-----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, EIXvDSbhdqBcmjrt41PnkyBuu1rAewQm+SDYd3wDkHHcThKEjoqCsYQbOILWajBg 0MiEm7SzlATt1r1U8TKOMg== 0000950135-99-001715.txt : 19990402 0000950135-99-001715.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950135-99-001715 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K SEC ACT: SEC FILE NUMBER: 001-13936 FILM NUMBER: 99580219 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-K 1 BOSTON FEDERAL SAVINGS BANK 1 ------------------------------------------------------------------------ ------------------------------------------------------------------------ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 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 No.) of incorporation or organization)
17 NEW ENGLAND EXECUTIVE PARK, BURLINGTON, MASSACHUSETTS 01803 (Address of principal executive offices) Registrant's telephone number, including area code: (781) 273-0300 Securities registered pursuant to Section 12(b) of the Act:
TITLE OF CLASS NAME OF EXCHANGE ON WHICH REGISTERED -------------- ------------------------------------ Common Stock par value $0.01 per share The American Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes [X] No [ ] (2) 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. [ ] The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant, i.e., persons other than directors and executive officers of the registrant is $85.8 million and is based upon the last sales price as quoted on the American Stock Exchange for March 5, 1999. The number of shares of Common Stock outstanding as of March 5, 1999 is 5,093,841. DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1998 ARE INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-K. PORTIONS OF THE PROXY STATEMENT FOR THE 1999 ANNUAL MEETING OF STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 INDEX PART I PAGE Item 1. Business.................................................. 3 Item 2. Properties................................................ 41 Item 3. Legal Proceedings......................................... 41 Item 4. Submission of Matters to a Vote Security Holders.......... 41 PART II Item 5. Market for Registrant's Common Equity and Related Stockholders Matters...................................... 42 Item 6. Selected Financial Data................................... 42 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 42 Item 7A. Quantitative and Qualitative Disclosure About Market Risks.............................................. 42 Item 8. Financial Statements and Supplementary Data .............. 42 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure....................... 42 PART III Item 10. Directors and Executive Officers of the Registrant........ 43 Item 11. Executive Compensation.................................... 43 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................ 43 Item 13. Certain Relationships and Related Transactions............ 43 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................... 44 SIGNATURES................................................................ 46 2 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 ("BFS"). On October 24, 1995, BFS 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 BFS. On February 7, 1997, the Company acquired Broadway National Bank ("BNB"), using the purchase method of accounting, at a cost of approximately $22 million. The Company's business is conducted primarily through its ownership of BFS and BNB (collectively, the "Banks"). BFS's administrative branch office is located in Burlington, Massachusetts and its seven other branch offices are located in Arlington, Bedford, Billerica, Boston, Lexington, Peabody and Wellesley, all of which are in the greater Boston metropolitan area. As the result of its acquisition of BNB, the Company added two banking offices (Chelsea and Revere) to its franchise in the greater Boston metropolitan area. As a result of the acquisition of BNB, a nationally chartered commercial bank, the Company became a multi-bank holding company subject to regulation by the Federal Reserve Bank ("FRB"). Prior to its acquisition of BNB, 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. The Company also remained subject to regulations of the Office of Thrift Supervision ("OTS") for the first three years following the initial public offering. See "Regulation and Supervision - Holding Company Regulation." 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 commercial real estate, construction and land, multi-family mortgage, equity lines of credit, business 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 retail deposits, wholesale brokered deposits, principal and interest payments on loans, investments and mortgage-backed securities, Federal Home Loan Bank-Boston ("FHLB") advances, repurchase agreements and proceeds from the sale of loans. 3 4 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'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. 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, 1998, the Company had total loans outstanding, including mortgage loans held for sale, of $984.3 million, of which $829.6 million were one-to four-family, residential mortgage loans, or 84.3% of the Company's total loans. At such date, the remainder of the loan portfolio consisted of: $22.9 million of multi-family residential loans, or 2.3% of total loans; $49.0 million of commercial real estate loans, or 5.0% of total loans; $41.6 million of construction and land loans, or 4.2% of total loans; and other loans, primarily home equity lines of credit, of $41.3 million or 4.2% of total loans. The Company had $17.0 million of mortgage loans held for sale at December 31, 1998 consisting of one- to four-family fixed and variable-rate mortgage loans. At that same date, 65.6% of the Company's 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. 4 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, -------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------------ ------------------ ------------------ ------------------ ------------------ PERCENT PERCENT PERCENT PERCENT PERCENT AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) Mortgage Loans: Residential: One- to four-family(1)..... $829,572 84.27% $702,102 86.11% $607,792 88.00% $447,033 85.44% $427,716 84.77% Multi-family............... 22,889 2.33 18,874 2.32 21,381 3.10 27,986 5.35 29,212 5.79 Commercial real estate....... 48,951 4.97 36,400 4.46 28,136 4.07 26,412 5.05 28,714 5.69 Construction and land........ 41,608 4.23 20,497 2.51 12,532 1.81 3,435 .66 3,450 0.68 Other loans(2)................. 41,308 4.20 37,465 4.60 20,850 3.02 18,343 3.50 15,504 3.07 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans.............. 984,328 100.00% 815,338 100.00% 690,691 100.00% 523,209 100.00% 504,596 100.00% ====== ====== ====== ====== ====== Less: Allowance for loan losses.... (8,500) (6,600) (4,400) (4,275) (3,700) Construction loans in process.................... (17,133) (8,527) (6,936) (805) (1,078) Net unearned premium (discount) on loans purchased................ (5) (114) (163) (262) (525) Deferred loan origination (fees) costs............... 1,980 1,448 1,448 560 96 -------- -------- -------- -------- -------- Loans, net and mortgage loans held for sale..... $960,670 $801,545 $680,640 $518,427 $499,389 ======== ======== ======== ======== ========
- ----------------- (1) Includes mortgage loans held for sale of $17.0 million, $9.8 million, $4.0 million, $8.9 million and $316,000 at December 31, 1998, 1997, 1996, 1995 and 1994, respectively. (2) These loans primarily consist of one- to four-family lines of credit secured by mostly second mortgages which amounted to $32.1 million, $28.1 million, $17.4 million, $14.9 million and $12.8 million at December 31, 1998, 1997, 1996, 1995 and 1994, respectively. 5 6 LOAN MATURITY. The following table shows the remaining contractual maturity of the Company's loans at December 31, 1998. There were $17.0 million of mortgage loans held for sale at December 31, 1998. The table does not include the effect of future principal prepayments. Principal prepayments on total loans were $316.4 million, $167.2 million and $95.4 million for the years ended December 31, 1998, 1997 and 1996, respectively.
AT DECEMBER 31, 1998 --------------------------------------------------------------------------- ONE- TO FOUR- MULTI- COMMERCIAL CONSTRUCTION OTHER TOTAL FAMILY FAMILY REAL ESTATE AND LAND LOANS LOANS -------- ------- ----------- ------------- ------- -------- (IN THOUSANDS) Amounts due: One year or less........................... $ 1,315 $ 5 $ 455 $19,903 $ 2,784 $ 24,462 -------- ------- ------- ------- ------- -------- After one year: More than one year to three years........ 4,460 128 661 21,193 3,354 29,796 More than three years to five years...... 17,489 280 197 25 3,774 21,765 More than five years to 10 years......... 104,647 4,718 4,054 -- 30,062 143,481 More than 10 years to 20 years........... 176,444 9,103 24,888 275 419 211,129 More than 20 years....................... 525,217 8,655 18,696 212 915 553,695 -------- ------- ------- ------- ------- -------- Total due after one year................. 828,257 22,884 48,496 21,705 38,524 959,866 -------- ------- ------- ------- ------- -------- Total amount due......................... $829,572 $22,889 $48,951 $41,608 $41,308 984,328 ======== ======= ======= ======= ======= Less: Allowance for loan losses............ (8,500) Construction loans in process........ (17,133) Net unearned discount on loans purchased.......................... (5) Deferred loan origination costs...... 1,980 -------- Loans, net, and mortgage loans held for sale............................... 960,670 Mortgage loans held for sale............. (17,008) -------- Loans, net............................... $943,662 ========
6 7 The following table sets forth at December 31, 1998 the dollar amount of loans contractually due after December 31, 1999, and whether such loans have fixed interest rates or adjustable interest rates.
DUE AFTER DECEMBER 31, 1999 ---------------------------------- FIXED ADJUSTABLE TOTAL -------- ---------- -------- (IN THOUSANDS) Mortgage loans: Residential: One- to four-family............................ $303,722 $524,535 $828,257 Multi-family................................... 6,642 16,242 22,884 Commercial real estate........................... 13,772 34,724 48,496 Construction and land............................ 119 21,586 21,705 Other loans......................................... 6,125 32,399 38,524 -------- -------- -------- Total loans ................................. $330,380 $629,486 $959,866 ======== ======== ========
ORIGINATION, SALE, SERVICING AND PURCHASE OF LOANS. The Company's mortgage lending activities are conducted primarily by its commissioned loan personnel, through its ten 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 a substantial majority of the one- to four-family fixed-rate mortgage loans with maturities over ten years that it originates and to retain a substantial majority of adjustable-rate and fixed-rate loans with maturities of ten years or less of the one- to four-family mortgage loans which it originates. The Company retains the servicing of loans sold in most cases. At December 31, 1998, the Company serviced $648.3 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, 1998, the Company had $17.0 million of mortgage loans held for sale consisting of fixed and adjustable-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 $7.0 million of purchased loans at December 31, 1998. 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, and loans that qualify for Community Reinvestment Act ("CRA") purposes, the Company currently does not purchase loans or participate 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 7 8 are made to the time until the loans are securitized or packaged and sold. The Company currently utilizes forward loan sale commitment contracts with Fannie Mae ("FNMA"), Freddie Mac ("FHLMC"), and other approved investors as its method 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 that can be delivered to fulfill the forward commitment contracts. The amount of forward coverage of the "pipeline" of mortgages is set on a day-to-day basis by an operating officer, within policy guidelines, based on the Company's assessment of the general direction of interest rates and levels of mortgage-origination activity. For the year ended December 31, 1998, the Company had $3.2 million in net gains attributable to the sale of loans. 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, ----------------------------------------- 1998 1997 1996 ---------- ---------- --------- (IN THOUSANDS) Net loans: Beginning balance ........................................... $ 791,728 $ 676,670 $ 509,496 Loans originated: One- to four-family .................................. 773,655 321,039 362,534 Multi-family ......................................... 7,911 869 4,204 Commercial real estate ............................... 25,363 7,294 5,942 Construction and land ................................ 32,348 16,870 11,638 Other(1) ............................................. 37,055 34,055 16,124 ---------- ---------- --------- Total loans originated ............................... 876,332 380,127 400,442 Loans purchased(2) ...................................... 25,042 17,013 46,208 Loans from BNB acquisition .............................. -- 66,093 -- ---------- ---------- --------- Total ............................................ 1,693,102 1,139,903 956,146 Less: Principal repayments and other, net ..................... (382,475) (226,143) (122,346) Loan (charge-offs) recoveries, net ...................... 258 (116) (1,169) Sale of mortgage loans .................................. (350,215) (111,566) (148,025) Transfer of mortgage loans to real estate owned ......... -- (533) (3,966) ---------- ---------- --------- Loans, net and mortgage loans held for sale ................. 960,670 801,545 680,640 Mortgage loans held for sale ............................ (17,008) (9,817) (3,970) ---------- ---------- --------- Loans, net .................................................. $ 943,662 $ 791,728 $ 676,670 ========== ========== =========
- ------------------------ (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 or for CRA purposes. 8 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 obtained at the Company's branch offices and 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, 1998, the Company's total loans outstanding were $984.3 million, of which $829.6 million, or 84.3%, 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, 36.6% were fixed-rate loans, and 63.4% 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 287 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 (generally 2%) and overall caps (generally 6%) on the increase or decrease in interest rate at any adjustment date and 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 current conforming FNMA/FHLMC limit of $240,000 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 1998, the Company's retained portion of this loan product was $5.4 million, or 0.7% 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. The Company currently originates multi-family loans on a limited and 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 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 9 10 the underlying property to a maximum amount of $6.0 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, or may require limited recourse on such loans, depending on the creditworthiness of the borrower and amount of the down payment. 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, 1998, totalled $22.9 million or 2.3% of total loans. The Company's largest multi-family loan at December 31, 1998, was a $2.9 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 $6.0 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 twenty-five years, the majority of which contain adjustable-rates and 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, or may require limited recourse on such loans, depending on the creditworthiness of the borrowers and the amount of the down payment. The Company's commercial real estate loan portfolio at December 31, 1998 was $49.0 million, or 5.0% of total loans. The largest commercial real estate loan in the Company's portfolio at December 31, 1998 was a $3.5 million performing loan secured by an office building located in Cambridge, Massachusetts. 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 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 standards. 10 11 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 land, the Company generally does not originate such loans unless the borrower has also secured sub-division approval and 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, or limited recourse may be required on such loans, depending on the creditworthiness of the borrower and amount of the down payment. The Company's current loan limit is $6.0 million. The Company's largest construction and land loan at December 31, 1998 was a performing loan with a $4.6 million line of credit with an outstanding balance of $2.2 million and secured by 108 age-restricted units in Bedford, New Hampshire. At December 31, 1998, the Company had $41.6 million of construction and land loans which amounted to 4.2% 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, 1998, amounting to $41.3 million or 4.2% of the Company's total loan portfolio, consisted primarily of home equity and improvement loans, and, to a significantly lesser extent, consumer 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, automobiles and business assets. 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, 1998, these loans totalled $32.1 million, or 3.3% of the Company's total loans and 77.8% 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 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 11 12 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. LOAN APPROVAL PROCEDURES AND AUTHORITY. The Board of Directors establishes the lending policies and loan approval limits of the Bank. Such limits are included in a matrix with the corresponding level of authority requirements. At BFS, Board of Directors' approval is required on all one- to four-family loans in excess of $1.5 million, on all commercial real estate, multi-family and non-owner occupied construction loans in excess of $2.0 million and on all business loans in excess of $1.0 million. At BNB, a similar matrix has been established and Board of Directors' approval is required on all loans in excess of $400,000. Pursuant to OTS and Office of the Comptroller of the Currency ("OCC") regulations, loans to one borrower cannot, subject to certain exceptions, exceed 15% of the Bank's unimpaired capital and surplus. At December 31, 1998, the loans to one borrower limit was $8.8 million and $1.5 million for BFS and BNB, respectively. 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. All of the loans currently being serviced for others are loans which have been sold by the Company. At December 31, 1998, the Company was servicing $648.3 million of loans for others. The gross servicing fee income from loans originated and purchased is generally 0.25% to 0.38% 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 quarterly and adjusts its capitalized mortgage servicing rights amortization schedule accordingly. As of December 31, 1998, the Company had $3.8 million 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 and OCC internal asset classifications for BFS and BNB, respectively, 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 12 13 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. BFS's and BNB's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS and OCC, respectively, which can order the establishment of additional general or specific loss allowances. The OTS and OCC, in conjunction with the other federal banking agencies, have 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 real estate market values and the significant losses experienced by many financial institutions just a few years ago, 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, OCC and the Federal Deposit Insurance Corporation ("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 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, 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. BFS's Asset Classification Committee reviews and classifies assets on a quarterly basis and reports the results of its review to the Board of Directors. BNB's assets are reviewed by a non-lending officer who reports classifications to the BNB Board on a quarterly basis. The Company classifies assets in accordance with the management guidelines described above. At December 31, 1998, the Company had, on a consolidated basis, $2.3 million of assets designated as "Special Mention," $4.1 million of assets designated as "Substandard," $11,000 of assets designated as "Doubtful" and $948,000 of assets designated as "Loss." All assets classified as "Loss" have been charged off for financial statement purposes. Included in these amounts was $809,000 in non-performing loans at December 31, 1998. In the opinion of management, the remaining special mention and "Substandard" loans of $5.6 million 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. 13 14 The following table sets forth delinquencies in the Company's loan portfolio as of the dates indicated:
AT DECEMBER 31, 1998 AT DECEMBER 31, 1997 -------------------------------------------- -------------------------------------------- 60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE -------------------- --------------------- -------------------- --------------------- PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS -------- --------- -------- --------- -------- --------- -------- --------- (DOLLARS IN THOUSANDS) Residential: One- to four-family .............. 16 $1,625 12 $ 618 36 $3,313 14 $ 865 Multi-family ..................... -- -- -- -- -- -- -- -- Commercial real estate ........... -- -- -- -- -- -- 3 21 Construction and land ............ -- -- -- -- -- -- -- -- Other loans ...................... 4 121 -- -- 6 139 3 6 --- ----- --- ----- --- ------ --- ----- Total ................................. 20 $1,746 12 $ 618 42 $3,452 20 $ 892 === ====== === ===== === ====== === ===== Delinquent loans to loans, net and mortgage loans held for sale ......................... 0.18% 0.06% 0.43% 0.11% 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) Residential: 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%
14 15 NON-PERFORMING ASSETS AND RESTRUCTURED LOANS. The following table sets forth information regarding non-accrual loans, restructured loans and real estate owned ("REO"). At December 31, 1998, restructured loans totalled $213,000, consisting of one loan, and REO, net, totalled $47,000, consisting of one property. 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, 1998, 1997, 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 $34,000, $146,000, $103,000, $303,000 and $281,000, respectively. For the same periods, the difference between the amount of interest income that would have been recognized on restructured loans if such loans were performing in accordance with their regular terms and amounts recognized was $1,000, $1,000, $73,000, $77,000 and $294,000, respectively.
