Item 1.
Business
General
Benjamin Franklin Bancorp (the “Company”) was organized in 1996 as a mutual holding company in connection with Benjamin Franklin Bank’s reorganization into the mutual holding company form of organization. Benjamin Franklin Bancorp is registered with the Federal Reserve Board as a bank holding company under the Bank Holding Company Act. On April 4, 2005, the Company completed its mutual-to-stock conversion and related stock offering, and the acquisition of Chart Bank, a $260.7 million-asset bank with three offices in Middlesex County. Since the formation of Benjamin Franklin Bancorp, it has owned 100% of Benjamin Franklin Bank’s outstanding capital stock. At December 31, 2005, Benjamin Franklin Bancorp had total assets of $867.1 million and total deposits of $611.7 million.
Benjamin Franklin Bank is a full-service, community-oriented financial institution offering products and services to individuals, families and businesses through nine offices located in Norfolk, Middlesex and Worcester counties in Massachusetts. Benjamin Franklin Bank was originally organized as a Massachusetts state-charted mutual savings bank in 1871. In 1996, it became a Massachusetts-chartered savings bank in stock form upon the formation of Benjamin Franklin Bancorp as its mutual holding company.
Benjamin Franklin Bank’s business consists primarily of making loans to its customers, including residential mortgages, commercial real estate loans, construction loans, commercial business loans and consumer loans, and investing in a variety of investment and mortgage-backed securities. Benjamin Franklin Bank funds these lending and investment activities with deposits from the general public, funds generated from operations and selected borrowings.
The Company’s principal website is www.benfranklinbank.com. Annual, quarterly and current reports, and amendments to those reports, are available free of charge on www.benfranklinbank.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Reports of beneficial ownership of the Company’s common stock, and changes in that ownership, by directors and officers on Forms 3, 4 and 5 are also available free of charge on our website. The information on the website is not incorporated by reference in this annual report on Form 10-K or in any other report, schedule, notice or registration statement filed with or submitted to the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically at www.sec.gov. You may also read and copy the materials filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW., Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Stock Conversion and Merger
The Company completed its mutual-to-stock conversion and related stock offering with the issuance of 5,977,419 shares (including 400,000 shares contributed to the Benjamin Franklin Bank Charitable Foundation) on April 4, 2005. An additional 2,511,479 shares were issued in connection with the acquisition of Chart Bank, which was consummated immediately following the stock conversion. The cash portion of the consideration paid to Chart Bank shareholders and option holders totaled $21,534,960. The Company’s stock began trading on April 5, 2005, on the Nasdaq National Market, under the symbol “BFBC”.
In connection with the stock conversion, the Company established the Benjamin Franklin Bank Charitable Foundation (the “Foundation”), funded with a contribution of 400,000 shares of newly-issued Benjamin Franklin Bancorp common stock. This contribution resulted in the recognition of expense in the second quarter of 2005 equal to the $10 offering price for each of the shares contributed, net of tax benefits. The effect of this transaction on the Company’s results for the second quarter was $2.6 million
($4.0 million expense, net of $1.4 million in tax benefits). The Foundation provides funding to support charitable causes and community development activities in the communities served by the Company.
Market Area and Competition
The Company offers a variety of financial products and services designed to meet the needs of the communities it serves. Benjamin Franklin Bank’s primary deposit-gathering area is concentrated west and southwest of Boston in the communities in which its nine banking offices are located - specifically in the towns of Franklin, Foxboro, Bellingham, Milford, Medfield, Waltham and Newton - and in contiguous communities in Norfolk, Middlesex and Worcester Counties. The Company’s lending area is broader than its deposit-gathering area and includes all of Massachusetts and northern Rhode Island, although most of the Company’s loans are made to customers located in its primary deposit-gathering market area.
The Company is headquartered in Franklin, Massachusetts, located 41 miles southwest of Boston. Five of the Benjamin Franklin Bank offices are located in Norfolk County, one office is located just across the county border in the town of Milford, in Worcester County, and three offices acquired in the Chart Bank acquisition are located in Middlesex County. The counties in which Benjamin Franklin Bank currently operates include a mixture of rural, suburban and urban markets. The economies of these areas were historically based on manufacturing, but similar to many areas of the country, have now evolved into more service-oriented economies with employment in most large economic sectors including wholesale/retail trade, service, manufacturing, finance, real estate and government. A large portion of Norfolk and Middlesex County residents work in other nearby areas, including the City of Boston and the greater Boston area. There is also significant employment located along the I-495 and I-95 corridors, which run directly through Benjamin Franklin Bank’s market areas in Norfolk and Middlesex counties, respectively. Certain key economic statistics for the counties in which the Bank operates are:
(1)
Bureau of Economic Analysis, as of June 2005.
(2)
Housing and Urban Development, as of March 2005.
(3)
FDIC website, as of December 2005.
Economic growth in Massachusetts slowed in 2005 when compared to 2004, and current forecasts call for slow economic growth in 2006 and beyond.(1) Forecasted rates of growth in employment range from .7 - .9% over the next several years.(2) Real state gross product is estimated to grow at an annual rate of 2.8% through 2009.(3) The Massachusetts housing market, after experiencing a significant increase in values over the past six years, has slowed in the late 2005 and early 2006, as evidenced by recent large increases in unsold inventory of single family homes. A recent forecast by the New England Economic Partnership projects a slight decline in housing prices (less than 3 percent) in the second half of 2006 before a recovery in early 2007.
The Company faces substantial competition in its efforts to originate loans and attract deposits and other fee-based business. Competition for the origination of real estate and other loans comes from other
(1) Source: New England Economic Partnership (“NEEP”) and Massachusetts Taxpayers Foundation.
(2) Source: NEEP and Massachusetts Taxpayers Foundation.
(3) Source: NEEP.
thrift institutions, commercial banks, insurance companies, finance companies, other institutional lenders and mortgage companies. Savings banks, credit unions, savings and loan associations and commercial banks operating in the Company’s primary market area have historically provided most of its competition for deposits. Many of these financial institutions are significantly larger and have greater financial resources than Benjamin Franklin Bank.
Lending Activities
General. Benjamin Franklin Bank’s gross loan portfolio aggregated $610.8 million at December 31, 2005, representing 70.3% of total assets at that date. In its lending activities, Benjamin Franklin Bank originates residential real estate loans secured by one-to-four-family residences, commercial real estate loans, residential and commercial construction loans, commercial loans, home equity lines-of-credit, fixed rate home equity loans, and other personal consumer loans. While Benjamin Franklin Bank makes loans throughout Massachusetts and northern Rhode Island, most of its lending activities are concentrated in its market area. Loans originated totaled $214.1 million in 2005 and $207.6 million in 2004. Residential mortgage loans sold in the secondary market, on a servicing-retained basis, totaled $23.2 million and $31.2 million during those same periods, respectively.
Loans originated by Benjamin Franklin Bank are subject to federal and state laws and regulations. Interest rates charged by Benjamin Franklin Bank on its loans are influenced by the demand for such loans, the amount and cost of funding available for lending purposes, current asset/liability management objectives and the interest rates offered by competitors.
The following table summarizes the composition of Benjamin Franklin Bank’s loan portfolio as of the dates indicated:
Residential Real Estate Loans. Benjamin Franklin Bank offers fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years and maximum loan amounts generally of up to $1.5 million. As of December 31, 2005, this portfolio totaled $286.2 million, or 46.9% of the total gross loan portfolio on that date, and had an average yield of 4.78%. Of the residential mortgage loans outstanding on that date, 66.9% were adjustable-rate loans with an average yield of 4.48% and 33.1% were fixed-rate mortgage loans with an average yield of 5.35%. Residential mortgage loans originations totaled $61.1 million and $116.9 million for 2005 and 2004, respectively.
The Bank offers fixed rate 15 and 30 year monthly payment residential mortgage loans, as well as fixed-rate bi-weekly payment residential mortgage loans with maturities generally ranging between 10 and 30 years. The decision to originate loans for portfolio or for sale in the secondary market is made by the Bank’s Asset/ Liability Management Committee, and is based on the organization’s interest rate risk profile. Current practice is to sell almost all newly originated fixed-rate 15 and 30 year monthly payment loans to Freddie Mac or Fannie Mae. Benjamin Franklin Bank continues to service loans sold to Freddie Mac and Fannie Mae and earns a fee equal to 0.25% of the loan amounts outstanding for providing these services. Generally, Benjamin Franklin retains in its portfolio bi-weekly loans with terms of 15 years or less and sells those with terms greater than 15 years in the secondary market, with servicing rights retained. The total of loans serviced for others as of December 31, 2005 is $122.4 million.
At December 31, 2005, 15 and 30 year fixed rate monthly payment loans held in portfolio totaled $22.2 million, or 7.8% of total residential real estate mortgage loans at that date, and bi-weekly residential mortgage loans held in portfolio totaled $72.8 million, or 25.4% of total residential mortgage loans on that date.
The adjustable-rate mortgage (ARM) loans offered by Benjamin Franklin Bank make up the largest portion of the residential mortgage loans held in portfolio. At December 31, 2005, ARM loans totaled $191.2 million or 66.9% of total residential loans outstanding at that date. ARMs are offered for terms of up to 30 years with initial interest rates that are fixed for 1, 3 or 5 years. After the initial fixed-rate period, the interest rates on the loans are reset based on the relevant U.S. Treasury CMT (Constant Maturity Treasury) Index plus add-on margins of varying amounts, for periods of 1, 3 or 5 years. Interest rate adjustments on such loans are typically limited to no more than 2.0% during any adjustment period and 6.0% over the life of the loan. This feature of ARM loans that allows for periodic adjustments in the interest rate charged helps to reduce Benjamin Franklin Bank’s exposure to changes in interest rates. However, ARM loans may possess an element of credit risk not inherent in fixed-rate mortgage loans, in that borrowers are potentially exposed to increases in debt service requirements over the life of the loan in the event market interest rates rise. Higher payments may increase the risk of default, though this risk has not had a material adverse effect on Benjamin Franklin Bank to date.
In its residential mortgage loan originations, Benjamin Franklin Bank lends up to a maximum loan-to-value ratio of 95.0% on mortgage loans secured by owner-occupied property, with the condition that private mortgage insurance is required for loans with a loan-to-value ratio in excess of 80.0%. Title insurance, hazard insurance and, if appropriate, flood insurance are required for all properties securing real estate loans made by the Bank. A licensed appraiser appraises all properties securing residential first mortgage loans.
In an effort to provide financing for low and moderate-income first-time home buyers, Benjamin Franklin Bank originates and services residential mortgage loans with private mortgage insurance provided by the Mortgage Insurance Fund (MIF) of the Massachusetts Housing Finance Agency, or MassHousing. The program provides mortgage payment protection as an enhancement to mortgage insurance coverage. This no-cost benefit, known as ‘MI Plus’, provides up to six monthly principal and interest payments in the event of a borrower’s job loss.
Commercial Real Estate Loans. Benjamin Franklin Bank originated $81.8 million and $26.2 million of commercial real estate loans in 2005 and 2004, respectively, and had $209.0 million of commercial real estate loans, with an average yield of 6.38%, in its portfolio as of December 31, 2005. Benjamin Franklin Bank has placed increasing emphasis on commercial real estate lending over the past several years, and as
a result of such increased emphasis and the Chart Bank merger, such loans have grown from 15.6% of the total loan portfolio at December 31, 2000 to 34.3% as of December 31, 2005. Benjamin Franklin Bank intends to further grow this segment of its loan portfolio, both in absolute terms and as a percentage of its total loan portfolio.
Benjamin Franklin Bank generally originates commercial real estate loans for terms of up to 25 years, typically with interest rates that adjust over periods of one to seven years based on various rate indices. Commercial real estate loans are generally secured by multi-family income properties, small office buildings, retail facilities, warehouses, industrial properties and owner-occupied properties used for business. Generally, commercial real estate loans do not exceed 80.0% of the appraised value of the underlying collateral.
In its evaluation of a commercial real estate loan application, Benjamin Franklin Bank considers the net operating income of the borrower’s business, the borrower’s expertise, credit history, and the profitability and value of the underlying property. In addition, for loans secured by rental properties, Benjamin Franklin Bank will also consider the terms of the leases and the quality of the tenants. Benjamin Franklin Bank generally requires that the properties securing these loans have debt service coverage ratios (the ratio of cash flow before debt service to debt service) of at least 1.20x. Benjamin Franklin Bank generally requires the borrowers seeking commercial real estate loans to personally guarantee those loans.
Commercial real estate loans generally have larger balances and involve a greater degree of risk than residential mortgage loans. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral value of the commercial real estate securing the loan. Economic events and changes in government regulations could have an adverse impact on the cash flows generated by properties securing Benjamin Franklin Bank’s commercial real estate loans and on the value of such properties. See “Risk Factors - Our Commercial Real Estate, Construction and Commercial Business Loans May Expose Us To Increased Credit Risks.”
Construction Loans. Benjamin Franklin Bank originates land acquisition, development and construction loans to builders and developers, as well as loans to individuals to finance the construction of residential dwellings for personal use. Benjamin Franklin Bank originated $49.4 million and $43.7 million in construction loans during 2005 and 2004, respectively, and as of December 31, 2005 had $60.4 million in construction loans in its portfolio, representing 9.9% of such portfolio, with an average yield of 7.47%. The unadvanced portion of construction loans totaled $24.4 million at December 31, 2005.
Acquisition loans help finance the purchase of land intended for further development, including single family houses and condominiums, multi-family houses and commercial income property. In some cases, Benjamin Franklin Bank makes an acquisition loan before the borrower has received approval to develop the land as planned. In general, the maximum loan-to-value ratio for a land acquisition loan is 75.0% of the lower of the cost or appraised value of the property. Benjamin Franklin Bank also makes development loans to builders in its market area to finance improvements to real estate, consisting mostly of single-family subdivisions, typically to finance the cost of utilities, roads, waste treatment facilities and other costs. Builders typically rely on the sale of single-family homes to repay development loans, although in some cases the improved building lots may be sold to another builder. The maximum amount loaned is generally limited to the cost of the improvements, not to exceed 80.0% of the appraised value, as completed. Advances are made in accordance with a schedule reflecting the cost of the improvements.
Benjamin Franklin Bank also grants construction loans to area builders, often in conjunction with the development loans. In the case of residential subdivisions, these loans finance the cost of completing homes on the improved property. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction. The maximum amount of the loan is generally limited to the lower of 80.0% of the appraised value of the property, as completed, or the property’s cost of construction. For construction loans on residential units being constructed without a pre-sale agreement, the loan amount is generally limited to 75.0% of the appraised value of the property, as completed. Repayment of construction loans on residential subdivisions is normally expected from the sale of units to individual purchasers. In the case of income-producing property, repayment is usually expected from permanent financing upon
completion of construction. Benjamin Franklin Bank commits to provide the permanent mortgage financing on most of its construction loans on income-producing property.
For owner-occupied, one-to-four family properties, Benjamin Franklin Bank will lend up to 95.0% of the lesser of appraised value upon completion of construction or the cost of construction, provided that private mortgage insurance coverage is obtained for any loan with a loan-to-value or loan-to-cost in excess of 80.0%.
Land acquisition, development and construction lending exposes Benjamin Franklin Bank to greater credit risk than residential mortgage lending to owner occupants. The repayment of these loans depends on the sale of the property to third parties or the availability of permanent financing upon completion of all improvements, and on the business and financial condition of the borrowers. In the event Benjamin Franklin Bank makes an acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. Development and construction loans also expose Benjamin Franklin Bank to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated. These events, as well as economic events and changes in government regulations could have an adverse impact on the value of properties securing construction loans and on the borrowers’ ability to repay. See “Risk Factors - Our Commercial Real Estate, Construction and Commercial Business Loans May Expose Us To Increased Credit Risks.”
Home Equity Lines-of-Credit and Loans. Benjamin Franklin Bank offers home equity lines-of-credit and home equity term loans. Benjamin Franklin Bank originated $18.0 million and $15.9 million of home equity lines-of-credit and loans during 2005 and 2004, respectively, and at December 31, 2005 had $32.4 million of home equity lines-of-credit and loans outstanding, representing 5.3% of the loan portfolio, with an average yield of 6.85% at that date.
Home equity lines-of-credit and loans are secured by second mortgages on one-to-four family owner occupied properties, and are made in amounts such that the combined first and second mortgage balances do not exceed 80.0% of the value of the property serving as collateral. The lines-of-credit are available to be drawn upon for 10 years, at the end of which time they become term loans amortized over 10 years. Interest rates on home equity lines normally adjust based on Benjamin Franklin Bank’s prime rate of interest. The undrawn portion of home equity lines-of-credit totaled $39.9 million at December 31, 2005.
Commercial Business Loans. Benjamin Franklin Bank originates secured and unsecured commercial business loans, including commercial lines of credit, to business customers in its market area for the purpose of financing equipment purchases, working capital, expansion and other general business purposes. Benjamin Franklin Bank originated $11.7 million and $3.3 million in commercial business loans during 2005 and 2004, respectively, and as of December 31, 2005 had $19.2 million in commercial business loans in its portfolio, representing 3.1% of such portfolio, with an average yield of 7.86%. Benjamin Franklin Bank intends to continue growing this segment of its lending business in the future.
Benjamin Franklin Bank’s commercial business loans are generally collateralized by equipment, accounts receivable and inventory, and are typically supported by personal guarantees. Benjamin Franklin Bank offers both term and revolving commercial loans. The former have either fixed or adjustable-rates of interest and generally fully amortize over a term of between three and seven years. Revolving loans are written for a one year term, renewable annually, with floating interest rates that are indexed to Benjamin Franklin Bank’s prime rate of interest.
When making commercial business loans, Benjamin Franklin Bank considers the financial statements of the borrower, the borrower’s payment history with respect to both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the borrower operates, the strength of personal guarantees, the value of any other guarantees (such as those provided by the SBA) and the value of the collateral. Benjamin Franklin Bank’s commercial business loans are not concentrated in any one industry.
Commercial business loans generally bear higher interest rates than residential mortgage loans of like duration because they involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower’s business and the sufficiency of collateral, if any. Because commercial business loans often depend on the successful operation or management of the business, repayment of such loans may be affected by adverse changes in the economy. Further, collateral securing such loans may depreciate in value over time, may be difficult to appraise and to liquidate, and may fluctuate in value. See “Risk Factors - Our Commercial Real Estate, Construction and Commercial Business Loans May Expose Us To Increased Credit Risks.”
Consumer and Other Loans. Benjamin Franklin Bank offers a variety of consumer and other loans, including auto loans and loans secured by passbook savings or certificate accounts. Benjamin Franklin Bank originated $2.0 million and $1.7 million of consumer and other loans during 2005 and 2004, respectively, and at December 31, 2005 had $2.4 million of consumer and other loans outstanding, representing 0.4% of the loan portfolio at that date, with an average yield of 8.04%.
