Annual Report — [x] Reg. S-K Item 405 — Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K405 Bostonfed Bancorp, Inc. Annual Report on Form 10-K 45 251K
2: EX-13.0 Annual Report to Shareholders 54 290K
3: EX-23 Consent of Independent Accountants 1 6K
4: EX-27 ƒ Financial Data Schedule 2± 9K
10-K405 — Bostonfed Bancorp, Inc. Annual Report on Form 10-K
Document Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1996
Commission File No.: 1-13936
BOSTONFED BANCORP, INC.
(exact name of registrant as specified in its charter)
DELAWARE 52-1940834
(State or other jurisdiction (IRS Employer Identification)
of incorporation or organization)
17 New England Executive Park, Burlington, Massachusetts 01803
(Address of principal executive offices)
Registrant's telephone number, including area code: (617) 273-0300
Securities registered pursuant to Section 12(b) of the Act:
Common Stock par value $0.01 per share
(Title of class)
Securities registered pursuant to Section 12(g) of the Act: None
The American Stock Exchange
(Name of exchange on which registered)
The registrant (1) has filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, i.e., persons other than directors and executive officers of the
registrant is $83.2 million and is based upon the last sales price as quoted on
the American Stock Exchange for March 7, 1997.
The number of shares of Common Stock outstanding as of March 7, 1997 is
5,962,502.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December
31, 1996 are incorporated by reference into Part II of this Form 10-K.
Portions of the Proxy Statement for the 1997 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-K. 53296
INDEX
PART I PAGE
----
Item 1. Business................................................... 1
Item 2. Properties................................................. 39
Item 3. Legal Proceedings.......................................... 39
Item 4. Submission of Matters to a Vote Security Holders........... 40
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholders Matters....................................... 40
Item 6. Selected Financial Data.................................... 40
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 40
Item 8. Financial Statements and Supplementary Data ............... 40
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.................. 40
PART III
Item 10. Directors and Executive Officers of the Registrant......... 41
Item 11. Executive Compensation..................................... 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................. 41
Item 13. Certain Relationships and Related Transactions............. 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K.................................. 41
SIGNATURES ..................................................... 43
PART I
Item 1. Business.
General
BostonFed Bancorp, Inc. (also referred to as the "Company" or "Registrant")
was incorporated under Delaware law on July 11, 1995, and subsequently became
the holding company for Boston Federal Savings Bank (the "Bank"). On October 24,
1995, the Bank completed its conversion from a mutual savings bank to a stock
form of ownership, while simultaneously, the Company issued 6,589,617 shares of
common stock utilizing a portion of the proceeds to acquire all of the stock of
the Bank.
The Company's business has been conducted primarily through its ownership
of the Bank which operates its administrative branch office located in
Burlington, Massachusetts and its seven other branch offices located in
Arlington, Bedford, Billerica, Boston, Lexington, Peabody and Wellesley, all of
which are located in the greater Boston metropolitan area. As the result of its
acquisition on February 7, 1997, of Broadway Capital Corp. and its commercial
bank, Broadway National Bank, ("Broadway National Bank") the Company added two
banking offices (Chelsea and Revere) to its franchise in the greater Boston
metropolitan area. On February 7, 1997, the Company acquired Broadway National
Bank, a nationally chartered commercial bank. As a result of the acquisition,
the Company became a multi-bank holding company subject to regulation by the
Federal Reserve Bank ("FRB"). Prior to its acquisition of Broadway National
Bank, the Company was a savings and loan holding company regulated by the Office
of Thrift Supervision ("OTS") and, as a result, was not subject to any
significant restrictions on the types of business activities in which it could
engage. As a bank holding company, the Company is subject to certain
restrictions and requirements imposed by the FRB on the activities in which the
Company may engage and the assets in which the Company may invest. See
"Regulation and Supervision - Holding Company Regulation." Since the acquisition
was consummated after December 31, 1996, the financial statements of the Company
and the following discussion regarding the Company's financial condition and
results of operations at and for the years ended December 31, 1996 and 1995, do
not include information and data related to Broadway National Bank.
The Company's principal business has been and continues to be attracting
retail deposits from the general public in the areas surrounding its branch
offices and investing those deposits, together with funds generated from
operations and borrowings, primarily in one- to four-family residential mortgage
loans. To a lesser extent, the Company invests in multi-family mortgage,
commercial real estate, construction and land and consumer loans. The Company
originates loans for investment and loans for sale in the secondary market,
generally retaining the servicing rights for loans sold. Loan sales are made
from loans held in the Company's portfolio designated as being held for sale or
originated for sale during the period. The Company's revenues are derived
principally from interest on its mortgage loans, and to a lesser extent,
interest and dividends on its investment and mortgage-backed securities, fees
and loan servicing income. The Company's primary sources of funds are deposits,
principal and interest payments on loans and mortgage-backed securities, FHLB
advances, repurchase agreements and proceeds from the sale of loans.
Market Area and Competition
The Company has been, and intends to continue to be, a community-oriented
financial institution offering a variety of financial products and services to
meet the needs of the communities it serves. The Company currently operates out
of its main office located in Burlington and its branch offices located in
Arlington, Bedford, Billerica, Boston, Lexington, Peabody and Wellesley, all of
which are located in the
1
greater Boston metropolitan area. The Company's deposit gathering is
concentrated in the communities surrounding its offices while its lending base
extends throughout eastern Massachusetts and, to a lesser extent, other areas
of New England.
The Company faces significant competition both in generating loans and in
attracting deposits. The Boston metropolitan area is a highly competitive
market. The Company's share of deposits and loan originations in eastern
Massachusetts amounts to less than one percent. The Company faces direct
competition from a significant number of financial institutions operating in
its market area, many with a state-wide or regional presence and, in some
cases, a national presence. Many of these financial institutions are
significantly larger and have greater financial resources than the Company. The
Company's competition for loans comes principally from commercial banks,
savings banks, mortgage banking companies, credit unions and insurance
companies. Its most direct competition for deposits has historically come from
savings and commercial banks. In addition, the Company faces increasing
competition for deposits from non-bank institutions such as brokerage firms and
insurance companies in such instruments as short-term money market funds,
corporate and government securities funds, mutual funds and annuities.
Competition may also increase as a result of the lifting of restrictions on the
interstate operations of financial institutions.
Lending Activities
Loan Portfolio Composition. The Company's loan portfolio consists primarily
of first mortgage loans secured by one- to four-family residences. At December
31, 1996, the Company had total loans outstanding, including mortgage loans
held for sale, of $690.7 million, of which $607.8 million were one- to
four-family, residential mortgage loans, or 88.0% of the Company's total loans.
At such date, the remainder of the loan portfolio consisted of: $21.4 million
of multi-family residential loans, or 3.1% of total loans; $28.1 million of
commercial real estate loans, or 4.1% of total loans; $12.5 million of
construction and land loans, or 1.8% of total loans; and other loans, primarily
home equity lines of credit, of $20.9 million or 3.0% of total loans. The
Company had $4.0 million of mortgage loans held for sale at December 31, 1996
consisting of one- to four-family fixed-rate mortgage loans. At that same date,
77.9% of the Company's total mortgage loans had adjustable interest rates,
most of which are indexed to the one-year Constant Maturity Treasury ("CMT")
Index.
The types of loans that the Company may originate are subject to federal
and state laws and regulations. Interest rates charged by the Company on loans
are affected by the demand for such loans and the supply of money available for
lending purposes and the rates offered by competitors. These factors are, in
turn, affected by, among other things, economic conditions, monetary policies of
the federal government, including the Federal Reserve Board, and legislative tax
policies.