AT DECEMBER 31, ------------------------------------------------------- 1998 1997 1996 1995 1994 --------- ------- ------- ------ ------- (DOLLARS IN THOUSANDS) Non-accrual loans: Residential real estate: One- to four-family...................... $ 784 $ 941 $ 1,463 $1,195 $ 848 Multi-family............................. -- -- -- 745 546 Construction and land...................... -- -- -- -- -- Commercial real estate..................... 25 458 25 3,312 2,126 Other loans................................ -- 6 14 -- 51 --------- ------- ------- ------ ------- Total................................. 809 1,405 1,502 5,252 3,571 Real estate owned, net(1).................... 47 195 2,668 971 387 --------- ------- ------- ------ ------- Total non-performing assets........... 856 1,600 4,170 6,223 3,958 Restructured loans........................... 213 369 2,489 2,941 4,834 --------- ------- ------- ------ ------- Total risk elements.......................... $ 1,069 $ 1,969 $ 6,659 $9,164 $ 8,792 ========= ======= ======= ====== ======= Allowance for loan losses as a percent of loans(2)................................ 0.88% 0.82% 0.64% 0.82% 0.74% Allowance for loan losses as a percent of non-performing loans(3)................. 1,029.06 469.75 293.02 81.40 103.61 Non-performing loans as a percent of loans(2), (3)........................... 0.09 0.17 0.22 1.00 0.71 Non-performing assets as a percent of total assets(4)......................... 0.08 0.16 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 REO. 15 16 At December 31, 1998, loans which were characterized as impaired pursuant to SFAS 114 and 118 totalled $1.5 million. All of the $1.5 million in impaired loans have been measured using the fair value of the collateral method. During the year ended December 31, 1998, the average recorded value of impaired loans was $1.8 million, $102,000 of interest income was recognized, all of which was recorded on a cash basis, and $137,000 of interest income would have been recognized under original terms. AT DECEMBER 31, ---------------------------------- 1998 1997 1996 ------ ------ ------ (IN THOUSANDS) Impaired loans: Residential real estate: One- to four-family $1,036 $ 999 $1,763 Multi-family 245 316 2,271 Commercial real estate 238 677 246 Other loans 10 99 112 ------ ------ ------ Total $1,529 $2,091 $4,392 ====== ====== ====== 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 fiscal years 1998, 1997, 1996, 1995 and 1994 were $1.6 million, $1.7 million, $1.3 million, $3.6 million and $283,000, respectively. During the year ended 1998, there were recoveries of $517,000 and charge-offs of $259,000 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, 1998, the Company's allowance for loan losses was 0.88% of total loans as compared to 0.82% as of December 31, 1997. Management believes this increased coverage ratio is prudent due to the balance increase in the combined total of construction and land, commercial real estate, multi-family, home equity and improvement, consumer and business loans. These combined total balances increased from $112.4 million at December 31, 1997 to $153.8 million at December 31, 1998, an increase of 36.8%. The Company had non-accrual loans of $809,000 and $1.4 million at December 31, 1998 and December 31, 1997, 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. 16 17 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, -------------------------------------------------- 1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ (IN THOUSANDS) Balance at beginning of period ................... $6,600 $4,400 $4,275 $3,700 $4,450 BNB allowance for loan losses at acquisition date ........................... -- 620 -- -- -- Provision for loan losses ........................ 1,642 1,696 1,294 3,614 283 Charge-offs: Real estate loans: Residential: One- to four-family .......................... 51 370 387 550 711 Multi-family ................................. 2 84 263 483 251 Commercial ..................................... 75 45 664 2,297 200 Construction and land .......................... 0 -- -- -- -- Other .......................................... 131 16 198 194 56 ------ ------ ------ ------ ------ Total ....................................... 259 515 1,512 3,524 1,218 Recoveries ....................................... 517 399 343 485 185 ------ ------ ------ ------ ------ Balance at end of period ......................... $8,500 $6,600 $4,400 $4,275 $3,700 ====== ====== ====== ====== ====== Ratio of net charge-offs (net recoveries) during the period to average loans outstanding during the period .............. (0.03)% 0.02% 0.19% 0.60% 0.23% ====== ====== ====== ====== ======
17 18 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, --------------------------------------------------------------------------------- 1998 1997 --------------------------------------- --------------------------------------- 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) Residential: One- to four-family .......... $2,186 25.72% 84.27% $1,997 30.26% 86.11% Multi-family ................. 214 2.52 2.33 206 3.12 2.32 Commercial real estate ......... 615 7.24 4.97 369 5.59 4.46 Construction and land .......... 3 0.03 4.23 152 2.30 2.51 Other loans .................... 731 8.60 4.20 266 4.03 4.60 Unallocated .................... 4,751 55.89 -- 3,610 54.70 -- ------ ------ ------ ------ ------ ------ Total allowance for loan losses .......... $8,500 100.00% 100.00% $6,600 100.00% 100.00% ====== ====== ====== ====== ====== ======
AT DECEMBER 31, ------------------------------------------------------------------------------------------------- 1996 1995 1994 ------------------------------- ------------------------------ ----------------------------- PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT OF OF LOANS OF OF LOANS OF OF LOANS ALLOWANCE IN EACH ALLOWANCE IN EACH ALLOWANCE IN EACH TO CATEGORY TO CATEGORY TO CATEGORY TOTAL TO TOTAL TOTAL TO TOTAL TOTAL TO TOTAL AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS ------ --------- -------- ------ --------- -------- ------- ---------- -------- (DOLLARS IN THOUSANDS) Residential: One- to four-family ......... $1,899 43.16% 88.00% $1,974 46.18% 85.44% $1,309 35.38% 84.77% Multi-family ................ 274 6.23 3.10 373 8.72 5.35 393 10.62 5.79 Commercial real estate ........ 451 10.25 4.07 1,285 30.06 5.05 655 17.70 5.69 Construction and land ......... 463 10.52 1.81 580 13.57 0.66 416 11.24 0.68 Other loans ................... 61 1.39 3.02 47 1.10 3.50 92 2.49 3.07 Unallocated ................... 1,252 28.45 -- 16 0.37 -- 835 22.57 -- ------ ------ ------ ------ ------ ------ ------ ------ ------ Total allowance for loan losses ....... $4,400 100.00% 100.00% $4,275 100.00% 100.00% $3,700 100.00% 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ======
18 19 REAL ESTATE OWNED At December 31, 1998, the Company had $47,000 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 and OCC 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 Company's investment and mortgage-backed securities purchased for the held to maturity portfolio totalled $30.2 million, or 2.7% of assets. At December 31, 1998, the available for sale portfolio totalled $70.2 million or 6.2% 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. BFS's Investment Committee and BNB's Board are provided with monthly activity reports and summaries of the held to maturity and available for sale investment portfolios of BFS and BNB, respectively, on a quarterly basis. At December 31, 1998, the Company had invested $43.9 million in mortgage-backed securities, or 3.9% of total assets, which were guaranteed by GNMA, insured by either FNMA or FHLMC or privately issued. Of the $43.9 million, $22.6 million were GNMA securities, of which $20.1 million were adjustable-rate with 1.5% maximum annual rate adjustments and lifetime maximum interest rates of 12.5%. 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 or increasing 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, 1998, mortgage-backed securities available for sale and held-to-maturity amounted to $21.0 million and $22.9 million, respectively. 19 20 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, ------------------------------------------------------------------- 1998 1997 1996 ------------------- ------------------- ----------------------- PERCENT PERCENT PERCENT AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL ------- -------- ------- -------- ---------- -------- (DOLLARS IN THOUSANDS) Mortgage-backed securities: GNMA(1),(2),.............................. $22,626 51.49% $33,106 57.60% $40,321 60.53% FHLMC(3),(4),............................. 5,684 12.94 9,544 16.60 11,239 16.87 FNMA...................................... 428 0.97 894 1.56 1,147 1.72 Privately issued collateralized mortgage obligations(5),(6)............. 15,204 34.60 13,931 24.24 13,905 20.88 ------- ------ ------- ------ ------- ------ Total mortgage-backed securities........ 43,942 100.00% 57,475 100.00% 66,612 100.00% ======= ====== ====== Less: Mortgage-backed securities available for sale - GNMA(2).......................... 5,982 10,681 13,710 Mortgage-backed securities available for sale - FHLMC(4)..................... 5,002 8,444 9,883 Privately issued collateralized mortgage obligations(6).......................... 10,045 -- -- ------- ------- ------- Mortgage-backed securities held to maturity........................ $22,913 $38,350 $43,019 ======= ======= =======
- -------------------- (1) Includes $151,000, $213,000 and $341,000 of unamortized premiums related to GNMA securities as of December 31, 1998, 1997 and 1996, respectively. (2) Is net of unrealized gain of $65,000 at December 31, 1998. (3) Includes $104,000, $144,000 and $187,000 of unamortized premiums related to FHLMC securities as of December 31, 1998, 1997 and 1996, respectively. (4) Is net of unrealized gain of $6,000 at December 31, 1998. (5) Includes $8,000 of unamortized discounts related to privately issued collateralized mortgage obligations at December 31, 1998. (6) Is net of unrealized gain of $23,000 at December 31, 1998. 20 21 The following tables set forth the Company's mortgage-backed securities activities for the periods indicated:
FOR THE YEAR ENDED DECEMBER 31, -------------------------------------- 1998 1997 1996 -------- ------- -------- (IN THOUSANDS) Beginning balance ....................................... $ 57,475 $66,612 $ 58,989 Mortgage-backed securities purchased: Available for sale ................................. 10,856 -- 10,666 Held to maturity ................................... -- -- 13,891 Less: Sale of mortgage-backed securities available for sale ............................... -- (1,084) (10,614) Principal repayments ............................... (24,275) (8,448) (5,934) Change in unrealized gains (losses) ................ (25) 440 (322) Accretion of premium, net of discount .............. (89) (45) (64) -------- ------- -------- Ending balance .......................................... $ 43,942 $57,475 $ 66,612 ======== ======= ========
The following table sets forth certain information regarding the carrying amount and fair values of the Company's mortgage-backed securities at the dates indicated:
AT DECEMBER 31, ----------------------------------------------------------------------------- 1998 1997 1996 --------------------- --------------------- --------------------- CARRYING FAIR CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE -------- ------- -------- ------- -------- ------- (IN THOUSANDS) Mortgage-backed securities: Held to maturity: FNMA .................................. $ 428 $ 438 $ 894 $ 902 $ 1,147 $ 1,129 FHLMC ................................. 682 695 1,100 1,108 1,356 1,330 GNMA .................................. 16,645 16,991 22,425 22,858 26,611 26,696 Privately issued collateralized mortgage obligations................. 5,158 5,209 13,931 14,035 13,905 13,878 ------- ------- ------- ------- ------- ------- Total held to maturity .............. 22,913 23,333 38,350 38,903 43,019 43,033 ------- ------- ------- ------- ------- ------- Available for sale: Privately issued collateralized mortgage obligations............. 10,045 10,045 -- -- -- -- GNMA .................................. 5,982 5,982 10,681 10,681 13,710 13,710 FHLMC ................................. 5,002 5,002 8,444 8,444 9,883 9,883 ------- ------- ------- ------- ------- ------- Total available for sale ............ 21,029 21,029 19,125 19,125 23,593 23,593 ------- ------- ------- ------- ------- ------- Total mortgage-backed securities .......................... $43,942 $44,362 $57,475 $58,028 $66,612 $66,626 ======= ======= ======= ======= ======= =======
21 22 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, ------------------------------------------------------------------- 1998 1997 1996 ------------------- -------------------- ------------------- CARRYING FAIR CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE -------- ------- -------- ------- -------- ------- (IN THOUSANDS) Daily federal funds sold and short-term investments.... $18,069 $18,069 $ 3,448 $ 3,448 $ 2,943 $ 2,943 Investment securities: Held to maturity: Certificates of deposit ........................... -- -- -- -- 250 250 U.S. Government obligations, federal agency obligations, and other obligations ..................................... 7,302 7,371 20,630 20,630 18,920 18,795 ------- ------- ------- ------- ------- ------- Total held to maturity ................................ 7,302 7,371 20,630 20,630 19,170 19,045 ------- ------- ------- ------- ------- ------- Available for sale: U.S. Government obligations, federal agency obligations, and other obligations .................................... 13,064 13,064 30,617 30,617 -- -- Mortgage-Related Mutual Funds ..................... 16,031 16,031 -- -- -- -- Other Mutual funds(1) ............................. 1,974 1,974 1,150 1,150 1,085 1,085 Equity Investments -- Common Stock ................ 1,776 1,776 -- -- -- -- ------- ------- ------- ------- ------- ------- Total available for sale ....................... 32,845 32,845 31,767 31,767 1,085 1,085 ------- ------- ------- ------- ------- ------- Total investment securities ........................... $58,216 $58,285 $55,845 $55,845 $23,198 $23,073 ======= ======= ======= ======= ======= =======
- ------------------------ (1) Consists of securities issued by an institutional mutual fund which primarily invests in short-term U.S. Government securities. 22 23 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, 1998.
AT DECEMBER 31, 1998 ------------------------------------------------------------------ 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 INVESTMENTS .......................................... $18,009 4.69% $ 60 5.00% $ -- --% Investment Securities: Held to maturity: U.S. Government obligations, federal agency obligations, and other obligations ............. 1,250 6.69 5,027 6.37 1,025 6.61 ------- ---- ------- ---- ------- ---- TOTAL HELD TO MATURITY ....................... 1,250 6.69 5,027 6.37 1,025 6.61 ------- ---- ------- ---- ------- ---- Available for sale: U.S. Government obligations, federal agency obligations, and other obligations ............. 13,064 6.08 16,291 6.16 -- -- Mortgage-Related Mutual Funds .................... 16,031 6.04 -- -- -- -- Other Mutual Funds ............................... 1,974 5.38 -- -- -- -- Equity Investments ............................... 1,776 N/A -- N/A -- N/A ------- ---- ------- ---- ------- ---- TOTAL AVAILABLE FOR SALE ..................... 32,845 6.01 16,291 6.16 -- -- ------- ---- ------- ---- ------- ---- TOTAL INVESTMENT SECURITIES .......................... $52,104 5.37% $21,378 6.21% $ 1,025 6.61% ======= ==== ======= ==== ======= ==== Mortgage-backed securities: Held to maturity: FNMA ............................................. $ -- --% $ 429 7.00% $ -- --% GNMA ............................................. -- -- 94 6.50 -- -- FHLMC ............................................ -- -- 682 7.00 2,309 8.23 Privately issued collateralized mortgage obligation...................................... -- -- -- -- -- -- ------- ---- ------- ---- ------- ---- TOTAL HELD TO MATURITY ....................... -- -- 1,205 6.96 2,309 8.23 ------- ---- ------- ---- ------- ---- Held for sale: GNMA ............................................. -- -- -- -- -- -- FHLMC ............................................ -- -- -- -- 5,002 6.42 Privately issued collateralized mortgage obligation...................................... -- -- -- -- -- -- ------- ---- ------- ---- ------- ---- TOTAL HELD FOR SALE .......................... -- -- -- -- 5,002 6.42 ------- ---- ------- ---- ------- ---- TOTAL MORTGAGE-BACKED SECURITIES ..................... $ -- --% $ 1,205 6.96% $ 7,311 6.99% ======= ==== ======= ==== ======= ==== AT DECEMBER 31, 1998 --------------------------------------------- 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 .......................................... $ -- --% $18,069 5.30% Investment Securities: Held to maturity: U.S. Government obligations, federal agency obligations, and other obligations ............. -- -- 7,302 5.53 ------- ---- ------- ---- TOTAL HELD TO MATURITY ....................... -- -- 7,302 5.53 ------- ---- ------- ---- Available for sale: U.S. Government obligations, federal agency obligations, and other obligations ............. -- -- 29,355 6.12 Mortgage-Related Mutual Funds .................... -- -- 16,031 6.04 Other Mutual Funds ............................... -- -- 1,974 5.38 Equity Investments ............................... -- N/A 1,776 N/A ------- ---- ------- ---- TOTAL AVAILABLE FOR SALE ..................... -- -- 49,136 6.06 ------- ---- ------- ---- TOTAL INVESTMENT SECURITIES .......................... $ -- --% $74,057 5.53% ======= ==== ======= ==== Mortgage-backed securities: Held to maturity: FNMA ............................................. $ -- --% $ 429 7.00% GNMA ............................................. 14,241 7.03 14,335 7.03 FHLMC ............................................ -- -- 2,991 7.95 Privately issued collateralized mortgage obligation...................................... 5,158 7.16 5,158 7.16 ------- ---- ------- ---- TOTAL HELD TO MATURITY ....................... 19,399 7.06 22,913 7.19 ------- ---- ------- ---- Held for sale: GNMA ............................................. 5,982 6.82 5,982 6.82 FHLMC ............................................ -- -- 5,002 6.42 Privately issued collateralized mortgage obligation...................................... 10,045 6.30 10,045 6.30 ------- ---- ------- ---- TOTAL HELD FOR SALE .......................... 16,027 6.49 21,029 6.48 ------- ---- ------- ---- TOTAL MORTGAGE-BACKED SECURITIES ..................... $35,426 6.81% $43,942 6.84% ======= ==== ======= ====
23 24 SOURCES OF FUNDS GENERAL. Retail deposits, wholesale brokered 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, 1998, core deposits represented 52.3% 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 except through the use of wholesale brokered deposits which provided $7.7 million and $75.0 million of deposits during 1998 and 1997 respectively, for terms of two to five years. The following table presents the deposit activity of the Company for the periods indicated:
FOR THE YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ------- -------- ------- (IN THOUSANDS) Net deposits (withdrawals) ................................ $63,456 $ 47,355 $(6,425) Interest credited on deposit accounts ..................... 23,867 18,626 16,139 Deposits acquired from BNB acquisition .................... -- 125,022 -- ------- -------- ------- Total increase (decrease) in deposit accounts ............. $87,323 $191,003 $ 9,714 ======= ======== =======
At December 31, 1998, the Company had $29.0 million in certificate accounts in amounts of $100,000 or more (excluding wholesale deposits) maturing as follows: WEIGHTED MATURITY PERIOD AMOUNT AVERAGE RATE - ---------------------------------------------- ------- ------------ (DOLLARS IN THOUSANDS) Three months or less.......................... $ 3,694 5.19% Over 3 through 6 months....................... 6,888 5.53 Over 6 through 12 months...................... 10,853 5.58 Over 12 months................................ 7,571 5.53 ------- ---- Total......................................... $29,006 5.50% ======= ==== 24 25 The following table sets forth the distribution of the Company's average deposit accounts for the periods indicated and the average cost on each category of deposits presented.
FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------ 1998 1997 1996 ---------------------------- ----------------------------- ---------------------------- PERCENT PERCENT PERCENT OF TOTAL OF TOTAL OF TOTAL AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE DEPOSITS COST BALANCE DEPOSITS COST BALANCE DEPOSITS COST -------- -------- ------- -------- -------- ------- -------- -------- ------- (DOLLARS IN THOUSANDS) Money market deposit accounts....... $ 62,739 9.56% 2.93% $ 61,800 11.18% 2.95% $ 46,540 11.10% 3.00% Savings accounts.................... 121,092 18.45 2.48 116,247 21.03 2.43 90,763 21.63 2.44 NOW accounts........................ 104,532 15.94 1.11 96,590 17.47 1.11 66,336 15.82 1.34 Non-interest-bearing accounts....... 54,808 8.36 -- 41,017 7.42 -- 16,177 3.86 -- -------- ------ -------- ------ -------- ------ Total.......................... 343,171 52.31 1.75 315,654 57.10 1.81 219,816 52.41 2.05 -------- ------ -------- ------ -------- ------ Certificate accounts: Less than six months............. 29,423 4.49 4.99 33,573 6.07 5.16 23,748 5.66 4.97 Over six through 12 months....... 42,483 6.48 5.42 54,876 9.93 5.41 49,259 11.74 5.49 Over 12 through 36 months........ 187,285 28.55 6.02 94,157 17.04 5.99 70,849 16.90 5.78 Over 36 months................... 5,442 0.83 5.67 6,859 1.24 5.43 6,973 1.66 5.41 IRA/KEOGH........................ 48,177 7.34 5.73 47,650 8.62 5.78 48,769 11.63 5.82 -------- ------ -------- ------ -------- ------ Total certificate accounts..... 312,810 47.69 5.79 237,115 42.90 5.68 199,598 47.59 5.61 -------- ------ -------- ------ -------- ------ Total average deposits....... $655,981 100.00% 3.68% $552,769 100.00% 3.47% $419,414 100.00% 3.74% ======== ====== ======== ====== ======== ======
25 26 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, 1998.
PERIOD TO MATURITY FROM DECEMBER 31, 1998 AT DECEMBER 31, ---------------------------------------------------------- ---------------------------------- LESS THAN ONE TO TWO TO THREE TO FOUR TO ONE YEAR TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS 1998 1997 1996 --------- --------- ----------- ---------- ---------- -------- -------- -------- (IN THOUSANDS) Certificate accounts: 0 to 4.00%............ $ 1,447 $ -- $ -- $ -- $ -- $ 1,447 $ 1,367 $ 1,486 4.01 to 5.00%......... 36,591 8,566 920 5 732 46,814 1,885 1,630 5.01 to 6.00%......... 158,308 83,362 8,495 1,639 3,459 255,263 203,481 151,893 6.01 to 7.00%......... 1,778 33,357 -- -- -- 35,135 76,802 45,021 7.01 to 8.00%......... -- -- -- -- -- -- 94 94 -------- -------- ------ ------ ------ -------- -------- -------- Total.............. $198,124 $125,285 $9,415 $1,644 $4,191 $338,659 $283,629 $200,124 ======== ======== ====== ====== ====== ======== ======== ========
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. 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, OCC and the FHLB. See "Regulation Federal Home Loan Bank System." During the year ended December 31, 1998, the Company had net borrowings of $81.0 million from the FHLB. At December 31, 1998, the Company had $337.5 million in outstanding advances from the FHLB and no repurchase agreements. 26 27 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, -------------------------------------- 1998 1997 1996 -------- -------- -------- (DOLLARS IN THOUSANDS) FHLB advances: Average balance outstanding..................... $306,575 $287,128 $217,628 Maximum amount outstanding at any month-end during the period.............. $337,500 $310,792 $303,374 Balance outstanding at end of period............ $337,500 $256,500 $296,500 Weighted average interest rate during the period............................ 5.94% 6.00% 5.84% Weighted average interest rate at end of period................................... 5.69% 5.96% 5.88%
AT OR FOR THE YEAR ENDED DECEMBER 31, -------------------------------------- 1998 1997 1996 ------ ------- ------- (DOLLARS IN THOUSANDS) Securities sold under agreements to repurchase and other: Average balance outstanding..................... $1,616 $11,948 $ 7,496 Maximum amount outstanding at any month-end during the period.............. $7,140 $21,861 $10,016 Balance outstanding at end of period............ $ 0 $ 7,140 $ 3,500 Weighted average interest rate during the period............................ 6.05% 5.62% 5.53% Weighted average interest rate at end of period................................... N/A 5.98% 5.45%
SUBSIDIARY ACTIVITIES Leader Corporation ("Leader Corp.") and BFS Service Corp., both incorporated under Massachusetts law, are wholly owned subsidiaries of BFS. Aygro Corp. is a wholly owned subsidiary of BNB. In 1994, BFS, through Leader Corp., permitted Liberty Financial, a third party securities broker, to offer various uninsured investment products to BFS's customers. Leader Corp. entered into a contract with such third party brokerage concern to perform brokerage services in segregated areas of BFS's branches. Under this contract, Liberty Financial leases space from BFS at three of BFS's branch locations, pays rent and a percentage of sales to Leader Corp. Leader Corp. had net income of $25,000 and $753,000, respectively for the years ended December 31, 1998 and 1997. 27 28 During 1997, BFS Service Corp. and Aygro Corp. were activated in order to establish BFS Preferred Capital Corp. ("BFSPCC") and BNB Preferred Capital Corp. ("BNBPCC"), respectively. BFSPCC and BNBPCC are real estate investment trusts organized under Massachusetts law and satisfy the requirements of Section 856 of the Internal Revenue Code of 1986, as amended. During 1998, BFS Service Corp. and Aygro Corp. established BFS Security Corp. ("BFSSC") and BNB Security Corp. ("BNBSC"), respectively. BFSSC and BNBSC are investment subsidiaries organized under Massachusetts law. PERSONNEL As of December 31, 1998, the Company had 249 authorized full-time employee positions and 69 authorized part-time employee positions, for a total of approximately 279 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 BNB in February 1997, the Company became a bank holding company and ceased to be a savings and loan 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 BFS, are governed by the Home Owner's Loan Act ("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. BFS is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. BFS is a member of the Federal Home Loan Bank System and its deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. BFS 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. BNB is subject to extensive regulation, examination and supervision by and reporting with the OCC, as its primary federal regulator, and the FDIC, as the deposit insurer. BNB is a member of the Bank Insurance Fund ("BIF") managed by the FDIC. The OTS and/or the FDIC conduct periodic examinations to test BFS's safety and soundness and compliance with various regulatory requirements and the OCC and/or FDIC conduct similar examinations of BNB. 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, BFS and/or BNB and their operations. Certain of the regulatory requirements applicable to BFS, BNB and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to depository 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 BFS, BNB and the Company. 28 29 HOLDING COMPANY REGULATION FEDERAL REGULATION. Due to its control of BNB, 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, the Company would, directly or indirectly, own or control more than 5% of any class of voting shares of such bank or bank holding company. In evaluating such transactions, the FRB considers such matters as the financial and managerial resources of and future prospects of the companies involved, competitive factors and the convenience and needs of the communities to be served. Bank holding companies may acquire additional banks in any state, subject to certain restrictions such as deposit concentration limits. 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 banks 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 BFS, 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 BFS and the OCC for BNB. 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 its 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 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. 29 30 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 potentially 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, BFS or BNB. 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 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 Massachusetts 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 2% tangible capital ratio, a 4% leverage (core) capital ratio, a 4% risk-based Tier I capital ratio and 8% risk-based total capital ratio. 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 30 31 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 believed inherent in the type of asset. Core (or Tier 1) 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 mortgage servicing rights and credit card relationships. 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 a leverage (core) capital ratio at least equal to 4% (3% for institutions receiving the highest rating on the CAMELS financial institution examination rating system), a risk-based Tier I capital ratio of 4% and an 8% risk-based capital ratio. National banks are subject to identical requirements as savings institutions under the prompt corrective action standards. Both the OTS and the OCC have the discretion to establish higher capital requirements on a case-by-case basis where deemed appropriate in the circumstances of a particular institution. The Company is subject to consolidated capital requirements pursuant to the regulations of the FRB. Generally, a bank holding company must have a consolidated ratio of core (Tier 1) capital to total assets of at least 3% if it receives the FRB's highest examination rating and 4% otherwise. A bank holding company also must maintain a total capital to risk-based assets ratio of at least 8% and a Tier 1 (core) capital to risk-based assets ratio of at least 4%. 31 32 The following table presents BFS's and BNB's capital position at December 31, 1998 relative to fully phased-in regulatory requirements.