Loan Origination and Underwriting. Loan originations come from a variety of sources. The primary source of originations are our salaried and commissioned loan personnel, and to a lesser extent, local mortgage brokers, advertising and referrals from customers. From time to time Benjamin Franklin Bank purchases adjustable-rate residential mortgages from mortgage correspondents in the greater Boston area with whom the Bank has established relationships. Benjamin Franklin Bank also occasionally purchases participation interests in commercial real estate loans from banks located in the Boston area. Benjamin Franklin Bank underwrites such residential and commercial purchased loans using its own underwriting criteria.
Benjamin Franklin Bank issues loan commitments to prospective borrowers conditioned on the occurrence of certain events. Commitments are made in writing on specified terms and conditions and are generally honored for up to 60 days from approval. At December 31, 2005, Benjamin Franklin Bank had loan commitments and unadvanced loans and lines-of-credit totaling $118.2 million. For information about Benjamin Franklin Bank’s loan commitments outstanding as of December 31, 2005, see Item 7A - “Quantitative and Qualitative Disclosures About Market Risk - Liquidity Risk Management.”
Benjamin Franklin Bank charges origination fees, or points, and collects fees to cover the costs of appraisals and credit reports on most residential mortgage loans originated. Benjamin Franklin Bank also collects late charges on real estate loans, and origination fees and prepayment penalties on commercial mortgage loans. For information regarding Benjamin Franklin Bank’s recognition of loan fees and costs, please refer to Note 1 to the Consolidated Financial Statements of Benjamin Franklin Bancorp beginning on page.
The following table sets forth certain information concerning Benjamin Franklin Bank’s portfolio loan originations, inclusive of loan purchases:
Residential mortgage loans are underwritten by the Bank’s staff of residential loan underwriters. Conforming loans sold to Freddie Mac or Fannie Mae require the approval of the Senior Underwriter. Residential mortgage loans of less than $1,000,000 to be held in portfolio require the approval of the Senior Residential Loan Officer. Residential mortgage loans of $1,000,000 or more but less than $1.5 million require the approval of the management Credit Committee. Residential mortgage loans $1.5 million or greater require the approval of the Executive Committee of the Board of Directors (the “Board”).
Commercial real estate and commercial business loans are underwritten by commercial credit analysts. For commercial real estate loans, loan officers may approve loans up to $100,000, while loans up to $500,000 may be approved by the Senior Loan Officer. Commercial real estate loans of up to $1,500,000 may be approved by the management Credit Committee. For commercial business loans, individual loan officer authority is limited to $65,000 ($25,000 for unsecured loans). The Senior Loan Officer may approve commercial loans of up to $350,000 ($50,000 if unsecured), while the management Credit Committee may approve loans of up to $500,000 ($100,000 if unsecured). Loans over these limits require the approval of the Executive Committee of the Board.
Consumer loans are underwritten by consumer loan underwriters. Loan officers and Branch Managers have approval authorities ranging from $25,000 to $35,000 ($3,500 to $10,000 if unsecured) for these loans. The Senior Residential Loan Officer may approve consumer loans of up to $300,000 ($25,000 if unsecured) while the management Credit Committee may approve loans of up to $750,000 ($50,000 if unsecured). All consumer loans in excess of these limits require the approval of the Executive Committee of the Board.
Pursuant to its loan policy, Benjamin Franklin Bank generally will not make loans aggregating more than $10.0 million to one borrower (or related entity). Exceptions to this limit require the approval of the Executive Committee of the Board prior to loan origination. As of December 31, 2005, Benjamin Franklin Bank had no borrower relationships in excess of this policy guideline. Benjamin Franklin Bank’s internal lending limit is lower than the Massachusetts legal lending limit, which is 20.0% of a bank’s surplus and capital stock accounts, or $18.3 million for Benjamin Franklin Bank as of December 31, 2005.
Benjamin Franklin Bank has established a risk rating system for its commercial real estate, construction and commercial loans. This system evaluates a number of factors useful in indicating the risk of default and risk of loss associated with a loan. These ratings are performed by commercial credit analysts who do not have responsibility for loan originations. See “- Asset Quality - Classification of Assets and Loan Review.”
Loan Maturity. The following table summarizes the scheduled repayments of Benjamin Franklin Bank’s loan portfolio at December 31, 2005. Demand loans, loans having no stated repayment schedule, and overdraft loans are reported as being due in one year or less:
The following table sets forth, at December 31, 2005, the dollar amount of total loans, net of unadvanced funds on loans, contractually due after December 31, 2006 and whether such loans have fixed interest rates or adjustable interest rates.
Asset Quality
General. One of Benjamin Franklin Bank’s most important operating objectives is to maintain a high level of asset quality. Management uses a number of strategies in furtherance of this goal including maintaining sound credit standards in loan originations, monitoring the loan portfolio through internal and third-party loan reviews, and employing active collection and workout processes for delinquent or problem loans.
Delinquent Loans. Management performs a monthly review of all delinquent loans. The actions taken with respect to delinquencies vary depending upon the nature of the delinquent loans and the period of delinquency. Generally, the Bank’s requirement is that a delinquency notice be mailed no later than the 10th or 16th day, depending on loan type, after the payment due date. A late charge is normally assessed on loans where the scheduled payment remains unpaid after a 10 or 15 day grace period. After mailing delinquency notices Benjamin Franklin Bank’s loan collection personnel call the borrower to ascertain the reasons for delinquency and the prospects for repayment. On loans secured by one-to-four family owner-occupied property, Benjamin Franklin Bank initially attempts to work out a payment schedule with the borrower in order to avoid foreclosure. Any such loan restructurings must be approved by the level of officer authority required for a new loan of that amount. If these actions do not result in a satisfactory resolution, Benjamin Franklin Bank refers the loan to legal counsel and counsel initiates foreclosure proceedings. For commercial real estate, construction and commercial loans, collection procedures may vary depending on individual circumstances.
The following table sets forth delinquencies, including loans that are both delinquent and on non-accrual status, in Benjamin Franklin Bank’s loan portfolio as of the dates indicated:
Other Real Estate Owned. Benjamin Franklin Bank classifies property acquired through foreclosure or acceptance of a deed in lieu of foreclosure as other real estate owned (“OREO”) in its financial statements. When property is placed into OREO, it is recorded at the lower of the carrying value or the fair value less estimated costs to sell at the date of foreclosure or acceptance of deed in lieu of foreclosure. At the time of transfer to OREO, any excess of carrying value over fair value is charged to the allowance for loan losses. Management inspects all OREO property periodically. Holding costs and declines in fair value result in charges to expense after the property is acquired. At December 31, 2005, Benjamin Franklin Bank had no property classified as OREO.
Classification of Assets and Loan Review. Benjamin Franklin Bank uses an internal rating system to monitor and evaluate the credit risk inherent in its loan portfolio, both at the time of loan origination and on an ongoing basis. At the time a loan is approved, all commercial real estate, construction and commercial business loans are assigned a risk rating based on all of the factors considered in originating the loan. The initial risk rating is recommended by the credit analyst charged with underwriting the loan, and subsequently approved by the relevant loan approval authority. With the exception of commercial borrowing relationships of less than $100,000, current financial information is sought for all commercial real estate, construction and commercial borrowing relationships, and is evaluated on at least an annual basis to determine whether the risk rating classification is appropriate.
In Benjamin Franklin Bank’s loan rating system, there are three classifications for problem assets: Substandard, Doubtful and Loss. An asset is considered Substandard if it is inadequately protected by the
current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard assets are characterized by the distinct possibility that Benjamin Franklin Bank will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of Substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full questionable, on the basis of currently existing facts, and there is a high possibility of loss. Assets classified Loss are considered uncollectible and of such little value that continuance as an asset of Benjamin Franklin Bank is not warranted. Assets that possess some weaknesses, but that do not expose Benjamin Franklin Bank to risk sufficient to warrant classification in one of the aforementioned categories, are designated as Special Mention. If an asset or portion thereof is classified as Loss, it is charged off in the quarter in which it is so classified. For assets designated as Special Mention, Substandard or Doubtful, Benjamin Franklin Bank establishes reserves in amounts management deems appropriate within the allowance for loan losses. This determination as to the classification of assets and the amount of the loss allowances established are subject to review by regulatory agencies, which can order the establishment of additional loss allowances. See “- Asset Quality - Allowance for Loan Losses” and “Management’s Discussion and Analysis - Critical Accounting Policies - Allowance for Loan Losses.”
Benjamin Franklin Bank engages an independent third party to conduct a semi-annual review of its commercial real estate, construction and commercial loan portfolios. These loan reviews, which typically include a 70.0% penetration of the various commercial portfolios, provide a credit evaluation of individual loans to determine whether the risk ratings assigned are appropriate. In addition, independent loan reviews are performed on a quarterly basis for the residential mortgage portfolio, based on a sampling of newly originated loans during the period. Independent loan review findings are presented directly to the Executive Committee of the Board of Directors.
At December 31, 2005, loans classified Substandard totaled $332,000, consisting entirely of commercial business loans. Special Mention loans totaled $4.4 million, consisting of $4.3 million in commercial real estate loans and $0.1 million in residential mortgage loans. No loans were classified as Doubtful or Loss at December 31, 2005.
Non-Performing Assets. The table below sets forth the amounts and categories of non-performing assets at the dates indicated. At each date presented, the Company had no troubled debt restructurings (loans for which a portion of interest or principal has been forgiven and loans modified at interest rates materially less than current market rates).
Loans are placed on non-accrual status either when reasonable doubt exists as to the full timely collection of interest and principal, or when a loan becomes 90 days past due, unless an evaluation by the management Credit Committee clearly indicates that the loan is well-secured and in the process of collection. Restructured loans represent performing loans for which concessions were granted due to a borrower’s financial condition. Such concessions may include reductions of interest rates to below-market terms and/or extension of repayment terms.
Allowance for Loan Losses. In originating loans, Benjamin Franklin Bank recognizes that losses will be experienced on loans and that the risk of loss will vary with many factors, including the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan over the term of the loan. Benjamin Franklin Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio, and as such, this allowance represents management’s best estimate of the probable known and inherent credit losses in the loan portfolio as of the date of the financial statements.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, portfolio volume and mix, geographic and large borrower concentrations, estimated credit losses based on internal and external portfolio reviews, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. See “- Asset Quality - Classification of Assets and Loan Review.” The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that Benjamin Franklin Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, Benjamin Franklin Bank does not separately identify individual consumer and residential loans for impairment disclosures. At December 31, 2005, impaired loans totaled $264,000 and in the aggregate carried a valuation allowance within the allowance for loan losses of $140,000.
While Benjamin Franklin Bank believes that it has established adequate specific and general allowances for losses on loans, adjustments to the allowance may be necessary if future conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, Benjamin Franklin Bank’s regulators periodically review the allowance for loan losses. These regulatory agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination, thereby negatively affecting Benjamin Franklin Bank’s financial condition and earnings.
The following table sets forth activity in Benjamin Franklin Bank’s allowance for loan losses for the periods indicated:
(1)
The increase in the allowance for loan losses as a percentage of the loan portfolio as of December 31, 2005 compared to December 31, 2004 was primarily due to an increase in the proportion of commercial loans in the portfolio.
The following tables set forth Benjamin Franklin Bank’s percent of allowance by loan category and the percent of the loans to total loans in each of the categories listed at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories:
(1)
The unallocated portion of the allowance for loan losses is intended to capture the exposure, if any, that may exist as a result of a number qualitative factors that are difficult to quantify with precision. The Company increased the unallocated portion of the allowance in 2004 and 2005, compared to 2003, based on management’s analysis of general business and economic conditions, the seasoning of the loan portfolio, the level of real estate values in Massachusetts, changes in the composition of the loan officer and support staff, and the allowance as a percentage of total loans.
Investment Activities
General. Benjamin Franklin Bank’s investment policy is established by its Board of Directors. The Chief Executive Officer and Chief Financial Officer, as authorized by the Board, implement this policy based on the established guidelines within the written policy. The primary objective of the investment portfolio is to achieve a competitive rate of return without incurring undue interest rate and credit risk, to complement Benjamin Franklin Bank’s lending activities, to provide and maintain liquidity, and to assist in managing the interest rate sensitivity of its balance sheet. Individual investment decisions are made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with Benjamin Franklin Bank’s asset/liability management objectives.
SFAS No. 115 requires Benjamin Franklin Bank to designate its securities as held to maturity, available for sale or trading, depending on Benjamin Franklin Bank’s intent with regard to its investments at the time of purchase. At December 31, 2005, $125.0 million or 92.4% of the portfolio was classified as available for sale, and $0.1 million or 0.1% of the portfolio was classified as held to maturity. The remainder of the portfolio at December 31, 2005 consisted of restricted equity securities totaling $10.0 million, representing 7.5% of the portfolio at that date. At December 31, 2005, the net unrealized loss on securities classified as available for sale was $2.6 million. Benjamin Franklin Bank does not currently maintain a trading portfolio of securities.
Government-sponsored Enterprise Obligations. At December 31, 2005, Benjamin Franklin Bank’s Government-sponsored enterprise securities portfolio (described in previous reports as U.S. Agency securities) totaled $86.1 million, or 63.8% of the total portfolio on that date.
Corporate and Municipal Obligations. At December 31, 2005, Benjamin Franklin Bank’s portfolio of corporate and municipal obligations totaled $4.7 million, or 3.5% of the portfolio at that date. Benjamin Franklin Bank’s policy requires that investments in corporate and municipal obligations be restricted only to those obligations that are readily marketable and rated ‘A’ or better by a nationally recognized rating agency at the time of purchase. At December 31, 2005, all investments in corporate and municipal obligations were rated ‘A’ or better.
Mortgage-Backed Securities. At December 31, 2005, Benjamin Franklin Bank’s portfolio of mortgage-backed securities totaled $34.1 million, or 25.2% of the portfolio on that date, and consisted of pass-through securities ($2.7 million) and collateralized mortgage obligations (“CMOs”) ($31.4 million) directly insured or guaranteed by Freddie Mac, Fannie Mae or the Government National Mortgage Association (Ginnie Mae). In its purchase of collateralized mortgage obligations, Benjamin Franklin Bank has targeted instruments in the three to five year weighted average life tranches, with expected average life extensions up to a maximum of seven years in a rising rate environment. The objective of this strategy has been to limit the potential interest rate risk due to extension of this portfolio in a rising rate environment. The Company’s portfolio of CMOs was purchased in 2003, at a time when short-term interest rates were approximately 250-300 basis points lower than current levels. Of the remaining CMO portfolio, $19.2 million are subject to significant duration extension risk if market interest rates rise by more than 300 basis points. Management considers this risk to be acceptable given the size of this portfolio relative to the total earning assets of the Company.
Restricted Equity Securities. At December 31, 2005, Benjamin Franklin Bank’s portfolio of restricted equity securities totaled $10.0 million or 7.4% of the portfolio at that date. These securities consisted primarily of stock in the Federal Home Loan Bank of Boston ($7.5 million) which must be held as a
condition of membership in the Federal Home Loan Bank System and as a condition to Benjamin Franklin Bank’s borrowing under the Federal Home Loan Bank of Boston advance program. The remainder ($2.5 million) consisted of certain other equity investments in Savings Bank Life Insurance (“SBLI”), the Community Investment Fund and the Depositors Insurance Fund (“DIF”).
The following table sets forth certain information regarding the amortized cost and market values of Benjamin Franklin Bank’s securities at the dates indicated:
The table below sets forth certain information regarding the amortized cost, weighted average yields and contractual maturities of Benjamin Franklin Bank’s debt securities portfolio at December 31, 2005. In the case of mortgage-backed securities, the table shows the securities by their contractual maturities, however there are scheduled principal payments for these securities and there will also be unscheduled prepayments prior to their contractual maturity:
Sources of Funds
General. Deposits are the primary source of Benjamin Franklin Bank’s funds for lending and other investment purposes. In addition to deposits, Benjamin Franklin Bank obtains funds from the amortization and prepayment of loans and mortgage-backed securities, the sale or maturity of securities, advances from the Federal Home Loan Bank of Boston, and cash flows generated by operations.
Deposits. Consumer and commercial deposits are gathered primarily from Benjamin Franklin Bank’s primary market area through the offering of a broad selection of deposit products including checking,
regular savings, money market deposits and time deposits, including certificate of deposit accounts and individual retirement accounts. The FDIC insures deposits up to certain limits (generally, $100,000 per depositor) and the Depositors Insurance Fund (DIF), which is neither a government agency nor backed by the full faith and credit of the Commonwealth of Massachusetts, fully insures amounts in excess of such limits.
The maturities of Benjamin Franklin Bank’s certificate of deposit accounts range from seven days to five years. In addition, Benjamin Franklin Bank offers a variety of commercial business products to small businesses operating within its primary market area. Currently, Benjamin Franklin Bank does not generally negotiate interest rates to attract jumbo certificates of deposit, but accepts deposits of $100,000 or more from customers within its market area based on posted rates. Benjamin Franklin Bank does not use brokers to obtain deposits.
Benjamin Franklin Bank relies primarily on competitive pricing of its deposit products, customer service and long-standing relationships with customers to attract and retain deposits. Market interest rates, rates offered by financial service competitors, the availability of other investment alternatives, and general economic conditions significantly affect Benjamin Franklin Bank’s ability to attract and retain deposits.
The following tables set forth certain information relative to the composition of Benjamin Franklin Bank’s average deposit accounts and the weighted average interest rate on each category of deposits:
The following table sets forth the time deposits of Benjamin Franklin Bank classified by interest rate as of the dates indicated:
The following table sets forth the amount and maturities of time deposits at December 31, 2005:
As of December 31, 2005, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $104.9 million. The following table sets forth the maturity of those certificates as of December 31, 2005:
Borrowings. Benjamin Franklin Bank utilizes advances from the Federal Home Loan Bank of Boston, primarily in connection with the funding of growth in its assets. Federal Home Loan Bank of Boston advances are secured primarily by certain of Benjamin Franklin Bank’s mortgage loans, certain securities and by Benjamin Franklin Bank’s holding of Federal Home Loan Bank of Boston stock. As of December 31, 2005, Benjamin Franklin Bank had outstanding $128.9 million in Federal Home Loan Bank of Boston advances, and had the ability to borrow an additional $73.3 million based on available collateral.
