $540,356 and $491,794 at December 31, 1996 and 1995, respectively. Of these loans serviced for others, $1,010 and $1,028 at December 31, 1996 and 1995, respectively, had been sold with recourse by the Company. In addition, at December 31, 1996 and 1995, respectively, the Company had retained the secondary layer of recourse risk on $9,861 and $10,788 of serviced loans, with such risk limited to $267 and $267 after the first layer (25% of each such loss, not to exceed $2,200) is exhausted. The losses incurred on loans subject to recourse amounted to $53 and $137 for the years ended December 31, 1995 and 1994, respectively. There were no such losses on loans subject to recourse in 1996. (Continued) 35 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Proceeds from the sales of mortgage loans were $148,693 for 1996, $69,640 for 1995 and $102,349 for 1994. At December 31, 1996 and 1995, the Company had capitalized excess service fees from loans sold of $384 and $495, respectively, included in prepaid expenses and other assets. A summary of the activity of the mortgage servicing rights, which is included as a component of other assets, for the year ended December 31 follows: Balance at December 31, 1995 $ -- Capitalized mortgage servicing rights 1,095 Amortization (107) ------- Balance at December 31, 1996 $ 988 ======= The Company has determined that the fair value of mortgage servicing rights at December 31, 1996 exceeds their carrying amount. Therefore, a valuation allowance for the mortgage servicing rights was not established. The regulations established by FIRREA implemented a "loan to one borrower limit" equal to 15% of capital and general valuation reserves or approximately $10,000 for the Company. The Company did not have any borrower relationships which exceeded the limit as of December 31, 1996 and 1995. In the ordinary course of business, the Company makes loans to its directors and officers and their related interests at substantially the same terms prevailing at the time of origination for comparable transactions with borrowers. The following is a summary of related party loan activity: 1996 1995 ---- ---- Balance, beginning of year $ 951 988 Originations -- -- Payments (86) (37) Net changes in equity lines (19) ----- --- Balance, end of year $ 846 951 ===== === At December 31, 1996 and 1995, total impaired loans were $4,392 and $8,356, respectively. In the opinion of management, no impaired loans required a specific valuation allowance at December 31, 1996 and $618,000 of impaired loans required a specific valuation allowance of $618,000 at December 31, 1995. All impaired loans have been measured using the fair value of the collateral method. The average recorded value of impaired loans was $5,450 during 1996 and $8,683 during 1995. The Company follows the same policy for recognition of income on impaired loans as it does for all other loans. (Continued) 36 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The following table summarizes information regarding the reduction of interest income on impaired loans at December 31: 1996 1995 ---- ---- Income in accordance with original terms $497 943 Income recognized 321 563 --- --- Foregone interest income during year $176 380 ==== === All of the Company's non-accrual loans are considered to be impaired loans. Non-accrual loans at December 31, 1996 and 1995 were $1,502 and $5,252, respectively. The foregone interest on non-accrual loans was $103 in 1996, $303 in 1995 and $281 in 1994. At December 31, 1996 and 1995, there were no commitments to lend additional funds to those borrowers whose loans were classified as impaired. (7) Allowance for Loan Losses (In Thousands) The following is a summary of the activity in the allowance for loan losses for the years ended December 31: 1996 1995 1994 ---- ---- ---- Balance, beginning of year $ 4,275 3,700 4,450 Provision charged to income 1,294 3,614 283 Recoveries 343 485 185 Charge-offs (1,512) (3,524) (1,218) ------- ------ ------ Balance, end of year $ 4,400 4,275 3,700 ======= ====== ====== (8) Accrued Interest Receivable (In Thousands) Accrued interest receivable as of December 31 is presented in the following table: 1996 1995 ---- ---- Investment and mortgage-backed securities $ 13 569 Loans 4,054 3,127 ----- ----- $4,067 3,696 ====== ===== (Continued) 37 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (9) Premises and Equipment (In Thousands) A summary of the cost, accumulated depreciation and amortization of land, buildings and equipment is as follows at December 31: 1996 1995 ---- ---- Land $ 519 519 Buildings 3,114 3,086 Furniture, fixtures and equipment 4,841 4,280 Leasehold improvements 1,296 1,251 ------- ----- 9,770 9,136 Less accumulated depreciation and amortization (4,791) (3,890) ------- ----- $ 4,979 5,246 ======= ===== The Company presently leases office space at three locations and is committed to minimum annual rentals plus lease escalations. Such leases expire at various dates with options to renew. Minimum future rentals are as follows at December 31: Year ended December 31, 1997 $1,022 1998 889 ------ $1,911 ====== Rent expense was $1,095 in 1996, $1,059 in 1995 and $1,009 in 1994. The Company leases, as lessor, office