FOR CAPITAL ADEQUACY TO BE WELL ACTUAL PURPOSES CAPITALIZED ------------------ ------------------- ----------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- ----- ------- ----- ------- ----- (DOLLARS IN THOUSANDS) As of December 31, 1998 Risk-based Total Capital: BFS....................... $57,944 10.2% $45,538 8.0% $56,923 10.0% BNB....................... 10,131 15.3 5,291 8.0 6,614 10.0 Core Capital: BFS....................... 50,820 5.1 39,533 4.0 49,417 5.0 BNB....................... 9,492 7.4 5,167 4.0 6,459 5.0 Risk-based Tier I Capital: BFS....................... 50,820 8.9 22,769 4.0 34,154 6.0 BNB....................... 9,492 14.4 2,645 4.0 3,968 6.0 Tangible Capital: BFS....................... 50,820 5.1 19,767 2.0 49,417 5.0 As of December 31, 1997: Risk-based Total Capital: BFS....................... $54,731 11.9% $36,758 8.0% $45,948 10.0% BNB....................... 9,477 16.4 4,618 8.0 5,722 10.0 Core Capital: BFS....................... 48,987 5.9 24,952 3.0 41,586 5.0 BNB....................... 8,799 7.4 4,753 4.0 5,941 5.0 Risk-based Tier I Capital: BNB....................... 8,799 15.2 2,309 4.0 3,463 6.0 Tangible Capital: BFS....................... 48,987 5.9 12,476 1.5 41,586 5.0
The Company's regulatory capital ratios at December 31, 1998 were 7.1%, 12.6% and 13.8% for Tier 1 leverage ratio, Tier 1 risk-based capital ratios and total capital ratios, respectively. PROMPT CORRECTIVE REGULATORY ACTION. The OTS and OCC are required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (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." A savings 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 a savings 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 OTS and OCC are 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 or OCC within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly 32 33 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 OTS and OCC 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 BFS are presently insured by the Federal Deposit Insurance Corporation ("FDIC") through the SAIF while BNB's deposits are insured by the BIF. Both the SAIF and the BIF 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 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 BFS 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 BFS, 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 BFS as an expense in the quarter ended September 30, 1996 and was tax deductible. The SAIF Special Assessment recorded by BFS amounted to $2.7 million on a pre-tax basis and approximately $1.6 million on an after-tax basis. The Funds Act also spread the obligations for payment of the FICO bonds across all SAIF and BIF members. During 1998, FICO payments for SAIF members approximated 6.10 basis points, while Bank Insurance Fund ("BIF") members paid 1.22 basis points. Under current law, there will be equal sharing of FICO payments between SAIF and BIF members on the earlier of January 1, 2000 or the date the SAIF and BIF are merged. This issue is currently being considered by Congress. As a result of the Funds Act, the FDIC 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. 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. 33 34 BFS's assessment rate for fiscal 1998 ranged from 5 to 6 basis points and the premium paid for this period was $314,000. BNB paid $16,000 to the FDIC for 1998. A significant increase in FDIC insurance premiums would likely have an adverse effect on the operating expenses and results of operations of BFS and/or BNB. 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 BFS and BNB does not know of any practice, condition or violation that might lead to termination of deposit insurance. THRIFT RECHARTERING LEGISLATION. Legislation enacted in 1996 provided that the BIF and SAIF were to have merged on January 1, 1999 if there were no more savings associations as of that date. Various proposals to eliminate the federal savings association charter, create a uniform financial institutions charter, abolish the OTS and restrict savings and loan holding company activities have been introduced in Congress. The Company is unable to predict whether such legislation will be enacted or the extent to which the legislation would restrict or disrupt its operations. LOANS TO ONE BORROWER. Federal law provides that 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 and surplus, 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, 1998, BFS's limit on loans to one borrower was $8.8 million and BNB's limit was $1.5 million. At December 31, 1998, BFS's largest aggregate outstanding balance of loans to one borrower was $7.9 million and BNB's largest aggregate outstanding balance of loans to one borrower was $1.5 million. QTL TEST. The HOLA requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or 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 qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of December 31, 1998, BFS maintained approximately 90% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments." National banks such as BNB 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 its shares, payments 34 35 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 BFS's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, BFS'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. At December 31, 1998, BFS was a Tier 1 Bank. National banks may not pay dividends out of their 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. BFS 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 4% 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. Monetary penalties may be imposed for failure to meet these liquidity requirements. BFS's liquidity ratio for December 31, 1998 was 6.9%, which exceeded the applicable requirement. BFS has never been subjected to monetary penalties for failure to meet its liquidity requirements. BNB, under OCC regulations, is not subject to separate 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 BFS's latest quarterly thrift financial report. The assessments paid by BFS for the fiscal year ended December 31, 1998 totalled $178,000. National banks pay semi-annual assessments to the OCC to fund its operations based on asset size. Such assessments for BNB amounted to $39,000 for the year ended December 31, 1998. BRANCHING. OTS regulations permit nationwide branching by federally chartered savings institutions. 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 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 was authorized on June 1, 1997 unless the state in 35 36 which the Bank is to branch has enacted a law opting out of interstate branching. Massachusetts did not enact any law opting out of interstate branching. De novo interstate branching is permitted by the Act to the extent the state into which BFS 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 BFS 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. Certain transaction between sister institutions in a holding company are exempt from these requirements. The authority of BFS and BNB 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. Both banks have complied with Regulation O requirements. 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. Neither bank is under any enforcement action. The FRB has similar enforcement authority with respect to the Company. 36 37 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 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). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $46.5 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts aggregating greater than $46.5 million, the reserve requirement is $1.395 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 $46.5 million. The first $4.9 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. BFS and BNB are also in compliance with these requirements. 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. 37 38 FEDERAL AND STATE TAXATION FEDERAL TAXATION GENERAL. The Company and the Banks 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 BFS's reserve for bad debts discussed below. BNB also reports its income on a consolidated basis with the Company and BFS 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 Banks or the Company. BFS was audited by the IRS during 1996, and covered the tax years 1991, 1992 and 1993. For its 1998 taxable year, the Company is subject to a maximum federal income tax rate of 35%. 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. Under the Small Business Job Protection Act of 1996 (the "1996 Act"), for its current and future taxable years, BFS is not permitted to make additions to its tax bad debt reserves. In addition, BFS 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 BFS makes "non-dividend distributions" to the Company, such distributions will be considered to have been made from BFS's unrecaptured tax bad debt reserves (including the balance of its reserves as of December 31, 1987) to the extent thereof, and then from its 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 BFS's income. Non-dividend distributions include distributions in excess of BFS'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 BFS's current or accumulated earnings and profits will not be so included in BFS'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 BFS 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 35% federal corporate income tax rate. BFS does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves. The bad debt reserves subject to recapture amount to $13.3 million for which no deferred taxes have been provided. 38 39 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 being 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 a 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 BFS and BNB conducting business in Massachusetts must file separate Massachusetts state tax returns and are taxed as corporations. 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. Certain affiliates chartered in Massachusetts pay taxes at less than statutory rates. 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 BFS'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 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and displaying comprehensive income, which is defined as all changes to equity except investments by and distributions to shareholders. Net income is a component of comprehensive income with all other components referred to in the aggregate as other comprehensive income. This statement is effective for 1998 financial statements. 39 40 Also in June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"), which establishes standards for reporting information about operating segments. An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and evaluate performance. SFAS 131 requires a company to disclose certain income statement and balance sheet information by operating segment, as well as provide a reconciliation of operating segment information to the Company's consolidated balances. SFAS 131 is effective for the 1998 annual financial statements. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Under this statement, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The adoption of this statement is not expected to have a material impact on the Company's financial position. 40 41 ITEM 2. PROPERTIES. The Company conducts its business through an administrative and full service office located in Burlington and 9 other full service branch offices. The Company believes its current facilities are adequate to meet the present and immediately foreseeable needs of the Company.
ORIGINAL NET BOOK VALUE OF LEASED YEAR DATE OF PROPERTY OR LEASEHOLD OR LEASED OR LEASE IMPROVEMENTS AT LOCATION OWNED ACQUIRED EXPIRATION DECEMBER 31, 1998 - ---------------------------------- ------ --------- -------------- --------------------- (In thousands) ADMINISTRATIVE/BRANCH/HOME OFFICE: 17 New England Executive Park Leased 1988 November, 2008 $2,465 Burlington, MA 01803 BRANCH OFFICES: 980 Massachusetts Avenue Owned 1976 -- 481 Arlington, MA 02174 60 The Great Road Owned 1971 -- 420 Bedford, MA 01730 459 Boston Road Owned 1972 -- 485 Billerica, MA 01821 75 Federal Street Leased 1988 August, 2003 73 Boston, MA 02110 457 Broadway Owned 1969 428 Chelsea, MA 02150 1840 Massachusetts Avenue Owned 1960 -- 1,153 Lexington, MA 02173 31 Cross Street Owned 1971 -- 507 Peabody, MA 01960 411 Broadway Owned 1977 -- 427 Revere, MA 02150 200 Linden Street Leased 1973 November, 2003 175 Wellesley, MA 02181 ------ Total........................... $6,614 ======
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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 41 42 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 1998 Annual Report to Stockholders on page 64 and is incorporated herein by reference. Information relating to dividend restrictions for Registrant's common stock appears under "Regulation and Supervision." ITEM 6. SELECTED FINANCIAL DATA. The above-captioned information appears under "Selected Financial Data" of the Corporation in the Registrant's 1998 Annual Report to Stockholders on pages 6 through 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 1998 Annual Report to Stockholders on pages 9 through 24 and is incorporated herein by reference. ITEMS 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS. The above captioned information appears under the heading "Market Risk and Management of Interest Rate Risk" in the Registrant's 1998 Annual Report to Stockholders on pages 11 through 14 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 1998 Annual Report to Stockholders on pages 25 through 63 and are incorporated herein by reference. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 42 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, 1999 at pages 4 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, 1999 at pages 7 through 15. 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, 1999, at pages 3 through 5. 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, 1999, at page 15. 43 44 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 1998 Annual Report to Stockholders: PAGE Independent Auditors' Report............................................ 25 Consolidated Balance Sheets as of December 31, 1998 and 1997............................................ 26 Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996...................................... 27 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996...................... 28-30 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996................................ 31-32 Notes to Consolidated Financial Statements.............................. 33-63 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 BFS and David F. Holland and Employment Agreement between the Company and David F. Holland* 10.2 Employment Agreement between BFS and David P. Conley and Employment Agreement between the Company and David P. Conley* 10.3 Employment Agreement between BFS and John A. Simas and Employment Agreement between the Company and John A. Simas* 10.4 Form of Change in Control Agreement between BFS and Executive and between the Company and Executive* 10.5 Boston Federal Savings Bank Employee Severance Compensation Plan* 44 45 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 Option Plan*** 11.0 Computation of earnings per share (see Consolidated Statements of Income on page located on page 27 of the 1998 Annual Report) 13.0 Portions of the 1998 Annual Report to Stockholders (filed herewith) 21.0 Subsidiary information is incorporated herein by reference to "Part I - Subsidiaries" 23.0 Consent of Independent Auditors (filed herewith) 27.0 Financial Data Schedule (filed herewith) 99.0 Proxy Statement for 1999 Annual Meeting (previously filed on March 30, 1999) ------------------------ * Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, and any amendments thereto, originally filed on July 21, 1995, as amended and declared effective on September 11, 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. The Company filed a report on Form 8-K, on January 22, 1999, declaring a $.10 per share dividend and announcing its intention to repurchase 5% of its outstanding common stock. The Form 8-K also included the Company's fourth quarter results and the announcement of the 1999 Annual Meeting date, April 28, 1999. 45 46 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: March 31, 1999 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 Executive March 31, 1999 - ----------------------------- Officer and Chairman of the Board David F. Holland /s/ David P. Conley Director, Executive Vice President, March 31, 1999 - ----------------------------- Assistant Treasurer and Assistant Secretary David P. Conley /s/ John A. Simas Executive Vice President, March 31, 1999 - ----------------------------- Corporate Secretary and Chief Financial John A. Simas Officer (Principal accounting officer) /s/ Edward P. Callahan Director March 31, 1999 - ----------------------------- Edward P. Callahan /s/ Richard J. Dennis, Sr. Director March 31, 1999 - ----------------------------- Richard J. Dennis, Sr. /s/ Charles R. Kent Director March 31, 1999 - ----------------------------- Charles R. Kent /s/ W. Robert Mill Director March 31, 1999 - ----------------------------- W. Robert Mill /s/ Irwin W. Sizer Director March 31, 1999 - ----------------------------- Irwin W. Sizer
46 EX-13 2 1998 ANNUAL REPORT TO STOCKHOLDERS 1 EXHIBIT 13 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF THE COMPANY The selected consolidated financial and other data of the Company set forth below is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere in this Annual Report. Prior to October 24, 1995, the Company had no significant assets, liabilities or operations, and accordingly, the data prior to such time represents the financial condition and results of operations of BFS.
