ITEM 1. BUSINESS
General. Westfield Bank was formed in 1853 and reorganized into a mutual holding company structure without a stock offering in 1995. In July 2004, Westfield Bank converted from a Massachusetts-chartered savings bank to a federally-chartered savings bank regulated by the Office of Thrift Supervision. Westfield Financial, Inc. ("Westfield Financial") was organized as a Massachusetts-chartered stock holding company in November 2001 in connection with the reorganization of Westfield Mutual Holding Company, a federally-chartered mutual holding company. As part of the reorganization, Westfield Financial offered for sale 47% of its common stock. The remaining 53% of Westfield Financial's shares were issued to Westfield Mutual Holding Company. The reorganization and related stock offering were completed on December 27, 2001.
On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007.
For financial reporting purposes, net proceeds of $171.7 million from the second step conversion were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts.
Historically, Westfield Bank has been a community-oriented provider of banking products and services to businesses and individuals, including traditional products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. In recent years, however, Westfield Bank has developed and implemented a lending strategy that focuses less on residential real estate lending and more on servicing commercial customers, including increased emphasis on commercial and industrial lending and commercial deposit relationships, extending its branch network and broadening its product lines and services. Westfield Bank believes that this business strategy is best for its long term success and viability, and complements its existing commitment to high quality customer service.
In September 2001, Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans. Westfield Bank receives a fee for each of the loans originated by the third party mortgage company. Westfield Bank may purchase residential real estate loans from the third party mortgage company depending on market conditions. To date, Westfield Bank has not purchased a significant amount of loans from the third party mortgage company.
Westfield Bank's revenues are derived principally from interest on its loans and interest and dividends on its investment securities. Its primary sources of funds are deposits, Federal Home Loan Bank advances, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities, and funds provided by operations.
Elm Street Securities Corporation, a Massachusetts-chartered corporation, was formed by Westfield Financial for the primary purpose of holding qualified investment securities. In February 2007, Westfield Financial also formed WFD Securities, Inc., a Massachusetts-chartered corporation, for the primary purpose of holding qualified investment securities.
Unless the context otherwise requires, all references in this document to Westfield Financial or Westfield Bank include Westfield Financial, Westfield Bank, Elm Street Securities and WFD Securities, Inc. on a consolidated basis.
Market Area. Westfield Bank operates through 11 banking offices in Agawam, East Longmeadow, Holyoke, Southwick, Springfield, West Springfield and Westfield, Massachusetts. It also has eight free-standing ATM locations in Agawam, Feeding Hills, Springfield, West Springfield and Westfield, Massachusetts. Westfield Bank's primary deposit gathering area is concentrated in the communities surrounding these locations and its primary lending area includes all of Hampden County in western Massachusetts. In addition, Westfield Bank provides online banking services through its website located at www.westfieldbank.com.
The markets served by Westfield Bank's branches are primarily suburban in character, as Westfield Bank operates only two offices in Springfield, the Pioneer Valley's primary urban market. Westfield, Massachusetts, is located in the Pioneer Valley near the intersection of U.S. Interstates 90 (the Massachusetts Turnpike) and 91. Interstate 90 is the major east-west highway that crosses Massachusetts. Interstate 91 is the major north-south highway that runs directly through the heart of New England. The Pioneer Valley of western Massachusetts encompasses the fourth largest metropolitan area in New England. The Springfield Metropolitan area covers a relatively diverse area ranging from densely populated urban areas, such as Springfield, to outlying rural areas. Westfield is located approximately 90 miles west of Boston, Massachusetts, 70 miles southeast of Albany, New York and 30 miles north of Hartford, Connecticut. The 2005 population estimates for Westfield and Springfield were approximately 41,187 and 153,975, respectively. The estimated population for Hampden County was 460,520 as of 2006.
The economy of Westfield Bank's market area historically has been supported by a variety of industries. Its primary market area has benefited from the presence of large employers centered in insurance, health care, warehousing, manufacturing and education. Among the largest employers currently in its market area are Bay State Health Systems, Big Y Foods, Friendly Ice Cream Corporation, Mass Mutual Life Insurance Company, Mestek, Noble Hospital, the University of Massachusetts, Westfield State College, American International College, and the Sullivan Paper Company. In addition, other employment and economic activity is provided by a substantial number of small and medium size businesses in the area.
Westfield Bank's future growth opportunities will be influenced by the growth and stability of the statewide and regional economies, other demographic population trends and the competitive environment. Westfield Bank believes that it has developed lending products and marketing strategies to address the diverse credit-related needs of the residents in its market area.
Median household and per capita income levels in Hampden County are below the state average, which is dominated by relatively high income levels prevailing in the populous Boston metropolitan area. Similarly, the median household and per capita income levels in Westfield Bank's markets more closely approximate but also fall below the national averages.
As of December 2007, the unemployment rate of Hampden County and Massachusetts was 4.6% and 4.5%, respectively, compared to 5.9% and 5.3%, respectively, in December 2006.
Competition. Westfield Bank faces intense competition both in making loans and attracting deposits. Its primary market area is highly competitive and it faces direct competition from approximately 19 financial institutions, many with a local, state-wide or regional presence and, in some cases, a national presence. Many of these financial institutions are significantly larger than and have greater financial resources than Westfield Bank. Westfield Bank's competition for loans comes principally from commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. Historically, Westfield Bank's most direct competition for deposits has come from savings and commercial banks. Westfield Bank faces additional competition for deposits from internet-based institutions, brokerage firms and insurance companies.
Lending Activities
Loan Portfolio Composition. Westfield Bank's loan portfolio primarily consists of commercial and industrial loans, commercial real estate loans, residential real estate loans, home equity loans, and consumer loans.
At December 31, 2007, Westfield Bank had total loans of $420.0 million, of which 67.3% were adjustable rate loans and 32.7% were fixed rate loans. Commercial real estate loans and commercial and industrial loans totaled $190.0 million and $116.5 million, respectively. The remainder of its loans at December 31, 2007 consisted of residential real estate loans, home equity loans and consumer loans. Residential real estate and home equity loans outstanding at December 31, 2007 totaled $108.1 million. Consumer loans outstanding at December 31, 2007 were $5.5 million.
The interest rates Westfield Bank charges on loans are affected principally by the demand for loans, the supply of money available for lending purposes and the interest rates offered by its competitors. These factors are, in turn, affected by general and local economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters. The following table presents the composition of Westfield Bank's loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated.
Loan Maturity and Repricing. The following table shows the repricing dates or contractual maturity dates as of December 31, 2007. The table does not reflect prepayments or scheduled principal amortization. Demand loans, loans having no stated maturity, and overdrafts are shown as due in within one year.
The following table presents, as of December 31, 2007, the dollar amount of all loans contractually due or scheduled to reprice after December 31, 2008 and whether such loans have fixed interest rates or adjustable interest rates.
Due After December 31, 2008 ------------------------------------- Fixed Adjustable Total ----- ---------- ----- (In thousands) Real Estate Loans Residential (1) $ 36,033 $ 22,538 $ 58,571 Home equity 26,090 - 26,090 Commercial real estate 17,585 120,624 138,209 -------- -------- -------- Total real estate loans 79,708 143,162 222,870 -------- -------- --------
Other Loans Commercial and industrial 48,517 9,182 57,699 Consumer 4,640 - 4,640 -------- -------- -------- Total other loans 53,157 9,182 62,339 -------- -------- --------
Total loans $132,865 $152,344 $285,209 ======== ======== ========
- ------------------------------------------------------------------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company.
The following table presents our loan originations, purchases, sales and principal payments for the years indicated:
For the Year Ended December 31, -------------------------------- 2007 2006 2005 ---- ---- ---- (In thousands) Loans: Balance outstanding at beginning of year $390,174 $383,873 $373,449
Originations: Real estate loans: Residential (1) 3,692 4,337 2,016 Home equity 17,158 15,336 10,947 Commercial 44,811 52,807 58,382 -------- -------- -------- Total mortgage originations 65,661 72,480 71,345
Commercial and industrial loans 59,812 34,864 43,465 Consumer loans 3,161 3,657 3,325 -------- -------- -------- Total originations 128,634 111,001 118,135 Purchases of one-to-four-family mortgage loans 1,759 11,845 1,236 -------- -------- -------- 130,393 122,846 119,371 -------- -------- -------- Less: Principal repayments, unadvanced funds and other, net 100,389 116,170 108,627 Loan charge-offs, net 111 375 320 -------- -------- -------- Total deductions 100,500 116,545 108,947 -------- -------- -------- Ending balance $420,067 $390,174 $383,873 ======== ======== ======== - ------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company.
Commercial and Industrial Loans. Westfield Bank offers commercial and industrial loan products and services which are designed to give business owners borrowing opportunities for modernization, inventory, equipment, construction, consolidation, real estate, working capital, vehicle purchases and the financing of existing corporate debt. Westfield Bank offers business installment loans, vehicle and equipment financing, lines of credit, equipment leasing and other commercial loans. At December 31, 2007, Westfield Bank's commercial and industrial loan portfolio consisted of 816 loans, totaling $116.5 million or 27.7% of its total loans. Since 2003, commercial and industrial loans have grown $31.2 million, or 36.6%, from $85.3 million at December 31, 2003 to $116.5 million at December 31, 2007. Westfield Bank's commercial loan team includes eight commercial loan officers, one business development manager, four credit analysts and one portfolio manager. Westfield Bank may hire additional commercial loan officers on an as needed basis.
As part of Westfield Bank's strategy of increasing its emphasis on commercial lending, Westfield Bank seeks to attract its business customers' entire banking relationship. Most commercial borrowers also maintain commercial deposits at Westfield Bank. Westfield Bank provides complementary commercial products and services, including an equipment leasing program with a third party vendor, a variety of commercial deposit accounts, cash management services, internet banking, sweep accounts, a broad ATM network and night deposit services. In 2006, Westfield Bank introduced a remote deposit capture product whereby commercial customers can receive credit for check deposits by electronically transmitting check images from their own locations. Commercial loan officers are based in its main and branch offices, and Westfield Bank views its potential branch expansion as a means of facilitating these commercial relationships. Westfield Bank intends to continue to expand the volume of its commercial business products and services within its current underwriting standards.
Westfield Bank's commercial and industrial loan portfolio does not have any significant loan concentration by type of property or borrower. The largest concentration of loans was for colleges and universities, which comprise approximately 3.57% of the total loan portfolio as of December 31, 2007. At December 31, 2007, Westfield Bank's largest commercial and industrial loan relationship was $16.0 million to a private New England college. The loans of this borrower have performed to contractual terms.
Commercial and industrial loans generally have terms of seven years or less, however on an occasional basis, may have terms of up to ten years. Among the $116.5 million Westfield Bank has in its commercial and industrial loan portfolio as of December 31, 2007, $64.6 million have adjustable interest rates and $51.9 million have fixed interest rates. Whenever possible, Westfield Bank seeks to originate adjustable rate commercial and industrial loans. Borrower activity and market conditions however, may influence whether Westfield Bank is able to originate adjustable rate loans rather than fixed rate loans. Westfield Bank generally requires the personal guarantee of the business owner. Interest rates on commercial and industrial loans generally have higher yields than residential or commercial real estate loans.
Commercial and industrial loans are generally considered to involve a higher degree of risk than residential or commercial real estate loans because the collateral may be in the form of intangible assets and/or inventory subject to market obsolescence. Please see "Risk Factors - Our loan portfolio includes loans with a higher risk of loss." Commercial and industrial loans may also involve relatively large loan balances to single borrowers or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation and income stream of the borrower. These risks can be significantly affected by economic conditions. In addition, business lending generally requires substantially greater oversight efforts by Westfield Bank's staff compared to residential or commercial real estate lending. In order to mitigate this risk, Westfield Bank monitors its loan concentration and its loan policies generally to limit the amount of loans to a single borrower or group of borrowers. Westfield Bank also utilizes the services of an outside consultant to conduct credit quality reviews of the commercial and industrial loan portfolio.
Commercial Real Estate Loans. Westfield Bank originates commercial real estate loans to finance the purchase of real property, which generally consists of apartment buildings, business properties, multi-family investment properties and construction loans to developers of commercial and residential properties. In underwriting commercial real estate loans, consideration is given to the property's historic cash flow, current and projected occupancy, location and physical condition. At December 31, 2007, Westfield Bank's commercial real estate loan portfolio consisted of 387 loans, totaling $190.0 million, or 45.2% of total loans. Since 2003, commercial real estate loans have grown by $58.7 million, or 44.7%, from $131.3 million at December 31, 2003 to $190.0 million at December 31, 2007.
The majority of the commercial real estate portfolio consists of loans which are collateralized by properties in the Pioneer Valley of Massachusetts and northern Connecticut. Westfield Bank's commercial real estate loan portfolio is diverse, and does not have any significant loan concentration by type of property or borrower. Westfield Bank generally lends up to a loan-to-value ratio of 80% on commercial properties, Westfield Bank, however will lend up to a maximum of 85% loan-to-value ratio generally requires a minimum debt coverage ratio of 1.15 times. Its largest commercial real estate loan relationship had an outstanding balance of $10.4 million at December 31, 2007 which was secured by three commercial investment properties located in Massachusetts, and one commercial investment property located in Connecticut. The loans of this borrower have performed to contractual terms.
Westfield Bank also offers construction loans to finance the construction of commercial properties located in its primary market area. Westfield Bank had $13.1 million in commercial construction loans and commitments at December 31, 2007.
Commercial real estate lending involves additional risks compared with one- to four-family residential lending. Payments on loans secured by commercial real estate properties often depend on the successful management of the properties, on the amount of rent from the properties, or on the level of expenses needed to maintain the properties. Repayment of such loans may therefore be adversely affected by conditions in the real estate market or the general economy. Also, commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. In order to mitigate this risk, Westfield Bank monitors its loan concentration on a quarterly basis and its loan policies generally limit the amount of loans to a single borrower or group of borrowers.
Because of increased risks associated with commercial real estate loans, Westfield Bank's commercial real estate loans generally have higher rates than residential real estate loans. Please see "Risk Factors - Our loan portfolio includes loans with a higher risk of loss." Commercial real estate loans generally have adjustable rates with repricing dates of five years or less; however, occasionally repricing dates may be as long as ten years. Whenever possible, Westfield Bank seeks to originate adjustable rate commercial real estate loans. Borrower activity and market conditions, however, may influence whether Westfield Bank is able to originate adjustable rate loans rather than fixed rate loans.
Residential Real Estate Loans and Originations. In September, 2001, Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans. Westfield Bank receives a fee for each of these loans originated by the third party mortgage company.
Even though substantially all residential real estate loan originations are referred to a third party mortgage company, Westfield Bank still holds residential real estate loans in its loan portfolio. The loans consist primarily of loans originated by Westfield Bank prior to September 2001, the commencement of the third party residential mortgage referral program, or loans purchased by Westfield Bank. Westfield Bank occasionally purchases adjustable rate mortgages, which are serviced by the originating institutions, from other banks located in Massachusetts. As of December 31, 2007, loans on one- to four-family residential properties, including home equity lines, accounted for $108.1 million, or 25.7%, of Westfield Bank's total loan portfolio.
Westfield Bank's residential adjustable rate mortgage loans generally are fully amortizing loans with contractual maturities of up to 30 years, payments due monthly. Its adjustable rate mortgage loans generally provide for specified minimum and maximum interest rates, with a lifetime cap and floor, and a periodic adjustment on the interest rate over the rate in effect on the date of origination. As a consequence of using caps, the interest rates on these loans are not generally as rate sensitive as its cost of funds. The adjustable rate mortgage loans that Westfield Bank originates generally are not convertible into fixed rate loans.
Adjustable rate mortgage loans generally pose different credit risks than fixed rate loans, primarily because as interest rates rise, the borrower's payments rise, increasing the potential for default. To date, Westfield Bank has not experienced difficulty with payments for these loans. At December 31, 2007, its residential real estate and home equity loan portfolio included $45.8 million in adjustable rate loans, or 10.9% of its total loan portfolio, and $62.3 million in fixed rate loans, or 14.8% of its total loan portfolio.
Westfield Bank's home equity loans totaled $35.9 million, or 8.6% of total loans at December 31, 2007. Home equity loans include $26.1 million in fixed rate loans, or 6.2% of total loans, and $9.8 million in adjustable rate loans, or 2.3% of total loans. These loans may be originated in amounts of the existing first mortgage, or up to 90% of the value of the property securing the loan. Westfield Bank requires or obtains insurance on mortgages whose loan-to-value ratio exceeds 80%. The term to maturity on Westfield Bank's home equity and home improvement loans may be up to 15 years.
Consumer Loans. Consumer loans are generally originated at higher interest rates than residential and commercial real estate loans, but they also generally tend to have a higher credit risk than residential real estate loans because they are usually unsecured or secured by rapidly depreciable assets. Management, however, believes that offering consumer loan products helps to expand and create stronger ties to Westfield Bank's existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.
Westfield Bank offers a variety of consumer loans to retail customers in the communities it serves. Examples of its consumer loans include automobile loans, secured passbook loans, credit lines tied to deposit accounts to provide overdraft protection, and unsecured personal loans. At December 31, 2007, the consumer loan portfolio totaled $5.5 million or 1.3% of total loans. Westfield Bank's consumer lending will allow it to diversify its loan portfolio while continuing to meet the needs of the individuals and businesses that it serves.
Loans collateralized by rapidly depreciable assets such as automobiles or that are unsecured entail greater risks than residential real estate loans. In such cases, repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance, since there is a greater likelihood of damage, loss or depreciation of the underlying collateral. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. Further, collections on these loans are dependent on the borrower's continuing financial stability and, therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. There was no repossessed collateral relating to consumer loans at December 31, 2007. Finally, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans if a borrower defaults.
Loan Approval Procedures and Authority
Individuals authorized to make loans on behalf of Westfield Bank are designated by Westfield Bank's Senior Lending Officer and approved by the Board of Directors. Each loan officer has loan approval authority up to prescribed limits that depend upon the officer's level of experience.
Upon receipt of a completed loan application from a prospective borrower, Westfield Bank orders a credit report and verifies other information. If necessary, Westfield Bank obtains additional financial or credit related information. Westfield Bank also requires an appraisal for all commercial real estate loans greater than $250,000, which is performed by licensed or certified third party appraisal firms and reviewed by Westfield Bank's lending department. Appraisals for home equity loans are required for loans in excess of $250,000; otherwise, a designated employee of Westfield Bank conducts an inspection of the property. Westfield Bank requires title insurance on most commercial real estate loans. Westfield Bank also requires borrowers to obtain flood insurance, if applicable, prior to closing, for all loans secured by real estate within a designated flood zone.
Commercial and Industrial Loans and Commercial Real Estate Loans. Westfield Bank lends up to a maximum loan-to-value ratio of 85% on commercial properties and the majority of three loans require a minimum debt coverage ratio of 1.15. Commercial real estate lending involves additional risks compared with one- to four-family residential lending. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, and/or the collateral value of the commercial real estate securing the loan, repayment of such loans may be subject, to a greater extent, to adverse conditions in the real estate market or the economy. Also, commercial real estate loans typically involve large loan balances to single borrowers or groups or related borrowers. Westfield Bank's loan policies limit the amounts of loans to a single borrower or group of borrowers to reduce this risk.
Westfield Bank's lending policies permit its underwriting department to review and approve commercial and industrial loans and commercial real estate loans up to $1 million. Any commercial and industrial or commercial real estate loan application that exceeds $1 million or that would result in the borrower's total credit exposure with Westfield Bank to exceed $1 million, or whose approval requires an exception to Westfield Bank's standard loan approval procedures, requires approval of the Executive Committee of the Board of Directors. An example of an exception to Westfield Bank's standard loan approval procedures would be if a borrower was located outside Westfield Bank's primary lending area. For loans requiring Board approval, management is responsible for presenting to the Board information about the creditworthiness of a borrower and the estimated value of the subject equipment or property. Generally, these determinations are based on financial statements, corporate and personal tax returns, as well as any other necessary information, including real estate and or equipment appraisals.
