ITEM 1. BUSINESS
General
Medford Bancorp Inc., (the "Company") was organized in 1997 as a Massachusetts corporation to be the holding company for Medford Savings Bank (the "Bank").
Established as a Massachusetts savings bank in 1869, the Bank converted from mutual to stock form on March 18, 1986 and issued 3,680,000 shares of common stock. The Bank is principally engaged in the business of attracting deposits from the general public, originating residential and commercial real estate mortgages, consumer and commercial loans, and investing in securities on a continuous basis. For a detailed description of the Company's business and financial information, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this report. The Bank is headquartered in Medford, Massachusetts, which is located approximately seven miles north of downtown Boston. The Bank principally offers its products and services through a network of seventeen banking offices located in Medford, Malden, Arlington, Belmont, Burlington, North Reading, Tewksbury, Waltham, and Wilmington. The Bank's primary market area includes these communities as well as other cities and towns in Middlesex County and the surrounding area north of Boston.
The Bank presently has one wholly-owned subsidiary, Medford Securities Corporation ("MSC"), which became operational on March 1, 1995. MSC engages exclusively in the buying, selling, dealing in, and holding of securities.
Supervision and Regulation
General. The Company is a Massachusetts corporation and a bank holding company subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") pursuant to the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and files with the Federal Reserve Board an annual report and such additional reports as the Federal Reserve Board may require. The Company is also subject to the jurisdiction of the Massachusetts Commissioner of Banks. As a bank holding company, the Company's activities are limited to the business of banking and activities closely related or incidental to banking. Provided that it does not become a "financial holding company" under the recently enacted Gramm-Leach-Bliley Act (as discussed below), the Company may not directly or indirectly acquire the ownership or control of more than 5 percent of any class of voting shares or substantially all of the assets of any company that is not engaged in activities determined by the Federal Reserve Board prior to November 12, 1999 by order or regulation to be closely related to banking, and also generally must provide notice to or obtain approval of the Federal Reserve Board in connection with any such acquisition.
As a Massachusetts-chartered savings bank, the Bank is subject to comprehensive regulation and examination by the Federal Deposit Insurance Corporation (the "FDIC") which insures its deposits to the maximum extent permitted by law, and by the Commissioner of Banks of the Commonwealth of Massachusetts (the "Commissioner"). The Bank is also subject to certain requirements established by the Federal Reserve Board and is a member of the Federal Home Loan Bank of Boston (the "FHLBB").
Federal Deposit Insurance Corporation. The FDIC insures the Bank's deposit accounts to the $100,000 maximum per separately insured account. As a state-chartered, FDIC-insured nonmember savings bank, the Bank is subject to regulation, examination, and supervision by the FDIC, and to reporting requirements of the FDIC. The FDIC has adopted requirements setting minimum standards for capital adequacy. Pursuant to FDIC requirements, the Bank must maintain a Tier 1 capital to risk-weighted assets ratio of 4.00% and a total capital to risk-weighted assets ratio of 8.00%. The FDIC also imposes a leverage capital ratio of at least 3.00% for the most highly rated banks and a leverage capital ratio between 4.00% and 5.00% for other banks. The Bank exceeded all applicable requirements at December 31, 1999. Furthermore, under the capital standards established pursuant to the FDIC Improvement Act of 1991 ("FDICIA"), the Bank is currently well-capitalized. International bank supervisory organizations, principally the Basel Committee on Banking Supervision, currently are considering changes to the risk-based capital adequacy framework, which ultimately could affect the FDIC's guidelines.
Federal Home Loan Bank System. The Federal Home Loan Bank System functions as a reserve credit source for its member financial institutions and is governed by the Federal Housing Finance Board ("FHFB"). The Bank is a voluntary member of the FHLBB. Members of the FHLBB are required to own capital stock that is directly proportionate to the member's home mortgage loans and borrowings from the FHLBB outstanding from time to time. FHLBB advances must be secured by specific types of collateral and may be obtained principally for the purpose of providing funds for residential housing finance.
Federal Reserve Board Regulations. Regulation D promulgated by the Federal Reserve Board requires all depository institutions, including the Bank, to maintain reserves against its transaction accounts (generally, demand deposits, NOW accounts and certain other types of accounts that permit payments or transfer to third parties) or non-personal time deposits (generally, money market deposit accounts or other savings deposits held by corporations or other depositors that are not natural persons, and certain other types of time deposits), subject to certain exemptions. 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 the amount of the institution's interest-bearing assets.
Massachusetts Commissioner of Banks and Board of Bank Incorporation. The Bank is also subject to regulation, examination and supervision by the Commissioner and to the reporting requirements promulgated by the Commissioner. Massachusetts statutes and regulations govern, among other things, investment powers, lending powers, deposit activities, maintenance of surplus and reserve accounts, the distribution of earnings, the payment of dividends, issuance of capital stock, branching, acquisitions and mergers and consolidation. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Commissioner may be subject to sanctions for noncompliance. The Commissioner may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the Bank's business in a manner which is unsafe, unsound or contrary to the depositor's interest, or been negligent in the performance of their duties.
In response to a Massachusetts law enacted in 1996, the Commissioner finalized rules in 1997 and 2000 that give Massachusetts banks, and their subsidiaries, many powers equivalent to those of national banks. The Commissioner also has adopted procedures expediting branching by strongly capitalized banks.
Depositors Insurance Fund. Massachusetts-chartered savings banks are required to be members of the Depositors Insurance Fund ("DIF"), a corporation created by the Commonwealth of Massachusetts for the purpose of insuring savings bank deposits not covered by federal deposit insurance. To the extent the Bank's deposit accounts are not insured by federal insurance, such deposits are insured by the DIF.
Federal Deposit Insurance Corporation Improvement Act of 1991. FDICIA made extensive changes to the federal banking laws. Among other things, FDICIA requires federal bank regulatory agencies to take prompt corrective action to address the problems of, and imposes significant restrictions on, under-capitalized banks. With certain exceptions, FDICIA prohibits state banks from making equity investments and engaging, as principals, in activities which are not permissible for national banks, such as insurance underwriting. FDICIA required banks to divest any impermissible equity investments by December 19, 1996. FDICIA also amends federal statutes governing extensions of credit to directors, executive officers and principal shareholders of banks, savings associations and their holding companies, limits the aggregate amount of depository institutions' loans to insiders to the amount of the institution's unimpaired capital and surplus, restricts depository institutions that are not well-capitalized from accepting brokered deposits without an express waiver from the FDIC, and imposes certain advance notice requirements before closing a branch office. Pursuant to the FDICIA, the FDIC has adopted a framework of risk-based deposit insurance assessments that take into account different categories and concentrations of bank assets and liabilities. Effective January 1999, the FDIC revised its regulations relating to FDICIA to generally ease the ability of state nonmember banks and their subsidiaries to engage in certain activities not permissible for a national bank, such as real estate development.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Riegle-Neal"), different types of interstate transactions and activities are permitted. Interstate transactions and activities provided for under the law include: (i) bank holding company acquisitions of separately held banks in a state other than a bank holding company's home state; (ii) mergers between banks with different home states, including consolidations of affiliated banks; (iii) establishment of interstate branches either de novo or by branch acquisition; and (iv) affiliate banks acting as agents for one another for certain banking functions without being considered a "branch". In general, subject to certain limitations, nationwide interstate acquisitions are now permissible, irrespective of state law limitations other than limitations related to deposit concentrations and bank age requirements. Interstate mergers also are permissible. Affiliated banks may act as agents for one another. Each of the transactions and activities must be approved by the appropriate federal bank regulator, with separate and specific criteria established for each category.
In 1996, Massachusetts enacted interstate banking laws in response to Riegle-Neal. The laws permit, subject to certain deposit and other limitations, interstate acquisitions, mergers and branching on a reciprocal basis.
The Gramm-Leach-Bliley Act. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act, which, in part, is intended to permit bank holding companies that qualify and elect to be treated as a financial holding company to engage in a significantly broader range of financial activities. At this time, the Company has not determined whether it will become a financial holding company.
More specifically, the Gramm-Leach-Bliley Act repeals provisions of the Glass-Steagall Act: Section 20, which restricted the affiliation of banks with firms "engaged principally" in specified securities activities, and Section 32, which restricts officer, director, or employee interlocks between a bank and any company or person "primarily engaged" in specified securities activities. Moreover, the general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit a holding company system, such as the Company, to engage in a full range of financial activities through a new entity known as a financial holding company. "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
Generally, although significant implementing regulations have yet to be published, the Gramm-Leach-Bliley Act:
o repeals historical restrictions on, and eliminates many federal and state law barriers to, affiliations among banks, securities firms, insurance companies, and other financial service providers;
o provides a uniform framework for the functional regulation of the activities of banks, savings institutions, and their holding companies;
o broadens the activities that may be conducted by national banks (and, derivatively, state banks), banking subsidiaries of bank holding companies, and their financial subsidiaries;
o provides an enhanced framework for protecting the privacy of consumer information;
o adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system;
o modifies the laws governing the implementation of the Community Reinvestment Act of 1977; and
o addresses a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.
In order to elect to become a financial holding company and engage in the new activities, a bank holding company, such as the Company, must meet certain tests and file an election form with the Federal Reserve Board that generally is acted on within thirty days. To qualify, all of a bank holding company's subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities each of the bank holding company's banks must have been rated "satisfactory" or better in its most recent federal Community Reinvestment Act evaluation. Furthermore, a bank holding company that elects to be treated as a financial holding company may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the Federal Reserve Board that imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions.
Further, the Gramm-Leach-Bliley Act includes new sections of the National Bank Act and the Federal Deposit Insurance Act governing the establishment and operation of financial subsidiaries to permit national banks and state banks, to the extent permitted under state law, to engage in certain new activities which are permissible for subsidiaries of a financial holding company. In addition, the Gramm-Leach-Bliley Act expressly preserves the ability of national banks and state banks to retain all existing subsidiaries. In order to form a financial subsidiary, a national bank or state bank must be well-capitalized, and such banks would be subject to certain capital deduction, risk management and affiliate transaction rules.
Federal Securities Laws. Pursuant to the Securities Exchange Act of 1934 (the "Exchange Act"), the Company files annual, quarterly, and periodic reports with the Securities and Exchange Commission (the "SEC"). The Company is also subject to the insider trading requirements of Sections 16(a) and 16(b) of the Exchange Act, as administered by the SEC.
The Gramm-Leach-Bliley Act also amended the federal securities laws to, effective May, 2001, eliminate the blanket exceptions that banks traditionally have had from the definition of broker-dealer and investment adviser. Accordingly, banks not falling within the specific exemptions provided by the new law may have to register with the SEC as a broker-dealer and/or investment adviser, as appropriate, and become subject to SEC jurisdiction.
Other Activities
The Bank owns stock in The Savings Bank Life Insurance Company of Massachusetts ("SBLI"). The Bank sells life insurance and tax-deferred annuities and sold over $1.9 million in SBLI annuities in 1999, making it the top seller of this product in Massachusetts.
The Bank provides safe deposit services at nine of its branches.
