Item 1. Business
General
Bay State Bancorp, Inc. (the "Company") was incorporated under Delaware law on October 24, 1997. The Company was formed to acquire Bay State Federal Savings Bank, Brookline, Massachusetts (the "Bank") and its subsidiaries as part of the Bank's conversion from a mutual to stock form of organization (the "Conversion"). In connection with the Conversion, on March 27, 1998 the Company issued an aggregate 2,535,232 shares of its common stock, par value $0.01 per share (the "Common Stock"), at a purchase price of $20 per share, of which 2,347,437 shares were sold in a subscription offering and 187,795 shares were issued to The Bay State Federal Savings Charitable Foundation (the "Foundation"), a charitable foundation established by the Bank. The Company is a savings and loan holding company and is subject to regulation by the Office of Thrift Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC") and the Securities and Exchange Commission ("SEC"). Currently, the Company does not transact any material business other than through the Bank. At March 31, 2000, the Company had total assets of $460.1 million, total deposits of $247.3 million and total stockholders' equity of $52.6 million.
The reporting entity is Bay State Bancorp, Inc. and its wholly owned subsidiaries, Bay State Funding Corporation and Bay State Federal Savings Bank, and the Bank's wholly owned subsidiaries: BSF Service Corporation, BSFS Securities Corporation and Bay Leaf Securities Corporation.
The Bank was organized in 1920 as a state-chartered mutual co-operative bank under the name Coolidge Corner Co-operative Bank. In 1936, the Bank converted to a federally-chartered mutual savings and loan association and changed its name to Brookline Federal Savings and Loan Association. In 1960, the Bank changed its name to Bay State Federal Savings and Loan Association and, in 1983, changed its name again to Bay State Federal Savings Bank. In February 1997, the Bank merged with Union Federal Savings Bank ("Union Federal"), which at the time of the merger had $38.2 million of total assets, $35.5 million of deposits and $2.7 million of retained earnings and operated two branches located in Boston and Westwood, Massachusetts. On February 7, 2000 the Bank opened its sixth retail office in Walpole, Massachusetts. The Bank currently maintains six banking offices located in the greater Boston metropolitan area.
The Bank's principal business has been and continues to be attracting retail deposits from the general public in the areas surrounding its branch offices and investing those deposits, together with funds generated from operations and borrowings, primarily in adjustable-rate and shorter-term fixed-rate one- to four-family residential mortgage loans, multi-family and commercial real estate. To a lesser extent, the Bank invests in construction and development, commercial and consumer loans. The Bank operates through its six full service banking offices and one administrative office, all of which are located in the greater Boston metropolitan area. The Bank originates loans for investment and loans for sale in the secondary market; generally retaining the servicing rights on all loans sold. The Bank's revenues are derived principally from interest on its mortgage loans and, to a lesser extent, interest on its investment and mortgage-backed and mortgage-related securities and loan servicing income. The Bank's primary sources of funds are deposits, principal and interest payments on loans and securities and Federal Home Loan Bank ("FHLB") advances.
Market Area and Competition
The Bank is headquartered in Brookline, Massachusetts and is a community-oriented savings institution offering a variety of financial products and services to meet the needs of the communities it serves. The Bank's primary deposit gathering area is concentrated in the communities surrounding its six full service banking offices located in Brookline, Boston, Dedham, Norwood, Westwood and Walpole Massachusetts. All of the Bank's branch offices are located within 20 miles of Brookline. The Bank's primary lending area is significantly broader than its deposit gathering area and includes all of Massachusetts, with a concentration in the greater Boston metropolitan area.
Brookline, Massachusetts is a fully-developed and densely populated town located west of and adjacent to Boston. The major traffic roadways running through Brookline are heavily traveled and lined with commercial and retail business operations and Brookline's 1990 census population was approximately 54,000.
The residents of Brookline are generally comprised of white- and blue-collar workers and college students. The towns of Dedham, Norwood, Westwood and Walpole are situated southwest of Boston. These towns are primarily residential communities consisting of single-family residences and are populated by middle- to high-income individuals employed in the greater Boston metropolitan area.
New England has generally lagged behind the rest of the nation in coming out of the recession of the late 1980s and early 1990s. During this time, the market values of many one- to four-family residences declined throughout the region. Loan demand diminished and competition for such loans increased. However, over the past few years, the regional economy in the Bank's primary market area, based on economic indicators such as unemployment rates, residential and commercial real estate values and vacancy rates and household income trends, has strengthened. Small business, technology and service firms, institutions of higher education and tourism form the backbone of the economy of the greater Boston metropolitan area.
The Bank faces significant competition both in generating loans and in attracting deposits. The Bank's primary market area is highly competitive and the Bank faces direct competition from a significant number of financial institutions, many with a state-wide or regional presence and, in some cases, a national presence. Many of these financial institutions are significantly larger and have greater financial resources than the Bank. The Bank's competition for loans comes principally from commercial banks, savings banks, credit unions, mortgage brokers, mortgage banking companies and insurance companies. Its most direct competition for deposits has historically come from other financial institutions. In addition, the Bank faces significant competition for deposits from non-bank institutions such as brokerage firms and insurance companies in such instruments as short-term money market funds, corporate and government securities funds, mutual funds and annuities. Competition may also increase as a result of the lifting of restrictions on the interstate operations of financial institutions. The Bank has also experienced significant competition from credit unions, which have a competitive advantage, as they do not pay state or federal income taxes. This competitive disadvantage has placed increased pressure on the Bank with respect to its loan and deposit pricing.
The increase of internet accessible financial institutions, which solicit deposits and originate loans on a nationwide basis, may also increase competition for the Bank's customers. Additionally, competition is likely to increase as a result of recent regulatory actions and legislative changes, most notably the recent enactment of the Gramm-Leach-Bliley Act of 1999. These changes have eased and likely will continue to ease restrictions on interstate banking and the entrance into the financial services market by non-depository and non-traditional financial services providers, including insurance companies, securities brokerage and underwriting firms and specialty financial services companies (such as internet-based providers).
Personnel
As of March 31, 2000 the Bank had 83 full-time employees and 17 part-time employees. The employees are not represented by a collective bargaining unit and the Bank considers its relationship with its employees to be good.
Lending Activities
Loan Portfolio Composition. The types of loans that the Bank may originate are subject to federal and state laws and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and local competitive influences. These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal government, including the Federal Reserve Board ("FRB") and legislative tax policies.
The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.
- ------------------------------------------------------ (1) Includes committed but unadvanced loan amounts.
Loan Maturity. The following table shows the remaining contractual maturity of the Bank's loans at March 31, 2000. The table does not include the effect of future principal prepayments.
- ---------- (1) Includes equity lines. (2) Includes construction and development loans, which will convert to one- to four-family mortgage loans upon the completion of the construction.
The following table sets forth at March 31, 2000, the dollar amount of loans, excluding mortgage loans held for sale, contractually due after March 31, 2001 and whether such loans have fixed interest rates or adjustable interest rates.
Due After March 31, 2001 ----------------------------------- Fixed Adjustable Total ------- ---------- ------- (In thousands) Mortgage loans: One- to four-family.......... $43,662 $155,634 $199,296 Multi-family................. 28,746 49,550 78,296 Commercial real estate....... 19,940 75,923 95,863 Construction and development. 3,150 3,280 6,430 ------- -------- -------- Total mortgage loans...... 95,498 284,387 379,885 ------- -------- -------- Commercial loans................ -- 225 225 ------- -------- -------- Consumer loans: Equity lines................. -- 9,500 9,500 Other consumer loans......... 893 1,835 2,728 ------- -------- -------- Total consumer loans...... 893 11,335 12,228 ------- -------- -------- Total loans.................... $96,391 $295,947 $392,338 ======= ======== ========
Origination, Sale and Servicing of Loans. The Bank's mortgage lending activities are conducted primarily by its loan personnel operating at its six branch offices and one administrative office and through a network of loan correspondents, wholesale loan brokers and other financial institutions approved by the Bank. All loans originated by the Bank, either through internal sources or external sources, are underwritten by the Bank pursuant to the Bank's policies and procedures. The Bank originates both adjustable-rate and fixed-rate loans. The Bank's ability to originate fixed- or adjustable-rate loans is dependent upon the relative customer demand for such loans, which is affected by the current and expected future level of interest rates.
Generally, all adjustable-rate mortgage loans ("ARM") originated by the Bank are originated for investment. While the Bank has from time-to-time, retained fixed-rate one- to four-family loans, it is currently the general policy of the Bank to sell substantially all one- to four-family fixed-rate mortgage loans with scheduled repricing greater than 15 years. The one- to four-family mortgage loan products currently originated for sale by the Bank include a variety of loans which conform to the underwriting standards specified by Freddie Mac ("conforming loans") and, to a lesser extent, loans which do not conform to Freddie Mac standards due to loan amounts ("jumbo loans"). All one- to four-family mortgage loans sold by the Bank are sold pursuant to master commitments negotiated with Freddie Mac and other investors to purchase loans meeting such investors' defined criteria. The Bank generally retains the servicing rights on the mortgage loans sold.
At March 31, 2000, the Bank maintained a servicing portfolio consisting of $379.2 million of loans held for portfolio, net, and $20.8 million of loans serviced for others. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. Substantially all of the loans currently being serviced for others are loans which have been sold by the Bank. The gross servicing fee income from loans sold is generally 24 to 48 basis points of the total balance of the loan serviced.
During the fiscal years ended March 31, 2000 and 1999, the Bank originated and purchased $66.6 million and $84.0 million of fixed-rate and adjustable-rate one- to four-family loans, respectively, of which $64.4 million, and $73.2 million, respectively, were retained for the Bank's portfolio. When loans are sold the Bank recognizes, at the time of sale, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold. On April 1, 1996, the Bank implemented SFAS No. 122 "Accounting for Mortgage Servicing Rights an amendment of FASB Statement No. 65" ("SFAS No. 122") pursuant to which the value of servicing rights may be recognized as an asset of the Bank. In the fiscal years ended March 31, 2000 and 1999, the fair value of servicing rights under SFAS No. 122 and SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125") was not material and was not recognized in the consolidated financial statements for those periods. The Bank has, from time-to-time, purchased whole loans, primarily one- to four-family mortgage loans or purchased a participation interest in loans originated by other financial institutions, primarily multi-family and commercial real estate loans and, at March 31, 2000, had $64.2 million of purchased loans and $9.3 million in loan participation interests. Loans purchased from correspondent financial institutions are underwritten pursuant to the Bank's policies and generally closed in the name of the correspondent financial institution and then purchased by the Bank.
The following table sets forth the Bank's loan originations, purchases, sales and principal repayments for the periods indicated:
- ------------------------ (1) Includes mortgage loans held-for-sale.
One-to Four-Family Lending. The Bank currently offers both fixed-rate and adjustable-rate mortgage loans with maturities of up to 30 years secured by one- to four-family residences. Most of such loans are located in the Bank's primary market area. One- to four-family mortgage loan originations are generally obtained through the Bank's in-house loan representatives, existing or past customers, mortgage brokers and referrals from members of the Bank's local communities. At March 31, 2000, the Bank's one- to four-family mortgage loans totalled $201.3 million, or 50.3%, of total loans. Of the one- to four-family mortgage loans outstanding at that date, 21.9% were fixed-rate mortgage loans and 78.1% were ARM loans.
The Bank currently offers ARM loans with terms of up to 30 years and interest rates which adjust every one, three or five years from the outset of the loan and adjust annually after the initial rate period. The interest rates for the Bank's ARM loans are indexed to either the one, three or five year Constant Maturity Treasury ("CMT") Index. The Bank originates ARM loans with initially discounted rates, often known as "teaser rates." The Bank's ARM loans generally provide for periodic (not more than 2%) and overall (not more than 6%) caps on the increase or decrease in the interest rate at any adjustment date and over the life of the loan. The Bank generally retains for its portfolio all adjustable-rate one- to four-family loans.
The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps reduce the Bank's exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Periodic and lifetime caps on interest rate increases help to reduce the risks associated with adjustable-rate loans but also limit the interest rate sensitivity of such loans.
All one- to four-family mortgage loans are underwritten according to the Bank's policies and guidelines. Generally, the Bank originates one- to four-family residential mortgage loans in amounts up to 80% of the lower of the appraised value or the selling price of the property securing the loan and up to 95% of the appraised value or selling price if private mortgage insurance ("PMI") is obtained. Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Bank's consent. Due-on-sale clauses are an important means of adjusting the yields on the Bank's fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses. The Bank requires fire, casualty, title and, in certain cases, flood insurance on all properties securing real estate loans made by the Bank.