2
The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
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At December 31,
----------------------------------------------------------------------------------
1996 1995 1994
-------------------------- ------------------------- ---------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------------- ------------ ------------- ----------- ------------- -------------
(Dollars in thousands)
Mortgage Loans:
Residential:
One- to four-family(1)....... $607,792 88.00% $447,033 85.44% $427,716 84.77%
Multi-family................. 21,381 3.10 27,986 5.35 29,212 5.79
Commercial real estate......... 28,136 4.07 26,412 5.05 28,714 5.69
Construction and land.......... 12,532 1.81 3,435 .66 3,450 0.68
Other loans(2)................... 20,850 3.02 18,343 3.50 15,504 3.07
-------- ------ -------- ------ -------- ------
Total loans................ 690,691 100.00% 523,209 100.00% 504,596 100.00%
====== ====== ======
Less:
Allowance for loan losses...... (4,400) (4,275) (3,700)
Construction loans in
process...................... (6,936) (805) (1,078)
Net unearned discount on
loans purchased.............. (163) (262) (525)
Deferred loan origination
(fees) costs................. 1,448 560 96
-------- -------- --------
Loans, net and mortgage
loans held for sale....... $680,640 $518,427 $499,389
======== ======== ========
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At December 31,
-----------------------------------------------------
1993 1992
-------------------------- -------------------------
Percent Percent
Amount of Total Amount of Total
------------- ------------ ------------- -----------
Mortgage Loans:
Residential:
One- to four-family(1)....... $340,584 81.57% $315,894 78.46%
Multi-family................. 30,418 7.28 32,150 7.99
Commercial real estate......... 24,548 5.88 30,734 7.63
Construction and land.......... 4,704 1.13 4,922 1.22
Other loans(2)................... 17,276 4.14 18,934 4.70
------- ------ -------- ------
Total loans................ 417,530 100.00% 402,634 100.00%
====== ======
Less:
Allowance for loan losses...... (4,450) (4,381)
Construction loans in
process...................... (1,175) (149)
Net unearned discount on
loans purchased.............. (489) (742)
Deferred loan origination
(fees) costs................. 150 (858)
-------- --------
Loans, net and mortgage
loans held for sale....... $411,566 $396,504
======== ========
----------
(1) Includes mortgage loans held for sale of $4.0 million, $8.9 million,
$316,000, $25.9 million and $29.7 million at December 31, 1996, 1995, 1994,
1993 and 1992, respectively.
(2) These loans primarily consist of home equity and improvement lines of
credit secured by mostly second mortgages which amounted to $17.4 million
$14.9 million, $12.8 million, $12.0 million and $13.9 million at December
31, 1996, 1995, 1994, 1993 and 1992, respectively.
3
Loan Maturity. The following table shows the remaining contractual maturity
of the Company's loans at December 31, 1996. There were $4.0 million of mortgage
loans held for sale at December 31, 1996. The table does not include the effect
of future principal prepayments. Principal prepayments on total loans were $95.4
million, $57.8 million and $44.3 million for the years ended December 31, 1996,
1995 and 1994, respectively.
[Enlarge/Download Table]
At December 31, 1996
------------------------------------------------------------------------------
One- to
Four- Multi- Commercial Construction Other Total
Family Family Real Estate and Land Loans Loans
------------- ----------- ------------- ------------- ----------- --------
(In thousands)
Amounts due:
One year or less................................. $ 697 $ 1,534 $ 61 $11,408 $ 578 $14,278
-------- -------- -------- ------- -------- -------
After one year:
More than one year to three years............. 4,869 41 2,697 1,124 378 9,109
More than three years to five years........... 12,509 183 117 -- 323 13,132
More than five years to 10 years.............. 58,126 6,601 14,029 -- 13,570 92,326
More than 10 years to 20 years................ 71,184 3,839 5,980 -- 2,289 83,292
More than 20 years............................ 460,407 9,183 5,252 -- 3,712 478,554
------- ----- ------ ------- ------ -------
Total due after one year...................... 607,095 19,847 28,075 1,124 20,272 676,413
------- ------ ------ ------ ------ -------
Total amount due.............................. $607,792 $21,381 $28,136 $12,532 $20,850 690,691
======== ======= ======= ======= =======
Less:
Allowance for loan losses.............. (4,400)
Construction loans in process.......... (6,936)
Net unearned discount on loans
purchased.......................... (163)
Deferred loan origination costs........ 1,448
---------
Loans, net, and mortgage loans held for sale.. $680,640
Mortgage loans held for sale.................. (3,970)
----------
Loans, net.................................... $676,670
========
4
The following table sets forth at December 31, 1996 the dollar amount of
loans contractually due after December 31, 1997, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 1997
--------------------------------------
Fixed Adjustable Total
----------- ------------- --------
(In thousands)
Mortgage loans:
Residential:
One- to four-family............. $142,377 $464,718 $607,095
Multi-family.................... 1,574 18,273 19,847
Commercial real estate............ 1,891 26,184 28,075
Construction and land............. 65 1,059 1,124
Other loans.......................... 1,599 18,673 20,272
-------- -------- --------
Total loans .................. $147,506 $528,907 $676,413
======== ======== ========
Origination, Sale, Servicing and Purchase of Loans. The Company's mortgage
lending activities are conducted primarily by its commissioned loan personnel,
through its eight branch offices, and through wholesale brokers and other
financial institutions approved by the Company. All loans originated by the
Company, either through internal sources or through wholesale brokers or other
correspondent financial institutions are underwritten by the Company pursuant to
the Company's policies and procedures. The Company originates both
adjustable-rate and fixed-rate mortgage loans. The Company's ability to
originate loans is dependent upon the relative customer demand for fixed-rate or
adjustable-rate loans, which is affected by the current and expected future
level of interest rates. While the Company has in the past, from time to time,
sold adjustable-rate one-to four-family loans, it is currently the general
policy of the Company to sell substantially all of the one- to four-family
fixed-rate mortgage loans with maturities over ten years that it originates and
to retain substantially all adjustable-rate and loans with maturities of under
ten years, one- to four-family mortgage loans which it originates. The Company
retains the servicing of loans sold in most cases. At December 31, 1996, the
Company serviced $540.4 million of loans for others. The Company recognizes, at
the time of sale, the cash gain or loss on the sale of the loans based on the
difference between the net cash proceeds received and the carrying value of the
loans sold. See "- Lending Activities - Loan Servicing." At December 31, 1996,
the Company had $4.0 million of mortgage loans held for sale consisting of
fixed-rate one- to four-family loans. The Company has, in the past, from time to
time, purchased loans or participations of loans, primarily one- to four-family
mortgage loans, and had $9.0 million of purchased loans at December 31, 1996.
With the exception of purchases of loans from correspondent financial
institutions, which are underwritten pursuant to the Company's policies and
closed in the name of the correspondent financial institution but immediately
purchased by the Company for its mortgage banking activities, the Company
currently does not purchase loans or participations in loans.
The Company engages in certain hedging activities to facilitate the sale of
its originated and purchased mortgage loans in an attempt to minimize interest
rate risk from the time the loan commitments are made to the time until the
loans are securitized or packaged and sold. The Company currently utilizes
forward loan sale commitment contracts with FNMA, FHLMC, and other approved
investors as its method
5
of hedging loan sales in an attempt to protect the Company from fluctuations in
market interest rates. Generally, the Company will enter into contracts to
deliver loans or agency mortgage-backed securities to purchasers at a future
date for a specified price while the Company simultaneously processes and closes
loans, thereby protecting the price of currently processed loans from interest
rate fluctuations that may occur from the time the interest rate on the loan is
fixed to the time of sale. As loans are closed and funded, they may also be
pooled to create mortgage-backed securities which will be delivered to fulfill
the forward commitment contracts. For the year ended December 31, 1996, the
Company had $668,000 in net gains attributable to the sale of loans. These gains
were primarily the result of implementation of FASB 122, "Accounting for
Mortgage Servicing Rights."
The following table sets forth the Company's loan originations, purchases,
sales and principal repayments for the periods indicated:
For the Year Ended December 31,
------------------------------------
1996 1995 1994
--------- --------- ---------
(In thousands)
Net loans:
Beginning balance........................ $509,496 $499,073 $411,566
Loans originated:
One- to four-family............... 362,534 146,303 246,272
Multi-family...................... 4,204 440 1,068
Commercial real estate............ 5,942 906 2,659
Construction and land............. 11,638 5,728 3,375
Other(1).......................... 16,124 11,356 8,632
--------- --------- ---------
Total loans originated............ 400,442 164,733 262,006
Loans purchased(2)................... 46,208 6,356 1,877
--------- --------- ---------
Total......................... 956,146 670,162 675,449
Less:
Principal repayments and
other, net........................ (122,346) (77,937) (71,220)
Loan charge-offs, net................ (1,169) (3,039) (1,033)
Sale of mortgage loans............... (148,025) (69,426) (103,097)
Transfer of mortgage loans to REO.... (3,966) (1,333) (710)
--------- --------- ---------
Loans, net and mortgage loans held
for sale............................. 680,640 518,427 499,389
Mortgage loans held for sale......... (3,970) (8,931) (316)
--------- --------- ---------
Loans, net .............................. $676,670 $509,496 $499,073
========= ========= =========
----------
(1) Other loans primarily consist of one- to four-family lines of credit
secured by mortgages. The amounts indicated primarily include new amounts
drawn on such home-equity lines of credit during the periods presented.
(2) Includes loans purchased from correspondent financial institutions which
are underwritten pursuant to the Company's policies and closed in the name
of the financial institution but immediately purchased by the Company for
its mortgage banking activities.