The following table sets forth certain information concerning balances and interest rates on Benjamin Franklin Bank’s Federal Home Loan Bank of Boston advances at the dates and for the periods indicated:
Of the $128.9 million in advances outstanding at December 31, 2005, $36.0 million, bearing a weighted-average interest rate of 4.47%, are callable by the FHLBB at its option and in its sole discretion. Based on the current and predicted level of market interest rates, management considers it likely that these advances will be called by the FHLBB in the next 12 months. Further, one advance in the amount of $10.0 million maturing in June 2010 will become immediately payable if 3-month LIBOR rises above 6.0% (at December 31, 2005, 3-month LIBOR was 4.47%). In the event the FHLBB calls these advances, the Bank will evaluate its liquidity and interest rate sensitivity position at that time and determine whether to replace the called advances with new borrowings.
In 2002, Benjamin Franklin Bancorp raised net proceeds of $8.7 million in a sale of $9.0 million of subordinated debentures to Benjamin Franklin Capital Trust I (the “Trust”). The Trust funded the purchase by participating in a pooled offering of 9,000 capital securities representing preferred ownership interests in the assets of the Trust with a liquidation value of $1,000 each. Interest payable on the subordinated debentures and cumulative dividends payable quarterly on the preferred securities is 6.94% for the first five years and thereafter will be at a rate equal to the three month LIBOR rate plus 3.45%. Benjamin Franklin Bancorp has the option to defer interest payments on the subordinated debentures for up to five years and, accordingly, the Trust may defer dividend distributions for up to five years. The debentures and the preferred securities mature in November 2032 unless Benjamin Franklin Bancorp elects and obtains regulatory approval to accelerate the maturity to November 2007 or thereafter.
Employees
As of December 31, 2005, Benjamin Franklin Bank had 140 full-time and 25 part-time employees. Employees are not represented by a collective bargaining unit and Benjamin Franklin Bank considers its relationship with its employees to be good.
Subsidiary Activities
Benjamin Franklin Bancorp conducts its principal business activities through its wholly-owned subsidiary, Benjamin Franklin Bank. Subsidiaries of Benjamin Franklin Bancorp and Benjamin Franklin Bank are as follows:
Benjamin Franklin Bank Capital Trust I, a Delaware Trust, is a wholly-owned subsidiary of Benjamin Franklin Bancorp. In 2002, Benjamin Franklin Bancorp raised net proceeds of $8.7 million in a sale of $9.0 million in junior subordinated notes due 2032 to Benjamin Franklin Capital Trust I (the “Trust”). The Trust funded the purchase by participating in a pooled offering of 9,000 capital securities representing preferred ownership interests in the assets of the Trust with a liquidation value of $1,000 each. The interest rate payable on the subordinated notes is 6.94% for the first five years and thereafter will be at a rate equal to the three month LIBOR rate plus 3.45%.
Benjamin Franklin Securities Corp., a Massachusetts corporation, is a wholly-owned subsidiary of Benjamin Franklin Bank. Benjamin Franklin Securities Corp. (“BFSC”) engages exclusively in buying, selling and holding investment securities on its own behalf and not as a broker. The income earned on
BFSC’s investment securities is subject to a significantly lower rate of state tax than that assessed on income earned on investment securities maintained at Benjamin Franklin Bank. At December 31, 2005, BFSC had total assets of $99.9 million, consisting primarily of cash and securities.
Creative Strategic Solutions, Inc. (“CSSI”), a Massachusetts corporation, is a wholly-owned subsidiary of Benjamin Franklin Bank. Through CSSI, Benjamin Franklin Bank supplies cash to automatic teller machines, or ATMs, owned by independent service organizations (“ISOs”). CSSI also provides related cash management services to a nationwide customer base of ISOs. At December 31, 2005, Benjamin Franklin Bank cash managed and supplied to ISOs by CSSI totaled $37.2 million.
Regulation and Supervision
General.
Benjamin Franklin Bank is a Massachusetts-chartered stock savings bank and a wholly owned subsidiary of Benjamin Franklin Bancorp. Benjamin Franklin Bank’s deposits are insured up to applicable limits by the FDIC through the Bank Insurance Fund and by the DIF of the Depositors Insurance Fund of Massachusetts for amounts in excess of the FDIC insurance limits. Benjamin Franklin Bank is subject to extensive regulation by the Massachusetts Division of Banks, as its chartering agency, and by the FDIC, as its deposit insurer and primary federal regulator. Benjamin Franklin Bank is required to file reports with, and is periodically examined by, the FDIC and the Massachusetts Division of Banks concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other banks. Benjamin Franklin Bank is a member of the Federal Home Loan Bank and is subject to certain limited regulation by the Federal Reserve Board.
Benjamin Franklin Bancorp, as a bank holding company, is subject to regulation by the Federal Reserve Board and is required to file reports with the Federal Reserve Board.
Massachusetts Bank Regulation.
General. As a Massachusetts-chartered savings bank, Benjamin Franklin Bank is subject to supervision, regulation and examination by the Massachusetts Division of Banks and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts, distribution of earnings and payment of dividends. In addition, Benjamin Franklin Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The Massachusetts Commissioner of Banks’s approval is required for a Massachusetts bank to establish or close branches, merge with other banks, organize a holding company, issue stock and undertake certain other activities.
In response to a Massachusetts law enacted in 1996, the Massachusetts Commissioner of Banks adopted rules that generally give Massachusetts banks powers equivalent to those of national banks. The Commissioner also has adopted procedures reducing regulatory burdens and expense and expediting branching by well-capitalized and well-managed banks.
Investment Activities. In general, Massachusetts-chartered savings banks may invest in preferred and common stock of any corporation organized under the laws of the United States or any state provided such investments do not involve control of any corporation and do not, in the aggregate, exceed 4.0% of the bank’s deposits. Massachusetts-chartered savings banks may in addition invest an amount equal to 1.0% of their deposits in stocks of Massachusetts corporations or companies with substantial employment in the commonwealth which have pledged to the Massachusetts Commissioner of Banks that such monies will be used for further development within the Commonwealth. See also “- Federal Regulations - Investment Activities” for federal restrictions on equity investments.
Lending Activities. Massachusetts banking laws grant banks broad lending authority. However, with certain limited exceptions, total obligations of one borrower to a stock bank may not exceed 20.0% of the total of the bank’s capital, which includes capital stock, surplus and undivided profits.
Dividends. A Massachusetts stock bank may declare from net profits cash dividends not more frequently than quarterly and non-cash dividends at any time. No dividends may be declared, credited or paid if the bank’s capital stock is impaired. The approval of the Massachusetts Commissioner of Banks is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Net profits for this purpose means the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting from the total thereof all current operating expenses, actual losses, accrued dividends on preferred stock, if any, and all federal and state taxes.
Regulatory Enforcement Authority. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be subject to sanctions for non-compliance, including seizure of the property and business of the bank and suspension or revocation of its charter. The Massachusetts Commissioner of Banks may under certain circumstances suspend or remove officers or directors who have violated the law, conducted the bank’s business in a manner which is unsafe, unsound or contrary to the depositors’ interests or been negligent in the performance of their duties. In addition, upon finding that a bank has engaged in an unfair or deceptive act or practice, the Massachusetts Commissioner of Banks may issue an order to cease and desist and impose a fine on the bank concerned. Finally, Massachusetts consumer protection and civil rights statutes applicable to Benjamin Franklin Bank permit private individual and class action law suits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damages and attorneys’ fees in the case of certain violations of those statutes.
Insurance Sales. Massachusetts banks may engage in insurance sales activities if the Massachusetts Commissioner of Banks has approved its plan of operation for insurance activities and it obtains a license from the Massachusetts Division of Insurance. A bank may be licensed directly or indirectly through an affiliate or a subsidiary corporation established for this purpose.
DIF. All Massachusetts-chartered savings banks are required to be members of the Deposit Insurance Fund of the Depositors Insurance Fund of Massachusetts, a corporation that insures savings bank deposits in excess of federal deposit insurance coverage. The DIF is authorized to charge savings banks an annual assessment of up to 1/50th of 1.0% of a savings bank’s deposit balances in excess of amounts insured by the FDIC.
Federal Regulations.
Capital Requirements. Under FDIC regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as Benjamin Franklin Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the FDIC to not be anticipating or experiencing significant growth and to be, in general, a strong banking organization rated composite 1 under the Uniform Financial Institutions Ranking System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier 1 capital to total assets of 3.0%. For all other institutions, the minimum leverage capital ratio is not less than 4.0%. Tier 1 capital is the sum of common stockholders’ equity, non-cumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and certain other specified items.
The FDIC regulations require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of regulatory capital to regulatory risk-weighted assets is referred to as a bank’s “risk-based capital ratio.” Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items (including recourse obligations, direct credit substitutes and residual interests) to four risk-weighted categories ranging from 0.0% to 100.0%, with higher levels of capital being required for the categories perceived as representing greater risk. For example, under the FDIC’s risk-weighting system, cash and securities backed by the full faith and credit
of the U.S. government are given a 0.0% risk weight, loans secured by one- to four-family residential properties generally have a 50.0% risk weight, and commercial loans have a risk weighting of 100.0%.
State non-member banks must maintain a minimum ratio of total capital to risk-weighted assets of at least 8.0%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and certain other capital instruments, and a portion of the net unrealized gain on equity securities. The includable amount of Tier 2 capital cannot exceed the amount of the institution’s Tier 1 capital. Banks that engage in specified levels of trading activities are subject to adjustments in their risk based capital calculation to ensure the maintenance of sufficient capital to support market risk.
The Federal Deposit Insurance Corporation Improvement Act (FDICIA) required each federal banking agency to revise its risk-based capital standards for insured institutions to ensure that those standards take adequate account of interest-rate risk, concentration of credit risk, and the risk of nontraditional activities, as well as to reflect the actual performance and expected risk of loss on multi-family residential loans. The FDIC, along with the other federal banking agencies, has adopted a regulation providing that the agencies will take into account the exposure of a bank’s capital and economic value to changes in interest rate risk in assessing a bank’s capital adequacy. The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon determination that an institution’s capital level is, or is likely to become, inadequate in light of the particular circumstances.
As a bank holding company, Benjamin Franklin Bancorp is subject to capital adequacy guidelines for bank holding companies similar to those of the FDIC for state-chartered banks. Benjamin Franklin Bancorp’s stockholders’ equity exceeds these requirements as of December 31, 2005.
Standards for Safety and Soundness. As required by statute, the federal banking agencies adopted final regulations and Interagency Guidelines Establishing Standards for Safety and Soundness to implement safety and soundness standards. 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 guidelines address internal controls and information systems, internal audit system, credit underwriting, loan documentation, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. Most recently, the agencies have established standards for safeguarding customer information. 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.
Investment Activities. Since the enactment of FDICIA, all state-chartered FDIC insured banks, including savings banks, have generally been limited in their investment activities to principal and equity investments of the type and in the amount authorized for national banks, notwithstanding state law. FDICIA and the FDIC permit exceptions to these limitations. For example, state chartered banks may, with FDIC approval, continue to exercise state authority to invest in common or preferred stocks listed on a national securities exchange or the Nasdaq National Market and in the shares of an investment company registered under the Investment Company Act of 1940, as amended. The maximum permissible investment is 100.0% of Tier 1 Capital, as specified by the FDIC’s regulations, or the maximum amount permitted by Massachusetts law, whichever is less. Such authority may be terminated upon the FDIC’s determination that such investments pose a safety and soundness risk. Benjamin Franklin does not currently have authority to invest in equity securities. In addition, the FDIC is authorized to permit state-chartered banks institutions to engage in state authorized activities or investments not permissible for national banks (other than non-subsidiary equity investments) if they meet all applicable capital requirements and it is determined that such activities or investments do not pose a significant risk to the Bank Insurance Fund. The FDIC has adopted revisions to its regulations governing the procedures for institutions seeking approval to engage in such activities or investments. The Gramm-Leach-Bliley Act of 1999 specifies that a nonmember bank may control a subsidiary that engages in activities as principal that
would only be permitted for a national bank to conduct in a “financial subsidiary” if a bank meets specified conditions and deducts its investment in the subsidiary for regulatory capital purposes.
Interstate Banking and Branching. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or the Interstate Banking Act, permits adequately capitalized bank holding companies to acquire banks in any state subject to specified concentration limits and other conditions. The Interstate Banking Act also authorizes the interstate merger of banks. In addition, among other things, the Interstate Banking Act permits banks to establish new branches on an interstate basis provided that such action is specifically authorized by the law of the host state.
Prompt Corrective Regulatory Action. Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.
The FDIC has adopted regulations to implement the prompt corrective action legislation. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater and a leverage ratio of 5.0% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and generally a leverage ratio of 4.0% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or generally a leverage ratio of less than 4.0%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%. As of December 31, 2005 and 2004, Benjamin Franklin Bank was a “well capitalized” institution.
“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. A bank’s compliance with such a plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5.0% of the institution’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions are subject to additional measures including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
Transactions with Affiliates. Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding company context, the parent bank holding company and any companies which are controlled by such parent holding company are affiliates of the bank. Generally, Sections 23A and 23B of the Federal Reserve Act (i) limit the extent to which the bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10.0% of such institution’s capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20.0% of such institution’s capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other similar transactions. In addition, loans or other extensions of credit by the financial institution to the affiliate are
required to be collateralized in accordance with the requirements set forth in Section 23A of the Federal Reserve Act.
The Gramm-Leach-Bliley Act amended several provisions of section 23A and 23B of the Federal Reserve Act. The amendments provide that so-called “financial subsidiaries” of banks are treated as affiliates for purposes of sections 23A and 23B of the Federal Reserve Act, but the amendment provides that (i) the 10.0% capital limit on transactions between the bank and such financial subsidiary as an affiliate is not applicable, and (ii) the investment by the bank in the financial subsidiary does not include retained earnings in the financial subsidiary. Certain anti-evasion provisions have been included that relate to the relationship between any financial subsidiary of a bank and sister companies of the bank: (1) any purchase of, or investment in, the securities of a financial subsidiary by any affiliate of the parent bank is considered a purchase or investment by the bank; or (2) if the Federal Reserve Board determines that such treatment is necessary, any loan made by an affiliate of the parent bank to the financial subsidiary is to be considered a loan made by the parent bank.
Effective April 1, 2003, the Federal Reserve Board adopted Regulation W that deals with the provisions of Sections 23A and 23B. The regulation unifies and updates staff interpretations issued over the years, incorporates several new interpretations and provisions (such as to clarify when transactions with an unrelated third party will be attributed to an affiliate), and addresses new issues arising as a result of the expanded scope of non-banking activities engaged in by banks and bank holding companies in recent years and authorized for financial holding companies under the Gramm-Leach-Bliley Act.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h) of the Federal Reserve Act, loans to a director, an executive officer and to a greater than 10.0% stockholder of a financial institution, and certain affiliated interests of these, may not exceed, together with all other outstanding loans to such person and affiliated interests, the financial institution’s loans to one borrower limit, generally equal to 15.0% of the institution’s unimpaired capital and surplus. Section 22(h) of the Federal Reserve Act also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a financial institution to insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore, Section 22(g) of the Federal Reserve Act places additional restrictions on loans to executive officers.
Enforcement. The FDIC has extensive enforcement authority over insured savings state banks, including Benjamin Franklin Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices. The FDIC has authority under Federal law to appoint a conservator or receiver for an insured bank under limited circumstances. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state non-member bank if that bank was “critically undercapitalized” on average during the calendar quarter beginning 270 days after the date on which the institution became “critically undercapitalized.” The FDIC may also appoint itself as conservator or receiver for an insured state non-member institution under specific circumstances on the basis of the institution’s financial condition or upon the occurrence of other events, including: (1) insolvency; (2) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (3) existence of an unsafe or unsound condition to transact business; and (4) insufficient capital, or the incurring of losses that will deplete substantially all of the institution’s capital with no reasonable prospect of replenishment without federal assistance.
Insurance of Deposit Accounts. The FDIC has adopted a risk-based insurance assessment system. The FDIC assigns an institution to one of three capital categories based on the institution’s financial condition consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal
regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds. An institution’s assessment rate depends on the capital category and supervisory category to which it is assigned. Assessment rates for insurance fund deposits currently range from 0 basis points for the strongest institution to 27 basis points for the weakest. Bank Insurance Fund members are also required to assist in the repayment of bonds issued by the Financing Corporation in the late 1980’s to recapitalize the Federal Savings and Loan Insurance Corporation. For 2005 and 2004, Benjamin Franklin Bank’s total FDIC assessment was $64,329 and $58,298, respectively. The FDIC is authorized to raise the assessment rates. The FDIC has exercised this authority several times in the past and may raise insurance premiums in the future. If such action is taken by the FDIC, it could have an adverse effect on the earnings of Benjamin Franklin Bank.
The FDIC may terminate insurance of deposits if it finds that the institution is in an unsafe or unsound condition to continue operations, has engaged in unsafe or unsound practices, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The management of Benjamin Franklin Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Federal Reserve System.
The Federal Reserve Board regulations require depository institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for that portion of transaction accounts between $7.8 million and $48.3 million (which may be adjusted by the Federal Reserve Board) the reserve requirement is 3.0%; and for amounts greater than $48.3 million, 10.0% (which may be adjusted by the Federal Reserve Board between 8.0% and 14.0%), against that portion of total transaction accounts in excess of $48.3 million. The first $7.8 million of otherwise reservable balances (which may be adjusted by the Federal Reserve Board) are exempted from the reserve requirements. Benjamin Franklin Bank is in compliance with these requirements.
Federal Home Loan Bank System.
Benjamin Franklin Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Members of the Federal Home Loan Bank are required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. Benjamin Franklin Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2005 of $7.5 million. At December 31, 2005, Benjamin Franklin Bank had $129.0 million in Federal Home Loan Bank advances.
The Federal Home Loan Banks are required to provide funds for certain purposes including the resolution of insolvent thrifts in the late 1980s and to contributing funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, a member bank affected by such reduction or increase would likely experience a reduction in its net interest income. Recent legislation has changed the structure of the Federal Home Loan Banks’ funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. For 2005 and 2004, cash dividends from the Federal Home Loan Bank to Benjamin Franklin Bank amounted to approximately $274,074 and $110,090, respectively. There can be no assurance that such dividends will continue in the future. Further, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks also will not cause a decrease in the value of the Federal Home Loan Bank stock held by Benjamin Franklin Bank.
Holding Company Regulation.
General. As a bank holding company, Benjamin Franklin Bancorp is subject to comprehensive regulation and regular examinations by the Federal Reserve Board. The Federal Reserve Board also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
As a bank holding company, Benjamin Franklin Bancorp must obtain the approval of the Federal Reserve Board before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5.0% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. In addition, Benjamin Franklin Bancorp must obtain the approval of the Massachusetts Board of Bank Incorporation before becoming a “bank holding company” for Massachusetts law purposes. Under Massachusetts law, a bank holding company is generally defined as a company that directly or indirectly owns, controls or holds with power to vote 25.0% of the voting stock of each of two or more banking institutions.
Under Federal Reserve Board policy, a bank holding company must serve as a source of strength for its subsidiary bank. Under this policy, the Federal Reserve Board may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank.