Residential Real Estate Loans. In September 2001, Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans. Westfield Bank receives a fee for each of the loans originated by the third party mortgage company.
Home Equity Loans. Home equity loans are originated and funded by Westfield Bank. These loans may be originated in amounts of the existing first mortgage, or up to 90% of the value of the property securing the loan. Westfield Bank requires or obtains insurance on mortgages whose loan-to-value ratio exceeds 80%. Westfield Bank's underwriting department may approve home equity loans up to $200,000. Home equity loans in amounts greater than $200,000 and up to $350,000 may be approved by certain officers of Westfield Bank who have been approved by the Board of Directors. Home equity loans over $350,000, or whose approval requires an exception to Westfield Bank's standard loan approval procedures, are reviewed and approved by the Executive Committee of the Board of Directors.
Asset Quality
One of Westfield Bank's key operating objectives has been and continues to be the achievement of a high level of asset quality. Westfield Bank maintains a large proportion of loans secured by residential and commercial properties, sets sound credit standards for new loan originations and follows careful loan administration procedures. Westfield Bank also utilizes the services of an outside consultant to conduct credit quality reviews of Westfield Bank's commercial and industrial and commercial real estate loan portfolio on a semi-annual basis. These practices and relatively favorable economic and real estate market conditions have resulted in historically low delinquency ratios and, in recent years, a low level of nonaccrual loans.
Delinquent Loans and Foreclosed Assets. Westfield Bank's policies require that management continuously monitor the status of the loan portfolio and report to the Board of Directors on a monthly basis. These reports include information on delinquent loans and foreclosed real estate, as well as Westfield Bank's actions and plans to cure the delinquent status of the loans and to dispose of the foreclosed property.
The following table presents information regarding nonperforming mortgage, consumer and other loans, and foreclosed real estate as of the dates indicated. All loans where the interest payment is 90 days or more in arrears as of the closing date of each month are placed on non-accrual status. At December 31, 2007, 2006, and 2005, Westfield Bank had $1.2 million, $1.0 million, and $1.9 million, respectively, of nonaccrual loans. If all nonaccrual loans had been performing in accordance with their terms, Westfield Bank would have earned additional interest income of $65,000, $67,000, and $176,000 for the years ended December 31, 2007, 2006, and 2005, respectively.
Allowance for Loan Losses. The following table presents the activity in Westfield Bank's allowance for loan losses and other ratios (annualized as applicable) at or for the dates indicated.
Westfield Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio based on ongoing quarterly assessments of the estimated losses. Westfield Bank's methodology for assessing the appropriateness of the allowance consists of a review of the components, which include a specific valuation allowance for identified problem loans and a formula or general allowance for current performing loans. Fluctuations in the balances of impaired loans affect the specific valuation allowance while fluctuations in volume and concentrations of loans affects the general reserve and the allocation of the allowance of the loan losses among loan types. Other factors considered in the allowance calculation include general economic or industry conditions that might impact the loan portfolio along with trends in the quality of the portfolio as measured by delinquency, non-performing and charge-offs.
The specific valuation allowance incorporates the results of measuring impairment for specifically identified non-homogenous problem loans in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting By Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." In accordance with SFAS No. 114 and No. 118, the specific allowance reduces the carrying amount of the impaired loans to their estimated fair value. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan's contractual terms. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, Westfield Bank expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. Measurement of impairment does not apply to large groups of smaller balance homogenous loans that are collectively evaluated for impairment such as Westfield Bank's portfolios of home equity loans, real estate mortgages, installment and other loans.
The general allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. As part of this analysis, each quarter Westfield Bank prepares an allowance for loan losses worksheet which categorizes the loan portfolio by risk characteristics such as loan type and loan grade. The general allowance is inherently subjective as it requires material estimates that may be susceptible to significant change. There are a number of factors that are considered when evaluating the appropriate level of the allowance. These factors include current economic and business conditions that affect key lending areas of the company, new loan products, collateral values, loan volumes and concentrations, credit quality trends such as nonperforming loans, delinquency and loan losses, and specific industry concentrations within the portfolio segments that may impact the collectibility of the loan portfolio.
In addition, management employs an independent third party to perform a semi-annual review of all of Westfield Bank's commercial and industrial loans and owner occupied commercial real estate loans with balances or commitments equal or greater than $750,000. The third party also reviews all commercial investment real estate loans in excess of $750,000, as well as all adversely rated loans.
Westfield Bank's methodologies include several factors that are intended to reduce the difference between estimated and actual losses. The loss factors that are used to establish the allowance for pass graded loans are designated to be self-correcting by taking into account changes in loan classification, loan concentrations and loan volumes and by permitting adjustments based on management's judgments of qualitative factors as of the evaluation date. Similarly, by basing the pass graded loan loss factors on loss experience over the prior three years, the methodology is designed to take Westfield Bank's recent loss experience into account.
Westfield Bank's allowance methodology has been applied on a consistent basis. Based on this methodology, Westfield Bank believes that it has established and maintained the allowance for loan losses at adequate levels. Future adjustments to the allowance for loan losses, however, may be necessary if economic, real estate and other conditions differ substantially from the current operating environment resulting in estimated and actual losses differing substantially. Adjustments to the allowance for loan losses are charged to income through the provision for loan losses.
A summary of the components of the allowance for loan losses is as follows:
In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews Westfield Bank's loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The Office of Thrift Supervision may require Westfield Bank to adjust the allowance for loan losses or the valuation allowance for foreclosed real estate based on their judgments of information available to them at the time of their examination, thereby adversely affecting Westfield Bank's results of operations.
For the year ended December 31, 2007, Westfield Bank provided $400,000 to the allowance for loan losses based on its evaluation of the items discussed above. Westfield Bank believes that the allowance for loan losses accurately reflects the level of risk in the current loan portfolio as of December 31, 2007.
Investment Activities. The Board of Directors reviews and approves Westfield Bank's investment policy on an annual basis. The Chief Executive Officer and Chief Financial Officer, as authorized by the Board of Directors, implement this policy based on the established guidelines within the written policy.
Westfield Bank's investment policy is designed primarily to manage the interest rate sensitivity of its assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement its lending activities and to provide and maintain liquidity within the range established by policy. In determining Westfield Bank's investment strategies, it considers its interest rate sensitivity, yield, credit risk factors, maturity and amortization schedules, and other characteristics of the securities to be held.
Federally-chartered savings banks have authority to invest in various types of assets, including U.S. Treasury obligations, securities of various government-sponsored enterprises, mortgage-backed securities, certain certificates of deposit of insured financial institutions, repurchase agreements, overnight and short term loans to other banks and corporate debt instruments.
Securities Portfolio. Westfield Financial classifies securities as held to maturity or available for sale at the date of purchase. Westfield Financial does not have any securities classified as trading. Held to maturity securities are reported at cost, adjusted for amortization of premium and accretion of discount. Available for sale securities are reported at fair market value. At December 31, 2007, held to maturity securities totaled $278.6 million, or 53.3% of the total securities portfolio, and available for sale investments totaled $244.2 million, or 46.7% of Westfield Financial's total securities portfolio. Westfield Financial classifies U.S. Government securities and Government-sponsored enterprise securities as available for sale and held to maturity. These securities predominately have maturities of less than five years, although Westfield Financial also invests in adjustable rate securities with maturities of up to 30 years. Westfield Financial's mortgage-backed securities, which are directly or indirectly insured or guaranteed by Freddie Mac, Ginnie Mae or Fannie Mae or are rated AAA, consist of both fixed rate and adjustable rate securities primarily with average lives of less than five years. Westfield Financial also invests in municipal bonds issued by cities and towns in Massachusetts and are AAA rated by Moody's, Standard and Poor's, or Fitch, and the majority of which are also independently insured. These securities generally have maturities between seven and 20 years; however, many have earlier call dates. In addition, Westfield Financial has investments in Federal Home Loan Bank stock and mutual funds that invest only in securities allowed by the Office of Thrift Supervision.
Sources of Funds
General. Deposits, scheduled amortization and prepayments of loan principal, maturities and calls of investments securities and funds provided by operations are Westfield Bank's primary sources of funds for use in lending, investing and for other general purposes. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
Deposits. Westfield Bank offers a variety of deposit accounts having a range of interest rates and terms. Westfield Bank currently offers regular savings deposits (consisting of passbook and statement savings accounts), NOW accounts, noninterest-bearing demand accounts, money market accounts and time deposits. Westfield Bank has expanded the types of deposit products that it offers to include jumbo certificates of deposit, tiered money market accounts and customer repurchase agreements to compliment its increased emphasis on attracting commercial banking relationships.
Deposit flows are influenced significantly by general and local economic conditions, changes in prevailing interest rates, pricing of deposits and competition. Westfield Bank's deposits are primarily obtained from areas surrounding its offices. Westfield Bank relies primarily on paying competitive rates, service and long-standing relationships with customers to attract and retain these deposits. Westfield Bank does not use brokers to obtain deposits.
When Westfield Bank determines its deposit rates, it considers local competition, U.S. Treasury securities offerings and the rates charged on other sources of funds. Core deposits (defined as regular accounts, money market accounts, NOW accounts and demand accounts) represented 41.4% of total deposits on December 31, 2007 and 40.4% on December 31, 2006. At December 31, 2007 and December 31, 2006, time deposits with remaining terms to maturity of less than one year amounted to $266.2 million and $270.0 million, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Net Interest and Dividend Income" for information relating to the average balances and costs of Westfield Bank's deposit accounts for the years ended December 31, 2007, 2006 and 2005.
Certificate of Deposit Maturities. At December 31, 2007, Westfield Bank had $90.8 million in time certificates of deposit with balances of $100,000 and over maturing as follows:
Weighted Average Maturity Period Amount Rate - ----------------------------------------- ------ -------- (Dollars in thousands) Three months or less $28,786 4.85% Over three months through six months 23,798 4.50 Over six months through twelve months 15,190 4.42 Over twelve months 23,021 4.38 ------- Total $90,795 4.57% =======
Short-term and Long-term Debt. Westfield Bank also utilizes short-term borrowings and long-term debt as an additional source of funds to finance Westfield Bank's lending and investing activities and to provide liquidity for daily operations. Short-term borrowings are made up of Federal Home Loan Bank advances with an original maturity of less than one year as well as customer repurchase agreements, which have an original maturity of one day. Short-term borrowings issued by the Federal Home Loan Bank were $18.4 million at December 31, 2007 and $10.0 million at December 31, 2006. Westfield Bank's repurchase agreements are with commercial customers. These agreements are linked to customers' checking accounts. Excess funds are swept out of certain commercial checking accounts and into repurchase agreements where the customers can earn interest on their funds. By law, a bank cannot pay interest on commercial checking accounts; however, interest can be paid on non-deposit products such as repurchase agreements. Since these repurchase agreements are not deposits, they are not insured by the Federal Deposit Insurance Corporation. At December 31, 2007 and 2006, such repurchase agreements borrowings totaled $16.8 million and $17.9 million, respectively.
Long-term debt consists of Federal Home Loan Bank advances with an original maturity of one year or more. At December 31, 2007 and 2006, Westfield Bank's long-term debt was $105.0 million and $45.0 million, respectively.
Personnel
As of December 31, 2007, Westfield Bank had 145 full-time employees and 46 part-time employees. The employees are not represented by a collective bargaining unit, and Westfield Bank considers its relationship with its employees to be excellent.
TAXATION
Federal
General. The following discussion is intended as only a summary and does not purport to be a comprehensive description of the tax rules applicable to Westfield Bank or Westfield Financial. For federal income tax purposes, Westfield Bank reports its income on the basis of a taxable year ending December 31, using the accrual method of accounting, and Westfield Financial is generally subject to federal income taxation in the same manner as other corporations. Since December 27, 2001, Westfield Bank and Westfield Financial have constituted an affiliated group of corporations and, therefore, have reported their income on a consolidated basis. The tax years up to and including the year ended December 31, 2003 are closed.
Distributions. To the extent that Westfield Bank makes "non-dividend distributions" to stockholders, such distributions will be considered to result in distributions from Westfield Bank's unrecaptured tax bad debt reserve "base year reserve" (i.e. its reserve as of December 31, 1987), to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed, but no more than the amount of these reserves, will be included in Westfield Bank's taxable income. Non-dividend distributions include distributions in excess of Westfield Bank's current and accumulated earnings and profits, distributions in
redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of Westfield Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not constitute non-dividend distributions and, therefore, will not be included in Westfield Bank's income.
The amount of additional income created from a non-dividend distribution is equal to the lesser of Westfield Bank's base year reserve and supplemental reserve for losses on loans or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in some situations, approximately one and one-half times the non-dividend distribution would be includible in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate. Westfield Bank does not intend to pay dividends that would result in the recapture of any portion of the bad debt reserves.
Corporate Alternative Minimum Tax. The alternative minimum tax rules have been devised to ensure that at least a minimum amount of income tax is paid by high-income corporate taxpayers who take advantage of substantial tax savings due to the use of certain tax deductions and exemptions. In essence, the alternative minimum tax functions as a recapture mechanism, reclaiming some of the tax deductions and credits utilized by these taxpayers when calculating their regular federal income tax liability. In general, a corporation's alternative minimum taxable income is equal to its regular taxable income, increased by its preference items for the year and adjusted by computing certain items under special rules that negate the acceleration of certain tax benefits which are available under the regular tax rules. The alternative minimum tax rate is 20%. Such preference items include adjustments for tax exempt interest, inside build-up of life insurance policies and accelerated depreciation deductions. During the past five years, we have not been subject to alternative minimum tax and therefore have no alternative minimum tax net operating losses or credit to utilize.
Elimination of Dividends; Dividends Received Deduction. Westfield Financial may exclude from its income 100% of dividends received from Westfield Bank as a member of the same affiliated group of corporations.
Net Operating Losses. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding twenty taxable years. At December 31, 2007, Westfield Financial had no net operating loss carry forwards for federal income tax purposes.
State
Financial institutions in Massachusetts are not allowed to file consolidated income tax returns. Instead, each entity in the consolidated group files a separate annual income tax return. The Massachusetts excise tax rate for savings banks is currently 10.5% of federal taxable income, adjusted for certain items. Taxable income includes gross income as defined under the Internal Revenue Code, plus interest from bonds, notes and evidences of indebtedness of any state, including Massachusetts, less deductions, but not the credits, allowable under the
provisions of the Internal Revenue Code, except for those deductions relating to dividends received and income or franchise taxes imposed by a state or political subdivision. Carryforwards and carrybacks of net operating losses and capital losses are not allowed.
Westfield Financial's state tax returns, as well as those of its subsidiaries, are not currently under audit.
REGULATION
General. As a federally-chartered savings bank, Westfield Bank is subject to regulation, examination, and supervision by the Office of Thrift Supervision as its chartering authority, and the Federal Deposit Insurance Corporation as its deposit insurer. Westfield Bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation describing its activities and financial condition. Westfield Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board. This supervision and regulation is intended primarily for the protection of depositors.
Westfield Financial is a savings and loan holding company regulated by the Office of Thrift Supervision. As such, Westfield Financial is registered with and subject to Office of Thrift Supervision examination and supervision, as well as certain Office of Thrift Supervision reporting requirements. In addition, the Office of Thrift Supervision has enforcement authority over Westfield Financial and Westfield Financial's non-savings association subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings association. Unlike bank holding companies, federal savings and loan holding companies are not subject to any regulatory capital requirements or to supervision by the Federal Reserve Board. Westfield Financial also is required to file reports with the Office of Thrift Supervision and the Securities and Exchange Commission, and otherwise comply with the rules and regulations of the Office of Thrift Supervision and the Securities and Exchange Commission under federal securities laws.
The Office of Thrift Supervision and the Federal Deposit Insurance Corporation have significant discretion in connection with their supervisory and enforcement activities and examination policies. Any change in such policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission or the United States Congress, could have a material adverse impact on Westfield Bank and Westfield Financial's operations and stockholders.
The following discussion is intended to be a summary of the material statutes and regulations applicable to federal savings banks and their holding companies, and it does not purport to be a comprehensive description of all such statutes and regulations.
Regulation of Federal Savings Banks
Business Activities. Westfield Bank derives its lending and investment powers from the Home Owners' Loan Act, as amended, and Office of Thrift Supervision regulations. The Home Owners' Loan Act and the Office of Thrift Supervision regulations also limit Westfield Bank's authority to invest in certain types of loans or other investments. Permissible investments include, but are not limited to, mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities, and certain other assets. Westfield Bank may also establish service corporations that may engage in activities not otherwise permissible for Westfield Bank, including certain real estate equity investments and securities and insurance brokerage.
Loans to One Borrower. Westfield Bank is generally subject to the same limits on loans to one borrower as is a national bank. With specified exceptions, Westfield Bank's total loans or extensions of credit to a single borrower cannot exceed 15% of Westfield Bank's unimpaired capital and surplus, which does not include accumulated other comprehensive income. Westfield Bank may lend additional amounts up to 10% of its unimpaired capital and surplus which does not include accumulated other comprehensive income, if the loans or extensions of credit are fully-secured by readily-marketable collateral. Westfield Bank currently complies with applicable loans-to-one borrower limitations.
Qualified Thrift Lender Test. The Home Owners' Loan Act requires that Westfield Bank, as a savings association, comply with the qualified thrift lender test. Under the qualified thrift lender test, Westfield Bank is required to maintain at least 65% of its portfolio assets in certain "qualified thrift investments" in at least nine months of the most recent twelve-month period. "Portfolio assets" means, in general, Westfield Bank's total assets less the sum of:
o specified liquid assets up to 20% of total assets;
o goodwill and other intangible assets; and
o the value of property used to conduct Westfield Bank's business.
Westfield Bank also may satisfy the qualified thrift lender test by qualifying as a domestic building and loan association as defined in the Internal Revenue Code of 1986. If Westfield Bank fails the qualified thrift lender test, and is unable to correct that failure for a period of time, it must either operate under certain restrictions on its activities or convert to a bank charter.
Westfield Bank met the qualified thrift lender test at December 31, 2007 and in each of the prior 12 months, and, therefore, is a "qualified thrift lender."
Capital Requirements. Office of Thrift Supervision regulations require Westfield Bank to meet three minimum capital standards:
(1) a tangible capital ratio requirement of 1.5% of total assets as adjusted under Office of Thrift Supervision regulations;
(2) a leverage ratio requirement of 3% of core capital to such adjusted total assets, if a savings association has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Rating System; and
(3) a risk-based capital ratio requirement of 8% of core and supplementary capital to total risk-based assets, provided that the amount of supplementary capital used to satisfy this requirement may not exceed the amount of core capital.
The minimum leverage capital ratio for any other depository institution that does not have a composite rating of 1 will be 4%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. In determining the amount of risk-weighted assets for purposes of the risk-based capital requirement, a savings association must compute its risk-based assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the United States Government or its agencies to 100% for consumer and commercial loans, as assigned by the Office of Thrift Supervision capital regulation based on the risks found by the Office of Thrift Supervision to be inherent in the type of asset.
Tangible capital is defined, generally, as common stockholders' equity (including retained earnings), certain non-cumulative perpetual preferred stock and related earnings, minority interests in equity accounts of fully consolidated subsidiaries, less intangibles (other than certain mortgage servicing rights), and investments in and loans to subsidiaries engaged in activities not permissible for a national bank. Core capital (or Tier 1 capital) is defined similarly to tangible capital, but core capital also includes certain qualifying supervisory goodwill and certain purchased credit card relationships. Supplementary capital (or Tier 2 capital) currently includes cumulative and other preferred stock, mandatory convertible debt securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses. In addition, up to 45% of unrealized gains on available-for-sale equity securities with a readily determinable fair value may be included in Tier 2 capital. The allowance for loan and lease losses includable in Tier 2 capital is limited to a maximum of 1.25% of risk-weighted assets.