6
One- to Four-Family Mortgage Lending. The Company offers both fixed-rate
and adjustable-rate mortgage loans secured by one- to four-family residences
located in the Company's primary market area, with maturities of up to thirty
years. Substantially all of such loans are secured by property located in the
Company's primary market area. Loan originations are generally obtained from the
Company's commissioned loan representatives, correspondent banking relationships
and wholesale brokers and their contacts with the local real estate industry,
existing or past customers, and members of the local communities.
At December 31, 1996, the Company's total loans outstanding were $690.7
million, of which $607.8 million, or 88.0%, were one- to four-family residential
mortgage loans, most of which were primarily owner-occupied properties. Of the
one- to four-family residential mortgage loans outstanding at that date, 23.5%
were fixed-rate loans, and 76.5% were adjustable-rate mortgage loans. The
interest rates for the majority of the Company's adjustable-rate mortgage loans
are indexed to the CMT Index. The Company currently offers fixed-rate mortgage
loans with amortization periods of five to thirty years. The Company currently
offers a number of adjustable-rate mortgage loan programs with interest rates
which adjust annually with amortization schedules of ten to thirty years. The
Company's adjustable-rate mortgage loans are originated with interest rates
which are fixed for an initial period of one, three, five or seven years and at
the end of such period will adjust thereafter either annually or a greater
period according to their terms. The Company's one- to four-family
adjustable-rate loan products generally reprice based on a margin, currently 275
to 325 basis points, over the CMT Index for the Treasury security of a maturity
which is comparable to the interest adjustment period for the loan. Generally,
all of the Company's adjustable-rate mortgage loans provide for periodic and
overall caps on the increase or decrease in interest rate at any adjustment date
and over the life of the loan. Included in the Company's adjustable-rate
mortgage loan portfolio is a type of adjustable-rate loan which is originated at
an interest rate below the fully-indexed rate and which limits the adjustment of
the interest rate to 1% annually and 6% over the life of the loan. The Company
also offers a single-family loan product which has been popular with its
customers consisting of a fixed-rate loan up to the conforming FNMA/FHLMC limit
of $214,000 coupled with a second mortgage adjustable-rate loan for the amount
of the loan in excess of the FNMA/FHLMC limit. After origination, the Company
will typically sell the fixed-rate portion of the loan (to FNMA/FHLMC) and
retain the adjustable-rate second mortgage portion of the loan for its
portfolio. During 1996, the Company's retained portion of this loan product was
$18.0 million, or 4.4% of total originations.
The Company generally originates one- to four-family residential mortgage
loans in amounts up to 80% of the lower of the appraised value or the selling
price of the property securing the loan and up to 95% of the appraised value or
selling price if private mortgage insurance is obtained on the portion of the
loan in excess of 75% of the lesser of the appraised value or selling price.
However, the Company may originate single-family owner-occupied mortgage loans
in amounts up to 85% of the lesser of the appraised value or selling price
without private mortgage insurance. Mortgage loans originated by the Company
generally include due-on-sale clauses which provide the Company with the
contractual right to deem the loan immediately due and payable in the event the
borrower transfers ownership of the property without the Company's consent.
Due-on-sale clauses are an important means of adjusting the rates on the
Company's fixed-rate mortgage loan portfolio and the Company has generally
exercised its rights under these clauses.
Multi-Family Mortgage Lending. The Company originates multi-family mortgage
loans generally secured by 5 to 120 unit apartment buildings located in the
Company's primary market area. As a result of uncertain market conditions in its
primary market area, the Company currently originates multi-family loans on a
limited and highly selective basis. In reaching its decision on whether to make
a multi-family loan, the Company considers the value of the underlying property
as well as the qualifications of the
7
borrower. Other factors relating to the property to be considered are: the net
operating income of the mortgaged premises before debt service and depreciation;
the debt service ratio (the ratio of earnings before debt service to debt
service); and the ratio of loan amount to appraised value. The Company generally
requires a debt service ratio of 115% or greater. Pursuant to the Company's
current underwriting policies, a multi-family mortgage loan may only be made in
an amount up to 85% of the appraised value of the underlying property to a
maximum amount of $4.0 million. However, generally loans are not granted which
exceed 80% of the appraised value. Generally, all multi-family loans made to
corporations, partnerships and other business entities require personal
guarantees by the principal borrowers. On an exception basis, the Company may
not require a personal guarantee on such loans depending on the creditworthiness
of the borrower and amount of the downpayment. Subsequent declines in the real
estate values in the Company's primary market area have resulted in some
increase in the loan-to-value ("LTV") ratio on some mortgage loans.
When evaluating the qualifications of the borrower for a multi-family loan,
the Company considers the financial resources and income level of the borrower,
the borrower's experience in owning or managing similar property, and the
Company's lending experience with the borrower. The Company's underwriting
guidelines require that the borrower be able to demonstrate strong management
skills and the ability to maintain the property from current rental income. The
borrower is required to present evidence of the ability to repay the mortgage
and a history of making mortgage payments on a timely basis. In making its
assessment of the creditworthiness of the borrower, the Company generally
reviews the financial statements, employment and credit history of the borrower,
as well as other related documentation. The Company's multi-family loan
portfolio at December 31, 1996, totalled $21.4 million or 3.1% of total loans.
The Company's largest multi-family loan at December 31, 1996, was a $3.8 million
performing loan secured by a 118 unit apartment complex located in Malden,
Massachusetts.
Loans secured by apartment buildings and other multi-family residential
properties are generally larger and involve a greater degree of risk than one-
to four-family residential mortgage loans. Because payments on loans secured by
multi-family properties are often dependent on successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to the then prevailing conditions in the real estate market or
the economy. The Company seeks to minimize these risks through its underwriting
policies.
Commercial Real Estate Lending. The Company originates commercial real
estate loans that are secured by properties generally used for business purposes
such as small office buildings or retail facilities located in the Company's
primary market area. The Company's underwriting procedures provide that
commercial real estate loans may be made in amounts up to the lesser of 85% of
the appraised value of the property, or the Company's current loan limit which
is $4.0 million. However, generally loans are not granted which exceed 80% of
the appraised value. The Company currently originates commercial real estate
loans with terms of up to thirty years only with adjustable-rates which are
indexed to the CMT Index. The Company's underwriting standards and procedures
are similar to those applicable to its multi-family loans, whereby the Company
considers the net operating income of the property and the borrower's expertise,
credit history and profitability. The Company has generally required that the
properties securing commercial real estate loans have debt service coverage
ratios of at least 115%. Generally, all commercial real estate loans made to
corporations, partnerships and other business entities require personal
guarantees by the principal borrowers. On an exception basis, the Company may
not require a personal guarantee on such loans depending on the creditworthiness
of the borrowers and the amount of the downpayment. The Company's commercial
real estate loan portfolio at December 31, 1996 was $28.1 million, or 4.1% of
total loans. The largest commercial real estate loan in the Company's portfolio
at December 31, 1996 was a performing loan which had an outstanding carrying
balance of $2.3 million and is secured by an office building located in
Watertown, Massachusetts.
8
Loans secured by commercial real estate properties are generally larger and
involve a greater degree of risk than one- to four-family residential mortgage
loans. Because payments on loans secured by commercial real estate properties
are often dependent on successful operation or management of the properties,
repayment of such loans may be subject to a great extent to the then prevailing
conditions in the real estate market or the economy. The Company seeks to
minimize these risks through its underwriting standards.
Construction and Land Lending. The Company originates loans for the
acquisition and development of property to licensed and experienced contractors
in its primary market area. The Company's construction loans primarily have been
made to finance the construction of one- to four-family, owner-occupied
residential properties. While the Company originates loans secured by raw land,
the Company generally does not originate such loans unless the borrower has also
secured financing with the Company for the construction of structures on the
property. These loans are primarily adjustable-rate loans with maturities of
less than two years. Construction and land mortgage loans are originated in
amounts up to 75% of the lesser of the appraised value of the property, as
improved, or sales price, unless such loan is for the construction of a
residential property which cannot exceed an 80% loan to value ("LTV") ratio.
Proceeds of such loans are dispersed as phases of the construction are
completed. Generally, if the borrower is a corporation, partnership or other
business entity, personal guarantees by the principal borrowers are required.
However, personal guarantees may not be required on such loans depending on the
creditworthiness of the borrower and amount of the downpayment. The Company's
current loan limit is $4 million. The Company's largest construction and land
loan at December 31, 1996 was a performing loan with a revolving $4.5 million
line of credit with a carrying balance of $941,000 and secured by a 70 unit
residential subdivision in Southborough, Massachusetts. However, at no time will
the loan exceed $4 million At December 31, 1996, the Company had $12.5 million
of construction and land loans which amounted to 1.8% of the Company's total
loan portfolio. Working with experienced land developers in the local community,
the Company will continue to expand this area of its lending business.