space at two of its branch locations. The leases expire at various dates with options to renew. Minimum future rental income is as follows at December 31: Year ended December 31, 1997 $125 1998 117 1999 101 2000 61 2001 15 ---- $419 ==== (10) Real Estate Held for Sale or Development (In Thousands) The Company's investment in real estate held for sale or development consists of the following: Type of Property 1996 1995 ---------------- ---- ---- Land $ 2,459 2,459 Write-downs to net realizable value (1,585) (1,585) ------ ------ Net investment in real estate $ 874 874 ====== ====== (Continued) 38 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Sales in the Company's joint venture interests resulted in the following: 1995 1994 ---- ---- Gross sales $ 200 427 Cost of sales (87) (226) ----- --- Operating gain (loss) 113 201 Recoveries (write-downs) 54 (55) ----- --- Net gain $ 167 146 ===== === There were no sales in the Company's joint venture interests for the year ended December 31, 1996. Operating expenses on real estate held for sale or development were $51 in 1996, $309 in 1995 and $148 in 1994. (11) Real Estate Owned (In Thousands) The table below presents the composition of real estate owned by property type at December 31: 1996 1995 ---- ---- Single-family homes $ 84 166 Condominiums -- 31 Multi-family 167 -- Apartment buildings 720 -- Land subdivisions 86 87 Commercial property 2,047 930 ------- --- 3,104 1,214 Valuation allowance to net fair value (436) (243) ------- --- $ 2,668 971 ======= === At December 31, 1996, all real estate owned apartment buildings represent property classified as substantively repossessed. Commercial property includes $411 in property classified as substantively repossessed at December 31, 1996 and 1995. (Continued) 39 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The following is a summary of the activity in the valuation allowance for real estate owned: 1996 1995 1994 ---- ---- ---- Balance, beginning of year $ 243 168 1,372 Provision charged to income 335 246 322 Charge-offs (142) (171) (1,526) ------ --- ----- Balance, end of period $ 436 243 168 ====== === ===== The table below summarizes the operating results of real estate owned: 1996 1995 1994 ---- ---- ---- Income from holding real estate $ 163 3 147 Expenses of holding real estate (294) (63) (65) Losses from disposition of properties (44) -- (224) Additions to the valuation allowance (335) (246) (322) ----- ---- ---- Net loss $(510) (306) (464) ===== ==== ==== (12) Deposit Accounts (Dollars in Thousands) A summary of deposit balances by type is as follows at December 31:
1996 1995 ----------------------- ----------------------- Weighted Weighted average average Amount rate Amount rate ------ ---- ------ ---- NOW $ 78,517 1.21% $ 71,374 1.45% Regular and statement savings 88,100 2.49 91,492 2.50 Money market 45,788 3.01 47,897 3.00 Demand deposits and official checks 16,289 -- 12,167 -- -------- -------- Total noncertificate accounts 228,694 1.98 222,930 2.13 -------- -------- Certificate accounts: 3 to 6 months 29,257 5.03 19,468 5.00 1 to 3 year 115,946 5.57 121,190 5.75 Greater than 3 years 7,061 5.44 6,917 5.38 IRA/Keogh 47,860 5.77 48,599 6.00 -------- -------- Total certificate accounts 200,124 5.53 196,174 5.72 -------- -------- $428,818 3.64% $419,104 3.81% ======== ==== ======== ==== Contractual maturity of certificate accounts: Within one year $135,026 $129,819 One to two years 37,949 42,487 Two to three years 16,546 12,140 Over three years 10,603 11,728 -------- -------- $200,124 $196,174 ======== ========
(Continued) 40 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Aggregate amount of certificate accounts of $100 or more were $15,256 and $15,062 at December 31, 1996 and 1995, respectively. Deposit amounts in excess of $100 are not federally insured. Interest expense on deposits consisted of the following for the years ended December 31: 1996 1995 1994 ---- ---- ---- NOW $ 890 931 1,017 Regular and statement savings 2,219 2,485 3,185 Money market 1,395 1,472 1,442 Certificate accounts 11,194 10,235 7,043 ------- ------ ------ $15,698 15,123 12,687 ======= ====== ====== (13) Securities Sold Under Agreement to Repurchase (Dollars in Thousands) 1996 1995 ------------- ------------- Amount Rate Amount Rate ------ ---- ------ ---- Securities sold under agreements to repurchase, due on demand $ 3,500 5.45% $7,000 5.43% ======= ==== ====== ==== Securities sold under agreements to repurchase are collateralized by mortgage-backed securities with a book value of $3,566 and a fair value of $3,578 at December 31, 1996. At December 31, 1995, mortgage-backed securities with a book value and fair value of $7,407 were pledged as collateral against securities sold under agreements to repurchase. During the year ended December 31, 1994, there were no securities sold under agreements to repurchase. The securities had $26 and $64 of accrued interest receivable at December 31, 1996 and 1995, respectively. Securities sold under agreement to repurchase averaged $7,496 during 1996, and $96 during 1995. Maximum amounts outstanding at any month end during 1996 and 1995 were $9,973 during 1996 and $7,000 during 1995. The average costs of repurchase