The Bank originates 30-year, fixed-rate, residential 1-4 family loans in correspondent relationships with third parties such as Plymouth Mortgage Company and Chase Manhattan Mortgage Corporation, whereby the Bank originates loans in exchange for an origination fee. The Bank does not retain the servicing rights for these loans.
Competition
The Company faces substantial competition for loan origination and for the attraction and retention of deposits. Competition for loan origination arises primarily from commercial banks, other thrift institutions, credit unions and mortgage companies. The Company competes for loans on the basis of product variety and flexibility, competitive interest rates and fees, service quality and convenience.
Competition for the attraction and retention of deposits arises primarily from commercial banks, other thrift institutions, and credit unions having a presence within and around the market area served by the Bank's main office and its community branch and ATM network. There are approximately 200 of these financial institutions in the Bank's market area. In addition, the Company competes with regional and national firms which offer stocks, bonds, mutual funds and other investment alternatives to the general public. The Company competes on its ability to satisfy such requirements of savers and investors as product alternatives, competitive rates, liquidity, service quality, convenience, and safety against loss of principal and earnings.
Moreover, under the Gramm-Leach-Bliley Act, effective March 11, 2000, securities firms, insurance companies and other financial services providers that elect to become financial holding companies may acquire banks and other financial institutions. The Gramm-Leach-Bliley Act may significantly change the competitive environment in which the Company and its subsidiaries conduct business. See "Supervision and Regulation--The Gramm-Leach-Bliley Act" above. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services.
Management believes that the Company's emphasis on personal service and convenience, coupled with active involvement within the communities it serves, contributes to its ability to compete successfully.
Employees
As of December 31, 1999, the Bank employed 215 full-time staff, including 51 officers, and 78 part-time staff. None of the Bank's employees is represented by a labor union. The Company has no officers or employees separate from the Bank.
Executive Officers of the Company and Bank
The executive officers of the Company and/or the Bank, their positions with the Company and/or the Bank and their ages as of February 29, 2000 are as follows:
Name Age Position
Arthur H. Meehan 64 President and Chief Executive Officer of the Company and the Bank; Chairman of the Board of Directors of the Company and the Bank
Phillip W. Wong 50 Executive Vice President, Chief Financial Officer and Treasurer of the Company; Executive Vice President and Chief Financial Officer of the Bank
George A. Bargamian 51 Executive Vice President of the Bank (Retail)
Name Age Position
Eric B. Loth 57 Senior Vice President of the Bank (Lending)
William F. Rivers 44 Senior Vice President of the Bank (Administration)
Arthur H Meehan. Mr. Meehan commenced his employment with the Bank in February 1992. Prior to this date, Mr. Meehan served as Executive Vice President of the Bank of New England Corporation.
Phillip W. Wong. Mr. Wong commenced his employment with the Bank as Senior Vice President in December 1992 and was promoted to Executive Vice President in 1997. Prior to this date, Mr. Wong served as Chief Financial Officer of Guaranty-First Trust Co. in Waltham, Massachusetts.
George A. Bargamian. Mr. Bargamian was hired by the Bank as Director of Marketing in 1988, and was promoted to Senior Vice President in 1988 and Executive Vice President of the Bank during 1999. Mr. Bargamian formerly served as Assistant Vice President of Marketing for First Mutual of Boston.
Eric B. Loth. Mr. Loth commenced his employment with the Bank as Senior Vice President in August 1994. Prior to this date, Mr. Loth served as Vice President of Lending at Sterling Bank in Waltham, Massachusetts.
William F. Rivers. Mr. Rivers commenced his employment with the Bank in January 1974, served as Assistant Treasurer from 1980-1985, Vice President from 1985-1988, and was promoted to Senior Vice President in 1988.
ITEM 2.
ITEM 2. PROPERTIES
All of the Bank's branches located in Medford (except for the West Medford branch), the branch located in Arlington, and the Malden Center, Maplewood and Oak Grove branches located in Malden, and the Tewksbury branch, located in Tewksbury, are owned by the Bank. All other branches are leased from unrelated third parties. The Company recently sold one of its buildings and consolidated staff and resources into its main operations center. Additional space in this operations center is leased to third parties. Subject to the foregoing, the Company believes that its properties are adequate for its present needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company is a party or to which any of its property is subject, although the Company is a party to ordinary routine litigation incidental to its business.
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 STOCK AND RELATED STOCKHOLDER MATTERS
The Company's (and, prior to the reorganization into a bank holding company structure, the Bank's) common stock is quoted on the Nasdaq National Market System under the symbol "MDBK." The following table sets forth cash dividends declared on common stock and the high and low closing prices for the quarters indicated. All prices set forth below are based on information provided by the National Association of Securities Dealers, Inc.
Common Stock Sale Prices ------------------------ Dividends Declared High Low Per Share ---- --- --------- 1999 1st quarter $18 13/16 $17 $0.11 2nd quarter 18 7/16 15 1/4 0.11 3rd quarter 19 1/4 15 0.11 4th quarter 17 5/8 15 3/4 0.18
1998 1st quarter $22 $17 3/4 $0.10 2nd quarter 22 1/8 20 1/4 0.10 3rd quarter 21 1/4 16 1/8 0.10 4th quarter 18 3/4 13 1/2 0.20
At March 1, 2000, according to the Company's transfer agent, the Company had approximately 1,091 record holders of its common stock. The number of holders of record does not reflect the number of persons or entities who or which held their stock in nominee or "street" name through various brokerage firms or other entities.
The declaration of future dividends to the Company's stockholders is subject to future operating results, financial conditions, tax and legal considerations and other factors, such as the Bank's ability to declare and pay dividends to the Company. As the principal asset of the Company, the Bank currently provides the only source of payment of dividends by the Company. FDICIA limits the ability of undercapitalized insured banks to pay dividends. Moreover, under Massachusetts law, a stock-form savings bank may pay dividends no more frequently than quarterly only out of its net profits and only to the extent such dividends do not impair the Bank's capital stock and surplus, as defined; and the Commissioner's approval may be required under certain circumstances. Under Federal Reserve Board and FDIC regulations, the Company and the Bank would be prohibited from declaring dividends if, among other things, they were not in compliance with applicable regulatory capital requirements. If there is no surplus, dividends may be paid out of net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Funds held by the Company are available for various corporate uses, including the payment of future dividends.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Form 10-K contains certain statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," "intend," "estimate," "assume" and other similar expressions which predict or indicate future events and trends and which do not relate to historical matters. The Company's actual results could differ materially from those projected in the forward-looking statements as a result, among other factors, of changes in general, national or regional economic conditions, changes in loan default and charge-off rates, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in interest rates, changes in laws and regulations, and changes in the assumptions used in making such forward-looking statements. These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
The following discussion should be read in conjunction with the accompanying consolidated financial statements and selected consolidated financial data included within this report. Given that the Company's principal activity currently is ownership of the Bank, for ease of reference, the term "Company" in this Item generally will refer to the investments and activities of the Company and the Bank, except where otherwise noted.
GENERAL
The Company's net income is primarily attributable to its level of net interest income, which represents the difference between interest and dividend income earned on earning assets and interest paid on deposits and other borrowed money. The main components of the Company's earning assets are loans, investment securities and short-term investments. Interest-bearing deposits include NOW, savings, money market and term certificates of deposit. The net interest income performance of the Company is significantly affected by general economic conditions, by the Company's corporate strategies, its asset/liability management, tactical programs and by the policies of regulatory authorities. Sources of non-interest income such as loan servicing fees, gains on sales of investment securities and other fees derived from various banking services contribute positively to the Company's results. The principal operating expenses of the Bank are salaries and employee benefits, occupancy and equipment expenses, data processing expenses, amortization of intangibles, advertising and marketing and other general and administrative expenses.
1999 marks the seventh consecutive year that the Company achieved record earnings, with net income of $12.7 million, an increase of $399,000, or 3.3%, compared to net income of $12.3 million for 1998. Earnings per share for 1999 were $1.51 ($1.44 on a diluted basis) compared with $1.38 ($1.31 on a diluted basis) for 1998, an increase of 13 cents on a diluted basis or 9.9% compared to the previous year.
At December 31, 1999, total assets were $1.22 billion, an increase of 6.4% from the prior year. Total loans increased 7.8% to $633.5 million at December 31, 1999. Investment securities, including restricted equity securities, increased 4.5% to $535.9 million at December 31, 1999 while total deposits increased $39.6 million, or 4.6%, to $911.3 million, and borrowed funds increased 26.8% to $215.7 million. Stockholders' equity totaled $90.9 million at December 31, 1999, representing a book value of $10.84 per share, compared to $11.74 per share at December 31, 1998. The capital to assets ratio was 7.42% at December 31, 1999, exceeding all regulatory requirements.
FINANCIAL CONDITION
Investment Portfolio
The investment policy of the Company is structured to provide an adequate level of liquidity in order to meet anticipated deposit outflows, normal working capital needs and expansion of the loan portfolio within guidelines approved by the Board of Directors, while earning market returns. Accordingly, the majority of investments are in shorter-term government, agency, or high-quality (rated "A" or better) corporate securities. Investment bonds purchased generally have maturities or call dates within three years or less. Although the emphasis on short-term and medium-term investments reduces the overall yield, this strategy is in accordance with the Company's desire to minimize interest rate risk.
Investment securities, including restricted equity securities, were higher than 1998 year-end levels, at $535.9 million at December 31, 1999 versus $512.6 million at December 31, 1998. During 1999, the Company continued to modify the mix of the investment portfolio to generate higher levels of interest income. The strategy included replacing U.S. Government and federal agencies as they matured or were sold with mortgage-backed securities and corporate bonds. Investments in corporate bonds consisted primarily of "A" rated or better bonds with maturities of three years or less. At December 31, 1997, U.S. Government and federal agencies represented 37% of total investment securities, and mortgage-backed securities represented 24%. At December 31, 1998, U.S. Government and federal agencies were reduced to 18% of total investment securities while mortgage-backed securities were increased to 43%. At December 31, 1999, U.S. Government and federal agencies equaled 12% of total investment securities while mortgage-backed securities and corporate bonds represented 40% and 46%, respectively. The mortgage-backed securities pools added to this portfolio throughout 1998 and 1999 consisted primarily of fixed-rate, low-coupon, government-backed securities that have limited extension or contraction risk. Consideration is given to the underlying collateral, the impact of rising or falling rates on the average life of these securities and other factors associated with the Bank's investment policies and strategies.
Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and reflected at amortized cost. As of December 31, 1999 and 1998, the net unrealized gain on investments classified as "held to maturity" was $6,000 and $286,000, respectively. All other marketable investment securities are classified as "available for sale" and reflected on the balance sheet at fair value, with unrealized gains and losses excluded from earnings and reported, net of tax, in other comprehensive income (loss) in stockholders' equity. The fair value of the Company's marketable investment securities, principally fixed income securities, classified as "available for sale" is influenced by the volatility and changes in general market rates. In the rising rate environment of 1999, the fair value of the "available for sale" portfolio has been negatively affected. As of December 31, 1999, the net unrealized loss on investments classified as "available for sale" was $15.4 million as compared to the net unrealized gain on investments of $5.0 million as of December 31, 1998.
The Bank also holds limited amounts of equity securities subject to the investment limitations imposed by FDICIA and the Commissioner.