Construction and land financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development compared to the estimated cost (including interest)
of construction. If the estimate of value proves to be inaccurate, the Company
may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
Other Lending. Other loans at December 31, 1996, amounting to $20.9 million
or 3.0% of the Company's total loan portfolio, consisted primarily of home
equity and improvement loans, and, to a significantly lesser extent, new and
used automobile loans originated by the Company, personal loans, student loans,
business loans and loans secured by savings accounts. Such loans are generally
originated in the Company's primary market area and generally are secured by
real estate, personal property, savings accounts and automobiles. These loans
are shorter term and generally contain higher interest rates than residential
mortgage loans.
Substantially all of the Company's home equity lines of credit are
primarily secured by second mortgages on one- to two-family residences located
in the Company's primary market area. At December 31, 1996, these loans totalled
$17.4 million, or 2.5% of the Company's total loans and 83.3% of other loans.
Generally, under the terms of the Company's home-equity lines of credit,
borrowers have the ability to draw on such lines and repay outstanding principal
and interest on a monthly basis on a certain percentage of the outstanding
principal over a period of up to ten years and, thereafter, the outstanding
balance drawn on such lines is converted to an adjustable-rate loan with terms
of up to ten years. The
9
underwriting standards employed by the Company for these loans include a
determination of the applicant's credit history and an assessment of the
applicant's ability to meet existing obligations and payments on the proposed
loan and the value of the collateral securing the loan. The stability of the
applicant's monthly income may be determined by verification of gross monthly
income from primary employment and, additionally, from any verifiable secondary
income. Creditworthiness of the applicant is of primary consideration.
Loans secured by rapidly depreciable assets such as automobiles or that are
unsecured entail greater risks than one- to four-family residential mortgage
loans. In such cases, repossessed collateral for a 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 December 31, 1996, there
were three consumer or other loans, totalling $14,000, 90 days or more
delinquent.
Loan Approval Procedures and Authority. The Board of Directors establishes
the lending policies and loan approval limits of the Company. In connection with
one- to four-family mortgage loans, the Board of Directors has authorized the
following persons and committees to approve loans up to the amounts indicated:
loans in amounts up to $750,000 must be approved by two designated members of
the Company's management; mortgage loans in excess of $750,000 and up to $1.0
million require, in addition to the foregoing, the approval of the Loan
Committee and ratification by the Investment Committee; loans in excess of $1.0
million and up to $1.5 million require, in addition to the foregoing approvals,
the approval of the Investment Committee; and loans in excess of $1.5 million
require, in addition to the foregoing approvals, the approval of the Board of
Directors.
In connection with commercial real estate loans, multi-family and
construction (non-owner occupied) real estate lending, the Board of Directors
has authorized the following persons and committees to approve loans up to the
amounts indicated: loans in amounts up to $750,000 must be approved by two
designated members of the Company's management, one of whom must be a member of
the Loan Committee; mortgage loans in excess of $750,000 and up to $1.0 million
require, in addition to the foregoing, the approval of the Loan Committee; loans
in excess of $1.0 million and up to $2.0 million require, in addition to the
foregoing approvals, the approval of the Investment Committee; and loans in
excess of $2.0 million require, in addition to the foregoing approvals, the
approval of the Board of Directors. Loans over $500,000 and $1.5 million require
ratification of the Investment Committee and Board of Directors, respectively
Pursuant to OTS regulations, loans to one borrower cannot, subject to
certain exceptions, exceed 15% of the Bank's unimpaired capital and surplus. At
December 31, 1996, the loans to one borrower limit was $10.0 million.
Loan Servicing. The Company also services mortgage loans for others. Loan
servicing includes collecting and remitting loan payments, accounting for
principal and interest, making inspections as required of mortgaged premises,
contacting delinquent mortgagors, supervising foreclosures and property
dispositions in the event of unremedied defaults, making certain insurance and
tax payments on behalf of the borrowers and generally administering the loans.
The Company has recognized gains from excess servicing, which is the present
value of any difference between the interest rate charged to the borrower and
the interest rate paid to the purchaser after deducting a normal servicing fee,
and is recognizable as
10
an adjustment to the cash gain or loss. The excess servicing gain or loss is
dependent on prepayment estimates and discount rate assumptions. All of the
loans currently being serviced for others are loans which have been sold by the
Company. At December 31, 1996, the Company was servicing $540.4 million of loans
for others. The gross servicing fee income from loans originated and purchased
is generally .25% to .38% of the total balance of the loan serviced. The Company
currently does not purchase servicing rights related to mortgage loans
originated by other institutions. The Company recognizes the present value of
the servicing income, net of servicing expenses, attributable to servicing
rights upon sale of the loan. The Company amortizes the capitalized mortgage
servicing rights using a method which approximates the level yield method in
proportion to, and over the period of, estimated net servicing income. The
Company reviews prepayment activity on its serviced loans at least semi-annually
and adjusts its capitalized mortgage servicing rights amortization schedule
accordingly. As of December 31, 1996, the Company had $988,000 of capitalized
mortgage servicing rights.
Nonperforming and Problem Assets.
Classified Assets. Federal regulations and the Company's Asset
Classification Policy require that the Company utilize an internal asset
classification system as a means of reporting problem and potential problem
assets. The Company has incorporated the OTS internal asset classifications as a
part of its credit monitoring system. The Company currently classifies problem
and potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An
asset is considered "Substandard" if it is inadequately protected by the current
net worth and paying capacity of the obligor or of the collateral pledged, if
any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "Doubtful" have all of the
weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "Loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
which do not currently expose the insured 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 collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional
11
real estate market values and the significant losses experienced by many
financial institutions, there has been a greater level of scrutiny by regulatory
authorities of the loan portfolios of financial institutions undertaken as part
of the examination of institutions by the OTS and the FDIC. While the Company
believes that it has established an adequate allowance for loan losses, there
can be no assurance that regulators, in reviewing the Company's loan portfolio,
will not request the Company to materially increase at that time its allowance
for loan losses, thereby negatively affecting the Company's financial condition
and earnings at that time. Although management believes that, based on
information currently available to it 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 Company's Asset Classification Committee reviews and classifies the
Company's assets on a quarterly basis and reports the results of its review to
the Board of Directors. The Company classifies assets in accordance with the
management guidelines described above. At December 31, 1996, the Company had
$7.7 million of loans designated as "Special Mention," $3.8 million of loans
designated as "Substandard," and $2.4 million of loans designated as "Loss."
All loans classified as "Loss" have been charged off for financial statement
purposes. There were no loans classified as "Doubtful." Included in these
amounts was $1.5 million in non-performing loans at December 31, 1996. In the
opinion of management, the remaining special mention and "Substandard" loans of
$10.0 million evidence one or more weaknesses or potential weaknesses and,
depending on the regional economy and other factors, may become non-performing
loans in future periods.
12
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
At December 31, 1996
-----------------------------------------------
60-89 Days 90 Days or More
----------------------- --------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
--------- ---------- --------- ---------
(Dollars in thousands)
One- to four-family.......... 15 $1,481 24 $1,463
Multi-family................. 1 60 -- --
Commercial real estate....... -- -- -- --
Construction and land........ -- -- -- --
Other loans.................. 4 56 3 14
--- ------ --- ------
Total........................ 20 $1,597 27 $1,477
=== ====== === ======
Delinquent loans to loans, net
and mortgage loans
held for sale........... 0.23% 0.22%
At December 31, 1995
-----------------------------------------------
60-89 Days 90 Days or More
----------------------- --------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
--------- ---------- --------- ---------
One- to four-family.......... 11 $ 923 23 $1,178
Multi-family................. -- -- 1 720
Commercial real estate....... 1 202 4 2,693
Construction and land........ -- -- -- --
Other loans.................. -- -- -- --
--- ------ --- ------
Total........................ 12 $1,125 28 $4,591
=== ====== === ======
Delinquent loans to loans, net
and mortgage loans
held for sale........... 0.22% 0.89%
At December 31, 1994
-----------------------------------------------
60-89 Days 90 Days or More
----------------------- --------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
--------- ---------- --------- ---------
(Dollars in thousands)
One- to four-family.......... 16 $1,206 27 $848
Multi-family................. 3 732 3 546
Commercial real estate....... 1 1,232 3 2,126
Construction and land........ -- - - -
Other loans.................. -- - 4 51
--- -------- --- --------
Total........................ 20 $3,170 37 $3,571
=== ====== === ======
Delinquent loans to loans, net
and mortgage loans held
for sale................ 0.63% 0.72%
13
Non-Performing Assets and Restructured Loans. The following table sets
forth information regarding non-accrual loans, restructured loans and
real estate owned ("REO"). A restructured loan is one for which the Bank
has modified the terms to provide a temporary reduction in the rate of interest
below the current market rate and, in certain instances, an extension of
payments of principal or interest or both due to the deterioration in the
financial position of the borrower. At December 31, 1996, restructured loans
totalled $2.5 million, consisting of six loans, and REO totalled $2.7 million,
consisting of 10 properties. It is the policy of the Company to cease
accruing interest on loans 90 days or more past due and charging off all
accrued interest. For the years ended December 31, 1996, 1995, 1994,
1993 and 1992, the amount of additional interest income that would have been
recognized on non-accrual loans if such loans had continued to perform in
accordance with their contractual terms was $103,000, $303,000, $281,000,
$421,000 and $922,000, respectively. For the same periods, the difference
between the amount of interest income which would have been recognized on
restructured loans if such loans were performing in accordance with their
regular terms and amounts recognized was $73,000, $77,000, $294,000,
$461,000 and $443,000, respectively.