At December 31, 2007, Westfield Bank met each of its capital requirements, in each case on a fully phased-in basis. The table below presents Westfield Bank's regulatory capital as compared to the OTS regulatory capital requirements at December 31, 2007:
Bank Capital Requirements Excess Capital ---- -------------------- -------------- (In thousands)
Tangible capital 21.95% 19,348 193,044 Core capital 21.95% 38,696 173,696 Risk-based capital 38.76% 45,021 173,097
Community Reinvestment. Under the Community Reinvestment Act, as implemented by Office of Thrift Supervision regulations, Westfield Bank has a continuing and affirmative obligation, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act 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 Community Reinvestment Act. The Community Reinvestment Act requires the Office of Thrift Supervision, in connection with its examination of a savings association, to assess Westfield Bank's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by Westfield Bank.
The Community Reinvestment Act regulations establish an assessment system that bases an association's rating on its actual performance in meeting community needs. In particular, the assessment system focuses on three tests:
o a lending test, to evaluate the institution's record of making loans in its assessment areas;
o an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses in its assessment area or a broader area that includes its assessment area; and
o a service test, to evaluate the institution's delivery of services through its retail banking channels and the extent and innovativeness of its community development services.
Westfield Bank received a "Satisfactory" Community Reinvestment Act rating in its most recent examination.
Transactions with Affiliates. Westfield Bank's authority to engage in transactions with its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve Board's Regulation W, as made applicable to federal savings associations by the Home Owners' Loan Act and the Office of Thrift Supervision regulations. In general, these transactions must be on terms that are as favorable to Westfield Bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of Westfield Bank's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from Westfield Bank. In addition, Office of Thrift Supervision regulations prohibit a savings association from lending to any of its affiliates that engage in activities not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
Loans to Insiders. Westfield Bank's authority to extend credit to its directors, executive officers and principal stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board, as made applicable to federal savings associations by the Home Owners' Loan Act and the Office of Thrift Supervision regulations. Among other things, these provisions require that extensions of credit to insiders: (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Westfield Bank's capital. In addition, extensions for credit in excess of certain limits must be approved by Westfield Bank's Board of Directors.
Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over savings associations, including Westfield Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations as well as in response to unsafe or unsound practices.
Standards for Safety and Soundness. Pursuant to the Federal Deposit Insurance Act, the Office of Thrift Supervision has adopted a set of guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings standards, compensation, fees and benefits. In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.
In addition, the Office of Thrift Supervision adopted regulations that authorize, but do not require, the Office of Thrift Supervision to order a savings association that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being notified, a savings association fails to submit an acceptable plan of compliance or fails in any material respect to implement an accepted plan, the Office of Thrift Supervision must issue an order directing action to correct the deficiency, may issue an order directing other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of the Federal Deposit Insurance Act. If a savings association fails to comply with such an order, the Office of Thrift Supervision may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Prompt Corrective Regulatory Action. Pursuant to the Federal Deposit Insurance Act and the Office of Thrift Supervision prompt corrective action regulations, the Office of Thrift Supervision is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings associations. For this purpose, a savings association would be placed in one of the following four categories based on the association's capital:
o well-capitalized;
o adequately capitalized;
o undercapitalized; or
o critically undercapitalized.
When appropriate, the Office of Thrift Supervision can require corrective action by a savings and loan holding company under the "prompt corrective action" provisions of the Federal Deposit Insurance Act.
At December 31, 2007, Westfield Bank met the criteria for being considered "well-capitalized."
Capital Distributions. The Office of Thrift Supervision imposes various restrictions or requirements on Westfield Bank's ability to make capital distributions, including the payment of cash dividends. A savings association that is the subsidiary of a savings and loan holding company must file a notice with the Office of Thrift Supervision at least 30 days before making a capital distribution. Westfield Bank must file an application for prior approval if the total amount of its capital distributions for the applicable calendar year would exceed an amount equal to Westfield Bank's net income for that year plus Westfield Bank's retained net income for the previous two years.
The Office of Thrift Supervision may disapprove of a notice of application if:
o Westfield Bank would be undercapitalized following the distribution;
o the proposed capital distribution raises safety and soundness concerns; or
o the capital distribution would violate a prohibition contained in any statute, regulation, or agreement.
Liquidity. Westfield Bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
Insurance of Deposit Accounts. Westfield Bank is a member of the Deposit Insurance Fund, maintained by the Federal Deposit Insurance Corporation, and Westfield Bank pays its deposit insurance assessments to the Deposit Insurance Fund. The Deposit Insurance Fund was formed on March 31, 2006 following the merger of the Bank Insurance Fund and the Savings Association Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005. In addition to merging the insurance funds, the Federal Deposit Insurance Reform Act established a statutory minimum and maximum designated reserve ratio for the Deposit Insurance Fund and granted the Federal Deposit Insurance Corporation greater flexibility in establishing the required reserve ratio. In its regulations implementing the Federal Deposit Insurance Reform Act, the Federal Deposit Insurance Corporation has set the current annual designated reserve ratio for the Deposit Insurance Fund at 1.25%.
In order to maintain the Deposit Insurance Fund, member institutions are assessed an insurance premium. The amount of each institution's premium is currently based on the balance of insured deposits and the degree of risk the institution poses to the Deposit Insurance Fund. Under the assessment system, the Federal Deposit Insurance Corporation assigns an institution to one of nine risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory subgroup assignment). Each risk category is assigned an assessment rate. Assessment rates currently range from 0% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.43% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concerns). The Federal Deposit Insurance Corporation is authorized to raise the assessment rates as necessary to maintain the Deposit Insurance Fund. Westfield Bank's assessment rate at December 31, 2007 was 0.0125%. Any increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including Westfield Bank.
In addition, all Federal Deposit Insurance Corporation-insured institutions are required to pay a pro rata portion of the interest due on obligations issued by the Financing Corporation to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2007, the Federal Deposit Insurance Corporation assessed Deposit Insurance Fund-insured deposits 1.14 basis points per $100 of deposits to cover those obligations. The Financing Corporation rate is adjusted quarterly to reflect changes in assessment bases of the Deposit Insurance Fund. This obligation will continue until the Financing Corporation bonds mature in 2017.
Federal Home Loan Bank System. Westfield Bank is a member of the Federal Home Loan Bank of Boston, which is one of the regional Federal Home Loan Banks composing the Federal Home Loan Bank System. Each Federal Home Loan Bank serves as a central credit facility primarily for its member institutions. Westfield Bank, as a member of the Federal Home Loan Bank of Boston, is required to acquire and hold shares of capital stock in the Federal Home Loan Bank of Boston. While the required percentages of stock ownership are subject to change by the Federal Home Loan Bank of Boston, Westfield Bank was in compliance with this requirement with an investment in Federal Home Loan Bank of Boston stock at December 31, 2007 of $7.3 million. Any advances from an Federal Home Loan Bank must be secured by specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for residential housing finance.
The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of earnings that the Federal Home Loan Banks can pay as dividends to their members and could also 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, Westfield Bank's net interest income would be affected.
Federal Reserve System. Westfield Bank is subject to provisions of the Federal Reserve Act and the Federal Reserve Board's regulations under which depository institutions may be required to maintain non-interest-earning reserves against their deposit accounts and certain other liabilities. Currently, reserves must be maintained against transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations exempt $8.5 million of otherwise reservable balances from the reserve requirements. A 3.0% reserve is required for transaction account balances over $8.5 million and up to $45.8 million. Transaction account balances over $45.8 million are subject to a reserve requirement of $1,119,000 plus 10% of the amount over $45.8 million. Westfield Bank is in compliance with the foregoing reserve requirements. Because required reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a Federal Reserve Bank, or a pass-through account as defined by the Federal Reserve Board, the effect of this reserve requirement is to reduce Westfield Bank's interest-earning assets. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision. Federal Home Loan Bank System members are also authorized to borrow from the Federal Reserve Board discount window, but Federal Reserve Board regulations require such institutions to exhaust all Federal Home Loan Bank sources before borrowing from the Federal Reserve Board.
Prohibitions Against Tying Arrangements. Federal savings associations are subject to prohibitions on certain tying arrangements. A savings association is prohibited, subject to some exceptions, from extending credit or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain credit or services from a competitor of the institution.
The Bank Secrecy Act. Westfield Bank and Westfield Financial are subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act, which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, and mandatory transaction reporting obligations. By way of example, the Bank Secrecy Act imposes an affirmative obligation on Westfield Bank to report currency transactions that exceed certain thresholds and to report other transactions determined to be suspicious.
Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among financial institutions, bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other requirements, the USA PATRIOT Act imposes the following obligations on financial institutions:
o financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program;
o financial institutions must establish and meet minimum standards for customer due diligence, identification and verification;
o financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) must establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering through those accounts;
o financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and are subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks; and
o bank regulators are directed to consider a depository institutions's or holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.
Office of Foreign Asset Control. Westfield Bank and Westfield Financial are, like all United States companies and individuals, prohibited from transacting business with certain individuals and entities named on the Office of Foreign Asset Control's list of Specially Designated Nationals and Blocked Persons. Failure to comply may result in fines and other penalties. The Office of Foreign Asset Control has issued guidance directed at financial institutions in which it asserts that it may, in its discretion, examine institutions determined to be high-risk or to be lacking in their efforts to comply with these prohibitions.
Holding Company Regulation
Activities Restrictions Applicable to Westfield Financial. Under the Gramm-Leach-Bliley Act, Westfield Financial is prohibited from engaging in non-financial activities. As a result, Westfield Financial's activities are restricted to:
o furnishing or performing management services for a savings institution subsidiary of such holding company;
o conducting an insurance agency or escrow business;
o holding, managing, or liquidating assets owned or acquired from a savings association subsidiary of such company;
o holding or managing properties used or occupied by a savings association subsidiary of such company;
o acting as trustee under a deed of trust;
o any other activity (i) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Director of the Office of Thrift Supervision, by regulation, prohibits or limits any such activity for savings and loan holding companies, or (ii) in which multiple savings and loan holding companies were authorized by regulation to directly engage in on March 5, 1987;
o purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such holding company is approved by the Director of the Office of Thrift Supervision; and
o any activity permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act.
Permissible activities which are deemed to be financial in nature or incidental thereto under Section 4(k) of the Bank Holding Company Act include:
o lending, exchanging, transferring, investing for others, or safeguarding money or securities;
o insurance activities or providing and issuing annuities, and acting as principal, agent, or broker;
o financial, investment, or economic advisory services;
o issuing or selling instruments representing interests in pools of assets that a bank is permitted to hold directly;
o underwriting, dealing in, or making a market in securities;
o activities previously determined by the Federal Reserve Board to be closely related to banking;
o activities that bank holding companies are permitted to engage in outside of the U.S.; and
o portfolio investments made by an insurance company.
In addition, we cannot be acquired or acquire a company unless the acquirer is engaged solely in financial activities.
Restrictions on Acquisition of Control Applicable to Westfield Financial. The Home Owners' Loan Act prohibits all savings and loan holding companies, including Westfield Financial, from acquiring, directly or indirectly:
o control (as defined under the Home Owners' Loan Act) of another savings association (or a holding company parent) without prior Office of Thrift Supervision approval;
o through merger, consolidation, or purchase of assets, another savings association or a holding company thereof, or acquiring all or substantially all of the assets of such savings association (or a holding company) without prior Office of Thrift Supervision approval; or
o control of any depository institution not insured by the Federal Deposit Insurance Corporation (except through a merger with and into the holding company's savings association subsidiary that is approved by the Office of Thrift Supervision).
A savings and loan holding company may not acquire as a separate subsidiary a savings association that has a principal office outside of the state where the principal office of its subsidiary savings association is located, except:
o in the case of certain emergency acquisitions approved by the Federal Deposit Insurance Corporation;
o if such holding company controls a savings savings association subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or
o if the laws of the state in which the savings association to be acquired is located specifically authorize a savings association chartered by that state to be acquired by a savings association chartered by the state where the acquiring savings association or savings and loan holding company is located or by a holding company that controls such a state-chartered association.
Federal Securities Laws. Westfield Financial's common stock is registered with the Securities and Exchange Commission under Section 12(b) of the Securities Exchange Act of 1934, as amended, and Westfield Financial is subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Securities Exchange Act of 1934, as amended.
The Sarbanes-Oxley Act. As a public company, Westfield Financial is subject to the Sarbanes-Oxley Act of 2002, which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. The Sarbanes-Oxley Act's principal legislation and the derivative regulation and rule making promulgated by the Securities and Exchange Commission includes:
o the creation of an independent accounting oversight board;
o auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients;
o additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;
o a requirement that companies establish and maintain a system of internal control over financial reporting and that a company's management provide an annual report regarding its assessment of the effectiveness of such internal control over financial reporting to the company's independent accountants and that such accountants provide an attestation report with respect to management's assessment of the effectiveness of the company's internal control over financial reporting;
o the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
o an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the company's independent auditors;
o the requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;
o the requirement that companies disclose whether at least one member of the committee is a "financial expert" (as such term is defined by the Securities and Exchange Commission) and if not, why not;
o expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;
o a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;
o disclosure of a code of ethics and the requirement of filing of a Form 8-K for a change or waiver of such code;
o mandatory disclosure by analysts of potential conflicts of interest; and
o a range of enhanced penalties for fraud and other violations.
Section 402 of the Sarbanes-Oxley Act prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act). The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as Westfield Bank, that are subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act.
Quotation on Nasdaq. Westfield Financial's common stock is quoted on The Nasdaq Stock Market. In order to maintain such quotation, Westfield Financial is subject to certain corporate governance requirements, including:
o a majority of its board must be composed of independent directors;
o it is required to have an audit committee composed of at least three directors, each of whom is an independent director, as such term is defined by the rules of the National Association of Securities Dealers and by the Exchange Act regulations;
o its nominating committee and compensation committee must also be composed entirely of independent directors; and
o each of its audit committee and nominating committee must have a publicly available written charter.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our loan portfolio includes loans with a higher risk of loss. Westfield Bank originates commercial and industrial loans, commercial real estate loans, consumer loans, and residential mortgage loans primarily within our market area. In recent years, Westfield Bank has developed and implemented a lending strategy that focuses less on residential real estate lending and more on servicing commercial customers, including increased emphasis on commercial and industrial lending and commercial deposit relationships. Commercial and industrial loans, commercial real estate loans, and consumer loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial real estate and commercial and industrial loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit risk than residential real estate for the following reasons:
o Commercial and Industrial Loans. Repayment is generally dependent upon the successful operation of the borrower's business.
o Commercial Real Estate Loans. Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.
o Consumer Loans. Consumer loans are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage or loss.
Any downturn in the real estate market or local economy could adversely affect the value of the properties securing the loans or revenues from the borrower's business, thereby increasing the risk of non-performing loans. Decreases in real estate values could adversely affect the value of property used as collateral for our commercial real estate loans. Adverse changes in the economy may also have a negative effect on the ability of our commercial borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings. In addition, if poor economic conditions result in decreased demand for loans, our profits may decrease because our alternative investments may earn less income for us than loans.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease. Our loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We therefore may experience significant loan losses, which could have a material adverse effect on our operating results.
Material additions to our allowance for loan losses also would materially decrease our net income, and the charge-off of loans may cause us to increase the allowance. We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance.
Changes in interest rates could adversely affect our results of operations and financial condition. Our profitability, like that of most financial institutions, depends substantially on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. Increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits, which will result in a decrease of our net interest income.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities.
Changes in the national and local economy may affect our future growth possibilities. Our current market area is principally located in Hampden County, Massachusetts. Our future growth opportunities depend on the growth and stability of our regional economy and our ability to expand our market area. A downturn in our local economy may limit funds available for deposit and may negatively affect our borrowers' ability to repay their loans on a timely basis, both of which could have an impact on our profitability.
During 2007, there has been a decline in the housing and real estate markets and in the general economy, both nationally and locally with some reports indicating that the national economy is bordering on a recession. Housing market conditions in our market area have deteriorated during 2007 as evidenced by reduced levels of sales, increasing inventories of houses on the market, declining house prices and an increase in the length of time houses remain on the market. No assurance can be given that these conditions will improve or will not worsen or that such conditions will not result in a decrease in our interest income, a decrease in fee income from our relationship with a third party mortgage company, an increase in our non-performing loans, an increase in our provision for loan losses or an adverse impact on our loan losses.
The second half of 2007 has been highlighted by significant disruption and volatility in the financial and capital marketplaces. This turbulence has been attributable to a variety of factors, including the fallout associated with the sub-prime mortgage market. One aspect of this fallout has been significant deterioration in the activity of the secondary residential mortgage market. The disruptions have been exacerbated by the acceleration of the decline of the real estate and housing market. We cannot assure you that these conditions will improve or will not worsen or that such conditions will not result in a decrease in our interest income, a decrease in fee income from our relationship with a third party mortgage company, or an adverse impact on our loan losses.
We depend on our executive officers and key personnel to continue the implementation of our long-term business strategy and could be harmed by the loss of their services. We believe that our continued growth and future success will depend in large part upon the skills of our management team. The competition for qualified personnel in the financial services industry is intense, and the loss of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business. We cannot assure you that we will be able to retain our existing key personnel or attract additional qualified personnel. We will
have employment agreements with our Chairman and Chief Executive Officer, President and Chief Operating Officer, and Chief Financial Officer, and change of control agreements with several other senior executive officers, and the loss of the services of one or more of our executive officers and key personnel could impair our ability to continue to develop our business strategy.
We operate in a highly regulated environment, and changes in laws and regulations to which we are subject may adversely affect our results of operations. Westfield Bank is subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, as its chartering authority, and by the Federal Deposit Insurance Corporation as the insurer of its deposits up to certain limits. In addition, the Office of Thrift Supervision regulates and oversees Westfield Financial and Westfield Mutual Holding Company. 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. 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 Federal Deposit Insurance Corporation regulation, the Federal Deposit Insurance Corporation'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, and the Real Estate Settlement Procedures Act. Any change in the laws or regulations applicable to us, or in banking regulators' supervisory policies or examination procedures, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, other state or federal regulators, or the United States Congress could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Competition in our primary market area may reduce our ability to attract and retain deposits and originate loans. We operate in a competitive market for both attracting deposits, which is our primary source of funds, and originating loans. Historically, our most direct competition for deposits has come from savings and commercial banks. Our competition for loans comes principally from commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. We also face additional competition from internet-based institutions, brokerage firms and insurance companies. Competition for loan originations and deposits may limit our future growth and earnings prospects.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Westfield Bank currently conducts its business through its eleven banking offices and eight off-site ATMs. As of December 31, 2007, the properties and leasehold improvements owned by us had an aggregate net book value of $12.7 million.