In an effort to provide financing for first-time home buyers, the Bank offers a first-time home buyer loan program, which offers one- to four-family residential mortgage loans to qualified individuals. These loans are offered with adjustable- and fixed-rates of interest and terms of up to 30 years. Pursuant to this program, borrowers receive reduced loan origination fees and closing costs. Such loans must be secured by an owner-occupied residence. These loans are originated using the same underwriting guidelines as are the Bank's other one- to four-family mortgage loans.
Multi-Family and Commercial Real Estate Lending. The Bank originates multi-family and commercial real estate loans that are generally secured by 5 or more unit apartment buildings and properties used for business purposes such as office buildings, industrial facilities or retail facilities located in the Bank's primary market area. The Bank's multi-family and commercial real estate underwriting policies provide that such real estate loans may be made in amounts up to 80% of the appraised value of the property, subject to the Bank's current loans-to-one-borrower limit, which at March 31, 2000 was $6.9 million. The Bank's multi-family and commercial real estate loans are made with terms up to 30 years and with interest rates that adjust periodically and are generally indexed to the prime rate as reported in The Wall Street Journal. In reaching its decision on whether to make a multi-family or commercial real estate loan, the Bank considers the net operating income of the property, the borrower's expertise, credit history, the value of the underlying property, and the financial conditions of the Borrower/Guarantor. The Bank generally requires that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.25x. In addition, depending on the perceived environmental risk of the property an environmental impact survey may be required for multi-family and commercial real estate loans. Generally, all multi-family and commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals. On occasion the Bank may not require a personal guarantee on such loans depending on the creditworthiness of the borrower, the amount of the down payment and other mitigating circumstances. The Bank's multi-family real estate loan portfolio at March 31, 2000 was $78.6 million, or 19.7%, of total loans and the Bank's commercial real estate loan portfolio at such date was $95.9 million, or 24.0%, of total loans. The largest multi-family or commercial real estate loan in the Bank's portfolio at March 31, 2000 was a $4.9 million real estate loan secured by a blanket mortgage on five retail/office buildings.
The Bank also purchases participation interests in multi-family and commercial real estate loans. Most of these loans are secured by real estate located in the Bank's primary market area. The Bank will underwrite its participation interest according to its own underwriting standards. At March 31, 2000, the Bank had $9.3 million in multi-family and commercial real estate loan participation interests, or 2.3% of total loans.
Loans secured by multi-family and commercial real estate properties generally involve larger principal amounts. Additionally, because payments on loans secured by multi-family and commercial real estate properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy and thus poses a greater degree of risk than one- to four-family residential mortgage loans. The Bank seeks to minimize these risks through its underwriting standards.
Construction and Development Lending. The Bank originates short-term balloon fixed-rate construction loans for the development of residential and commercial property. Construction and development loans are offered primarily to experienced local developers operating in the Bank's market area. The Bank currently does not originate loans secured by raw land. The majority of the Bank's construction and development loans are originated to finance the construction by developers of one- to four-family residential real estate and, to a lesser extent, multi-family and commercial real estate properties located in the Bank's primary market area. Construction loans are generally offered with terms of up to 12 months and may be made in amounts up to 80% of the appraised value of the property on multi-family and commercial real estate construction and 85% on one- to four-family residential construction. Construction loan proceeds are disbursed periodically, in increments, as construction progresses and as inspections by the Bank's lending officers warrant. At March 31, 2000, the Bank's largest construction and development loan was a performing loan with a $1.3 million outstanding principal balance secured by three residential properties in Wellesley. At March 31, 2000, construction and development loans totalled $10.0 million (including unadvanced loan amounts), or 2.5%, of the Bank's total loans.
The Bank also originates construction and development loans to individual borrowers for the construction of single-family owner-occupied residential properties with permanent financing commitments by the Bank. The Bank's underwriting standards and procedures for such loans are similar to those applicable for one- to four-family residential mortgage lending. Proceeds for such loans are disbursed as phases of the construction are completed. All such loans are originated as one- to four-family interest-only adjustable-rate mortgage loans. Upon completion of the construction, such loans convert to principal and interest over the remaining term. At March 31, 2000, such loans totalled $4.4 million, or 44.0%, of the $10.0 million of construction and development loans.
Construction and development financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development compared to the estimated cost (including interest) of construction and other assumptions, including the estimated time to sell residential properties. If the estimate of value proves to be inaccurate, the Bank may be confronted with a property, when completed, having a value which is insufficient to assure full repayment.
Consumer and Other Lending. Total consumer loans at March 31, 2000 amounted to $14.0 million, or 3.5%, of the Bank's total loans and consisted primarily of equity lines of credit and, to a significantly lesser extent, secured and unsecured personal loans and new and used automobile loans. Such loans are generally originated in the Bank's primary market area and generally are secured by real estate, deposit accounts, personal property and automobiles. These loans are typically shorter term and generally have higher interest rates than one- to four-family mortgage loans.
Loans secured by rapidly depreciable assets such as automobiles or that are unsecured entail greater risks than one- to four-family residential mortgage loans. In such cases, repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance, since there is a greater likelihood of damage, loss or depreciation of the underlying collateral. Further, consumer loan collections on these loans are dependent on the borrower's continuing financial stability and, therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Finally, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the event of a default. At March 31, 2000, the Bank had three consumer loans 90 days or more delinquent, whose balances totalled $50,000.
Loan Approval Procedures and Authority
The Board of Directors of the Bank establishes the lending policies of the Bank. Such policies provide that all loans up to $300,000 are approved by the Bank's Internal Loan Committee. In the event a loan is above $300,000, it may be approved by the President or Executive Vice President. All loans are submitted to the full Board of Directors or the Bank's Executive Committee for approval or ratification on a monthly basis.
Delinquent Loans, Classified Assets and Real Estate Owned
Delinquencies and Classified Assets. Reports listing all delinquent accounts are generated and reviewed by management on a monthly basis and the Board of Directors performs a monthly review of all loans or lending relationships delinquent 90 days or more and all Real Estate Owned ("REO"). The procedures taken by the Bank with respect to delinquencies vary depending on the nature of the loan, period and cause of delinquency and whether the borrower is habitually delinquent. When a borrower fails to make a required payment on a loan, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. The Bank generally sends the borrower a written notice of non-payment after the loan is first past due. The Bank's guidelines provide that telephone, written correspondence and/or face-to-face contact will be attempted to ascertain the reasons for delinquency and the prospects of repayment. When contact is made with the borrower at any time prior to foreclosure, the Bank attempts to obtain full payment, work out a repayment schedule with the borrower to avoid foreclosure and in rare instances, accept a deed in lieu of foreclosure. In the event payment is not then received or the loan not otherwise satisfied, additional letters and telephone calls generally are made. If the loan is still not brought current or satisfied and it becomes necessary for the Bank to take legal action, which typically occurs after a loan is 90 days or more delinquent, the Bank will commence foreclosure proceedings against any real property that secures the loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the property securing the loan generally is sold at foreclosure and, if purchased by the Bank, becomes real estate owned.
Federal regulations and the Bank's Asset Classification Policy require that the Bank utilize an internal asset classification system as a means of reporting problem and potential problem assets. The Bank has incorporated the OTS internal asset classifications as a part of its credit monitoring system. The Bank currently classifies problem and potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected.
Assets classified as "Doubtful" have all of the weaknesses inherent in those classified "Substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as "Loss" are those considered "uncollectable" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated "Special Mention."
When an insured institution classifies one or more assets or portions thereof, as Substandard or Doubtful, it is required to establish a general valuation allowance for loan losses in an amount deemed prudent by management. General valuation allowances represent loss allowances, which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies one or more assets or portions thereof, as "Loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which can order the establishment of additional general or specific loss allowances. The OTS, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement.
Although management believes that, based on information currently available to it at this time, its allowance for loan losses is adequate, actual losses are dependent upon future events and, as such, further additions to the level of allowances for loan losses may become necessary.
The Bank's Classification of Assets Committee reviews and classifies the Bank's assets on a quarterly basis and the Board of Directors reviews the results of the reports on a quarterly basis. The Bank classifies assets in accordance with the management guidelines described above. At March 31, 2000, the Bank had $774,000, or 0.2%, of total assets, designated as Substandard consisting of two one- to four-family mortgage loans and two commercial real estate loans. At March 31, 2000, one single-family residential loan totalling $63,000 and two installment loans totalling $28,000 were classified as Doubtful. As of March 31, 2000, the Bank had a total of three one- to four-Family loans, totaling $480,000, designated as Special Mention.
The following table sets forth the delinquencies in the Bank's loan portfolio as of the dates indicated.
Nonperforming Assets and Impaired Loans. The following table sets forth information regarding nonaccrual loans and REO. At March 31, 2000, the Bank had $62,000 of REO in its portfolio. It is the policy of the Bank to cease accruing interest on loans 90 days or more past due and to charge off all accrued interest. For the fiscal years ended March 31, 2000, 1999 and 1998, the amount of interest income that was recorded on nonaccrual loans was $157,000, $213,000 and $130,000, respectively. For the fiscal years ended March 31, 2000, 1999 and 1998, the amount of additional interest income that would have been recognized on nonaccrual loans if such loans had continued to perform in accordance with their contractual terms was $83,000, $87,000 and $144,000, respectively. There were no loans that met the definition of an impaired loan per SFAS No. 114 at or during the fiscal year ended March 31, 2000 and 1998. As of March 31, 1999 loans totaling $280,000 were considered to be impaired with an allowance for credit loss of $82,000.
The following table sets forth activity in the Bank's allowance for loan losses for the periods as indicated.
- ------------------------- (1) Loans are presented before allowance for loan losses.
(2) Nonperforming loans consist of all loans 90 days or more past due and other loans which have been identified by the Bank as presenting uncertainty with respect to the collectibility of interest or principal.
(3) Nonperforming assets consist of nonperforming loans and REO.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses on loans which are deemed probable and estimable based on information currently known to management. The allowance is based upon a number of factors, including economic conditions, actual loss experience and industry trends. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management. The economy in the Bank's primary market area suffered significantly in the late 1980s and early 1990s. These adverse economic conditions negatively affected the Bank's loan loss and delinquency activities and led to a deterioration of the collateral values of the Bank's loans during those years. In more recent years, the economy and real estate market in and around the greater Boston metropolitan area has improved which has had a positive impact on the Bank's loan loss and delinquency activities and the value of properties securing the Bank's loans. As of March 31, 2000, the Bank's allowance for loan losses was 0.99% of total loans, as compared to 0.98% as of March 31, 1999. The Bank had nonaccrual loans of $1.2 million and $2.0 million at March 31, 2000 and March 31, 1999, respectively. The Bank will continue to monitor and modify its allowances for loan losses as conditions dictate. While management believes the Bank's allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Bank's level of allowance for loan losses will be sufficient to cover loan losses incurred by the Bank or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.
The following table sets forth activity in the Bank's allowance for loan losses for the periods as indicated.
- -------------------------- (1) Loans are presented before deducting the allowance for loan losses.
(2) Nonperforming loans consist of all loans 90 days or more past due and other loans which have been identified by the Bank as presenting uncertainty with respect to the collectibility of interest or principal.
The following table sets forth the Bank's percentage of allowance for loan losses to total allowance for loan losses and the percent of loans to total loans in each of the categories listed at the dates indicated.
Real Estate Owned At March 31, 2000 the Bank had $62,000 in REO. At March 31, 1999 the Bank had no REO. When the Bank acquires property through foreclosure or deed in lieu of foreclosure, it is initially recorded at the lower of the recorded investment in the corresponding loan or the fair value of the related assets at the date of foreclosure, less costs to sell. Thereafter, if there is a further deterioration in value, the Bank provides for a specific valuation allowance and charges operations for the diminution in value. It is the policy of the Bank to have obtained an appraisal on all real estate subject to foreclosure proceedings prior to the time of foreclosure. It is the Bank's policy to require appraisals on a periodic basis on foreclosed properties and conduct inspections on foreclosed properties.
Investment Activities
Federally-chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certificates of deposit of insured banks and savings institutions, bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally-chartered savings institutions may also invest their assets in commercial paper, investment-grade corporate debt securities and mutual funds whose assets conform to the investments that a federally-chartered savings institution is otherwise authorized to make directly. Additionally, the Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. Historically, the Bank has maintained liquid assets above the minimum OTS requirements and at a level considered being adequate to meet its normal daily activities.