[Enlarge/Download Table]
At December 31,
-----------------------------------------------------------------------
1996 1995 1994 1993 1992
------------- ------------- ------------- ------------- -----------
(Dollars in thousands)
Non-accrual loans:
Residential real estate:
One- to four-family.................... $1,463 $1,195 $ 848 $2,088 $3,794
Multi-family........................... -- 745 546 -- 6,005
Construction and land.................... -- -- -- 738 246
Commercial real estate................... 25 3,312 2,126 -- 100
Other loans.............................. 14 -- 51 14 35
------ ------ ------ ------- -------
Total.................................. 1,502 5,252 3,571 2,840 10,180
Real estate owned, net(3).................. 2,668 971 387 3,103 8,834
------ ------ ------ ------- -------
Total non-performing assets............ 4,170 6,223 3,958 5,943 19,014
Restructured loans......................... 2,489 2,941 4,834 4,668 12,112
------ ------ ------ ------- -------
Total risk elements........................ $6,659 $9,164 $8,792 $10,611 $31,126
====== ====== ====== ======= =======
Allowance for loan losses as a percent
of loans(1).............................. 0.64% 0.82% 0.74% 1.07% 1.09%
Allowance for loan losses as a percent
of non-performing loans(2)............... 293.02 81.40 103.61 156.69 43.04
Non-performing loans as a percent
of loans(1)(2)........................... 0.22 1.00 0.71 0.68 2.54
Non-performing assets as a percent
of total assets(4)....................... 0.51 0.97 0.68 1.19 3.73
----------
(1) Loans includes loans, net and mortgage loans held for sale, excluding
allowance for loan losses.
(2) Non-performing loans consist of all 90 days or more past due and other
loans which have been identified by the Company as presenting uncertainty
with respect to the collectability of interest or principal.
(3) REO balances are shown net of related valuation allowances.
(4) Non-performing assets consist of non-performing loans and real estate owned
(REO).
14
The Company adopted a new accounting method for measuring loan impairment on
January 1, 1995. Adoption of this accounting standard did not have a material
effect on the comparability of the above tables. See "Impact of New Accounting
Standards." At December 31, 1996, loans which were characterized as impaired
pursuant to SFAS 114 and 118 totalled $4.4 million. All of the $4.4 million in
impaired loans have been measured using the fair value of the collateral method.
During the year ended December 31, 1996, the average recorded value of impaired
loans was $5.4 million, $321,000 of interest income was recognized, all of which
was recorded on a cash basis, and $497,000 of interest income would have been
recognized under original terms. For a discussion of SFAS 114, see "Impact of
New Accounting Standards."
At December 31, 1996
---------------------------
1996 1995
------- -------
(In thousands)
Impaired loans:
Residential real estate:
One-to four-family $1,763 $2,828
Multi-family 2,271 1,367
Commercial real estate 246 4,062
Other loans 112 99
Impaired loan valuation
allowance -- (618)
------- -------
Total $4,392 $7,738
====== ======
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to cover
estimated losses in loans receivable which are deemed probable and estimable
based on information currently known to management. Amounts provided for the
years 1996, 1995 and 1994 were $1.3 million, $3.6 million, and $283,000,
respectively. During the year ended 1996, there were recoveries of $343,000 and
charge-offs of $1.5 million made against this allowance. The allowance is based
upon a number of factors, including current economic conditions, actual loss
experience and industry trends. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the Company to make
additional provisions for estimated loan losses based upon judgments different
from those of management. As of December 31, 1996, the Company's allowance for
loan losses was 0.64% of total loans as compared to 0.82% as of December 31,
1995. The Company had non-accrual loans of $1.5 million and $5.3 million at
December 31, 1996 and December 31, 1995, respectively. The Company will continue
to monitor and modify its allowance for loan losses as conditions dictate.
While management believes the Company's allowance for loan losses is sufficient
to cover losses inherent in its loan portfolio at this time, no assurances can
be given that the Company's level of allowance for loan losses will be
sufficient to cover future loan losses incurred by the Company or that future
adjustments to the allowance for loan losses will not be necessary if economic
and other conditions differ substantially from the economic and other conditions
used by management to determine the current level of the allowance for loan
losses.
15
The following table sets forth activity in the Company's allowance for loan
losses for the periods set forth in the following table.
[Enlarge/Download Table]
At or For the Year Ended December 31,
----------------------------------------------------------------------
1996 1995 1994 1993 1992
------------ ------------- ------------- ------------- -------------
(In thousands)
Balance at beginning of period ............. $4,275 $3,700 $4,450 $4,381 $5,000
Provision for loan losses................... 1,294 3,614 283 3,918 5,487
Charge-offs:
Real estate loans:
One -to-four-family...................... 387 550 711 2,114 2,330
Multi-family............................. 263 483 251 1,114 1,288
Commercial............................... 664 2,297 200 805 1,241
Construction and land.................... -- -- -- 4 1,268
Other..................................... 198 194 56 17 3
------ ------ ------ ------ ------
Total.................................. 1,512 3,524 1,218 4,054 6,130
Recoveries.................................. 343 485 185 205 24
------ ------ ------ ------ ------
Balance at end of period.................... $4,400 $4,275 $3,700 $4,450 $4,381
====== ====== ====== ====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period............. 0.19% 0.60% 0.23% 0.94% 1.54%
==== ==== ==== ==== ====
16
The following tables set forth the Company's percent of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated.
[Enlarge/Download Table]
At December 31,
-------------------------------------------------------------------------------------------
1996 1995
------------------------------------------- --------------------------------------------
Percent of Percent of Percent of Percent of
Allowance Loans in Allowance Loans in
to Total Each Category to Total Each Category
Amount Allowance to Total Loans Amount Allowance to Total Loans
------------ ------------ --------------- ------------ -------------- -------------
(Dollars in thousands)
One- to four-family.... $1,899 43.16% 88.00% $1,974 46.18% 85.44%
Multi-family........... 274 6.23 3.10 373 8.72 5.35
Commercial real estate. 451 10.25 4.07 1,285 30.06 5.05
Construction and land.. 463 10.52 1.81 580 13.57 0.66
Other loans............ 61 1.39 3.02 47 1.10 3.50
Unallocated............ 1,252 28.45 -- 16 0.37 --
------ ------ ------ ------ ------ ------
Total allowance
for loan losses.. $4,400 100.00% 100.00% $4,275 100.00% 100.00%
====== ====== ====== ====== ====== ======
[Enlarge/Download Table]
At December 31,
-----------------------------------------------------------------------------------------------
1994 1993 1992
------------------------------ ------------------------------ -----------------------------
Percent Percent Percent of
of Loans of Loans of Loans
Percent of in Each Percent of in Each Percent in Each
Allowance Category Allowance Category Allowance Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
-------- --------- -------- ------- --------- -------- ------- -------- ---------
(Dollars in thousands)
One-to
four-family....... $1,309 35.38% 84.77% $1,467 32.97% 81.57% $1,564 35.70% 78.46%
Multi-family......... 393 10.62 5.79 369 8.29 7.28 334 7.63 7.99
Commercial real
estate............ 655 17.70 5.69 646 14.52 5.88 691 15.77 7.63
Construction and land 416 11.24 0.68 594 13.35 1.13 252 5.75 1.22
Other loans.......... 92 2.49 3.07 98 2.20 4.14 128 2.92 4.70
Unallocated.......... 835 22.57 -- 1,276 28.67 -- 1,412 32.23 --
------ ------ -------- ------ ------ -------- ------ ------ ------
Total allowance
for loan losses $3,700 100.00% 100.00% $4,450 100.00% 100.00% $4,381 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
17
Real Estate Owned
At December 31, 1996, the Company had $2.7 million of real estate owned,
net of valuation allowances. When the Company acquires property through
foreclosure or deed in lieu of foreclosure, it is initially recorded at the
lower of the recorded investment in the corresponding loan or the fair value of
the related assets at the date of foreclosure, less costs to sell. Thereafter,
if there is a further deterioration in value, the Company provides for a
specific valuation allowance and charges operations for the diminution in value.