agreements was 5.86% in 1996 and 5.43% in 1995. The $3,500 represents one commitment with a scheduled maturity of December 26, 1997. The securities collateralizing the agreements are not under the Company's control. Interest expense was $439 in 1996 and $5 in 1995. (Continued) 41 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (14) Federal Home Loan Bank ("FHLB") of Boston Advances (Dollars in Thousands) FHLB of Boston advances by year of maturity at December 31 were: 1996 1995 ------------------- -------------------- Weighted Weighted average average Amount rate Amount rate ------ ---- ------ ---- 1996 $ -- --% $ 97,909 6.03% 1997 165,000 5.81 10,000 5.50 1998 58,000 5.79 10,000 5.73 1999 56,000 6.05 2,000 5.63 2000 13,500 6.26 -- -- 2001 3,000 6.43 -- -- 2002 1,000 6.55 -- -------- -------- Total $296,500 5.88% $119,909 5.95% ======== ==== ======== ==== The advances are secured by FHLB of Boston stock and a blanket lien on certain qualified collateral, defined principally as 90% of the market value of U.S. Government and federal agency obligations and 75% of the carrying value of first mortgage loans on owner-occupied residential property. Applying these ratios, the Company's overall borrowing capacity was approximately $430,095 and $318,661 at December 31, 1996 and 1995, respectively. Additionally, as a member of FHLB of Boston, the Company has a line of credit of approximately $12,184 at December 31, 1996. As a member of the FHLB of Boston, the Company is required to maintain a minimum investment in the capital stock of the Federal Home Loan Bank of Boston, at cost, in an amount not less than 1% of its outstanding home loans or 1/20 of its outstanding notes payable to the Federal Home Loan Bank of Boston, whichever is greater, as calculated at December 31 of each year. The investment exceeds the required level by $1,470 and $2,378 at December 31, 1996 and 1995, respectively. Any excess may be redeemed by the Company or called by FHLB of Boston at par. Interest expense was $12,754 in 1996, $8,424 in 1995 and $4,335 in 1994. (Continued) 42 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (15) Income Taxes (Dollars in Thousands) An analysis of the current and deferred federal and state income tax expense (benefit) follows: 1996 1995 1994 ---- ---- ---- Current income tax expense: Federal income tax $1,142 607 1,724 State income tax 366 159 635 ------ --- ----- Total current expense 1,508 766 2,359 ------ --- ----- Deferred income tax expense (benefit): Federal deferred income tax 442 82 207 State income tax 127 72 54 Change in valuation allowance 6 (105) (300) ------ --- ----- Total deferred expense (benefit) 575 49 (39) ------ --- ----- Total income tax expense $2,083 815 2,320 ====== === ===== The temporary differences (the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases) that give rise to significant portions of the deferred tax asset and liability are as follows at December 31: 1996 1995 ---- ---- Deferred tax assets: Allowance for loan losses $ 1,796 1,751 Deferred compensation 91 84 Real estate owned 687 615 State net operating loss carryforwards 135 131 Depreciation 87 67 Unrealized loss on securities available for sale 110 -- Other 52 81 ------- ----- Gross deferred assets 2,958 2,729 Valuation allowance (403) (287 ------- ----- Net deferred tax assets before deferred tax liabilities 2,555 2,442 ------- ----- Deferred liabilities: Premium on loans sold 438 53 Deferred loan fees 576 195 Other 4 82 ------- ----- Gross deferred liabilities 1,018 330 ------- ----- Net deferred tax asset $ 1,537 2,112 ======= ===== (Continued) 43 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The valuation allowance of $403 at December 31, 1996 is attributable to unrealized state losses and state net operating loss carryforwards and unrealized losses on securities available for sale. Management believes that existing net deductible temporary differences which give rise to the net deferred tax asset will reverse during periods in which the Company generates net taxable income. For the year ending December 31, 1996, the Company generated approximately $3,500 of taxable income. Factors beyond management's control, such as the general state of the economy and real estate values, can affect future levels of taxable income and no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences. Management believes it is more likely than not that the net deferred tax asset will be realized. Of the change in the valuation allowance of $116, approximately $110 was attributable to the unrealized losses on securities available for sale and consequently is not recorded in the statement of income. In August 1996, the provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996". The new rules eliminate the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts beginning after December 31, 1995. These rules also require that all thrift institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Company has previously recorded a deferred tax liability equal to the bad debt recapture and as such, the new rules will have no effect on net income or income tax expense. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provision of present law that require recapture in the case of certain excess distributions to shareholders. The tax effect of pre-1988 bad debt reserves subject to recapture in the case of certain excess distributions is approximately $5.5 million. A reconciliation between the amount of total tax expense and expected tax expense, computed by applying the federal statutory rate to income before taxes, follows: 1996 1995 1994 ---- ---- ---- Computed expected expense at statutory rate $1,707 663 2,153 Items affecting federal income tax rate: State income tax, net of federal income tax benefit and before valuation allowance 325 152 455 Change in valuation allowance 6 (105) (300 Allocated ESOP share appreciation 98 45 -- Other (53) 60 12 ------ --- ----- Effective income tax expense $2,083 815 2,320 ====== === ===== Effective income tax rate 41.5% 41.8% 36.7% ====== === ===== (Continued) 44 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (16) Employee Benefits (Dollars in Thousands, Except for Per Share Data) Employee Stock Ownership Plan Effective January 1, 1995, the Company adopted an Employee Stock Ownership Plan ("ESOP"). The Plan is designed to provide retirement benefits for eligible employees of the Bank. Because the Plan invests primarily in the stock of the Company, it will also give eligible employees an opportunity to acquire an ownership interest in the Company. Employees are eligible to participate in the Plan after reaching age twenty-one, completing one year of service and working at least one thousand hours of consecutive service during the previous year. Contributions are allocated to eligible participants on the basis of compensation. During October 1995, the Company issued a total of 529,000 shares to the ESOP at a total purchase price of $5,290. The purchase was made from the proceeds of a $5,290 loan from B.F. Funding Corporation, a wholly-owned subsidiary of the Company, bearing interest at the prime rate. Repayment of the loan is secured by contributions the Bank is obliged to make under a contribution agreement with the ESOP. The Bank made contributions to the ESOP totaling $606 in 1996 and $755 in 1995 to enable the ESOP to make principal payments on the loan. The amount contributed was charged to compensation and benefits expense. The Company recognized $287 in 1996 and $132 in 1995 in compensation and benefit expense and an increase in additional paid-in capital related to the appreciation in the fair value of allocated ESOP shares. The balance of the loan will be repaid over a period of approximately six years, principally with funds from the Bank's future contributions to ESOP, subject to IRS limitations. Shares used as collateral to secure the loan are released and available for allocation to eligible employees as the principal balance of the loan is repaid. Employees vest in their ESOP account at a rate of 33-1/3% annually commencing after the completion of one year of credited service or immediately if service was terminated due to death, retirement, disability, or change in control. Dividends on released shares are credited to the participants' ESOP accounts or paid out proportionally or applied towards payment of the loan. Dividends on unreleased shares will generally be applied towards payment of the loan. At December 31, 1996 and 1995, shares held in suspense to be released annually as the loan is paid down amounted to 392,929 and 453,429, respectively. The fair value of unallocated ESOP shares was $5,796 and $5,328 at December 31, 1996 and 1995, respectively. Dividends on ESOP shares are charged to retained earnings and ESOP shares committed-to-be released are considered outstanding in determining earnings per share. 1996 Stock-Based Incentive Plan On April 30, 1996, the Company's stockholders approved the 1996 Stock-Based Incentive Plan ("SIP"). The objective of the SIP is to enable the Company to provide officers and directors with a proprietary interest in the Company as an incentive to encourage such persons to remain with the Company. The SIP acquired 263,584 shares in the open market at an average price of $12.255 per share. This acquisition represents deferred compensation which is initially recorded as a reduction in stockholders' equity and charged to compensation expense over the vesting period of each annual stock award. (Continued) 45 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Awards are granted in the form of common stock held by the SIP. During 1996, 242,500 shares were awarded on April 30, 1996 and 8,584 shares were awarded on October 15, 1996. Awards outstanding vest in five annual installments commencing on the date of the award. As of December 31, 1996, 12,500 shares remain unallocated under the SIP. Compensation expense in the amount of the fair value of the stock at the date of the grant, will be recognized over the applicable service period for the portion of each award that vests equally over a five-year period. In addition, compensation expense has been recognized related to the appreciation in the fair value of the SIP shares with an offset to additional paid-in capital. The Company recognized $917 related to the earned shares and $187 related to the appreciation in the fair value of the shares in compensation