The investment policy of the Bank, as approved by the Board of Directors, requires management to maintain adequate liquidity and a high quality investment portfolio. The Bank primarily utilizes investments in securities for liquidity management and as a method of deploying excess funds not utilized for investment in loans. Generally, the Bank's investment policy is more restrictive than the OTS regulations allow and, accordingly, the Bank has invested primarily in U.S. Government and agency securities, which qualify as liquid assets under the OTS regulations, federal funds and U.S. Government sponsored agency issued mortgage-backed securities. The Bank is required by SFAS No. 115 to categorize its securities as held-to-maturity, available-for-sale or held for trading. As of March 31, 2000, the Bank's securities portfolio consisted of investment securities, marketable equity securities and mortgage-backed and mortgage-related securities. The carrying amounts of the held-to-maturity portfolio totalled $527,000, or 0.11% of total assets, and the available-for-sale securities portfolio totalled $31.8 million, or 6.9% of total assets.
Short term investments primarily consist of overnight deposits at the FHLB and the Co-operative Central Bank Liquidity Fund. The Liquidity Fund is a no-load diversified, open-ended money market investment fund whose objective is maximum current income consistent with liquidity and the preservation of capital. The Fund is designed solely for use by eligible investors as an economical and convenient way to make liquid investments.
As of March 31, 2000, $15.3 million, or 3.33% of total assets, of the Bank's securities portfolio consisted of investment securities, primarily debt securities issued by the U.S. Government or government sponsored agencies (such as the FHLB) and marketable equity securities, primarily consisting of mutual fund securities, common stocks, preferred stocks, trust preferred stocks and corporate bonds and notes. The Bank generally invests in U.S. Treasury and agency obligations with maturities of 24 to 60 months. The weighted average maturities of the Bank's fixed rate investment securities portfolio, excluding any equity securities, were 22 months as of March 31, 2000.
At March 31, 2000, the Bank had $17.0 million of mortgage-backed and mortgage-related securities, or 3.69% of total assets, all of which were backed by fixed-rate mortgages and which consisted of mortgage-backed securities and collateralized mortgage obligations ("CMOs") insured or issued by Ginnie Mae, Fannie Mae and Freddie Mac or private issuers, such as GE Capital Mortgage Services, Inc. At March 31, 2000, the weighted average estimated maturity of its mortgage-backed and mortgage-related securities portfolio was 39 months. Investments in mortgage-backed and mortgage-related securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates.
While investments in privately issued mortgage-backed securities generally bear yields higher than mortgage-backed securities insured by government sponsored agencies, they involve a greater degree of risk than those issued by government sponsored agencies, as such, securities are not insured or guaranteed by such government sponsored agencies.
The following table sets forth certain information regarding the amortized cost and fair value of the Bank's securities at the dates indicated.
The following table sets forth certain information regarding the amortized cost and fair values of the Bank's mortgage-backed and mortgage-related securities.
- ----------------------------- (1) Based on amortized cost.
The following table sets forth the Bank's mortgage-backed and mortgage-related securities activities for the periods indicated.
For the Year Ended March 31, --------------------------------------- 2000 1999 1998 --------------------------------------- (In thousands)
Beginning balance ............. $ 6,327 $ 2,271 $ 3,250 Principal repayments ....... (4,741) (2,010) (973) Purchases .................. 15,830 6,074 -- Accretion of discount and amortization of (premium) 48 (8) (6) -------- -------- -------- Ending balance ................ $ 17,464 $ 6,327 $ 2,271 ======== ======== ========
The table below sets forth certain information regarding the amortized cost, weighted average yields and contractual maturities of the Bank's debt securities.
- ------------------------------------------------------- (1) Consists of government agency obligations, and corporate bonds and notes.
Deposit Activities and Other Sources of Funds
General. Deposits, loan repayments and prepayments, proceeds from sales of loans, cash flows generated from operations and FHLB advances are the primary sources of the Bank's funds for use in lending, investing and for other general purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Bank's deposits consist of business checking, money market, savings, NOW and certificate accounts. For the year ended March 31, 2000, the average balance of core deposits represented 49.2% of total average deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Bank's deposits are obtained predominantly from the areas surrounding its branch offices. The Bank has historically relied primarily on providing a higher level of customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank's ability to attract and retain deposits. The Bank uses traditional means of advertising its deposit products, including print media, and generally does not solicit deposits from outside its market area. While the Bank does not actively solicit certificate accounts in excess of $100,000 or use brokers to obtain deposits, the Bank may solicit, from time-to-time, such deposits depending upon market conditions. The Bank offers negotiated rates on some of its certificate accounts. At March 31, 2000, $112.8 million, or 50.3%, of total average deposits were certificate accounts with a weighted average remaining maturity of 11.1 months.
For the year ended March 31, 2000, certificate accounts in excess of $100,000 increased $9.0 million, or 58.8%, from $15.3 million to $24.3 million. The increase in certificate accounts was due to offering new competitively priced certificate account products which, in part, resulted in a decrease in the average cost of certificates of deposit from 5.43% for fiscal 1999 to 5.18% for fiscal 2000. Further increases in certificate accounts, which tend to be more sensitive to movements in market interest rates than core deposits, may result in the Bank's deposit base being less stable than if it had a larger amount of core deposits which, in turn, may result in further increases in the Bank's cost of deposits and may adversely affect net interest income in future periods.
The following table presents the average deposit activity of the Bank for the periods indicated:
At March 31, 2000, the Bank had $24.3 million in certificate accounts in amounts of $100,000 or more maturing as follows:
Amount Weighted Average Maturity Period Rate ------------------------ ---------------------- (Dollars in thousands)
3 months or less ....... $ 5,687 5.21% Over 3 through 6 months 8,248 5.32 Over 6 through 12 months 5,043 5.50 Over 12 months ......... 5,302 6.06 ------- ---- Total ............ $24,280 5.49% ======= ====
The following table sets forth the distribution of the Bank's average deposit accounts for the periods indicated and the weighted average interest rates on each category of deposits presented. Averages for the periods presented utilize month-end balances.
- ------------------------------------------ (1) Based on remaining maturity of certificates.
(2) Includes retirement accounts such as IRA and Keogh accounts.
The following table presents by various rate categories, the amount of certificate accounts outstanding at the dates indicated and the periods to maturity of the certificate accounts outstanding at March 31, 2000.
Borrowings. As part of its operating strategy, the Bank utilizes advances from the FHLB as an alternative to retail deposits to fund its operations. The Bank has increased its emphasis on the utilization of FHLB borrowings to fund its asset growth. By utilizing FHLB advances, which possess varying stated maturities, the Bank can meet its liquidity needs without otherwise being dependent upon retail deposits and revising its deposit rates to attract retail deposits, which have no stated maturities (except for certificates of deposit), which are interest rate sensitive and which are subject to withdrawal from the Bank at any time. These FHLB advances are collateralized primarily by mortgage loans and mortgage-backed securities held by the Bank and secondarily by the Bank's investment in capital stock of the FHLB. FHLB advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB will advance to member institutions, including the Bank, fluctuates from time-to-time in accordance with the policies of the FHLB. At March 31, 2000, the Bank had $147.5 million in outstanding advances from the FHLB and $8.1 million in other borrowings, as compared to $77.1 million and none at March 31, 1999, respectively.
The following table sets forth certain information regarding the Bank's borrowed funds at or for the periods ended on the dates indicated:
REGULATION AND SUPERVISION.
General
As a savings and loan holding company, the Company is required by federal law to file reports with, and otherwise comply with, the rules and regulations of the OTS. The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank System and its deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The OTS and/or the FDIC conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the Company was not generally restricted as to the types of business activities in which it may engage, provided that the Bank continued to be a qualified thrift lender. See "Federal Savings Institution Regulation - QTL Test." The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, such as the Company, so long as the Bank continues to comply with the QTL Test. Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the qualified thrift lender test and is deemed to be a savings institution by the OTS, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the OTS, and certain activities authorized by OTS regulation.
A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company, without prior written approval of the OTS and from acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS considers the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the OTS 30 days before declaring any dividend to the Company.
In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are governed by federal law and regulations. These laws and regulations delineate the nature and extent of the activities in which federal associations may engage. In particular, many types of lending authority for federal association, e.g., commercial, non-residential real property loans and consumer loans, are limited to a specified percentage of the institution's capital or assets.
Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS rating system), and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The OTS regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OTS capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The capital regulations also incorporate an interest rate risk component. Savings institutions with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. For the present time, the OTS has deferred implementation of the interest rate risk component. At March 31, 2000, the Bank met each of its capital requirements.
The following table presents the Bank's capital position at March 31, 2000.
Prompt Corrective Regulatory Action. The OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently insured by the SAIF. The FDIC maintains a risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends upon the categories to which it is assigned. Assessment rates for SAIF member institutions are determined semiannually by the FDIC and currently range from zero basis points for the healthiest institutions to 27 basis points for the riskiest.
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 1999, FICO payments for SAIF members approximated 6.10 basis points, while Bank Insurance Fund ("BIF") members paid 1.22 basis points. By law, there is equal sharing of FICO payments between SAIF and BIF members as of January 1, 2000.
The Bank's assessment rate for fiscal 2000 ranged from 2.08 to 5.92 basis points and the premium paid for this period was $90,000, which represents payment toward the FICO bonds. The FDIC has the authority to increase insurance assessments. A significant increase in SAIF Insurance premiums would likely have an adverse effect on the operating expenses and results of the operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. A savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral. At March 31, 2000, the Bank's limit on loans to one borrower was $6.9 million, and the Bank's largest aggregate outstanding balance of loans to one borrower was $6.6 million.
QTL Test. The HOLA requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period.
A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of March 31, 2000, the Bank maintained 76.5% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the new OTS regulation effective on April 1, 1999, an application to and the prior approval of the OTS is required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under OTS regulations (i.e., generally, examination ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with OTS. If an application is not required, the institution must still provide prior notice to OTS of the capital distribution if, like the Bank, it is a subsidiary of a holding company. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice.
Liquidity. The Bank is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement is currently 4%, but may be changed from time to time by the OTS to any amount within the range of 4% to 10%. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Bank's regulatory liquidity ratio for March 31, 2000 was 6.12%, which exceeded the applicable requirements. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended March 31, 2000 totaled $82,000.
Transactions with Related Parties. The Bank's authority to engage in transactions with "affiliates" (e.g., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law.
The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is also governed by federal law. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. Recent legislation created an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval procedures to be followed.
Enforcement. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that a savings institution fails to meet any standard prescribed by the guidelines, the OTS may require the institution to submit an acceptable plan to achieve compliance with the standard.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. The Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at March 31, 2000 of $8.1 million.
The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank's net interest income would likely also be reduced. Recent legislation has changed the structure of the Federal Home Loan Banks funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain noninterest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $44.3 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts aggregating greater than $44.3 million, the reserve requirement is $1.329 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $44.3 million. The first $5.0 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The Bank complies with the foregoing requirements.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their income on a fiscal year, consolidated basis and the accrual method of accounting, and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Bank has not been audited by the IRS or the Massachusetts Department of Revenue for eight years, since 1992, which covered the tax years 1992 and previous. For its 2000 taxable year, the Company is subject to a maximum federal income tax rate of 34%.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995, thrift institutions which qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans (generally secured by interests in real property improved or to be improved) under (i) the Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience Method. The reserve for nonqualifying loans was computed using the Experience Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was enacted on August 20, 1996, repeals the reserve method of accounting for bad debts for tax years beginning after 1995 and requires savings institutions to recapture (i.e., take into income) certain portions of their accumulated bad debt reserves. Thrift institutions eligible to be treated as "small banks" (assets of $500 million or less) are allowed to use the Experience Method applicable to such institutions, while thrift institutions that are treated as large banks (assets exceeding $500 million) are required to use only the specific charge-off method. Thus, the PTI Method of accounting for bad debts is no longer available for any financial institution.
A thrift institution required to change its method of computing reserves for bad debts will treat such change as a change in method of accounting, initiated by the taxpayer, and having been made with the consent of the IRS. Any Section 481(a) adjustment required to be taken into income with respect to such change generally will be taken into income ratably over a six-taxable year period, beginning with the first taxable year beginning after 1995, subject to a 2-year suspension if the "residential loan requirement" is satisfied.
Under the residential loan requirement provision, the recapture required by the 1996 Act will be suspended for each of two successive taxable years, beginning with the Bank's 1996 taxable year, in which the Bank originates a minimum of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding its current taxable year.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend distributions" to the Company, such distributions will be considered to have been made from the Bank's unrecaptured tax bad debt reserves (including the balance of its reserves as of December 31, 1987) to the extent thereof, and then from the Bank's supplemental reserve for losses on loans, to the extent thereof, and an amount based on the amount distributed (but not in excess of the amount of such reserves) will be included in the Bank's income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank's current or accumulated earnings and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a non-dividend distribution to the Company, approximately one and one-half times the amount of such distribution (but not in excess of the amount of such reserves) would be includable in income for federal income tax purposes, assuming a 35% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee on every $100 of thrift deposits held on March 31, 1995. For financial statement purposes, this assessment was reported as an expense for the quarter ended September 30, 1996. The Funds Act includes a provision, which states that the amount of any special assessment paid to capitalize SAIF under this legislation is deductible under Section 162 of the Code in the year of payment.