The following table sets forth certain information concerning the investment portfolio, including restricted equity securities, at carrying value:
At December 31, ------------------------------ 1999 1998 1997 -------- -------- -------- (In thousands) Investment securities: Debt securities: U.S. Government and federal agency $ 62,127 $ 93,735 $190,579 Mortgage-backed securities 214,456 218,197 122,447 Corporate bonds 246,767 190,019 185,859 Equity securities 12,508 10,697 14,533 -------- -------- --------
Total investment securities $535,858 $512,648 $513,418 ======== ======== ========
The following table sets forth the maturity distribution of debt securities (excluding mortgage-backed securities) at carrying value, with related weighted average yields:
Loan Portfolio
The Company offers a variety of lending products, including fixed-rate and adjustable-rate residential mortgages, equity lines of credit, fixed-rate and adjustable-rate commercial mortgages, construction loans, consumer loans and commercial business loans. As a portfolio lender, the Company generally retains all newly originated loans. From time to time, the Company originates and retains 30-year, fixed-rate residential loans. More frequently, however, the 30-year, fixed-rate residential loan product is generally offered whereby the Bank originates these loans for correspondent banks and collects origination fees therefrom.
Real estate and commercial loan originations are initiated by the Bank's officers and lending personnel from a number of sources, including referrals from realtors, builders, attorneys, and customers. Direct mail to existing and potential customers is used to solicit other loan services. Advertising media is also used to promote loans. The Bank employs on-the-road originators and pays them commissions for loan originations. Applications for residential and consumer loans are accepted at all of the Bank's locations and are referred to the main office for processing.
The Company has lending policies in place which are intended to control credit risk inherent in the origination and retention of loans in portfolio. Among other considerations, these policies delineate the Bank's geographic market region, and establish credit procedures and acceptable loan-to-value ratios for all loans. Additional specific policies are in effect for commercial and commercial real estate loans.
Total loans increased to $633.5 million at December 31, 1999 compared to $587.5 million at December 31, 1998. The increase in loans was primarily in residential mortgages, with year-to-year growth of $44.0 million, or 10.4%. Commercial real estate loans also increased $2.5 million, or 2.3%, to $112.1 million from $109.6 million in 1998. Construction loan commitments decreased to $25.2 million at December 31, 1999, with commercial construction and residential construction loan commitments totaling $20.3 million and $4.9 million, respectively, from $28.6 million at December 31, 1998. All other loan categories remained relatively stable from December 31, 1998. In addition, the Bank sold $11.0 million of education loans in 1998 thereby exiting this business due to profitability concerns. The Company expects continued intense competition for loans within its geographic region. Within this framework, management continues intense marketing efforts for loans.
The following table shows the composition of the loan portfolio by type of loan:
* Residential first mortgages represent qualified collateral under a blanket lien securing FHLBB borrowings. See "Borrowed Funds".
The following table presents the maturity distribution of commercial and construction loans at December 31, 1999:
Maturities ---------------------------------------------------------- 1 Year Over 1 Year Over or Less to 5 Years 5 Years Total ----------- -------------- ----------- ---------- (In thousands)
Commercial loans $ 11,205 $ 6,107 $ 812 $ 18,124 Construction loans 3,691 5,978 3,835 13,504
Generally, construction loans provide for payments of interest only during the construction period, and then payments of principal and interest throughout the remaining life of the loans. In all cases, these construction loans have adjustable interest rates.
Commercial loans with maturities of over one year are subject to interest rate adjustment or maturity according to the following schedule:
Scheduled Maturity or Rate Adjustment ---------------------------------------------- Over 1 Year Over to 5 Years 5 Years Total ------------- ------------- ------------- (In thousands)
Predetermined rates $ 2,921 $ 42 $ 2,963 Adjustable rates 3,186 770 3,956 ------------- ------------- -------------
$ 6,107 $ 812 $ 6,919 ============= ============= =============
Non-performing Assets
It is the Bank's policy to discontinue the accrual of interest on loans over 90 days past due. Interest accrual ceases, and all previously accrued but unpaid interest is reversed, when a loan is placed on non-accrual status. At the option of management, a loan may be placed on non-accrual status prior to being 90 days past due if the collection of future interest and principal is, in the opinion of management, doubtful. Non-accrual loans are generally classified as impaired loans.
The Bank recognizes impaired loans based on Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan." Under this Statement, a loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All of the Bank's loans, which have been identified as impaired, have been measured by the fair value of existing collateral. When impaired loans become 90 days or more past due, they are maintained on non-accrual status whereby interest income is recognized only when received. The Bank does not apply SFAS No. 114 to individual consumer loans which are collectively evaluated for impairment.
The following table sets forth information with respect to impaired and non-accrual loans and foreclosed real estate, at the dates indicated. There were no loans 90 days or more past due and still accruing at the dates indicated.
For non-accrual loans at December 31, 1999, gross interest income of $453,000 would have been recorded during the year had the loans remained current in accordance with original terms. The amount of interest income on such loans that was included in net income for the period was $280,000.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged through the statement of income. Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based on management's evaluation of the amount required to absorb estimated losses inherent in the loan portfolio after weighing various factors. Ultimate losses may vary significantly from current estimates.
Quarterly reviews of the loan portfolio are performed to identify loans for which specific allowance allocations are considered prudent. Specific allocations include the results of measuring impaired loans under SFAS No. 114. General risk allocations are determined by formula whereby the loan portfolio is stratified by loan type and by risk rating category. Loss factors are then applied to each category based on various considerations including historical loss experience, delinquency trends, current economic conditions, industry standards and regulatory guidelines. Any remaining unallocated portion is reviewed for adequacy in relation to the overall loan portfolio and in recognition of estimates inherent in the calculation methodology.
An analysis of the allowance for loan losses is presented in the following table:
An analysis of the allocation of the allowance for loan losses is presented in the following table:
While management considers the allowance for loan losses to be adequate at December 31, 1999, there is no assurance that additional charge-offs and provisions will not be necessary in 2000. The provision for loan losses during 2000 will depend primarily on market conditions and the Bank's actual experience.
Loan Concentrations
Other than the focus of the Bank's lending activities to its market area, the Bank does not have a concentration of loans exceeding 10% of total loans at the end of 1999.
Deposits
Deposits historically have been the Bank's primary source of funds. The Bank offers a wide variety of deposit products to attract both short-term and long-term deposits from individuals, partnerships and corporations, non-profits and municipalities. Deposit products include regular savings accounts, NOW accounts, money market deposit accounts, individual retirement accounts, term certificates, and retail and commercial demand deposit accounts. The Bank also solicits corporate and municipal jumbo term deposits.
The Bank's Retail Banking Division places emphasis on sales of its products and quality of service to attract and retain customers. Management measures the sales performance of platform personnel in terms of cross-sales of additional products above the primary product which the customer requests. Platform personnel are evaluated, in part, based on a cross-sell ratio which is the total number of these additional products sold to a customer divided by the number of customers.
The Bank utilizes products and services such as its FREEDOM 55(TM) mature market program targeted to particular market segments to attract depositors interested in long-term savings and to create multiple account relationships with these depositors. Management believes that customers attracted to these programs have an increased sense of loyalty to the Bank, and, accordingly, the funds deposited into these programs are less volatile than other deposits.
While deposit flows are by nature unpredictable, management controls the Bank's deposit growth through selective pricing and sales oriented marketing programs. Despite the $40 million, or 4.5%, deposit growth experienced during 1999, with the continuing rising interest rate environment and with increases in stock market and mutual fund values, the task of attracting and retaining deposits remains a significant challenge to the Bank.
To maintain stable deposit rates and manage interest rate risk, the Bank's strategy has been to attract deposits through selective promotions. To increase core deposits, the Bank continues to promote its "ComboPlus" account which combines a statement savings account and checking account into one convenient account offered at a competitive rate which exceeds the regular statement and passbook savings account rates. This account type has contributed significantly to the increase in savings and demand deposits.
Total deposits increased $39.6 million, or 4.6%, to $911.3 million at December 31, 1999 from $871.7 million at December 31, 1998. When compared to the prior year, demand deposits decreased 1.4% while NOW deposits decreased 6.3%. Savings and money market deposits increased 9.1% and term certificates increased 3.1%. The growth in both its savings and money market accounts and term certificates are reflective of the Company's successful efforts in promotion of its Combo Plus accounts and its solicitation of corporate and municipal jumbo term deposits.
The following table indicates the balances in various deposit accounts at the end of each reported period:
At December 31, ----------------------------------------- 1999 1998 1997 --------- --------- --------- (In thousands)
Demand accounts $ 51,202 $ 51,936 $ 44,196 NOW accounts 60,811 64,888 59,368 Savings and money market accounts 382,970 351,047 325,340 Term certificates 416,345 403,831 392,802 --------- --------- ---------
$ 911,328 $ 871,702 $ 821,706 ========= ========= =========
The following table sets forth the average deposits of the Bank with related average rates paid during each reported period:
Included in term certificates of deposit are certificates having balances of $100,000 or more. At December 31, 1999, such term certificates had the following maturities:
At December 31, 1999 -------------------------------------------------------------------- 3 Months Over 3 Months Over 6 Months Over or Less to 6 Months to 12 Months 12 Months Total ------------ ------------- ------------- ------------- -------- (In thousands)
$ 46,379 $ 7,973 $ 11,692 $ 23,154 $ 89,198
Borrowed Funds
The Bank is a voluntary member of the FHLBB. As such, the Bank may borrow up to its qualified collateral, as defined by the FHLBB.
The Bank has selectively borrowed funds from the FHLBB to fund purchases of loans or large loan originations in addition to purchases of mortgage-backed securities. Short-term borrowings typically fund purchases or originations of one-year adjustable-rate loans or are used to meet the Bank's daily liquidity needs. Long-term debt typically funds purchases of three-year adjustable-rate residential mortgage loans or the origination of certain commercial real estate loans. The Bank also enters into repurchase or reverse repurchase agreements with a number of authorized brokers as an alternative source of funds. Securities sold under agreements to repurchase are borrowings that mature within one year and are secured by U.S. government obligations. Total borrowed funds increased to $215.7 million at December 31, 1999 from $170.1 million at December 31, 1998.
The following table presents, by category, the borrowings of the Bank for the reported periods:
Stockholders' Equity
The Bank's capital to assets ratio was 7.42% at December 31, 1999, compared to 8.88% at December 31, 1998. The Bank's capital ratios at December 31, 1999 and 1998 exceeded all regulatory requirements. Book value at December 31, 1999 was $10.84 per share, compared with $11.74 per share at December 31, 1998. (See "Liquidity and Capital Resources.")
RESULTS OF OPERATIONS
General
In 1999, the Company reported consolidated net income of $12.7 million or $1.51 basic earnings per share, as compared to net income of $12.3 million or $1.38 per share in 1998 and net income of $11.4 million or $1.25 per share in 1997. Diluted earnings per share were $1.44, $1.31 and $1.19 for 1999, 1998 and 1997, respectively. Consolidated net income in 1999 increased 3.3% over 1998 and consolidated net income in 1998 increased 7.6% over 1997. Diluted earnings per share in 1999 increased 9.9% over 1998 and diluted earnings per share in 1998 increased 10.1% over 1997. The Company's return on assets was 1.07% for 1999, as compared to 1.09% in 1998 and 1.05% in 1997. The return on equity increased to 13.52% in 1999 from 11.99% in 1998 and 11.81% in 1997.