The Banking Holding Company Act also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5.0% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve Board regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the Federal Reserve Board includes, among other things: (i) operating a savings institution, mortgage company, finance company, credit card company or factoring company; (ii) performing certain data processing operations; (iii) providing certain investment and financial advice; (iv) underwriting and acting as an insurance agent for certain types of credit-related insurance; (v) leasing property on a full-payout, non-operating basis; (vi) selling money orders, travelers’ checks and United States Savings Bonds; (vii) real estate and personal property appraising; (viii) providing tax planning and preparation services; (ix) financing and investing in certain community development activities; and (x) subject to certain limitations, providing securities brokerage services for customers. Benjamin Franklin Bancorp has no present plans to engage in any of these activities.
Dividends. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve Board, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”
Bank holding companies are required to give the Federal Reserve Board 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 10.0% or more of the consolidated net worth of the bank holding
company. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve Board order or any condition imposed by, or written agreement with, the Federal Reserve Board. This notification requirement does not apply to any company that meets the well-capitalized standard for commercial banks, is “well managed” within the meaning of the Federal Reserve Board regulations and is not subject to any unresolved supervisory issues.
Financial Modernization. The Gramm-Leach-Bliley Act permits greater affiliation among banks, securities firms, insurance companies, and other companies under a type of financial services company known as a “financial holding company.” A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The act also permits the Federal Reserve Board and the Treasury Department to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a “satisfactory” Community Reinvestment Act rating. A financial holding company must provide notice to the Federal Reserve Board within 30 days after commencing activities previously determined by statute or by the Federal Reserve Board and Department of the Treasury to be permissible. Benjamin Franklin Bancorp has not submitted notice to the Federal Reserve Board of its intent to be deemed a financial holding company. However, it is not precluded from submitting a notice in the future should it wish to engage in activities only permitted to financial holding companies.
Miscellaneous Regulation.
Community Reinvestment Act. Under the Community Reinvestment Act (CRA), as amended as implemented by FDIC regulations, a bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA does require the FDIC, in connection with its examination of a bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications to acquire branches and other financial institutions. The CRA requires the FDIC to provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. Benjamin Franklin Bank’s latest FDIC CRA rating was “satisfactory.”
Massachusetts has its own statutory counterpart to the CRA which is also applicable to Benjamin Franklin Bank and Chart Bank. The Massachusetts version is generally similar to the CRA but utilizes a five-tiered descriptive rating system. Massachusetts law requires the Massachusetts Commissioner of Banks to consider, but not be limited to, a bank’s record of performance under Massachusetts law in considering any application by the bank to establish a branch or other deposit-taking facility, to relocate an office or to merge or consolidate with or acquire the assets and assume the liabilities of any other banking institution. Benjamin Franklin Bank’s most recent rating under Massachusetts law was “high satisfactory.”
Consumer Protection And Fair Lending Regulations. Massachusetts savings banks are subject to a variety of federal and Massachusetts statutes and regulations that are intended to protect consumers and prohibit discrimination in the granting of credit. These statutes and regulations provide for a range of sanctions for non-compliance with their terms, including imposition of administrative fines and remedial orders, and referral to the Attorney General for prosecution of a civil action for actual and punitive damages and injunctive relief. Certain of these statutes authorize private individual and class action lawsuits and the award of actual, statutory and punitive damages and attorneys’ fees for certain types of violations.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), a federal law that has imposed significant additional requirements and restrictions on publicly-held companies, is intended to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
The provisions of Sarbanes-Oxley include requirements governing the independence, composition and responsibilities of audit committees, financial disclosures and reporting and restrictions on personal loans to directors and officers. Sarbanes-Oxley, among other things, requires that the chief executive and chief financial officer certify as to the accuracy of periodic reports filed by the Company with the Securities and Exchange Commission, subject to civil and criminal penalties if they knowingly or willingly violate this certification requirement. For accelerated filers and large accelerated filers, Section 404 of Sarbanes-Oxley also requires the inclusion of an internal control report and assessment by management in the annual report to stockholders, and requires a company’s independent registered public accounting firm that issues the audit report to attest to and report on management’s assessment of the company’s internal controls. The Company expects that, as a result of becoming an accelerated filer in 2006, it will be required to comply with the requirements of Section 404 of Sarbanes-Oxley for the year ended December 31, 2006.
Forward-Looking Statements
This Annual Report contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include:
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statements of our goals, intentions and expectations;
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statements regarding our business plans and prospects and growth and operating strategies;
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statements regarding the asset quality of our loan and investment portfolios; and
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estimates of our risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events:
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our ability to enter new markets successfully and take advantage of growth opportunities;
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significantly increased competition among depository and other financial institutions;
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inflation, changes in the interest rate environment (including changes in the shape of the yield curve) that reduce our margins or reduce the fair value of financial instruments;
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general economic conditions, either nationally or in our market areas, that are worse than expected;
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adverse changes in the securities markets;
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legislative or regulatory changes that adversely affect our business;
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changes in consumer spending, borrowing and savings habits;
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changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board;
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changes in our organization, compensation and benefit plans; and
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the risk factors described above.
Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. We discuss these and other uncertainties in “Risk Factors.” We disclaim any intent or obligation to update forward-looking statements whether in response to new information, future events or otherwise.
Item 1.A.
Risk Factors That May Affect Future Results
The following risk factors are relevant to our future results and financial success, and you should read them with care:
Our Commercial Real Estate, Construction And Commercial Business Loans May Expose Us To Increased Credit Risks, And This Risk Will Increase If We Succeed In Increasing These Types Of Loans.
Residential real estate loans represent a smaller proportion of our loan portfolio than the average for savings institutions in New England. As of December 31, 2005, commercial real estate, construction and commercial business loans represented 47.3% of our loan portfolio. This proportion has increased significantly since December 31, 2004, when that percentage stood at 30.9%. The increase is the result of the acquisition of Chart Bank, which had a higher proportion of commercial loans in its portfolio than did Benjamin Franklin, and of internally-generated growth in commercial credits in 2005. We intend to grow commercial real estate and commercial business loans further as a proportion of our portfolio over the next several years. Construction loans, while they are not likely to increase as a percentage of total loans, are expected to increase in absolute terms in line with the overall growth in the bank’s loan portfolio. In general, construction loans, commercial real estate loans and commercial business loans generate higher returns, but also pose greater credit risks, than do owner-occupied residential mortgage loans. As our various commercial loan portfolios increase, the corresponding risks and potential for losses from these loans may also increase.
The repayment of construction and commercial real estate loans depends on the business and financial condition of borrowers and, in the case of construction loans, on the economic viability of projects financed. A number of our borrowers have more than one construction or commercial real estate loan outstanding with us. Further, these loans are concentrated primarily in Eastern Massachusetts. Economic events and changes in government regulations, which we and our borrowers cannot control, could have an adverse impact on the cash flows generated by properties securing our construction and commercial real estate loans and on the values of the properties securing those loans. Commercial properties tend to decline in value more rapidly than residential owner-occupied properties during economic recessions. We held $269.4 million in construction and commercial real estate loans in our loan portfolio as of December 31, 2005 representing 44.3% of total loans on that date.
We make both secured and some short-term unsecured commercial business loans, holding $19.2 million of these loans in our loan portfolio as of December 31, 2005, representing 3.1% of total loans on that date. Repayment of both secured and unsecured commercial business loans depends substantially on borrowers’ underlying business, financial condition and cash flows. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses. Secured commercial business loans are generally collateralized by equipment, leases, inventory and accounts receivable. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed.
Our Continuing Concentration Of Loans In Our Primary Market Area May Increase Our Risk.
Our success depends primarily on the general economic conditions in the counties in which we conduct business, and in the Boston metropolitan area in general. Unlike larger banks that are more geographically diversified, we provide banking and financial services to customers primarily in Norfolk, Middlesex and Worcester Counties, Massachusetts. The local economic conditions in our market area have a significant impact on our loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would affect these local economic conditions and could adversely affect our financial condition and results of operations. Additionally, because we have a significant amount of commercial real estate loans, decreases in tenant occupancy may also have a
negative effect on the ability of many of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.
Our Return On Equity May Initially Be Low Compared To Other Financial Institutions. A Low Return Could Lower The Trading Price Of Our Common Stock.
Net income divided by average equity, known as “return on equity,” is a ratio many investors use to compare the performance of a financial institution to its peers. Our return on equity may be reduced due to the expenses we will incur in pursuing our growth strategies, the costs of being a public company and added expenses associated with our employee stock ownership plan and planned stock-based incentive plan. The increase in our core deposit intangible asset created by the Chart Bank acquisition will continue to have a negative impact on our return on equity, and if our periodic evaluation of the goodwill created by the Chart Bank acquisition results in a determination of impairment, we would be required to reduce its carrying value through a charge to earnings. Until we can increase our net interest income and non-interest income, we expect our return on equity to be below the industry average for public thrifts, which may negatively affect the value of our common stock.
We May Have Difficulty Meeting Our Branch Expansion Goals, And Our Branch Expansion Strategy May Not Be Accretive To Earnings.
Our growth plans include the opening of new branch offices in communities located between our Norfolk County and Middlesex County branches, as well as in other communities contiguous to those currently served by Benjamin Franklin Bank. Our ability to establish new branches will depend upon whether we can identify suitable sites and negotiate acceptable lease or purchase and sale terms, and we may not be able to do so, or it may take longer than we expect. Moreover, once we establish a new branch, numerous factors will contribute to its performance, such as a suitable location, qualified personnel and an effective marketing strategy. Additionally, it takes time for a new branch to gather significant loans and deposits to generate enough income to offset its expenses, some of which, like salaries and occupancy expense, are relatively fixed costs. There can be no assurance that our branch expansion strategy will be accretive to our earnings, or that it will be accretive to earnings within a reasonable period of time.
Strong Competition Within Our Market Area May Limit Our Growth And Profitability.
We face significant competition both in attracting deposits and in the origination of loans. Savings banks, credit unions, savings and loan associations and commercial banks operating in our primary market area have historically provided most of our competition for deposits. In addition, and particularly in times of high interest rates, we face additional and significant competition for funds from money-market mutual funds and issuers of corporate and government securities. Competition for the origination of real estate and other loans comes from other thrift institutions, commercial banks, insurance companies, finance companies, other institutional lenders and mortgage companies. Many of our competitors have substantially greater financial and other resources than ours. Moreover, we may face increased competition in the origination of loans if competing thrift institutions convert to stock form, because such converting thrifts would likely seek to invest their new capital into loans. Finally, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than savings banks. As a result, credit unions may enjoy a competitive advantage over us. This advantage places significant competitive pressure on the prices of our loans and deposits.
Our Ability to Grow May Be Limited if We Cannot Make Acquisitions.
In an effort to increase our loan and deposit growth, we will continue to seek to expand our banking franchise, including through acquisitions of other financial institutions or branches if opportunities arise. Our ability to grow through selective acquisitions of other financial institutions or branches will depend on successfully identifying, acquiring and integrating them. We compete with other financial institutions with respect to proposed acquisitions. We cannot assure you that we will be able to identify attractive acquisition candidates or make acquisitions on favorable terms. In addition, we cannot assure you that we
can successfully integrate any acquired financial institutions or branches into our banking organization in a timely or efficient manner, that we will be successful in retaining existing customer relationships or that we can achieve anticipated operating efficiencies.
We Operate In A Highly Regulated Environment And May Be Adversely Affected By Changes In Law And Regulations.
We are subject to extensive regulation, supervision and examination. See “Regulation and Supervision.” Any change in the laws or regulations applicable to us, or in banking regulators’ supervisory policies or examination procedures, whether by the Massachusetts Commissioner of Banks, the FDIC, the Federal Reserve Board, other state or federal regulators, the United States Congress or the Massachusetts legislature could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We are subject to regulations promulgated by the Massachusetts Division of Banks, as our chartering authority, and by the FDIC as the insurer of our deposits up to certain limits. We also belong to the Federal Home Loan Bank System and, as a member of such system, we are subject to certain limited regulations promulgated by the Federal Home Loan Bank of Boston. In addition, the Federal Reserve Board regulates and oversees Benjamin Franklin Bancorp, as a Bank holding company.
This regulation and supervision limits the activities in which we may engage. The purpose of regulation and supervision is primarily to protect our depositors and borrowers and, in the case of FDIC regulation, the FDIC’s insurance fund. Regulatory authorities have extensive discretion in the exercise of their supervisory and enforcement powers. They may, among other things, impose restrictions on the operation of a banking institution, the classification of assets by such institution and such institution’s allowance for loan losses. Regulatory and law enforcement authorities also have wide discretion and extensive enforcement powers under various consumer protection and civil rights laws, including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act and Massachusetts’s deceptive acts and practices law. These laws also permit private individual and class action law suits and provide for the recovery of attorneys fees in certain instances. No assurance can be given that the foregoing regulations and supervision will not change so as to affect us adversely.
Changes in Market Interest Rates Could Adversely Affect Our Financial Condition and Results of Operations.
Our profitability, like that of most financial institutions, depends to a large extent upon our net interest income, which is the difference, or spread, between our gross interest income on interest-earning assets, such as loans and securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowed funds. Accordingly, our results of operations and financial condition depend largely on movements in market interest rates and our ability to manage our interest-rate-sensitive assets and liabilities in response to these movements, including our adjustable-rate mortgage loans, which represent the largest portion of our residential loan portfolio. Changes in interest rates could have a material adverse effect on our business, financial condition, results of operations and cash flows. Because, as a general matter, our interest-bearing liabilities re-price or mature more quickly than our interest-earning assets, an increase in interest rates generally would result in a decrease in our interest rate spread and net interest income.
Changes in interest rates also affect the value of our interest-earning assets, including, in particular, the value of our investment securities portfolio. Generally, the value of securities fluctuates inversely with changes in interest rates. At December 31, 2005, our securities portfolio totaled $132.5 million, including $122.4 million of securities available for sale. Unrealized gains and losses on securities available for sale are reported as a separate component of stockholders’ equity, net of related taxes. Decreases in the fair value of securities available for sale therefore would have an adverse affect on our stockholders’ equity. We are also subject to reinvestment risk relating to interest rate movements. Decreases in interest rates can
result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce their borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are not able to reinvest funds from such prepayments at rates that are comparable to the rates on the prepaid loans or securities. On the other hand, increases in interest rates on adjustable-rate mortgage loans result in larger mortgage payments due from borrowers, which could potentially increase our level of loan delinquencies and defaults. Refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information on the Company’s exposure to changes in market interest rates.
Our Stock-Based Benefit Plans Will Increase Our Costs, Which Will Reduce Our Income.
We have adopted an employee stock ownership plan, and our shareholders will be asked to approve a stock-based incentive plan at our annual meeting on May 11, 2006. The allocation to employees of shares under the employee stock ownership plan and the granting of restricted stock awards and stock options under the stock-based incentive plan will increase our future compensation costs, thereby reducing our earnings. Please refer to the introductory section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information about the estimated cost of implementing this plan.
Our Stock Value May Suffer From Anti-Takeover Provisions That May Impede Potential Takeovers.
Our governing statute, and our articles and by-laws, contain provisions (sometimes known as anti-takeover provisions) that may impede efforts to acquire us, or stock purchases in furtherance of an acquisition, even though acquisition efforts or stock purchases might otherwise have a favorable effect on the price of our common stock. Those provisions will also make it more difficult to remove our board and management. The Massachusetts Business Corporation Law provides for staggered directors’ terms, limits the stockholders’ ability to remove directors and empowers only the directors to fill board vacancies. Even if our board elects to opt out of these statutory provisions, our articles contain similar provisions. Our articles and by-laws also provide for, among other things, restrictions on the acquisition of more than 10.0% of our outstanding voting stock for a period of five years after completion of the conversion, and approval of certain actions, including certain business combinations, by specified percentages of our “disinterested Directors” (as defined in the articles) or by specified percentages of the shares outstanding and entitled to vote. The articles also authorize the Board of Directors to issue shares of preferred stock, the rights and preferences of which may be designated by the Board, without the approval of our stockholders. The articles also establish supermajority voting requirements for amendments to the articles and by-laws, limit stockholders’ ability to call special meetings of stockholders, and impose advance notice provisions on stockholders’ ability to nominate directors or to propose matters for consideration at stockholder meetings.
Federal and state regulations and laws may also have anti-takeover effects. The Change in Bank Control Act and the Bank Holding Company Act, together with Federal Reserve Board regulations under those acts, require that a person obtain the consent of the Federal Reserve Board before attempting to acquire control of a bank holding company. In addition, Massachusetts laws place certain limitations on acquisitions of the stock of banking institutions and imposes restrictions on business combination transactions between publicly held Massachusetts corporations and stockholders owning 5% or more of the stock of those corporations.
Item 1.B.
Unresolved Staff Comments
Not applicable.
Item 2.
Item 2.
Properties
Benjamin Franklin Bank conducts its business through its main office located in Franklin, Massachusetts and eight other offices located east and southeast of the Boston metropolitan area. The following table sets forth information about our offices as of December 31, 2005:
Item 3.
Item 3.
Legal Proceedings
Benjamin Franklin Bancorp is not involved in any legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Management believes that those routine legal proceedings involve, in the aggregate, amounts that are immaterial to the financial condition and results of operations of Benjamin Franklin Bancorp.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a)(1) Market Information.
The Company’s common stock began trading on the NASDAQ Stock Exchange under the symbol ‘BFBC’ on April 5, 2005. Before that, the Company was a mutual holding company and had never issued capital stock. The following table sets forth the high and low prices of our common stock and the dividends declared per share for the periods indicated:
(a)(2) Holders.
As of December 31, 2005, there were 8,488,898 shares of common stock outstanding, which were held by approximately 1,440 registered holders and an estimated 2,790 beneficial holders.
(a)(3) Dividends.
The Company began paying quarterly dividends on its common stock in the third quarter of 2005 and currently intends to continue to do so for the foreseeable future. The payment of dividends will depend upon a number of factors, including capital requirements, Benjamin Franklin Bancorp’s and Benjamin Franklin Bank’s financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in the future.
The only funds available for the payment of dividends on the capital stock of Benjamin Franklin Bancorp will be cash and cash equivalents held by Benjamin Franklin Bancorp, dividends paid by Benjamin Franklin Bank to Benjamin Franklin Bancorp and borrowings. Benjamin Franklin Bank will be prohibited from paying cash dividends to Benjamin Franklin Bancorp to the extent that any such payment would reduce Benjamin Franklin Bank’s capital below required capital levels or would impair the liquidation account to be established for the benefit of Benjamin Franklin Bank’s eligible account holders and supplemental eligible account holders at the time of the conversion.