State and Local Taxation
Commonwealth of Massachusetts Taxation. On July 27, 1995, the Governor of Massachusetts approved legislation to reduce the tax rate applicable to financial institutions, including savings banks, from 12.54% on their net income to 10.50% on their net income apportioned to Massachusetts. The reduced rate is to be phased-in over a five year period whereby the rate was 11.71% for 1996, 11.32% for 1997, 10.91% for 1998, and will be 10.50% for future years. Net income for years beginning before January 1, 1999 includes gross income as defined under the provisions of the Code, plus interest from bonds, notes and evidences of indebtedness of any state, including Massachusetts, less the deductions, excluding the deductions for dividends received, state taxes, and net operating losses, as defined under the provisions of the Code. For taxable years beginning on or after January 1, 1999, the definition of state taxable income is modified to allow a deduction for 95% of dividends received from stock where the Company owns 15% or more of the voting stock of the institution paying the dividend and to allow deductions from certain expenses allocated to federally tax exempt obligations. Subsidiary corporations of the Company conducting business in Massachusetts must file separate Massachusetts state tax returns and are taxed as financial institutions, with certain modifications and grandfathering for taxable years before 1996. The net worth or tangible property of such grandfathered subsidiaries is taxed at a rate of 0.26%. Such grandfathered subsidiaries may file consolidated tax returns on the net earnings portion of the corporate tax.
Corporations that qualify as "securities corporations," as defined by the Massachusetts tax code, are taxed at a special rate of 0.33% of their gross income if they qualify as a "bank-holding company" under the Massachusetts tax code. The Company qualifies for this reduced tax rate provided that it is exclusively engaged in activities of a "securities corporation." The Company qualifies as a securities corporation because a separate subsidiary was formed to make the loan to the Bank's Employee Stock Ownership Plan and related trust and all of the Company's other activities qualify as activities permissible for a securities corporation. If the Company fails to so qualify, however, it will be taxed as a financial institution at a rate of 10.50% beginning in fiscal 2001.
The Bank has two subsidiary corporations that qualify as "securities corporations," as defined by the Massachusetts tax code, which are taxed at a special rate of 1.32% of their net income under the Massachusetts tax code. The subsidiaries qualify for this reduced tax rate provided that they exclusively engaged in investment activities that can also be done by the Bank.
Delaware Taxation. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware.
Item 2.
Item 2. Properties
The Bank currently conducts its business through its executive, administrative and full service offices. The Company believes that the Bank's current facilities are adequate to meet the present needs of the Bank and the Company.
- --------------------- (1) The Bank has an option to renew this lease for one additional five-year period. (2) The Bank is in the process of renewing this lease for a five-year period, with an option for an additional five-year period. (3) The Bank has an option to renew this lease for one additional ten-year period.
Item 3.
Item 3. Legal Proceedings.
The Bank is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.
The Common Stock of the Company is traded on the American Stock Exchange under the symbol "BYS." The stock began trading on March 30, 1998. As of May 31, 2000, there were 432 registered recordholders of the Common Stock of the Company, which includes shares held in street name. The following table sets forth for the quarters indicated the range of high and low sale price information for the Common Stock of the Company as reported on the American Stock Exchange.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation
The following discussion should be read in conjunction with the "Selected Financial Data" and Consolidated Financial Statements and related Notes appearing elsewhere in this Form 10-K.
General
The Company does not transact any material business other than through its wholly-owned subsidiary, the Bank. The Bank's results of operations are dependent primarily on net interest income, which is the difference between the income earned on its loan and investment portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the Bank's provision for loan losses, loan sale activities and loan servicing. The Bank's non interest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, federal deposit insurance premiums, data processing, advertising and business promotion and other expenses. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact the Bank.
This Form 10-K contains forward looking statements that are based on assumptions and describe future plans, strategies, and expectations of the Company. These forward looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and the subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market area and changes in relevant accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. The Company does not undertake--and specifically disclaims any obligation--to publicly release the result of any revisions which may be made to any forward looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
Operating Strategy
Management's primary goal has been to maintain the Bank's profitability, asset quality and its capital position by: (i) investing primarily in one- to four-family loans secured by properties located in its primary market area; (ii) investing in multi-family, commercial real estate and construction and development loans secured by properties located in the Bank's primary market area, to the extent that such loans meet the Bank's general underwriting criteria; (iii) investing funds not utilized for loan investments in short-term U.S. Treasury and mortgage-backed and mortgage-related securities; and (iv) managing interest rate risk by emphasizing the origination of adjustable-rate loans and short-term fixed-rate loans and investing in short-term securities and generally selling longer-term fixed-rate loans that the Bank originates. The Bank intends to continue this operating strategy in an effort to enhance its long-term profitability while maintaining a reasonable level of interest rate risk and enhance such strategy by expanding the products and services it offers, as necessary, in order to improve its market share in its primary market area. In this regard, the Bank offers business checking accounts, 24-hour banking by telephone, debit card services and Internet banking.
Comparison of Financial Condition at March 31, 2000 and March 31, 1999
Total assets at March 31, 2000 were $460.1 million, compared to $359.4 million at March 31, 1999, an increase of $100.7 million, or 28.0%. Asset growth was primarily due to the increased loan and investment securities portfolios; funded by an increase of $70.4 million in FHLB borrowings and an $28.4 million increase in deposits.
Investments at March 31, 2000 totalled $32.9 million, an increase of $1.2 million, or 3.8%, compared to $31.7 million at March 31, 1999. The increase was the result of the purchase of mortgage backed securities, offset by a reduction in short-term investments, which were used to fund loan growth.
Loans receivable, net of allowance for loan losses and deferred loan origination fees, increased $88.7 million to $393.1 million at March 31, 2000, or 29.1%, compared to $304.4 million at March 31, 1999. The increase in loans was due to a $32.5 million, or 19.2%, increase in one- to four-family loans, a $20.9 million, or 36.1%, increase in multi-family loans, a $28.0 million, or 41.4%, increase in commercial real estate loans, a $3.1 million, or 76.5%, increase in construction and development loans and a $5.3 million, or 61.3%, increase in consumer loans.
Non-performing assets at March 31, 2000 were $1.3 million, compared to $2.0 million at March 31, 1999, a decrease of 35.0%. This decrease was the result of certain non-accrual loans being paid off or brought current. The allowance for loan losses increased $875,000 to $3.9 million at March 31, 2000, compared to $3.0 million at March 31, 1999, an increase of 30.0%. At March 31, 2000 the allowance represents 319.8% of non-performing loans and 0.99% of total loans, compared to 154.1% of non-performing loans and 0.98% of total loans at March 31, 1999. Total REO at March 31, 2000 was $62,000 and there was no REO at March 31, 1999.
Deposits increased 12.9%, to $247.3 million at March 31, 2000 from $219.0 million at March 31, 1999. The deposit growth occurred primarily in MMDA accounts and Certificate of Deposit accounts, which increased $16.9 million, or 31.2%, and $11.0 million, or 10.1%, respectively. Borrowed funds which consist of Federal Home Loan Bank borrowings, and to a lesser extent a repurchase agreement and Federal Funds Purchased, totalled $155.7 million at March 31, 2000, a 101.9% increase over the $77.1 million in borrowings at March 31, 1999, which consisted solely of Federal Home Loan Bank borrowings. The increased level of FHLB borrowings were in the 10-year maturity, with callable features after one-year at the option of the lender, fixed maturity advances, and two-, three- and five-year amortizing advances. The repurchase agreement totalled $5.6 million and Federal Funds purchased totalled $2.5 million, at March 31, 2000. The increased borrowings were used to fund asset growth.
Total equity was $52.6 million, or 11.4% of total assets at March 31, 2000, a decrease of $7.7 million, or 12.7%, from the $60.3 million, or 16.8% of total assets at March 31, 1999. The change in equity was primarily the result of the repurchase of 452,190 shares of common stock at a cost of $8.8 million, and the reduction in the market value of investment securities classified as available-for-sale offset by net income of $2.8 million for the period. The Company's book value per share at March 31, 2000 was $29.06, compared to $26.88 at March 31, 1999.
Comparison of Operating Results for the Years Ended March 31, 2000 and 1999
General
Net income for the fiscal year ended March 31, 2000, totalled $2.8 million, or $1.34 per share, compared to $2.2 million, or $0.97 per share for the fiscal year ended March 31, 1999. This represents an increase of 23.3% in net income and a 38.1% increase in earnings per share, over the last fiscal year. The net income for the fiscal year ended March 31, 2000 represents a return on average assets of 0.65% and a return on average equity of 4.82%, compared to 0.71% and 3.58% for the last fiscal year, respectively.
Interest Income
Interest income for the fiscal year ended March 31, 2000 was $31.0 million, compared to $23.4 million for the year ended March 31, 1999, an increase of $7.6 million, or 32.5%. The increase in interest income was a result of an increase in the average balance of interest earning assets. The average balance of interest-earning assets increased from $302.5 million for fiscal year 1999 to $402.2 million for fiscal year 2000, an increase of $99.7 million, or 33.0%. The increase in the average balance of interest-earning assets was primarily a result of an increase in the average balance of loans, net, of $95.4 million, or 36.5%, and an increase in investment securities and mortgage-backed securities totalling $17.8 million, or 68.4%. The yield on average interest-earning assets decreased 4 basis points to 7.70%.
Interest Expense
Interest expense for the fiscal year ended March 31, 2000 was $16.4 million, compared to $10.8 million for the year ended March 31, 1999, an increase of $5.6 million, or 52.0%. The increase in interest expense was primarily due to an increase in the average balance and cost of interest-bearing liabilities. The average balance of interest-bearing liabilities increased from $245.3 million for fiscal year 1999 to $358.0 million, an increase of $112.7 million, or 45.9%. The increase in the average balance of interest-bearing liabilities was primarily a result of an increase in the average balance of borrowed funds totalling $98.7 million, or 250%, and an increase in the average balance of deposit accounts totalling $14.1 million, or 6.8%. The cost of average interest-bearing liabilities increased 19 basis points to 4.57%, for the fiscal year ended March 31, 2000.
Net Interest Income
Net interest income before the provision for loan losses increased $2.0 million, or 15.4%, for the fiscal year ended March 31, 2000, primarily attributable to a growth in the loan portfolio. For the fiscal year ended March 31, 2000 the net interest margin was 3.63%, compared to 4.19% for the Fiscal year ended March 31, 1999
Provision for Loan Losses
The provision for loan losses was $875,000 for the fiscal year ended March 31, 2000, compared to $617,000 for the fiscal year ended March 31, 1999. The level of the reserve position for the fiscal year ended March 31, 2000 was a direct result of the growth in the loan portfolio and the increased level of multi-family and commercial real estate loans, which generally bear a higher risk than single family residential lending. Management believes that the provision for loan losses and the allowance for loan losses are currently reasonable and adequate to cover any losses reasonably expected in the existing loan portfolio.
While management estimates loan losses using the best available information, no assurances can be given that future additions to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding problem loans, identification of additional problem loans and other factors, both within and outside of management's control. Additionally, with the expectation of the Bank to grow its existing loan portfolio, future additions to the allowance may be necessary to maintain adequate coverage ratios.
Noninterest Income
For the fiscal year ended March 31, 2000 noninterest income totalled $1.1 million, compared to $431,000 for the fiscal year ended March 31, 1999, an increase of $675,000, or 157%. These increases were primarily a result of tax-advantaged income received on bank owned life insurance policies, fees on loans and deposit accounts and income received from alternative investment services offered by the bank. In addition the Company recognized unrealized gains on trading securities, which represents an increase in the market value of the assets supporting certain employee benefit plans, which also results in a corresponding expense in salaries and benefits.