The increased earnings for 1999 when compared to 1998 reflect a $551,000 increase in net interest income due to higher average earning assets partially offset by interest rate margin compression, and a decrease in the provision for loan losses of $75,000. This is partially offset by an increase in operating expenses of $227,000. The increased earnings for 1998 when compared to 1997 reflect a $206,000 increase in net interest income due to higher average earning assets, and an increase in net gains on the sales of securities and loans amounting to $899,000. In 1998, salaries and employee benefits increased $468,000 while all other categories were relatively flat or down compared to 1997. Included in 1997 expenses were one-time expenses of approximately $200,000 related to the formation of the holding company, and $260,000 applicable to tax filing matters.
Net Interest Income
Net interest income was $34.7 million in 1999; an increase of $551,000 or 1.6% from 1998. Average earning assets in 1999 increased $65.3 million as compared to an increase of $64.4 million of increased interest-bearing liabilities. As a result, the excess of earning assets over interest-bearing liabilities increased 0.83% to $108.8 million from $107.9 million in 1998.
Net interest income was $34.2 million in 1998; an increase of $206,000 or 0.6% from $34.0 million in 1997. Average earning assets in 1998 increased $40.5 million as compared to an increase of $32.5 million of increased interest-bearing liabilities; the difference resulting from higher demand deposits and capital. As a result, the excess of earning assets over interest-bearing liabilities increased 8.0% to $107.9 million from $99.9 million in 1997. The earnings on this excess flow directly to net interest income.
The continued flatness of the yield curve in 1999, along with increases in the prime rate, compressed the net interest margin and spread. As a result, lower yields on earning assets, albeit somewhat offset by lower costs of funds, reduced the net interest margin in 1999 to 3.03% from 3.16% in 1998 and 3.26% in 1997. The Company's most integral challenge is managing net interest income. Management continues to focus on minimizing net interest margin compression by closely monitoring the behavior of the loan portfolio under varying market rate environments in order to maximize the yield on earning assets. During 1999, average loan balances represented 52.5% of average earning assets. This compares with 53.7% in 1998, and 55.3% in 1997. The average investment securities balance was 47.5% of average earning assets in 1999 as compared to 46.3% in 1998 and 44.7% in 1997. As the percentage of loans to assets decreases, and the percentage of investments to assets increases, the net interest margin generally declines because loans are typically a higher yielding asset than the types of securities in which the Bank generally invests.
Management also closely monitors funding costs, and utilizes borrowings as an alternative to deposits when pricing or availability is more advantageous. Average deposits represented 82.0%, and average borrowings represented 18.0%, of total interest bearing liabilities in 1999, as compared to 81.2% and 18.8%, respectively, in 1998, and 82.0% and 18.0%, respectively, in 1997.
Interest and Dividend Income
Interest and dividend income totalled $77.8 million for 1999, an increase of $1.0 million or 1.4% from 1998. Interest and dividend income totalled $76.8 million for 1998, an increase of $1.5 million or 2.0% from 1997. The weighted average yield on earning assets was 6.78% in 1999, compared to 7.09% in 1998 and 7.23% in 1997.
Interest income on loans decreased 1.5% or $698,000 to $45.0 million in 1999 whereby increases in the average loans outstanding were more than offset by a reduction in the average yield on loans to 7.48%. Increased residential 1-4 family loan volume contributed $999,000 of additional interest income. The average yield on residential 1-4 family loans declined to 7.06% when compared with the 7.36% earned in 1998, the result of lower origination rates and significant refinancing. Interest income on commercial and industrial loans increased $53,000 as a result of greater volume, offset by lower yields. The yield on commercial and industrial loans declined to 8.51% when compared to 9.41% in 1998. Commercial real estate loans contributed $1.4 million less interest income in 1999 as outstanding loans declined; the result of the Bank's refusal to meet highly aggressive pricing on these loans by competitors in its marketplace.
Interest income on loans was $45.7 million in 1998 compared with $46.2 million in 1997. Increases in the average loans outstanding were more than offset by a reduction in the average yield on loans to 7.87%. Interest income on residential 1-4 family loans increased $720,000 in 1998 compared to 1997 levels as loan volume increased. Interest income on commercial loans increased $63,000 on a $937,000 increase in volume. Interest income on consumer loans decreased by $802,000, or 53.8%, from the prior year primarily due to the sale of all the education loans in 1997 and 1998.
Interest income on investments increased $1.7 million to $32.8 million in 1999 compared with $31.1 million in 1998. The $44.0 million increase in the average balance of investment securities contributed $2.7 million of interest income in 1999, offset by a $929,000 decrease as a result of the decline in the yield on investment securities to 6.03% in 1999 from 6.20% in 1998.
Interest income on investments was $31.1 million in 1998 compared with $29.1 million in 1997. The increase of $35.6 million in the average balance of investment securities in 1998, principally in higher yielding corporate bonds and mortgage-backed securities, contributed $1.9 million of additional interest income. The weighted average yield on investment securities, including short-term investments, decreased from 6.27% in 1997 to 6.20% in 1998.
Interest Expense
Interest expense was $43.1 million in 1999, up $496,000 or 1.2% from 1998. Interest expense was $42.6 million in 1998, an increase of $1.3 million or 3.1% from 1997. The cost of funds decreased to 4.15% in 1999 from 4.37% in 1998 and 4.39% in 1997, principally as a result of declining rates paid on term certificates and borrowings.
Interest expense on deposits was $32.8 million in 1999, compared with $32.0 million in 1998. Average interest-bearing deposits increased $60.7 million resulting in an increase in interest expense of $776,000. The Company continues to focus on increasing certain core deposit accounts. As a result, pricing strategies were implemented raising certain deposit rates while lowering others. The weighted average rate paid on savings and money market deposits increased to 3.08% in 1999 compared with 3.02% in 1998. This increased rate coupled with a $37.7 million increase in the average balance added $1.3 million of interest expense in 1999. The weighted average rate paid on term certificates decreased to 5.02% in 1999 from 5.39% in 1998. Lower rates on term certificates more than offset the increased interest expense resulting from a $22.2 million increase in the average outstandings. The average balance of NOW deposits increased $820,000. This volume increase was more than offset by the lowering of the rate paid, thereby reducing interest expense by $244,000. The overall weighted average rate paid on deposits decreased to 3.85% in 1999 from 4.04% in 1998. The decrease is principally due to greater volume in the liquid savings and money market deposit products at lower rates coupled with lower rates paid on term certificates.
Interest expense on borrowed funds was $10.4 million in 1999, compared with $10.6 million in 1998. Longer-term FHLBB borrowings were acquired to fund and manage the interest rate risk resulting from growth in the residential loan portfolio. The decrease in interest expense is the result of a $3.7 million increase in the average balance of borrowings being more than offset by a weighted average rate that was 26 basis points lower than the prior year's rate.
Interest expense on deposits was $32.0 million and interest expense on borrowed funds was $10.6 million in 1998, compared with $31.3 million and $10.0 million, respectively, in 1997. While average interest-bearing deposit levels grew modestly in 1998 as compared with 1997, the average rate paid on interest-bearing deposits remained stable at 4.04% in 1998 versus 4.05% in 1997. In addition, the Bank leveraged its capital position by increasing average borrowed funds to $183.5 million at an average cost of 5.80% in 1998 from $169.4 million at an average cost of 5.92% in 1997.
Rate/Volume Analysis
The following table presents, for the periods indicated, changes in interest and dividend income and changes in interest expense attributable to changes in interest rates and volumes of interest-bearing assets and liabilities. Changes attributable to both rate and volume have been allocated proportionally to the two categories.
Distribution of Assets and Liabilities; Interest Rates and Interest Differential
The following presents an analysis of average yields earned and rates paid for the years indicated. Average balances are computed using daily averages except for average stockholders' equity for which month-end balances are used.
(a) Includes non-accrual loans. (b) Weighted average yield on earning assets less weighted average rate paid on interest-bearing liabilities. (c) Net interest income divided by average earning assets.
Provision for Loan Losses
The provision for loan losses represents a charge against current earnings and an addition to the allowance for loan losses. The provision is determined by management on the basis of many factors, including the quality of specific loans, risk characteristics of the loan portfolio, the level of non-performing loans, current economic conditions, trends in delinquency and charge-offs, and collateral values of the underlying security. Ultimate losses may vary from current estimates.
The Bank recorded no provision for loan losses in 1999. This compares with a provision of $75,000 for the year ended December 31, 1998 and $125,000 for the year ended December 31, 1997. Gross loans charged-off declined to $164,000 in 1999 versus $165,000 and $831,000 in 1998 and 1997, respectively. Net loans charged-off totaled $97,000 and $623,000, respectively, for the years ended December 31, 1999 and 1997 while in 1998, the Company experienced net loan recoveries of $68,000.
The increase in the loan portfolio of $45.9 million during 1999 related principally to residential real estate loans, which are assigned a relatively low risk rating as compared to other categories in the Company's loan portfolio. The impact of applying general risk allocations to this growth was effectively offset by the net improvement in the general risk ratings applicable to certain commercial lending relationships. While management considers the allowance for loan losses to be adequate at December 31, 1999, there is no assurance that additional charge-offs and provisions will not be necessary in 2000. The provision for loan losses during 2000 will depend primarily on market conditions and the Bank's actual experience.
Other Income
Total other income amounted to $4.2 million for the year ended December 31, 1999, as compared to $4.8 million for year ended December 31, 1998, and $3.8 million for the year ended December 31, 1997. In 1999, customer service fees declined $27,000 from 1998 and an additional $95,000 from 1997, in part reflecting lower revenues on deposit accounts as customers migrate to deposit products with lower or no service fees. Net gains on the sale of securities were $1.5 million in 1999, compared with of $1.7 million and $835,000 in 1998 and 1997, respectively. Management elects to sell securities when tactical and/or market opportunities arise to do so and recognize a gain without impairing the yield or liquidity of the investment portfolio. The net gain on the sale of loans of $370,000 in 1998 and $306,000 in 1997 was related to the sale of education loans.
Operating Expenses
Operating expenses were $19.3 million for 1999, up $227,000 or 1.2% over 1998 operating expenses of $19.1 million. Occupancy, equipment and data processing rose $287,000 or 7.7% when compared to 1998 as a result of additional operating expenses associated with the reopening and opening, respectively, of our North Reading and Tewksbury branch sites. Professional fees increased $132,000 or 25% over 1998 as a result of expenses applicable to shareholder matters. 1998 operating expenses were $20,000 or 0.10% greater when compared to 1997. The Bank's expense ratio, which is the ratio of operating expenses to average assets, was 1.63% in 1999 compared with 1.69% in 1998 and 1.76% in 1997. Management continues to focus on cost containment with the intent to be a low cost provider of high quality banking products and services.
Provision for Income Taxes
The Bank's effective tax rate for the year ended December 31, 1999 was 35.6% as compared with 38.1% and 38.9% for the years ended December 31, 1998 and 1997, respectively. The effective tax rates exceeded the statutory federal tax rate of 35.0% (for taxable income exceeding $10.0 million) principally due to state taxes. The impact of state taxation has been reduced as a result of investment activity in the Bank's security corporation.