Year of Lease or Location Ownership Year Opened License Expiration - -------- --------- ----------- ------------------
Main Office:
141 Elm St. Owned 1964 N/A Westfield, MA
Branch Offices:
206 Park St. Owned 1957 N/A West Springfield, MA
655 Main St. Owned 1968 N/A Agawam, MA
26 Arnold St. Owned 1976 N/A Westfield, MA
300 Southampton Rd. Owned 1987 N/A Westfield, MA
462 College Highway Owned 1990 N/A Southwick, MA
382 North Main St. Leased 1997 2012 E. Longmeadow, MA
1500 Main St. Leased 2006 2016 Springfield, MA
1642 Northampton St. Owned 2001 N/A Holyoke, MA
1342 Liberty St. Owned 2001 N/A Springfield, MA
560 East Main St. Leased 2007 2046 Westfield, MA
ATMs:
337 N. Westfield St. Leased 1988 2013 Feeding Hills, MA
830 Suffield St. Tenant at will 1997 N/A Agawam, MA
516 Carew St. Tenant at will 2002 N/A Springfield, MA
1000 State St. Tenant at will 2003 N/A Springfield, MA
115 West Silver St. Tenant at will 2005 N/A Westfield, MA
788 Memorial Ave. Leased 2006 2016 West Springfield, MA
2620 Westfield St. Leased 2006 2020 West Springfield, MA
98 Southwick Rd. Leased 2006 2021 Westfield, MA
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Westfield Financial is not involved in any pending legal proceeding other than routine legal proceedings occurring in the ordinary course of business. In the opinion of management, no legal proceedings will have a material effect on Westfield Financial's consolidated financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Effective on August 21, 2007, Westfield Financial switched the listing of its common stock from the American Stock Exchange to the NASDAQ Stock Market and retained the symbol "WFD." At December 31, 2007, there were 31,933,549 shares of common stock issued and outstanding, and there were approximately 5,656 shareholders of record.
On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007.
The table below shows the high and low sales price during the periods indicated as well as dividends declared per share. The information set forth in the table below was provided by the American Stock Exchange and NASDAQ.
Cash Dividends Price Per Share Declared ----------------- --------- For the Year Ended December 31, 2007 High Low ------------------------------------ ---- --- Fourth Quarter ended December 31, 2007 $10.18 $ 9.49 $0.25 Third Quarter ended September 30, 2007 10.25 8.73 0.05 Second Quarter ended June 30, 2007 10.83 9.97 0.05 First Quarter ended March 31, 2007 11.02 10.16 0.05
Cash Dividends Price Per Share(*) Declared(*) ----------------- --------- For the Year Ended December 31, 2006 High Low ------------------------------------ ---- --- Fourth Quarter ended December 31, 2006 $10.64 $ 9.63 $0.11 Third Quarter ended September 30, 2006 10.04 8.37 0.05 Second Quarter ended June 30, 2006 8.84 7.07 0.11 First Quarter ended March 31, 2006 7.69 7.31 0.05
---------------- (*) Per share amounts related to periods prior to the date of completion of the conversion (January 3, 2007) have been restated to give retroactive recognition to the exchange ratio applied in the conversion.
A quarterly cash dividend of $0.05 per share was declared on January 23, April 24, July 17, and October 23, 2007 by the Board of Directors. In addition, the Board of Directors declared a special cash dividend of $0.20 per share on October 23, 2007. The continued payment of dividends depends upon our debt and equity structure, earnings, financial condition, need for capital in connection with possible future acquisitions and other factors, including economic conditions, regulatory restrictions and tax considerations. Westfield Financial cannot guarantee the payment of dividends or that, if paid, that dividends will not be reduced or eliminated in the future.
The only funds available for the payment of dividends on the capital stock of Westfield Financial will be cash and cash equivalents held by Westfield Financial, dividends paid by Westfield Bank to Westfield Financial, and borrowings. Westfield Bank will be prohibited from paying cash dividends to Westfield Financial to the extent that any such payment would reduce Westfield Bank's capital below required capital levels or would impair the liquidation account to be established for the benefit of Westfield Bank's eligible account holders and supplemental eligible account holders at the time of the reorganization and stock offering.
There were no sales by Westfield Financial of unregistered securities during the year ended December 31, 2007.
Performance Graph
The following graph compares Westfield Financial, Inc.'s total cumulative shareholder return by an investor who invested $100.00 on December 31, 2002 to December 31, 2007, to the total return by an investor who invested $100.00 in each of the Russell 2000 Index and the Nasdaq Bank Index for the same period.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN Among Westfield Financial, Inc., The Russell 2000 Index and the NASDAQ Bank Index
[GRAPH OMITTED]
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The summary information presented below at or for each of the years presented is derived in part from the consolidated financial statements of Westfield Financial. The following information is only a summary, and you should read it in conjunction with our consolidated financial statements and notes beginning on page.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview. Westfield Financial strives to remain a leader in meeting the financial service needs of the local community and to provide quality service to the individuals and businesses in the market areas that it has served since 1853. Historically, Westfield Bank has been a community-oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. Westfield Bank meets the needs of its local community through a community-based and service-oriented approach to banking.
On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007. Proceeds, net of stock issuance costs, were approximately $171.7 million.
Westfield Financial has adopted a growth-oriented strategy that has focused on increased commercial lending. Westfield Financial's strategy also calls for increasing deposit relationships and broadening its product lines and services. Westfield Financial believes that this business strategy is best for its long term success and viability, and complements its existing commitment to high quality customer service. In connection with its overall growth strategy, Westfield Bank seeks to:
o continue to grow its commercial and industrial and commercial real estate loan portfolio by targeting businesses in its primary market area and in northern Connecticut as a means to increase the yield on and diversify its loan portfolio and build transactional deposit account relationships;
o focus on expanding its retail banking franchise and increase the number of households served within its market area; and
o depending on market conditions, refer substantially all of the fixed-rate residential real estate loans to a third party mortgage company which underwrites, originates and services these loans in order to diversify its loan portfolio, increase fee income and reduce interest rate risk.
Please review our financial results for the year ended December 31, 2007 in the context of this strategy.
o Net income for the year ended December 31, 2007 was $8.7 million, or $0.29 per diluted share compared to $4.7 million, or $0.15 per diluted share for the same period in 2006. The increase in earnings was primarily the result of an increase in net interest income, partially offset by increased noninterest expenses.
o Net interest income increased $7.3 million to $30.2 million for the year ended December 31, 2007, compared to $22.9 million for the same period in 2006. The net interest margin, on a tax equivalent basis, was 3.25% and 3.05% for the years ended December 31, 2007 and 2006, respectively. The increase in net interest margin was primarily the
result of the reinvestment of the proceeds of Westfield Financial's second step stock offering, which was completed on January 3, 2007.
o Noninterest expense was $21.8 million for the year ended December 31, 2007, compared to $19.4 million for the same period in 2006. This increase was primarily due to an increase of $1.8 million in salaries and benefits to $13.7 million for the year ended December 31, 2007. Salaries expense increased $1.2 million as a result of hiring new employees and normal increases in employee salaries. A portion of the hiring was associated with a new branch which opened for business during the second quarter of 2007. Expenses related to share-based compensation increased $848,000 for the year ended December 31, 2007 as a result of new grants of restricted stock and stock options in the third quarter of 2007, along with expenses related to Westfield Financial's tax-qualified employee stock ownership plan.
o Total assets increased $43.0 million to $1.0 billion at December 31, 2007 from $996.8 million at December 31, 2006. Investment securities increased $113.8 million to $522.8 million at December 31, 2007 from $409.0 million at December 31, 2006. Investment securities increased as management invested the proceeds of Westfield Financial's second step conversion, which was completed on January 3, 2007. Cash and cash equivalents decreased $116.9 million to $37.6 million at December 31, 2007 from $154.5 million at December 31, 2006. The decrease in cash and cash equivalents was the result of management investing the proceeds of Westfield Financial's second step stock offering, which was completed on January 3, 2007, in investment securities and loans.
o Total loans during the period increased by $29.9 million to $420.1 million at December 31, 2007 from $390.2 million at December 31, 2006. The increase in total loans was primarily the result of an increase in commercial and industrial loans and commercial real estate loans. Commercial and industrial loans increased $16.3 million to $116.5 million at December 31, 2007 from $100.2 million at December 31, 2006. Commercial real estate loans increased $15.4 million to $190.0 million at December 31, 2007 from $174.6 million at December 31, 2006.
o Residential real estate loans were $108.1 million at December 31, 2007 and $109.5 million at December 31, 2006. Since September 2001, Westfield Bank has referred substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans.
o Asset growth was funded primarily through a $68.4 million increase in Federal Home Loan Bank borrowings, which totaled $123.4 million at December 31, 2007. Management placed less emphasis on gathering time deposits in favor of using other types of funding, such as borrowings.
o Total deposits decreased $24.8 million to $602.7 million at December 31, 2007 from $627.5 million at December 31, 2006. The decrease in deposits was due to a decrease in time deposits and money market accounts, partially offset by an increase in regular savings and checking accounts. Time deposits decreased $20.7 million to $353.3 million at December 31, 2007. The increases in both regular savings and checking accounts were fueled by new products with higher interest rates than Westfield Bank's other comparable products.
o Stockholders' equity decreased $2.9 million to $286.5 million at December 31, 2007 from $289.4 million at December 31, 2006. This represented 27.6% of total assets as of December 31, 2007 and 29.0% of total assets as of December 31, 2006. The change is primarily comprised of the payment of regular and special dividends amounting to $0.40 per share in 2007 for a total of $12.1 million, partially offset by net income of $8.7 million for the year ended December 31, 2007.
o Nonperforming loans were $1.2 million at December 31, 2007 and $1.0 million December 31, 2006. This represents 0.29% and 0.26% of total loans at December 31, 2007 and December 31, 2006, respectively. Charge-offs decreased by $267,000 to $317,000 for the year ended December 31, 2007 from $570,000 for the year ended December 31, 2006.
o The allowance for loan losses was $5.7 million at December 31, 2007 and $5.4 million at December 31, 2006. This represents 1.36% of total loans at December 31, 2007 and 1.39% of total loans at December 31, 2006. At these levels, the allowance for loan losses as a percentage of nonperforming loans was 476% at December 31, 2007 and 529% at December 31, 2006.
General. Westfield Financial's consolidated results of operations are comprised of earnings on investments and the net income recorded by its principal operating subsidiary, Westfield Bank. Westfield Bank's consolidated results of operations depend primarily on net interest and dividend income. Net interest and dividend income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Interest-earning assets consist primarily of commercial real estate loans, commercial and industrial loans, residential real estate loans, consumer loans, mortgage-backed securities and investment securities. Interest-bearing liabilities consist primarily of certificates of deposit and money market account, NOW account and savings account deposits and borrowings from the Federal Home Loan Bank of Boston. The consolidated results of operations also depend on provision for loan losses, noninterest income, and noninterest expense. Noninterest expense includes salaries and employee benefits, occupancy expenses and other general and administrative expenses. Noninterest income includes service fees and charges, income on bank-owned life insurance, and gains (losses) on sales of securities.
Critical Accounting Policies. Westfield Financial's accounting policies are disclosed in Note 1 to the Consolidated Financial Statements. Given Westfield Financial's current business strategy and asset/liability structure, the more critical policies are accounting for nonperforming loans, the allowance for loan losses and provision for loan losses, the classification of securities as either held to maturity or available for sale, other than temporary impairment of securities, and discount rate assumptions used for benefit liabilities. In addition to the informational disclosure in the Notes to the Consolidated Financial Statements, Westfield Financial's policy on each of these accounting policies is described in detail in the applicable sections of "Management's Discussion and Analysis of Financial Condition and Results of Operations." Senior management has discussed the development and selection of these accounting estimates and the related disclosures with the Audit Committee of Westfield Financial's Board of Directors.
On a quarterly basis, Westfield Financial reviews investment securities with unrealized depreciation on a judgmental basis to assess whether the decline in fair value is temporary or other than temporary. 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 and near-term prospects of the issuer, and (3) the intent and ability of Westfield Financial to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Securities, including mortgage-backed securities, which management has the positive intent and ability to hold until maturity are classified as held to maturity and are carried at amortized cost. Securities, including mortgage-backed securities, that have been identified as assets for which there is not a positive intent to hold to maturity are classified as available for sale and are carried at fair value with unrealized gains and losses, net of income taxes, reported as a separate component of equity. Accordingly, a misclassification would have a direct effect on stockholders' equity. Sales or reclassification as available for sale (except for certain permitted reasons) of held to maturity securities may result in the reclassification of all such securities to available for sale. Westfield Financial has never sold held to maturity securities or reclassified such securities to available for sale other than in specifically permitted circumstances. Westfield Financial does not acquire securities or mortgage-backed securities for purposes of engaging in trading activities.
Westfield Financial's general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and when subsequent performance reduces the concern as to the collectibility of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans.
The process of evaluating the loan portfolio, classifying loans and determining the allowance and provision is described in detail in "Business of Westfield Financial and Westfield Bank - Lending Activities - Allowance for Loan Losses." Westfield Financial's methodology for assessing the allocation of the allowance consists of two key components, which are a specific allowance for identified problems or impaired loans and a formula allowance for the remainder of the portfolio. Measurement of impairment can be based on present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The allocation of the allowance is also reviewed by management based upon its evaluation of then-existing economic and business conditions affecting Westfield Financial's key lending areas and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Although management believes it has established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
The discount rate assumptions used to measure benefit liabilities are set to reflect prevailing yields on high quality fixed income investments. A higher discount rate decreases the present value of benefit obligations and decreases pension expense.
Average Balance Sheet and Analysis of Net Interest and Dividend Income
The following table sets forth information relating to Westfield Financial's condition and net interest and dividend income for the years ended December 31, 2007, 2006 and 2005 and reflect the average yield on assets and average cost of liabilities for the years indicated. The yields and costs were derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the years shown. Average balances were derived from actual daily balances over the years indicated. Interest income includes fees earned from making changes in loan rates or terms, and fees earned when commercial real estate loans were prepaid or refinanced.
The interest earned on tax exempt assets is adjusted to a tax equivalent basis to recognize the income tax savings which facilitates comparison between taxable and tax exempt assets.
Rate/Volume Analysis. The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected Westfield Financial's interest and dividend income and interest expense during the periods indicated. Information is provided in each category with respect to: (1) interest income changes attributable to changes in volume (changes in volume multiplied by prior rate); (2) interest income changes attributable to changes in rate (changes in rate multiplied by prior volume); and (3) the net change.
The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Comparison of Financial Condition at December 31, 2007 and December 31, 2006
Total assets increased $43.0 million to $1.0 billion at December 31, 2007 from $996.8 million at December 31, 2006. Cash and cash equivalents decreased $116.9 million, to $37.6 million at December 31, 2007 from $154.5 million at December 31, 2006. The decrease in cash and cash equivalents was the result of management investing the proceeds of Westfield Financial's second step stock offering, which was completed on January 3, 2007, in investment securities and loans.
Securities and mortgage-backed securities increased $113.8 million to $522.8 million at December 31, 2007 from $409.0 million at December 31, 2006. Investment securities increased as management invested the proceeds of Westfield Financial's second step stock offering, which was completed on January 3, 2007. The securities portfolio is primarily comprised of mortgage-backed securities, which totaled $380.8 million at December 31, 2007, the majority of which were issued by government-sponsored enterprises such as Fannie Mae. Privately issued mortgage-backed securities comprised 11.9% of the mortgage-backed securities portfolio at December 31, 2007, are rated AAA by Standard & Poors, and contain no sub-prime collateral.
Debt securities issued by government-sponsored enterprises increased by $20.4 million to $102.2 million at December 31, 2007 from $81.8 million at December 31, 2006. Securities issued by government-sponsored enterprises consist entirely of bonds issued by the Fannie Mae, Freddie Mac and the Federal Home Loan Bank of Boston. Westfield Financial also invests in municipal bonds issued by cities and towns in Massachusetts and are AAA rated by Moody's, Standard & Poor's, or Fitch, and the majority of which are also independently insured. Municipal bonds were $33.0 million at December 31, 2007 and $30.2 million at December 31, 2006. In addition, Westfield Financial has investments in Federal Home Loan Bank stock and mutual funds that invest only in securities allowed by the Office of Thrift Supervision.
Net loans increased by $29.7 million to $414.9 million at December 31, 2007 from $385.2 million at December 31, 2006. This was primarily the result of an increase in commercial and industrial loans and commercial real estate loans. Commercial and industrial loans increased $16.3 million to $116.5 million at December 31, 2007 from $100.2 million at December 31, 2006. Commercial real estate loans increased $15.4 million to $189.9 million at December 31, 2007 from $174.5 million at December 31, 2006. The increase in commercial and industrial loans and commercial real estate loans were due to increased loan originations.
Residential real estate loans decreased $1.4 million to $108.1 million at December 31, 2007 from $109.5 million at December 31, 2006. Since September 2001, Westfield Bank has referred substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans.
Asset growth was funded primarily through a $68.4 million increase in Federal Home Loan Bank borrowings and debt, which totaled $123.4 million at December 31, 2007. Customer repurchase agreements decreased $1.1 million to $16.8 million at December 31, 2007 from $17.9 million at December 31, 2006. A customer repurchase agreement is an agreement by Westfield Bank to sell to and repurchase from the customer an interest in specific securities issued by or guaranteed by the United States Government. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. At December 31, 2007, all of Westfield Bank's customer repurchase agreements were held by commercial customers.
Total deposits decreased $24.8 million to $602.7 million at December 31, 2007 from $627.5 million at December 31, 2006. The decrease in deposits was due to a decrease in time deposit and money market accounts, partially offset by an increase in regular savings and checking accounts. Time deposits decreased $20.7 million to $353.3 million at December 31, 2007. Management placed less emphasis on gathering time deposits in favor of using other types of funding, such as borrowings and debt.
Money market accounts decreased $19.8 million to $74.6 million at December 31, 2007. These decreases were partially offset by increases of $11.0 million in regular savings and $4.9 million in checking accounts. The increases in both regular savings and checking accounts were fueled by new products with higher interest rates than Westfield Bank's other comparable products.
Stockholders' equity decreased $2.9 million to $286.5 million at December 31, 2007 from $289.4 million at December 31, 2006. This represented 27.6% of total assets as of December 31, 2007 and 29.0% of total assets as of December 31, 2006. The change is primarily comprised of paying out regular and special dividends amounting to $0.40 per share in 2007 for a total of $12.1 million, partially offset by net income of $8.7 million for the year ended December 31, 2007.
Comparison of Operating Results for Years Ended December 31, 2007 and 2006
General. Net income for the year ended December 31, 2007 was $8.7 million, or $0.29 per diluted share, compared to $4.7 million, or $0.15 per diluted share for the same period in 2006. The increase in earnings was primarily the result of increase in net interest income, partially offset by increased noninterest expenses.
Interest and Dividend Income. Total interest and dividend income increased $11.2 million, or 26.3%, to $53.6 million for the year ended December 31, 2007, compared to $42.4 million for the same period in 2006.
The increase in interest income was primarily the result of a $166.7 million increase in average earnings assets as a result of funds raised in Westfield Financial's second step stock offering, which was completed on January 3, 2007. Average earning assets were $943.9 million for the year ended December 31, 2007 compared to $777.2 million for the same period in 2006. The average yield on earning assets, on a tax equivalent basis, increased 17 basis points to 5.73% for the twelve months ended December 31, 2007 from 5.56% for the same period in 2006.
Interest and dividends on securities was $23.9 million for the year ended December 31, 2007 and $16.1 million for the same period in 2006. The average balance on securities increased $119.5 million to $492.0 million at December 31, 2007 from $372.5 million at December 31, 2006. In addition, the tax equivalent yield on securities increased to 4.95% for the year 2007 from 4.50% for the year 2006. The increase in interest and dividend income was primarily the result of the reinvestment of the proceeds of Westfield Financial's second step stock offering, which was completed on January 3, 2007. In addition, as lower yielding investments purchased in a higher rate environment matured, were called or paid down in 2007, the funds were reinvested at higher rates.
Interest income from commercial and industrial loans and commercial real estate loans increased $1.2 million for the year ended December 31, 2007 from the year ended December 31, 2006. In accordance with Westfield Bank's strategic plan, the average balance of commercial and industrial loans and commercial real estate loans increased $13.7 million to $282.9 million for the year ended December 31, 2007, compared to $269.2 million for the same period in 2006.