It is the policy of the Company to have obtained an appraisal on all real estate
subject to foreclosure proceedings prior to the time of foreclosure. It is the
Company's policy to require appraisals on a periodic basis on foreclosed
properties and conduct periodic inspections on foreclosed properties.
Investment Activities
The investment policy of the Company, as approved by the Board of
Directors, requires management to maintain adequate liquidity, generate a
favorable return on investments without incurring undue interest rate and credit
risk and to complement the Company's lending activities. Generally, the
Company's investment policy is more restrictive than the OTS regulations allow
and, accordingly, the Company has invested primarily in U.S. Government and
Agency securities, FDIC insured certificates of deposit, mutual funds which
qualify as liquid assets under the OTS regulations, federal funds and U.S.
government sponsored agency issued mortgage-backed securities. As required by
SFAS 115, the Company has established an investment portfolio of securities that
are categorized as held to maturity, available for sale or held for trading. The
Company does not currently maintain a portfolio of securities categorized as
held for trading. The substantial majority of the Company's investment and
mortgage-backed securities are purchased for the held to maturity portfolio
which such portfolio totalled $62.2 million, or 7.6% of assets. The Company's
current policies restrict the amount of securities classified as available for
sale to 5% of the Company's assets. At December 31, 1996, the available for sale
portfolio totalled $24.7 million or 3.0% of the Company's assets. The investment
policy provides different management levels of approval, from the investment
officer up to and including the Board of Directors, depending on the size of
purchase or sale and monthly cumulative purchase or sale amounts. Generally,
pursuant to the Company's policies, the Board must provide prior approval for
all individual securities investments over $10.0 million and approval for all
monthly purchases which aggregate $25.0 million or more. The Investment
Committee of the Board is provided a detail of the held to maturity and
available for sale investment portfolio on a quarterly basis. The Board of
Directors ratifies all of the activity in the investment portfolio on a monthly
basis.
At December 31, 1996, the Company had invested $66.6 million in
mortgage-backed securities, or 8.1% of total assets, which were guaranteed by
GNMA, insured by either FNMA or FHLMC or privately issued. Of the $66.6 million,
$40.3 million were GNMA securities, of which $36.0 million were adjustable-rate
with 1% maximum annual rate adjustments and lifetime maximum interest rates of
10% to 13%. Investments in mortgage-backed securities involve a risk that actual
prepayments will be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby reducing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities or in the event such securities are redeemed by
the issuer. In addition, the market value of such securities may be adversely
affected by changes in interest rates. At December 31, 1996, mortgage-backed
securities available for sale and held to maturity amounted to $23.6 million and
$43.0 million, respectively.
18
The following table sets forth the composition of the Company's
mortgage-backed securities portfolio in dollar amounts and in percentages of the
respective portfolios at the dates indicated.
[Enlarge/Download Table]
At December 31,
-------------------------------------------------------------------------
1996 1995 1994
--------------------- ---------------------- ----------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
---------- --------- -------- ---------- ---------- ---------
(Dollars in thousands)
Mortgage-backed securities:
GNMA(1)(3)............................. $40,321 60.53% $44,385 75.24% $35,671 89.62%
FHLMC(2)(4)............................ 11,239 16.87 13,092 22.20 2,349 5.90
FNMA................................... 1,147 1.72 1,512 2.56 1,781 4.48
Privately issued collateralized
mortgage obligations................. 13,905 20.88 -- -- -- --
------ ------ ------ ------ ------ ------
Total mortgage-backed securities..... 66,612 100.00% 58,989 100.00% 39,801 100.00%
====== ====== ======
Less:
Mortgage-backed securities available
for sale - GNMA(3)................... 13,710 12,605 --
Mortgage-backed securities available
for sale - FHLMC(4).................. 9,883 11,268 --
----- ------ -------
held to maturity....................... $43,019 $35,116 $39,801
======= ======= =======
----------
(1) Includes $341,000, $527,000 and $305,000 of unamortized premiums related to
GNMA securities as of December 31, 1996, 1995 and 1994, respectively. Also
includes $77,000 of unamortized discounts related to GNMA securities as of
December 31, 1996.
(2) Includes $187,000 and $234,000 of unamortized premiums related to FHLMC
securities as of December 31, 1996 and 1995, respectively.
(3) Is net of unrealized loss of $169,000 at December 31, 1996.
(4) Is net of unrealized loss of $153,000 at December 31, 1996.
19
The following tables set forth the Company's mortgage-backed securities
activities for the periods indicated:
For the Year
Ended December 31,
---------------------------
1996 1995 1994
------- ------- -------
(In thousands)
Beginning balance ............................. $58,989 $39,801 $45,232
Mortgage-backed securities purchased -
available for sale........................ 10,666 23,873 --
held to maturity.......................... 13,891 -- --
Less:
Sale of mortgage-backed securities
available for sale ..................... 10,614) -- --
Principal repayments ..................... (5,934) (4,586) (5,307)
Change in unrealized losses............... (322) -- --
Accretion of premium, net of discount..... (64) (99) (124)
------- -------- -------
Ending balance ................................ $66,612 $58,989 $39,801
======= ======= =======
The following table sets forth certain information regarding the carrying
amounts and fair values of the Company's mortgage-backed securities at the
dates indicated:
[Enlarge/Download Table]
At December 31,
---------------------------------------------------------------------------
1996 1995 1994
---------------------- ---------------------- -------------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
---------- --------- ---------- --------- ---------- ------------
(In thousands)
Mortgage-backed securities:
Held to maturity:
FNMA.......................... $1,147 $1,129 $1,512 $1,531 $ 1,781 $ 1,630
FHLMC......................... 1,356 1,330 1,824 1,830 2,349 2,136
GNMA.......................... 26,611 26,696 31,780 32,286 35,671 32,855
Privately issued collateralized
mortgage obligations........ 13,905 13,878 -- -- -- --
------ ------ ------ ------ -------- --------
Total held to maturity...... 43,019 43,033 35,116 35,647 39,801 36,621
------ ------ ------ ------ -------- --------
Available for sale:
GNMA.......................... 13,710 13,710 12,605 12,605 -- --
FHLMC......................... 9,883 9,883 11,268 11,268 -- --
------ ------ ------- ------- -------- --------
Total available for sale.... 23,593 23,593 23,873 23,873 -- --
------ ------ ------ ------- -------- --------
Total mortgage-backed
securities.................. $66,612 $66,626 $58,989 $59,520 $39,801 $36,621
======= ======= ======= ======= ======= =======
20
The following table sets forth certain information regarding the carrying
amount and fair values of the Company's short-term investments and investment
securities at the dates indicated:
[Enlarge/Download Table]
At December 31,
--------------------------------------------------------------------------
1996 1995 1994
---------------------- ---------------------- ------------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
---------- --------- ---------- ---------- ----------- -----------
(In thousands)
Daily federal funds sold and
short-term investments.............. $ 2,943 $ 2,943 $10,460 $10,460 $ 448 $ 448
------- ------ ------ ------ ------ ------
Investment securities:
Held to maturity:
Certificates of deposit......... 250 250 495 495 198 198
U.S. Government obligations,
federal agency
obligations, and other
obligations................... 18,920 18,795 16,309 16,411 14,586 13,697
------- ------ ------ ------ ------ ------
Total held to maturity.......... 19,170 19,045 16,804 16,906 14,784 13,895
------- ------ ------ ------ ------ ------
Available for sale:
U.S. Government obligations,
federal agency
obligations, and other
obligations.................. -- -- -- -- -- --
------- ------ ------ ------ ------ ------
Cash management fund(1)......... 1,085 1,085 1,022 1,022 -- --
------- ------- ------- ------- ------- -------
Total available for sale..... 1,085 1,085 1,022 1,022 -- --
------- ------- ------- ------- ------- -------
Total investment securities......... $23,198 $23,073 $28,286 $28,388 $15,232 $14,343
======= ======= ======= ======= ======= =======
----------
(1) Consists of securities issued by an institutional mutual fund which
primarily invests in short-term U.S. Government securities.