IMPACT OF INFLATION
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and results of operations in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Bank is reflected in increased operating costs. Unlike most industrial companies, virtually all assets of a financial institution are monetary in nature. As a result, interest rates have a more significant effect on a financial institution's performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's principal sources of funds are customer deposits, amortization and payoff of existing loan principal, and sales or maturities of various investment securities. The Bank is a voluntary member of the FHLBB and, as such, may take advantage of the FHLBB's borrowing programs to enhance liquidity and leverage its favorable capital position. The Bank also may draw on lines of credit at the FHLBB and a large commercial bank or enter into repurchase or reverse repurchase agreements with authorized brokers. These various sources of liquidity are used to fund withdrawals, new loans, and investments.
Management seeks to promote deposit growth while controlling the Bank's cost of funds. Sales-oriented programs to attract new depositors and the cross-selling of various products to its existing customer base are currently in place. Management reviews, on an ongoing basis, possible new products, with particular attention to products and services which will aid in retaining the Bank's base of lower-costing deposits.
Maturities and sales of investment securities provide significant liquidity to the Bank. The Bank's policy of purchasing shorter-term debt securities reduces market risk in the bond portfolio while providing significant cash flow. For the year ended December 31, 1999, cash flow from maturities of securities was $66.3 million and proceeds from sales of securities totaled $105.4 million, compared to maturities of securities of $127.0 million and proceeds from sales of securities of $138.0 million for the year ended December 31, 1998. Principal payments on mortgage-backed investments during the years ended December 31, 1999 and 1998 totaled $47.4 million and $39.1 million, respectively. Purchases of securities during 1999 and 1998 totaled $261.7 million and $299.1 million, respectively. These purchases consisted primarily of short-term debt instruments. During periods of high interest rates or active mortgage origination, maturities in the bond portfolio have provided significant liquidity to the Bank, generally at a lower cost than borrowings.
Amortization and pay-offs of the loan portfolio contribute significant liquidity to the Bank. Traditionally, amortization and pay-offs are reinvested into loans. Excess liquidity is invested in short-term debt instruments.
The Bank has also used borrowed funds as a source of liquidity. At December 31, 1999, the Bank's outstanding borrowings from the FHLBB were $193.7 million. The Bank also utilizes repurchase agreements to fund loan purchases or to leverage the balance sheet. At December 31, 1999, securities sold under agreements to repurchase totaled $21.2 million.
Residential and commercial mortgage loan originations for the years ended December 31, 1999, 1998 and 1997 totaled $147.9 million, $159.5 million and $124.2 million, respectively. Commitments to originate commercial and residential real estate mortgages at December 31, 1999 were $15.3 million, excluding unadvanced construction funds totaling $11.7 million. Unadvanced funds on equity and commercial lines of credit aggregated $35.9 million at December 31, 1999. Management believes that adequate liquidity is available to fund loan commitments utilizing deposits, loan amortization, maturities of securities, or borrowings.
The Bank's capital position (total stockholders' equity) was $90.9 million, or 7.42% of total assets at December 31, 1999, compared with $102.3 million, or 8.88% of total assets at December 31, 1998. In 1999, the Company utilized the holding company structure to exercise greater control in managing capital with the announcement and completion of a 5% stock repurchase plan. A total of 425,796 shares of common stock were repurchased. In addition, the Company recently announced another stock repurchase plan of up to 5% of outstanding shares.
The FDIC imposes capital guidelines on the Bank. The guidelines define core or "tier 1" capital and supplementary or "tier 2" capital and assign weights to broad categories of assets and certain off-balance sheet items. Ratios of tier 1 and tier 1 plus tier 2 capital to assets are then calculated. Banks must maintain a tier 1 capital to risk-weighted assets ratio of 4.00% and a total capital to risk-weighted assets ratio of 8.00%. The consolidated Company and the Bank's tier 1 risk-based capital ratios, as defined by the FDIC, at December 31, 1999 were 13.0% and 12.7%, respectively, which exceeds both risk-based capital requirements.
Massachusetts-chartered savings banks insured by the FDIC are required to maintain minimum leverage capital (tier 1 capital) of 3.0% to 5.0% of total assets, as adjusted, depending on an individual bank's rating. The Bank's leverage capital ratio at December 31, 1999, as defined by the FDIC, was 7.7%, which exceeds the FDIC's requirements.
YEAR 2000 DISCLOSURE
The statements in the following section include "Year 2000 readiness disclosure" within the meaning of the "Year 2000 Information and Readiness Disclosure Act."
The Year 2000 ("Y2K") issue existed because many computer systems and applications used two-digit date fields to designate a year. As the century date change occurs, date sensitive systems may recognize the year 2000 as 1900, or not at all. This inability to recognize or properly treat the year 2000 could have caused systems to process critical financial and operational information incorrectly.
A Year 2000 Task Force Committee ("Task Force") represented by members of senior management was formed in 1997 and was responsible for Y2K compliance. Diligent efforts, with management's participation, were conducted by the Company to address Y2K concerns that could affect its operations. The objective of the Company's Y2K compliance efforts was to enable its internal systems to function normally with dates prior to, during, or after the year 2000. Additionally, compliance should also include out-sourced systems upon which the Company relied for normal bank operations. The Company monitored compliance efforts of these vendors to adequately assess readiness and received written assurances from vendors of critical systems.
To become Y2K compliant, the Company followed the Federal Financial Institutions Examination Council interagency statement of Year 2000 project management issued May 1997. The statement outlines five phases essential to the Y2K remediation process. The Company's Task Force prepared a "Year 2000 Action Plan" to define the tasks and monitor its progress in each of the five phases. The Company completed the five required phases: Awareness Phase, Assessment Phase, Renovation Phase, Validation Phase and Implementation Phase.
Costs of Y2K compliance efforts during 1999 and 1998 totaled $98,900 and $20,440, respectively, and were expensed as incurred. A substantial part of the Y2K compliance effort was accomplished by reallocation of existing personnel and resources. In addition, investments in new software and hardware planned by the Company in 1998 fell within the ordinary course of business of maintaining industry technology standards, and are not considered to be instrumental to the Company within the context of the Y2K project.
The Company also established a Remediation Contingency Plan, Business Resumption Plan and a Liquidity Contingency Plan to address problems that could have arisen in the event of a Y2K problem. In addition, the Company's efforts to become Y2K compliant were monitored by its federal banking regulators. Failure to be Y2K compliant could have subjected the Company to formal supervisory enforcement actions.
After several years of intensive planning and preparation, the Company successfully made the Y2K transition without any disruptions to operating systems and customer service.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Through the Bank's Asset-Liability Management Committee ("ALCO"), which is comprised of certain senior and middle management personnel, the Bank closely monitors the level and general mix of interest rate-sensitive assets and liabilities. The primary objective of the Bank's ALCO program is to manage the assets and liabilities of the Bank to enhance profitability and capital at prudent levels of liquidity, interest rate, credit and market risk.
Market risk is the risk of loss from adverse changes in market prices and interest rates. The Bank's market risk arises primarily from interest rate risk inherent in lending, investing in marketable securities, deposit taking, and borrowing activities. To that end, management actively monitors and manages its interest rate risk exposure. In addition, the Bank is exposed to equity price risk associated with investing in marketable equity securities, which is not material.
The Bank's primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Bank's net interest income and capital, while adjusting the Bank's asset-liability mix to achieve the maximum yield to cost spread from the mix. However, a sudden and substantial increase or decrease in interest rates may adversely impact the Bank's earnings to the extent that interest sensitive assets and liabilities do not change at the same speed, to the same extent, or on the same basis. It is ALCO's general policy to closely match the maturity or rate sensitivity of its assets and liabilities. Strategies implemented to improve the match between interest-rate sensitive assets and liabilities include, but are not limited to: daily monitoring of the Bank's changing cash requirements, with particular concentration on investment in shorter-term securities; a general policy of originating adjustable-rate and fifteen-year, fixed-rate mortgage loans for the Bank's own portfolio, monitoring the cost and composition of deposits; and generally using matched borrowings to fund specified purchases of loan packages and large loan originations. Occasionally, management may choose to deviate somewhat from specific matching of maturities of assets and liabilities to take advantage of an opportunity to enhance yields.
The Bank seeks to manage its liability portfolio in order to effectively plan and manage growth and maturities of deposits. Plans designed to achieve growth of different deposit types are reviewed regularly. Programs which are designed to build multiple relationships with customers and to enhance the Bank's ability to retain deposits at controlled rates of interest have been implemented. Management has also adopted a policy of reviewing interest rates on an ongoing basis on all deposit accounts in order to monitor deposit growth and interest costs.
In addition to attracting deposits, the Bank has selectively borrowed funds using advances from the FHLBB and reverse repurchase agreements.
The following table presents, as of December 31, 1999, interest-rate sensitive assets and liabilities categorized by expected maturity and weighted average rate. Expected maturities are contractual maturities adjusted for amortization and prepayments of principal. For adjustable-rate instruments, contractual maturity is deemed to be the earliest possible interest rate adjustment date.
The prepayment experience reflected is based on the Bank's historical experience. Based on the Bank's experience, partial or full payment prior to contractual maturity can be expected and is reflected. Given the interest rate environment at December 31, 1999, management applies the assumption that on average, 7% of the outstanding loan and mortgage-backed securities balances will prepay annually. When adjustable-rate loans reprice at the rate adjustment date, they are generally indexed to the one-, three-, or five-year Treasury rate with an average spread of 275 basis points, with average period caps of 2.0% and life-time caps of 6.0%. The table does not include loans which have been placed on non-accrual status.
Assets and liabilities that immediately reprice are placed in the overnight column. These financial instruments do not have a contractual maturity date. Although NOW, savings and money market deposit accounts are subject to immediate repricing or withdrawal, based on the Bank's history, management considers these liabilities to have longer lives and less interest rate sensitivity than term certificates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Medford Bancorp, Inc.:
We have audited the consolidated balance sheets of Medford Bancorp, Inc. and subsidiary as of December 31, 1999 and 1998, 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, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Medford Bancorp, Inc. and subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999 in conformity with generally accepted accounting principles.
/s/ Wolf & Company, P.C.
Boston, Massachusetts January 20, 2000, except for Note 11 as to which the date is January 25, 2000
MEDFORD BANCORP, INC. CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 1999, 1998 and 1997
See accompanying notes to consolidated financial statements.
MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
See accompanying notes to consolidated financial statements.
MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
See accompanying notes to consolidated financial statements.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1999, 1998 and 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
The consolidated financial statements include the accounts of Medford Bancorp, Inc. (the "Company") and its wholly-owned subsidiary, Medford Savings Bank (the "Bank"). The Bank's wholly-owned subsidiary, Medford Securities Corporation, engages in the buying, selling, dealing in, or holding of securities. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for losses on loans.