Interest income from residential real estate loans increased $250,000 to $6.6 million for the year ended December 31, 2007 compared to $6.4 million for the same period in 2006. The average balance of residential real estate loans decreased $664,000 to $109.9 million for the year ended December 31, 2007 from $110.6 million for the year ended December 31, 2006. The average balance of home equity loans increased $6.4 million to $33.4 million but was offset by payments and payoffs in other areas.
Interest Expense. Interest expense for the year ended December 31, 2007 increased $3.8 million to $23.4 million from the comparable 2006 period. This was attributable to the average cost of interest-bearing liabilities increasing 55 basis points to 3.50% for the year ended December 31, 2007 from 2.95% for the same period in 2006. In addition, the average balance of total interest-bearing liabilities increased $7.0 million to $669.2 million for the year ended December 31, 2007 from $662.2 million for the same period in 2006. The increase in the average cost of interest-bearing liabilities was primarily due to an increase in the cost of time deposits resulting from the rising interest rate environment. Interest expense on short-term borrowings and long-term debt increased $1.6 million for the year ended December 31, 2007. The average balance of short-term borrowings and long-term debt increased $27.7 million to $92.8 million at December 31, 2007. In addition, the average cost of short-term borrowings and long-term debt increased 66 basis points to 4.17% for the year ended December 31, 2007 from 3.51% for the same period in 2006.
Net Interest and Dividend Income. Net interest and dividend income increased $7.3 million to $30.2 million for the year ended December 31, 2007 as compared to $22.9 million for same period in 2006. The net interest margin, on a tax equivalent basis, was 3.25% and 3.05% for the years ended December 31, 2007 and 2006, respectively. The increase in net interest margin was primarily the result of the reinvestment of the proceeds of Westfield Financial's second step stock offering, which was completed on January 3, 2007.
Provision for Loan Losses. The provision for loan losses is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting the key lending areas of Westfield Financial and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio.
The amount that Westfield Bank provided for the provision for loan losses during the year ended December 31, 2007 was based upon the changes that occurred in the loan portfolio during that same period. The changes in the loan portfolio, described in detail below, include a decrease in net charge-offs, tempered by an increase in commercial and industrial loans and commercial real estate loans and an increase in nonperforming loans. After evaluating these factors, Westfield Bank provided $400,000 for loan losses for the year ended December 31, 2007, compared to $390,000 for the same period in 2006. The allowance was $5.7 million at December 31, 2007 and $5.4 million at December 31, 2006.
For the year ended December 31, 2007, Westfield Bank recorded net charge-offs of $111,000 compared to net charge-offs of $375,000 for the year ended December 31, 2006. The 2007 period was comprised of charge-offs of $317,000 for the year ended December 31, 2007, partially offset by recoveries of $206,000 for the same period. The 2006 period was comprised of charge-offs of $584,000 for the year ended December 31, 2006, partially offset by recoveries of $209,000 for the same period.
Nonperforming loans increased $174,000 to $1.2 million at December 31, 2007 from $1.0 million at December 31, 2006. Nonperforming residential real estate loans increased $89,000 to $995,000 at December 31, 2007 from $906,000 at December 31, 2006. The majority of nonperforming residential real estate loans have balances under $80,000, are collateralized by first liens and are seasoned, i.e. originated more than five years ago. Nonperforming commercial and industrial loans decreased $25,000 to $19,000 at December 31, 2007 from $44,000 at December 31, 2006. The balance of nonperforming commercial and industrial loans as of December 31, 2007 was comprised of a single loan relationship.
At December 31, 2007, commercial and industrial loans increased $16.3 million to $116.5 million compared to December 31, 2006. Westfield Bank considers these types of loans to contain more credit risk and market risk than both commercial real estate loans and conventional residential real estate mortgages. Commercial real estate loans increased by $15.4 million to $189.9 million at December 31, 2007.
Although management believes it has established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
Noninterest Income. Noninterest income increased $1.5 million to $4.6 million for the year ended December 31, 2007 compared to $3.1 million for the same period in 2006. The 2007 results include a pre-tax gain of $546,000 on the sale of a piece of vacant land in Feeding Hills, Massachusetts. The results for the 2007 year also include a pre-tax gain of $315,000 resulting from the curtailment of a defined benefit plan, specifically pertaining to providing a life insurance benefit to employees who retire from Westfield Bank. The results for the year ended December 31, 2006 included a pre-tax loss of $378,000 on the sale of premises, which was the result of the sale of a building that previously housed Westfield Bank's branch in downtown Springfield, Massachusetts.
Income from bank-owned life insurance increased $459,000 to $1.3 million for the year ended December 31, 2007 compared to the same period in 2006. This was primarily the result of a $11.2 million increase in the average balance of bank-owned life insurance in 2007 compared to 2006.
Net checking account processing fee income decreased $301,000 to $1.1 million for the year ended December 31, 2007 compared to $1.4 million for the same period in 2006. This was primarily the result of a decrease in fees collected from customers who overdraw their checking accounts.
Noninterest Expense. Noninterest expense for the year ended December 31, 2007 was $21.8 million compared to $19.4 million for the same period in 2006. This increase was primarily due to an increase of $1.8 million in salaries and benefits to $13.7 million for the year ended December 31, 2007. Salaries expense increased $1.2 million as a result of hiring new employees and normal increases in the employee salaries. A portion of the new hiring was associated with a new Westfield Bank branch which opened for business during the second quarter of 2007. Expenses related to share-based compensation increased $848,000 for the year ended December 31, 2007 as a result of new grants of restricted stock and stock options in the third quarter of 2007, along with expenses related to Westfield Financial's tax-qualified employee stock ownership plan.
Professional services expense increased $319,000 to $1.4 million for the year ended December 31, 2007 compared to $1.1 million for the same period in 2006. This was primarily the result of expenses related to corporate legal matters and fees paid to an industry consultant.
Income Taxes. Income taxes increased $2.3 million to $3.8 million primarily as a result of an increase in income before income taxes. The effective tax rate was 30.5% for the year ended December 31, 2007 and 24.7% for the same period in 2006. The increase in the effective tax rate is due primarily to a reduction in tax advantaged income as a percentage of income before income taxes.
Comparison of Financial Condition at December 31, 2006 and December 31, 2005
Total assets increased $191.7 million to $996.8 million at December 31, 2006 from $805.1 million at December 31, 2005. Westfield Financial completed its second step stock offering with the issuance of 18,400,000 shares on January 3, 2007. Consequently, net proceeds, in the amount of $171.7 million, were recognized by Westfield Financial and reported in its balance sheet as December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts.
Cash and cash equivalents increased $128.0 million, to $154.5 million at December 31, 2006 from $26.5 million at December 31, 2005. The increase in cash and cash equivalents is the result of funds raised in the stock offering.
Net loans during this period increased by $6.4 million to $385.2 million at December 31, 2006, from $378.8 million at December 31, 2005.
Commercial real estate loans increased $5.0 million to $174.5 million at December 31, 2006 from $169.5 million at December 31, 2005. Commercial and industrial loans increased $218,000 to $100.2 million at December 31, 2006 from $100.0 million at December 31, 2005. Westfield Bank's strategic plan calls for emphasis on commercial lending. The success of the plan to grow commercial loans is primarily dependent upon the health of the local and national economy and competition for commercial loans.
Residential real estate loans increased $2.6 million to $109.5 million at December 31, 2006 from $106.9 million at December 31, 2005. This increase is primarily attributable to a $6.1 million increase in fixed rate home equity loans. Westfield Bank refers its residential real estate borrowers to a third party mortgage company for all real estate loans other than home equity loans. As a result, substantially all of Westfield Bank's residential real estate loans are underwritten, originated and serviced by a third party mortgage company. Westfield Bank receives a fee from each of these loans originated. Westfield Bank believes that this program has diversified its loan portfolio and continues to reduce interest rate risk by reducing the amount of long-term fixed rate residential mortgages held in Westfield Bank's loan portfolio.
Securities, including mortgage-backed securities increased $54.1 million to $409.0 million at December 31, 2006 as compared to $354.9 million at December 31, 2005. The largest segment of the securities portfolio is mortgage-backed securities, the majority of which are adjustable rate instruments. Management feels that investing funds in adjustable rate mortgage- backed securities has helped provide cash flow and in addition, helped reduce interest rate risk.
Total deposits increased $4.5 million to $627.5 million at December 31, 2006 from $623.0 million at December 31, 2005. Time deposits increased $39.0 million to $374.0 million at December 31, 2006, while regular savings and money market accounts decreased $43.1 million. As the rates paid on term deposits increased throughout 2006, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits. Checking accounts increased $8.5 million to $122.8 million at December 31, 2006. The increase was primarily due to a new checking account product that paid higher rates to customers who maintain large balances.
Federal Home Loan Bank debt increased $10.0 million to $55.0 million at December 31, 2006 from $45.0 million at December 31, 2005. Customer repurchase agreements increased $3.5 million to $17.9 million at December 31, 2006 from $14.4 million at December 31, 2005. A customer repurchase agreement is an agreement by Westfield Bank to sell to and repurchase from the customer an interest in specific securities issued by government-sponsored enterprises. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. All the customer repurchase agreements are held by Westfield Bank's commercial loan customers. The increase in customer repurchase agreements is consistent with Westfield Bank's strategy to emphasize commercial customer relationships.
Stockholder's equity at December 31, 2006 and December 31, 2005 was $289.4 million and $115.8 million, respectively, which represented 29.0% of total assets as of December 31, 2006 and 14.4% of total assets as of December 31, 2005. The change is primarily attributable to net proceeds of $171.7 million from Westfield Financial's second step stock offering.
Comparison of Operating Results for Years Ended December 31, 2006 and 2005
General. Net income for the year ended December 31, 2006 was $4.7 million, or $0.15 per diluted share, compared to $6.2 million, or $0.20 per diluted share for the year ended December 31, 2005.
Interest and Dividend Income. Total interest and dividend income increased $5.1 million, or 13.7%, to $42.4 million for the year ended December 31, 2006, compared to $37.3 million for the same period in 2005.
The increase in interest income was primarily the result in an increase in the yield on earning assets. The average yield on earning assets increased 50 basis points to 5.53% for the year ended December 31, 2006 compared to 5.03% for the same period in 2005. The increase in yield on earning assets was primarily the result of the rising interest rate environment.
Interest and dividends on securities was $16.1 million for the years ended December 31, 2006 and $13.4 million for the same period in 2005. The average balance on securities increased $27.9 million to $372.5 million at December 31, 2006 from $344.6 million at December 31, 2005. In addition, the fully taxable equivalent yield on securities increased from 4.09% for the year 2005 to 4.50% for the same period in 2006. As lower yielding investments purchased in a higher rate environment matured, were called, or paid down in 2006, the funds were reinvested at higher rates. In addition, the interest rate on adjustable rate securities repriced upward in the rising interest rate environment.
Interest income from commercial real estate loans and commercial and industrial loans increased $2.8 million for the year ended December 31, 2006 from the year ended December 31, 2005. In accordance with Westfield Bank's strategic plan, the average balance of commercial real estate loans and commercial and industrial loans increased $9.9 million to $269.2 million for the year ended December 31, 2006, compared to $259.3 million for the same period in 2005.
Interest income from residential real estate loans decreased $69,000 to $6.4 million for the year ended December 31, 2006, compared to $6.5 million for the same period in 2005. The average balance of residential real estate loans decreased $4.6 million to $110.6 million for the year ended December 31, 2006 from $115.2 million for the year ended December 31, 2005 due to our residential real estate loan program with a third party mortgage company. In addition, interest on consumer loans decreased $221,000 to $410,000 for the year ended December 31, 2006, compared to $631,000 for the same period in 2005. This was primarily the result of a decrease in the average balance of consumer loans from $9.0 million for 2005 to $6.3 million for 2006 due to management's decision to discontinue indirect automobile loan originations in 2003 and allow the portfolio to paydown.
Interest Expense. Interest expense for the year ended December 31, 2006 increased $6.0 million to $19.6 million from the comparable 2005 period. This was attributable to an increase in the average cost of interest-bearing liabilities increasing 81 basis points to 2.95% for the year ended December 31, 2006 from 2.14% for the same period in 2005. In addition, the average balance of total interest-bearing liabilities increased $26.2 million to $662.2 million for the year ended December 31, 2006 from $636.0 million for the same period in 2005.
As the rates paid on term deposits increased throughout 2006, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits.
Net Interest and Dividend Income. Net interest and dividend income decreased $825,000 to $22.9 million for the year ended December 31, 2006 as compared to $23.7 million for the same period in 2005. The net interest margin, on a fully taxable equivalent basis, was 3.05%, for the twelve months ended December 31, 2006 compared to 3.24% for the twelve months ended December 31, 2005.
The decrease in the net interest margin was primarily the result of higher funding costs. The average cost of interest-bearing liabilities increased 81 basis points to 2.95% for the twelve months ended December 31, 2006 from 2.14% for same period in 2005. The yield on interest-earning assets, on a fully taxable equivalent basis, increased 53 basis points to 5.56% for the twelve months ended December 31, 2006 from 5.03% for same period in 2005. The increase in the average cost of interest-bearing liabilities is primarily due to an increase in the cost of time deposits resulting from the rising rate environment.
Provision for Loan Losses. The provision for loan losses is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting the key lending areas of Westfield Financial and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio.
The amount that Westfield Bank allocated to the provision for loan losses during the year ended December 31, 2006 was based upon the changes that occurred in the loan portfolio during that same period. The changes in the loan portfolio, described in detail below, include partially replenishing the net charge offs for the same period, tempered by a reduction in nonperforming loans and a net decrease in the loan portfolio. After evaluating these factors, Westfield Bank provided $390,000 for loan losses for the year ended December 31, 2006, compared to $465,000 for the same period in 2005. The allowance was $5.4 million at both December 31, 2006 and December 31, 2005. The allowance for loan losses was 1.39% of total loans at December 31, 2006 and 1.41% at December 31, 2005.
At December 31, 2006 commercial real estate loans and commercial and industrial loans increased $5.2 million as compared to December 31, 2005. Commercial real estate loans and commercial and industrial loans comprised 70.4% of Westfield Bank's loan portfolio as of December 31, 2006 compared to 70.2% as of December 31, 2005. Westfield Bank considers these types of loans to contain more credit risk and market risk than conventional residential real estate mortgages, which increased by $2.6 million during the year ended December 31, 2006. Consumer loans decreased $1.5 million from December 31, 2005 and remained stable at $5.8 million as of December 31, 2006. Nonperforming loans were $1.0 million December 31, 2006 and $1.9 million at December 31, 2005.
Net charge offs were $375,000 for the year ended December 31, 2006. This was comprised of charge-offs of $584,000 for the year ended December 31, 2006, partially offset by recoveries of $209,000 for the same period.
Although management believes it has established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
Noninterest Income. Noninterest income decreased $299,000 to $3.1 million for the year ended December 31, 2006 compared to $3.4 million for the same period in 2005. The 2006 results included a net loss of $378,000 on the sale of fixed assets, which was primarily the result of the sale of a building that housed a former Westfield Bank branch.
Fees received from the third party mortgage company were $96,000 for the year ended December 31, 2006, compared to $107,000 for the same period in 2005. Fee income from the third party mortgage company in the future may be affected by borrower activity, which generally decreases in a rising interest rate environment.
Income from bank-owned life insurance increased $43,000 to $801,000 for the year ended December 31, 2006 compared to the same period in 2005. This was primarily the result of a $1.5 million increase in the average balance of bank-owned life insurance in 2006 compared to 2005.
Noninterest Expense. Noninterest expense for the year ended December 31, 2006 was $19.4 million compared to $18.5 million for the same period in 2005. Salaries and benefits increased $830,000 for the year ended December 31, 2006, compared to the same period in 2005. This was primarily the result of an increase in salary expense of $385,000 related to hiring additional personnel and normal salary increases. In addition, Westfield Financial recorded expenses of $293,000 related to stock options for the year ended December 31, 2006 compared to none for the same period in 2005. The requirement to expense share-based compensation related to stock options became effective for Westfield Financial for the fiscal year beginning on January 1, 2006.
Income Taxes. Income taxes decreased $410,000 to $1.5 million in 2006 primarily as a result of a decrease in income before income taxes. The effective tax rate was 24.7% in 2006 compared to 23.7% for 2005. The effective tax rate for 2006 reflects the utilization of Elm Street Securities Corporation, a Massachusetts corporation, and in 2005, also includes Westfield Securities Corporation, a Massachusetts corporation. Westfield Securities Corporation was dissolved in the third quarter of 2005.
Liquidity and Capital Resources
The term "liquidity" refers to Westfield Financial's ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals and operating expenses. Westfield Financial's primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by our operations. Westfield Bank also can borrow funds from the Federal Home Loan Bank based on eligible collateral of loans and securities. Outstanding borrowings from the Federal Home Loan Bank were $123.4 million at December 31, 2007 and $55.0 million at December 31, 2006. At December 31, 2007, Westfield Bank had $19.8 million in available borrowing capacity with the Federal Home Loan Bank. Westfield Bank has the ability to increase its borrowing capacity with the Federal Home Loan Bank by pledging investment securities or loans. In addition, Westfield Bank may enter into reverse repurchase agreements with approved broker-dealers. Reverse repurchase agreements are agreements that allow Westfield Bank to borrow money using its securities as collateral.
Westfield Bank also has outstanding at any time, a significant number of commitments to extend credit and provide financial guarantees to third parties. These arrangements are subject to strict credit control assessments. Guarantees specify limits to Westfield Bank's obligations. Because many commitments and almost all guarantees expire without being funded in whole or in part, the contract amounts are not estimates of future cash flows. Westfield Bank is also obligated under agreements with the Federal Home Loan Bank to repay borrowed funds and is obligated under leases for certain of its branches and equipment. A summary of lease obligations, borrowings, and credit commitments at December 31, 2007 follows:
Maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds.
Westfield Financial's primary investing activities are the origination of commercial real estate, commercial and industrial and consumer loans, and the purchase of mortgage-backed and other investment securities. During the year ended December 31, 2007, Westfield Bank originated loans of approximately $128.6 million, and during the comparable period of 2006, Westfield Bank originated loans of approximately $111.0 million. Under Westfield Bank's residential real estate loan program, Westfield Bank refers its residential real estate borrowers to a third party mortgage company and substantially all of Westfield Bank's residential real estate loans are underwritten, originated and serviced by a third party mortgage company. Purchases of securities totaled $230.7 million for the year ended December 31, 2007 and $138.8 million for the year ended December 31, 2006. At December 31, 2007, Westfield Bank had loan commitments to borrowers of approximately $34.9 million, and available home equity and unadvanced lines of credit of approximately $62.0 million.
Deposit flows are affected by the level of interest rates, by the interest rates and products offered by competitors and by other factors. Total deposits decreased $24.8 million during the year ended December 31, 2007 and increased $4.4 million during the year ended December 31, 2006. Time deposit accounts scheduled to mature within one year were $266.2 million at December 31, 2007. Based on Westfield Bank's deposit retention experience and current pricing strategy, it anticipates that a significant portion of these certificates of deposit will remain on deposit. Westfield Bank monitors its liquidity position frequently and anticipates that it will have sufficient funds to meet its current funding commitments.
At December 31, 2007, Westfield Bank exceeded each of the applicable regulatory capital requirements. Westfield Bank's tier 1 leverage capital was $212.4 million, or 22.0% to adjusted total assets. Westfield Bank's tier 1 capital to risk weighted assets was $212.4 million or 37.7%. Westfield Bank had total capital to risk weighted assets of $218.1 million or 38.8%.
Westfield Financial does not anticipate any material capital expenditures during calendar year 2008, nor do we have any balloon or other payments due on any long-term obligations or any off-balance sheet items other than the commitments and unused lines of credit noted above.