Noninterest Expense
Total noninterest expense was $10.6 million for the fiscal year ended March 31, 2000, compared to $8.7 million for the fiscal year ended March 31, 1999, an increase of $1.9 million, or 21.9%. Total salaries and benefits increased $1.3 million, or 23.5%, the result of an increase in compensation expense associated with the Company's stock-based benefit plans, and a general increase in salaries and employee benefit plans due to the increase in the number of employees, compared to the year ended March 31, 1999. Occupancy and equipment expenses totalled $1.2 million compared to $1.0 million for the fiscal year ended March 31, 1999, an increase of $180,000, or 17.7%. This increase was a result of the increased depreciation on building and leasehold improvements, and lease payments and expenses associated with the purchases of furniture, fixtures and equipment for the additional office space leased and the opening of the new branch location. Advertising expenses totalled $538,000 for the fiscal year ended March 31, 2000, compared to $240,000 for the fiscal year ended March 31, 1999, an increase of $298,000, or 124%, primarily a result of the development and roll out of new deposit products and retail services and the opening of the Walpole branch. Data processing expense totalled $274,000 for the fiscal year ended March 31, 2000, compared to $249,000 for the fiscal year ended March 31, 1999, an increase of 10.0%. Other expenses increased $252,000, or 27.0%.
Income Taxes
For the fiscal year ended March 31, 2000, income taxes of $1.5 million were provided on net income before tax of $4.2 million, for an effective rate of 35.0%, compared to $1.5 million on income before taxes of $3.8 million for an effective rate of 40.9%, for the fiscal year ended March 31, 1999. The effective tax rate for the current periods are lower than the prior periods due to various tax planning strategies implemented by the Company, specifically the purchase of tax-advantaged life insurance products and the establishment of two Massachusetts securities corporations at the Bank level, which lowered state taxes.
Comparison of Operating Results for the Years Ended March 31, 1999 and 1998
General
Net income for the fiscal year ended March 31, 1999 totalled $2.2 million, or $0.97 per share, compared to a net loss of $1.8 million for the March 31, 1998 period. Since the Company converted to a stock form of ownership on March 27, 1998, earnings per share data for the previous year is not available. The net loss for the fiscal year ended March 31, 1998 resulted primarily from the recognition of certain items related to the Conversion. As part of the Conversion the Company established The Bay State Federal Savings Charitable Foundation by donating 187,795 shares of the Company's stock to the Foundation. The total contribution expense associated with the transaction was $3.8 million, or $2.5 million net of income taxes.
Additionally, due to the timing of the consummation of the Conversion and the establishment of the Bank's Employee Stock Ownership Plan ("ESOP"), which was funded with 8% of stock issued in the Conversion, or 202,818 shares, the Company incurred additional compensation expense of $601,000, or $433,000 net of income taxes, relating to the ESOP allocation for the fiscal year ended March 31, 1998. In addition, certain non-recurring expenses and adjustments associated with the Conversion totalled $688,000, or $405,000 net of income taxes. Excluding the effect of these items, the Company would have recognized net income for the fiscal year ended March 31, 1998 of approximately $1.6 million. The increased level of earnings for the fiscal year ended March 31, 1999 was primarily attributable to increases in interest earned on loans and securities due to the asset growth of the Company.
Interest Income
Interest income for the fiscal year ended March 31, 1999 was $23.4 million, compared to $19.2 million for the March 31, 1998 period, an increase of $4.2 million, or 21.7%. The increase in interest income was the net result of an increase in the average balance of interest-earning assets and a decrease in the yield on interest-earning assets. The average balance of interest-earning assets increased from $237.1 million for fiscal 1998 to $302.5 million for fiscal 1999, an increase of $65.4 million, or 27.6%.
Interest Expense
Interest expense for the fiscal year ended March 31, 1999 was $10.8 million, compared to $10.2 million for the March 31, 1998 period, an increase of $600,000, or 5.5%. This increase in interest expense was primarily due to an increase in the average balance of interest-bearing liabilities offset by a decrease in the cost of interest-bearing liabilities. The average balance of interest-bearing liabilities increased from $222.6 million for fiscal 1998 to $245.3 million for fiscal 1999, an increase of $22.7 million, or 10.2%.
Net Interest Income
Net interest income before the provision for loan losses increased $3.6 million, or 40.0%, for the fiscal year. The increase was primarily the result of the increased level of the loan and investment portfolios and a 37 basis point increase in net interest margin. The net interest margin was 4.19% for the fiscal year ended March 31, 1999, compared to 3.82% for the March 31, 1998 period.
Provision for Loan Losses
The provision for loan losses was $617,000 for the fiscal year ended March 31, 1999, compared to $856,000 for the March 31, 1998 period. The level of reserve provision for the fiscal year ended March 31, 1998 was made after an assessment of the Bank's loan portfolio, in particular specific loan pools that were internally classified by the Bank, specifically loans acquired in the Union Federal merger. The level of reserve provision for the fiscal year ended March 31, 1999, was a result of management's assessment of the loan portfolio and, more specifically, the growth in the loan portfolio.
At March 31, 1999 the allowance for loan losses totalled $3.0 million, representing 154.12% of nonperforming loans and 0.98% of total loans, compared to $2.5 million, representing 110.27% of nonperforming loans and 1.10% of total loans at March 31, 1998.
Noninterest Income
Noninterest income for the fiscal year ended March 31, 1999 totalled $431,000 compared to $313,000 for the March 31, 1998 period, an increase of $118,000, or 37.7%. These increases were primarily the result of an increase in gains on the sale of loans, fees on deposit accounts and income recognized on bank owned life insurance policies purchased by the Bank.
Noninterest Expense
Total noninterest expense was $8.7 million for the fiscal year ended March 31, 1999, compared to $11.0 million for the March 31, 1998 period, a decrease of 20.9%. Total salaries and benefits increased $994,000, or 21.9%, the result of an increase of $418,000 in compensation expense associated with the Company's stock-based benefit plans, and a general increase in salaries and benefits due to the increase in the number of employees compared to the same period last year. Occupancy and equipment expense totalled $1.0 million compared to $944,000 for the same period last year, an increase of 7.94%, primarily from the increased level of depreciation on building and leasehold improvements. Advertising expense increased $66,000, or 37.9% associated with the development and marketing of certain new deposit products and investment services.
Other expenses, after adjusting for the previous years contribution expense of $3.8 million in forming the Foundation and $439,000 in expenses associated with the Conversion, increased $710,000, primarily as a result of increases in general expenses associated with the development of certain products and programs as part of the strategic planning for the future and approximately $35,000 in expenses associated with upgrades to certain systems for Year 2000 compliance.
Income Taxes
For the fiscal year ended March 31, 1999 income taxes of $1.5 million were provided on net income before tax of $3.8 million for an effective rate of 40.9%, compared to a tax benefit of $751,000 on a loss before taxes of $2.5 million for an effective rate of 30.0%, for the same period last year. The effective tax rate for the current period was different than the prior periods due to the nondeductibility of certain expenses associated with the Conversion and the reduction in the state tax rate for banks.
Average Balances, Interest and Average Yields/Costs.
The following table sets forth certain information relating to the Bank for the years ended March 31, 2000, 1999, and 1998. The average yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown except where noted otherwise and reflect annualized yields and costs. Average balances are derived from average month-end balances. Management does not believe that the use of average monthly balances instead of average daily balances has caused any material differences in the information presented. The yields and costs include fees, which are considered adjustments to yields. Loan interest and yield data does not include any accrued interest from non-accruing loans.
- ----------------------------------------- (1) Includes investment securities available-for-sale and held-to-maturity, Co-operative Central Bank Liquidity Fund, and stock in FHLB-Boston.
(2) Amount is net of deferred loan origination costs, undisbursed proceeds of construction loans in process, allowance for loan losses and includes non-accruing loans. The Bank records interest income on non-accruing loans on a cash basis.
(3) Demand deposits primarily represent noninterest-bearing custodial accounts and Treasurers checks issued not yet cleared.
(4) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income as a percentage of average interest-earning assets.
Rate/Volume Analysis. The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Bank's interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated on a proportional basis between changes in rate and volume.
Management of Interest Rate Risk and Market Risk Analysis
The principal objective of the Bank's interest rate risk management function is to evaluate the interest rate risk included in certain balance sheet accounts, determine the appropriate level of risk given the Bank's business strategy, operating environment, capital and liquidity requirements and performance objectives and manage the risk consistent with the Board of Directors' approved guidelines. Through such management, the Bank seeks to reduce the vulnerability of its operations to changes in interest rates. The Bank monitors its interest rate risk as such risk relates to its operating strategies. The Bank's Board of Directors has an Asset/Liability Committee which reviews its asset/liability policies and interest rate risk position. Such Committee, which meets on a regular basis, reports trends and interest rate risk position to the Board of Directors on a quarterly basis. The extent of the movement of interest rates is an uncertainty that could have a negative impact on the earnings of the Bank.
In recent years, the Bank has primarily utilized the following strategies to manage interest rate risk: (i) emphasizing the origination and purchase of adjustable-rate loans; (ii) investing primarily in short-term U.S. Government securities or mortgage-backed and mortgage-related securities with shorter estimated maturities; (iii) utilizing FHLB advances to better structure the maturities of its interest rate sensitive liabilities; and (iv) to a substantially lesser extent, selling in the secondary market longer-term fixed-rate mortgage loans originated while generally retaining the servicing rights on such loans.
Gap Analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring a bank's interest rate sensitivity "gap." An asset and liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. At March 31, 2000, the Company's cumulative one year interest rate gap (which is the difference between the amount of interest-earning assets maturing or repricing within one year and interest-bearing liabilities maturing or repricing within one year) as a percentage of total assets, was a negative 16.4%. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Accordingly, during a period of rising interest rates, an institution with a negative gap position would be in a worse position to invest in higher yielding assets as compared to an institution with a positive gap position which, consequently, may result in the cost of its interest-bearing liabilities increasing at a rate faster than its yield on interest-earning assets than if it had a positive gap. During a period of falling interest rates, an institution with a negative gap position would tend to have its interest-bearing liabilities repricing downward at a faster rate than its interest-earning assets as compared to an institution with a positive gap which, consequently, may tend to positively affect the growth of its net interest income. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at March 31, 2000, which are anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the "Gap Table"). Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table sets forth an approximation of the projected repricing of assets and liabilities at March 31, 2000, on the basis of contractual maturities, and scheduled rate adjustments within a one year period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans. Money Market accounts, Regular Savings accounts and NOW accounts are assumed to have annual decay rates of 80%, 15% and 5%, respectively. Deposit decay rates can have a significant impact on the Company's estimated gap. While the Company believes such assumptions to be reasonable, there can be no assurance that assumed decay rates will approximate future withdrawal activity.
(1) Excludes nonaccrual loans.
(2) Fair value of securities, including mortgage-backed securities, is based on quoted market prices, where available. If quoted market prices are not available, fair value is based on quoted market prices of comparable instruments. Fair value of loans is, depending on the type of loan, based on carrying values or estimates based on discounted cash flow analyses. Fair value of deposit liabilities are either based on carrying amounts or estimates based on a discounted cash flow calculation. Fair values for FHLB advances are estimated using a discounted cash flow analysis that applies interest rates concurrently being offered on advances to a schedule of aggregated expected monthly maturities on FHLB advances.
(3) Fair value of loans includes nonaccrual loans.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react to different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase.
Net Portfolio Value. As part of its interest rate risk analysis, the Bank uses an interest rate sensitivity model which generates estimates of the change in the Bank's net portfolio value ("NPV") over a range of interest rate scenarios and which is prepared by the OTS on a quarterly basis. NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The OTS produces such analysis using its own model, based upon data submitted on the Bank's quarterly Thrift Financial Reports, including estimated loan prepayment rates, reinvestment rates and deposit decay rates. The following table sets forth the Bank's NPV as of December 31, 1999 (the latest NPV analysis prepared by the OTS), as calculated by the OTS.
------------- (1) Expressed in basis points
As is the case with the Gap Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV model presented assumes that the composition of the Bank's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of the Bank's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Bank's net interest income and will differ from actual results.
Liquidity and Capital Resources
The Bank's primary sources of funds are deposits, principal and interest payments on loans, mortgage-backed and investment securities and FHLB advances. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank has continued to maintain the required levels of liquid assets as defined by OTS regulations. This requirement of the OTS, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The Bank's current required liquidity ratio is 4%. At March 31, 2000 and March 31, 1999, the Bank's liquidity ratios were 6.1% and 5.8%, respectively. The Bank manages its liquidity position and demands for funding primarily by investing excess funds in short-term investments and utilizing FHLB advances in periods when the Bank's demands for liquidity exceed funding from deposit inflows.
The Bank's most liquid assets are cash and cash equivalents and securities. The levels of these assets are dependent on the Bank's operating, financing, lending and investing activities during any given period. At March 31, 2000, cash and cash equivalents and investment securities totalled $38.3 million, or 8.3% of total assets.
The Bank has other sources of liquidity if a need for additional funds arises, including FHLB advances. At March 31, 2000, the Bank had $147.5 million in advances outstanding from the FHLB and an additional overall borrowing capacity from the FHLB of $49.6 million. Depending on market conditions, the pricing of deposit products and FHLB advances, the Bank may continue to rely on FHLB borrowings to fund asset growth.