21
The table below sets forth certain information regarding the carrying
amount, weighted average yields and contractual maturities of the Company's
short-term investments, investment securities and mortgage-backed securities as
of December 31, 1996.
[Enlarge/Download Table]
At December 31, 1996
---------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years
------------------------ ---------------------- -------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Amount Yield Amount Yield Amount Yield
---------- ----------- ---------- ---------- ----------- -----------
(Dollars in thousands)
Daily federal funds sold and short-term
FP
investments.......................... $2,943 5.75% $ -- --% $ -- --%
Investment securities:
Held to maturity:
Certificates of deposit......... -- -- 250 5.17 -- --
U.S. Government obligations,
federal agency obligations,
and other obligations........ 2,004 5.64 15,916 6.03 1,000 7.00
------ ---------- -------
Total held to maturity...... 2,004 5.64 16,166 6.02 1,000 7.00
------ ---------- ---- -------
Available for sale:
U.S. Government obligations,
federal agency obligations,
and other obligations...... -- -- -- -- -- --
Cash management fund(1)......... 1,085 5.98 -- -- -- --
------ ---------- -------
Total available for sale...... 1,085 5.98 -- -- -- --
------ ---------- -------
Total investment securities.......... $6,032 5.75% $ 16,166 6.02% $1,000 7.00%
====== ===== ========== ==== ======= ====
Mortgage-backed securities:
Held to maturity:
FNMA............................ $ -- --% $ -- --% $1,063 7.00%
GNMA............................ -- -- 51 6.50 3,066 8.19
FHLMC........................... -- -- -- -- 1,356 7.00
Privately issued collateralized
mortgage obligation........... -- -- -- -- -- --
------ ---------- ----
Total held to maturity........ $ -- -- $ 51 6.50 $5,485 7.67
------ ---------- ------
Held for sale:
GNMA............................ $ -- -- $ -- -- $ -- --
FHLMC........................... -- -- -- -- 9,883 6.98
------ ---------- ------
Total held for sale........... -- -- -- -- 9,883 6.98
------ ---------- ------
Total mortgage-backed securities..... $ -- --% $ 51 6.50% $15,368 7.23%
====== ===== ========== ==== ======= ====
At December 31, 1996
--------------------------------------------------------
More than Ten Years Total
-------------------------- ----------------------------
Weighted Weighted
Carrying Average Carrying Average
Amount Yield Amount Yield
----------- ------------ ------------ -------------
(Dollars in thousands)
Daily federal funds sold and short-term
investments.......................... $ -- --% $ 2,943 5.75%
Investment securities:
Held to maturity:
Certificates of deposit......... -- -- 250 5.17
U.S. Government obligations,
federal agency obligations,
and other obligations........ -- -- 18,920 6.04
----- -------
Total held to maturity...... -- -- 19,170 6.03
----- -------
Available for sale:
U.S. Government obligations,
federal agency obligations,
and other obligations...... -- -- -- --
Cash management fund(1)......... -- -- 1,085 5.98
----- -------
Total available for sale...... -- -- 1,085 5.98
----- -------
Total investment securities.......... $ -- --% $23,198 5.99%
===== ==== ======= ====
Mortgage-backed securities:
Held to maturity:
FNMA............................ $ 83 6.98% $ 1,146 7.00%
GNMA............................ 23,495 7.09 26,612 7.22
FHLMC........................... -- -- 1,356 7.00
Privately issued collateralized
mortgage obligation........... 13,905 7.16 13,905 7.16
------- -------
Total held to maturity........ $37,483 7.12 $43,019 7.19
------- -------
Held for sale:
GNMA............................ $13,710 5.98 $13,710 5.98
FHLMC........................... -- -- 9,883 6.98
------- -------
Total held for sale........... 13,710 5.98 23,593 6.40
------- -------
Total mortgage-backed securities..... $51,193 6.81% $66,612 6.91%
======= ==== ======= ====
----------
(1) Consists of securities issued by an institutional mutual fund which
primarily invests in short-term U.S. Government securities.
22
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 Company's funds for use in lending, investing and for other
general purposes.
Deposits. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposits consist of savings, NOW
accounts, checking accounts, money market accounts and certificate accounts. For
the year ended December 31, 1996, core deposits represented 49.3% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Company's deposits are obtained predominantly from the
areas in which its branch offices are located. The Company relies primarily on
customer service and long-standing relationships with customers to attract and
retain these deposits; however, market interest rates and rates offered by
competing financial institutions significantly affect the Company's ability to
attract and retain deposits. The Company uses traditional means of advertising
its deposit products, including radio and print media and generally does not
solicit deposits from outside its market area. Certificate accounts in excess of
$100,000 are not actively solicited by the Company and the Company did not use
brokers to obtain deposits during 1996.
The following table presents the deposit activity of the Company for the
periods indicated:
For the Year Ended December 31,
----------------------------------------
1996 1995 1994
---------- ----------- -----------
(In thousands)
Net withdrawals..................... $(6,425) $(9,179) $(36,430)
Interest credited on
deposit accounts.................. 16,139 15,119 12,696
------ ------ --------
Total increase (decrease)
in deposit accounts............... $9,714 $ 5,940 $(23,734)
====== ======= ========
At December 31, 1996, the Company had $15.3 million in certificate accounts
in amounts of $100,000 or more maturing as follows:
Weighted
Maturity Period Amount Average Rate
-------------------------------------------- ----------- --------------
(Dollars in thousands)
Three months or less........................ $ 4,376 5.38%
Over 3 through 6 months..................... 3,705 5.48
Over 6 through 12 months.................... 2,663 5.47
Over 12 months.............................. 4,512 5.78
------
Total....................................... $15,256 5.54%
======= =====
23
The following table sets forth the distribution of the Company's average
deposit accounts for the periods indicated and the weighted average nominal
interest rates on each category of deposits presented. Averages for the periods
presented utilize average month-end balances.
[Enlarge/Download Table]
For the Year Ended December 31,
-------------------------------------------------------------------------------------------------
1996 1995 1994
------------------------------- --------------------------------- -------------------------------
Percent Weighted Percent Weighted Percent Weighted
of Total Average of Total Average of Total Average
Average Average Nominal Average Average Nominal Average Average Nominal
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
--------- --------- ----------- --------- ----------- ----------- ---------- ---------- --------
(Dollars in thousands)
Money market deposit accounts.. $46,540 11.01% 3.01% $49,693 11.89% 2.99% $ 59,699 14.08% 2.46%
Savings accounts............... 90,763 21.47 2.49 99,498 23.81 2.49 119,253 28.13 2.50
NOW accounts................... 66,336 15.69 1.36 65,661 15.71 1.49 64,875 15.30 1.50
Non-interest-bearing accounts.. 19,542 4.62 14,016 3.35 11,589 2.73
-------- ------ -------- ------ -------- ------
Total..................... 223,181 52.79 228,868 54.76 255,416 60.24
-------- ------ -------- ------ -------- ------
Certificate accounts:
Less than six months........ 23,748 5.62 4.96 16,682 3.99 4.81 17,161 4.05 2.92
Over six through 12 months.. 49,259 11.65 5.48 41,343 9.89 5.57 28,278 6.67 3.69
Over 12 through 36 months... 70,849 16.75 5.77 75,445 18.05 5.44 64,941 15.32 4.67
Over 36 months.............. 6,973 1.65 5.40 6,670 1.60 5.44 7,277 1.72 5.67
IRA/KEOGH................... 48,769 11.54 5.81 48,940 11.71 5.68 50,915 12.00 4.68
-------- ------ -------- ------ -------- ------
Total certificate accounts 199,598 47.21 189,080 45.24 168,572 39.76
-------- ------ -------- ------ -------- ------
Total average deposits.. $422,779 100.00% $417,948 100.00% $423,988 100.00%
======== ====== ======== ====== ======== ======
24
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1996.