Off-Balance Sheet Arrangements
Westfield Financial does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Management of Market Risk
As a financial institution, Westfield Financial's primary market risk is interest rate risk since substantially all transactions are denominated in U.S. dollars with no direct foreign exchange or changes in commodity price exposure. Fluctuations in interest rates will affect both our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates will also affect the market value of all interest-earning assets.
The primary goal of Westfield Financial's interest rate management strategy is to limit fluctuations in net interest income as interest rates vary up or down and control variations in the market value of assets, liabilities and net worth as interest rates vary. Westfield Financial seeks to coordinate asset and liability decisions so that, under changing interest rate scenarios, net interest income will remain within an acceptable range.
To achieve the objectives of managing interest rate risk, Westfield Bank's Asset and Liability Management Committee meets monthly to discuss and monitor the market interest rate environment relative to interest rates that are offered on its products. The Asset and Liability Management Committee presents periodic reports to the Board of Directors of Westfield Bank and Westfield Financial, Inc. at their regular meetings.
In recent years, Westfield Bank's lending activities have emphasized commercial real estate and commercial and industrial loans. Commercial real estate loans have grown $15.4 million or 8.8% since December 31, 2006. Commercial and industrial loans have grown $16.3 million or 16.3% since December 31, 2006. Management believes that Westfield Bank's increased emphasis on commercial lending has allowed it to diversify its loan portfolio while continuing to meet the needs of the businesses and individuals that it serves.
Westfield Bank's primary source of funds has been deposits, consisting primarily of time deposits, money market accounts, savings accounts, demand accounts and NOW accounts, which have shorter terms to maturity than the loan portfolio. Several strategies have been employed to manage the interest rate risk inherent in the asset/liability mix, including but not limited to:
o maintaining the diversity of Westfield Bank's existing loan portfolio through the origination of commercial loans and commercial real estate loans which typically have variable rates and shorter terms than residential mortgages; and
o emphasizing investments with an expected average duration of five years or less.
In addition, emphasis on commercial loans has reduced the average maturity of Westfield Bank's loan portfolio. Moreover, the actual amount of time before loans are repaid can be significantly affected by changes in market interest rates. Prepayment rates will also vary due to a number of other factors, including the regional economy in the area where the loans were originated, seasonal factors, demographic variables and the assumability of the loans. However, the major factors affecting prepayment rates are prevailing interest rates, related financing opportunities and competition. Westfield Financial monitors interest rate sensitivity so that it can adjust its asset and liability mix in a timely manner and minimize the negative effects of changing rates.
Each of Westfield Bank's sources of liquidity is vulnerable to various uncertainties beyond the control of Westfield Bank. Scheduled loan and security payments are a relatively stable source of funds, while loan and security prepayments and calls, and deposit flows vary widely in reaction to market conditions, primarily prevailing interest rates. Asset sales are influenced by pledging activities, general market interest rates and unforeseen market conditions. Westfield Bank's financial condition is affected by its ability to borrow at attractive rates, retain deposits at market rates and other market conditions. Management considers Westfield Bank's sources of liquidity to be adequate to meet expected funding needs and also to be responsive to changing interest rate markets.
Net Interest and Dividend Income Simulation. We use a simulation model to monitor interest rate risk. This model reports the net interest income at risk primarily under seven different interest rate environments. Specifically, net interest income is measured in one scenario that assumes no change in interest rates, and six scenarios where interest rates increase 100, 200 and 300 and decrease 100, 200 and 300 basis points, respectively, from current rates over the one year time period following the current consolidated financial statements.
The changes in interest income and interest expense due to changes in interest rates reflect the rate sensitivity of our interest earning assets and interest bearing liabilities. For example, in a rising interest rate environment, the interest income from an adjustable rate loan is likely to increase depending on its repricing characteristics while the interest income from a fixed rate loan would not increase until the funds were repaid and loaned out at a higher interest rate.
The tables below set forth as of December 31, 2007 the estimated changes in net interest and dividend income that would result from incremental changes in interest rates over the applicable twelve-month period.
For the Year Ending December 31, 2008 (Dollars in thousands) ------------------------------------------------------ Changes in Net Interest Interest Rates (Basis and Dividend Points) Income % Change --------------------- ------------ -------- 300 31,726 1.6% 200 31,500 0.9% 100 31,471 0.8% 0 31,218 0.0% -100 30,770 - 1.4% -200 29,124 - 6.7% -300 27,299 -12.6%
Market rates were assumed to increase 100, 200 and 300 basis points and decrease 100, 200 and 300 basis points, in even increments over the twelve month period. The repricing and/or new rates of assets and liabilities moved in tandem with market rates. However, in certain deposit products, the use of data from a historical analysis indicated that the rates on these products would move only a fraction of the rate change amount.
We have developed consolidated balance sheet growth projections for the twelve month period. The same product mix and growth strategy was used for all rate change simulations, except for the shift into term deposits in certain scenarios as described in the previous paragraph. Income from tax-exempt assets is calculated on a fully taxable equivalent basis.
Pertinent data from each loan account, deposit account and investment security was used to calculate future cash flows. The data included such items as maturity date, payment amount, next repricing date, repricing frequency, repricing index and spread. Prepayment speed assumptions were based upon the difference between the account rate and the current market rate.
The income simulation analysis was based upon a variety of assumptions. These assumptions include but are not limited to balance sheet growth, asset mix, prepayment speeds, the timing and level of interest rates, and the shape of the yield curve. As market conditions vary from the assumptions in the income simulation analysis, actual results will differ. As a result, the income simulation analysis does not serve as a forecast of net interest income, nor do the calculations represent any actions that management may undertake in response to changes in interest rates.
Recent Accounting Pronouncements
In March 2006, the Financial Accounting Standards Board ("FASB") issued Statement No. 156, "Accounting for Servicing of Financial Assets," which amends FASB Statement No. 140. This statement requires 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 Statement permits 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 (the "fair value method"). This statement was effective for new transactions occurring and for subsequent measurement as of January 1, 2007. Management did not adopt the fair value method of accounting for its servicing rights. Therefore, the adoption of this Statement did not have a material impact on Westfield Financial's consolidated financial statements.
In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. Westfield Financial adopted FIN 48 on January 1, 2007 and this adoption did not have a material impact on Westfield Financial's consolidated financial statements. Westfield Financial accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes. Westfield Financial has no penalties or interest recorded for the year ended December 31, 2007.
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. Emphasis is placed on fair value being a market-based measurement, not an entity-specific measurement, and therefore a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering these market participant assumptions, a fair value hierarchy has been established to distinguish between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). This Statement is effective for Westfield Financial on January 1, 2008. Management has determined that the adoption of this Statement will not have a material impact on Westfield Financial's consolidated financial statements.
In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115." This Statement permits entities to choose to measure many financial instruments and certain other items at fair value, which the objective of improving financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions, and is expected to expand the use of fair value measurement. An entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may generally be applied instrument by instrument and is irrevocable. This Statement is effective for Westfield Financial on January 1, 2008 and is not expected to have a material impact on Westfield Financial's consolidated financial statement.
In December 2007, the FASB issued Statement No. 141 (revised), "Business Combinations." This Statement replaces FASB Statement No. 141, and applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for certain business combinations. Under Statement No. 141 (revised) an acquirer is required to recognize at fair value the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date. This replaces the cost-allocation process under Statement No. 141, which resulted in the non-recognition of some assets and liabilities at the acquisition date and in measuring some assets and liabilities at amounts other than their fair values at the acquisition date. This Statement requires that acquisition costs and expected restructuring costs be recognized separately from the acquisition, and that the acquirer in a business combination achieved in stages recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values. This Statement also requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, while Statement 141 allowed for the deferred recognition of pre-acquisition contingencies until certain recognition criteria were met, and an acquirer is only required to recognize assets or liabilities arising from all other contingencies if it is more likely than not that they meet the definition of an asset or a liability. Under this Statement, an acquirer is required to recognize contingent consideration at the acquisition date, whereas contingent consideration obligations usually were not recognized at the acquisition date under Statement 141. Further, this Statement eliminates the concept of negative goodwill and requires gain recognition in instances in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any non-controlling interest in the acquiree. This Statement makes significant amendments to other Statements and other authoritative guidance, and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.
In December 2007, the FASB issued Statement No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51." This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years beginning on or after December 15, 2008.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and accompanying Notes of Westfield Financial have been prepared in accordance with Accounting Principles Generally Accepted in the United States of America ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of Westfield Financial's operations. Unlike industrial companies, Westfield Financial's assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk," for a discussion of quantitative and qualitative disclosures about market risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Westfield Financial may be found on pages through of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including Westfield Financial's Chairman and Chief Executive Officer and Chief Financial Officer and Treasurer, has evaluated the effectiveness of Westfield Financial's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, Westfield Financial's Chairman and Chief Executive Officer and Chief Financial Officer and Treasurer concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports Westfield Financial files and submits under the Exchange Act (i) is recorded, processed, summarized and reported as and when required and (ii)
accumulated and communicated to Westfield Financial's management including the Chairman and Chief Executive Officer and Chief Financial Officer and Treasurer, as appropriate to allow timely discussion regarding required disclosure.
There have been no changes in Westfield Financial's internal control over financial reporting identified in connection with the evaluation that occurred during Westfield Financial's last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, Westfield Financial's internal control over financial reporting.
Management Report on Internal Control Over Financial Reporting
o The management of Westfield Financial is responsible for establishing and maintaining adequate internal control over financial reporting. Westfield Financial's internal control system is a process designed to provide reasonable assurance to Westfield Financial's management and board of directors regarding the preparation and fair presentation of published financial statements.
o Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of Westfield Financial's; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Westfield Financial's assets that could have a material effect on our financial statements.
o Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
o Westfield Financial, Inc.'s management assessed the effectiveness of Westfield Financial's internal control over financial reporting as of December 31, 2007. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment we believe that, as of December 31, 2007, Westfield Financial's internal control over financial reporting is effective based on those criteria.
o Westfield Financial Inc.'s Independent Registered Public Accounting Firm has issued an audit report on the effective operation of Westfield Financial's internal control over financial reporting as of December 31, 2007. This report appears on pages and.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following information included in the Proxy Statement is incorporated herein by reference: "Information About Our Board of Directors," "Information About Our Executive Officers," "Corporate Governance," and "Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following information included in the Proxy Statement is incorporated herein by reference: "Corporate Governance - Compensation Committee Interlocks," "Compensation Discussion and Analysis," "Compensation Committee Report," and "Compensation of Directors and Executive Officers."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following information included in the Proxy Statement is incorporated herein by reference: "Security Ownership of Certain Beneficial Owners and Management" and "Compensation of Directors and Executive Officers - Compensation Plans and Compensation Plan Tables."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The following information included in the Proxy Statement is incorporated herein by reference: "Transactions with Certain Related Persons" and "Board of Directors Independence."
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following information included in the Proxy Statement is incorporated herein by reference: "Principal Accounting Fees and Services."
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a. Financial Statements
Reference is made to the Consolidated Financial Statements included in Item 8 of Part II hereof.
b. Exhibits
2.1 Amended and Restated Plan of Conversion and Stock Issuance of Westfield Mutual Holding Company, Westfield Financial, Inc. and Westfield Bank. (1)
3.1 Articles of Organization of Westfield Financial, Inc. (2)
3.2 Bylaws of Westfield Financial, Inc. (2)
4.1 Form of Stock Certificate of Westfield Financial, Inc. (1)
10.1 Form of Employee Stock Ownership Plan of Westfield Financial, Inc. (3)
10.2 Amendments to the Employee Stock Ownership Plan of Westfield Financial, Inc. (4)
10.3 Form of Director's Deferred Compensation Plan. (5)
10.4 The 401(k) Plan adopted by Westfield Bank. (6)
10.5 Amended and Restated Benefit Restoration Plan of Westfield Financial, Inc. (7)
10.6 Form of Amended and Restated Deferred Compensation Agreement with Donald A. Williams. (5)
10.7 Amended and Restated Employment Agreement between Donald A. Williams and Westfield Bank. (7)
10.8 Amended and Restated Employment Agreement between Michael J. Janosco, Jr. and Westfield Bank. (7)
10.9 Amended and Restated Employment Agreement between James C. Hagan and Westfield Bank. (7)
10.10 Amended and Restated Employment Agreement between Donald A. Williams and Westfield Financial, Inc. (7)
10.11 Amended and Restated Employment Agreement between Michael J. Janosco, Jr. and Westfield Financial, Inc. (7)
10.12 Amended and Restated Employment Agreement between James C. Hagan and Westfield Financial, Inc. (7)
10.13 Form of Amended and Restated Change in Control Agreement by and among certain officers, Westfield Financial Inc. and Westfield Bank. (7)
10.14 Agreement between Westfield Bank and Village Mortgage Company. (1)
14.1 Code of Ethics. (8)
23.1 Consent of Wolf & Company, P.C.
31.1 Rule 13a-14(a)/15d-14(a) Certifications
32.1 Section 1350 Certifications
- --------------- (1) Incorporated by reference to the Registration Statement No. 333-137024 on Form S-1 filed with the Securities and Exchange Commission on August 31, 2006, as amended. (2) Incorporated by reference to the Form 8-K filed with the Securities and Exchange Commission on January 5, 2007. (3) Incorporated herein by reference to the Registration Statement No. 333-68550 on Form S-1 filed with the Securities and Exchange Commission on August 28, 2001, as amended. (4) Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 31, 2003. (5) Incorporated by reference to the Form 8-K filed with the Securities and Exchange Commission on December 22, 2005. (6) Incorporated herein by reference to the Post-Effective Amendment No. 1 to the Registration Statement No. 333-73132 on Form S-8 filed with the Securities and Exchange Commission on April 28, 2006. (7) Incorporated by reference to the Form 8-K filed with the Securities and Exchange Commission on October 25, 2007. (8) Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 15, 2005.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 14, 2007.
WESTFIELD FINANCIAL, INC.
By: /s/ Donald A. Williams ------------------------------- Donald A. Williams Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, and any rules and regulations promulgated thereunder, this Annual Report on Form 10-K, has been signed by the following persons in the capacities and on the dates indicated.
Name Title Date ---- ----- ----
/s/ Donald A. Williams Chairman and Chief Executive March 14, 2008 - ----------------------------- Officer (Principal Executive Donald A. Williams Officer)
/s/ Michael J. Janosco, Jr. Chief Financial Officer and March 14, 2008 - ----------------------------- Treasurer (Principal Accounting Michael J. Janosco, Jr. Officer)
/s/ Victor J. Carra Director March 14, 2008 - ----------------------------- Victor J. Carra
/s/ David C. Colton, Jr. Director March 14, 2008 - ----------------------------- David C. Colton, Jr.
/s/ Robert T. Crowley, Jr. Director March 14, 2008 - ----------------------------- Robert T. Crowley, Jr.
/s/ Harry C. Lane Director March 14, 2008 - ----------------------------- Harry C. Lane
/s/ William H. McClure Director March 14, 2008 - ----------------------------- William H. McClure
/s/ Mary C. O'Neil Director March 14, 2008 - ----------------------------- Mary C. O'Neil
/s/ Richard C. Placek Director March 14, 2008 - ----------------------------- Richard C. Placek
/s/ Paul R. Pohl Director March 14, 2008 - ----------------------------- Paul R. Pohl
/s/ Charles E. Sullivan Director March 14, 2008 - ----------------------------- Charles E. Sullivan
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders Westfield Financial, Inc.
We have audited the accompanying consolidated balance sheets of Westfield Financial, Inc. and subsidiaries (the "Company") as of December 31, 2007 and 2006, 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, 2007. 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 Westfield Financial, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Accounting Oversight Board (United States), Westfield Financial, Inc. and subsidiaries' internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 11, 2008 expressed an unqualified opinion on the effectiveness of Westfield Financial, Inc.'s internal control over financial reporting.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts March 11, 2008
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share amounts)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands, except per share amounts)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in thousands)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2007, 2006, AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Basis of Presentation - Westfield Financial, Inc. (the "Company" or "Westfield Financial") was organized as a Massachusetts-chartered stock holding company in November 2001 in connection with the reorganization of Westfield Mutual Holding Company, a federally-chartered mutual holding company. As part of the reorganization, Westfield Financial offered for sale 47% of its common stock. The remaining 53% of Westfield Financial's shares were issued to Westfield Mutual Holding Company. The reorganization and related stock offering were completed on December 27, 2001.
On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007.
For financial reporting purposes, net proceeds of $171.7 million from the second step conversion were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts.
Westfield Bank (the "Bank") is a federally-chartered stock savings bank subsidiary of Westfield Financial. Westfield Bank's deposits are insured to the limits specified by the Federal Deposit Insurance Corporation ("FDIC"). Westfield Bank operates eleven branches in Western Massachusetts. Westfield Bank's primary source of revenue is earnings on loans to small and middle-market businesses and to residential property homeowners.
Elm Street Securities Corporation and WFD Securities Corporation, Massachusetts-chartered security corporations, were formed by Westfield Financial for the primary purpose of holding qualified investment securities. In the third quarter of 2005, the Company dissolved Westfield Securities Corporation in order to streamline operations.
The conversion was accounted for as a reorganization in corporate form with no change in the historical basis of Westfield Financial's assets, liabilities, and equity. All references to the number of shares outstanding, including references for purposes of calculating per share amounts, are restated to give retroactive recognition to the exchange ratio applied in the conversion.
Principles of Consolidation - The consolidated financial statements include the accounts of the Company, the Bank, Elm Street Securities Corporation, WFD Securities Corporation as well as Westfield Securities Corp., prior to its dissolution. All material intercompany balances and transactions have been eliminated in consolidation.
Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses for each. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and other than temporary impairment of investment securities.
Cash and Cash Equivalents - The Company defines cash on hand, cash due from banks, federal funds sold and interest-bearing deposits having an original maturity of 90 days or less as cash and cash equivalents. Cash and due from banks at December 31, 2007 and 2006 includes partially restricted cash of approximately $351,000, and $417,000 respectively, for Federal Reserve Bank of Boston cash reserve requirements.
Securities and Mortgage-Backed Securities - Debt securities, including mortgage-backed securities, which management has the positive intent and ability to hold until maturity are classified as held to maturity and are carried at amortized cost. Securities, including mortgage-backed securities, which have been identified as assets for which there is not a positive intent to hold to maturity are classified as available for sale and are carried at fair value with unrealized gains and losses, net of income taxes, reported as a separate component of comprehensive income. The Company does not acquire securities and mortgage-backed securities for purposes of engaging in trading activities.
Realized gains and losses on sales of securities and mortgage-backed securities are computed using the specific identification method and are included in noninterest income. The amortization of premiums and accretion of discounts is determined by using the level yield method to the maturity date.
Other than Temporary Impairment of Securities - On a quarterly basis, the Company reviews investment securities with unrealized depreciation on a judgmental basis to assess whether the decline in fair value is temporary or other than temporary. 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 and near-term prospects 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.
Loans - Loans are recorded at the principal amount outstanding, adjusted for charge-offs, unearned premiums and deferred loan fees and costs. Interest on loans is calculated using the effective yield method on daily balances of the principal amount outstanding and is credited to income on the accrual basis to the extent it is deemed collectible. The Company's general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more based on the contractual terms of the loan, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of the principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and when subsequent performance reduces the concern as to the collectibility of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans. Compensation to an auto dealer is normally based upon a spread that a dealer adds on the loan base rate set by the Company.
Allowance for Loan Losses - The allowance for loan losses is established through provisions for loan losses charged to expense. Loans are charged off against the allowance when management believes that the collectibility of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.
The Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio based on ongoing quarterly assessments of the estimated losses. The Bank's methodology for assessing the appropriateness of the allowance consists of two key components, which are a specific allowance for identified problem loans and a formula allowance for the remainder of the portfolio. The specific allowance incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The appropriateness of the allowance is also reviewed by management based upon its evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Although management believes it has established and maintained the allowance for loan losses at appropriate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan's contractual terms. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Company expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the fair value of the impaired loan is less than the related recorded amount, a specific valuation allowance is established within the allowance for loan losses or a writedown is charged against the allowance for loan losses if the impairment is considered to be permanent. Measurement of impairment does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment such as the Company's portfolios of consumer and residential real estate loans.
In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews the loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The Office of Thrift Supervision may require adjustment to the allowance for loan losses based on their judgments of information available to them at the time of their examination, thereby adversely affecting results of operations.
Management believes that the allowance for loan losses accurately reflects estimated credit losses for specifically identified loans, as well as probable credit losses inherent in the remainder of the portfolio as of the end of the years presented.
Transfers and Servicing 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 (free of conditions that constrain it from taking advantage of that 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.
Premises and Equipment - Land is carried at cost. Buildings and equipment are stated at cost, less accumulated depreciation and amortization, computed on the straight-line method over the estimated useful lives of the assets, or the expected lease term, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured. The estimated useful lives of the assets are as follows:
Years -----
Buildings 39 Leasehold Improvements 5-20 Furniture and Equipment 3-7
The cost of maintenance and repairs is charged to expense when incurred. Major expenditures for betterments are capitalized and depreciated.
Other Real Estate Owned - Other real estate owned represents property acquired through foreclosure or deeded to the Company in lieu of foreclosure. Other real estate owned is recorded at the lower of the carrying value of the related loan, or the estimated fair value of the real estate acquired, net of estimated selling costs. Initial write-downs are charged to the allowance for loan losses at the time the loan is transferred to other real estate owned. Subsequent valuations are periodically performed by management and the carrying value is adjusted by a charge to expense to reflect any subsequent declines in the estimated fair value. Operating costs associated with other real estate owned are expensed as incurred. There was no other real estate owned at December 31, 2007 and 2006, respectively.
Retirement Plans and Employee Benefits - The Company provides a defined benefit pension plan for eligible employees through membership in the Savings Banks Employees Retirement Association ("SBERA"). The Company's policy is to fund pension cost as accrued. Employees are also eligible to participate in a 401(k) plan through the Principal Financial Group. The Company makes matching contributions to this plan at 50% of up to 6% of the employees' eligible compensation.
The Company currently offers postretirement life insurance benefits to retired employees. Such postretirement benefits represent a form of deferred compensation which requires that the cost and obligations of such benefits are recognized in the period in which services are rendered.
In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Post Retirement Plans" ("SFAS 158"), which requires employers to (a) recognize in its statement of financial position the funded status of a benefit plan, (b) measure a plan's assets and its obligations that determine its funded status as of the end of the employer's fiscal year, (c) recognize, through other comprehensive income, net of tax, changes in the funded status of the benefit plan that are not recognized as net periodic benefit cost, and (d) disclosure additional information about certain effects on net periodic benefit cost for the next fiscal year that relate to the delayed recognition of certain benefit cost elements.
Income Taxes - The Company uses the asset and liability method for income tax accounting, whereby, 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. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings per Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock awards and options and are determined using the treasury stock method.
Earnings per common share for the years ended December 31, have been computed based on the following:
Stock options and awards that would have an antidilutive effect on diluted earnings per share are excluded from the calculation. At December 31, 2007, 1,501,857 shares were anti-dilutive. No shares were anti-dilutive at December 31, 2006 and 2005.
Reclassifications - Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation.
Adoption of SFAS 123(R) Share-Based Payment - On January 1, 2006, the Company adopted SFAS 123(R), "Share-Based Payment" ("SFAS 123(R)" or the "Statement"), which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The effect of SFAS 123(R) is that entities are required to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award. SFAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. The Company uses the binomial model for its adoption of the Statement.
The Company adopted SFAS 123(R) using the "modified prospective" method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS 123(R). Also under this method, expense is recognized for awards that were granted prior to January 1, 2006 but vest after January 1, 2006, based on the fair value determined at the grant date under SFAS 123, "Accounting for Stock-Based Compensation" (SFAS 123). Prior to the adoption of SFAS 123(R), the Company accounted for stock compensation under the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations. Accordingly, the Company previously recognized no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant.
The adoption of SFAS 123(R) by the Company resulted in additional share-based compensation expense of $418,000 and $293,000, and related tax benefit of $101,000 and $69,000 for the years ended December 31, 2007 and 2006, respectively. The increase in stock-based compensation expense resulted in a $0.01 decrease in basic earnings per share and a $0.01 decrease in diluted earnings per share for the years ended December 31, 2007 and 2006. As of December 31, 2007, the compensation cost of unvested stock options amounted to $3.8 million, with a related tax benefit of $1.0 million.
Had compensation cost been determined based on the fair value at the grant date of awards under the plans consistent with the method prescribed by SFAS 123(R), the Company's net income and income per share for the year ended December 31, 2005 and would have been adjusted to the pro forma amounts as follows:
(In thousands, except per share data)
Net income, as reported $ 6,219
Less: Compensation expense determined under fair value based method for all awards, net of tax effects (333) ------- Pro forma net income $ 5,886 =======
Net income per share: Basic as reported $ 0.20 Basic pro forma 0.19 Diluted as reported 0.20 Diluted pro forma 0.19
The fair value of each option grant is estimated on the date of grant using the binomial pricing model with the following weighted average assumptions:
Options granted under the 2002 Stock Option Plan:
Years Ended December 31, 2007 2005 ---- ----
Expected dividend yield low 1.98% 1.62% Expected dividend yield high 3.00% 3.00% Expected life 10 years 10 years Expected volatility 16.39% 21.16% Risk-free interest rate 4.83% 4.19%
Options granted under the 2007 Stock Option Plan:
Expected dividend yield low 1.99 % - Expected dividend yield high 3.00 % - Expected life 10 years - Expected volatility 20.39 % - Risk-free interest rate 4.53 % -
No stock options were granted in 2006.
Comprehensive Income/Loss
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 equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
The components of other comprehensive income/loss and related tax effects are as follows:
Years Ended December 31, 2007 2006 2005 ---- ---- ---- (In thousands)
Unrealized holding gains (losses) on available for sale securities $2,096 $ 578 $(1,665) Reclassification adjustment for gains realized in income (41) - (19) ------ ----- ------- Net unrealized gains (losses) 2,055 578 (1,684) Tax effect (757) (204) 629 ------ ----- ------- Net-of-tax amount 1,298 374 (1,055) ------ ----- -------
Gains arising during the period pertaining to defined benefit plans 734 - - ------ ----- ------- Reclassification adjustment for transition obligation recognized in net periodic benefit cost pertaining to defined benefit plans (11) - - Net adjustments pertaining to defined benefit plans 723 - - ------ ----- ------- Tax effect (246) - - ------ ----- ------- Net-of-tax amount 477 - - ------ ----- ------- $1,775 $ 374 $(1,055) ====== ===== =======
The components of accumulated other comprehensive income (loss), included in stockholders' equity, are as follows:
December 31, 2007 2006 ------ ------- (In thousands)
Net unrealized gain (loss) on securities available for sale $ 781 $(1,274) Tax effect (286) 471 ------ ------- Net-of-tax amount 495 (803) ------ -------
Unrecognized transition liability pertaining to defined benefit plans 81 92 Unrecognized deferred gain pertaining to defined benefit plans 759 25 ------ ------- 840 117 Tax effect (286) (40) ------ ------- Net-of-tax amount 554 77 ------ -------
$1,049 $ (726) ====== =======
An actuarial gain of $35,000 is included in accumulated other comprehensive income at December 31, 2007, and is expected to be recognized as a component of net periodic pension cost for the year ending December 31, 2008. A transition asset of $11,000 is included in accumulated other comprehensive income at December 31, 2007, and is expected to be recognized as a component of net periodic pension cost for the year ending December 31, 2008.
Recent Accounting Pronouncements
In March 2006, the Financial Accounting Standards Board ("FASB") issued Statement No. 156, "Accounting for Servicing of Financial Assets", which amends FASB Statement No. 140. This Statement requires 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 Statement permits 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 (the "fair value method"). This Statement was effective for new transactions occurring and for subsequent measurement as of January 1, 2007. Management did not adopt the fair value method of accounting for its servicing rights, therefore, the adoption of this Statement did not have a material impact on the Company's consolidated financial statements.
In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes". FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. The Company adopted FIN 48 on January 1, 2007 and this adoption did not have a material impact on the Company's consolidated financial statements. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes. The Company has no penalties or interest recorded for the year ended December 31, 2007.
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. Emphasis is placed on fair value being a market-based measurement, not an entity-specific measurement, and therefore a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering these market participant assumptions, a fair value hierarchy has been established to distinguish between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). This Statement is effective for the Company on January 1, 2008. Management has determined that the adoption of this Statement will not have a material impact on the Company's consolidated financial statements.
In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115." This Statement permits entities to choose to measure many financial instruments and certain other items at fair value, with the objective of improving financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions, and is expected to expand the use of fair value measurement. An entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may generally be applied instrument by instrument and is irrevocable. This Statement is effective for the Company on January 1, 2008 and is not expected to have a material impact on the Company's consolidated financial statements.
In December 2007, the FASB issued Statement No. 141 (revised), "Business Combinations." This Statement replaces FASB Statement No. 141, and applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for some business combinations. Under Statement No. 141 (revised) an acquirer is required to recognize at fair value the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date. This replaces the cost-allocation process under Statement No. 141, which resulted in the non-recognition of some assets and liabilities at the acquisition date, and in measuring some assets and liabilities at amounts other than their fair values at the acquisition date. This Statement requires that acquisition costs and expected restructuring costs be recognized separately from the acquisition, and that the acquirer in a business combination achieved in stages recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values. This Statement also requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, while Statement 141 allowed for the deferred recognition of pre-acquisition contingencies until certain recognition criteria were met, and an acquirer is only required to recognize assets or liabilities arising from all other contingencies if it is more likely than not that they meet the definition of an asset or a liability. Under this Statement, an acquirer is required to recognize contingent consideration at the acquisition date, whereas contingent consideration obligations usually were not recognized at the acquisition date under Statement 141. Further, this Statement eliminates the concept of negative goodwill and requires gain recognition in instances in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any non-controlling interest in the acquiree. This Statement makes significant amendments to other Statements and other authoritative guidance, and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.
In December 2007, the FASB issued Statement No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51." This Statement amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years beginning on or after December 15, 2008.
2. SECURITIES
Securities are summarized as follows:
Information pertaining to securities with gross unrealized losses at December 31, 2007 and 2006, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
At December 31, 2007, five debt securities have gross unrealized losses of 0.9% from the Company's amortized cost basis of temporarily impaired debt securities which existed for less than twelve months. Because these losses relate to highly rated municipal obligations, are the result of fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2007, four debt securities have gross unrealized losses of 0.5% from the Company's amortized cost basis of temporarily impaired debt securities which existed for greater than twelve months. Because these losses relate to government-sponsored enterprises and highly rated municipal obligations, are the result of fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2007, three equity securities have an unrealized loss of 2.9% from the Company's cost basis which existed for greater than twelve months and is principally related to fluctuations in interest rates. These losses relate to mutual funds which invest primarily in short-term debt instruments and adjustable rate mortgage-backed securities. Because these losses are the result of fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2007, one equity security has an unrealized loss of 37.8% from the Company's cost basis. The security is an adjustable rate preferred stock issued by a government-sponsored enterprise. The unrealized loss is related to both fluctuations in interest rates and recent conditions regarding the issuer's capital. The issues regarding the issuer's capital affected the estimated fair value beginning in December 2007. Management feels that because the decline occurred recently and the Company has the intent and ability to hold the security a writedown at December 31, 2007 is not necessary.
The amortized cost and fair value of debt securities at December 31, 2007, by maturity, are shown below. Actual maturities may differ form contractual maturities because certain issues have the right to call or repay obligations.
Amortized Estimated Cost Fair Value --------- --------- (In thousands) Held to maturity: Due in one year or less $ 3,000 $ 2,992 Due after one year through five years 26,788 27,233 Due after five years through ten years 60,386 61,566 Due after ten years 13,851 14,038 -------- --------
Total held to maturity $104,025 $105,829 ======== ========
Available for sale: Due in one year or less $ - $ - Due after one year through five years 5,000 5,037 Due after five years through ten years 25,874 26,174 Due after ten years - - -------- --------
Total available for sale $ 30,874 $ 31,211 ======== ========
Proceeds from the sale of securities available for sale amounted to $15.1 million, $5.0 million and $3.8 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Gross realized gains of $51,000, $0, and $34,000, and gross realized losses of $13,000, $0, and $1,000 were recorded on securities during the years ended December 31, 2007, 2006, and 2005, respectively. There were no impairment losses recognized during the years ended December 31, 2007, 2006 and 2005.
Securities with a carrying value of $49 million and $40 million were pledged as collateral to the Federal Reserve Bank of Boston at December 31, 2007 and 2006, respectively, to secure public deposits and repurchase agreements.
Net unrealized losses on securities available for sale, net of tax were $107,000 and $240,000 at December 31, 2007 and 2006, respectively.
3. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are summarized as follows:
Proceeds from the sale of mortgage-backed securities available for sale amounted to $272,000, $0, and $17.0 million at December 31, 2007, 2006 and 2005, respectively.
Gross realized gains of $3,000, $0 and $27,000 and gross realized losses of $0, $0, and $41,000 were recorded on sales of mortgage-backed securities during the years ended December 31, 2007, 2006, and 2005, respectively.
Net unrealized gains (losses) on mortgage-backed securities available for sale, net of tax were $602,000 and ($563,000) at December 31, 2007 and 2006, respectively.
Information pertaining to securities with gross unrealized losses at December 31, 2007 and 2006, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
At December 31, 2007, twenty-six mortgage-backed securities have gross unrealized losses of 1.4% from the Bank's amortized cost basis which existed for less than twelve months. At December 31, 2007, eighty mortgage-backed securities have gross unrealized losses of 1.4% from the Bank's amortized cost basis which existed for greater than twelve months. Because these losses relate to mortgage-backed securities, which were primarily issued by government-sponsored enterprises, are the result of fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
4. LOANS
Loans consisted of the following amounts: December 31, ----------------------- 2007 2006 ----------------------- (In thousands)
Commercial real estate $189,964 $174,556 Residential real estate: Owner-occupied 1-4 family loans 63,929 70,640 Other residential real estate loans 44,181 38,900 Commercial and industrial 116,514 100,237 Consumer 5,479 5,841 -------- -------- Total Loans 420,067 390,174 Unearned premiums and deferred loan fees and costs, net 561 447 Allowance for loan losses (5,726) (5,437) -------- -------- $414,902 $385,184 ======== ========
The following table summarizes information regarding impaired loans:
December 31, ----------------- 2007 2006 ----------------- (In thousands)
Impaired loans without a valuation allowance $ 196 $ 84 Impaired loans with a valuation allowance - 55 ----- ----- Total impaired loans $ 196 $ 139 ===== =====
Specific allowance for impaired loans $ - $ 20 ===== =====
Impaired loans in nonaccrual status $ 196 $ 139 ===== =====
Years Ended December 31, ------------------------- 2007 2006 2005 ------------------------- (In thousands)
Average recorded investment in impaired loans $ 119 $ 490 $1,532 Income recorded on cash basis during the period for impaired loans 28 300 -
No additional funds are committed to be advanced in connection with impaired loans.
There were no restructured loans during the years ended December 31, 2007, 2006 and 2005.
Nonaccrual loans at December 31, 2007, 2006 and 2005 and related interest income are summarized as follows:
At or For the Years Ended December 31, ------------------------- 2007 2006 2005 ------------------------- (In thousands)
Nonaccrual loans $1,202 $1,028 $1,919 Interest income that would have been recorded under the original terms 65 67 176
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balances of these loans totaled $10.5 million and $13.0 million at December 31, 2007 and 2006, respectively. Net service fee income of $17,000, $22,000, and $24,000 was recorded for the years ended December 31, 2007, 2006, and 2005, respectively, and is included in service charges and fees on the consolidated statements of income.
5. ALLOWANCE FOR LOAN LOSSES
An analysis of changes in the allowance for loan losses is as follows:
Years Ended December 31, 2007 2006 2005 ----------------------------- (In thousands)
Balance, beginning of year $5,437 $5,422 $5,277 Provision 400 390 465 Charge-offs (317) (584) (612) Recoveries 206 209 292 ------ ------ ------
Balance, end of year $5,726 $5,437 $5,422 ====== ====== ======
6. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
December 31, -------------------- 2007 2006 -------------------- (In thousands)
Land $ 1,826 $ 2,201 Buildings 11,751 10,008 Leasehold improvements 1,435 1,435 Furniture and equipment 7,173 6,174 Construction in process 28 835 ------- ------- Total 22,213 20,653
Accumulated depreciation and amortization (9,501) (8,406) ------- -------
Premises and equipment, net $12,712 $12,247 ======= =======
Depreciation and amortization expense for the years ended December 31, 2007, 2006, and 2005 amounted to $1,096,000, $1,030,000, and $950,000, respectively.
7. DEPOSITS
Deposit accounts by type and weighted average rates are summarized as follows:
December 31, --------------------------------------- 2007 2006 ---------------- ---------------- Amount Rate Amount Rate ---------------- ---------------- (Dollars in thousands)
Demand and Now: Now accounts $ 85,316 1.62% $ 80,527 1.40% Demand accounts 42,408 - 42,383 -
Savings: Regular accounts 47,072 1.24 36,110 0.50 Money market accounts 74,601 1.24 94,441 1.51
Time certificates of deposit 353,279 4.44 374,005 4.39 -------- ---------
Total Deposits $602,676 3.08% $ 627,466 3.05% ======== =========
Time deposits of $100,000 or more totaled approximately $90.8 million and $93.5 million at December 31, 2007 and 2006, respectively. Interest expense on such deposits totaled $4.4 million, $3.6 million and $2.0 million for the years ended December 31, 2007, 2006, and 2005 respectively.
Cash paid for interest on deposits and borrowings was:
Years Ended December 31, ----------------------------- 2007 2006 2005 ----------------------------- (In thousands)
Deposits $19,429 $17,249 $11,807 Customer repurchase agreements 592 438 312 Federal Home Loan Bank of Boston advances 3,020 1,785 1,462 ------- ------- ------- Total $23,041 $19,472 $13,581 ======= ======= =======
At December 31, 2007, the scheduled maturities of time certificates of deposit (in thousands) are as follows:
2008 $266,234 2009 58,436 2010 21,370 2011 6,932 2012 307 -------- $353,279 ========
Interest expense on deposits for the years ended December 31, 2007, 2006, and 2005 is summarized as follows:
Years Ended December 31, ----------------------------- 2007 2006 2005 ----------------------------- (In thousands)
Savings $ 329 $ 226 $ 217 Money market accounts 1,301 1,684 2,117 Time certificates of deposit 16,574 14,450 9,154 Other interest bearing 1,340 908 325 ------- ------- ------- $19,544 $17,268 $11,813 ======= ======= =======
8. CUSTOMER REPURCHASE AGREEMENTS
The following table summarizes information regarding repurchase agreements:
Years Ended December 31, ---------------------- 2007 2006 ---------------------- (Dollars in thousands)
Balance outstanding, end of year $16,824 $17,919 Maximum amount outstanding at any month end during year 23,619 20,137 Average amount outstanding during year 19,967 16,632 Weighted average interest rate, end of year 2.65% 3.03% Amortized cost of collateral pledged, end of year 44,477 30,380 Fair value of collateral pledged, end of year 45,299 29,995
The Company`s repurchase agreements are collateralized by government-sponsored enterprises and certain mortgage-backed securities. The weighted average interest rate on the pledged collateral was 4.96% at December 31, 2007.