At March 31, 2000, the Bank had commitments to fund loans and unused outstanding lines of credit and undisbursed proceeds of construction mortgages totalling $25.0 million. The Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificate accounts, including IRA and Keogh accounts, which are scheduled to mature in less than one year from March 31, 2000, totalled $93.0 million.
At March 31, 2000, the Bank exceeded all of its regulatory capital requirements with a tangible capital level of $41.6 million, or 9.2%, of total adjusted assets, which is above the required level of $6.8 million, or 1.5%; core capital of $41.6 million, or 9.2%, of total adjusted assets, which is above the required level of $18.2 million, or 4.0%; and risk-based capital of $45.7 million, or 15.8%, of risk-weighted assets, which is above the required level of $23.1 million, or 8.0%.
Year 2000 Compliance
The Bank accomplished the objectives established in its Year 2000 Action Plan. All internal software and hardware used in Bank's business made it through the transition from 1999 to 2000 without any known abnormalities or inaccurate results. In addition, the Bank's critical vendors and suppliers have informed the Bank that they have also made the transition successfully. Furthermore, the Bank has not been notified by any of its significant borrowers of any material Year 2000 related problems that would adversely affect the borrowers' abilities to satisfy their current obligations to the Bank.
Other critical, future dates previously identified as being potentially vulnerable to the Year 2000 problem were tested as part of the century rollover testing. All critical applications thought to be impacted by future dates were evaluated and further testing of various dates conducted as necessary. Any potential problems identified during this testing have been corrected.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented elsewhere in this Form 10-K have been prepared in accordance with generally accepted accounting principles ("GAAP"), which require the measurement of financial position and operating results generally in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Impact of New Accounting Standards
In June of 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Under this statement, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. In June 1999, the FASB issued SFAS No. 137 Accounting for Derivative Instruments and Hedging Activities - Deferral of the effective Date of FASB Statement No. 133, which defers the effective date of SFAS No. 133. SFAS No. 133 is now effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of this settlement is not expected to have a material impact on the Company's financial position.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
For a discussion of the Company's Market Risk see "Management of Interest Rate Risk and Market Risk Analysis" under Item 7 of this Form 10-K.
Item 8
Item 8 Financial Statements and Supplementary Data.
[LETTERHEAD OF SHATSWELL, MACLEOD & COMPANY, P.C.]
The Board of Directors and Stockholders Bay State Bancorp, Inc. Brookline, Massachusetts
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of Bay State Bancorp, Inc. and Subsidiaries as of March 31, 2000 and 1999 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 March 31, 2000. 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 consolidated financial position of Bay State Bancorp, Inc. and Subsidiaries as of March 31, 2000 and 1999 and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2000, in conformity with generally accepted accounting principles.
/s/ Shatswell, MacLeod & Company, P.C. SHATSWELL, MacLEOD & COMPANY, P.C.
April 18, 2000
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (In Thousands, Except Per Share Data)
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (In Thousands)
(Continued)
Reclassification disclosure for the years ended March 31:
Accumulated other comprehensive income (loss) as of March 31, 2000, 1999 and 1998 consists of net unrealized holding gains (losses) on available-for-sale securities, net of taxes.
The accompanying notes are an integral part of these consolidated financial statements.
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (In Thousands)
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (Continued)
(In Thousands)
BAYSTATE BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MARCH 31, 2000, 1999 and 1998 (Dollars in Thousands)
NOTE 1 - NATURE OF OPERATIONS
Bay State Bancorp, Inc. (Company) is a Delaware corporation that was organized to become the holding company of Bay State Federal Savings Bank (Bank). The Company's primary purpose is to act as the holding company for the Bank.
In connection with the organization of the Company, on March 27, 1998, the Bank became a wholly owned subsidiary of the Company and the Bank converted from a federally-chartered mutual savings bank to a federally-chartered capital stock savings bank as described in Note 16.
The Bank was incorporated in 1920 and is headquartered in Brookline, Massachusetts. The Bank operates its business from six banking offices located in Massachusetts. The reporting entity is Bay State Bancorp, Inc. and its wholly owned subsidiaries, Bay State Funding Corporation and Bay State Federal Savings Bank and the Bank's wholly owned subsidiaries, BSF Service Corporation, Bay State Federal Savings Securities Corporation and Bay Leaf Securities Corporation.
The Company provides a full range of banking services to individual and business customers in eastern Massachusetts. The Company is subject to competition from other financial institutions doing business in eastern Massachusetts.
NOTE 2 - ACCOUNTING POLICIES
The accounting and reporting policies of the Company and its subsidiaries conform to generally accepted accounting principles and predominant practices within the banking industry. The consolidated financial statements were prepared using the accrual basis of accounting. The significant accounting policies are summarized below to assist the reader in better understanding the consolidated financial statements and other data contained herein.
PERVASIVENESS OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates.
BASIS OF PRESENTATION:
The accompanying consolidated financial statements include the accounts of Bay State Bancorp, Inc. and its wholly owned subsidiaries Bay State Funding Corporation and Bay State Federal Savings Bank and the Bank's wholly owned subsidiaries, BSF Service Corporation, Bay State Federal Savings Securities Corporation and Bay Leaf Securities Corporation. BSF Service Corporation is a subsidiary which was formed for the purpose of real estate development activities. Bay State Funding Corporation was established to lend funds to the Company sponsored employee stock ownership plan and related trust for the purchase of stock in the initial public offering. Bay State Federal Savings Securities Corporation and Bay Leaf Securities Corporation were established in the fiscal year ended March 31, 2000 to hold securities for the Bank. All significant intercompany balances and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, cash items, due from banks, Federal Home Loan Bank overnight account and shares of the Co-operative Central Bank Liquidity Fund. Cash and due from banks as of March 31, 2000 and 1999 includes $865 and $764, respectively which is subject to withdrawal and usage restrictions to satisfy the reserve requirements of the Federal Reserve Bank.
SECURITIES:
Investments in debt securities are adjusted for amortization of premiums and accretion of discounts calculated using the interest method. Gains or losses on sales of investment securities are computed on a specific identification basis.
The Company classifies debt and equity securities into one of three categories: available-for-sale, held-to-maturity or trading. This security classification may be modified after acquisition only under certain specified conditions. In general, securities may be classified as held-to-maturity only if the Company has the positive intent and ability to hold them to maturity. Trading securities are defined as those bought and held principally for the purpose of selling them in the near term. All other securities must be classified as available-for-sale.
-- Available-for-sale securities are carried at fair value on the balance sheet. Unrealized holding gains and losses are not included in earnings, but are reported as a net amount (less expected tax) in a separate component of capital until realized.
-- Held-to-maturity securities are measured at amortized cost in the balance sheet. Unrealized holding gains and losses are not included in earnings or in a separate component of capital. They are merely disclosed in the notes to the consolidated financial statements.
-- Trading securities are carried at fair value on the balance sheet. Unrealized holding gains and losses for trading securities are included in earnings.
LOANS:
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances reduced by amounts due to borrowers on unadvanced loans, any charge-offs, the allowance for loan losses and any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans.
Interest on loans is recognized on a simple interest basis.
Loan origination and commitment fees and certain direct origination costs are deferred, and the net amount amortized as an adjustment of the related loan's yield. The Company is amortizing these amounts over the contractual life of the related loans using the interest method.
Cash receipts of interest income on impaired loans is credited to principal to the extent necessary to eliminate doubt as to the collectibility of the net carrying amount of the loan. Some or all of the cash receipts of interest income on impaired loans is recognized as interest income if the remaining net carrying amount of the loan is deemed to be fully collectible. When recognition of interest income on an impaired loan on a cash basis is appropriate, the amount of income that is recognized is limited to that which would have been accrued on the net carrying amount of the loan at the contractual interest rate. Any cash interest payments received in excess of the limit and not applied to reduce the net carrying amount of the loan are recorded as recoveries of charge-offs until the charge-offs are fully recovered.
ALLOWANCE FOR LOAN LOSSES:
The allowance is increased by provisions charged to current operations and is decreased by loan losses, net of recoveries. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses on loans which are deemed probable and estimable based on information currently known to management. The allowance is based upon a number of factors, including current economic conditions, actual loss experience and industry trends.
The Company considers a loan to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company measures impaired loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent.
The Company considers for impairment all loans, except large groups of smaller balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value or at the lower of cost or fair value, leases, and convertible or nonconvertible debentures and bonds and other debt securities. The Company considers its residential real estate loans and consumer loans that are not individually significant to be large groups of smaller balance homogeneous loans.
Factors considered by management in determining impairment include payment status, net worth and collateral value. An insignificant payment delay or an insignificant shortfall in payment does not in itself result in the review of a loan for impairment. The Company reviews its loans for impairment on a loan-by-loan basis. The Company does not review aggregations of loans that have risk characteristics in common with other impaired loans. Interest on a loan is not generally accrued when the loan becomes ninety or more days overdue. The Company may place a loan on nonaccrual status but not classify it as impaired, if (i) it is probable that the Company will collect all amounts due in accordance with the contractual terms of the loan or (ii) the loan is an individually insignificant residential mortgage loan or consumer loan. Impaired loans are charged-off when management believes that the collectibility of the loan's principal is remote. Substantially all of the Company's loans that have been identified as impaired have been measured by the fair value of existing collateral.
LOANS HELD-FOR-SALE:
Loans held-for-sale are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Cost and related allowances for depreciation and amortization of premises and equipment retired or otherwise disposed of are removed from the respective accounts with any gain or loss included in income or expense. Depreciation and amortization are calculated principally on the straight-line method over the estimated useful lives of the assets.
BANK-OWNED LIFE INSURANCE:
In fiscal years ended 2000 and 1999, the Company invested in bank-owned life insurance (BOLI) to help finance the cost of certain employee benefit plan expenses. BOLI represents life insurance on the lives of certain employees through insurance companies. The Company is the beneficiary of the insurance policies. Increases in the cash value of the policies, as well as insurance proceeds received, are recorded in other income, and are not subject to income taxes as long as those policies are not surrendered for the cash value prior to the death of the individual employees.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:
Other real estate owned includes properties acquired through foreclosure and properties classified as in-substance foreclosures in accordance with Financial Accounting Standards Board Statement No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructuring." These properties are carried at the lower of cost or estimated fair value less estimated costs to sell. Any writedown from cost to estimated fair value required at the time of foreclosure or classification as in-substance foreclosure is charged to the allowance for loan losses. Expenses incurred in connection with maintaining these assets, subsequent writedowns and gains or losses recognized upon sale are included in other expense.
The Company classifies loans as in-substance repossessed or foreclosed if the Company receives physical possession of the debtor's assets regardless of whether formal foreclosure proceedings take place.
INCOME TAXES:
The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled.
PENSION:
Pension costs are funded as accrued.
FAIR VALUES OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," requires that the Company disclose estimated fair value for its financial instruments. Fair value methods and assumptions used by the Company in estimating its fair value disclosures are as follows:
Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values.
Securities (including mortgage-backed securities): Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other 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.
Accrued interest receivable: The carrying amount of accrued interest receivable approximates its fair value.
Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificate accounts 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 certificate accounts.
Federal Home Loan Bank Advances: Fair values for Federal Home Loan Bank advances are estimated using a discounted cash flow technique that applies interest rates currently being offered on advances to a schedule of aggregated expected monthly maturities on Federal Home Loan Bank advances.
Securities sold under agreements to repurchase: The carrying amounts of securities sold under agreements to repurchase approximate their fair values.
Other borrowed funds: Fair values of other borrowed funds are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Off-balance sheet instruments: The fair value of commitments to originate loans is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments and the unadvanced portion of loans, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligation with the counterparties at the reporting date.
EARNINGS PER SHARE (EPS):
Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
RECLASSIFICATION:
Certain amounts in the prior years have been reclassified to be consistent with the current year's statement presentation.
NOTE 3 - INVESTMENTS IN SECURITIES
Debt and equity securities have been classified in the consolidated balance sheets according to management's intent. The amortized cost basis of available-for-sale and held-to-maturity securities and their approximate fair values are as follows:
The scheduled maturities of debt securities were as follows as of March 31, 2000:
As of March 31, 2000 and 1999, securities with carrying amounts totaling $6,920 and $0, respectively were pledged to secure repurchase agreements, treasury tax and loan deposits and other borrowed funds.
During the years ended March 31, 2000, 1999 and 1998 there were no sales of available-for-sale securities.
For information on trading securities, see Note 12.