FDIC regulations limit Benjamin Franklin Bank’s ability to pay dividends to Benjamin Franklin Bancorp under certain circumstances. For example, Benjamin Franklin Bank could not pay dividends if it was not in compliance with applicable regulatory capital requirements. In addition, Massachusetts law provides that dividends may not be declared, credited or paid by Benjamin Franklin Bank so long as there is any impairment of capital stock. No dividend may be declared on Benjamin Franklin Bank’s common stock for any period other than for which dividends are declared upon preferred stock, except as authorized by the Massachusetts Commissioner of Banks. The approval of the Commissioner is also required for Benjamin Franklin Bank to declare a dividend, if the total of all dividends declared by it in any calendar year shall exceed the total of its net profits for that year combined with its retained net profits of the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock.
(a)(4) Securities Authorized for Issuance under Equity Compensation Plans.
Not applicable.
(b) Not applicable.
(c) Repurchases of Equity Securities.
The Company’s employee stock ownership plan, an affiliated purchaser, purchased the following shares of the Company’s common stock during the fourth quarter of 2005:
(1)
In a press release issued on March 31, 2005 and in a Current Report on Form 8-K filed on April 1, 2005, the Company announced that its employee stock ownership plan (the “ESOP”) intended to purchase in the public offering after market up to 478,194 shares of the Company’s common stock, or 8% of the shares sold in the offering and issued to the Benjamin Franklin Bank Charitable Foundation. In the second and third quarters of 2005, the ESOP purchased 432,700 shares, resulting in a total of 478,194 shares purchased through December 31, 2005, the maximum provided for in the ESOP.
Item 6.
Item 6.
Selected Financial Data
The following tables contain certain information concerning the consolidated financial position and results of operations of Benjamin Franklin Bancorp at the dates and for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements of Benjamin Franklin Bancorp, Inc. and Subsidiaries and notes thereto appearing in Item 8 of this Annual Report and Management’s Discussion and Analysis appearing in Item 7
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section is intended to help readers understand the financial performance of Benjamin Franklin Bancorp and Benjamin Franklin Bank through a discussion of the factors affecting our financial condition at December 31, 2005, 2004 and 2003 and our consolidated results of operations for the years ended December 31, 2005, 2004 and 2003. This section should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements that appear in Item 8 of this Annual Report. In this section, we sometimes refer to Benjamin Franklin Bank and Benjamin Franklin Bancorp together as “Benjamin Franklin” since the financial condition and results of operation of Benjamin Franklin Bancorp closely reflect the financial condition and results of operation of its sole operating subsidiary, Benjamin Franklin Bank.
The discussion beginning in the “Overview” section below reviews the Company’s performance for the 2005 and 2004 years. In 2006, there are several factors that may serve to reduce the Company’s earnings below current levels:
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The Company is committed to opening new branches, most likely in the markets contiguous to its existing branch communities. One such location has already been identified in Wellesley Hills, Massachusetts, where the Company expects to open a branch in mid-2006. Management estimates the annual direct costs of operating this branch at $610,000. This branch opening, and any others that occur, are likely reduce the Company’s earnings until such time as they attain profitability.
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The Company experienced net interest margin (“NIM”) compression in the fourth quarter of 2005, due to the effect of increased price competition for certificate accounts and the continued flattening of the Treasury yield curve, which had the effect of reducing the spread between the Company’s earning assets and its core deposit accounts. Management expects that the Company’s NIM will contract further in 2006 as a result of the relatively flat yield curve and continued competitive pressure on both certificate and money market account interest rates. Interest rates on money market accounts in particular have tended to lag the rise in market interest rates over the past year, and management considers it likely that those rates will rise significantly in the coming months.
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The Board of Directors has adopted the Benjamin Franklin Bancorp, Inc. Stock Incentive Plan (the “Plan”), subject to approval by the stockholders. The Company anticipates that compensation expense will increase as a result of this Plan, as follows:
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the stock-based incentive plan would award 239,096 shares of restricted stock to eligible participants, which would be expensed as the awards vest. Assuming that all shares of restricted stock under the stock-based incentive plan are awarded at a price of $14.07 per share (the Company’s market price per share at of the close of business on December 31, 2005), and that the awards vest over a five year period, the corresponding annual expense (pre-tax) associated with shares awarded under the stock-based incentive plan would be approximately $673,000. The actual expense of the restricted stock awards granted under the stock-based incentive plan will be determined by the fair market value of the stock on the grant date, which might be different than $14.07 per share;
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the stock-based incentive plan would grant options to acquire common stock equal to 597,741 shares to eligible participants, which would be expensed as the awards vest. Using the Black-Scholes option pricing model, assuming that all option grants are made at a grant-date share price and option exercise price of $14.07 and that options vest over a 5 year period, the options would be valued at $2,365,000 and the corresponding annual expense (pre-tax) associated with options granted under the stock-based incentive plan would be approximately $473,000. The actual expense of the options granted will be determined by the results of the Black-Scholes option pricing model at the date of grant for the actual period under measurement. The assumptions and factors considered in this pricing model will include the grant-date share price and option exercise price, the dividend yield, if any, the expected option life, the option vesting period, the risk-free interest rate, and the volatility rate for the stock, all of which may differ from the information used herein to estimate the effect of stock option grants on future earnings.
Overview
Income. Benjamin Franklin Bancorp’s results of operations are dependent mainly on net interest income, which is the difference between the income earned on its loan and investment portfolios and interest expense incurred on its deposits and borrowed funds. Results of operations are also affected by fee income from banking and non-banking operations, provisions for loan losses, gains (losses) on sales of loans and securities available for sale, loan servicing income and other miscellaneous income.
Expenses. Benjamin Franklin’s expenses consist primarily of compensation and employee benefits, office occupancy, technology, marketing, general administrative expenses and income tax expense.
Results of operations are also significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact Benjamin Franklin’s financial condition and results of operations.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assessments by management, and which could potentially result in materially different results under different assumptions and conditions. Benjamin Franklin considers the following to be critical accounting policies:
Allowance for Loan Losses. This accounting policy is considered critical due to the high degree of judgment involved, the subjectivity of the underlying assumptions used, and the potential for changes in the economic environment that could result in material changes in the amount of the allowance for loan losses considered necessary. The allowance is evaluated on a regular basis by management and is based on a periodic review of the collectibility of the loans in light of historical experience, the nature and size of the loan portfolio, adverse situations that may affect borrowers’ ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. For a full discussion of the allowance for loan losses, please refer to “Business - Asset Quality” in Item 1.
Income Taxes. Benjamin Franklin uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance related to deferred tax assets is established 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. Deferred tax assets applicable to capital loss carryforwards that expire in 2006 are recoverable only to the extent that capital gains can be realized during the carryforward period. Accordingly, given Benjamin Franklin’s limited opportunity to realize capital gains through the sale of capital assets within the required timeframe, management has provided a valuation allowance of $2.7 million against 100% of the deferred tax assets related to capital loss carryforwards at December 31, 2005. This valuation allowance is assessed periodically for recoverability. The judgments applied by management consider the likelihood that capital gain income will be realized within the carryforward period in light of Benjamin Franklin’s tax planning strategies and changes in market conditions.
Intangible Assets. Benjamin Franklin considers accounting for goodwill to be critical because significant judgment is exercised in performing periodic valuations of this asset, which arose through the acquisitions of Chart Bank and Foxboro National Bank. Goodwill is evaluated for potential impairment on an annual basis as of each December 31st, or more frequently if events or circumstances indicate a potential for impairment. At the time of each acquisition, the operations of Chart Bank and Foxboro National Bank were combined with the operations of Benjamin Franklin based on similar economic characteristics. Accordingly, discrete financial information is not separately maintained to evaluate the operating results of the former Chart Bank and Foxboro National Bank and, as a result, in performing a goodwill impairment evaluation, Benjamin Franklin measures the fair value of the entire company, rather than that of each of the acquired banks. If impairment is detected, the carrying value of goodwill is reduced through a charge to earnings. The evaluation of goodwill involves estimations of discount rates and the timing of projected future cash flows, which are subject to change with changes in economic conditions and other factors. Such changes in the assumptions used to evaluate this intangible asset affect its value and could have a material adverse impact on Benjamin Franklin’s results of operations.
This discussion has highlighted those accounting policies that management considers to be critical, however all accounting policies are important, and therefore the reader is encouraged to review each of the policies included in Note 1 to the Consolidated Financial Statements to gain a better understanding of how Benjamin Franklin’s financial performance is measured and reported.
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 rates earned or paid on them.
The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. Most average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
(1)
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.
(2)
Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(3)
Net interest margin represents net interest income divided by average total interest-earning assets.
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of Benjamin Franklin’s interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Comparison of Financial Condition At December 31, 2005 and December 31, 2004
Total Assets. Total assets increased by $349.7 million, or 67.6%, from $517.4 million at December 31, 2004 to $867.1 million at December 31, 2005. This increase was primarily the result of the Chart Bank acquisition ($290.4 million), supplemented by internal growth ($59.3 million).
The Chart Bank acquisition added $290.4 million to total assets on April 4, 2005, consisting primarily of loans ($184.0 million), investments and short-term investments ($39.3 million), and goodwill and other intangibles ($35.0 million). Internal asset growth of $59.3 million was concentrated in loans and cash and cash equivalents, totaling $37.7 and $20.1 million, respectively.
Cash and Short-term Investments. Cash and correspondent bank balances increased by $51.5 million to $65.8 million as of December 31, 2005 when compared to December 31, 2004. Of that increase, $37.2 million consists of cash supplied to ATM customers of Creative Strategic Solutions, Inc. (“CSSI”). CSSI is a wholly owned subsidiary of Benjamin Franklin Bank that supplies cash to ATMs owned by
independent service organizations and provides related cash management services to a nationwide customer base. Over the yearly period, short-term investments, comprised of overnight fed funds sold ($10.8 million) and money market funds ($1.3 million), increased $6.5 million to $12.1 million at December 31, 2005. The higher level of short-term investments at period-end was precipitated by normal fluctuations in the Bank’s short-term liquidity accounts.
Securities. The investment portfolio totaled $132.5 million at December 31, 2005, an increase of 42.1%, or $39.3 million, from $93.3 million at December 31, 2004. $36.1 million of this increase represented the acquisition of the Chart Bank securities portfolio, which consisted primarily of Government-sponsored enterprise obligations. During the year 2005, Government-sponsored enterprise obligations increased by $52.2 million, while mortgage-backed securities decreased $15.6 million. Management chose to reinvest principal pay-downs on its mortgage-backed securities into other investments, primarily Government-sponsored enterprise obligations, and into loans.
Net Loans. Net loans as of December 31, 2005 were $605.1 million, an increase of $221.8 million, or 57.8%, over net loan balances of $383.4 million as of December 31, 2004. Net loans represented 69.8% of total assets at December 31, 2005. While the Chart Bank acquisition accounted for $184.0 million of the year’s growth, another $37.8 million of net growth was generated internally, primarily in commercial real estate loans. The Company is committed to expanding its commercial lending business, and increased the size of its commercial lending staff to twelve persons by year-end 2005, compared to four at year-end 2004. Investments were also made in expanding commercial credit analysis, processing, review and monitoring resources to support this growth effort. Year-over-year increases in commercial loan categories include commercial real estate ($123.1 million), construction ($31.7 million), and commercial business ($14.8 million), resulting in commercial loans comprising 47.3% of total loans, compared to 30.8% at December 31, 2004. In addition to the commercial loan growth, the residential mortgage and home equity loan portfolios increased by $45.1 and $9.2 million, respectively.
Deposits. Deposits increased by $215.2 million to $611.7 million at December 31, 2005, an increase of 54.3% over a total of $396.5 million at December 31, 2004. The $215.2 million increase in the Bank’s deposits is attributable to an increase of $217.4 million in deposits as a result of the Chart Bank acquisition, offset by a $2.2 million decline since December 31, 2004. While all deposit categories increased year-over-year, the largest increases were in certificates of deposit ($125.6 million), money market accounts ($41.2 million) and demand accounts ($36.6 million).
The Company experienced a shift in deposit mix during the year 2005, as deposit customers displayed a marked preference toward certificates of deposits as compared to other interest-bearing deposit products, such as savings, NOW, or money market accounts. Excluding $93.8 million absorbed in the Chart Bank acquisition, certificate balances increased by $31.8 million over the twelve-month period ending December 31, 2005. Conversely, savings and money market categories had net outflows of $13.7 and $20.1 million, respectively, exclusive of the acquired balances. The Company’s recent experience has shown that, as short-term interest rates have risen gradually over the past two years, customers have been more aggressive in seeking competitive market yields for their deposit dollars.
Borrowed Funds. Borrowed funds of $140.3 million at December 31, 2005 primarily include Federal Home Loan Bank of Boston (“FHLBB”) borrowings of $128.9 million and $9.0 million in subordinated debt. FHLBB borrowings increased during 2005 by $56.9 million, including $25.4 million provided in the Chart Bank acquisition. Of the borrowed funds acquired from Chart, $20.5 million matured during the second and third quarters of 2005. Those borrowings and the remainder of the net increase, or $36.4 million, were replaced by new FHLBB borrowings with original maturities of three to five years. The $9.0 million balance in subordinated debt was unchanged during 2005.
Stockholders’ Equity. Total stockholders’ equity was $108.1 million as of December 31, 2005, an increase of $76.8 million compared to $31.3 million at December 31, 2004. The increase was primarily attributable to the Company’s mutual-to-stock conversion and issuance of shares in connection with the acquisition of Chart Bank. The components of the net increase were: a) the recording of common stock and additional paid-in capital in the initial public offering in the amount of $53.7 million, net of offering
expenses of $2.1 million, b) shares issued to the Benjamin Franklin Bank Charitable Foundation in the amount of $4.0 million, c) shares issued to Chart Bank shareholders in the amount of $25.1 million, d) net income of $431,000, net of e) a decrease due to dividends paid to shareholders in the amount of $486,000, f) a reduction of $657,000 in other comprehensive income resulting from a decrease in the fair market value of investments available for sale, and g) a decrease of $5.4 million, representing the valuation of common shares purchased and held by the employee stock ownership plan.
Comparison of Operating Results For The Year Ended December 31, 2005 and December 31, 2004
Net Income. Net income for the year ended December 31, 2005 was $431,000, $1.3 million lower than the $1.7 million in net income for the year 2004. The reduction in net income was primarily a result of two non-recurring charges incurred in the second quarter of 2005: 1) a $2.4 million after-tax contribution made to the Benjamin Franklin Bank Charitable Foundation, and 2) the recognition of a net after-tax loss of $1.0 million on the sale/write-down of bank-owned land. Significant increases in net interest income and non-interest income, due to the acquisition of the operations of Chart Bank and to internally generated balance sheet growth, partially offset the non-recurring charges. Operating expenses also increased significantly year-over-year due to the addition of Chart Bank’s operations, as well as to higher costs related to generating internal growth and meeting the demands of operating as a public company.
Net Interest Income. Net interest income increased $8.3 million to $22.0 million for the year ended December 31, 2005, up 60.0% from $13.8 million for the year ended December 31, 2004. The 60% increase was the result of an increase in average interest-earning assets of $227.6 million, greater than the increase in average interest-bearing liabilities of $192.8 million, and to a 21 basis point increase in the net interest margin. The funds received in the Company’s public stock offering and an increase in non-interest bearing deposit accounts were the primary reasons that average interest-earning assets grew by more than average interest-bearing liabilities in 2005, when compared to 2004.
The increase in average interest-earning assets was due primarily to the Chart Bank acquisition, as $220.2 million of interest-earning assets were acquired on April 4, 2005, including $184.0 million in net loans. Internally generated growth in loans outstanding, exclusive of the addition of the Chart Bank loan portfolio, represented the remaining increase in average interest-earning assets. As a whole, average loan balances increased $209.3 million year-over-year. The yield on average interest-earning assets increased by 60 basis points year-over-year, due to an increase in market interest rates overall and the favorable mix of the assets acquired from Chart Bank.
Funding liabilities also increased due to the Chart Bank acquisition on April 4, 2005, including $217.4 million in deposits and $25.4 million of borrowed funds. Including the acquisition, interest-bearing deposits grew $143.0 million on average, while the average balances of outstanding borrowings increased by $49.8 million. Rates paid on interest-bearing liabilities increased by 44 basis points, as a 47 basis point increase in deposit costs was partially offset by a reduction in the weighted average rate paid on borrowed funds.
Interest Income. Interest income for the year ended December 31, 2005 was $35.1 million, an increase of $14.3 million or 69.0% compared to $20.8 million earned in the prior year. Most of the increase was the result of the $227.6 million increase in average interest earning assets, augmented by a sizable 60 basis point increase in the yield earned on average interest-earning assets. The increase in average interest-earning assets was primarily the result of the acquisition of Chart Bank and the Company’s public stock offering. The largest increase occurred in average loan balances ($209.3 million) due to the acquisition of the $184.0 million Chart Bank loan portfolio and internally generated growth. By itself, the $209.3 million increase in average loan balances year-over-year resulted in $11.5 million in growth of interest income. Increases in average balances of securities and short-term investments of $12.9 million and $5.3 million, respectively, were also related to both the acquisition of Chart Bank and the stock offering. The increases in yields earned on securities and short-term investments of 40 basis points and 171 basis points, respectively, were due mainly to the increase in market interest rates during the last two
years. The increase in the loan yield of 44 basis points was due to the increase in market interest rates, the addition of the Chart Bank loan portfolio, which was more heavily weighted toward higher-yielding commercial loans than that of Benjamin Franklin, and to internally-generated growth in higher-yielding commercial loans.
Interest Expense. Interest expense for the year ended December 31, 2005 increased by $6.1 million, or 86.5%, to $13.1 million as compared to $7.0 million for the year ended December 31, 2004. Much of the increase was the result of the $192.8 million increase in average interest-bearing liabilities, in addition to a 44 basis point increase in their rate paid.
The $192.8 million increase in average interest-bearing liabilities was caused primarily by the Chart Bank acquisition, which added $242.8 million to the Company’s funding liabilities (including non-interest bearing demand deposits) on April 4, 2005. Overall, average interest-bearing deposits increased $143.0 million year-over-year, while borrowed funds increased by $49.8 million.
A 47 basis point increase in the average rate paid on interest-bearing deposits during the year 2005 was due in part to the increase in market interest rates, the composition of the Chart Bank deposit base, which had a greater proportion of higher-cost certificate balances than did that of Benjamin Franklin, and a trend, particularly late in the year, toward CD demand as compared to other types of deposits. With gradually rising market interest rates, the Company and other financial institutions in its market area responded to customer demand by increasing their rates paid on CD accounts. Within the Company’s deposit portfolio, the average balance of CDs increased by $88.5 million year-over-year, while the other interest-bearing deposit categories combined increased $54.5 million. Outside of CDs and money market accounts, the Company was generally able to restrain from raising its deposit rates in 2005. The cost of borrowed funds dropped by 22 basis points year-over-year, as borrowings acquired from Chart Bank were at lesser rates than that of Benjamin Franklin.