9. SHORT-TERM BORROWINGS
Federal Home Loan Bank Advances - Federal Home Loan Bank advances with an original maturity of less than one year, amounted to $18.0 million and $10.0 million at December 31, 2007 and 2006, respectively, at a weighted average rate of 4.68% and 5.43%, respectively.
The Company has an "Ideal Way" line of credit with the Federal Home Loan Bank of Boston for $9,541,000 for the years ended December 31, 2008 and 2007. Interest on this line of credit is payable at a rate determined and reset by the Federal Home Loan Bank on a daily basis. The outstanding principal shall be due daily but the portion not repaid will be automatically renewed. $444,000 was outstanding under this line at December 31, 2007 and no amount at December 31, 2006. The weighted average interest rate on this outstanding principal was 4.20% at December 31, 2007.
Federal Home Loan Bank advances are collateralized by a blanket lien on the Company's residential real estate loans and certain mortgage-back securities.
10. LONG-TERM DEBT
The following fixed rate advances are collateralized by a blanket lien on the Company's residential real estate loans and certain mortgage-backed securities.
Weighted Average Amount Rate December 31, December 31, ----------------------------------------- 2007 2006 2007 2006 ----------------------------------------- Year of Maturity (Dollars in thousands)
2007 $ - $20,000 -% 3.1% 2008 20,000 15,000 4.7 4.4 2009 30,000 5,000 4.8 3.3 2010 30,000 - 4.5 - 2012 20,000 - 4.6 - 2014 5,000 5,000 5.0 5.0 -------- ------- --- --- Total advances $105,000 $45,000 4.7% 4.1% ======== ======= === ===
At December 31, 2007, the Company had $20.0 million in callable Federal Home Loan Bank of Boston advances. Of this amount, $10.0 million is callable on September 8, 2008 and $10.0 million is callable on December 15, 2008.
11. STOCK PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN
Stock Options - Under Westfield Financial's 2002 Stock Option Plan and 2007 Stock Option Plan, Westfield Financial may grant options to its directors, officers, and employees of up to 1,631,682 shares and 1,560,101 shares, respectively, of common stock. Both incentive stock options and non-statutory stock options may be granted under the plan. The exercise price of each option equals the market price of Westfield Financial's stock the date of grant with a maximum term of ten years. All options currently outstanding vest at 20% per year.
As of May 2007, all remaining shares under the 2002 Stock Option Plan were fully allocated and no shares are currently available for future grants. The 2007 Stock Option Plan was approved by the shareholders at the annual meeting of shareholders on July 19, 2007. In August, 2007, 1,351,702 shares of common stock were granted from the 2007 Stock Option Plan. At December 31, 2007, 208,399 shares were available for future grants.
A summary of the status of Westfield Financial's stock options at December 31, 2007 is presented below:
Weighted Average Shares Exercise Price ------ ----------------
Balance at December 31, 2005 1,345,531 $ 4.42 Granted - - Exercised (128,481) 4.39 --------- Balance at December 31, 2006 1,217,050 4.43
Granted under 2002 Stock Option Plan 150,155 10.11 Granted under 2007 Stock Option Plan 1,351,702 10.04 Exercised (9,574) 4.39 --------- Balance at December 31, 2007 2,709,333 $ 7.54 =========
The weighted average fair value of the options granted in 2007 and 2005 were $2.67 per share and $2.08 per share, respectively. No options were granted during the twelve months ended December 31, 2006. The total intrinsic value of options exercised during the years ended December 31, 2007, 2006 and 2005 was $57,000, $526,000 and $405,000, respectively. Cash received for options exercised during the years ended December 31, 2007, 2006, and 2005 was $42,000, $563,000 and $541,000, respectively. At December 31, 2007, total unrecognized compensation cost for stock options was $3.8 million, with a remaining life of 4.8 years.
Information pertaining to options outstanding at December 31, 2007, 2006 and 2005 is as follows:
Stock Awards - Under Westfield Financial's 2002 Recognition and Retention Plan and 2007 Recognition and Retention Plan, Westfield Financial may grant stock awards to its directors, officers and employees of up to 652,664 shares and 624,041 shares, respectively, of common stock. In May 2007, all remaining shares under the 2002 Recognition and Retention Plan were fully allocated and no shares are currently available for future grants. The 2007 Recognition and Retention Plan was approved by the shareholders at the annual meeting of shareholders on July 19, 2007. In August 2007, 559,000 shares of common stock were granted under the 2007 Recognition and Retention Plan. As of December 31, 2007, 65,041 shares were available for future grants.
A summary of the status of Westfield Financial's Recognition and Retention Plan at December 31, 2007 is presented below:
Weighted Average Grant Shares Date Fair Value ------ ---------------
Balance at December 31, 2006 111,170 $ 4.56 Shares Granted under 2002 Recognition and Retention Plan 20,029 10.11 Shares Granted under 2007 Recognition and Retention Plan 559,000 10.04 Shares Vested (107,233) 4.39 ------- Balance at December 31, 2007 582,966 $ 7.54 =======
Westfield Financial applies SFAS 123(R) in accounting for stock awards. The stock allocations, based on the market price at the date of grant, are recorded as unearned compensation. Unearned compensation is amortized over the vesting period. Westfield Financial recorded compensation cost related to the stock awards of approximately $751,000, $481,000, and $706,000 for the years ended December 31, 2007, 2006, and 2005, respectively. Unrecognized compensation cost for stock awards was $5.5 million at December 31, 2007, with a remaining life of 4.8 years.
In 2007, 559,000 shares were granted as stock awards, having a fair value of $10.04 per share. Stock awards of 3,281 shares were granted in 2006 and 2005, having a fair value of $7.59 and $7.52 per share, respectively. Total fair value of the stock awards vested was $477,000 for the years ended December 31, 2007 and 2006, and $731,000 for the year ended December 31, 2005.
Employee Stock Ownership Plan - In January 2002, Westfield Financial established an Employee Stock Ownership Plan (the "ESOP") for the benefit of each employee that has reached the age of 21 and has completed at least 1,000 hours of service in the previous twelve-month period. As part of the conversion, Westfield Financial provided a loan to the Westfield Financial Employee Stock Ownership Plan Trust which was used to purchase 8%, or 1,305,359 shares, of Westfield Financial's outstanding stock in the open market.
In January 2007, as part of the second step stock conversion, Westfield Financial provided a loan to the Westfield Financial Employee Stock Ownership Plan Trust which was used to purchase 4.0%, or 736,000 shares, of the 18,400,000 shares of common stock sold in the offering. The 2002 and 2007 loans bear interest equal to 8.0% and provide for annual payments of interest and principal.
At December 31, 2007 the remaining principal balance is payable as follows:
Years Ending December 31, (In thousands) ------------ --------------
2008 $ 447 2009 447 2010 447 2011 447 2012 447 Thereafter 9,714 ------- $11,949 =======
Westfield Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loans. The loans are secured by the shares purchased, which are held in a suspense account for allocation among the participants as the loans are paid. Total compensation expense applicable to the ESOP amounted to $973,000, $521,000 and $458,000 for the years ended December 31, 2007, 2006, and 2005, respectively.
Shares held by the ESOP include the following at December 31, 2007 and 2006.
2007 2006 ---- ----
Allocated 278,881 224,725 Committed to be allocated 96,182 60,729 Unallocated 1,645,393 1,005,575 --------- --------- 2,020,456 1,291,029 ========= =========
Cash dividends received on allocated shares are allocated to participants and cash dividends received on shares held in suspense are applied to repay the outstanding debt of the ESOP. The fair value of unallocated shares was approximately $16.0 million and $10.6 million at December 31, 2007 and 2006, respectively.
ESOP shares are considered outstanding for earnings per share calculations as they are committed to be allocated. Unallocated ESOP shares are excluded from earnings per share calculations. Dividends declared on allocated ESOP shares are charged to retained earnings. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders' equity.
12. RETIREMENT PLANS AND EMPLOYEE BENEFITS
Pension Plan - The Company provides basic and supplemental pension benefits for eligible employees through the SBERA Pension Plan (the "Plan"). Employees must work a minimum of 1,000 hours per year to be eligible for the Plan. Eligible employees become vested in the Plan after five years of service.
The following table provides information for the Plan at or for the years ended December 31:
Net pension cost includes the following components for the years ended December 31:
The following actuarial assumptions were used in determining the pension benefit obligation and service costs for the years ended December 31:
2007 2006 2005 ---- ---- ---- Weighted-average assumptions: Discount rate 5.75% 5.75% 5.75% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 5.00% 5.00% 5.00%
The expected long term rate of return on plan assets is based on prevailing yields of high quality fixed income investments increased by a premium of 3% to 5% for equity investments. The Company expects to contribute $557,000 to its pension plan in 2008.
The Company's pension plan asset allocation at December 31, 2007 and 2006 are as follows:
Percentage of Plan Assets at December 31, Asset Category 2007 2006 -------------- ---- ----
Fixed Income Securities (including money market) 39.2% 36.5% Domestic Equity Securities 44.8 48.5 International Equity Securities 16.0 15.0 ----- ----- 100.0% 100.0% ===== =====
The target allocation mix for the pension plan for 2007 was an equity-based investment deployment range from 55% to 75% of total portfolio assets. The remainder of the portfolio is allocated to fixed income.
Trustees of SBERA select investment managers for the portfolio and a special investment advisory firm is retained to provide allocation analysis. The overall investment objective is to diversify equity investments across a spectrum of types, small cap, large cap and international, along with investment styles such as growth and value.
The Company estimates that the benefits to be paid from the pension plan for years ended December 31, are as follows:
Benefit Payments to Year Participants ---- ------------------- (In thousands)
2008 $ 420 2009 1,039 2010 44 2011 630 2012 807 In Aggregate for 2013 - 2017 3,382 ------- $ 6,322
The Company expects to contribute $557,000 to the plan in 2008.
Postretirement Benefits - The Company provided postretirement life insurance benefits to employees based on the employee's salary at time of retirement. As of December 31, 2007 and 2006, the accrued liability recorded in other liabilities on the consolidated balance sheet amounted to $335,000 and $622,000, respectively. Total expense associated with this plan amounted to $19,000, $88,000 and $81,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
In 2007, Westfield Financial curtailed its postretirement life insurance benefits for active employee to offset rising compensation costs. The curtailment resulted in a pre-tax gain of $315,000.
Supplemental Retirement Benefits - The Company provides supplemental retirement benefits to certain key officers. At December 31, 2007 and 2006, the Company had accrued $2.4 million and $2.3 million, respectively, relating to these benefits. Amounts charged to expense were $350,000, $270,000, and $389,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
401(k) - Employees are eligible to participate in a 401(k) plan. The Company makes a matching contribution of 50% with respect to the first 6% of each participant's annual earnings contributed to the plan. The Company's contributions to the plan were $161,000, $149,000 and $150,000, for the years ended December 31, 2007, 2006 and 2005, respectively.
13. REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision. 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 Bank's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of 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. Prompt corrective action provisions are not applicable to savings and loan holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined),Tier 1 capital (as defined) to average assets (as defined) and of tangible capital (as defined) to tangible assets (as defined). Management believes, as of December 31, 2007 and 2006, that the Bank met all capital adequacy requirements to which it is subject.
As of December 31, 2007, the most recent notification from the Office of Thrift Supervision 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. There are no conditions or events since that notification that management believes have changed the Bank's category. The Company's and the Bank's actual capital ratios as of December 31, 2007 and 2006 are also presented in the table.
In July 2004, the Company announced that the Board of Directors had approved a share repurchase program (the "Repurchase Program") which authorized the repurchase of up to 502,550 shares or five percent of its outstanding shares of common stock, continuing until its completion. At December 31, 2006, the Company had 99,862 shares remaining to be purchased under this program. Upon completion of the second step stock offering, the Repurchase Program was eliminated.
The Company and the Bank are subject to dividend restrictions imposed by various regulators, including a limitation on the total of all dividends that the Bank may pay to the Company in any calendar year, to an amount that shall not exceed the Bank's net income for the current year, plus the Bank's net income retained for the two previous years, without regulatory approval. In addition, the Bank may not declare or pay dividends on, and the Company 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. At December 31, 2007 and 2006, the Bank's retained earnings available for payment of dividends was $19.2 million and $16.5 million, respectively. Accordingly, $46.3 million and $42.7 million of the Company's equity in net assets of the Bank was restricted at December 31, 2007 and 2006, respectively.
The only funds available for the payment of dividends on the capital stock of Westfield Financial will be cash and cash equivalents held by Westfield Financial, dividends paid from Westfield Bank to Westfield Financial, and borrowings. Westfield Bank will be prohibited from paying cash dividends to Westfield Financial to the extent that any such payment would reduce Westfield Bank's capital below required capital levels.
The following is a reconciliation of the Company's GAAP capital to regulatory Tier 1 capital:
14. INCOME TAXES
Income taxes consist of the following:
The reasons for the differences between the statutory federal income tax rate and the effective rates are summarized below:
Cash paid for income taxes for the years ended December 31, 2007, 2006, and 2005 was $3.8 million, $1.8 million and $1.4 million, respectively.
The tax effects of each item that gives rise to deferred taxes, included in other assets, are as follows:
A summary of the change in the net deferred tax asset is as follows:
The federal income tax reserve for loan losses at the Bank's base year is $5.8 million. 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 fiscal year in which used. As the Bank intends to use the reserve solely to absorb loan losses, a deferred tax liability of $2.4 million has not been provided.
15. TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS
The Company has had, and expects to have in the future, loans with its directors and executive officers. Such loans, in the opinion of management do not include more than the normal risk of collectibility or other unfavorable features. Following is a summary of activity for such loans:
Years Ended December 31, --------------------------- 2007 2006 --------------------------- (In thousands)
Balance, beginning of year $13,415 $13,538 Principal distributions 3,913 770 Repayments of principal (4,435) (893) ------- -------
Balance, end of year $12,893 $13,415 ======= =======
16. COMMITMENTS AND CONTINGENCIES
In the normal course of business, various commitments and contingent liabilities are outstanding, such as standby letters of credit and commitments to extend credit with off-balance-sheet risk that are not reflected in the consolidated financial statements. Financial instruments with off-balance-sheet risk involve elements of credit, interest rate, liquidity and market risk.
Management does not anticipate any significant losses as a result of these transactions. The following summarizes these financial instruments and other commitments and contingent liabilities at their contract amounts:
December 31, ------------------------ 2007 2006 ------------------------ (In thousands)
Commitment to extend credit: Unused lines of credit $61,975 $58,275 Loan commitments 19,163 35,443 Existing loan agreements 8,419 3,210 Standby letters of credit 7,364 6,159
The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.
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. Since some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are written conditional commitments issued by the Company that guarantees the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
At December 31, 2007 outstanding commitments to extend credit totaled $96.9 million, with $13.3 million in fixed rate commitments with interest rates ranging from 5.25% to 12.00% and $83.6 million in variable rate commitments. At December 31, 2006, outstanding commitments to extend credit totaled $103.1 million, with $18.7 million in fixed rate commitments with interest rates ranging from 6.00% to 10.00% and $84.4 million in variable rate commitments.
In the ordinary course of business, the Company is party to various legal proceedings, none of which, in the opinion of management, will have a material effect on the Company's consolidated financial position or results of operations.
The Company leases facilities and certain equipment under cancelable and noncancelable leases expiring in various years through the year 2046. Certain of the leases provide for renewal periods for up to forty years at the discretion of the Company. Rent expense under operating leases was $363,000, $246,000, and $197,000 for the years ended December 31, 2007, 2006, and 2005, respectively.
Aggregate future minimum rental payments under the terms of the operating leases at December 31, 2007, are as follows:
Years Ending (In thousands) ------------
2008 378 2009 377 2010 371 2011 371 2012 282 Thereafter 6,762 ------ $8,541
17. CONCENTRATIONS OF CREDIT RISK
Most of the Company's loans consist of residential and commercial real estate loans located in Western Massachusetts. As of December 31, 2007 and 2006, the Company's residential and commercial related real estate loans represented 71% of total loans. The Company's policy for collateral requires that the amount of the loan may not exceed 100% and 85% of the appraised value of the property for residential and commercial real estate, respectively, at the date the loan is granted. For residential loans, in cases where the loan exceeds 80%, private mortgage insurance is typically obtained for that portion of the loan in excess of 80% of the appraised value of the property.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
Methods and assumptions for valuing the Company's financial instruments are set forth below for financial instruments that have fair values different than their carrying values. Estimated fair values are calculated based on the value without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications or estimated transaction costs.
Cash and Cash Equivalents, Accrued Interest Receivable and Accrued Interest Payable - The carrying amounts of these items are considered to be a reasonable estimate of fair value due to their short-term nature.
Securities and Mortgage-Backed Securities - The estimated fair values for securities and mortgage-backed securities are based on quoted market prices for identical or similar assets.
Federal Home Loan Bank and Other Stock - These investments are carried at cost which approximates fair value.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, net of the applicable portion of the allowance for loan losses, such as commercial and industrial, commercial real estate, residential mortgage, and consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.
The fair value of performing loans, except residential mortgage loans, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources adjusted to reflect differences in credit costs.
Estimated fair value for impaired loans is based on recent external appraisals if the loan is collateral dependent. Assumptions regarding credit risk cash flows and discount rates are judgmentally determined using available market information and specific borrower information.
Management has made estimates of fair value discount rates that it believes to be reasonable.
Deposits -The estimated fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market and checking accounts, is equal to the amount payable on demand. The estimated fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Customer Repurchase Agreements -The fair value of these agreements is estimated based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered.
Federal Home Loan Bank Advances - The estimated fair value of these borrowings is based upon the discounted value of contractual cash flows. The discount rate is estimated using Federal Home Loan Bank of Boston advance rates currently offered for borrowings with similar maturities.
Commitments to Extend Credit - The stated value of commitments to extend credit approximates fair value as the current interest rates for similar commitments do not differ significantly. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Such differences are not considered significant.
The estimated fair values of the Company's financial instruments at December 31 are as follows:
Limitations - Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment. Changes in assumptions could significantly affect the estimates.
19. SEGMENT INFORMATION
The Company has one reportable segment, "Community Banking." All of the Company's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit.
The Company operates only in the U.S. domestic market, primarily in Western Massachusetts. For the years ended December 31, 2007, 2006 and 2005 there is no customer that accounted for more than 10% of the Company's revenue.
20. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The condensed balance sheets of the Company are as follows:
December 31, ----------------------- 2007 2006 ---- ---- (In thousands)
ASSETS: Due from banks $ 2,691 $171,737 Federal funds sold 10,979 636 Securities held to maturity 6,885 1,883 Securities available for sale 10,163 - Mortgage-backed securities held to maturity 11,964 399 Mortgaged-backed securities available for sale 27,331 - Investment in subsidiaries 213,574 113,297 Other assets 3,072 1,528 -------- -------- TOTAL ASSETS $286,659 $289,480 ======== ========
LIABILITIES AND EQUITY: Liabilities $ 127 $ 72 Equity 286,532 289,408 -------- -------- TOTAL LIABILITIES AND EQUITY $286,659 $289,480 ======== ========
The condensed statements of income for the Company are as follows:
The condensed statement of cash flows of the Company are as follows:
21. OTHER NONINTEREST EXPENSE
There is no item that as a component of other noninterest expense, exceeds 1% of the aggregate of total interest income and noninterest income for the years ended December 31, 2007, 2006 and 2005 respectively.
22. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders Westfield Financial, Inc.
We have audited Westfield Financial, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Westfield Financial Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Westfield Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Westfield Financial, Inc. and our report dated March 11, 2008 expressed an unqualified opinion.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts March 11, 2008