The aggregate amortized cost basis and fair value of securities of issuers which exceeded 10% of stockholders' equity were as follows as of March 31, 2000:
Amortized Cost Fair Issuer Basis Value --------------------------- --------- ------ Asset Management Fund, Inc. $5,971 $5,894
NOTE 4 - LOANS
Loans consisted of the following as of March 31:
2000 1999 --------- --------- (In Thousands) Mortgage loans: Residential - secured by 1-4 family $ 201,256 $ 168,786 Equity lines 9,500 5,156 Residential - secured by multi-family 78,610 57,744 Construction and development 7,184 4,070 Commercial real estate 95,869 67,806 --------- --------- Total mortgage loans 392,419 303,562 --------- --------- Commercial loans 225 500 --------- --------- Other loans: Loans secured by deposit accounts 380 375 Other consumer loans 4,140 3,160 --------- --------- Total other loans 4,520 3,535 --------- --------- Total principal balance 397,164 307,597 --------- --------- Allowance for loan losses (3,915) (3,027) Deferred loan origination fees (156) (198) --------- --------- (4,071) (3,225) --------- --------- Loans, net $ 393,093 $ 304,372 ========= =========
Certain directors and executive officers of the Company and companies in which they have significant ownership interest were customers of the Bank during the year ended March 31, 2000. Total loans to such persons and their companies amounted to $5,980 as of March 31, 2000. During the year ended March 31, 2000 principal payments and advances totaled $291 and $1,492, respectively.
Changes in the allowance for loan losses were as follows for the years ended March 31:
2000 1999 1998 ------- ------- ------- (In Thousands) Balance at beginning of period $ 3,027 $ 2,513 $ 1,687 Loans charged off (1) (103) (49) Provision for loan losses 875 617 856 Recoveries of loans previously charged off 14 -- 19 ------- ------- ------- Balance at end of period $ 3,915 $ 3,027 $ 2,513 ======= ======= =======
Information about loans that meet the definition of an impaired loan in Statement of Financial Accounting Standards No. 114 is as follows as of March 31:
In the fiscal years ending March 31, 2000 and 1999 the Company sold mortgage loans totaling $2,172 and $10,860, respectively and retained the servicing rights. The fair value of those rights under SFAS No. 125 is not material and has not been recognized in the consolidated financial statements for the years ended March 31, 2000 and 1999.
NOTE 5 - PREMISES AND EQUIPMENT, NET OF DEPRECIATION AND AMORTIZATION
The following is a summary of premises and equipment as of March 31:
Estimated Useful 2000 1999 Life ------- ------- ----------- (In Thousands) Land $ 355 $ 355 Building and improvements 1,936 1,936 25-50 years Furniture, fixtures and equipment 2,038 1,558 5-10 years Leasehold improvements 203 203 5-10 years Construction in progress 370 8 ------- ------- 4,902 4,060 Accumulated depreciation and amortization (1,824) (1,496) ------- ------- $ 3,078 $ 2,564 ======= =======
NOTE 6 - DEPOSITS
The aggregate amount of time deposit accounts in denominations of $100 or more as of March 31, 2000 and 1999 was approximately $24,280 and $15,312, respectively.
For time deposits as of March 31, 2000, the scheduled maturities for each of the following five years ended March 31 and thereafter, are:
2001 $ 93,012 2002 19,903 2003 4,232 2004 659 2005 2,851 Thereafter 1 -------- $120,658 ========
NOTE 7 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
The Bank is a member of the FHLB of Boston and as such is required to invest in $100 par value stock in the amount of 1% of its outstanding home loans or 5% of its outstanding advances from the FHLB or 1% of 30% of total assets, whichever is highest. When such stock is redeemed, the Company receives from the FHLB an amount equal to the par value of the stock.
Advances consist of funds borrowed from the FHLB.
Maturities of advances from the FHLB for the five fiscal years ending after March 31, 2000 and thereafter are summarized as follows:
INTEREST RATE RANGE AMOUNT -------------------- ------ 2001 4.85% - 6.51% $ 78,118 2002 4.87% - 6.51% 12,383 2003 4.88% - 5.52% 1,535 2004 4.88% 991 2005 -- -- Thereafter 5.10% - 6.09% 54,500 -------- $147,527 ========
As of March 31, 2000, $54,500 of advances from the FHLB were redeemable at par at the option of the FHLB on dates ranging from April 10, 2000 through October 9, 2001.
Amortizing advances are being repaid in equal monthly payments and are being amortized from the date of the advance to the maturity date on a direct reduction basis.
Advances are secured by the Company's stock in that institution, its residential real estate mortgage portfolio and the remaining U.S. government and agencies obligation not otherwise pledged.
NOTE 8 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The securities sold under agreements to repurchase as of March 31, 2000 are securities sold on a short term basis by the Company that have been accounted for not as sales but as borrowings. The securities consisted of mortgage-backed and U.S. Agency Securities. The securities were held in the Company's safekeeping account at Morgan Stanley Dean Witter, Inc. under the control of the Company and pledged to the purchasers of the securities. The purchasers have agreed to sell to the Company substantially identical securities at the maturity of the agreements.
NOTE 9 - OTHER BORROWED FUNDS
Other borrowed funds consist of federal funds purchased and treasury tax and loan deposits and generally are repaid within one to 120 days from the transaction date.
NOTE 10 - INCOME TAXES (BENEFIT)
The components of the income tax expense (benefit) are as follows for the years ended March 31:
The reasons for the differences between the statutory federal income tax rates and the effective tax rates are summarized as follows for the years ended March 31:
The Company had gross deferred tax assets and gross deferred tax liabilities as follows as of March 31:
Based on the Company's historical and current pretax earnings, management believes it is more likely than not that the Company will realize the net deferred tax asset existing as of March 31, 2000 and 1999. Management believes that existing net deductible temporary differences which give rise to the net deferred tax asset will reverse during periods in which the Company generates net taxable income. In addition, gross deductible temporary differences are expected to reverse in periods during which offsetting gross taxable temporary differences are expected to reverse. Factors beyond management's control, such as the general state of the economy and real estate values, can affect future levels of taxable income and no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences.
In prior years, the Bank was allowed a special tax-basis bad debt deduction under certain provisions of the Internal Revenue Code. As a result, retained earnings of the Bank as of March 31, 2000 includes approximately $5,812 for which federal and state income taxes have not been provided. If the Bank no longer qualifies as a bank as defined in certain provisions of the Internal Revenue Code, this amount will be subject to recapture in taxable income ratably over six (6) years, subject to a combined federal and state tax rate of approximately 41.0%.
NOTE 11 - REGULATORY MATTERS
The Company and its subsidiary 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 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. Their 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 table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), of Tier 1 capital (as defined) to adjusted total assets (as defined) and Tangible capital (as defined) to Tangible assets (as defined). Management believes, as of March 31, 2000, that the Company and the Bank meets all capital adequacy requirements to which they are subject.
As of March 31, 2000, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 and Tangible capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
NOTE 12 - EMPLOYEE BENEFIT PLANS
All eligible officers and employees are included in a noncontributory defined benefit pension plan provided by the Company as a participating employer in the Financial Institutions Retirement Fund (Fund), a multi-employer plan as defined by Statement of Financial Accounting Standards No. 87. Employees are eligible to participate in the Retirement Plan after the completion of 12 consecutive months of employment with the Company and the attainment of age 21. Hourly paid employees are excluded from participation in the Retirement Plan. Contributions are based on individual employers' experience. According to the Fund's administrators, as of June 30, 1999, the date of the latest actuarial valuation, the market value of the Fund's net assets exceeded the actuarial present value of vested and nonvested benefits in the aggregate, using an assumed rate of return of 8.0%. Therefore, due to full funding, the Company was not required to contribute to the plan and made no contributions for this plan for the years ended March 31, 2000, 1999 and 1998.
The Company sponsors a defined contribution plan, the Financial Institutions Thrift Plan (Thrift Plan), covering substantially all of its employees. Employees are eligible to participate in the Thrift Plan upon the completion of 12 months of continuous employment with the Company (during which period they complete at least 1,000 hours of service) and the attainment of age 21. Employees paid on a hourly basis are not eligible for participation. Thrift Plan contributions made by the Company were $58, $53 and $45 for the years ended March 31, 2000, 1999 and 1998, respectively.
The Company has a deferred compensation benefit equalization plan for officers and employees designated by management. The liability for such plan as of March 31, 2000 and 1999 was $1,957 and $1,205, respectively, and is included in other liabilities on the balance sheets.
In the years ended March 31, 2000, 1999 and 1998 the Company distributed $583, $455 and $704, respectively to a Rabbi Trust in connection with the deferred compensation benefit equalization plan. This asset has been included in the Company's balance sheets as of March 31, 2000 and 1999 under other assets. The investment is included in assets because it is available to the general creditors of the Company in the event of the Company's insolvency.
The investment in the Rabbi Trust as of March 31, 2000 and 1999 consisted of mutual funds classified as trading securities and is included in other assets. The investment as of March 31, 2000 and 1999 was carried at its fair value of $2,109 and $1,200, respectively which includes net unrealized holding gains of $240 and $4, respectively.
NOTE 13 - COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases space for three branches, two administrative offices and one ATM site under noncancelable operating leases which expire between May 2000 and December 2009. The following is a schedule by years of future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of March 31, 2000:
Year ended March 31, (In Thousands) - -------------------- 2001 $ 561 2002 482 2003 190 2004 183 2005 138 Thereafter 180 ------ Total minimum lease payments $1,734 ======
The rental expense for all operating leases for the years ended March 31, 2000, 1999 and 1998 was $500, $406 and $387, respectively.
NOTE 14 - FINANCIAL INSTRUMENTS
The Company is 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 originate loans, standby letters of credit and unadvanced funds on loans. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies, but may include secured interests in mortgages, accounts receivable, inventory, property, plant and equipment and income-producing properties.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The estimated fair values of the Company's financial instruments, all of which are held or issued for purposes other than trading, are as follows as of March 31:
The carrying amounts of financial instruments shown in the above tables are included in the consolidated balance sheets under the indicated captions except that trading securities are included in other assets. Accounting policies related to financial instruments are described in Note 2.
Notional amounts of financial instrument liabilities with off-balance sheet credit risk are as follows as of March 31:
2000 1999 -------- -------- Notional Notional Amount Amount -------- -------- (In Thousands) Commitments to originate loans $10,429 $30,417 Unadvanced funds on loans: Residential loans 957 1,505 Multi-family loans 2,947 2,941 Equity loans 5,668 3,836 Commercial loans 2,136 2,743 Construction loans 2,825 1,424 Consumer loans 85 -- ------- ------- $25,047 $42,866 ======= =======
There is no material difference between the notional amount and the estimated fair value of loan commitments and unadvanced portions of loans.
The Company has no derivative financial instruments subject to the provisions of SFAS No. 119, "Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments."
NOTE 15 - CONCENTRATIONS OF CREDIT RISK
Most of the Bank's business activity is with customers located within the state. There are no concentrations of credit to borrowers that have similar economic characteristics. The majority of the Bank's loan portfolio is comprised of loans collateralized by real estate located in the state of Massachusetts.
NOTE 16 - CONVERSION TO FEDERALLY CHARTERED CAPITAL STOCK SAVINGS BANK
On September 9, 1997, the Board of Directors of the Bank approved a Plan of Conversion, as amended, for Bay State Federal Savings Bank ("Plan"). Under the Plan, the Bank converted, in the year ended March 31, 1998, from a federally-chartered mutual savings bank to a federally-chartered capital stock savings bank. As of March 31, 2000, all of the stock of the Bank was held by the Company.
In the year ended March 31, 1998, the Company issued 2,535,232 shares of its common stock through a public offering which provided net proceeds of $49,024 after costs of $1,681.
Pursuant to the Plan, the Company established a charitable foundation ("Foundation") in connection with the Conversion. Under the Plan, the Bank and the Company donated, in the year ended March 31, 1998, an amount of the Company's common stock equal to 8% of the common stock sold in the Conversion. The Foundation is dedicated to charitable purposes within the communities in which the Bank operates and to complement the Bank's existing community activities.
The contribution of the Company's common stock to the Foundation by the Company is tax deductible, subject to a limitation based on 10% of the Company's annual taxable income. The Company, however, will be able to carry forward any unused portion of the deduction for five years following the contribution. Upon funding the Foundation, the Company recognized an expense in the full amount of the contribution, offset in part by the corresponding tax deduction.
At the time of the Conversion, the Bank established a liquidation account in an amount equal to its equity as reflected in the latest balance sheet used in the conversion prospectus. The liquidation account is maintained for the benefit of eligible account holders and supplemental eligible account holders who continue to maintain their accounts at the Bank after the Conversion. The liquidation account is reduced annually to the extent that eligible account holders and supplemental eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an eligible account holder's or supplemental eligible account holder's interest in the liquidation account. In the event of a complete liquidation of the Bank, each eligible account holder and supplemental eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held.