and benefit expense and as an increase in additional paid-in capital. A recipient will be entitled to all voting and other stockholder rights. The unallocated SIP shares, with the exception of the unawarded SIP shares, are considered outstanding in the calculation of earnings per share. Stock Option Plan The Company has adopted a stock option plan for officers, key employees and directors. Pursuant to the terms of the plan, the number of shares reserved for issuance is 658,961. All options have been issued at not less than fair market value at the date of the grant and expire in 10 years from the date of the grant. All stock options vest and become fully exercisable after 5 years from the date of grant. During 1996, the Company granted employees and directors options to purchase 604,500 shares of common stock at between $12.44 and $14.82 per share. A summary of option activity follows: Number of Weighted Average Shares Exercise Price ------ -------------- Balance at December 31, 1995 -- $ -- Granted 604,500 12.51 ------- ----- Balance at December 31, 1996 604,500 $ 12.51 ======= ======= The Company applies APB Opinion No. 25 in accounting for stock options and, accordingly, no compensation expense has been recognized in the financial statements. Had the Company determined compensation expense based on the fair value at the grant date for its stock options under SFAS 123, the Company's net income would have been reduced to the pro forma amounts indicated below: 1996 ---- Net income as reported $ 2,937 Pro forma net income 2,533 Earnings per share as reported .48 Pro forma earnings per share .41 (Continued) 46 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The per share weighted average fair value of stock options granted during 1996 was $5.22 determined using the Flexible Binomial option pricing model with the following weighted average assumptions: 1996 ---- Expected dividend yield 1.63% Risk-free interest rate 6.47% Expected volatility 32.75% Expected life (years) 7.8 Pension Plan All eligible officers and employees are included in a noncontributory defined benefit pension plan provided by the Bank as a participating employer with Pentegra, formerly known as the Financial Institutions Retirement Fund. Salaried employees are eligible to participate in the plan after reaching age twenty-one and completing one year of service. Pentegra does not segregate the assets or liabilities by participating employer and, accordingly, disclosure of accumulated vested and nonvested benefits and net assets available for benefits required by SFAS No. 87 is not possible. Contributions are based on individual employer experience. According to Pentegra's Administrators, as of June 30, 1996, the date of the latest actuarial valuation, the market value of Pentegra's net assets exceeded the actuarial present value of vested benefits in the aggregate. There was no pension expense recorded for 1996, 1995 and 1994, except for an administration fee of approximately $5 per year. Profit Sharing Plan The Company must attain a minimum profitability requirement of at least 50 basis points (before income tax, profit sharing, and 401k expenses) of net average assets to generate any profit sharing payouts. The expense relative to this plan was $438 for the year ended December 31, 1994. There was no expense relative to this plan for the years ended December 31, 1996 and 1995. The plan was dissolved effective December 31, 1995. Deferred Thrift Incentive Plan On January 1, 1994, the Company implemented an employee tax deferred thrift incentive plan (the "401K plan") under which employee contributions to the plan are matched by the Company up to 50% of the participant's first 4% contributed. All employees who meet specified age and length of service requirements are eligible to participate in the 401K plan. The amounts matched by the Company are included in compensation and employee benefits expense. The amounts matched was $88 for 1996 and $97 for 1995. Additionally, the Company accrued a supplemental distribution of $45 (deducted from the profit sharing pool to eligible participants) which was paid to eligible participants in January 1996. There was no such supplemental distribution to be paid in 1997. (Continued) 47 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Executive Officer Employment Agreements The Company and Bank entered into employment agreements with its President and Chief Executive Officer, Executive Vice President, and Chief Financial Officer. The employment agreements generally provide for the continued payment of specified compensation and benefits for three years and provide payments for the remaining term of the agreement after the officers are terminated, unless the termination is for OcauseO as defined in the employment agreements. The agreements also provide for payments to the officer upon voluntary or involuntary termination of the officer following a change in control, as defined in the agreements. In addition, the Bank entered into change in control agreements with certain other executives which provide for the payment, under certain circumstances, to the officer upon the officer's termination after a change of control, as defined in their