AT DECEMBER 31, ------------------------------------------------------ 1998 1997 1996 1995 1994 ---------- -------- -------- -------- -------- (IN THOUSANDS) Selected Financial Condition Data: Total assets ........................................ $1,139,123 $974,680 $820,567 $640,752 $583,645 Investment securities available for sale(1) ......... 49,137 31,767 1,085 1,022 -- Investment securities held to maturity(1) ........... 7,302 20,630 19,170 16,906 14,784 Mortgage-backed securities available for sale(l) .... 21,029 19,125 23,593 23,873 -- Mortgage-backed securities held to maturity(1) ...... 22,913 38,350 43,019 35,116 39,801 Mortgage loans held for sale ........................ 17,008 9,817 3,970 8,931 316 Loans, net .......................................... 943,662 791,728 676,670 509,496 499,073 Allowance for loan losses ........................... 8,500 6,600 4,400 4,275 3,700 Deposit accounts .................................... 707,144 619,821 428,818 419,104 413,164 Borrowed funds ...................................... 337,500 263,640 300,000 126,909 135,031 Stockholders' equity ................................ 81,794 81,611 86,355 90,701 30,047
FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------ 1998 1997 1996 1995 1994 ---------- -------- -------- -------- -------- (IN THOUSANDS) Selected Operating Data: Interest income ..................................... $ 74,775 $ 68,037 $ 52,678 $ 42,454 $ 36,527 Interest expense .................................... 42,557 37,129 28,891 23,552 17,022 ---------- -------- -------- -------- -------- Net interest income ................................ 32,218 30,908 23,787 18,902 19,505 Provision for loan losses .......................... 1,642 1,696 1,294 3,614 283 ---------- -------- -------- -------- -------- Net interest income after provision for loan losses ................................... 30,576 29,212 22,493 15,288 19,222 Total non-interest income ........................... 6,128 4,806 3,567 2,672 1,640 Total non-interest expense .......................... 23,932 21,458 21,040 16,009 14,531 ---------- -------- -------- -------- -------- Income before income taxes .......................... 12,772 12,560 5,020 1,951 6,331 Income tax expense (benefit) ........................ 5,151 5,505 2,083 815 2,320 ---------- -------- -------- -------- -------- Net income .......................................... $ 7,621 $ 7,055 $ 2,937 $ 1,136 $ 4,011 ========== ======== ======== ======== ========
6 2 SELECTED FINANCIAL RATIOS AND OTHER DATA
AT OR FOR THE YEAR ENDED DECEMBER 31, ----------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- -------- -------- -------- -------- Performance ratios:(2) Return on average assets ............................... 0.72% 0.75% 0.40% 0.19% 0,75% Return on average stockholders' equity ................. 9.02 8.21 3.21 2.57 14.53 Dividend payout ratio .................................. 24.70 20.31 31.25 NM NM Average stockholders' equity to average assets ......... 7.99 9.11 12.35 7.36 5.16 Stockholders' equity to total assets at end of period .. 7.18 8.37 10.52 14.16 5.15 Average interest rate spread(3) ........................ 2.69 2.94 2.79 2.98 3.69 Net interest margin(4) ................................. 3.17 3.42 3.34 3.28 3.82 Average interest-earning assets to average interest-bearing liabilities .......................... 111.60 111.53 113.40 107.40 104.16 Asset quality ratios:(2) Non-performing loans as a percent of loans(5)(6) ...... 0.09 0.17 0.22 1.00 0.71 Non-performing assets as a percent of total assets(6).. 0.08 0.16 0.51 0.97 0.68 Allowance for loan losses as a percent of loans(5) .... 0.88 0.82 0.64 0.82 0.74 Allowance for loan losses as a percent of non-performing loans(6) .............................. 1,029.06 469.75 293.02 81.40 103.61 Number of full-service customer facilities ............. 10 10 8 8 8 Number of shares outstanding at end of period (in thousands) .............................. 5,112 5,520 6,260 6,590 -- Per Share Data: Basic earnings per common share ....................... $ 1.50 $ 1.28 $ 0.48 $ NM -- Diluted earnings per common share ..................... 1.43 1.24 0.48 NM -- Dividends per common share ............................ 0.37 0.26 0.15 NM -- Book value per common share at end of period .......... 16.84 15.72 14.75 14.78 -- Market value per common share at end of period ........ 17.63 21.88 14.75 11.75 --
- ------------------ (1) The balance does not include FHLB-Boston stock. (2) Asset Quality Ratios and Regulatory Capital Ratios are end of period ratios. (3) The average interest rate spread represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities. (4) The net interest margin represents net interest income as a percent of average interest-earning assets. (5) Loans includes loans, net, and mortgage loans held for sale, excluding the allowance for loan losses. (6) Non-performing assets consist of non-performing loans and real estate owned ("REO"). Non-performing loans consist of all loans 90 days or more past due and other loans which have been identified by the Company as presenting uncertainty with respect to the collectibility of interest or principal. It is the Bank's policy to cease accruing interest on all such loans. NM -- Not Meaningful/Earnings per share is not presented for the period of October 24, 1995 (the day of conversion to stockownership) 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. 7 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL BostonFed Bancorp, Inc. (the "Company") was incorporated in Delaware on July 11, 1995. On October 24, 1995 it became the holding company for Boston Federal Savings Bank ("BFS") when it issued 6,589,617 shares of common stock, utilizing a portion of the proceeds to acquire all of the outstanding stock of BFS which simultaneously completed its conversion from a mutual savings bank to a stock form of ownership. On February 7, 1997, the Company acquired Broadway National Bank, ("BNB"), using the purchase method of accounting, at a cost of approximately $22 million. The Company's business has been conducted primarily through its ownership of BFS and BNB, (collectively the "Banks"). BFS 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, and BNB operates two banking offices (Chelsea and Revere) which are also 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 loans, and to a lesser extent, interest and dividends on its investment and mortgage-backed securities, gains on sale of loans, fees and loan servicing income. The Company's primary sources of funds are deposits, principal and interest payments on loans, investments, 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. As a result of the acquisition of BNB, the Company became a bank holding company subject to regulation by the Federal Reserve Bank ("FRB") and for the first three years following the initial public offering was also subject to the regulations of the Office of Thrift Supervision, ("OTS"). BFS continues to be regulated by the OTS and BNB continues to be regulated by the Office of the Comptroller of the Currency ("OCC"). Since the acquisition of BNB was consummated at the close of business on February 7, 1997, 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, 1998 and 1997, include information and data related to BNB only from February 8, 1997 to December 31, 1998. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds are deposits, (including brokered deposits), principal and interest payments on loans, investments, 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. The Company has maintained the required minimum levels of liquid assets at BFS as defined by Office of Thrift Supervision ("OTS") regulations. This requirement, which may be varied at the direction of 9 4 the OTS depending upon economic conditions and deposit flows, is based upon a percentage of BFS's deposits and short-term borrowings. BFS's currently required liquidity ratio is 4%. At December 31, 1998 and 1997, BFS's liquidity ratio was 6.9% 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 funds to repay higher cost FHLB advances or repurchase agreements. The OCC does not have specific guidance for liquidity ratios for BNB, but does require banks to maintain reasonable and prudent liquidity levels. Management believes such levels have been maintained since the acquisition date. The Company's most liquid assets are cash, overnight federal 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, 1998, cash, short-term investments and investment securities available for sale totaled $86.3 million or 7.6% of total assets. Additional investments were available which qualified for BFS's regulatory liquidity requirements. The Company has other sources of liquidity if a need for additional funds arise, including FHLB advances and wholesale brokered deposits and repurchase agreements (collateralized borrowings). At December 31, 1998, the Company had $337.5 million in advances outstanding from the FHLB and had, with existing collateral, an additional $130.5 million in overall borrowing capacity from the FHLB. Additional collateral was available at BNB, however, a collateral report for BNB was not required to be prepared as of December 31, 1998. The Company generally avoids paying the highest deposit rates in its market and accordingly utilizes alternative sources of funds such as FHLB advances, repurchase agreements and wholesale brokered deposits to supplement cash flow needs. At December 31, 1998, the Company had commitments to originate loans and unused outstanding lines of credit totaling $157.3 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, 1998, totaled $198.1 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, BFS 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 BFS, each eligible account holder will be entitled to receive a distribution from the liquidation account. BFS 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, 1998 was approximately $9.5 million. Prior to the Company's acquisition of BNB, 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 acquisition of BNB and its resultant 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 Banks. At December 31, 1998, the consolidated capital to assets ratio of the Company was 7.2%, which exceeded the minimum regulatory capital requirements for the Company. As of December 31, 1998, BFS exceeded all of its regulatory capital requirements with tangible, core, risk-based tier 1, and risk-based capital ratios of 5.1%, 5.1%, 8.9% and 10.2%, respectively, compared to the minimum regulatory requirements of 2.0%, 4.0%, 4.0% and 8.0%, respectively. BNB also exceeded the minimum regulatory capital requirements with leverage capital, risk-based tier 1 capital and risk-based total capital ratios of 7.4%, 14.4% and 15.3%, respectively, compared to the minimum regulatory requirements of 4.0%, 4.0% and 8.0%, respectively. 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 throughout the Company's operations. Unlike industrial companies, nearly all of the assets and 10 5 liabilities of the Company are monetary in nature. As a result, interest rates 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. MARKET RISK AND MANAGEMENT OF INTEREST RATE RISK The principal market risk affecting the Company is interest rate risk. The 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 that is responsible for reviewing the Company's asset/liability policies and interest rate risk position. The Committee meets frequently 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 mortgage loans; (2) generally selling in the secondary market substantially all fixed-rate mortgage loans originated with terms greater than 15 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 such as wholesale brokered deposits and utilizing FHLB advances to replace short-term, rate sensitive, retail deposits. The volatile and generally rising rate environment of 1996 allowed the Company to originate record loan volume, the majority of loans originated were adjustable-rate loans, which were primarily retained for BFS's portfolio. Many of these loans, however, do not reprice until the third or fifth year of their term. As interest rates generally fell during the second half of 1997 and throughout 1998, customer preference shifted to longer-term fixed rate mortgages, the vast majority of which were sold in the secondary market. 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. These differences are a primary component of the risk to net interest income. 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, 1998, 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, 1998, 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 21.7% and 14.7%, respectively. Annual prepayment rates for adjustable-rate and fixed-rate mortgage-backed securities are assumed to be 15.1% and 12.8%, respectively. Money market deposit accounts are assumed to be immediately rate-sensitive, while passbook accounts and negotiable order of withdrawal ("NOW") accounts are 11 6 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 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, 1998 and 1997:
3 More than More than More than More than More Months 3 Months 6 Months 1 Year to 3 Years 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 ............... $ 17,895 $ 8 $ 60 $ 105 $ 0 $ 0 $ 18,068 Investment securities ................ 26,786 7,031 4,282 14,256 3,059 1,025 56,439 Fixed Rate Loans(1) .................. 16,833 16,425 30,914 103,070 75,719 80,585 323,546 Adjustable Rate Loans(1) ............. 123,401 61,363 115,329 233,364 92,956 18,402 644,815 Mortgage-backed securities ........... 18,474 2,997 8,750 12,529 1,192 0 43,942 Stock in FHLB-Boston ................. 17,802 0 0 0 0 0 17,802 -------- ------- -------- -------- -------- -------- ---------- Total Interest-earning assets ...... 221,191 87,824 159,335 363,324 172,926 100,012 1,104,612 -------- ------- -------- -------- -------- -------- ---------- INTEREST-BEARING LIABILITIES Money market deposit accounts ........ 61,756 0 0 0 0 0 61,756 Savings accounts ..................... 3,925 3,925 7,850 31,402 31,402 52,339 130,843 NOW accounts ......................... 3,448 3,448 6,896 27,585 27,585 45,972 114,934 Certificate accounts ................. 35,867 63,911 88,344 144,704 5,833 0 338,659 FHLB Advances ........................ 26,000 10,000 78,000 159,500 44,000 20,000 337,500 -------- ------- -------- -------- -------- -------- ---------- Total interest-bearing liabilities . 130,996 81,284 181,090 363,191 108,820 118,311 983,692 -------- ------- -------- -------- -------- -------- ---------- Interest-earning assets less interest-bearing liabilities ........ $ 90,195 $ 6,540 $ 21,755) $ 133 $ 64,106 $(18,299) $ 120,920 -------- ------- -------- -------- -------- -------- ---------- Cumulative interest rate sensitivity gap December 31, 1998 ................... $ 90,195 $96,735 $ 74,980 $ 75,113 $139,219 $120,920 $ 120,920 ======== ======= ======== ======== ======== ======== ========== Cumulative interest rate gap as a percentage of total assets at December 31, 1998 ................... 7.92% 8.49% 6.58% 6.59% 12.22% 10.62% Cumulative interest rate gap as a percentage of total interest-earning assets at December 31, 1998 ......... 8.17% 8.76% 6.79% 6.80% 12.60% 10.95% Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at December 31, 1998 ................... 168.85% 145.57% 119.06% 109.93% 116.09% 112.29% Cumulative interest rate sensitivity gap December 31, 1997 ................... $ 4,078 $26,304 $ 99,198 $ 57,359 $143,246 $104,363 $ 104,363 ======== ======= ======== ======== ======== ======== ========== Cumulative interest rate gap as a percentage of total assets at December 31, 1997 ................... 0.42% 2.70% 10.18% 5.88% 14.70% 10.71% Cumulative interest rate gap as a percentage of total interest-earning assets at December 31, 1997 ......... 0.44% 2.81% 10.59% 6.12% 15.29% 11.14% Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at December 31, 1997 ................ 102.40% 110.92% 128.25% 108.52% 119.27% 112.54%
- ------------ (1) Includes total loans net of non-performing loans 12 7 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 Company's Board of Directors has established certain NPV maximum percentage change limits by interest rate shock. These approved limits are included in the following table. The Company is operating within the maximum limits imposed by the Board of Directors. The OTS also produces a similar analysis using its own model, based upon data submitted on the Company's quarterly Thrift Financial Reports for BFS, 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, 1998 and 1997, as calculated by the Company.
Net Portfolio Value as of December 31, 1998 -------------------------------------------- Change in Interest Rates In Basis Points $ $ % Board NPV (Rate Shock) Amount Change Change Limits % Ratio - ----------------------------------------- ------- -------- ------- -------- ----- (Dollar in thousands) 400 ................................. 93,985 (30,759) (24.7) (30.0) 8.3 300 ................................. 103,788 (20,956) (16.8) (25.0) 9.1 200 ................................. 113,61l (11,133) (8.9) (20.0) 10.0 100 ................................. 120,618 (4,126) (3.3) (10.0) 10.6 Static .............................. 124,744 11.0 (100) ............................... 126,627 1,883 1.5 (10.0) 11.1 (200) ............................... 126,108 1,364 1.1 (20.0) 11.1 (300) ............................... 123,260 (1,484) (1.2) (25.0) 10.8 (400) ............................... 119,726 (5,018) (4.0) (30.0) 10.5
Net Portfolio Value as of December 31, 1997 -------------------------------------------- Change in Interest Rates In Basis Points $ $ % Board NPV (Rate Shock) Amount Change Change Limits % Ratio - ----------------------------------------- ------- -------- ------- -------- ----- (Dollar in thousands) 400 ................................. 76,878 (24,583) (24.2) (30.0) 7.9 300 ................................. 85,462 (15,599) (15.8) (25.0) 8.8 200 ................................. 91,425 (10,036) (9.9) (20.0) 9.4 100 ................................. 97,847 (3,614) (3.6) (10.0) 10.0 Static .............................. 101,461 10.4 (100) ............................... 107,732 6,271 6.2 (10.0) 11.1 (200) ............................... 110,465 9,004 8.9 (20.0) 11.3 (300) ............................... 111,689 10,228 10.1 (25.0) 11.5 (400) ............................... 113,447 11,986 11.8 (30.0) 11.6
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 13 8 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. During 1998, the Company continued to follow its past practice of selling, while generally retaining the servicing rights, certain fixed-rate and adjustable-rate mortgage loans which were either sold as whole loans or, prior to sale, converted to mortgage-backed securities. In conjunction with this mortgage banking activity, the Company uses forward contracts in order to reduce exposure to interest rate risk. The amount of forward coverage of the "pipeline" of mortgages is set on a day-to-day basis by an operating officer, within policy guidelines, based on the Company's assessment of the general direction of interest rates and the levels of mortgage origination activity. 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, 1998, 1997 and 1996. 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. The average balance data is derived from daily balances. The yields and costs include fees, premiums and discounts which are considered adjustments to yields.
FOR THE YEAR ENDED DECEMBER 31, AT ------------------------------------------------------------------------------ DECEMBER 31,1998 1998 1997 1996 ----------------- ------------------------- ------------------------- ------------------------ AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE COST BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST ---------- ------ ---------- -------- ------- -------- -------- ------- ------- -------- ------- (DOLLARS IN THOUSANDS) ASSETS: Interest-earning assets: Investment securities(1) ... $ 92,309 5.73% $ 88,166 $ 5,400 6.12% $ 82,701 $ 5,003 6.05% $ 36,678 $ 2,167 5.91% Loans, net and mortgage loans held for sale(2) ... 960,670 7.38 876,344 66,040 7.54 759,312 58,805 7.74 603,585 45,513 7.54 Mortgage-backed securities(3) ............ 43,942 6.88 50,375 3,335 6.62 62,265 4,229 6.79 72,287 4,998 6.91 ---------- ---------- ------- ------- ------- -------- ------- Total interest-earning assets ................. 1,096,921 7.22 1,014,885 74,775 7.37 904,278 68,037 7.52 712,550 52,678 7.39 ---- ------- ---- ------- ---- ------- ---- Non-interest-earning assets ................... 42,202 42,683 39,770 28,354 ---------- ---------- ------- -------- Total assets ............. $1,139,123 $1,057,568 $944,048 $740,904 ========== ========== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing Liabilities: Money market deposit accounts ................. $ 61,756 2.83 $ 62,739 1,838 2.93 $ 61,800 1,822 2.95 $ 46,540 1,395 3.00 Savings accounts ........... 130,843 2.38 121,092 2,999 2.48 116,247 2,826 2 43 90,763 2,219 2.44 NOW accounts ............... 114,934 1.09 104,532 1,158 1.11 96,590 1,071 1.11 66,336 890 1.34 Certificate accounts ....... 338,659 5.72 312,810 18,101 5.79 237,115 13,457 5.68 199,598 11,194 5.61 ---------- ---------- ------- ------- ------- -------- ------- Total .................... 646,192 3.95 601,173 24,096 4.01 511,752 19,176 3.75 403,237 15,698 3.89 Borrowed Funds(4) .......... 337,500 5.69 308,191 18,461 5.99 299,076 17,953 6.00 225,124 13,193 5.86 ---------- ---------- ------- ------- ------- -------- ------- Total interest-bearing liabilities ............ 983,692 4.54 909,364 42,557 4.68 810,828 37,129 4.58 628,361 28,891 4.60 ---- ------- ---- ------- ---- ------- ---- Non-interest-bearing liabilities .............. 73,637 63,729 47,264 21,030 ---------- ---------- ------- -------- Total liabilities ........ 1,057,329 973,093 858,092 649,391 ---------- ---------- ------- -------- Stockholders' equity ....... 81,794 84,475 85,956 91,513 ---------- ---------- ------- -------- Total liabilities and stockholders' equity .... $1,139,123 $1,057,568 $944,048 $740,904 ========== ========== ======== ======== Net interest rate spread(5) ................ 2.68% $32,218 2.69% $30,908 2.94% $23,787 2.79% ==== ======= ==== ======= ==== ======= ==== Net interest margin(6) ..... 3.17% 3.42% 3.34% ==== ==== ==== Ratio of interest-earning assets to interest-bearing liabilities .............. 111.51% 111.60% 111.53% 113.40% ========== ========== ======== ========
- ----------- (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 5.94%, 5.98%, and 5.81% for the years ended December 31, 1998, 1997 and 1996, 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. 14 9 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 DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1997 COMPARED TO COMPARED TO YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996 ------------------------------ ------------------------------- INCREASE (DECREASE) INCREASE (DECREASE) DUE TO DUE TO -------------------- ------------------- VOLUME RATE NET VOLUME RATE NET ------- ------- ------ -------- ------ ------- (IN THOUSANDS) INTEREST-EARNING ASSETS: Investment securities .............................. $ 331 $ 66 $ 397 $ 2,720 $ 116 $ 2,836 Loans, net and mortgage loans held for sale ........ 9,058 (1,823) 7,235 11,742 1,550 13,292 Mortgage-backed securities ......................... (807) (87) (894) (693) (76) (769) ------ ------- ------ ------- ------ ------- Total interest-earning assets .................... 8,582 (1,844) 6,738 13,769 1,590 15,359 ------ ------- ------ ------- ------ ------- INTEREST-BEARING LIABILITIES: Money market deposit accounts ...................... 28 (12) 16 458 (31) 427 Savings accounts ................................... 118 55 173 622 (15) 607 NOW accounts ....................................... 88 (1) 87 405 (224) 181 Certificate accounts ............................... 4,299 345 4,644 2,104 159 2,263 ------ ------- ------ ------- ------ ------- Total ............................................ 4,533 387 4,920 3,589 (111) 3,478 ------ ------- ------ ------- ------ ------- Borrowed funds ..................................... 547 (39) 508 4,334 426 4,760 ------ ------- ------ ------- ------ ------- Total interest-bearing liabilities ............... 5,080 348 5,428 7,923 315 8,238 ====== ======= ====== ======= ====== ======= Net change in net interest income .................... $3,502 $(2,192) $1,310 $ 5,846 $1,275 $ 7,121 ====== ======= ====== ======= ====== =======
15 10 ASSET QUALITY The following table sets forth information regarding non-performing assets, which consist of: nonperforming loans and real estate owned ("REO"). In addition to identifying non-performing loans, as discussed below, the Company identifies loans that are characterized as impaired. Accordingly, loans categorized as impaired include non-performing loans as well as other identified loans. At December 31, 1998, non-performing loans totaled $809,000, (all of which are included in the balance of impaired loans), impaired loans totaled $1.5 million, consisting of 20 loans, and REO totaled $47,000, consisting of one property. 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, 1998, 1997, and 1996, 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 $34,000, $146,000, and $103,000, 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 $1,000, $1,000, and $73,000, respectively.