Business and Operating Segments
The Company is principally engaged in the business of attracting deposits from the general public, originating residential and commercial real estate mortgages and consumer and commercial loans, and investing in securities. The Company is headquartered in Medford, Massachusetts. It has a network of seventeen banking offices located in Medford, Malden, Arlington, Belmont, Burlington, North Reading, Tewksbury, Waltham, and Wilmington. The Company's primary market area includes these communities as well as other cities and towns in Middlesex County and the surrounding area north of Boston.
Management evaluates the Company's performance and allocates resources based on a single segment concept. Accordingly, there are no separately identified operating segments for which discrete financial information is available. The Company does not derive revenues from, or have assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Company's total revenues.
Cash and Cash Equivalents
Cash and cash equivalents include cash, amounts due from banks and interest-bearing deposits that mature overnight or on demand.
Investment Securities
Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and reflected at amortized cost. All other marketable investment securities are classified as "available for sale" and reflected on the consolidated balance sheet at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of related tax effects, in stockholders' equity. Purchase premiums and discounts on debt securities are amortized to earnings by the interest method over the terms of the investments. Declines in the value of investments that are deemed to be other than temporary are reflected in earnings when identified. Gains and losses on disposition of investments are recorded on the trade date and computed by the specific identification method.
Restricted equity securities are carried at cost and include stock of the Federal Home Loan Bank of Boston ( "FHLBB"), The Savings Bank Life Insurance Company of Massachusetts and Northeast Retirement Services.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loans
The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans in the eastern New England area. The ability of the Company's debtors to honor their obligations is dependent upon the real estate, construction, and general economic sectors of that region.
Loans, as reported, have been increased by the net premium on loans acquired and net deferred loan origination costs, and reduced by unadvanced loan funds and the allowance for loan losses.
Interest on loans is recognized on the interest method and is not accrued on loans which are ninety days or more past due. Loans may be placed on non-accrual status prior to becoming ninety days past due if the collection of principal and interest is, in the opinion of management, doubtful. Loans which are identified as impaired are generally placed on non-accrual status. Interest income previously accrued on such loans is reversed against current period earnings. Interest income on all non-accrual loans is recognized only to the extent of interest payments received.
Premiums and discounts on loans acquired and net deferred loan origination costs are amortized as an adjustment of the related loan yields by the interest method over the contractual lives of the loans.
Allowance for Loan Losses
The allowance for loan losses is established, as losses are estimated to have occurred, through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the collectibility of the loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, known inherent risks in the nature and volume of the loan portfolio, levels of non-performing loans, adverse situations that may affect the borrower's ability to repay, trends in delinquencies and charge-offs, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Ultimate losses may vary from current estimates and future additions to the allowance may be necessary.
A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. An impaired loan is required to be measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. All of the Company's loans, which have been identified as impaired, have been measured by the fair value of existing collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosure.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other general and administrative expenses.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Banking Premises and Equipment
Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets.
Intangible Assets
Intangible assets pertaining to core deposits acquired are amortized over 15 years on an accelerated basis, based on the expected run-off of the related deposits. Goodwill is amortized by the straight-line method over periods ranging from 10 to 15 years.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (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.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes. The Company's base amount of its federal income tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of a related deferred tax asset, if deemed realizable.
Pension Plan
The compensation cost of an employee's pension benefit is recognized on the net periodic pension cost method over the employee's approximate service period. The aggregate cost method is utilized for funding purposes.
Stock Compensation Plans
The Company measures compensation cost for its stock compensation plans using the intrinsic value based method of accounting, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company's stock option plans have no intrinsic value at the grant date and no compensation cost is recognized for them. The Company is required to make pro forma disclosures of net income and earnings per share as if compensation cost had been measured at the grant date based on the fair value of the award and recognized over the service period, which is usually the vesting period. The pro forma disclosures include the effects of all awards granted on or after January 1, 1995. (See Note 12.)
Advertising Costs
Advertising costs are charged to expense as incurred.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
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 conversion. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. The assumed conversion of outstanding dilutive stock options would increase the shares outstanding but would not require an adjustment to income as a result of the conversion.
For the years ended December 31, 1999, 1998 and 1997, options applicable to 62,000 shares, 61,000 shares, and 1,000 shares, respectively, were anti-dilutive and excluded from the diluted earnings per share computations.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on investment securities available for sale, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income (loss).
The components of other comprehensive income (loss) and related tax effects are as follows:
Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which, as amended by SFAS No. 137, is effective for fiscal years beginning after June 15, 2000. This Statement establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other contracts, and requires that an entity recognize all derivatives as assets or liabilities in the balance sheet and measure them at fair value. If certain conditions are met, an entity may elect to designate a derivative as follows: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of an unrecognized firm commitment, an available-for-sale security, a foreign currency denominated forecasted transaction, or a net investment in a foreign operation. The Statement generally provides for matching the timing of the recognition of the gain or loss on derivatives designated as hedging instruments with the recognition of the changes in the fair value of the item being hedged. Depending on the type of hedge, such recognition will be in either net income or other comprehensive income. For a derivative not designated as a hedging instrument, changes in fair value will be recognized in net income in the period of change. Management does not anticipate that the adoption of this Statement will have a material impact on the Company's consolidated financial statements.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. INVESTMENT SECURITIES
The amortized cost and fair value of investment securities, with gross unrealized gains and losses at December 31, 1999 and 1998, follows:
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. INVESTMENT SECURITIES (concluded)
The amortized cost and fair value of debt securities by contractual maturity at December 31, 1999 is as follows:
Available for Sale Held to Maturity -------------------- --------------------- Amortized Fair Amortized Fair Cost Value Cost Value -------- -------- -------- -------- (In thousands)
Within 1 year $ 64,996 $ 64,987 $ 5,000 $ 5,006 After 1 year through 5 years 238,848 234,204 -- -- After 5 years through 10 years 5,378 4,703 -- -- -------- -------- -------- -------- 309,222 303,894 5,000 5,006 Mortgage-backed securities 224,083 214,456 -- -- -------- -------- -------- --------
$533,305 $518,350 $ 5,000 $ 5,006 ======== ======== ======== ========
At December 31, 1999, U.S. Government obligations with an amortized cost of $21,865,000 and a fair value of $20,965,000 have been pledged as collateral for securities sold under agreements to repurchase. In addition, U.S. Government obligations with an amortized cost of $22,265,000 and a fair value of $21,022,000 have been pledged as collateral for a line of credit and to secure public funds. Mortgage-backed securities with an amortized cost of $24,767,000 and a fair value of $23,344,000 have been pledged as collateral for a loan and credit agreement. (See Note 6.)
For the years ended December 31, 1999, 1998 and 1997, proceeds from the sales of securities available for sale amounted to $105,440,000, $138,046,000 and $19,572,000, respectively. Gross realized gains amounted to $1,529,000, $1,711,000 and $800,000, respectively. Gross realized losses amounted to $7,000 in 1999 and $52,000 in 1998. For the years ended December 31, 1998 and 1997, proceeds from the sales of securities held to maturity that were sold within three months of maturity amounted to $15,003,000 and $12,034,000, respectively. These sales have been included in the Statement of Cash Flows as maturities. Gross realized gains on these sales amounted to $11,000 and $35,000, respectively.
Mortgage-backed investments consist of collateralized mortgage obligations and participation certificates guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. LOANS
A summary of the balances of loans follows: December 31, ----------------------- 1999 1998 --------- --------- (In thousands) Mortgage loans on real estate:
Residential 1 - 4 family $ 465,420 $ 421,462 Commercial 112,050 109,561 Construction 25,239 28,647 Second mortgages 774 1,111 Equity lines of credit 19,394 20,606 --------- --------- 622,877 581,387 Less: Unadvanced loan funds (11,735) (15,574) --------- --------- 611,142 565,813 --------- ---------
Other loans: Commercial 18,124 17,358 Personal 2,071 2,076 Other 841 1,069 --------- --------- 21,036 20,503 --------- ---------
Add: Net premium on loans acquired 198 223 Net deferred loan origination costs 1,154 1,002 --------- --------- Total loans 633,530 587,541 Less allowance for loan losses (6,779) (6,876) --------- ---------
Loans, net $ 626,751 $ 580,665 ========= =========
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. LOANS (concluded)
An analysis of the allowance for loan losses follows:
Years Ended December 31, ------------------------------- 1999 1998 1997 ------- ------- ------- (In thousands)
Balance at beginning of year $ 6,876 $ 6,733 $ 7,231 Provision for loan losses -- 75 125 Recoveries 67 233 208 Loans charged-off (164) (165) (831) ------- ------- -------
Balance at end of year $ 6,779 $ 6,876 $ 6,733 ======= ======= =======
The following is a summary of the recorded investment in impaired loans:
December 31, ------------------ 1999 1998 ------ ------ (In thousands)
Impaired loans with no valuation allowance $2,482 $ 302 Impaired loans with a corresponding valuation allowance -- 1,464 ------ ------
Total impaired loans $2,482 $1,766 ====== ======
Corresponding valuation allowance $ -- $ 56 ====== ======
No additional funds are committed to be advanced in connection with impaired loans.
For the years ended December 31, 1999, 1998 and 1997, the average recorded investment in impaired loans amounted to $2,888,000, $1,749,000 and $3,806,000, respectively. Impaired loans are generally placed on non-accrual status. The Bank recognized interest income on impaired loans, on a cash basis, of $52,000 in 1999, $39,000 in 1998 and $74,000 in 1997 during the periods that they were impaired.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. BANKING PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of banking premises and equipment follows:
December 31, --------------------- 1999 1998 -------- -------- (In thousands)
Banking Premises: Land $ 2,068 $ 1,957 Buildings 10,235 10,291 Equipment 6,305 6,283 -------- -------- 18,608 18,531 Less accumulated depreciation (7,042) (6,523) -------- --------
$ 11,566 $ 12,008 ======== ========
Depreciation expense for the years ended December 31, 1999, 1998 and 1997 amounted to $1,174,000, $1,005,000 and $1,024,000, respectively.
5. DEPOSITS
A summary of deposit balances, by type, is as follows:
December 31, -------------------- 1999 1998 -------- -------- (In thousands)
Demand $ 51,202 $ 51,936 NOW 60,811 64,888 Regular savings 314,353 279,191 Money market deposits 68,617 71,856 -------- -------- Total non-certificate accounts 494,983 467,871 -------- --------
Term certificates ($100,000 or more) 89,198 71,403 Other term certificates 327,147 332,428 -------- -------- Total term certificates 416,345 403,831 -------- --------
Total deposits $911,328 $871,702 ======== ========
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. DEPOSITS (concluded)
A summary of term certificate accounts, by maturity, is as follows:
December 31, 1999 December 31, 1998 -------------------- -------------------- Weighted Weighted Average Average Amount Rate Amount Rate -------- --------- --------- --------- (Dollars in thousands)
Within 1 year $ 251,711 4.85% $ 313,434 5.23% Over 1 year to 3 years 154,537 5.24 79,183 5.31 Over 3 years to 5 years 9,994 4.97 11,152 5.71 Over 5 years 103 5.26 62 4.55 --------- ---------
$ 416,345 5.00% $ 403,831 5.26% ========= =========
6. SHORT-TERM BORROWINGS
Short-term borrowings consist of the following:
Securities sold under agreements to repurchase are borrowings that mature within one month and are secured by U.S. Government obligations. (See Note 2.) The amount of securities collateralizing the agreements to repurchase remains in investment securities and the obligation to repurchase securities sold is reflected as a liability in the consolidated balance sheets.