Provision for Loan Losses. The Company records a provision for loan losses as a charge to its earnings when necessary in order to maintain the allowance for loan losses at a level sufficient to absorb potential losses inherent in the loan portfolio. Refer to “Business - Asset Quality” for additional information about the Company’s methodology for establishing its allowance for loan losses. Loan loss provisions were $686,000 and $620,000 during the years ended December 31, 2005 and 2004, respectively. Provisions in both years were primarily reflective of growth in the loan portfolio, as net charge-offs/ recoveries in both years were nominal. At December 31, 2005, the allowance for loan losses totaled $5.7 million, or 0.93% of the loan portfolio, compared to $3.2 million, or 0.82%, of total loans at December 31, 2004. The increase in the allowance for loan losses as a percentage of the loan portfolio was primarily due to an increase in the proportion of commercial loans in the portfolio.
Non-interest Income. Non-interest income for the year ended December 31, 2005 rose to $3.5 million, an increase of $1.4 million, or 64.2%, when compared to $2.1 million earned during the year ended December 31, 2004. This increase was produced primarily by growth in fee-based deposit accounts and the acquisition of Chart Bank. Non-interest income was also adversely impacted by a $1.0 million net loss on the sale/write-down of bank-owned land in June 2005.
During the second quarter of 2005, two parcels of land that had been held as future branch sites were sold for an aggregate gain of $380,000. A third parcel that had been held as a future branch site was written down by $1.4 million to its estimated net fair market value, once the decision was made by the Company to market the parcel for sale. The Company’s determination to sell the property followed a decision by the town planning board to reject the Company’s proposed plans for combined retail-banking development of the parcel, after the Company had reworked the plans to deal with the concerns previously raised by the planning board. Although the Company’s Executive Committee considered whether to again revise and resubmit development plans that would be acceptable both to the Company and the planning board, the Committee decided that under the circumstances it would not continue to pursue its combined retail-banking development plans. This decision was consistent with the Company’s emerging strategy of opting in favor of leasing rather than owning future branch locations. The Company’s current strategy
contemplates the opening of new branches over the next few years, and in all likelihood future branch locations will be leased rather than owned.
Exclusive of the land transactions, non-interest income increased by $2.4 million, or 112.2%, during the year 2005. The Chart Bank acquisition provided a new non-interest income source, fees earned on ATM servicing performed by CSSI, which yielded $1.6 million in revenues. CSSI provides cash to ATMs owned by independent service organizations nationwide. Fees are collected from the independent service organizations for managing the ATMs and for the use of the cash in the machines. Other significant revenue increases year-over-year included deposit service fees ($351,000), loan servicing fees ($188,000) and miscellaneous income ($117,000). Growth in fees earned on deposit accounts and miscellaneous income was mainly the result of the addition of the Chart Bank deposit accounts and branch locations, plus the addition of a new overdraft checking account offering to the Bank’s product line. Increases in loan servicing fees were a combination of higher fees collected on commercial loan transactions (primarily prepayment penalties and late charges) and a reduction in the amortization of mortgage servicing rights.
Non-interest Expense. Non-interest expense for the year ended December 31, 2005 was $23.3 million, an increase of $10.6 million, or 83.4%, when compared to $12.7 million incurred during the year ended December 31, 2004. Non-interest expenses increased significantly year-over-year due primarily to the acquisition of Chart Bank, expansion of the Company’s lending capabilities and the stock conversion, which has brought new costs associated with operating a public company. Also contributing to the rise was a $4.0 million contribution made to the Benjamin Franklin Bank Charitable Foundation in April of 2005. The contribution to the Foundation was one-time in nature, as the Company has no intention of making future contributions to the Foundation. Excluding the contribution, the increase in non-interest expenses would have been $6.6 million, or 51.9%.
The largest year-over-year increase in non-interest expense was in salaries and employee benefits expenses, which increased $2.4 million, or 32.0%, to $9.9 million for the year ended December 31, 2005. The increase was primarily attributable to the acquisition of Chart Bank and to a lesser degree to the addition of loan origination and support staff in 2005. Occupancy and equipment expenses increased $964,000, or 68.4%, to $2.4 million for the year ended December 31, 2005. This increase was mainly due to the addition of costs associated with Chart Bank’s three branch locations and its former corporate headquarters. The rental expense associated with the lease of the headquarters location ceased at the end of July 2005. Increases in data processing costs ($381,000 or 28.2%) and other general and administrative expenses ($2.2 million or 106.7%) were both due primarily to the effect of adding Chart Bank operations. Other general and administrative expenses for the year ended December 31, 2005 included non-cash charges of $1.4 million for the amortization of core deposit intangible assets, $1.2 million higher than the comparable period in 2004. This increase was entirely associated with the 2005 Chart Bank acquisition. Other large year-over-year increases in other general and administrative expenses included marketing and advertising, insurance premiums, postage and supplies, and directors’ fees. The increase in marketing costs was primarily due to branding efforts in the Chart Bank market area subsequent to the acquisition. Directors’ fees increased with the addition of six new Board members from Chart Bank, as a result of increases to the Board fee structure due to the increased responsibilities of being a director of a public company, and due to the implementation of a retirement plan for directors. Professional fees increased $648,000, or 173.7%, to $1.0 million for the year ended December 31, 2005. This increase was due primarily to increased legal, consulting, audit and investor relations fees, such increases consistent with the Company’s new status as a public company.
Income Taxes. Income tax expense was $1.1 million for the year ended December 31, 2005, an increase of $220,000, or 24.7%, from the $892,000 recorded for the year ended December 31, 2004. The effective tax rates for the 2005 and 2004 years were 72.1% and 34.6%, respectively. The significant increase in the effective tax rate in the year 2005 was primarily a function of the bank-owned land transactions. No tax benefit was recognized on the $1.0 million net loss on sale/write-down of bank-owned land.
Comparison of Financial Condition At December 31, 2004 and December 31, 2003
Total Assets. Total assets increased by $58.5 million, or 12.8%, from $458.8 million at December 31, 2003 to $517.4 million at December 31, 2004. This increase was largely the result of an increase in the loan portfolio, offset by reductions in cash, short-term investments and securities.
Cash and Short-term Investments. Cash and correspondent bank balances decreased by $6.0 million to $8.7 million as of December 31, 2004 when compared to December 31, 2003. Over the same period, short-term investments, comprised of overnight fed funds sold and money market funds, decreased $15.5 million to $5.5 million at December 31, 2004. These reductions in short-term liquidity served primarily to fund increases in Benjamin Franklin Bank’s loan portfolio.
Securities. The investment portfolio totaled $93.3 million at December 31, 2004, a decrease of $17.0 million, or 15.4%, from $110.3 million at December 31, 2003. This reduction, caused by net pay-downs in mortgage-backed securities totaling $25.4 million, offset by increases in holdings of Government-sponsored enterprise securities and corporate bonds totaling $3.7 million and $5.0 million, respectively, was used to fund growth in Benjamin Franklin Bank’s loan portfolio.
Net Loans. Net loans as of December 31, 2004 were $383.4 million, an increase of $94.5 million, or 32.7%, over net loan balances of $288.9 million as of December 31, 2003. Loan growth occurred in most product categories, including residential mortgage loans ($69.0 million), commercial real estate ($17.3 million), construction ($4.7 million), and consumer ($5.0 million), offset by a decline in commercial business loans ($1.2 million). The significant growth in residential mortgage loans can be attributed to the attractive rates offered on adjustable-rate mortgages and 15-year bi-weekly mortgage loans.
Deposits. Deposits increased by $16.2 million to $396.5 million at December 31, 2004, an increase of 4.3% over balances of $380.3 million at December 31, 2003. The largest increases came in certificates of deposit ($13.9 million), money market accounts ($3.1 million) and demand accounts ($2.0 million), offset by a decline in checking accounts ($2.2 million). The deposit increases overall were the result of Benjamin Franklin Bank’s continued marketing and promotional efforts in its market area, including efforts to remain competitive in all of its deposit product offerings.
Borrowed Funds. Funds borrowed from the Federal Home Loan Bank of Boston increased by $40.3 million to $76.3 million at December 31, 2004, a 111.9% increase over balances of $36.0 million as of December 31, 2003. These additional funds were borrowed in order to fund the continued growth in the Bank’s loan portfolio during the year ended December 31, 2004. The $9.0 million balance in subordinated debt remained unchanged from December 31, 2003 to December 31, 2004.
Retained Earnings. Retained earnings increased by $2.0 million to $31.3 million at December 31, 2004, an increase of 6.9% from a balance of $29.3 million as of December 31, 2003. This change was the result of net income for the year of $1.7 million and a decline of $338,000 in the net unrealized loss on marketable securities.
Comparison of Operating Results For The Year Ended December 31, 2004 and December 31, 2003
Net Income. Net income for the year ended December 31, 2004 was $1,689,000, essentially unchanged when compared to net income of $1,688,000 for 2003. A $983,000 increase in net interest income in 2004 was almost entirely offset by a decline in other income of $842,000 and a $110,000 reduction in net gains incurred on sales of securities.
Net Interest Income. Benjamin Franklin Bancorp earned net interest income of $13.8 million and $12.8 million in the years ended December 31, 2004 and 2003, respectively. The increase between the two periods of $983,000 or 7.7%, was due to a $30.5 million, or 7.1%, increase in average interest-earning assets, and to a lesser degree to a 2 basis point, or 0.7%, increase in the net interest margin. Within earnings assets, higher-yielding loans increased on average by $67.9 million, while lower-yielding securities and short-term investments declined by $37.4 million on average. Within Benjamin Franklin’s funding
liabilities, the mix shifted somewhat in favor of non-interest bearing accounts, which increased by $30.7 million on average. This shift was caused primarily by a change made in Benjamin Franklin Bank’s primary checking account product in September 2003, whereby the payment of interest was eliminated.
Interest Income. Interest income rose $1.3 million, or 6.5%, to $20.8 million for the year ended December 31, 2004 from $19.5 million for the year ended December 31, 2003. The increase was caused primarily by a $30.5 million increase in average interest-earning assets, which had the effect of increasing interest income by $1.2 million. Loans increased on average by $67.9 million, offset by decreases in the average balances of securities ($15.4 million) and short-term investments ($21.9 million). Despite the fact that the average yield on loans declined from 5.74% for the year ended December 31, 2003 to 5.12% for the same period in 2004, the overall yield on interest earning assets remained almost unchanged at 4.56% and 4.53% for 2003 and 2004, respectively, due to the change in the mix of interest earning assets.
Interest Expense. Interest expense for the year ended December 31, 2004 increased by $280,000, or 4.1%, to $7.0 million as compared to interest expense of $6.8 million for the year ended December 31, 2003. The effect of a 10 basis point, or 5.6%, increase in the average rates paid on interest-bearing liabilities was offset in part by an increase in non-interest-bearing liabilities, which grew by an average of $30.7 million in the 2004. The increase in average non-interest-bearing liabilities was primarily due to a change made in Benjamin Franklin Bank’s primary checking account product, which was converted to a non-interest bearing account in September 2003.
Provision for Loan Losses. Benjamin Franklin records a provision for loan losses as a charge to its earnings when necessary in order to maintain the allowance for loan losses at a level sufficient to absorb potential losses inherent in the loan portfolio. Refer to “Business - Asset Quality” for additional information about Benjamin Franklin’s methodology for establishing its allowance for loan losses. Benjamin Franklin recorded $620,000 and $625,000 in loan loss provisions during the years ended December 31, 2004 and 2003, respectively. Provisions in both years were reflective of growth in the loan portfolio, and in the case of the 2003 period, the recording of net charge-offs of $414,000. In 2004, net recoveries of $29,000 were realized. At December 31, 2004, the allowance for loan losses totaled $3.2 million, or 0.82% of the loan portfolio, compared to $2.5 million, or 0.87%, of total loans at December 31, 2003.
Non-interest Income. Non-interest income for the year ended December 31, 2004 declined to $2.1 million, a reduction of $952,000, or 31.0%, when compared to non-interest income of $3.1 million during the year ended December 31, 2003. An $852,000 decline in gains on loan sales, a $110,000 decrease in gains on sales of securities, an $82,000 reduction in loan servicing fees and a $46,000 reduction in deposit service fees were partially offset by an additional $111,000 in miscellaneous income and a $27,000 increase in income earned on bank-owned life insurance. The decline in gain on loan sales was attributable to the rise in market interest rates in 2004, which in turn caused a decline in the origination of fixed rate residential mortgage loans that the Bank typically sells at a small gain in the secondary market. Loan servicing fee income was also negatively affected by the reduction in fixed rate loan originations sold with servicing rights retained. The increase in miscellaneous income in the 2004 period was primarily attributable to an increase in fees earned on investment product sales, brought about by the addition of a second sales representative in the fourth quarter of 2003.
Non-interest Expense. Non-interest expense was essentially unchanged at $12.7 million for the years ended 2004 and 2003. Reductions in occupancy and equipment costs, and professional fees were offset by an increase in salaries and employee benefits.
Salaries and employee benefits expenses increased $819,000, or 12.3%, to $7.5 million for the year ended December 31, 2004. The increase was primarily due to normal merit increases averaging 4.5%, the addition of one senior officer position, and significantly lower deferral of loan origination costs due to a lower volume of loan originations in 2004 when compared to 2003. Occupancy and equipment expenses declined $378,000, or 21.1%, to $1.4 million for the year ended December 31, 2004. Most of this reduction was attributable to a decline in depreciation expense associated with branch-related capital expenditures made five years earlier. Professional fees decreased $612,000, or 62.0%, to $373,000 for the year ended December 31, 2004, due primarily to a decline in legal costs and loan origination expenses.
Income Taxes. Income tax expense was $892,000 for the year ended December 31, 2004, an increase of $73,000, or 8.9%, compared to $819,000 for the year ended December 31, 2003. The effective tax rates for the 2004 and 2003 years were 34.6% and 32.7%, respectively, and the increase was due to additional income in Benjamin Franklin Bank which is taxed at a higher rate for state tax purposes, and capital losses in 2004 for which Benjamin Franklin Bank received no tax benefit.
Off-Balance-Sheet Arrangements
Benjamin Franklin Bancorp does not have any off-balance-sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Impact of Inflation and Changing Prices
The financial statements, accompanying notes, and related financial data of Benjamin Franklin presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of Benjamin Franklin operations. Most of Benjamin Franklin’s assets and liabilities are monetary in nature, and therefore the impact of interest rates has a greater impact on its 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 prices of goods and services.
Impact of Recent Accounting Standards
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” which changes, among other things, the manner in which share-based compensation, such as stock options, will be accounted for by both public and non-public companies. SFAS No. 123R became applicable to the Company on January 1, 2006. For public companies, the cost of employee services received in exchange for equity instruments including options and restricted stock awards generally is now measured at fair value at the grant date. The grant date fair value is required to be estimated using option-pricing models adjusted for the unique characteristics of those options and instruments, unless observable market prices for the same or similar options are available. The cost must be recognized over the requisite service period, often the vesting period.
The provisions of SFAS No. 123R do not have an impact on the Company’s results of operations at this time. However, as anticipated in the prospectus used in the Company’s stock offering related to the mutual-to-stock conversion, the Board of Directors has adopted a stock-based incentive plan, subject to shareholder approval, which will be sought at the annual meeting on May 11, 2006. The granting of restricted stock awards and stock options under the stock-based incentive plan will increase the Company’s compensation costs in the periods in which such awards and options vest.
In August 2005, the FASB issued an exposure draft that would amend FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for servicing of financial assets. This proposed Statement would require that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this proposed Statement would permit an entity to choose either of the following subsequent measurement methods: (1) amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss, or (2) report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur. This proposed Statement also would require additional disclosures for all separately recognized servicing rights. This proposed Statement would be effective for new transactions occurring and for subsequent measurement in the earlier of the first fiscal year that begins after December 31, 2005, or fiscal years beginning during the fiscal quarter in which the final Statement is issued. This Statement is not expected to have a material impact on the Company’s consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Management and the Board of Benjamin Franklin recognize that taking and managing risk is fundamental to the business of banking. Through the development, implementation and monitoring of its policies with respect to risk management, the Bank strives to measure, evaluate and control the risks it faces. The Board and management understand that an effective risk management system is critical to the safety and soundness of the Bank. Chief among the risks faced by Benjamin Franklin are credit risk, market risk including interest rate risk, liquidity risk, operational (transaction) risk and compliance risk.
Within management, the responsibility for risk management rests with the Risk Management Committee, chaired by the Compliance and Risk Management Officer. Other members of the Committee include the Chief Executive Officer, Chief Financial Officer, Controller, and the senior officers responsible for lending, retail banking and human resources. The Risk Management Committee meets on a monthly basis to review the status of the Company’s risk management efforts, including reviews of internal and external audit findings, loan review findings, and the activities of the Asset/ Liability Committee with respect to monitoring interest rate and liquidity risk. The Committee tracks any open items requiring corrective action with the goal of ensuring that each is addressed on a timely basis. The Compliance and Risk Management Officer reports all findings of the Risk Management Committee directly to the Board’s Audit and Risk Management Committee.
Management of Credit Risk. Benjamin Franklin considers credit risk to be the most significant risk it faces, in that it has the greatest potential to affect the financial condition and operating results of the Bank. Credit risk is managed through a combination of policies established by the Board, the monitoring of compliance with these policies, and the periodic evaluation of loans in the portfolio, including those with problem characteristics. In general, Benjamin Franklin’s policies establish maximums on the amount of credit that may be granted to a single borrower (including affiliates), the aggregate amount of loans outstanding by type in relation to total assets and capital, and loan concentrations. Collateral and debt service coverage ratios, approval limits and other underwriting criteria are also specified. Policies also exist with respect to performing periodic credit reviews, the rating of loans, when loans should be placed on non-performing status and factors that should be considered in establishing the Bank’s allowance for loan losses. For additional information, refer to “Business - Lending Activities.”
Management of Market Risk. Market risk is the risk of loss due to adverse changes in market prices and rates, and typically encompasses exposures such as sensitivity to changes in market interest rates, foreign currency exchange rates, and commodity prices. Benjamin Franklin has no exposure to foreign currency exchange or commodity price movements. Because net interest income is Benjamin Franklin’s primary source of revenue, interest rate risk is a significant market risk to which the Bank is exposed.
Interest rate risk is the exposure of Benjamin Franklin’s net interest income to adverse movements in interest rates. Net interest income is affected by changes in interest rates as well as by fluctuations in the level and duration of Benjamin Franklin’s assets and liabilities. Over and above the influence that interest rates have on net interest income, changes in rates may also affect the volume of lending activity, the ability of borrowers to repay variable rate loans, the volume of loan prepayments and refinancings, the flow and mix of deposits, and the market value of the Bank’s assets and liabilities.