AT DECEMBER 31, ------------------------------------- 1998 1997 1996 --------- ------- ------- (DOLLARS IN THOUSANDS) NON-PERFORMING LOANS: Residential real estate: One- to four-family ............................................... $ 784 $ 941 $ 1,463 Commercial real estate ............................................ 25 458 25 Other Loans ....................................................... -- 6 14 --------- ------- ------- Total ............................................................. 809 1,405 1,502 Real estate owned, net(3) ............................................. 47 195 2,668 Total non-performing assets ....................................... 856 1,600 4,170 --------- ------- ------- Restructured loans .................................................... 213 369 2,489 Total risk elements ................................................... $ 1,069 $ 1,969 $ 6,659 --------- ------- ------- Allowance for loan losses as a percent of loans(1) .................... 0.88% 0.82% 0.64% ========= ======= ======= Allowance for loan losses as a percent of non-performing loans(2) ..... 1,029.06 469.75 293.02 Non-performing loans as a percent of loans(1)(2) ...................... 0.09 0.17 0.22 Non-performing assets as a percent of total assets(4) ................. 0.08 0.16 0.51
- -------------- (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). At December 31, 1998, loans that were characterized as impaired totaled $1.5 million. All of the impaired loans have been measured using the fair value of the collateral method. During the year ended December 31, 1998, the average recorded value of impaired loans was $1.8 million, $102,000 of interest income was recognized and $137,000 of interest income would have been recognized under original terms. The composition of impaired loans by type is shown below: DECEMBER 31, ---------------------- 1998 1997 ------ ------ (IN THOUSANDS) IMPAIRED LOANS: Residential real estate One- to four-family ....................... $1,036 $ 999 Multi-family .............................. 245 316 Commercial real estate ......................... 238 677 Total impaired loans .................. 10 99 ------ ------ $1,529 $2,091 ------ ------ 16 11 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 1998, 1997 and 1996 were $1.6 million, $1.7 million and $1.3 million, respectively. During the year ended December 31, 1998, there were recoveries of $517,000 credited to, and charge-offs of $259,000 taken against this allowance. As of December 31, 1998, the Company's allowance for loan losses was 0.88% of total loans compared to 0.82% as of December 31, 1997. Management believes this increased coverage ratio is prudent due to the balance increase in the combined total of construction and land, commercial real estate, home equity and improvement, consumer and business loans. These combined total balances increased from $93.5 million at December 31, 1997 to $130.9 million at December 31, 1998, an increase of 40%. These loans aggregated to 13.9% and 11.6% of the total loans, net, at December 31, 1998 and 1997, respectively. The Company had non-performing loans of $809,000 and $1.4 million at December 31, 1998 and December 31, 1997, 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 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, ----------------------------------------------------------- 1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ (IN THOUSANDS) Balance at beginning of period .............................. $6,600 $4,400 $4,275 $3,700 $4,450 BNB allowance for loan losses at acquisition date ........... -- 620 -- -- -- Provision for loan losses ................................... 1,642 1,696 1,294 3,614 283 Charge-offs: One-to four-family ..................................... 51 370 387 550 711 Multi-family ........................................... 2 84 263 483 251 Commercial ............................................. 75 45 664 2,297 200 Other ....................................................... 131 16 198 194 56 ------ ------ ------ ------ ------ Total .................................................. 259 515 1,512 3,524 1,218 Recoveries .................................................. 517 399 343 485 185 ------ ------ ------ ------ ------ Balance at end of period ................................................. $8,500 $6,600 $4,400 $4,275 $3,700 ====== ====== ====== ====== ====== Ratio of net charge-offs/(net recoveries) during the period to average loans outstanding during the period ...................................... (0.03)% 0.02% 0.19% 0.60% 0.23% ====== ====== ====== ====== ======
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, 1998, 1997 and 1996, the Company classified (excluding REO) $4.2 million, $5.8 million and $3.8 million of sub-standard assets, respectively. Included in these amounts were $809,000, $1.4 million and $1.5 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 nonperforming assets in future periods. 17 12 The preceding and following discussion may contain certain forward-looking statements which are based on management's current expectations regarding economic, legislative, and regulatory, issues that may impact the Company's earnings in future periods. Factors that could cause future results to vary materially from current management expectations include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company's operations, pricing, products and services. In particular, these issues may impact management's estimates used in evaluating market risk and interest rate risk in its GAP and NPV tables, loan loss provisions, classification of assets, Year 2000 issues, accounting estimates and other estimates used throughout this discussion. COMPARISON OF FINANCIAL CONDITION AND OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997. CHANGES IN FINANCIAL CONDITION The Company's assets surpassed the one billion dollar mark during 1998 as its assets increased $164.4 million to a balance of $1.139 billion at December 31, 1998, compared to $974.7 million at December 31, 1997, an increase of 16.9%. Asset growth was primarily in cash and cash equivalents of $12.5 million, investment securities available for sale of $17.4 million and loans, net, of $151.9 million, partially offset by decreases in investment securities held to maturity of $13.3 million and mortgage-backed securities held to maturity, of $15.4 million. The growth in loans, net was primarily due to increased originations of adjustable-rate and ten to fifteen year fixed-rate one- to four-family mortgage loans combined with increased lending for construction and land and commercial real estate. Loans, net, increased by $151.9 million from a balance of $791.7 million at December 31, 1997 to a balance of $943.7 million at December 31, 1998. Volatility in market interest rates and a generally falling interest rate environment throughout 1998 reduced customer demand for adjustable-rate loans and increased demand for longer term, fixed-rate loan products, the bulk of which were sold in the secondary market. Shorter term loans, generally 15 year or less, were originated for portfolio. Deposit accounts increased by $87.3 million from a balance of $619.8 million at December 31, 1997 to a balance of $707.1 million at December 31, 1998. This increase is mainly attributable to BFS' rollout of a new 15-month retail certificate of deposit acquisition program, a new money market deposit account and growth in NOW account balances, offset by decreases in regular certificates of deposit accounts. Mortgage-backed securities decreased by $13.5 million, or 23.5%, from a balance of $57.5 million at December 31, 1997 to a balance of $43.9 million at December 31, 1998. Mortgage loans held for sale totaled $17.0 million at December 31, 1998, compared to $9.8 million at December 31, 1997. FHLB advances increased $81.0 million to a balance of $337.5 million at December 31, 1998, compared to $256.5 million at December 31, 1997 as additional funds were needed to support balance sheet growth. Total stockholders' equity was $81.8 million at December 31, 1998 or $16.84 per share, compared to $81.6 million or $15.72 per share at December 31, 1997. Stockholders' equity remained essentially the same during the year ended December 31, 1998 due to combined effects of the completion of the fourth and commencement of the fifth 5% stock repurchase programs and dividends paid, offset by the change in market valuation, net of taxes of the available-for sale securities portfolio, net income and the amortization of the Stock-based Incentive Plans. The stockholders' equity to total assets ratio of the Company was 7.2% at December 31, 1998 and 8.4% at December 31, 1997. RESULTS OF OPERATIONS General Net income for the year ended December 31, 1998 was $7.6 million, or $1.50 basic earnings per share and $1.43 diluted earnings per share, compared to $7.1 million, or $1.28 basic earnings per share and $1.24 diluted earnings per share for the comparable period in 1997. The return on average stockholder's equity, improved to 9.02% during the year ended December 31, 1998, compared to 8.21% for the year ended December 31, 1997. Return on average assets declined by three basis points, from 0.75% for the year ended December 31, 1997 to 0.72% for the current year. Increased earnings were primarily attributable to higher net interest income, due to increased balances of interest earning assets, although with lower interest margins, improved gains on the sale of loans, offset by a reduction in real estate operations income. The net interest margin in 1998 decreased to 3.17% from 3.42% during 1997. 18 13 Generally falling longer term interest rates during 1998 created a flat yield curve that caused industry-wide margin compression. The Company's margin suffered as substantial volumes of adjustable-rate loans either refinanced into lower interest adjustable-rate mortgages or refinanced to fixed-rate loans, the vast majority of which were sold in the secondary market. Management is attempting to mitigate the margin compression by de-emphasizing one- to four-family residential lending and expanding the portfolio of commercial real estate, construction and land, consumer and business loans. Interest Income Total interest income for the year ended December 31, 1998 increased by $6.7 million to $74.8 million compared to $68.0 million for the year ended December 31, 1997. Interest on loans increased by $7.2 million, or 12.2%, to $66.0 million, during 1998 compared to $58.8 million during 1997. The increase in interest income in 1998 was attributable to increased average balances of interest earning assets, primarily due to an increase in the average balance of loans, from $759.3 million for 1997 to $876.3 million for 1998. The increased average loan, net, balances generated an additional $9.1 million of interest earned while lower yields decreased interest earned on loans, net, by $1.8 million. The lower yields were generally the result of falling interest rates during 1998 that created an opportunity for borrowers to refinance their mortgages at lower rates. The loan portfolio average loan yield decreased to 7.54% for 1998 compared to an average yield of 7.74% for 1997. Interest income on investment securities and overnight federal funds sold increased by $397,000 to $5.4 million for the year ended December 31, 1998, compared to $5.0 million for the year ended December 31, 1997. The primary reason for the increase is due to higher average balances of investment securities averaging $88.2 million during the year ended December 31, 1998, compared to average balances of $82.7 million for the prior year. Interest income on mortgage-backed securities decreased by $894,000 for the year ended December 31, 1998 due primarily to a decrease in average balances compared to the prior year. Average balances decreased by $11.9 million from an average of $62.3 million during 1997 to an average of $50.4 million during 1998. The majority of the mortgage-backed securities held in 1998 were adjustable GNMA securities. The yields on mortgage-backed securities decreased from an average yield of 6.79% in 1997 to 6.62% in 1998, resulting in a decrease in interest earned on such securities in 1998 of $87,000, compared to 1997. Interest Expense Interest expense increased by $5.4 million, or 14.6%, for the year ended December 31, 1998 to $42.6 million compared to $37.1 million for the year ended December 31, 1997. The increase in interest expense for the year ended December 31, 1998 was due primarily to higher interest expense on deposits. Interest expense on deposit accounts increased by $4.9 million for the year ended December 31, 1998 due primarily to the effects of higher average balances of $601.2 million for the year ended December 31, 1998 compared to average deposit balances of $511.8 million for the prior year. The increased average balances were primarily attributable to the acquisition of certificate accounts, which increased from an average balance of $237.1 for the year ended December 31, 1997, to an average balance of $312.8 million for the current year. The higher average balances in certificate accounts resulted in an increase in interest expense of $4.3 million for the year ended December 31, 1998 compared to the prior year. The average cost of deposit accounts increased from 3.75% for the year ended December 31, 1997 to an average cost of 4.01% for the current year. The acquisition of $90.8 million in the 15-month certificate of deposit program was the major contributing factor in increasing the cost of savings. Borrowed funds consisted primarily of FHLB advances that were used primarily to fund loan portfolio growth. Higher average balances of $308.2 million of borrowed funds for the year ended December 31, 1998, compared to average balances of $299.1 million for the prior year, resulted in a $547,000 increase in interest expense. The average cost of borrowed funds declined by one basis point, from 6.00% for the year ended December 31, 1997 to an average of 5.99% for the current year. Provision for Loan Losses The provision for loan losses amounted to $1.6 million for the year ended December 31, 1998 compared to $1.7 million for the prior year. The provision was based on management's evaluation of the growth and change in composition of the Company's loan portfolio, existing real estate market conditions, the level of charge-offs and classified assets. Total non-performing loans decreased to $809,000, or 0.08% of loans at December 31, 1998 from $1.4 million, or 0.16% at December 31, 1997. The Company recorded 19 14 net recoveries of $258,000 during the year ended December 31, 1998, compared to net charge-offs of $116,000, or 0.02% of average loans outstanding during 1997. The allowance for loan losses as a percentage of total loans was 0.88% at December 31, 1998 compared to 0.82% at December 31, 1997. As a percentage of total non-performing loans, the allowance for loan losses was 1,029% at December 31, 1998, compared to 469.8% a year earlier. See "Asset Quality" included elsewhere herein. Non-Interest Income Total non-interest income increased to $6.1 million for the year ended December 31, 1998 from $4.8 million for the year ended December 31, 1997. The primary contributing factor was increased gains on the sale of loans. The $3.2 million gain on sale of loans during 1998 exceeded the $1.1 million for the prior year, primarily due to the increased volume of loans sold resulting from the high volumes of refinancing to long-term fixed rate mortgages, which the Company generally sells in the secondary market. The continuation of a strong housing market and economy also contributed to increased volume for financing of home purchases during 1998. The high volume of refinancing of mortgages, however, necessitated an adjustment of $481,000 to reflect the impairment to the originated mortgage servicing rights, ("OMSR") during the year ended December 31, 1998. The adjustment for the impairment of the OMSR, combined with a decrease in the balance of loans serviced that were sold before OMSR was recorded, contributed to the decrease in loan processing and servicing fees which totaled $477,000 for the year ended December 31, 1998, compared to $1.2 million for the prior year. Deposit service fees were $1.7 million for the two years ended December 31, 1998 and 1997. Non-Interest Expense Total non-interest expense for the year ended December 31, 1998 was $23.9 million, compared to $21.5 million for 1997. The primary components of this increase were higher data processing expenses, lower real estate operations income and higher other non-interest expenses. Data processing expense was $1.3 million for the year ended December 31, 1998, compared to $968,000 for the prior year. The prior year total was lower than normal due to the receipt from the Company's data processor, of approximately $200,000 as reimbursement of expenses the Company had incurred in assisting the data processor in developing a new software program. Additionally, the Company incurred approximately $100,000 of costs related to the Year 2000 issue. For the year ended December 31, 1998, real estate operations earned $71,000, compared to earnings of $1.2 million for the prior year. The prior year total included approximately $891,000 from the sale of a land sub-division, sold by a subsidiary of BFS, during the first quarter of 1997. Other non-interest expense increased to $5.0 million for the year ended December 31, 1998 from $4.1 million for the prior year due to the inclusion of BNB's miscellaneous expenses for the full year and consulting and legal costs incurred to assist in establishing the Company's tax saving strategies that included the formation of real estate investment trusts and securities subsidiaries. Income Taxes Income tax expense was $5.2 million for the year ended December 31, 1998 (resulting in an effective rate of 40.3%), compared to a tax expense of $5.5 million for the year ended December 31, 1997 (resulting in an effective tax rate of 43.8%). The decrease in income tax expense and rate was due to the implementation of the tax saving strategies. Year 2000 Project Included in other non-interest expenses for the twelve months ended December 31, 1998 and 1997 are charges incurred in connection with the modification or replacement of software or hardware in order for the Company's computer and related systems to properly recognize dates beyond December 31, 1999. The impact of computer systems ability to process dates beyond 1999, or the "Year 2000 issue," creates a significant business challenge for the Company. The Company is addressing this issue as it affects all of its software, hardware and other systems to insure the Company is Year 2000 compliant. The Company has developed a plan that is based upon the Federal Financial Institutions Examination Council ("FFIEC") recommended phases and time frames for insuring Year 2000 compliance. These phases include awareness, assessment, renovation, validation and implementation. 20 15 The Company has completed the awareness phase through development of a Year 2000 committee and reporting structure including quarterly project status reports to the Company's Board. The assessment phase has been completed with a review of all software, hardware and business systems including an evaluation of the critical nature and Year 2000 business risk that each application presents. The Company primarily utilizes third-party vendors for the processing of its critical data processing applications. The Company is working closely with these critical vendors to monitor renovation and validation efforts to insure that the time frames set out in the Company's plan are met. Based upon review of vendor-provided Year 2000 disclosure statements, review of the applicable testing process and verification of test results, the Company estimates that 90% of the critical applications were renovated at December 31, 1998. The Company will continue to work with critical application vendors to verify test results and anticipates that the remaining critical applications will be renovated and verified by June 30, 1999, based upon analysis of information currently available from these vendors. The Company has created an internal Year 2000 testing environment and has developed test scripts incorporating typical transactions in order to validate the modified systems. Testing with critical application vendors was substantially completed in the fourth quarter of 1998. Additional testing including follow-up and interface testing will continue in 1999 and is expected to be completed by June 30, 1999, prior to any anticipated impact on operating systems. The Implementation phase is ongoing and incorporates review of replaced or modified and tested systems, as well as, contingency planning and customer awareness programs. In the event that the Company's third-party vendors do not successfully or timely achieve Year 2000 compliance, the Company's operations could be adversely affected. The Company has begun development of contingency plans in the event that one or all of these significant vendors fails to meet Year 2000 operating requirements. Plans for various failure scenarios are developed on an ongoing basis as such risks are identified and incorporate the Company's business resumption plan. Contingency plans for unexpected Year 2000 related business interruption will be completed for all mission critical applications after testing of modified systems, and is expected to be substantially complete by June 30, 1999. Further, the Company will seek alternative vendors should one of the critical vendors fail to achieve satisfactory Year 2000 compliance. In the event the Company's current third party data processing vendors were not to achieve Year 2000 compliance and the Company could not engage alternative vendors in a timely manner, the Company's operations would be adversely impacted. The total cost of the Year 2000 project is estimated at $400,000 to $500,000 which includes estimated costs and time associated with third-party Year 2000 issues and an allocation of payroll costs for personnel assigned to the Year 2000 project. Through December 31, 1998 the Company has expensed approximately $250,000 to date toward the Year 2000 remediation efforts. A significant portion of the costs associated with the Year 2000 project are not expected to be incremental to the Company, but rather represent a reprioritization of existing internal systems technology resources. Based on the remediation, testing and monitoring efforts to date, the Company expects that most of its critical systems will operate successfully through the century date change. Therefore, the Company believes that internal system failures are not likely to adversely affect the Company's operations or financial condition. The Company has already successfully tested with many of its critical application vendors and will continue to monitor and validate the remainder, including the Company's electrical power and telecommunications providers in 1999. At this time the Company believes the most likely "worst case" Year 2000 scenarios are temporary and localized disruptions in infrastructure services which could disrupt the ability of the Company to provide services to its customers and/or the ability of external service providers to provide services to the Company. The Company's evaluation of Year 2000 readiness is based upon management's best estimates and projections which are derived utilizing numerous assumptions of future events including the continued availability certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. 21 16 COMPARISON OF FINANCIAL CONDITION AND OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996. CHANGES IN FINANCIAL CONDITION Assets at December 31, 1997 totaled $974.7 million, an increase of $154.1 million, or 18.8%, compared to $820.6 million at December 31, 1996. Asset growth was primarily attributable to the acquisition of BNB and growth in loans, net, at BFS. This growth at BFS was primarily due to increased originations of adjustable-rate and ten to fifteen year fixed-rate one- to four-family mortgage loans which combined with BNB's portfolio caused loans, net, to increase by $115.1 million to a balance of $791.7 million at December 31, 1997, compared to a balance of $676.7 million at December 31, 1996. Volatility in market interest rates and a generally falling interest rate environment in the second half of 1997 reduced customer demand for adjustable-rate loans and increased demand for longer term, fixed-rate loan products, the bulk of which were sold in the secondary market. Shorter term loans, generally 15 year or less, were originated for portfolio. Deposit accounts increased by $191.0 million from a balance of $428.8 million at December 31, 1996 to a balance of $619.8 million at December 31, 1997. Of the increase, $125.0 million is attributable to the acquisition of BNB while the balance represents growth in BFS's deposit balances, $75.0 million of which were obtained through the wholesale certificates of deposit broker market. BFS obtained these funds for terms of two to three years and the funds were used primarily to support the growth in the loans, net. Mortgage-backed securities decreased by $9.1 million, or 13.7%, from a balance of $66.6 million at December 31, 1996 to a balance of $57.5 million at December 31, 1997. Mortgage loans held for sale totaled $9.8 million at December 31, 1997, compared to $4.0 million at December 31, 1996. FHLB advances decreased $40.0 million to a balance of $256.5 million at December 31, 1997, compared to $296.5 million at December 31, 1996 as funds from the brokered certificates of deposit mentioned above were also used to repay FHLB advances. Total stockholders' equity was $81.6 million at December 31, 1997 or $15.72 per share, compared to $86.4 million or $14.75 per share at December 31, 1996. The decrease in total stockholders' equity during the year ended December 31, 1997 was primarily due to the combined effects of the completion of the second and third and commencement of the fourth 5% stock repurchase programs and dividends paid, during the year ended December 31, 1997, offset by the change in market valuation, net of taxes, of the available-for sale securities portfolio, net income and the amortization of the Stock-based Incentive Plans. The stockholders' equity to total assets ratio of the Company was 8.4% at December 31, 1997 and 10.5% at December 31, 1996. RESULTS OF OPERATIONS General Net income for the year ended December 31, 1997 was $7.1 million, or $1.28 basic earnings per share and $1.24 diluted earnings per share, compared to $2.9 million, or $.48 basic and diluted earnings per share for the comparable period in 1996. Net income for the year ended December 31, 1996 was adversely impacted by the one time $2.7 million (approximately $1.6 million after tax, or $.26 per share) special assessment for the recapitalization of the Savings Association Insurance Fund ("SAIF"). The improved net income increased the return on average assets to 0.75% and the return on average stockholders' equity to 8.21% during the year ended December 31, 1997, compared to .40% and 3.21%, respectively, for the year ended December 31, 1996. Excluding the SAIF special assessment, the return on average assets was 0.61% and the return on average stockholders' equity was 4.96% for the year ended December 31, 1996. The increase was primarily attributable to higher net interest income, due to increased balances of interest earning assets, some of which had higher margins from the BNB acquisition, earnings from real estate operations and the non-repetition of the one-time $1.6 million after tax special assessment for the recapitalization of the SAIF. The net interest margin in 1997 increased to 3.42% from 3.34% during 1996. The improvement in the net interest margin in 1997 was primarily due to the impact of the acquisition of BNB which, like most commercial banks, earns a wider margin than thrifts such as BFS. Interest Income Total interest income for the year ended December 31, 1997 increased by $15.4 million to $68.0 million compared to $52.7 million for the year ended December 31, 1996. Interest on loans increased by $13.3 million, or 29.2%, to $58.8 million, during 1997 compared to $45.5 million during 1996. The 22 17 increase in interest income in 1997, was attributable to increased average balances of interest earning assets, primarily due to an increase in the average balance of loans, from $603.6 million for 1996 to $759.3 million for 1997. Approximately $66 million of such growth was due to the acquisition of BNB. The increased average loan, net, balances generated an additional $11.7 million of interest earned while improved yields increased interest earned on loans, net, by $1.6 million. The improved yields were generally the result of increasing rate adjustments to BFS's adjustable-rate loan portfolio, much of which had been originated at discounted rates in prior years. Additionally, as interest rates declined in the second half of 1997, BFS increased the volume of shorter-term, (ten to fifteen years}, higher yielding fixed-rate loans. The loan portfolio average loan yield increased to 7.74% for 1997 compared to an average yield of 7.54% for 1996. Interest income on investment securities and overnight federal funds sold increased by $2.8 million to $5.0 million for the year ended December 31, 1997, compared to $2.2 million for the year ended December 31, 1996. The primary reason for the increase is due to higher average balances of investment securities due to the acquisition of BNB. Interest income on mortgage-backed securities decreased by $769,000 for the year ended December 31, 1997 due primarily to a decrease in average balances compared to the prior year. Average balances decreased by $10.0 million from an average of $72.3 million during 1996 to an average $62.3 million during 1997. The majority of the mortgage-backed securities held in 1997 were adjustable GNMA securities. The yields on mortgage-backed securities decreased from an average yield of 6.91% in 1996 to 6.79% in 1997, resulting in a decrease in interest earned on such securities in 1997 of $76,000, compared to 1996. Interest Expense Interest expense increased by $8.2 million, or 