The Company had a $1,925,000 line of credit (treasury, tax and loan) with the Federal Reserve Bank of Boston ("FRB") at December 31, 1999 and 1998, of which $844,000 and $114,000, respectively, was advanced. The interest rate adjusts weekly and certain U.S. Government obligations have been pledged as collateral for the line of credit. At December 31, 1999, the Company also had a loan and credit agreement with the FRB at an interest rate which adjusts daily. Borrowings under the agreement are limited to 95% of the fair value of pledged collateral. Certain mortgage-backed securities have been pledged as collateral for the loan and credit agreement. (See Note 2.)
The FHLBB advances mature within five months. The Company also has an available line of credit with the FHLBB at an interest rate that adjusts daily. Borrowings under the line are limited to 2% of the Bank's total assets. All borrowings from the FHLBB are secured by a blanket lien on qualified collateral, defined principally as 75% of the carrying value of first mortgage loans on owner-occupied residential property and 90% of the market value of U.S. Government and federal agency securities.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. LONG-TERM DEBT
Long-term debt consists of FHLBB advances secured by a blanket lien on qualified collateral (see Note 6), as follows:
December 31, 1999 December 31, 1998 ------------------- ------------------- Weighted Weighted Average Average Maturity Amount Rate Amount Rate - --------------- -------- -------- -------- ------- (Dollars in thousands)
1999 $ -- --% $ 50,000 6.02% 2000 58,253 5.58 48,253 5.61 2001 65,000 5.57 28,000 5.45 2002 5,000 6.36 -- -- 2003 10,000 6.18 5,000 5.87 2004 10,000 5.29 -- -- 2005 400 5.61 400 5.61 -------- --------
$148,653 5.62% $131,653 5.74% ======== ========
The advance maturing in 2005 is callable on a quarterly basis by the FHLBB. The advance maturing in 2004 is callable on a quarterly basis beginning in 2000.
8. INCOME TAXES
Allocation of the provision for federal and state income taxes between current and deferred portions is as follows:
Years Ended December 31, ------------------------------- 1999 1998 1997 ------- ------- ------- (In thousands)
Current tax provision: Federal $ 6,702 $ 7,051 $ 6,672 State 388 839 1,194 ------- ------- ------- 7,090 7,890 7,866 ------- ------- ------- Deferred tax benefit: Federal (99) (296) (525) State (1) (48) (85) ------- ------- ------- (100) (344) (610) ------- ------- -------
$ 6,990 $ 7,546 $ 7,256 ======= ======= =======
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. INCOME TAXES (continued)
The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows:
Years Ended December 31, ---------------------------- 1999 1998 1997 ----- ----- -----
Statutory rate 35.0% 35.0% 35.0% Increase (decrease) resulting from: State taxes, net of federal tax benefit 1.3 2.6 3.9 Other, net (.7) .5 -- ----- ----- -----
Effective tax rates 35.6% 38.1% 38.9% ===== ===== =====
The components of the net deferred tax asset, included in other assets, are as follows:
December 31, ----------------------- 1999 1998 -------- -------- (In thousands)
Deferred tax assets: Federal $ 9,397 $ 4,413 State 2,450 1,530 -------- -------- 11,847 5,943 -------- -------- Deferred tax liabilities: Federal (1,203) (2,902) State (389) (822) -------- -------- (1,592) (3,724) -------- --------
Net deferred tax asset $ 10,255 $ 2,219 ======== ========
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. INCOME TAXES (concluded)
The tax effects of each type of income and expense item that give rise to deferred taxes 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 Company's base year is $8,265,000. If any portion of the reserve is used for purposes other than to absorb the losses for which it was established, approximately 150% of the amount actually used (limited to the amount of the reserve) would be subject to taxation in the year in which used. As the Company intends to use the reserve only to absorb loan losses, a deferred income tax liability of $3,389,000 has not been provided.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES
In the normal course of business, there are outstanding commitments and contingencies which are not reflected in the consolidated financial statements.
Employment and Special Termination Agreements
The Company has entered into an employment agreement with the President and Chief Executive Officer that provides for a specified minimum annual compensation and the continuation of benefits currently received. However, such employment may be terminated for cause, as defined, without incurring any continuing obligations. The Company and/or the Bank have also entered into special termination agreements with the President and Chief Executive Officer and certain senior executives. The agreements generally provide for certain lump-sum severance payments within a three-year period following a "change in control," as defined in the agreements.
Loan Commitments
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the consolidated balance sheet. The Company's exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
The following financial instruments were outstanding whose contract amounts represent credit risk:
Contract Amount at December 31, --------------------- 1999 1998 -------- -------- (In thousands)
Commitments to grant loans $ 15,314 $ 13,096 Unadvanced funds on equity lines of credit 25,182 24,246 Unadvanced funds on commercial lines of credit 10,734 7,386
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. Funds disbursed under these financial instruments are generally collateralized by real estate, except for the commercial lines of credit which are generally secured by the business assets of the borrower.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES (concluded)
Operating Lease Commitments
Pursuant to the terms of noncancelable lease agreements in effect at December 31, 1999, pertaining to banking premises and equipment, future minimum rent commitments aggregate $718,000 through the year 2008. In addition, the leases contain options to extend for periods up to fifteen years. Total rent expense for the years ended December 31, 1999, 1998 and 1997 amounted to $332,000, $285,000 and $290,000, respectively.
Other Commitments and Contingencies
Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will not have a material effect on the Company's consolidated financial statements.
10. STOCKHOLDERS' EQUITY
Minimum Regulatory Capital Requirements
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Holding companies are not subject to prompt corrective action provisions. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined) to risk-weighted assets (as defined) and of Tier 1 Capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999 and 1998, that the Company and the Bank met all capital adequacy requirements to which they are subject.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (continued)
Minimum Regulatory Capital Requirements (continued)
As of December 31, 1999, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. As a well capitalized entity, the Bank is entitled to engage in specified activities on a more expedited basis than entities that are not well capitalized. There are no conditions or events that management believes have changed the Bank's category. The Company's and the Bank's actual capital amounts and ratios as of December 31, 1999 and 1998, are also presented in the tables.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (concluded)
Restrictions on Dividends, Loans and Advances
Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. Under Massachusetts law, stock savings banks such as the Bank, like national banks, may pay dividends no more often than quarterly, and only out of net profits and to the extent that such payments will not impair the Bank's capital stock and surplus, as defined. Moreover, prior Commissioner approval is required if the total dividends for a calendar year would exceed net profits for that year combined with retained net profits for the previous two years. These restrictions on the ability of the Bank to pay dividends to the Company may restrict the ability of the Company to pay dividends to its stockholders. Loans or advances are limited to 10% of the Bank's capital stock and surplus, as defined, (which for this purpose represents Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for loan losses excluded from Tier 2 capital) on a secured basis.
In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements.
At December 31, 1999, $59,429,000 of the Company's equity in the Bank was restricted and funds available for loans or advances amounted to $10,035,000.
Shareholder Rights Plan
The Company has a Shareholder Rights Plan under which one preferred stock purchase right was distributed for each outstanding share of common stock. Such rights only become exercisable, or transferable apart from the common stock, ten business days after a person or group acquires beneficial ownership of, or commences a tender or exchange offer for, 15% or more of the Company's common stock, or the declaration by the Board of Directors that any person is an Adverse Person. Each right may then be exercised to acquire one one-hundredth of a share of Series A Junior Participating Cumulative Preferred Stock at an exercise price specified in the Company's Amended and Restated Shareholder Rights Agreement (the "Rights Agreement") subject to adjustment. If the Company is acquired in a merger or other business combination transaction, or 50% of the Company's assets or earning power is sold, the rights entitle holders to acquire common stock of the Acquiring Person (as defined in the Rights Agreement) having a value twice the exercise price of the rights. The rights may be redeemed in whole by the Company at $.01 per right at any time until the earliest of (i) the declaration of a person as an Adverse Person (as defined in the Rights Agreement), (ii) the tenth day following public announcement that a 15% position has been acquired, or (iii) the expiration date of the Rights Agreement. The rights will expire on September 22, 2003.
Director Deferred Compensation Plan
The Company has deferred compensation arrangements with certain members of the Board of Directors, whereby directors' fees earned are paid to a "Rabbi Trust" and used to purchase shares of the Company's common stock in the open market. The plan does not permit diversification of assets held, and the plan's obligation to each director must be settled by the delivery of the fixed number of shares of the Company's common stock purchased on the director's behalf. The Company has adopted Emerging Issues Task Force 97-14, "Accounting for Deferred Compensation Arrangements Where Amounts Earned are Held in a Rabbi Trust and Invested." Accordingly, the cost of the Company's common stock held by the rabbi trust, and the related deferred compensation obligation offset, are reflected in stockholders' equity.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. EMPLOYEE BENEFIT PLANS
Pension Plan
The Bank provides basic and supplemental pension benefits for eligible employees through the Savings Banks Employees Retirement Association Pension Plan. Each employee reaching the age of 21 and having completed at least 1,000 hours of service in one twelve-month period beginning with such employee's date of employment, or any anniversary thereof, automatically becomes a participant in the pension plan. Participants are fully vested after three years of such service. Information pertaining to activity in the plan is as follows:
Years Ended October 31, ----------------------- 1999 1998 ------- ------- (In thousands) Change in benefit obligation: Benefit obligation at beginning of year $ 5,472 $ 4,965 Service cost 642 591 Interest cost 369 360 Actuarial gain (1,010) (151) Benefits paid (367) (293) ------- ------- Benefit obligation at end of year 5,106 5,472 ------- -------
Change in plan assets: Fair value of plan assets at beginning of year 5,464 4,830 Actual return on plan assets 1,076 395 Employer contribution 706 532 Benefits paid (367) (293) ------- ------- Fair value of plan assets at end of year 6,879 5,464 ------- -------
Funded status 1,773 (8) Unrecognized net actuarial gain (3,242) (1,668) Transition asset (227) (247) ------- -------
Accrued pension cost $(1,696) $(1,923) ======= =======
Net periodic pension expense for the plan years ended October 31, 1999, 1998 and 1997 consisted of the following:
1999 1998 1997 ------- ------ ------- (In thousands)
Service cost $ 642 $ 591 $ 511 Interest cost 369 360 313 Expected return on plan assets (437) (386) (603) Net amortization and deferral (20) (19) (19) Net (gain) loss (75) (69) 224 ------- ------ -------
Net periodic pension expense $ 479 $ 477 $ 426 ======= ====== =======
Total pension expense for the years ended December 31, 1999, 1998 and 1997 amounted to $418,000, $486,000 and $426,000, respectively.
For the plan years ended October 31, 1999, 1998 and 1997, actuarial assumptions include an assumed discount rate on benefit obligations of 6.75%, 7.50% and 7.25%, respectively, and an expected long-term rate of return on plan assets of 8.00% for all years. An annual salary increase of 4.50%, 5.00% and 5.00% was used for the years ended October 31, 1999, 1998 and 1997, respectively.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. EMPLOYEE BENEFIT PLANS (concluded)
Pension Plan (concluded)
On January 25, 2000, the Board of Directors of the Bank voted to cease defined benefit pension plan accruals effective February 29, 2000 in conjunction with its termination of the plan to be effective March 31, 2000. As a result, the Company expects to recognize settlement and curtailment gains, net of income taxes, of approximately $1,861,000 during the year 2000. Termination of the plan is subject to approval by the Internal Revenue Service.