change of control agreements. Employee Severance Compensation Plan The Company established an Employee Severance Compensation Plan. The Plan provides eligible employees with severance pay benefits in the event of a change in control of the Bank or Company. Generally, employees are eligible to participate in the Plan if they have completed at least one year of service with the Company and are not eligible to receive benefits under the executive officer employment agreements. The Plan provides for the payment, under certain circumstances, of lump-sum amounts upon termination following a change of control, as defined in the Plan. The Company does not provide any postretirement benefits other than pensions. (17) Litigation Various legal proceedings are pending against the Company which have arisen in the normal course of business. In the opinion of management, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial position, the annual results of operations, or liquidity of the Company. (18) Financial Instruments with Off-balance-sheet Risk (In Thousands) In the normal course of business, the Company is party to financial instruments with off-balance-sheet risk, including commitments to originate or purchase loans, unadvanced amounts of construction loans, unused credit lines, standby letters of credit and forward commitments to sell loans and recourse agreements on assets sold. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. 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 with respect to loan commitments, unused credit lines and standby letters of credit 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. For forward commitments, the contract or notional amounts exceed the Company's exposure to credit loss. (Continued) 48 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Commitments to originate loans and unused credit lines are agreements to lend to a customer, provided the customer meets all conditions established in the contract. Commitments have fixed expiration dates and may require payment of a fee. The total commitment amounts do not necessarily represent total future cash requirements since many commitments are not expected to be drawn upon. The amount of collateral obtained, if necessary for the extension of credit, is based on the 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 loans to customers. Forward commitments to sell loans are contracts which the Company enters into for the purpose of reducing the market risk associated with originating loans for sale. In order to fulfill a forward commitment, the Company typically exchanges through FNMA or FHLMC its current production of loans for mortgage-backed securities which are then delivered to a securities firm at a future date at prices or yields specified by the contracts. Risks may arise from the possible inability of the Company to originate loans to fulfill the contracts, in which case the Company may purchase securities in the open market to deliver against the contracts. In addition to construction loans in process, the Company had the following outstanding commitments at December 31: 1996 1995 ---- ---- Commitments to originate mortgage loans: Fixed $ 7,540 6,620 Variable 23,116 10,813 Unused lines of credit: Home equity 30,080 29,756 Commercial loans 209 631 Standby letters of credit 34 77 Commitments to sell loans or swap loans for mortgage-backed securities 8,723 3,754 Loans sold with recourse (note 6) 1,010 1,028 (19) Fair Values of Financial Instruments (In Thousands) Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include real estate acquired by foreclosure, the deferred income tax asset, office properties and equipment, and core deposit and other intangibles. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. (Continued) 49 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for some of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, cash flows, current economic conditions, risk characteristics and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and changes in the loan, debt and interest rate markets could significantly affect the estimates. The following methods and assumptions were used by the Company in estimating fair values of its financial instruments: Cash and Cash Equivalents The fair values of cash and cash equivalents approximate the carrying amounts as reported in the balance sheet. Investment and Mortgage-backed Securities Fair values for investment securities and mortgage-backed securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Mortgage Loans Held for Sale Fair values for mortgage loans held for sale are based on quoted market prices. Commitments to originate loans and forward commitments to sell loans have been considered in the determination of the fair value of mortgage loans held for sale. Loans The fair values of loans are estimated using discounted cash flows analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The incremental credit risk for nonperforming loans has been considered in the determination of the fair value of loans. Accrued Interest Receivable The fair value of accrued interest receivable approximates the carrying amount as reported in the balance sheet because of its short-term nature. Stock