28.4%, for the year ended December 31, 1997 to $37.1 million compared to $28.9 million for the year ended December 31, 1996. The increase in interest expense for the year ended December 31, 1997 was due to higher interest expense on both deposits and borrowed funds. Borrowed funds consisted primarily of FHLB advances and were used primarily to fund loan portfolio growth. Higher average balances of borrowed funds resulted in a $4.3 million increase in interest expense, while a 14 basis point increase in the cost of borrowings resulted in a $426,000 increase in interest expense. The average cost of borrowings for the year ended December 31, 1997 was 6.0% compared to an average cost of 5.86% for the prior year. Interest expense on deposit accounts increased by $3.5 million for the year ended December 31, 1997 due primarily to the effects of higher average balances of $511.8 million for the year ended December 31, 1997 compared to average deposit balances of $403.2 million for the prior year. The increased average balances were primarily attributable to the acquisition of BNB and BFS's acquisition of wholesale brokered deposits. The average cost of deposit accounts decreased from 3.89% for the year ended December 31, 1996 to an average cost of 3.75% for the current year. A major contributing factor in lowering the cost of savings was the addition of BNB's savings portfolio which consisted entirely of lower costing core deposit accounts. BNB had not been offering certificates of deposit to its customers, as its previous lending needs did not necessitate such savings products. Provision for Loan Losses During 1997, the provision for loan losses was increased to $1.7 million from the prior year provision of $1.3 million. The higher provision was based on management's evaluation of the growth and change in composition of the Company's loan portfolio, existing real estate market conditions, the level of charge-offs and classified assets. Total non-performing loans decreased to $1.4 million, or 0.17% of loans at December 31, 1997 from $1.5 million, or 0.22% at December 31, 1996. Net charge-offs also decreased, amounting to $116,000, or 0.02% of average loans outstanding during 1997 compared with 1996's net charge-off total of $1.2 million or 0.19% of average loans outstanding. The allowance for loan losses as a percentage of total loans was 0.82% at December 31, 1997 compared to 0.64% at December 31, 1996. As a percentage of total non-performing loans, the allowance for loan losses was 469.8% at December 31, 1997, compared to 293.0% a year earlier. See "Asset Quality" included elsewhere herein. Non-Interest Income Total non-interest income increased to $4.8 million for the year ended December 31, 1997 from $3.6 million for the year ended December 31, 1996. The primary contributing factors were increased gains on the sale of loans and higher deposit service fees. The $1.1 million gain on sale of loans during the current year exceeded the $668,000 for the prior year, primarily due to more favorable market pricing of 23 18 loans sold in the secondary market during 1997. The improved gain on sale of loans was realized despite a reduction in the volume of loans sold during 1997. Deposit service fees improved to $1.7 million for the year ended December 31, 1997, compared to $1.1 million for the prior year due to the inclusion of BNB's deposit service fees and continued growth in BFS's transaction accounts and service fees collected thereon during 1997. Non-lnterest Expense Total non-interest expense for the year ended December 31, 1997 was $21.5 million, compared to $21.0 million for 1996. Excluding the SAIF special assessment of $2.7 million during 1996, non-interest expenses increased by $3.2 million or 17.5%. The primary components of this increase were compensation and benefits expenses and occupancy and equipment expenses, offset somewhat by reduced deposit insurance premiums and income from real estate operations. Compensation and benefits expense for the year ended December 31, 1997 amounted to $13.5 million, compared to $9.8 million for the prior year. The primary reasons for this increase of $3.7 million was the inclusion of $2.2 million of BNB's compensation expenses, a $468,000 increase in the ESOP expense resulting from appreciation in the Company's stock, and the establishment of a short-term incentive plan. Occupancy and equipment expense increased from $2.5 million for the year ended December 31, 1996 to $3.1 million for the year ended December 31, 1997, due essentially to the addition of BNB's expenses. The Company's Federal Deposit Insurance Premiums were lower this year, $293,000 compared to last year's total of $916,000 due to the benefits of the Company's payment of the non-recurring special assessment of $2.7 million to the SAIF in 1996. Data processing expense increased from $600,000 for the year ended December 31, 1996 to $968,000 for the current year due primarily to the added cost of BNB's data processing. Real estate operations provided income of $1.2 million during the year ended December 31, 1997, compared to an expense for the prior year. The two main contributing factors to the current year's income from real estate operations are the sale of a land sub-division owned by a subsidiary of BFS and recoveries from the sale of real estate owned, owing to improvement in general real estate market conditions during 1997. Other non-interest expense increased to $4.1 million for the year ended December 31, 1997 from $3.4 million for the prior year due to the inclusion of BNB's miscellaneous expenses. Income Taxes Income tax expense was $5.5 million for the year ended December 31, 1997 (resulting in an effective tax rate of 43.8%), compared to a tax expense of $2.1 million for the year ended December 31, 1996 (resulting in an effective tax rate of 41.5%). The increase in income tax expense is primarily attributable to an increase in pre-tax earnings while the slightly higher effective rate is due primarily to the non-deductibility of the appreciation of the allocated ESOP shares. Impact of New Accounting Standards In June 1997, the Financial Accounting Standards Board, ("FASB") issued Statement of Financial Accounting Standard, ("SFAS") No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes standards for reporting information about operating segments. An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and evaluate performance. This statement requires a company to disclose certain income statement and balance sheet information by operating segment, as well as provide a reconciliation of operating segment information to the company's consolidated balances. Reportable segments of the Company include BFS and BNB. In June 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Under this statement, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The adoption of this statement is not expected to have a material impact on the Company. 24 19 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders BostonFed Bancorp, Inc.: We have audited the accompanying consolidated balance sheets of BostonFed Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BostonFed Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP Boston, Massachusetts January 21, 1999 25 20 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets (dollars in thousands, except share and per share amounts) December 31, 1998 and 1997
1998 1997 ---------- -------- ASSETS Cash and due from banks (note 1) $ 19,133 $ 21,242 Overnight federal funds sold 17,795 3,330 Certificates of deposit 273 118 ---------- -------- Total cash and cash equivalents 37,201 24,690 Investment securities available for sale (amortized cost of $48,837 at 1998 and $31,554 at 1997) (note 3) 49,137 31,767 Investment securities held to maturity (fair value of $7,371 at 1998 and $20,630 at 1997) (notes 4 and 11) 7,302 20,630 Mortgage-backed securities available for sale (amortized cost of $20,935 at 1998 and $19,007 at 1997) (notes 3, 10 and 11) 21,029 19,125 Mortgage-backed securities held to maturity (fair value of $23,333 at 1998 and $38,903 at 1997) (notes 4 and 11) 22,913 38,350 Mortgage loans held for sale 17,008 9,817 Loans, net of allowance for loan losses of $8,500 at 1998 and $6,600 at 1997 (notes 5, 6 and 12) 943,662 791,728 Accrued interest receivable (note 7) 5,549 5,163 Stock in FHLB of Boston, at cost (note 11) 17,802 16,613 Premises and equipment, net (note 8) 6,614 6,842 Deferred income tax asset, net (note 12) 1,812 2,020 Prepaid expenses and other assets 9,094 7,935 ---------- -------- Total assets $1,139,123 $974,680 ========== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposit accounts (note 9) $ 707,144 $619,821 Securities sold under agreements to repurchase (note 10) -- 7,140 Federal Home Loan Bank advances (note 11) 337,500 256,500 Advance payments by borrowers for taxes and insurance 3,405 3,133 Accrued expenses and other liabilities 9,280 6,475 ---------- -------- Total liabilities 1,057,329 893,069 ---------- -------- Commitments and contingencies (notes 3, 4, 5, 7, 8, 16 and 18) Stockholders' equity (notes 2 and 13): Preferred stock, $.01 per value; 1,000,000 shares authorized; none issued -- -- Common stock, $0.01 par value; 17,000,000 shares authorized; 6,589,617 shares issued at 1998 and 1997 66 66 Additional paid-in capital 66,417 65,282 Retained earnings 44,256 38,645 Accumulated other comprehensive income 312 242 Treasury stock, at cost (1,477,176 and 1,069,180 shares at 1998 and 1997) (26,128) (18,146) Unallocated ESOP shares (2,418) (3,174) Unearned 1996 stock-based incentive plan (711) (1,304) ---------- -------- Total stockholders' equity 81,794 81,611 ---------- -------- Total liabilities and stockholders' equity $1,139,123 $974,680 ========== ========
See accompanying notes to consolidated financial statements. 26 21 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income (in thousands, except per share amounts) Years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ------- ------- ------- Interest income: Loans (note 5) $66,040 $58,805 $45,513 Mortgage-backed securities 3,335 4,229 4,998 Investment securities 5,258 4,736 2,001 Federal funds sold 142 267 166 ------- ------- ------- Total interest income 74,775 68,037 52,678 ------- ------- ------- Interest expense: Deposit accounts (note 9) 24,096 19,176 15,698 Borrowed funds (notes 10 and 11) 18,461 17,953 13,193 ------- ------- ------- Total interest expense 42,557 37,129 28,891 ------- ------- ------- Net interest income 32,218 30,908 23,787 Provision for loan losses (note 6) 1,642 1,696 1,294 ------- ------- ------- Net interest income after provision for loan losses 30,576 29,212 22,493 ------- ------- ------- Non-interest income: Loan processing and servicing fees (note 5) 477 1,241 1,330 Deposit service fees 1,658 1,710 1,140 Gain on sale of loans 3,173 1,114 668 Gain (loss) on sale of investments (note 3) 19 (18) (11) Other 801 759 440 ------- ------- ------- Total non-interest income 6,128 4,806 3,567 ------- ------- ------- Non-interest expense: Compensation and benefits (note 13) 13,728 13,543 9,841 Occupancy and equipment 3,187 3,087 2,479 Deposit insurance premiums 327 293 916 Advertising expense 523 682 588 Data processing 1,286 968 600 Real estate operations (71) (1,230) 561 SAIF special assessment -- -- 2,670 Other 4,952 4,115 3,385 ------- ------- ------- Total non-interest expense 23,932 21,458 21,040 ------- ------- ------- Income before income taxes 12,772 12,560 5,020 Income tax expense (note 12) 5,151 5,505 2,083 ------- ------- ------- Net income $ 7,621 $ 7,055 $ 2,937 ======= ======= ======= Basic earnings per share $ 1.50 $ 1.28 $ 0.48 ======= ======= ======= Diluted earnings per share $ 1.43 $ 1.24 $ 0.48 ======= ======= ======= Weighted average shares outstanding - basic 5,078 5,505 6,118 ======= ======= ======= Weighted average shares outstanding - diluted 5,328 5,690 6,128 ======= ======= =======
See accompanying notes to consolidated financial statements. 27 22 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity (in thousands, except per share amounts) Years ended December 31, 1998, 1997 and 1996
UNEARNED ACCUMULATED STOCK- OTHER BASED SHARES OF ADDITIONAL COMPREHENSIVE UNALLOCATED INCENTIVE TOTAL COMMON COMMON PAID-IN RETAINED TREASURY INCOME ESOP PLAN STOCKHOLDERS' STOCK STOCK CAPITAL EARNINGS STOCK (LOSS) SHARES ("SIP") EQUITY --------- ------ ---------- -------- --------- ------------- ----------- --------- ------------- Balance at December 31, 1995 6,590 $66 $63,987 $31,183 $ -- $ -- $(4,535) $ -- $ 90,701 Common stock repurchased (329 shares at an average price of $14.39 per share) -- -- -- -- (4,739) -- -- -- (4,739) Cash dividends declared and paid ($.15 per share) -- -- -- (989) -- -- -- -- (989) Reduction in unallocated ESOP shares charged to expense -- -- -- -- -- -- 606 -- 606 Appreciation in fair value of shares charged to expense for compensation plans -- -- 474 -- -- -- -- -- 474 Common stock acquired for SIP -- -- -- -- -- -- -- (3,230) (3,230) Earned portion of SIP shares charged to expense -- -- -- -- -- -- -- 917 917 Comprehensive income: Changes in net unrealized gain (loss) in investments available for sale, net -- -- -- -- -- (322) -- -- (322) Net income -- -- -- 2,937 -- -- -- -- 2,937 ----- --- ------- ------- -------- ----- ------- ------- -------- Comprehensive income 2,615 -------- Balance at December 31, 1996 6,590 66 64,461 33,131 (4,739) (322) (3,929) (2,313) 86,355
28 23 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity, Continued (in thousands, except per share amounts) Years ended December 31, 1998, 1997 and 1996
UNEARNED ACCUMULATED STOCK- OTHER BASED SHARES OF ADDITIONAL COMPREHENSIVE UNALLOCATED INCENTIVE TOTAL COMMON COMMON PAID-IN RETAINED TREASURY INCOME ESOP PLAN STOCKHOLDERS' STOCK STOCK CAPITAL EARNINGS STOCK (LOSS) SHARES ("SIP") EQUITY --------- ------ ---------- -------- --------- ------------- ----------- --------- ------------- Common stock repurchased (740 shares at an average price of $18.12 per share) -- $-- $ -- $ -- $(13,407) $ -- $ -- $ -- $(13,407) Cash dividends declared and paid ($.26 per share) -- -- -- (1,541) -- -- -- -- (1,541) Reduction in unallocated ESOP shares charged to expense -- -- -- -- -- -- 755 -- 755 Appreciation in fair value of shares charged to expense for compensation plans -- -- 821 -- -- -- -- -- 821 Earned portion of SIP shares charged to expense -- -- -- -- -- -- -- 1,009 1,009 Comprehensive income: Changes in net unrealized gain (loss) in investments available for sale, net -- -- -- -- -- 564 -- -- 564 Net income -- -- -- 7,055 -- -- -- -- 7,055 ----- --- ------- ------- -------- ----- ------- ------- -------- Comprehensive income 7,619 -------- Balance at December 31, 1997 6,590 66 65,282 38,645 (18,146) 242 (3,174) (1,304) 81,611
(Continued) 29 24 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity, Continued (in thousands, except per share amounts) Years ended December 31, 1998, 1997 and 1996
UNEARNED ACCUMULATED STOCK- OTHER BASED SHARES OF ADDITIONAL COMPREHENSIVE UNALLOCATED INCENTIVE TOTAL COMMON COMMON PAID-IN RETAINED TREASURY INCOME ESOP PLAN STOCKHOLDERS' STOCK STOCK CAPITAL EARNINGS STOCK (LOSS) SHARES ("SIP") EQUITY --------- ------ ---------- -------- --------- ------------- ----------- --------- ------------- Common stock repurchased (409 shares at an average price of $19.56 per share) -- $-- $ -- $ -- $ (7,998) $ -- $ -- $ -- $ (7,998) Stock options exercised (900 shares at an average price of $16.67 per share) -- -- -- -- 16 -- -- -- 16 Cash dividends declared and paid ($.37 per share) -- -- -- (2,010) -- -- -- -- (2,010) Reduction in unallocated ESOP shares charged to expense -- -- -- -- -- -- 756 -- 756 Appreciation in fair value of shares charged to expense for compensation plans -- -- 1,135 -- -- -- -- -- 1,135 Earned portion of SIP shares charged to expense -- -- -- -- -- -- -- 593 593 Comprehensive income: Changes in net unrealized gain (loss) in investments available for sale, net -- -- -- -- -- 70 -- -- 70 Net income -- -- -- 7,621 -- -- -- -- 7,621 ----- --- ------- ------- -------- ----- ------- ------- -------- Comprehensive Income 7,691 -------- Balance at December 31, 1998 6,590 $66 $66,417 $44,256 $(26,128) $ 312 $(2,418) $ (711) $ 81,794 ===== === ======= ======= ======== ===== ======= ======= ========
See accompanying notes to consolidated financial statements. 30 25 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (dollars in thousands) For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ---------- ---------- ---------- Net cash flows from operating activities: Net income $ 7,621 $ 7,055 $ 2,937 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and accretion, net 1,343 963 1,034 Earned SIP shares 593 1,009 917 Reduction in unallocated ESOP shares 756 755 606 Appreciation in fair value of shares charged to expense for compensation plans 1,135 821 474 Provision for loan losses 1,642 1,696 1,294 Recovery (provision) for valuation allowance for real estate owned 17 (350) 335 Loans originated for sale (357,405) (117,413) (143,064) Proceeds from sale of loans 353,387 112,680 148,693 Net loss (gain) on sale of investment securities (19) 18 11 Gain on sale of real estate held for sale or development, net -- (854) -- Decrease (increase) in deferred income taxes 208 (483) 575 (Gain) loss on sale of real estate acquired through foreclosure (60) 189 44 Gain on sale of loans (3,173) (1,114) (668) Increase in accrued interest receivable (386) (240) (371) (Increase) decrease in prepaid expenses and other assets (1,520) 3,066 (1,452) Increase in accrued expenses and other liabilities 2,818 795 787 --------- --------- --------- Net cash provided by operating activities 6,957 8,593 12,152 --------- --------- --------- Cash flows from investing activities: Net cash of acquired institution -- 11,908 -- Proceeds from sales of investment securities available for sale 5,000 14,008 -- Proceeds from sale of mortgage-backed securities available for sale -- 1,084 10,614 Proceeds from maturities of investment securities available for sale -- 4,000 -- Proceeds from maturities of investment securities held to maturity 14,850 9,100 1,745 Purchase of investment securities available for sale (32,217) (13,013) (63) Purchase of investment securities held to maturity (1,500) (5,900) (9,992) Purchase of mortgage-backed securities available for sale (10,856) -- (10,666) Principal repayments of investments securities available-for-sale 10,000 -- -- Purchase of mortgage-backed securities held-to-maturity -- -- (13,891) Principal repayments on investment securities held to maturity -- -- 6,009 Principal repayments on mortgage-backed securities held to maturity 15,432 4,641 5,934 Principal repayments on mortgage-backed securities available for sale 8,843 3,807 -- Increase in portfolio loans, net (153,576) (51,194) (172,557) Purchase of FHLB stock (1,189) (249) (7,921) Purchases of premises and equipment (887) (956) (617) Proceeds from sale of real estate held for sale or development -- 2,058 -- Proceeds from sale of real estate owned 191 3,167 2,249 Additional investments in real estate owned -- -- (359) --------- --------- --------- Net cash used in investing activities (145,909) (17,539) (189,515) --------- --------- ---------
(Continued) 31 26 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued (dollars in thousands) For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ---------- ---------- ---------- Cash flows from financing activities: Increase in deposits accounts $ 87,323 $ 65,981 $ 9,714 Proceeds from securities sold under agreement to repurchase -- 7,140 2,973 Repayments of securities sold under agreement to repurchase (7,140) (3,500) (6,473) Proceeds from Federal Home Loan Bank advances 546,073 276,200 670,304 Repayments of Federal Home Loan Bank advances (465,073) (316,200) (493,713) Increase in advanced payments by borrowers for taxes and insurance 272 685 569 Cash dividends paid (2,010) (1,541) (989) Common stock repurchased (7,998) (13,407) (4,739) Purchase of common stock for SIP -- -- (3,230) Stock options exercised 16 -- -- --------- --------- --------- Net cash provided by financing activities 151,463 15,358 174,416 --------- --------- --------- Net increase (decrease) in cash and cash equivalents 12,511 6,412 (2,947) Cash and cash equivalents at beginning of year 24,690 18,278 21,225 --------- --------- --------- Cash and cash equivalents at end of year $ 37,201 $ 24,690 $ 18,278 ========= ========= ========= Supplemental disclosure of cash flow information: Payments during the year for: Interest $ 42,017 $ 36,746 $ 27,889 ========= ========= ========= Taxes $ 3,306 $ 4,688 $ 1,664 ========= ========= ========= Supplemental schedule of noncash investing activities: Transfers of mortgage loans to real estate owned $ -- $ 533 $ 3,966 ========= ========= =========
See accompanying notes to consolidated financial statements. 32 27 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (DOLLARS IN THOUSANDS) BostonFed Bancorp Inc. (the "Company") is a Bank holding company which is headquartered in Burlington, Massachusetts and provides a variety of loan and deposit services to its customers through a network of ten locations. The Company's deposit gathering is concentrated in the communities surrounding its ten offices located in the greater Boston metropolitan area, municipalities of Arlington, Bedford, Billerica, Boston, Burlington, Chelsea, Lexington, Peabody, Revere and Wellesley. The Company acquired Broadway National Bank ("BNB") effective the close of business February 7, 1997, which was accounted for using the purchase method of accounting. 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 Company is subject to the regulations of, and periodic examination by the Federal Reserve Bank ("FRB"). Boston Federal Savings Bank ("BFS") is subject to the regulations of, and periodic examination by, the Office of Thrift Supervision ("OTS"). BNB, a national chartered commercial bank, is subject to the regulations of, and periodic examination by the Office of the Comptroller of the Currency ("OCC"). The Federal Deposit Insurance Corporation ("FDIC") insures the deposits of BFS through the Saving Association Insurance Fund ("SAIF") and insures the deposits of BNB through the Bank Insurance Fund ("BIF"). 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. (a) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: Boston Federal Savings Bank, Broadway National Bank and B.F. Funding Corporation ("B.F. Funding"). Boston Federal Savings Bank includes its wholly-owned subsidiaries, Leader Corporation and BFS Service Corporation. Broadway National Bank includes its wholly-owned subsidiary, Aygro Corporation. 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. (b) CASH AND DUE FROM BANKS BFS and BNB are required to maintain cash and reserve balances with the Federal Reserve Bank. Such reserve is calculated based upon deposit levels and amounted to $6,528 and $1,980 at BFS and BNB, respectively, at December 31, 1998. (Continued) 33 28 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (c) 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. 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 income. Gains and losses on the sale of investment and mortgage-backed securities are recognized at the time of sale on a specific identification basis. (d) 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 one to four 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 at the time of sale. Capitalized mortgage servicing rights are recognized, based on the allocated fair value of the rights to service mortgage loans for others. Mortgage servicing rights are amortized to loan processing and servicing fee income using a method which approximates the level yield method in proportion to, and over the period of, estimated net servicing income. 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 interest rate and loan origination date. (Continued) 34 29 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 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. (e) ALLOWANCE FOR LOAN LOSSES The Company maintains an allowance for probable losses that are inherent in the Company's loan portfolio. 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. Impaired loans are commercial real estate, multi-family, and non-accrual mortgage and consumer and other loans, except large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, 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. 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. 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. (f) GOODWILL Goodwill is amortized on a straight-line basis over fifteen years. Goodwill is reviewed for possible impairment when events or changed circumstances may affect the underlying basis of the asset. (Continued) 35 30 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (g) 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. (h) 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 Company'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 Company'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. A valuation allowance related to deferred tax assets is recognized when, in management's judgment, it is more likely than not that all, or a portion of such deferred tax assets will not be realized. (i) PENSION Pension cost is recognized over the employees' approximate service period. (j) EMPLOYEE BENEFITS The Company continues to follow APB Opinion No. 25, Accounting for Stock Issued to Employees. See footnote 13 for the expanded disclosures required by SFAS 123 regarding pro forma net income and earnings per share. (k) EARNINGS PER SHARE Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year 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"). Diluted earnings per share reflects the effect on weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method. A reconciliation of the weighted average shares outstanding for the years ended December 31 follows:
1998 1997 1996 ----- ----- ----- Basic shares 5,078 5,505 6,118 Dilutive impact of stock options 250 185 10 ----- ----- ----- Diluted shares 5,328 5,690 6,128 ===== ===== =====
(Continued) 36 31 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (l) RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board (FASB) and Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and displaying comprehensive income, which is defined as all changes to equity except investments by and distributions to shareholders. Net income is a component of comprehensive income, with all other components referred to in the aggregate as other comprehensive income. This statement has been adopted for the 1998 consolidated financial statements. The following table shows the components of other comprehensive income for the years ended December 31:
1998 1997 1996 ------ ----- ----- Net income $7,621 7,055 2,937 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains (loss) arising during the period 73 557 (326) Reclassification adjustment for (gain) losses included in net income, net of tax (3) 7 4 ------ ----- ----- 70 564 (322) ------ ----- ----- Comprehensive income $7,691 7,619 2,615 ====== ===== =====
Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes standards for reporting information about operating segments. An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and evaluate performance. This statement requires a company to disclose certain income statement and balance sheet information by operating segment, as well as provide a reconciliation of operating segment information to the company's consolidated balances. See footnote 17 for the Company's reportable segments. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Under this statement, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The adoption of this statement is not expected to have a material impact on the Company's financial position. (Continued) 37 32 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (2) STOCKHOLDERS' EQUITY Prior to the Company's initial public offering, in order to grant priority to eligible depositors, BFS established a liquidation account at the time of conversion in an amount equal to the retained earnings of BFS 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 BFS (and only in such an event), eligible depositors who continue to maintain accounts at BFS 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 $9.5 million (unaudited) at December 31, 1998. 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 has authorized 1,000,000 shares of preferred stock with a par value of $0.01 per share (the "Preferred Stock"). 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, 1998, there were no shares of preferred stock has been issued. BFS and BNB are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, BFS and BNB must meet specific capital guidelines that involve quantitative measures of BFS's and BNB's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. BFS's and BNB's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require BFS and BNB 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, 1998, that BFS and BNB meets all capital adequacy requirements to which it is subject. (Continued) 38 33 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 As of August 24, 1998, the most recent notification from the OTS categorized BFS as "well capitalized" by regulatory definition. As of December 4, 1998, the most recent notification from the OCC categorized BNB as "well capitalized." Under "capital adequacy" guidelines and the regulatory framework to be categorized as "well capitalized" BFS and BNB must maintain minimum risk-weighted capital, core capital, leverage, and tangible ratios as set forth in the table. As of December 31, 1998, BFS and BNB are categorized as "well capitalized" based on their ratios of risk-weighted core and tangible capital. These regulatory capital requirements are set forth in terms of (1) Risk-based Total Capital (Total Capital to Risk Weighted Assets), (2) Core Capital (Tier I Capital to Adjusted Tangible Assets), (3) Risk-based Tier I Capital (Tier I Capital to Risk Weighted Assets), (4) Tangible Capital (Tier I Capital to Tangible Assets), and (5) Leverage Capital (Tier I Capital to Average Assets). BFS's and BNB's actual capital amounts and ratios are presented in the table below.