401(k) Plan
The Bank maintains a 401(k) plan that provides for voluntary contributions by participating employees ranging from 1 percent to 15 percent of their compensation, subject to certain limits based on federal tax laws. Each employee reaching the age of 21 and having completed at least 1,000 hours of service in one twelve-month period beginning with such employee's date of employment, or any anniversary thereof, becomes eligible to participate in the plan. The Bank may choose to match a portion of the employees' contributions. During the years ended December 31, 1999, 1998 and 1997, the Bank made matching contributions equal to twenty-five percent (25%) of the first six percent (6%) of annual compensation contributed to the plan. For the years ended December 31, 1999, 1998 and 1997, expense attributable to the Plan amounted to $76,000, $83,000 and $77,000, respectively.
In conjunction with the aforementioned termination of the defined benefit pension plan, the Bank amended its 401(k) plan for year 2000. Employees will be eligible to participate in the plan upon hire and will receive matching contributions after three months of service. The Bank's matching contribution will be increased to seventy-five percent (75%) of the first six percent (6%) of annual compensation contributed to the plan.
Incentive Plan
Short-term incentives can be earned through a discretionary bonus plan, administered by the Compensation and Options Committee of the Board of Directors. Senior executive officers as well as other officers are eligible to receive a bonus payable prior to the end of the first quarter of the following year if the Company or the Bank meets or exceed certain base standards and individual performance warrants consideration. Incentive compensation expense amounted to $136,000, $195,000 and $166,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
Executive Supplemental Benefit Agreement
The Company has entered into supplemental executive retirement agreements with its President that are designed to provide benefits lost under defined benefit plans and to increase overall retirement benefits. The present value of future benefits is being accrued over the term of employment. Supplemental compensation expense for the years ended December 31, 1999, 1998 and 1997 amounted to $240,000, $239,000 and $99,000, respectively.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCK OPTION PLANS
The Company has stock option plans, for the benefit of directors, officers and full-time employees, covering 1,472,000 shares of common stock under the Medford Savings Bank 1986 Stock Option Plan (the options under which have all been granted) and 400,000 shares of common stock under the Medford Bancorp, Inc. Stock Option Plan. Both "Incentive Stock Options" and "Non-qualified Stock Options" may be granted under the plans, with a maximum option term of ten years. Under the terms of the plans, stock options may be granted as determined appropriate by the Compensation and Options Committee of the Board of Directors, and will have an exercise price equal to, or in excess of, the fair market value of a share of common stock of the Company on the date the option is granted. The plans also permit the inclusion of stock appreciation rights ("SARs") in any option granted which would permit the optionee to surrender an option (or portion thereof) for cancellation and to receive cash or common stock equal to the excess, if any, of the then fair market value of the common stock subject to such option or portion thereof over the option exercise price. No SARs have been granted to date.
The Company measures compensation cost for its stock option plans using the intrinsic value based method of accounting. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
Years Ended December 31, ---------------------------------- 1999 1998 1997 -------- -------- -------- (In thousands, except per share data)
Net income: As reported $ 12,651 $ 12,252 $ 11,390 Pro forma 12,459 12,023 11,044 Basic earnings per share: As reported $ 1.51 $ 1.38 $ 1.25 Pro forma 1.48 1.35 1.22 Diluted earnings per share: As reported $ 1.44 $ 1.31 $ 1.19 Pro forma 1.42 1.28 1.16
In determining the pro forma amounts, the fair value of each option grant was estimated as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Years Ended December 31, ---------------------------- 1999 1998 1997 ------- -------- --------
Dividend yield 3.1% 3.5% 3.7% Expected life 10 years 10 years 10 years Expected volatility 50% 52% 59% Risk-free interest rate 6.4% 5.3% 5.7%
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCK OPTION PLANS (concluded)
Stock option activity under the plans is as follows:
Information pertaining to options outstanding at December 31, 1999 is as follows:
13. EMPLOYEES' STOCK OWNERSHIP PLAN
The Company has an Employees' Stock Ownership Plan ("ESOP") for the benefit of each employee that has reached the age of 21 and has completed at least 500 hours of service with the Company in the previous twelve-month period. The Company may contribute to the ESOP cash or shares of common stock as voted by the Board of Directors, not to exceed the maximum amount deductible for federal income tax purposes. At December 31, 1999, the ESOP held 402,673 shares, all of which have been allocated to participants and included in outstanding shares for earnings per share calculations. Dividends on all shares held by the ESOP are allocated to participants on a pro rata basis. There were no contributions to the ESOP for the years ended December 31, 1999, 1998 or 1997.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", requires disclosures of estimated fair values of all financial instruments where it is practicable to estimate such values. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of cash and short-term instruments approximate fair values.
Investment securities: Fair values for investment securities are based on quoted market prices.
Restricted equity securities: The carrying value of FHLBB stock approximates fair value based on stock redemption provisions. The carrying value of SBLI and Northeast Retirement stock is deemed to approximate fair value.
Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Deposits: The fair values disclosed for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Borrowings: The carrying amounts of short-term borrowings maturing within ninety days approximate their fair values. Fair values of other borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Accrued interest: The carrying amounts of accrued interest approximate fair value.
Off-balance sheet instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing, and are not material.
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows:
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to Medford Bancorp, Inc. is as follows:
BALANCE SHEETS
December 31, --------------------- 1999 1998 -------- -------- (In thousands) Assets - ------
Short-term investments with Medford Savings Bank $ 468 $ 3,221 Investment in common stock of Medford Savings Bank 88,085 98,918 Restricted equity securities 31 -- Due from Medford Savings Bank 3,500 1,775 Other assets 309 104 -------- --------
Total assets $ 92,393 $104,018 ======== ========
Liabilities and Stockholders' Equity - ------------------------------------
Accrued expenses $ 2 $ 9 Other liabilities 1,521 1,742 -------- -------- Total liabilities 1,523 1,751
Stockholders' equity 90,870 102,267 -------- --------
Total liabilities and stockholders' equity $ 92,393 $104,018 ======== ========
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (concluded)
STATEMENTS OF INCOME
STATEMENTS OF CASH FLOWS
MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
16. QUARTERLY DATA (UNAUDITED)
A summary of consolidated operating results on a quarterly basis is as follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
With the exception of certain information regarding the executive officers of the Company and the Bank, the response to this item is incorporated by reference from the discussion under the captions "Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on April 24, 2000 (the "Proxy Statement"), to be filed with the SEC pursuant to Regulation 14A of the Exchange Act Rules.
Information regarding the executive officers of the Company and the Bank is contained in Item I of Part I to this Report under the caption "Executive Officers of the Company and Bank."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated by reference from the discussion under the captions "Executive Compensation" and "The Board of Directors, its Committees and Compensation" in the Company's Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is incorporated by reference from the discussion under the caption "Ownership by Management and Other Stockholders" in the Company's Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated by reference from the discussion under the caption "Relationships and Transactions with the Company" in the Company's Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Contents:
(1) Financial Statements: All financial statements are included in Item 8 of Part II to this Report.
(2) Financial Statement Schedules: All financial statement schedules have been omitted because they are not required, not applicable or are included in the consolidated financial statements or related notes.
(3) Exhibits:
EXHIBIT INDEX
Exhibit Description - ------- -----------
2.1 Plan of Reorganization and Acquisition dated as of July 29, 1997 between the Company and the Bank (filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on November 26, 1997, and incorporated herein by reference)
3.1 Amended Articles of Organization of the Company (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on May 15, 1998, and incorporated herein by reference)
3.2 Amended and Restated By-laws of the Company (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
4.1 Specimen certificate for shares of Common Stock of the Company (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K filed with the SEC on November 26, 1997, and incorporated herein by reference)
4.2 Articles IV, VI(A), VI(C), VI(I)-(J) of the Amended Articles of Organization of the Company (see Exhibit 3.1)
4.3 Articles II and V of the Amended and Restated By-laws of the Company (see Exhibit 3.2)
4.4 Amended and Restated Shareholder Rights Agreement, dated November 26, 1997, between Medford Bancorp, Inc. and State Street Bank and Trust Company, as Rights Agent (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on November 26, 1997, and incorporated herein by reference)
10.1 Amended and Restated Employment Agreement with Arthur H. Meehan (filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.2 Amended and Restated Special Termination Agreement with Arthur H. Meehan (filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.3 Amended and Restated Special Termination Agreement with Phillip W. Wong (filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.4 Amended and Restated Special Termination Agreement with George A. Bargamian (filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.5 Amended and Restated Special Termination Agreement with Eric B. Loth (filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.6 Amended and Restated Special Termination Agreement with William F. Rivers (filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.7 Supplemental Executive Retirement Plan and Corresponding Adoption Agreement with Arthur H. Meehan (filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.8 Executive Supplemental Benefit Agreement with Arthur H. Meehan (filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference)
10.9 Deferred Investment Plan for Outside Directors (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-8 filed with the SEC on December 24, 1997, and incorporated herein by reference)
10.10 First Amendment to Deferred Investment Plan for Outside Directors (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 filed with the SEC on December 24, 1997, and incorporated herein by reference)
10.11 Medford Savings Bank 1986 Stock Option Plan (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-8 filed with the SEC on November 26, 1997, and incorporated herein by reference)
10.12 Medford Bancorp, Inc. Stock Option Plan (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 filed with the SEC on November 26, 1997, and incorporated herein by reference)
10.13 Discretionary Bonus Plan (not set forth in a formal document -- a description of the plan is contained in both the Proxy Statement to be filed with the SEC, and incorporated herein by reference, under the caption "Compensation Committee Report on Executive Compensation" and in the "Notes to Consolidated Financial Statements" under the caption "Employee Benefit Plans -- Incentive Plan" in Item 8 to this Report)
11 Statement Regarding Computation of Per Share Earnings -- Such computation can be clearly determined from the material contained in this Report.
12 Statement Regarding Computation of Ratios -- As the Company does not have any debt securities registered under Section 12 of the Securities and Exchange Act of 1934, no ratio of earnings to fixed charges appears in this Report.
13 Medford Bancorp, Inc. 1999 Annual Report, which, except for those portions expressly incorporated herein by reference, is furnished only for the information of the SEC and is not deemed to be filed.
21 Subsidiaries of the Company -- The Company has one direct subsidiary: Medford Savings Bank, a Massachusetts-chartered savings bank in stock form. Medford Savings Bank has one subsidiary: Medford Securities Corporation, a Massachusetts corporation.
23 Consent of Wolf & Company, P.C. as independent certified public accountants
27 Financial Data Schedule
(b) Reports on Form 8-K: None.
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.
MEDFORD BANCORP, INC.
By: /s/ Arthur H. Meehan --------------------- Arthur H. Meehan Chairman, President, Chief Executive Officer and Director
Date: March 1, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.