in FHLB of Boston The fair value of Federal Home Loan Bank of Boston ("FHLB") stock approximates its carrying amount as reported in the balance sheet. If redeemed, the Company will receive an amount equal to the par value of the stock. Deposit Accounts and Advance Payments by Borrowers for Taxes and Insurance The fair values of demand deposits (e.g., NOW, regular and statement savings and money market accounts and advance payments by borrowers for taxes and insurance) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow technique that applies interest rates currently being offered on certificates with similar remaining maturities to a schedule of aggregated expected monthly maturities on such time deposits. (Continued) 50 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Federal Home Loan Bank Advances Fair values for FHLB advances are estimated using a discounted cash flow technique that applies interest rates currently being offered on advances to a schedule of aggregated expected monthly maturities of FHLB advances. Securities Sold Under Agreements to Repurchase Fair values of securities sold under agreements to repurchase are estimated using a discounted cash flow technique that applies interest rates currently being offered on securities sold under agreements to repurchase to a schedule of expected maturities of securities sold under agreements to repurchase. Off-balance-sheet Instruments The Company's commitments for unused lines and outstanding standby letters of credit and unadvanced portions of loans and loans sold with recourse are considered in estimating the fair value of loans. The carrying amounts and fair values of the Company's financial instruments at December 31 are as follows:
1996 1995 ---------------------- --------------------- Carrying Fair Carrying Fair amount value amount value ------ ----- ------ ----- Financial assets: Cash and cash equivalents $ 18,278 18,278 21,225 21,225 Investment securities available for sale 1,085 1,085 1,022 1,022 Investment securities held to maturity 19,170 19,045 16,906 16,804 Mortgage-backed securities available for sale 23,593 23,593 23,873 23,873 Mortgage-backed securities held to maturity 43,019 43,033 35,116 35,647 Loans, net and mortgage loans held for sale 680,640 678,602 518,427 520,101 Accrued interest receivable 4,067 4,067 3,696 3,696 Stock in FHLB of Boston 16,295 16,295 8,374 8,374 Financial liabilities: Deposit accounts $428,818 429,060 419,104 419,750 Securities sold under agreements to repurchase 3,500 3,487 7,000 6,940 FHLB advances 296,500 297,873 119,909 120,021 Advance payments by borrowers for taxes and insurance 2,100 2,100 1,531 1,531
(20) Subsequent Events - Acquisition In September 1996, the Company signed a definite agreement to acquire Broadway Capital Corporation and its subsidiary Broadway National Bank. The acquisition is expected to be completed in February 1997. Broadway Capital Corporation is a Massachusetts corporation that was organized in 1982 primarily to become the holding company of Broadway National Bank. Broadway National Bank is a national-chartered bank, which was incorporated in 1910 and is headquartered in Chelsea, Massachusetts. Broadway National Bank operates its business from two banking offices located in Chelsea and Revere, Massachusetts. Broadway National Bank is engaged principally in the business of attracting deposits from the general public and investing those deposits in residential real estate, consumer and small business loans. (Continued) 51 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1996 and 1995 Total assets of Broadway Capital Corporation were approximately $128,012 at December 31, 1996. Under the terms of the agreement, holders of Broadway Capital Corporation common stock will receive $369.31 in cash for each of their shares of common stock, which equates to an aggregate purchase price of approximately $22 million. The transaction will be accounted for using the purchase method of accounting. (21) Parent Company Only Financial Statements (Dollars In Thousands) The following are the condensed financial statements for BostonFed Bancorp, Inc. (the "Parent Company") only: Balance Sheet Assets 1996 1995 - ------ ---- ---- Cash and interest bearing deposit in subsidiary bank $ 10,854 1,672 Daily federal funds sold -- 10,000 Short-term investments 13 13 -------- ------ Total cash and cash equivalents 10,867 11,685 -------- ------ Mortgage-backed securities available for sale (amortized cost of $23,915 at 1996 and $23,873 at 1995) 23,593 23,873 Investment in subsidiaries, at equity 55,143 62,136 Accrued interest receivable 125 139 Other assets 200 -- -------- ------ Total assets $ 89,928 97,833 ======== ====== Liabilities and Stockholders' Equity Securities sold under agreement to repurchase $ 3,500 7,000 Accrued income taxes 45 93 Accrued expenses and other liabilities 28 39 -------- ------ Total liabilities 3,573 7,132 -------- ------ Preferred stock, $.01 par value, 1,000,000 shares authorized; none issued -- -- Common stock, $0.01 par value; 17,000,000 shares authorized; 6,589,617 issued at 1996 and 1995 66 66 Additional paid-in capital 64,461 63,987 Retained earnings 33,131 31,183 Net unrealized loss on investment