TO BE WELL FOR CAPITAL CAPITALIZED UNDER ADEQUACY REGULATORY ACTUAL PURPOSES DEFINITIONS --------------- --------------- ----------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- ----- ------- ----- -------- ------ (DOLLARS IN THOUSANDS) As of December 31, 1998: Risk-based Total Capital: BFS $57,944 10.2% $45,538 8.0% $56,923 10.0% BNB 10,131 15.3 5,291 8.0 6,614 10.0 Core Capital: BFS 50,820 5.1 39,533 4.0 49,417 5.0 Risk-based Tier I Capital: BFS 50,820 8.9 22,769 4.0 34,154 6.0 BNB 9,492 14.4 2,645 4.0 3,968 6.0 Tangible Capital: BFS 50,820 5.1 19,767 2.0 49,417 5.0 Leverage Capital: BNB 9,492 7.4 5,167 4.0 6,459 5.0 As of December 31, 1997: Risk-based Total Capital: BFS 54,731 11.9 36,758 8.0 45,948 10.0 BNB 9,477 16.4 4,618 8.0 5,772 10.0 Core Capital: BFS 48,987 5.9 24,952 3.0 41,586 5.0 Risk-based Tier I Capital: BNB 8,799 15.2 2,309 4.0 3,463 6.0 Tangible Capital: BFS 48,987 5.9 12,476 1.5 41,586 5.0 Leverage Capital: BNB 8,799 7.4 4,753 4.0 5,941 5.0
(Continued) 39 34 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 At December 31, 1998 and 1997, the consolidated capital to assets ratio was 7.2% and 8.4%, respectively, which exceeded the minimum capital requirements for the Company. During 1998, the Company's Board of Directors approved a program to repurchase up to 268,417 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, 1998, 408,896 shares were repurchased under this program and a previously approved program, at a total cost of $8 million. (3) INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE (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, 1998 ----------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------ Investment securities: U.S. Government, federal agency and other obligations: Maturing within 1 year $32,862 99 (116) 32,845 Maturing after 1 year but within 5 years 15,975 329 (12) 16,292 ------- --- ---- ------ Total investment securities $48,837 428 (128) 49,137 ======= === ==== ====== Mortgage-backed securities: Maturing after 5 years but within 10 years 4,996 6 -- 5,002 Maturing after 10 years 15,939 255 (167) 16,027 ------- --- ---- ------ Total mortgage-backed securities $20,935 261 (167) 21,029 ======= === ==== ======
(Continued) 40 35 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998
DECEMBER 31, 1997 ----------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------ Investment securities: Cash management funds $ 1,150 -- -- 1,150 U.S. Government, federal agencies and other obligations: Maturing within 1 year 7,987 14 (7) 7,994 Maturing after 1 year but within 5 years 22,417 206 -- 22,623 ------- --- ---- ------ Total investment securities $31,554 220 (7) 31,767 ======= === ==== ====== Mortgage-backed securities: Maturing after 5 years but within 10 years 8,454 -- (10) 8,444 Maturing after 10 years 10,553 151 (23) 10,681 ------- --- ---- ------ Total mortgage-backed securities $19,007 151 (33) 19,125 ======= === ==== ======
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. U.S. agency notes with an amortized cost and a fair value of $1,000 at December 31, 1998 were pledged to provide collateral for customers and the Company's employee tax withholdings that are to be remitted to the federal government in excess of the $100 of withholdings insured by the FDIC. At December 31, 1998, no mortgage-backed securities were pledged as collateral for securities sold under agreements to repurchase. Included in U.S. government, federal agency and other obligations are investments that can be called prior to final maturity with an amortized cost of $7,500 and a fair value of $7,565 at December 31, 1998. The composition by issuer of mortgage-backed securities available for sale follows:
DECEMBER 31, ------------------------------------------ 1998 1997 ------------------ ------------------ AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------- ------ --------- ------ FHLMC $ 4,996 5,002 8,454 8,444 GNMA 5,916 5,982 10,553 10,681 Privately issued collateralized mortgage obligations 10,023 10,045 -- -- ------- ------ ------ ------ $20,935 21,029 19,007 19,125 ======= ====== ====== ======
(Continued) 41 36 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 Proceeds from the sale of investment securities and mortgage-backed securities available for sale amounted to $5,000, $15,092 and $10,614 in 1998, 1997 and 1996, respectively. Realized losses on investment securities and mortgage-backed securities available for sale were $18 and $11 in 1997 and 1996, respectively. Realized gains amounted to $19 in 1998. (4) INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD TO MATURITY (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, 1998 ----------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------ Investment securities: U.S. government, federal agency and other obligations: Maturing within one year $ 1,250 1 -- 1,251 Maturing after 1 year but within 5 years 5,027 63 -- 5,090 Maturing after 5 years but within 10 years 1,025 5 -- 1,030 ------- --- --- ------ Total investment securities $ 7,302 69 -- 7,371 ======= === === ====== Mortgage-backed securities: Maturing after 1 year but within 5 years 1,205 23 -- 1,228 Maturing after 5 years but within 10 years 2,309 118 -- 2,427 Maturing after 10 years 19,399 279 -- 19,678 ------- --- --- ------ Total mortgage-backed securities $22,913 420 -- 23,333 ======= === === ======
(Continued) 42 37 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998
DECEMBER 31, 1997 ----------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------ Investment securities: U.S. government, federal agency and other obligations: Maturing within one year $ 5,939 7 (19) 5,927 Maturing after 1 year but within 5 years 13,691 49 (44) 13,696 Maturing after 5 years but within 10 years 1,000 7 -- 1,007 ------- --- --- ------ Total investment securities $20,630 63 (63) 20,630 ======= === === ====== Mortgage-backed securities: Maturing after 1 year but within 5 years 2,050 14 (1) 2,063 Maturing after 5 years but within 10 years 3,126 132 - 3,258 Maturing after 10 years 33,174 410 (2) 33,582 ------- --- --- ------ Total mortgage-backed securities $38,350 556 (3) 38,903 ======= === === ======
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, 1998, a U.S. agency note with an amortized cost and fair value of $500 was pledged to secure certain of BFS's recourse liabilities relating to loans sold as described in note 5. At December 31, 1998, investment securities with an amortized cost of $500 and a fair value of $501 were pledged to provide collateral for customers and the Company'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 that can be called prior to final maturity with an amortized cost of $5,999 and a fair value of $6,040 at December 31, 1998. The composition by issuer of mortgage-backed securities held to maturity follows:
DECEMBER 31, ------------------------------------------ 1998 1997 ------------------ ------------------ AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------- ------ --------- ------ FHLMC $ 682 695 1,100 1,108 FNMA 428 438 894 902 GNMA 16,645 16,991 22,425 22,858 Privately issued collateralized mortgage obligation 5,158 5,209 13,931 14,035 ------- ------ ------ ------ $22,913 23,333 38,350 38,903 ======= ====== ====== ======
(Continued) 43 38 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (5) LOANS (IN THOUSANDS) The Company's lending activities are conducted principally in eastern Massachusetts. The Company grants single-family and multi-family residential loans, commercial real estate loans, commercial loans, business loans and a variety of consumer loans. In addition, the Company grants loans for the construction of residential homes, multi-family 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 one to four 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. The Company's loan portfolio was comprised of the following at December 31:
1998 1997 -------- ------- Mortgage loans: Residential 1-4 family $812,564 692,285 Multi-family 22,889 18,874 Construction and land 41,608 20,497 Commercial real estate 48,951 36,400 -------- ------- 926,012 768,056 -------- ------- Consumer and other loans: Home equity and improvement 32,119 28,119 Secured by deposits 934 834 Consumer 4,637 4,984 Business 3,618 3,528 -------- ------- 41,308 37,465 -------- ------- Total loans 967,320 805,521 Less: Allowance for loan losses (note 6) (8,500) (6,600) Construction loans in process (17,133) (8,527) Net unearned discount on loans purchased (5) (114) Deferred loan origination costs 1,980 1,448 -------- ------- Loans, net $943,662 791,728 ======== =======
The Company services mortgage loans for investors which are not included in the accompanying consolidated balance sheets totaling approximately $648,279 and $549,422 at December 31, 1998 and 1997, respectively. Of these loans serviced for others, $694 and $827 at December 31, 1998 and 1997, respectively, had been sold with recourse by the Company. In addition, at December 31, 1998 and 1997, respectively, the Company had retained the secondary layer of recourse risk on $4,737 and $7,736 of serviced loans, with such risk limited to $221 and $223 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 $0, $44 and $0 for the years ended December 31, 1998, 1997 and 1996, respectively. (Continued) 44 39 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 Proceeds from the sales of loans were $353,387 for 1998, $112,680 for 1997 and $148,693 for 1996. Gains recognized on the sales of loans amounted to $3,173 in 1998, $1,114 in 1997, and $668 in 1996. A summary of the activity of the mortgage servicing rights, which is included as a component of other assets, for the years ended December 31 follows:
1998 1997 ------- ----- Balance, beginning of year $ 1,534 988 Capitalized mortgage servicing rights 3,149 836 Amortization (1,112) (290) ------- ----- Balance, end of year $ 3,571 1,534 ======= =====
The Company has determined that the fair value of mortgage servicing rights at December 31, 1998 approximates their carrying amount after an adjustment of $481 was recorded to reflect impairment value of mortgage servicing rights during 1998. A valuation allowance for the mortgage servicing rights was not established, as the mortgage servicing rights were adjusted through additional amortization. The regulations established by FIRREA implemented a "loan to one borrower limit" equal to 15% of capital and general valuation reserves. The regulatory limits for BFS and BNB, at December 31, 1998, are $8,800 and $1,500; respectively. A $1,527 lending relationship at BNB slightly exceeded the regulatory lending limit at December 31, 1998 as a portion of the loan had not been sold. The violation was remedied in the first quarter of 1999. BFS did not have any borrower relationships which exceeded the limit as of December 31, 1998 and 1997 and BNB did not have any borrower relationship which exceeded the limit as of December 31, 1997. 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:
1998 1997 ------ ------ Balance, beginning of year $1,052 846 Originations 145 22 Broadway acquisition -- 280 Payments (257) (106) Other changes 12 10 ------ ----- Balance, end of year $ 952 1,052 ====== =====
At December 31, 1998 and 1997, total impaired loans were $1,529 and $2,091, respectively. In the opinion of management, no impaired loans required a specific valuation allowance at December 31, 1998 and 1997. All impaired loans have been measured using the fair value of the collateral method. The average recorded value of impaired loans was $1,857 during 1998 and $3,829 during 1997. The Company follows the same policy for recognition of income on impaired loans as it does for all other loans. (Continued) 45 40 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 The following table summarizes information regarding the reduction of interest income on impaired loans at December 31:
1998 1997 1996 ---- ---- ---- Income in accordance with original terms $137 286 497 Income recognized 102 139 321 ---- --- --- Foregone interest income during year $ 35 147 176 ==== === ===
All of the Company's nonaccrual loans are considered to be impaired loans. Non-accrual loans at December 31, 1998 and 1997 were $809 and $1,405, respectively. At December 31, 1998 and 1997, there were no commitments to lend additional funds to those borrowers whose loans were classified as impaired. (6) 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:
1998 1997 1996 ------- ------ ------ Balance, beginning of year $ 6,600 4,400 4,275 BNB allowance for loan losses at acquisition date -- 620 -- Provision charged to income 1,642 1,696 1,294 Recoveries 517 399 343 Charge-offs (259) (515) (1,512) ------- ------ ------ Balance, end of year $ 8,500 6,600 4,400 ======= ====== ======
(7) ACCRUED INTEREST RECEIVABLE (IN THOUSANDS) Accrued interest receivable as of December 31 is presented in the following table:
1998 1997 ------ ----- Investment and mortgage-backed securities $ 697 871 Loans 4,852 4,292 ------ ----- $5,549 5,163 ====== =====
(Continued) 46 41 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (8) 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:
1998 1997 ------- ------ Land $ 2,083 2,083 Buildings 4,074 4,036 Furniture, fixtures and equipment 6,876 6,188 Leasehold improvements 1,402 1,291 ------- ------ 14,435 13,598 Less accumulated depreciation and amortization (7,821) (6,756) ------- ------ $ 6,614 6,842 ======= ======
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:
YEARS ENDED DECEMBER 31, ------------------------ 1999 $ 1,317 2000 1,317 2001 1,317 2002 1,317 Beyond 2003 7,062 ------- $12,330 =======
Rent expense was $1,257 in 1998, $1,178 in 1997 and $1,095 in 1996. 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:
YEARS ENDED DECEMBER 31, ------------------------ 1999 $ 144 2000 106 2001 52 ------- $ 302 =======
(Continued) 47 42 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (9) DEPOSIT ACCOUNTS (DOLLARS IN THOUSANDS) A summary of deposit balances by type is as follows at December 31:
1998 1997 -------- ------- NOW $114,934 106,637 Regular and statement savings 130,843 116,858 Money market 61,756 61,546 Demand deposits and official checks 60,952 51,151 -------- ------- Total noncertificate accounts 368,485 336,192 -------- ------- Certificate accounts: 3 to 6 months 26,066 33,471 1 to 3 year 262,103 196,892 Greater than 3 years 4,442 6,286 IRA/Keogh 46,048 46,980 -------- ------- Total certificate accounts 338,659 283,629 -------- ------- $707,144 619,821 ======== ======= Contractual maturity of certificate accounts: Within one year $198,124 137,520 One to two years 125,285 56,533 Two to three years 9,415 84,479 Over three years 5,835 5,097 -------- ------- $338,659 283,629 ======== =======
Aggregate amount of certificate accounts of $100 or more were $29,006 and $18,960 at December 31, 1998 and 1997, 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:
1998 1997 1996 ------- ------ ------ NOW $ 1,158 1,071 890 Regular and statement savings 2,999 2,826 2,219 Money market 1,838 1,822 1,395 Certificate accounts 18,101 13,457 11,194 ------- ------ ------ $24,096 19,176 15,698 ======= ====== ======
The Company has $82,722 of brokered deposits with a weighted average rate of 6.53% at December 31, 1998. Brokered deposits of $10,000, $67,705 and $5,017 mature in 1999, 2000 and after 2000, respectively. There were $75,000 of brokered deposits outstanding at December 31, 1997. (Continued) 48 43 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (10) SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE (DOLLARS IN THOUSANDS)
1998 1997 -------------- -------------- AMOUNT RATE AMOUNT RATE ------ ------ ------ ------ Securities sold under agreements to repurchase, due on demand $ -- $ --% $7,140 $5.98% ====== ===== ====== =====
At December 31, 1998, there were no securities sold under agreements to repurchase. Securities sold under agreement to repurchase averaged $1,575 during 1998 and $7,261 during 1997. Maximum amounts outstanding at any month end were $7,140 during 1998 and $21,861 during 1997. The average cost of repurchase agreements was 5.90% in 1998 and 5.62% in 1997. The securities collateralizing the agreements were not under the Company's control. Interest expense was $93 in 1998 and $671 in 1997. (11) FEDERAL HOME LOAN BANK ("FHLB") OF BOSTON ADVANCES (DOLLARS IN THOUSANDS) FHLB of Boston advances by year of maturity at December 31 were:
1998 1997 ------------------ ------------------ WEIGHTED WEIGHTED AVERAGE AVERAGE AMOUNT RATE AMOUNT RATE -------- -------- -------- -------- 1998 $ -- --% $118,000 5.76% 1999 114,000 5.56 56,000 6.05 2000 113,500 5.85 58,500 6.25 2001 49,000 5.59 13,000 6.14 2002 1,000 6.55 11,000 5.79 2003 40,000 5.57 -- -- Beyond 2003 20,000 5.99 -- -- -------- ---- -------- ---- Total $337,500 5.69% $256,500 5.96% ======== ==== ======== ====
The advances are secured by FHLB of Boston stock and a blanket lien on certain qualified collateral. The amount of advances is principally limited to 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, and other ratios on other qualifying collateral, the Company's overall borrowing capacity was approximately $474,168 and $438,187 at December 31, 1998 and 1997, respectively. Other qualifying assets were available at BNB, however, a collateral report was not required to be prepared as of December 31, 1998. 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 $927 and $3,788 at December 31, 1998 and 1997, respectively. Any excess may be redeemed by the Company or called by FHLB of Boston at par. Interest expense on FHLB advances was $18,219 in 1998, $17,226 in 1997 and $12,682 in 1996. (Continued) 49 44 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (12) INCOME TAXES (DOLLARS IN THOUSANDS) An analysis of the current and deferred federal and state income tax expense (benefit) follows:
1998 1997 1996 -------- ------- ----- Current income tax expense: Federal income tax $ 4,654 4,581 1,142 State income tax 287 1,407 366 ------- ------ ----- Total current expense 4,941 5,988 1,508 ------- ------ ----- Deferred income tax expense (benefit): Federal deferred income tax 313 (371) 442 State income tax 107 (29) 127 Change in valuation allowance (210) (83) 6 ------- ------ ----- Total deferred expense (benefit) 210 (483) 575 ------- ------ ----- Total income tax expense $ 5,151 5,505 2,083 ======= ====== =====
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:
1998 1997 ------ ------ Deferred tax assets: Allowance for loan losses $3,676 2,747 Deferred compensation 856 766 Real estate owned 7 157 State net operating loss carryforwards -- 86 Premises and equipment -- 80 Other 83 127 ------ ------ Gross deferred assets 4,622 3,963 Valuation allowance -- (210) ------ ------ Net deferred tax assets before deferred tax liabilities 4,622 3,753 ------ ------ Deferred liabilities: Premium on loans sold 1,527 696 Deferred loan fees 806 580 Unrealized gain on securities available for sale 82 89 Premises and equipment 358 368 Other 37 -- ------ ------ Gross deferred liabilities 2,810 1,733 ------ ------ Net deferred tax asset $1,812 2,020 ====== ======
There was no valuation allowance at December 31, 1998. The valuation allowance of $210 at December 31, 1997 is attributable to state net operating loss carryforwards. 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 ended December 31, (Continued) 50 45 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 1998, the Company generated approximately $12,450 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. As a result of the Tax Reform Act of 1996, the special tax bad debt provisions were amended to eliminate the reserve method. However, the base year reserve of approximately $13.3 million remains subject to recapture in the event that the Company pays dividends in excess of its earnings and profits or redeems its stock. 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:
1998 1997 1996 ------- ------ ------ Computed expected expense at statutory rate $4,343 4,396 1,707 Items affecting federal income tax rate: State income tax, net of federal income tax benefit and before valuation allowance 261 896 325 Change in valuation allowance (210) (83) 6 Allocated ESOP share appreciation 273 212 98 Other 484 84 (53) ------ ----- ----- Effective income tax expense $5,151 5,505 2,083 ====== ===== ===== Effective income tax rate 40.3% 43.8% 41.5% ====== ===== =====