The balance of the liquidation account was $6,462 and $9,563 as of March 31, 2000 and 1999, respectively.
The Bank may not declare or pay dividends on its stock if such declaration and payment would violate statutory or regulatory requirements.
NOTE 17 - STOCK COMPENSATION PLAN
In September 1998, the stockholders of the Company approved the Bay State Bancorp, Inc. 1998 Stock-Based Incentive Plan (Plan), as amended and approved by stockholders on July 22, 1999, which includes grants of options to purchase Company stock and awards of Company stock. The Plan is described below. The Company applies APB Opinion 25 and related interpretations in accounting for its Plan. Accordingly, no compensation cost has been recognized for its stock options granted. The compensation cost that has been charged against income for its stock awards was $842 and $506 for the years ended March 31, 2000 and 1999, respectively. The number of shares awarded was 97,609, in the year ended March 31, 1999, with a weighted-average fair value per share of $19.75. Had compensation cost for the Company's stock-based compensation plan been determined based on the fair value at the grant and award dates under the plan consistent with the method of FASB Statement 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
(Amounts in thousands, except per share data)
2000 1999 ------ ------ Net income As reported $2,755 $2,234 Pro forma $2,359 $2,057
Basic earnings per share As reported $1.34 $0.97 Pro forma $1.14 $0.89
Fully diluted earnings per share As reported $1.34 $0.95 Pro forma $1.14 $0.87
The stock subject to the Plan is the common stock of the Company. The number of shares of the common stock reserved for grants and awards is 354,932, consisting of 253,523 shares for stock options and 101,409 shares for stock awards. All employees and outside directors of the Company are eligible to receive awards.
The Company determines the exercise price of stock options but such exercise price shall not be less than 100% of the fair market value of the common stock of the Company at the date of the grant. The Company determines the term during which a participant may exercise a stock option, but in no event may a participant exercise a stock option more than ten years from the date of grant. The Company determines the date on which each stock option becomes exercisable.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for stock option grants in the year ended March 31, 1999: dividend yield of .25 percent; expected volatility of 35 percent; risk-free interest rate of 4.55 percent; and expected lives of 8 years.
A summary of the status of the Company's stock options as of March 31, and changes during the years then ended is presented below:
The following table summarizes information about fixed stock options outstanding as of March 31, 2000:
The Company determines the date on which stock awards granted to a participant vest and any terms or conditions which must be satisfied prior to the vesting of any stock award. The awards vest in installments over five years.
Under the Plan, the Company may make awards of the common stock of the Company contingent upon the satisfaction of any conditions related to the performance of the Company. The common stock may be issued without consideration.
The First Bankers Trust Company is the Trustee for the Bay State Bancorp, Inc. 1998 Stock-Based Incentive Plan, as amended and restated. A summary of purchases of the Company's common stock for issuance of awards under the Plan is as follows for the years ended March 31:
NOTE 18 - EMPLOYEE STOCK OWNERSHIP PLAN
On March 27, 1998 (the Conversion date) the Company adopted the Bay State Federal Savings Bank Employee Stock Ownership Plan (ESOP) that became effective as of April 1, 1997. On March 27, 1998 the ESOP purchased 202,818 shares of the common stock of the Company. To fund the purchases, the ESOP borrowed $4,056 from Bay State Funding Corporation, a subsidiary of the Company. The borrowing is at an interest rate of 8.5% and is to be repaid in ten equal installments of $615 commencing on March 31, 1998 through March 31, 2007. In addition, dividends paid on unreleased shares are used to reduce the principal balance of the loan. The collateral for the borrowing is the common stock of the Company purchased by the ESOP. Contributions by the Company to the ESOP are discretionary, however, the Company intends to make annual contributions to the ESOP in an aggregate amount at least equal to the principal and interest requirements on the debt. The shares of stock of the Company are held in a suspense account until released for allocation among participants. The shares will be released annually from the suspense account and the released shares will be allocated among the participants on the basis of the participant's compensation for the year of allocation. As any shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares and the shares will be outstanding for earnings-per-share purposes. The shares not released are reported as unearned ESOP shares in the stockholders' equity section of the balance sheet. ESOP expense for the years ended March 31, 2000, 1999 and 1998 was $357, $514 and $600, respectively. The ESOP expense for the year ended March 31, 2000 is net of the excess of the cost of the ESOP shares released for allocation over the fair market value of those shares. The excess amounted to $10. The offsetting charge was to paid-in capital. The ESOP shares as of March 31, were as follows:
2000 1999 1998 -------- -------- -------- Allocated shares 39,596 20,282 -- Shares released for allocation 20,282 20,948 20,282 Unreleased shares 141,306 161,588 182,536 -------- -------- -------- Total ESOP shares 201,184 202,818 202,818 ======== ======== ======== (In Thousands) Fair value of unreleased shares $ 2,376 $ 3,313 $ 5,453
NOTE 19 - CONTRIBUTION TO CHARITABLE FOUNDATION
On March 27, 1998, the Company contributed 187,795 shares of its common stock to The Bay State Federal Savings Charitable Foundation (Foundation). The contribution has been reflected as an expense of the Company at the conversion issue price of $20.00 per share. The Foundation directors are also officers of, or members of the Board of the Company or the Bank.
NOTE 20 - EMPLOYMENT AGREEMENTS AND SEVERANCE PLAN
The Bank and the Company entered into employment agreements with its President and Executive Vice President. The employment agreements provide for the continued payment of specified compensation and benefits for specified periods. The agreements also provide for termination by the Company for cause (as defined in the agreements) at any time. The employment agreements provide for the payment, under certain circumstances, of amounts upon termination following a "change in control" as defined in the agreements. The agreements also provide for certain payments in the event of the officers' termination for other than cause and in the case of voluntary termination.
The Bank and the Company entered into change-in-control agreements with certain officers, none of who are covered by an employment agreement. The agreements provide that in the event voluntary or involuntary termination follows a change in control of the Bank or the Company, the officer would be entitled to a severance payment equal to two times or three times (as the case may be) the officers annual compensation.
The Bank's Board of Directors established a severance plan which will provide eligible employees with severance pay benefits in the event of a change in control of the Bank or the Company. Management personnel with employment or change in control agreements are not eligible to participate in the severance plan. The benefit is equal to one-twelfth of annual compensation for each year of service up to a maximum of 199% of annual compensation.
NOTE 21 - EARNINGS PER SHARE
Reconciliation of the numerators and the denominators of the basic and diluted per share computations for net income are as follows:
Earnings per share data has not been presented for the year ended March 31, 1998 because such data would not be meaningful for fiscal 1998 given the short period during which common stock was outstanding.
NOTE 22 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following financial statements are for Bay State Bancorp, Inc. (Parent Company Only) and should be read in conjunction with the consolidated financial statements of Bay State Bancorp, Inc. and Subsidiaries.
BAY STATE BANCORP, INC. (Parent Company Only)
Balance Sheets
March 31, 2000 and 1999
(Dollars in Thousands)
2000 1999 ASSETS ------- ------- Cash $ 2,207 $ 5,990 Investments in available-for-sale securities (at fair value) 3,592 7,985 Investment in subsidiary, Bay State Federal Savings Bank 42,127 41,445 Investment in subsidiary, Bay State Funding Corp. 3,396 3,222 Accrued interest receivable 31 93 Deferred tax asset 1,137 1,429 Other assets 222 190 ------- ------- Total assets $52,712 $60,354 ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY Other liabilities $ 25 $ 56 Stockholders' equity 52,687 60,298 ------- ------- Total liabilities and stockholders' equity $52,712 $60,354 ======= =======
BAY STATE BANCORP, INC. (Parent Company Only)
Statements of Income
For the years ended March 31, 2000 and 1999 and for the period from March 28, 1998 to March 31, 1998
(Dollars in Thousands)
BAY STATE BANCORP, INC. (Parent Company Only)
Statements of Cash Flows
For the years ended March 31, 2000 and 1999 and for the period from March 28, 1998 to March 31, 1998
(Dollars in Thousands)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The information relating to Directors and Executive Officers of the Registrant is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on July 27, 2000 at pages 4 through 6.
Item 11.
Item 11. Executive Compensation.
The information relating to Directors' and executive compensation is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on July 27, 2000 at pages 7 through 11 (excluding the Executive Compensation Committee Report and Stock Performance Graph).
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on July 27, 2000, at pages 3 and 4.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information relating to certain relationships and related transactions is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on July 27, 2000, on page 15.
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company and its subsidiary are filed as a part of this Form 10-K, under Item 8.
- Independent Auditors' Report
- Consolidated Balance Sheets as of March 31, 2000 and 1999
- Consolidated Statements of Income for the Years Ended March 31, 2000, 1999 and 1998
- Consolidated Statements of Changes in Stockholders' Equity for the Years Ended March 31, 2000, 1999 and 1998
- Consolidated Statements of Cash Flows for the Years Ended March 31, 2000, 1999 and 1998
(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto.
(b) Reports on Form 8-K filed during the last quarter of fiscal 2000.
None.
(c) Exhibits required by Securities and Exchange Commission Regulation S-K:
2.1 Amended Plan of Conversion (including the Federal Stock Charter and Bylaws of Bay State Federal Savings Bank) (1)
3.1 Certificate of Incorporation of Bay State Bancorp, Inc. (1)
3.2 Amended and Restated Bylaws of Bay State Bancorp, Inc. (2)
4.0 Draft Stock Certificate of Bay State Bancorp, Inc. (1)
10.1 Employment Agreement between Bay State Bancorp, Inc. and John F. Murphy (filed herewith)
10.2 Employment Agreement between Bay State Federal Savings Bank and John F. Murphy (3)
10.3 Employment Agreement between Bay State Bancorp, Inc. and Denise M. Renaghan (filed herewith)
10.4 Employment Agreement between Bay State Federal Savings Bank and Denise M. Renaghan (3)
10.5 Change in Control Agreement between Bay State Bancorp, Inc. and Michael O. Gilles (3)
10.6 Change in Control Agreement between Bay State Federal Savings Bank and Michael O. Gilles (3)
10.7 Change in Control Agreement between Bay State Federal Savings Bank and Philip R. McNulty (3)
10.8 Form of Bay State Federal Savings Bank Management Supplemental Executive Retirement Plan (1)
10.9 Form of Bay State Federal Savings Bank Retirement Benefit Equalization Plan (1)
10.10 Bay State Bancorp, Inc. 1999 Option Plan (4)
10.11 Bay State Bancorp, Inc. 1998 Stock-Based Incentive Plan (as amended and restated) (4)
11.0 Computation of earnings per share is incorporated herein by reference to Note 21 of the Financial Statements
21.0 Subsidiary information is incorporated herein by reference to "Item 1. Business--General"
23.0 Consent of Shatswell, MacLeod & Company, P.C.
27.0 Financial Data Schedule
- ----------
(1) Incorporated by reference into this document from the Exhibits to Form SB-2, Registration Statement, and any amendments thereto, Registration No. 333-40115
(2) Incorporated by reference into this document from the Exhibits to Form 10-QSB as filed with the Securities and Exchange Commission on February 12, 1999.
(3) Incorporated by reference into this document from the Exhibits to Form 10-KSB as filed with the Securities Exchange Commission on June 14, 1999.
(4) Incorporated by reference into this document from the Appendix to the Proxy Statement for the Annual Meeting of Shareholders held on July 22, 1999, as filed with the Securities and Exchange Commission on June 14, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BAY STATE BANCORP, INC.
By: /s/ John F. Murphy ---------------------------- John F. Murphy President and Chief Executive Officer Treasurer and Chairman of the Board DATED: June 12, 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.
Name Title Date - ---- ----- ----
/s/ John F. Murphy President, Chief Executive Officer, June 12, 2000 - ------------------------ Treasurer and Chairman of the Board John F. Murphy (Principal Executive Officer)
/s/ Denise M. Renaghan Executive Vice President, Chief June 12, 2000 - ------------------------ Operating Officer and Director Denise M. Renaghan
/s/ Michael O. Gilles Chief Financial Officer June 12, 2000 - ------------------------ (Principal Accounting and Michael O. Gilles Financial Officer)
/s/ Robert B. Cleary Director June 12, 2000 - ------------------------ Robert B. Cleary
/s/ Leo F. Grace Director June 12, 2000 - ------------------------ Leo F. Grace
/s/ Richard F. Hughes Director June 12, 2000 - ------------------------ Richard F. Hughes
/s/ Richard F. McBride Director June 12, 2000 - ------------------------ Richard F. McBride
/s/ Kent T. Spellman Director June 12, 2000 - ------------------------ Kent T. Spellman