Exposure to interest rate risk is managed by Benjamin Franklin through periodic evaluations of the current interest rate risk inherent in its rate-sensitive assets and liabilities, coupled with determinations of the level of risk considered appropriate given the Bank’s capital and liquidity requirements, business strategy, and performance objectives. Through such management, Benjamin Franklin seeks to reduce the vulnerability of its net interest income to changes in interest rates.
Strategies used by Benjamin Franklin to reduce the potential volatility of its earnings include:
•
Emphasizing the origination and retention of adjustable-rate mortgage loans, variable rate commercial loans and variable rate home equity lines-of-credit;
•
Investing in securities with relatively short maturities and/or expected average lives;
•
Classifying nearly all of the investment portfolio as “available for sale” in order to provide for flexibility in liquidity management.
Benjamin Franklin’s Asset/ Liability Committee, comprised of several members of senior and middle management, is responsible for managing interest rate risk. On a quarterly basis, the Committee reviews with the Board of Directors its analysis of the Bank’s exposure to interest rate risk, the effect subsequent changes in interest rates could have on the Bank’s future net interest income, its strategies and other activities, and the effect of those strategies on Benjamin Franklin’s operating results. The Committee is also actively involved in the Bank’s planning and budgeting process as well as in determining pricing strategies for deposits and loans.
The Committee’s primary method for measuring and evaluating interest rate risk is income simulation analysis. This analysis considers the maturity and repricing characteristics of assets and liabilities, as well as the relative sensitivities of these balance sheet components over a range of interest rate scenarios. Interest rate scenarios tested generally include instantaneous rate shocks, rate ramps over a one year period, and static (or flat) rates. The simulation analysis is used to measure the exposure of net interest income to changes in interest rates over a specified time horizon, usually a two year period.
The table below sets forth, as of December 31, 2005, the estimated changes in Benjamin Franklin’s net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
As indicated in the table above, the result of an immediate 100 basis point parallel increase in interest rates is estimated to decrease net interest income by .98% over a 12-month horizon, when compared to the flat rate scenario. For an immediate 200 basis point parallel increase in the level of interest rates, net interest income is estimated to decline by 2.32% over a 12-month horizon, when compared against the flat rate scenario. Inherent in these estimates is the assumption that savings account deposit rates would increase by 25 basis points and that money market deposit account rates would increase by 36 basis points for each 100 basis point increase in market interest rates. These scenarios also assume no change in checking account interest rates. These assumptions are based on the Bank’s past experience with the changes in rates paid on these non-maturity deposits coincident with changes in market interest rates. The estimated change in net interest income from the flat rate scenario for a 100 basis point parallel decline in the level of interest rates is an increase of .25%, which assumes no decrease in interest-bearing checking rates or in savings rates and an average decrease in money market rates of 35 basis points.
There are inherent shortcomings in income simulation, given the number and variety of assumptions that must be made in performing the analysis. The assumptions relied upon in making these calculations of interest rate sensitivity include the level of market interest rates, the shape of the yield curve, the degree to which certain assets and liabilities with similar maturities or periods to repricing react to changes in market interest rates, the degree to which non-maturity deposits react to changes in market rates, the expected prepayment rates on loans and mortgage-backed securities, the degree to which early withdrawals occur on certificates of deposit and the volume of other deposit flows. As such, although the analysis shown above provides an indication of Benjamin Franklin’s sensitivity to interest rate changes at a point in
time, these estimates are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on Benjamin Franklin’s net interest income and will differ from actual results.
In its management of interest rate risk, Benjamin Franklin also relies on the analysis of its interest rate “gap,” which is the measure of the mismatch between the amount of Benjamin Franklin’s interest-earning assets and interest-bearing liabilities that mature or reprice within specified timeframes. An asset-sensitive position (positive gap) exists when there are more rate-sensitive assets than rate-sensitive liabilities maturing or repricing within a particular time horizon, and generally signifies a favorable effect on net interest income during periods of rising interest rates and a negative effect during periods of falling interest rates. Conversely, a liability-sensitive position (negative gap) would generally indicate a negative effect on net interest income during periods of rising rates and a positive effect during periods of falling rates.
The table below shows Benjamin Franklin’s interest sensitivity gap position as of December 31, 2005, indicating the amount of interest-earning assets and interest-bearing liabilities that are anticipated to mature or reprice in each of the future time periods shown. Generally, these assets and liabilities are shown in the table based on the earlier of the time remaining to repricing or contractual maturity. However, residential mortgage loans and mortgage-backed securities have been presented in a manner that also incorporates the estimated effects of prepayment assumptions. Interest-bearing checking, savings and money market deposit accounts are assumed to have annual rates of withdrawal (decay rates) of 9.2%, 38.3% and 59.5%, respectively.
Repricing Gap as of December 31, 2005
(1)
Excludes the allowance for loan losses, deferred fees and costs, and non-performing loans.
(2)
Securities are shown at amortized cost.
Certain factors may serve to limit the usefulness of the measurement of the interest rate gap. For example, interest rates on certain assets and liabilities are discretionary and may change in advance of, or may lag behind, changes in market rates. The gap analysis does not give effect to changes Benjamin Franklin may undertake to mitigate interest rate risk. Certain assets, such as adjustable-rate loans, have features that may restrict the magnitude of changes in interest rates both on a short-term basis and over the life of the assets. Further, in the event of changes in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the gap analysis. Lastly, should interest rates increase, the ability of borrowers to service their debt may decrease.
Liquidity Risk Management. Liquidity risk, or the risk to earnings and capital arising from an organization’s inability to meet its obligations without incurring unacceptable losses, is managed by Benjamin Franklin’s Chief Financial Officer, who monitors on a daily basis the adequacy of Benjamin Franklin’s liquidity position. Oversight is provided by the Asset/ Liability Committee, which reviews Benjamin Franklin’s liquidity on a weekly basis, and by the Board of Directors, which reviews the adequacy of Benjamin Franklin’s liquidity resources on a monthly basis.
Benjamin Franklin’s primary sources of funds are from deposits, amortization of loans, loan prepayments and the maturity of loans, mortgage-backed securities and other investments, and other funds provided by operations. While scheduled payments from amortization of loans and mortgage-backed securities and maturing loans and investment securities are relatively predictable sources of funds, deposit flows and loan prepayments can be greatly influenced by general interest rates, economic conditions and competition. Benjamin Franklin maintains excess funds in cash and short-term interest-bearing assets that provide additional liquidity. At December 31, 2005, cash and due from banks (excluding cash provided by CSSI to ATM customers), short-term investments and debt securities maturing within one year totaled $69.0 million or 8.0% of total assets.
Benjamin Franklin also relies on outside borrowings from the Federal Home Loan Bank of Boston, as an additional funding source. In 2005, Benjamin Franklin has expanded its use of Federal Home Loan Bank of Boston borrowings to fund growth in the loan portfolio and to assist in the management of its interest rate risk. Since December 31, 2004, Benjamin Franklin has increased Federal Home Loan Bank of Boston borrowings by $57.0 million to a total of $129.0 million outstanding as of December 31, 2005. On that date, Benjamin Franklin had the ability to borrow an additional $73.3 million from the Federal Home Loan Bank of Boston.
Benjamin Franklin uses its liquidity to fund existing and future loan commitments, to fund maturing certificates of deposit and borrowings, to fund other deposit withdrawals, to invest in other interest-earning assets and to meet operating expenses. Benjamin Franklin anticipates that it will continue to have sufficient funds and alternative funding sources to meet its current commitments.
The following tables present information indicating various contractual obligations and commitments of the Company as of December 31, 2005 and the respective maturity dates:
Contractual Obligations:
(1)
Secured under a blanket security agreement on qualifying assets, principally 1-4 Family Residential mortgage loans. Advances totalling $36 million shown with maturities of greater than three years may be called by the FHLB during the period remaining to maturity. These advances bear rates ranging from 3.99% to 4.91%, with a weighted average rate of 4.47%. Based on the current and predicted level of market interest rates, management considers it likely that these advances will be called by the FHLBB in the next 12 months. One advance in the amount of $10 million maturing in June, 2010 will become immediately payable if 3-month LIBOR rises above 6.0% (measured on a quarterly basis, beginning in June 2006).
(2)
Represents non-cancelable operating leases for branch offices.
(3)
Represents contracts for technology services and employment agreements.
Loan Commitments:
General: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract, and generally have fixed expiration dates or other termination clauses.
(1)
Commitments for loans are extended to customers for up to 180 days after which they expire.
(2)
Unused portion of checking overdraft lines of credit are available to customers in “good standing” indefinitely.
(3)
Unused portions of home equity lines of credit are available to the borrower for up to 10 years.
(4)
Unused portions of construction loans are available to the borrower for up to 2 years for development loans and up to 1 year for other construction loans.
Management of Other Risks. Two additional risk areas that receive significant attention by management and the Board are operational risk and compliance risk. Operational risk is the risk to earnings and capital arising from control deficiencies, problems with information systems, fraud, error or unforeseen catastrophes. Compliance risk is the risk arising from violations of, or nonconformance with, laws, rules, regulations, prescribed practices, internal policies and procedures or ethical standards. Compliance risk can expose the Company to fines, civil money penalties, payment of damages and the voiding of contracts.
Benjamin Franklin addresses such risks through the establishment of comprehensive policies and procedures with respect to internal control, the management and operation of its information and communication systems, disaster recovery, and compliance with laws, regulations and banking ‘best practice’. Monitoring of the efficacy of such policies and procedures is performed through a combination of Benjamin Franklin’s internal audit program, through periodic internal and third-party compliance reviews, and through the ongoing attention of its managers charged with supervising compliance and operational control. Oversight of these activities is provided by the Risk Management Committee and the Audit and Risk Management Committee of the Board.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The Consolidated Financial Statements of Benjamin Franklin Bancorp begin on page of this Annual Report.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Our President and Chief Executive Officer, our Chief Financial Officer, and other members of our senior management team have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on such evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by the Benjamin Franklin Bancorp, including our consolidated subsidiaries, in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.
The effectiveness of a system of disclosure controls and procedures is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of internal controls, and fraud. Due to such inherent limitations, there can be no assurance that any system of disclosure controls and procedures will be successful in preventing all errors or fraud, or in making all material information known in a timely manner to the appropriate levels of management.
(b) Changes in Internal Controls Over Financial Reporting. There were no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2005 that have materially affected, or that are reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B.
Other Information
Not applicable.
PART III
Item 10.
Item 10.
Directors and Executive Officers of the Registrant
The information required by this item is incorporated by reference from the Proxy Statement for the Annual Meeting of Stockholders of Benjamin Franklin Bancorp, Inc. scheduled to be held on May 11, 2006.
Item 11.
Item 11.
Executive Compensation
The information required by this item is incorporated by reference from the Proxy Statement for the Annual Meeting of Stockholders of Benjamin Franklin Bancorp, Inc. scheduled to be held on May 11, 2006.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference from the Proxy Statement for the Annual Meeting of Stockholders of Benjamin Franklin Bancorp, Inc. scheduled to be held on May 11, 2006.
Item 13.
Item 13.
Certain Relationships and Related Transactions
The information required by this item is incorporated by reference from the Proxy Statement for the Annual Meeting of Stockholders of Benjamin Franklin Bancorp, Inc. scheduled to be held on May 11, 2006.
Item 14.
Item 14.
Principal Accountant Fees and Services
The information required by this item is incorporated by reference from the Proxy Statement for the Annual Meeting of Stockholders of Benjamin Franklin Bancorp, Inc. scheduled to be held on May 11, 2006.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
(a) Exhibits
*
Relates to compensation.
Filed herewith.
Incorporated by reference to the Registrant’s Registration Statement on Form S-1, File No. 333-121154, filed on December 10, 2004.
Incorporated by reference to Amendment No. 1 to the Registrant’s Registration Statement on Form S-1, File No. 333-121154, filed on January 24, 2005.
Incorporated by reference to the Registrant’s Registration Statement on Form S-4, File No. 333-121608, filed on December 23, 2004.
Incorporated by reference to the Registrant’s Registration Statement on Form 8-A, File No. 000-51194, filed on March 9, 2005.
Incorporated by reference to the Registrant’s Annual Report on Form 10-K, filed on March 29, 2005.
Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed on March 3, 2006.
(b) Financial Statement Schedules
All schedules are omitted because they are not applicable or the required information is shown in our financial statements and related notes.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, Benjamin Franklin Bancorp, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Benjamin Franklin Bancorp, Inc.
By:
/s/ Thomas R. Venables
Thomas R. Venables
President and Chief Executive Officer
Date: March 28, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the indicated capacities as of March 28, 2006.
Benjamin Franklin Bancorp, Inc.
Annual Report on Form 10-K for the Year Ended December 31, 2005
Exhibits Filed Herewith
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Benjamin Franklin Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Benjamin Franklin Bancorp, Inc. and subsidiary as of December 31, 2005 and 2004, 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, 2005. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Benjamin Franklin Bancorp, Inc. and subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
March 8, 2006
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2005, 2004 and 2003
See accompanying notes to consolidated financial statements.
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2005, 2004 and 2003
(Dollars in Thousands)
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and consolidation
The consolidated financial statements include the accounts of Benjamin Franklin Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Benjamin Franklin Bank (the “Bank”). The Company completed a mutual to stock conversion and acquired Chart Bank, A Cooperative Bank (“Chart Bank”) on April 4, 2005 (see Note 2). The Bank has two subsidiaries, Benjamin Franklin Securities Corp., formed for the purpose of buying, holding, and selling securities, and Creative Strategic Solutions, Inc. (“CSSI”), which supplies cash to automatic teller machines owned by Independent Service Organizations (“ISOs”) and related cash management services to a nationwide customer base of ISOs. All significant intercompany balances and transactions have been eliminated in consolidation.
The Company’s wholly-owned subsidiary, Benjamin Franklin Capital Trust, is recorded on the equity method (see Note 12- Subordinated Debt).
Business and operating segments
The Company provides a variety of financial services to individuals and small businesses through its offices in Norfolk, Middlesex and Worcester counties. Its primary deposit products are checking, savings and term certificate accounts, and its primary lending products are residential and commercial mortgage loans. The Bank also provides non-deposit investment products to customers.
Management evaluates the Company’s performance and allocates resources based on a single segment concept. Accordingly, there are no separately identified operating segments for which discrete financial information is available. The Company does not derive revenues from, or have assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Company’s total revenues.
Use of estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, valuation of goodwill and other intangibles and the valuation of deferred tax assets.
Reclassifications
Certain amounts in the 2004 and 2003 consolidated financial statements have been reclassified to conform to the 2005 presentation.
Cash and cash equivalents
Cash and cash equivalents include cash and balances due from banks and short-term investments, all of which mature within ninety days.
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in Thousands)
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income/loss.
Purchase premiums and discounts are recognized into interest income using the interest method over the contractual terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and determined using the specific identification method.
Restricted equity securities, which consist primarily of Federal Home Loan Bank stock and stock in a community investment fund , are carried at cost.
Loans
The Bank grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans in the communities in which the Bank’s branches are located. The ability of the Bank’s debtors to honor their contracts is dependent upon the local real estate market and general economic conditions in this area.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Certain direct loan origination costs, net of origination fees are deferred and recognized as an adjustment of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for loan losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in Thousands)
and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of the loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.
Servicing
Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets, and are adjusted for prepayments. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by the original term of maturity ranging from 10-30 years and using a weighted average interest rate and maturity date within each strata. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum.
Premises and equipment
Land is carried at cost. Buildings and improvements and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of the options is reasonably assured.
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in Thousands)
Transfers of financial assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Goodwill and identifiable intangible assets
The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired. Identifiable intangible assets are subsequently amortized on a straight-line or accelerated basis, over their estimated lives. Management assesses the recoverability of intangible assets subject to amortization whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If carrying amount exceeds fair value an impairment charge is recorded to income. Goodwill is not amortized and is reviewed on an annual basis for impairment. In evaluating goodwill, management does not track the separate fair value of the acquired entities, but instead measures the fair value of the entire company. At December 31, 2005 and 2004, management concluded that no intangible assets were impaired.
Derivative financial instruments
The Company’s derivative financial instruments include commitments to potential borrowers for loans intended to be sold and related loan sale commitments to investors. All derivatives are recognized as assets or liabilities in the balance sheet and measured at fair value.
Retirement plan
The Company accounts for directors’ post-retirement pension plan benefits on the net periodic pension cost method for financial reporting purposes. This method recognizes the compensation cost of an employee’s pension benefit over the employee’s approximate service period.
Income taxes
Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes. The Bank’s base amount of its federal income tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of a related deferred tax asset, if deemed realizable.
A valuation allowance related to deferred tax assets is established when, in the judgment of management, it is more likely than not that all or a portion of such deferred tax assets will not be realized. (See Note 13.)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in Thousands)
Advertising costs
Advertising costs are expensed as incurred.
Comprehensive income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the stockholders’ equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income (loss). The components of other comprehensive income (loss) and related tax effects are as follows:
Earnings per share
Basic earnings per share (“EPS”) excludes dilution and is calculated by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted EPS is computed in a manner similar to that of basic EPS except that the weighted-average number of common shares outstanding is increased to include the number of incremental common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents (such as stock options and unvested restricted stock) were issued during the period. There were no potentially dilutive common stock equivalents outstanding during the year ended December 31, 2005. Unallocated common shares held by the ESOP are shown as a reduction in stockholders’ equity and are not included in the weighted-average number of common shares outstanding for either basic or diluted earnings per share calculations.
The Company converted to a stock company on April 4, 2005, resulting in shares outstanding for a period less than twelve months during the year ended December 31, 2005. Earnings per share for each of the three-month periods ended September 30 and December 31, 2005 can be found in Note 21 to the consolidated financial statements.
Recent accounting pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” which changes, among other things, the manner in which share-based compensation, such as stock options, will be accounted for by both public and non-public companies. SFAS No. 123R will be effective beginning with the first interim or annual reporting period of the Company’s first fiscal year that begins after June 15, 2005, which would be January 1, 2006 for the Company. For public companies, the cost of employee services received
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(Dollars in Thousands)
in exchange for equity instruments including options and restricted stock awards generally will be measured at fair value at the grant date. The grant date fair value will be estimated using option-pricing models adjusted for the unique characteristics of those options and instruments, unless observable market prices for the same or similar options are available. The cost will be recognized over the requisite service period, often the vesting period.
The provisions of SFAS No. 123R do not have an impact on the Company’s results of operations at this time. However, as disclosed in the prospectus used in the Company’s stock offering related to the mutual-to-stock conversion, the Company expects to adopt a stock-based incentive plan in 2006, subject to shareholder approval. The granting of restricted stock awards and stock options under the stock-based incentive plan will increase the Company’s compensation costs in the periods in which such awards and options vest.