(13) EMPLOYEE BENEFITS (DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS) (a) 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 BFS. 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 BFS is obliged to make under a contribution agreement with the ESOP. BFS made contributions to the ESOP totaling $755 in 1998 and 1997 and $606 in 1996 to enable the ESOP to make principal payments on the loan. (Continued) 51 46 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 The amount contributed was charged to compensation and benefits expense. The Company recognized $803 in 1998, $604 in 1997 and $287 in 1996 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 four years, principally with funds from BFS'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. At December 31, 1998 and 1997, shares held in suspense to be released annually as the loan is paid down amounted to 241,829 and 317,379, respectively. The fair value of unallocated ESOP shares was $4,263 and $6,944 at December 31, 1998 and 1997, 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. (b) 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 the award. Awards are granted in the form of common stock held by the SIP. A total of 242,500 shares were awarded on April 30, 1996 and 8,584 shares were awarded on October 15, 1996. During 1998, 51,230 shares were distributed. Awards outstanding vest in five annual installments generally commencing one year from the date of the award. As of December 31, 1998, 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. The Company recognized $608 and $1,226 related to the earned shares in compensation and benefit expense in 1998 and 1997, respectively. 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. (Continued) 52 47 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (c) STOCK OPTION PLANS The Company adopted a stock option plan in 1996 ("1996 Plan") for officers, key employees and directors. Pursuant to the terms of the 1996 plan, the number of common shares reserved for issuance is 658,961 of which 25,000 options remain unawarded. 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 granted vest over a five year period from the date of grant. During 1997, the Company adopted the 1997 stock option plan ("1997 Plan"). Pursuant to the terms of the 1997 plan, 250,000 common shares are reserved for issuance of which 85,100 remain unawarded. During 1998, the Company granted employees options to purchase 40,500 shares of common stock at between $18.13 and $24.81 per share. A summary of option activity follows:
1998 1997 ------------------------- ------------------------- WEIGHTED WEIGHTED NUMBER OF AVERAGE NUMBER OF AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE --------- -------------- --------- -------------- Balance, beginning of year 733,361 $13.63 604,500 $12.51 Granted 40,500 22.77 135,461 18.89 Forfeited -- -- (6,600) 17.52 Exercised (900) 16.43 -- -- ------- ------- Balance, end of year 772,961 $14.12 733,361 $13.63 ======= ====== ======= ====== Options exercisable 273,992 $13.40 120,900 $12.51 ======= ====== ======= ======
A summary of options outstanding and exercisable by price range as of December 31 follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------ ------------ -------- WEIGHTED OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED AS OF REMAINING AVERAGE AS OF AVERAGE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE 1998 LIFE PRICE 1998 PRICE ------------ ----------- -------- ------------ -------- 570,000 7.3 $12.44 228,000 $12.44 25,000 7.8 13.44 10,000 13.44 7,500 7.9 14.82 3,000 14.82 119,961 8.5 18.82 23,992 18.82 10,000 8.9 19.75 2,000 19.75 15,000 9.2 22.22 3,000 22.22 15,000 9.3 24.81 3,000 24.81 5,000 9.4 23.38 1,000 23.38 5,500 10.0 18.13 -- ------- ------- 772,961 7.6 $14.12 273,992 $13.40 ======= ==== ====== ======= ======
(Continued) 53 48 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 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:
1998 1997 ------ ------ Net income as reported $7,621 7,055 Pro forma net income 6,847 6,383 Basic earnings per share as reported 1.50 1.28 Diluted earnings per share as reported 1.43 1.24 Pro forma basic earnings per share 1.35 1.16 Pro forma diluted earnings per share 1.29 1.12
The per share weighted average fair value of stock options granted during 1998 was $5.28 per share determined using the Flexible Binomial option pricing model with the following weighted average assumptions:
1998 1997 ------ ------ Expected dividend yield 2.50% 1.54% Risk-free interest rate 5.23% 5.99% Expected volatility 24.88% 29.12% Expected life (years) 4.6 4.0
(d) PENSION PLAN All eligible officers and employees are included in a noncontributory defined benefit pension plan provided by BFS and BNB as participating employers 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, 1998, 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 1998, 1997 and 1996, except for an administration fee of approximately $5 per year. (e) DEFERRED THRIFT INCENTIVE PLAN BFS and BNB have employee tax deferred thrift incentive plans (the "401K plans") under which employee contributions to the plans are matched pursuant to the provisions of the respective plans. All employees who meet specified age and length of service requirements are eligible to participate in the 401K plans. The amounts matched by BFS and BNB are included in compensation and employee benefits expense. The amounts matched were $143 for 1998 and $119 for 1997. (Continued) 54 49 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (f) SHORT TERM INCENTIVE PLAN The Company established a short-term incentive plan during 1997. Generally, all BFS (effective in 1997) and BNB (effective in 1998) employees are eligible to participate in the incentive plan, and awards are granted based on the achievement of certain performance measures. Compensation expense related to this award amounted to $721 and $450 during 1998 and 1997, respectively. (g) EXECUTIVE OFFICER EMPLOYMENT AGREEMENTS The Company and BFS entered into employment agreements with its President and Chief Executive Officer, and two Executive Vice Presidents. 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 "cause" 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, BFS and BNB 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. (h) 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 Company or its two banks. 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. (14) 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. (15) 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 (Continued) 55 50 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 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. 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:
1998 1997 ------- ------ Commitments to originate mortgage loans $97,658 37,233 Unused lines of credit: Home equity 56,166 42,601 Commercial loans 3,454 1,185 Standby letters of credit 765 372 Commitments to sell loans or swap loans for mortgage-backed securities 44,942 21,872
(16) 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) 56 51 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 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. (a) CASH AND CASH EQUIVALENTS The fair values of cash and cash equivalents approximate the carrying amounts as reported in the balance sheet. (b) 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. (c) 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. (d) 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. (e) 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. (f) 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. (Continued) 57 52 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (g) 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. (h) 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. (i) 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. (j) 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:
1998 1997 ------------------ ------------------ CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------- ------- -------- ------- Financial assets: Cash and cash equivalents $ 37,201 37,201 24,690 24,690 Investment securities available for sale 49,137 49,137 31,767 31,767 Investment securities held to maturity 7,302 7,371 20,630 20,630 Mortgage-backed securities available for sale 21,029 21,029 19,125 19,125 Mortgage-backed securities held to maturity 22,913 23,333 38,350 38,903 Loans, net and mortgage loans held for sale 960,670 968,762 801,545 815,740 Accrued interest receivable 5,549 5,549 5,163 5,163 Stock in FHLB of Boston 17,802 17,802 16,613 16,613 Financial liabilities: Deposit accounts 707,144 711,063 619,821 625,117 Securities sold under agreements to repurchase -- -- 7,140 7,534 FHLB advances 337,500 341,415 256,500 258,934 Advance payments by borrowers for taxes and insurance 3,405 3,405 3,133 3,133
(Continued) 58 53 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (17) BUSINESS SEGMENTS The Company's wholly-owned bank subsidiaries, BFS and BNB (collectively "the Banks"), have been identified as reportable operating segments in accordance with the provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. BF Funding a wholly-owned subsidiary of the Company and various subsidiaries of the Banks, did not meet the quantitative thresholds for determining reportable segments. The Banks provide general banking services to their customers, including deposit accounts, residential, commercial, consumer and business loans. Each Bank also invests in mortgage-backed securities and other financial instruments. In addition to its own operations, the Company provides managerial expertise and other professional services. The results of the Company and BF Funding comprise the "Other" category. The Company evaluates performance and allocates resources based on the Banks' net income, net interest margin, return on average assets and return on average equity. The Banks follow generally accepted accounting principles as described in the summary of significant accounting policies. The Company and Banks have intercompany expense and tax allocation agreements. These inter-company expenditures are allocated at cost. Asset sales between the Banks were accounted for at current market prices at the time of sale and approximated cost. Each Bank is managed separately with its own president, who reports directly to the respective Boards of Directors of each Bank and the Chief Executive Officer of the Company and its Board of Directors. The following table sets forth certain information about and the reconciliation of reported net income for each of the reportable segments. The table includes information of BNB from the close of business of February 7, 1997, the date of its acquisition by the Company, through December 31, 1998.
TOTAL REPORTABLE CONSOLIDATED BFS BNB SEGMENTS OTHER ELIMINATIONS TOTALS --------- -------- ---------- ------ ------------ ------------ At or for the year ended December 31, 1998: Interest income $ 65,411 8,429 73,840 1,452 (517) 74,775 Interest expense 41,069 1,912 42,981 93 (517) 42,557 Provision for loan losses 1,542 100 1,642 -- -- 1,642 Non-interest income 5,579 704 6,283 10 (165) 6,128 Non-interest expense 19,393 4,234 23,627 470 (165) 23,932 Income tax expense 3,611 1,169 4,780 371 -- 5,151 Net income 5,375 1,718 7,093 528 -- 7,621 Total assets 988,747 137,209 1,125,956 87,464 (74,297) 1,139,123 Net interest margin 2.66% 5.14% n.m. n.m. n.m. 3.17% Return on average assets 0.59% 1.36% n.m. n.m. n.m. 0.72% Return on average equity 10.30% 13.90% n.m. n.m. n.m. 9.02% At or for the year ended December 31, 1997: Interest income $ 59,282 7,436 66,718 2,016 (697) 68,037 Interest expense 35,531 1,623 37,154 671 (696) 37,129 Provision for loan losses 1,651 45 1,696 -- -- 1,696 Non-interest income 4,296 645 4,941 45 (180) 4,806 Non-interest expense 17,662 3,546 21,208 430 (180) 21,458 Income tax expense 4,104 1,049 5,153 352 -- 5,505 Net income 4,630 1,818 6,448 607 -- 7,055 Total assets 832,133 123,165 955,298 92,559 (73,177) 974,680 Net interest margin 2.92% 5.12% n.m. n.m. n.m. 3.42% Return on average assets 0.65% 1.06% n.m. n.m. n.m. 0.75% Return on average equity 10.00% 7.43% n.m. n.m. n.m. 8.21%
n.m. = not meaningful 59 54 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (18) PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS (IN THOUSANDS) The following are the condensed financial statements for BostonFed Bancorp, Inc. (the "Parent Company") only: BALANCE SHEETS
1998 1997 ------- ------ ASSETS Cash and interest bearing deposit in subsidiary bank $ 6,716 6,812 Certificates of deposit 74 18 ------- ------ Total cash and cash equivalents 6,790 6,830 ------- ------ Mortgage-backed securities available for sale (amortized cost of $10,913 at 1998 and $19,007 at 1997) 10,983 19,125 Investment securities available for sale (amortized cost of $2,035 at 1998 and $0 at 1997) 2,032 -- Investment in subsidiaries, at equity 64,423 61,518 Accrued interest receivable 63 104 Other assets 15 1,298 ------- ------ Total assets $84,306 88,875 ======= ====== LIABILITIES AND STOCKHOLDERS' EQUITY Securities sold under agreement to repurchase -- 7,140 Accrued expenses and other liabilities 2,512 124 ------- ------ Total liabilities 2,512 7,264 ------- ------ Total stockholders' equity 81,794 81,611 ------- ------ Total liabilities and stockholders' equity $84,306 88,875 ======= ======
(Continued) 60 55 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 STATEMENTS OF INCOME
1998 1997 1996 -------- -------- -------- Interest income $ 1,186 $ 1,684 $ 2,164 Interest expense 93 671 439 -------- -------- -------- Net interest income 1,093 1,013 1,725 Non-interest income 13 45 -- Non-interest expense 469 428 307 -------- -------- -------- Income before income taxes 637 630 1,418 Income tax expense 261 226 536 -------- -------- -------- Income before equity in net income of subsidiaries 376 404 882 Equity in net income of subsidiaries 7,245 6,651 2,055 -------- -------- -------- Net income $ 7,621 $ 7,055 $ 2,937 ======== ======== ========
STATEMENTS OF CASH FLOWS
1998 1997 1996 -------- -------- -------- Net cash flows from operating activities: Net income $ 7,621 $ 7,055 $ 2,937 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries (7,245) (6,651) (2,055) Amortization and accretion, net 81 17 (1) Appreciation in fair value of shares charged to expense for compensation plans 1,135 821 474 Earned SIP shares 593 1,009 917 Reduction in unallocated ESOP shares 756 755 606 Loss on sale of investment securities -- -- 11 Decrease in accrued interest receivable 41 21 14 Decrease (increase) in other assets 1,283 (1,098) (200) Increase (decrease) in accrued expenses and other liabilities 2,505 175 (59) -------- -------- -------- Net cash provided by operating activities 6,770 2,104 2,644 -------- -------- --------
(Continued) 61 56 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 STATEMENTS OF CASH FLOWS, CONTINUED
1998 1997 1996 -------- -------- -------- Cash flow from investing activities: Purchase of BNB -- (22,000) -- Proceeds from sale of mortgage-backed securities for sale -- 1,084 10,614 Principal repayments on mortgage-backed securities available for sale 8,012 3,807 -- Purchase of mortgage-backed securities available for sale -- -- (10,666) Purchase of investment securities available for sale (2,035) -- -- Change in investment in subsidiaries 4,340 22,276 9,048 -------- -------- -------- Net cash used in investing activities 10,317 5,167 8,996 -------- -------- -------- Cash flow from financing activities: Proceeds from securities sold under agreement to purchase -- 7,140 2,973 Repayments of securities sold under agreement to purchase (7,140) (3,500) (6,473) Common stock repurchases (7,998) (13,407) (4,739) Purchase of common stock by SIP -- -- (3,230) Cash dividends paid (2,005) (1,541) (989) Stock options exercised 16 -------- -------- -------- Net cash provided (used) from financing activities (17,127) (11,308) (12,458) -------- -------- -------- Net decrease in cash and cash equivalents (40) (4,037) (818) Cash and cash equivalents at beginning of year 6,830 10,867 11,685 -------- -------- -------- Cash and cash equivalents at end of year $ 6,790 $ 6,830 $ 10,867 ======== ======== ======== Supplemental cash flow information: Cash paid during the year for: Interest 93 662 442 Income taxes 296 268 584
(Continued) 62 57 BOSTONFED BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1998 (19) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Summaries of consolidated operating results on a quarterly basis for the years ended December 31 follow:
1998 QUARTERS 1997 QUARTERS ------------------------------- ------------------------------ FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST ------- ------ ------ ------ ------ ------ ------ ------ Interest and dividend income $19,227 19,054 18,293 18,201 17,428 17,542 17,070 15,997 Interest expense 11,101 11,057 10,402 9,997 9,490 9,600 9,182 8,857 ------- ------ ------ ------ ------ ------ ------ ------ Net interest income 8,126 7,997 7,891 8,204 7,938 7,942 7,888 7,140 ------- ------ ------ ------ ------ ------ ------ ------ Provision for loan losses 455 442 342 403 421 395 455 425 Non-interest income 1,632 1,506 1,586 1,404 1,327 1,303 1,181 995 Non-interest expense 5,997 5,862 6,093 5,980 5,860 5,637 5,496 4,465 ------- ------ ------ ------ ------ ------ ------ ------ Income before income taxes 3,306 3,199 3,042 3,225 2,984 3,213 3,118 3,245 Income tax expense 1,295 1,281 1,239 1,336 1,249 1,512 1,413 1,331 ------- ------ ------ ------ ------ ------ ------ ------ Net income $ 2,011 1,918 1,803 1,889 1,735 1,701 1,705 1,914 ======= ====== ====== ====== ====== ====== ====== ====== Basic earnings per share $ 0.41 0.38 0.35 0.37 0.33 0.30 0.30 0.33 ======= ====== ====== ====== ====== ====== ====== ====== Diluted earnings per share $ 0.39 0.36 0.33 0.35 0.31 0.30 0.30 0.33 ======= ====== ====== ====== ====== ====== ====== ======
63 58 ANNUAL MEETING The annual meeting of stockholders will be held on Wednesday, April 28, 1999, at 2:00 p.m. The meeting will take place at the Burlington Marriot, 1 Mall Road, at the intersection of Routes 128 & 3A, Burlington, MA. STOCK LISTING BostonFed Bancorp, Inc. became a public company on October 24, 1995. BostonFed Bancorp, Inc. Common Stock is traded on the American Stock Exchange with the symbol "BFD." The stock is listed as "Bostnfd" in the Boston Globe and as "BstnfdBcp" in the Wall Street Journal. COMMON STOCK INFORMATION Initial Public Offering Price $10.00 per share. COMMON STOCK PRICE AND DIVIDENDS PAID (UNAUDITED)
1997 1998 _____________________________________ _________________________________ BY QUARTER 1 2 3 4 1 2 3 4 _______________________________________________________ _________________________________ Stock Price High .......... $17 1/8 $18 $22 1/8 $22 1/2 $23 $25 1/8 $24 $18 7/8 Low ........... 14 1/4 14 1/4 17 3/4 19 5/8 20 22 3/8 15 3/4 13 1/2 Dividend Paid .. .05 .07 .07 .07 .07 .10 .10 .10
As of December 31, 1998, the Company had 5,093,841 shares outstanding and approximately 625 stockholders of record, not including persons of entities holding stock in nominee or street name through brokers or banks. 10-K REPORT A copy of the Company's annual report to the Securities and Exchange Commission on Form 10-K may be obtained without charge upon written request to BostonFed Bancorp, Inc., Investor Relations, 17 New England Executive Park, Burlington, MA 01803. 64 EX-23 3 CONSENT OF KPMG PEAT MARWICK LLP 1 Exhibit 23 [LETTERHEAD OF KPMG PEAT MARWICK LLP] CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Nos. 333-23995 and 333-34521) on Form S-8 of BostonFed Bancorp, Inc. (the "Company") of our report, dated January 21, 1999, related to the consolidated balance sheets of the Company as of December 31, 1998 and 1997 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, which report is incorporated by reference in the Annual Report on Form 10-K of the Company for the year ended December 31, 1998. /s/ KPMG Peat Marwick LLP Boston, Massachusetts March 29, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
9 (THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K AND IS QUALIFIED IN ITS ENTIRELY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.) 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1999 36,928 273 0 0 70,166 30,219 30,704 960,670 8,500 1,139,123 707,144 114,000 12,685 223,500 0 0 66 81,728 1,139,123 66,040 8,735 0 74,775 24,096 42,557 32,218 1,542 0 23,932 12,772 12,772 0 0 7,621 0 1.43 3.17 809 0 213 0 6,600 259 517 8,500 0 0 8,500
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