securities available for sale (322) -- Treasury stock, at cost (329,300 shares at 1996) (4,739) -- Unallocated ESOP shares (3,929) (4,535) Unearned 1996 SIP (2,313) -- -------- ------ Total stockholders' equity 86,355 90,701 -------- ------ Total liabilities and stockholders' equity $ 89,928 97,833 ======== ====== (Continued) 52 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended December 31, 1996 and 1995 Statement of Income 1996 1995 - ------------------- ---- ---- Interest income $ 2,164 316 Interest expense 439 5 ------- ------- Net interest income 1,725 311 Non-interest expense 307 10 ------- ------- Income before income taxes 1,418 271 Income tax expense 536 93 ------- ------- Income before equity in net income of subsidiaries 882 178 Equity in net income of subsidiaries 2,055 958 ------- ------- Net income $ 2,937 1,136 ======== ======= Statement of Cash Flows Net cash flows from operating activities: Net income $ 2,937 1,136 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries (2,055) (908) Amortization and accretion, net (1) -- Appreciation in fair value of ESOP shares 287 132 Reduction in unearned SIP 917 -- Appreciation in fair value of SIP shares 187 -- Loss on sale of investment securities 11 -- Increase (decrease) in accrued interest receivable 14 (139) Increase in other assets (200) -- Increase (decrease) in accrued income taxes (48) 93 Increase (decrease) in accrued expenses and other liabilities (11) 39 ------- ------- Net cash provided by operating activities 2,038 353 ------- ------- Cash flow from investing activities: Proceeds from sale of mortgage-backed securities for sale 10,614 -- Purchase of mortgage-backed securities available for sale (10,666) (23,873) Change in investment in subsidiaries 9,048 (31,181) ------- ------- Net cash used in (provided by) investing activities 8,996 (55,054) ------- ------- (Continued) 53 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended December 31, 1996 and 1995 Statement of Cash Flows 1996 1995 ---- ---- Cash flow from financing activities: Proceeds from securities sold under agreement to repurchase $ 2,973 7,000 Repayments of securities sold under agreement to repurchase (6,473) -- Net proceeds from common stock issued pursuant to initial public offering -- 63,921 Payments to acquire common stock for ESOP -- 5,290 Reduction in unearned ESOP shares 606 755 Common stock repurchases (4,739) -- Purchase of common stock by SIP (3,230) -- Cash dividends paid (989) -- -------- ------ Net cash provided (used) from financing activities (11,852) 66,386 -------- ------ Net increase (decrease) in cash and cash equivalents (818) 11,685 Cash and cash equivalents at beginning of year 11,685 -- -------- ------ Cash and cash equivalents at end of year $ 10,867 11,685 ======== ====== Supplemental cash flow information: Cash paid during the year for: Interest $ 442 -- Income taxes 584 -- (Continued) 54 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (22) Quarterly Results of Operations (unaudited) Summaries of consolidated operating results on a quarterly basis for the year ended December 31 follows: 1996 Quarters ---------------------------------------- (In Thousands, Except Per Share Amounts) First Second Third Fourth ----- ------ ----- ------ Interest and dividend income $ 11,385 $ 12,627 $ 14,083 $ 14,583 Interest expense 5,867 6,754 7,937 8,333 -------- -------- -------- -------- Net interest income 5,518 5,873 6,146 6,250 -------- -------- -------- -------- Provision for loan losses 438 298 390 168 Non-interest income 969 856 839 903 SAIF special assessment -- -- 2,670 -- Non-interest expense 4,316 4,533 4,680 4,841 -------- -------- -------- -------- Income (loss) before income taxes 1,733 1,898 (755) 2,144 Income tax expense (benefit) 710 774 (334) 933 -------- -------- -------- -------- Net income (loss) $ 1,023 $ 1,124 $ (421) $ 1,211 ======== ======== ======== ======== Earnings (loss) per share $ 0.17 $ 0.18 $ (0.07) $ 0.20 ======== ======== ======== ======== EX-23 3 CONSENT OF INDEPENDENT ACCOUNTANTS 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement on Form S-8 of BostonFed Bancorp, Inc. (the "Company") of our report, dated January 30, 1997, related to the consolidated balance sheets of the Company as of December 31, 1996 and 1995 and the related statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ending December 31, 1996, which report is incorporated by reference in the Annual Report on Form 10-K of the Company for the year ended December 31, 1996. Our report refers to a change in the method of accounting for mortgage servicing rights. /s/ KPMG Peat Marwick LLP Boston, Massachusetts March 28, 1997 EX-27 4 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
9 THIS SCHEDULE CONTAINS SUMMARY INFORMATION EXTRACTED FROM THE FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 U.S. DOLLARS 12 MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 15,335 13 2,930 0 24,678 62,189 62,078 685,040 4,400 820,567 428,818 148,500 5,394 151,500 0 0 66 86,289 820,567 45,513 7,165 0 52,678 15,698 28,891 23,787 1,294 (11) 21,040 5,020 5,020 0 0 2,937 0.48 0.47 3.34 1,502 0 2,489 0 4,275 1,512 343 4,400 4,400 0 0
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