In August 2005, the FASB issued an exposure draft which would amend FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for servicing of financial assets. This proposed Statement would require that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this proposed Statement would permit an entity to choose either of the following subsequent measurement methods (1) amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss or (2) report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur. This proposed Statement also would require additional disclosures for all separately recognized servicing rights. This proposed Statement would be effective for new transactions occurring and for subsequent measurement in the earlier of the first fiscal year that begins after December 15, 2005, or fiscal years beginning during the fiscal quarter in which the final Statement is issued. This Statement is not expected to have a material impact on the Company’s consolidated financial statements.
2.
STOCK CONVERSION AND MERGER
The Company completed its mutual-to-stock conversion (the “Conversion”) and related stock offering with the issuance of 5,577,419 shares of common stock, at an offering price of $10 per share, on April 4, 2005. An additional 2,511,479 shares, valued at $10 per share, were issued in connection with the acquisition of 100% of the outstanding common stock of Chart Bank, which was consummated immediately following the stock conversion. The cash portion of the consideration paid to Chart Bank shareholders totaled $21,535, resulting in a total purchase price of $46,650. The Company’s stock began trading on April 5, 2005, on the Nasdaq National Market, under the symbol “BFBC”.
In connection with the Conversion, the Company established the Benjamin Franklin Bank Charitable Foundation (the “Foundation”), funded with a contribution of 400,000 shares of newly-issued Benjamin Franklin common stock. This contribution resulted in the recognition of expense in the second quarter of 2005 equal to the $10 offering price for each of the shares contributed, net of tax benefits. The Foundation provides funding to support charitable causes and community development activities in the communities served by the Company.
As part of the Conversion, the Company established a liquidation account in the amount of $31,327 which is equal to the net worth of the Company as of the date of the latest consolidated balance sheet appearing in the final prospectus distributed in connection with the Conversion. The liquidation account is maintained for the benefit of eligible account holders and supplemental eligible account holders who maintain their deposit accounts at the Bank after the Conversion. The liquidation account will be reduced annually to the extent that such account holders have reduced their qualifying deposits as of each
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anniversary date. Subsequent increases will not restore an account holder’s interest in the liquidation account. In the event of a complete liquidation, each eligible account holder will be entitled to receive balances for accounts then held.
The Company may not declare or pay dividends on, and may not repurchase, any of its shares of common stock if the effect thereof would cause stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration, payment or repurchase would otherwise violate regulatory requirements.
The acquisition of Chart Bank was accounted for using the purchase method of accounting and the allocation of purchase price is as follows:
The goodwill recognized in the acquisition of Chart Bank, in the amount of $29.5 million, is not tax deductible. Goodwill will not be amortized, but will be subject to periodic testing for impairment. Any impairment detected in the future as a result of such testing would result in a charge to earnings. Certain other purchase accounting adjustments, consisting of fair value adjustments of investments, loans, time deposits and borrowed funds and a core deposit intangible (Note 9), are being amortized/accreted into income over the estimated lives of those adjustments. The following table summarizes the Company’s estimated future amortization expense of the balance of these purchase accounting adjustments at December 31, 2005.
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(Dollars in Thousands)
The results of Chart Bank are included in the results of the Company beginning April 4, 2005. The following condensed pro forma consolidated statements of operations for the years ended December 31, 2005 and 2004 assume that Chart Bank had been acquired as of January 1, 2005 and 2004 and include the purchase accounting adjustments. The pro forma information is theoretical in nature and is not necessarily indicative of future consolidated results of operations of the Company or the consolidated results of operations that would have resulted had the Company acquired the stock of Chart Bank during the periods presented:
The pro forma results of operations for the year ended December 31, 2005 include a net $1.0 million loss on sale/write-down of bank-owned land and a $4.0 million expense for the contribution of 400,000 shares of Benjamin Franklin Bancorp common stock to the Foundation. Tax benefits have been reflected for the $4.0 million Foundation contribution, but no tax benefit has been recognized for the $1.0 loss on sale/write-down of bank owned land. These results also include $709,000 of non-tax deductible merger-related expenses recorded by Chart Bank during the period from January 1, 2005 to April 4, 2005.
3.
RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain daily average balances on hand or with the Federal Reserve Bank. At December 31, 2005 and 2004, these reserve balances amounted to $200.
4.
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
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5.
SECURITIES
The amortized cost and fair value of securities with gross unrealized gains and losses follows:
The amortized cost and estimated fair value of debt securities, excluding mortgage-backed securities, by contractual maturity at December 31, 2005 is as follows. Expected maturities will differ from contractual maturities on certain securities because of call or prepayment provisions.
Proceeds from the sale of securities available for sale during the years ended December 31, 2004 and 2003 amounted to $5,591 and $30,886, respectively. Gross gains of $15 and $189, and gross losses of $39 and $103, were realized during the years ended December 31, 2004 and 2003, respectively. There was no sale of securities during the year ended December 31, 2005.
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(Dollars in Thousands)
Information pertaining to securities with gross unrealized losses at December 31, 2005 and 2004, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
The above unrealized losses on debt securities at December 31, 2005 represent 2.08% of the securities’ amortized cost and reflect temporary declines in fair value attributable to changes in market interest rates. As management has both the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
6.
LOANS
A summary of the balances of loans follows:
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(Dollars in Thousands)
An analysis of the allowance for loan losses follows:
The following is a summary of impaired and non-accrual loans:
No additional funds are committed to be advanced in connection with impaired loans.
At December 31, 2005 and 2004, loans with a principal balance of $12,320 and $16,161, respectively, were pledged to the Federal Reserve Bank of Boston as part of the Borrower-in-Custody advance program for which there are no outstanding advances as of December 31, 2005 and 2004.
7.
SERVICING
Loans serviced by the Bank for others amounted to $122,447 and $130,559 at December 31, 2005 and 2004, respectively. All loans sold and serviced for others were sold without recourse provisions.
Mortgage servicing rights included in other assets at December 31, 2005 and 2004 were $503 and $653, respectively. The fair value of mortgage servicing rights was $943 and $1,001 at December 31, 2005 and 2004, respectively. Information applicable to mortgage servicing rights is as follows:
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8.
PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and equipment follows:
Depreciation expense for the years ended December 31, 2005, 2004 and 2003 amounted to $983, $679 and $872, respectively.
The Company leases two of its branch offices under lease agreements from entities owned and managed by a Director of the Company. Pursuant to the terms of these noncancelable lease agreements in effect at December 31, 2005, pertaining to banking premises, future minimum rent commitments under the operating leases are as follows:
The leases contain options to extend for periods of five years. The cost of such rentals is not included above. Total rent expense for the year ended December 31, 2005 amounted to $176. No rental expense was incurred during the years ended December 31, 2004 and 2003.
9.
IDENTIFIABLE INTANGIBLE ASSETS
The Company recorded an identifiable intangible asset for core deposits in connection with its 1998 acquisition of Foxboro National Bank and its 2005 acquisition of Chart Bank. The resulting core deposit intangible assets are being amortized over periods of 7 years on the straight-line basis and 15 years on the double declining balance method, respectively. The net book value of this asset at December 31, 2005 and 2004 is as follows:
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Amortization expense, relating solely to the core deposit intangible, was $1,400, $181 and $181 for each of the years ended December 31, 2005, 2004 and 2003, respectively. Expected future amortization expense as of December 31, 2005 is as follows:
10.
DEPOSITS
A summary of deposit balances, by type, is as follows:
A summary of term certificate accounts by maturity is as follows:
11.
SHORT-TERM BORROWINGS
There were no short-term borrowings outstanding at December 31, 2005. At December 31, 2004, short-term borrowings consisted of Federal Home Loan Bank (“FHLB”) advances in the amount of $4,250 with a weighted average rate of 2.53% at December 31, 2004. The advances are secured by a blanket lien on qualified collateral as described in Note 12.
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(Dollars in Thousands)
12.
LONG-TERM DEBT
Long-term debt consists of the following:
FHLB Advances
Additional information pertaining to FHLB advances at December 31, 2005 and 2004 is as follows:
*
Includes advances in aggregate of $46,000 that are callable in 2006.
The Bank also has an available line of credit with the FHLB at an interest rate that adjusts daily. At December 31, 2005 and 2004, borrowings under the line were limited to $500, none of which was outstanding.
FHLB borrowings are limited to 2% of the Bank’s total assets. All borrowings from the Federal Home Loan Bank are secured by a blanket lien on qualified collateral, defined principally as 75% of the carrying value of first mortgage loans on owner-occupied residential property. At December 31, 2005 and 2004, the carrying amount of assets qualifying as collateral for FHLB advances amounted to $268,249 and $220,513, respectively.
Subordinated Debt
During the fourth quarter of 2002, the Company raised net proceeds of $8.7 million in a sale of $9.0 million of subordinated debentures to Benjamin Franklin Capital Trust I (the “Trust”), a wholly-owned subsidiary of the Company. The Trust funded the purchase by participating in a pooled offering of 9,000 capital securities representing preferred ownership interests in the assets of the Trust with a liquidation value of $1,000 each. Using interest payments made by the Company on the debentures, the Trust will pay quarterly dividends to preferred security holders. The percentage rate of interest payable on the subordinated debentures and the cumulative dividends payable quarterly on the preferred securities is 6.94% for the first five years and thereafter will be at a rate equal to the three-month Libor rate plus
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(Dollars in Thousands)
3.45%. The Company has the option to defer interest payments on the subordinated debentures for up to five years and, accordingly, the Trust may defer dividend distributions for up to five years. The debentures and the preferred securities mature in November 2032 unless the Company elects and obtains regulatory approval to accelerate the maturity date to November 2007 or thereafter.
The outstanding preferred securities may be included in regulatory Tier 1 capital (See Note 15), subject to a limitation that such amounts not exceed 25% of Tier 1 capital. At December 31, 2005 and 2004, preferred securities aggregating $9,000 are included in Tier 1 capital. Deferred debt financing costs are included in other assets and are amortized over the life of the debentures.
Secured Borrowing
As of December 31, 2005, the Bank has a participating interest in a commercial loan which provides the Bank with the optional right to repurchase the participation at par. The Bank recorded the transfer as a secured borrowing and the outstanding par value of the participation amounted to $2,403 at December 31, 2005.
13.
INCOME TAXES
Allocation of the federal and state income taxes between current and deferred portions is as follows:
The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows:
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(Dollars in Thousands)
The components of the net deferred tax asset are as follows:
The tax effect of each item that gives rise to deferred taxes are as follows:
At December 31, 2005, the Company has a capital loss carryover of $6,353 available to offset future capital gains, of which $6,321 expires in 2006 and $32 expires in 2009. The change in the valuation reserve for the years ended December 31, 2005 and 2004 is due to the change in the capital loss carryforward, and the write-down of land for which no tax benefit can be recognized.
The federal income tax reserve for loan losses at the Bank’s base year amounted to $3,055. If any portion of the reserve is used for purposes other than to absorb loan losses, approximately 150% of the amount actually used (limited to the amount of the reserve) would be subject to taxation in the year in
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(Dollars in Thousands)
which used. As the Bank intends to use the reserve only to absorb loan losses, a deferred tax liability of $1,253 has not been provided.
14.
OTHER COMMITMENTS AND CONTINGENCIES
In the normal course of business, there are outstanding commitments which are not reflected in the accompanying consolidated financial statements.
Loan commitments
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and advance funds on outstanding lines-of-credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Bank’s exposure to credit loss is represented by the contractual amount of the commitments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
At December 31, 2005 and 2004, the following financial instruments were outstanding whose contract amounts represent credit risk:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines-of-credit may expire without being drawn upon, therefore, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. Funds disbursed under commitments to grant loans and home equity lines-of-credit are primarily secured by real estate, and commercial lines-of-credit are generally secured by business assets. Personal lines-of-credit are unsecured.
Commercial letters-of-credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters-of-credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters-of-credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments.
Derivative financial instruments
Loan commitments pertaining to loans that the Company is originating for sale are, by definition, derivative financial instruments. The Bank enters into investor loan sale commitments to mitigate the
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interest rate risk inherent in fixed-rate loan commitments. These sale commitments also meet the characteristics of a derivative financial instrument. These transactions involve both credit and market risk.
Loan commitments with individual borrowers require the Bank to originate a loan upon completion of various underwriting requirements, and may lock an interest rate at the time of commitment. In turn, the Bank generally enters into investor loan sale commitments which represent agreements to sell these loans to investors at a predetermined price. If the individual loan is not available for sale (i.e. the loan does not close), the Bank may fill the commitment with a similar loan, or pay a fee to terminate the contract. At December 31, 2005 and 2004, the Bank had $648 and $1,145, respectively, in commitments to grant mortgage loans under rate lock agreements with borrowers. At December 31, 2005 and 2004, the Bank had $648 and $1,145, respectively, in outstanding investor loan sale commitments. The fair value of these derivative financial instruments is zero at the date of commitment and subsequent changes are not material.
Other contingencies
Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.
15.
MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Bank holding companies are not covered by the prompt corrective action provisions of the capital guidelines.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined) to risk-weighted assets (as defined) and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2005 and 2004, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
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(Dollars in Thousands)
As of December 31, 2005, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Company’s and the Bank’s actual capital amounts and ratios as of December 31, 2005 and 2004 are also presented in the table.
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(Dollars in Thousands)
A reconciliation of the Company’s and Bank’s stockholders’ equity to regulatory capital follows:
16. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. While Federal regulations limit the amount of dividends that may be paid at any date to the retained earnings of the Bank, for State regulatory purposes, the approval of the Massachusetts Commissioner of Banks is required if the total of all dividends declared in any calendar year exceeds the total of the Bank’s net profits for that year combined with its retained net profits of the preceding two years. Loans or advances are limited to 10 percent of the Bank’s capital stock and surplus on a secured basis.
At December 31, 2005, the Bank’s total retained earnings available for the payment of dividends was $35,001. Accordingly, $56,244 of the Company’s equity in the net assets of the Bank was restricted at December 31, 2005. Funds available for loans or advances by the Bank to the Company amounted to $9,100.
In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements, or would impair the liquidation account established for the benefit of the Bank’s eligible account holders and supplemental account holders at the time of the Conversion.
17.
EMPLOYEE BENEFIT PLANS
401(k) plan
The Bank adopted a 401(k) savings plan, which provides for voluntary contributions by participating employees up to seventy-five percent of their compensation, subject to certain limitations. Under the terms of the plan, the Bank at its discretion will match two hundred percent of an employee’s contribution to the 401(k) plan subject to a maximum of 6% of the employee’s compensation. Total expense under the 401(k) plan for the years ended December 31, 2005, 2004 and 2003, amounted to $398, $334 and $437, respectively.
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Supplemental retirement plans
The Bank has adopted a Supplemental Executive Retirement Plan, which provides for certain of the Bank’s executives to receive monthly benefits upon retirement, subject to certain limitations as set forth in the Plan and a Benefit Restoration Plan which provides for restorative payments equal to (1) the amount of additional benefits the participants would receive under the 401(k) plan if there were no income limitations imposed by the Internal Revenue and (2) projected allocation under the ESOP plan as if the participant had continued through the full vesting term of the plan upon retirement. The present value of these future benefits is accrued over the executives’ terms of employment, and the expense for the years ended December 31, 2005, 2004 and 2003 amounted to $247, $197 and $101, respectively.
Director fee continuation plan
Effective April 4, 2005, the Company established an unfunded director fee continuation plan which provides certain benefits to all eligible non-employee members of the boards of directors of the Company and Bank upon retirement. Information pertaining to the activity in the plan follows:
The assumptions used to determine the benefit obligation are as follows:
The components of net periodic pension cost are as follows:
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The assumptions used to determine net periodic pension cost are as follows:
Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:
Executive employment and change in control agreements
Effective April 4, 2005, the Bank entered into Executive Employment Agreements with the President and the Chief Financial Officer for an initial term of three years. These agreements provide for, among other things, an annual base salary and severance upon termination of employment. However, such employment may be terminated for cause, as defined, without incurring any continuing obligation. These agreements also provide for automatic extensions such that, at any point in time, the then-remaining term of employment shall be three years.
The Company also entered into Change in Control Agreements with five of its senior officers on April 4, 2005. These agreements provide for a lump sum severance payment equal to either one or two times the officer’s annual compensation, as defined, and certain other benefits upon termination of the officer’s employment under certain circumstances within two years after a change in control.
Employee Stock Ownership Plan
As part of the Conversion, the Bank established an Employee Stock Ownership Plan (“ESOP”) for the benefit of its eligible employees. The Company provided a loan to the Benjamin Franklin Bank Employee Stock Ownership Trust of $5,538 which was used to purchase 478,194 shares of the Company’s outstanding stock. The loan bears interest equal to 5.75% and provides for annual payments of interest and principal over the 30-year term of the loan.
At December 31, 2005, the remaining principal balance on the ESOP debt is payable as follows:
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The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account for allocation among participants as the loan is repaid. Cash dividends paid on allocated shares are distributed to participants and cash dividends paid on unallocated shares are used to repay the outstanding debt of the ESOP.
Shares held by the ESOP include the following at December 31, 2005:
As ESOP shares are earned by participants, the Company recognizes compensation expense equal to the fair value of the earned ESOP shares. Total compensation expense recognized in connection with the ESOP was $197 for the year ended December 31, 2005.
18.
LOANS TO RELATED PARTIES
In the ordinary course of business, the Bank grants loans to its officers and directors and their affiliates as follows:
The Company leases two of its branch offices under noncancelable operating lease agreements from entities owned and managed by a Director of the Company (see Note 8.)
19.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No. 107, excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
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The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of these instruments approximate fair values.
Securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices. The carrying value of restricted equity securities approximates fair value based on the redemption provisions of the issuers.
Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for residential mortgage loans, commercial real estate and investment property mortgage loans, commercial and industrial loans and consumer loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using the lower of underlying collateral values or cost.
Deposits: The fair values disclosed for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of short-term borrowings approximate fair value.
Long-term debt: Fair values of long-term debt are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Accrued interest: The carrying amount of accrued interest approximates fair value.
Off-balance-sheet instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of these instruments is not material.
The estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in Thousands)
20.
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to Benjamin Franklin Bancorp, Inc. is as follows:
BALANCE SHEETS
STATEMENTS OF INCOME
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Dollars in Thousands)
STATEMENTS OF CASH FLOWS
BENJAMIN FRANKLIN BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
(Dollars in Thousands)
21.
QUARTERLY DATA (UNAUDITED)
(1)
Includes $4.0 million Foundation contribution and $1.0 million net loss on sale/writedown of bank-owned land.