[Enlarge/Download Table]
Period to Maturity from December 31, 1996 At December 31,
---------------------------------------------------------------- ------------------------------------
Less than One to Two to Three to Four to
One Year Two years Three years Four years Five years 1996 1995 1994
---------- ----------- ------------ ---------- ---------- ----------- ----------- ----------
(In thousands)
Certificate accounts:
0 to 4.00%............... $ 1,480 $ -- $ 2 $ -- $ 4 $ 1,486 $ 1,977 $ 49,119
4.01 to 5.00%............ 1,086 163 381 -- -- 1,630 16,130 73,328
5.01 to 6.00%............ 110,990 33,969 3,482 2,448 1,004 151,893 101,060 43,179
6.01 to 7.00%............ 21,470 3,817 12,587 5,927 1,220 45,021 76,878 6,656
7.01 to 8.00%............ -- -- 94 -- -- 94 129 278
8.01 to 9.00%............ -- -- -- -- -- -- -- 449
Over 9.01%............... -- -- -- -- -- -- -- 29
-------- ------- ------- ------ ------ -------- -------- --------
Total................. $135,026 $37,949 $16,546 $8,375 $2,228 $200,124 $196,174 $173,038
======== ======= ======= ====== ====== ======== ======== ========
Borrowings. The Company utilizes advances from the FHLB as an alternative
to retail deposits to fund its operations and may do so in the future as part of
its operating strategy. During 1996, the Company increasingly utilized FHLB
borrowings to fund its asset growth, primarily its origination of
adjustable-rate one- to four-family loans. These FHLB advances are
collateralized primarily by certain of the Company's mortgage loans and
mortgage-backed securities and secondarily by the Company's investment in
capital stock of the FHLB. FHLB advances are made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Company, fluctuates from time to time in accordance
with the policies of the OTS and the FHLB. See "Regulation - Federal Home Loan
Bank System." During the year ended December 31, 1996, the Company borrowed,
net of repayments, $176.6 million from the FHLB. At December 31, 1996, the
Company had $296.5 million in outstanding advances from the FHLB and $3.5
million in repurchase agreements.
25
The following tables set forth certain information regarding the Company's
borrowed funds and repurchase agreements at or for the periods ended on the
dates indicated:
At or For the Year
Ended December 31,
--------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands)
FHLB advances:
Average balance outstanding............. $217,628 $133,268 $ 77,645
======== ======== =========
Maximum amount outstanding at
any month-end during the period...... $303,374 $148,274 $141,390
======== ======== ========
Balance outstanding at end of period.... $296,500 $119,909 $135,031
======== ======== ========
Weighted average interest rate
during the period.................... 5.86% 6.30% 5.46%
==== ==== ====
Weighted average interest rate at end
of period........................... 5.88% 5.95% 5.99%
==== ==== ====
At or For the Year
Ended December 31,
------------------------
1996 1995
--------- --------
(Dollars in thousands)
Securities sold under agreements to repurchase:
Average balance outstanding..................... $7,496 $ 96
Maximum amount outstanding at
any month-end during the period.............. $9.973 $7,000
====== ======
Balance outstanding at end of period............ $3,500 $7,000
====== ======
Weighted average interest rate
during the period............................ 5.86% 5.43%
==== ====
Weighted average interest rate at end
of period................................... 5.45% 5.43%
==== ====
Subsidiary Activities
Leader Corporation ("Leader Corp.") and BFS Service Corp. ("BFS") are
wholly-owned subsidiaries of the Company. BFS is not currently conducting any
activities. In 1986 and 1987, Leader Corp. entered into four real estate limited
partnerships and invested in one other real estate project. With the subsequent
downturn in the local real estate market, all of the entities experienced
significant operating losses. One partnership and the wholly owned real estate
project was terminated in 1991. Two other partnerships substantially concluded
their business in 1993 and are in the process of being dissolved. The
26
fourth partnership, Connelly Hill Limited Partnership ("Connelly Hill"), sold
its only parcel of land to a developer on January 31, 1997.
In 1994, the Company, through Leader Corp., permitted Liberty Financial, a
third party securities broker, to offer various uninsured investment products to
the Company's customers. Leader Corp. entered into a contract with such third
party brokerage concern to perform brokerage services in segregated areas of the
Company's branches. Under this contract, Liberty Financial leases space from the
Company at three of the Company's branch locations, pays rent and a percentage
of sales to Leader Corp.
At December 31, 1996, Leader Corp. had a retained deficit of $2.4 million
and for the years ended December 31, 1996 and 1995 had a net loss of $38,000 and
$94,000, respectively.
Personnel
As of December 31, 1996, the Company had 169 authorized full-time employee
positions and 71 authorized part-time employee positions, for a total of
approximately 200 full time equivalents. The employees are not represented by a
collective bargaining unit and the Company considers its relationship with its
employees to be good.
REGULATION AND SUPERVISION
General
As a result of the Company's acquisition of Broadway National Bank in
February 1997, the Company became a bank holding company. The Company, as a bank
holding company, is required to file certain reports with, and otherwise comply
with the rules and regulations of the Federal Reserve Board ("FRB") under the
Bank Holding Company Act of 1956, as amended ("BHCA"). In addition, the
activities of savings institutions, such as the Bank, are governed by the HOLA
and the Federal Deposit Insurance Act ("FDI Act"). The activities of national
banks are generally governed by the National Bank Act and the FDI Act.
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 ("FHLB") 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 institutions. Broadway National
Bank is subject to extensive regulation examination and supervision and
reporting with the OCC, as its primary federal regulator, and the FDIC, as the
deposit insurer. Broadway National Bank is a member of the Bank Insurance Fund
("BIF") managed by the FDIC. 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
OCC, the FDIC or the Congress, could have a material adverse impact on the
Company, the Bank, Broadway National Bank and their operations. Certain of the
regulatory requirements applicable to the
27
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, Broadway National Bank and the Company.
Holding Company Regulation
Federal Regulation. Due to its control of Broadway National Bank, the
Company is subject to examination, regulation, and periodic reporting under the
BHCA, as administered by the FRB.
The Company is required to obtain the prior approval of the FRB to acquire
all, or substantially all, of the assets of any bank or bank holding company or
merge with another bank holding company. Prior FRB approval will also be
required for the Company to acquire direct or indirect ownership or control of
any voting securities of any bank or bank holding company if, after giving
effect to such acquisition, it would, directly or indirectly, own or control
more than 5% of any class of voting shares of such bank or bank holding company.
Bank holding companies may acquire additional banks in any state, subject to
certain restrictions such as deposit concentration. In addition to the approval
of the FRB, before any bank acquisition can be completed, prior approval may
also be required to be obtained from other agencies having supervisory
jurisdiction over the bank to be acquired.
A bank holding company is generally prohibited from engaging in, or
acquiring direct or indirect control of more than 5% of the voting securities of
any company engaged in, non-banking activities. One of the principal exceptions
to this prohibition is for activities found by the FRB to be so closely related
to banking or managing or controlling banks to be a proper incident thereto.
Some of the principal activities that the FRB has determined by regulation to be
closely related to banking are: (i) making or servicing loans; (ii) performing
certain data processing services; (iii) providing discount brokerage services;
(iv) acting as fiduciary, investment or financial advisor; (v) finance leasing
personal or real property; (vi) making investments in corporations or projects
designed primarily to promote community welfare; and (vii) acquiring a savings
association, like the Bank, provided that the savings association only engages
in activities permitted bank holding companies. The FRB has adopted capital
adequacy guidelines for bank holding companies (on a consolidated basis)
substantially similar to those of the OTS for the Bank and the OCC for Broadway
National Bank. See "Capital Requirements." The Company's total and Tier 1
capital exceeds these requirements.
Bank holding companies are generally required to give the FRB prior written
notice of any purchase or redemption of its outstanding equity securities if the
gross consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the Company's consolidated net worth. The FRB
may disapprove such a purchase or redemption if it determines that the proposal
would constitute an unsafe and unsound practice, or would violate any law,
regulation, FRB order or directive, or any condition imposed by, or written
agreement with, the FRB. The FRB has now adopted an exception to this approval
requirement for well-capitalized bank holding companies that meet certain other
conditions.
The FRB has issued a policy statement regarding the payment of dividends by
bank holding companies. In general, the FRB's policies provide that dividends
should be paid only out of current earnings and only if the prospective rate of
earnings retention by the bank holding company appears consistent with the
organization's capital needs, asset quality, and overall financial condition.
The FRB's policies also require that a bank holding company serve as a source of
financial strength to it subsidiary banks by standing ready to use available
resources to provide adequate capital funds to those banks during periods of
financial stress or adversity and by maintaining the financial flexibility and
capital-raising
28
capacity to obtain additional resources for assisting its subsidiary banks where
necessary. These regulatory policies could affect the ability of the Company to
pay dividends or otherwise engage in capital distributions.
The status of the Company as a registered bank holding company under the
BHCA does not exempt it from certain Federal and state laws and regulations
applicable to corporations generally, including, without limitation, certain
provisions of the Federal securities laws.
Under the FDI Act, depository institutions are liable to the FDIC for
losses suffered or anticipated by the FDIC in connection with the default of a
commonly controlled depository institution or any assistance provided by the
FDIC to such an institution in danger of default. This applies to depository
institutions controlled by the same bank holding company.
The Company and its subsidiaries will be affected by the monetary and
fiscal policies of various agencies of the United States Government, including
the Federal Reserve System. In view of changing conditions in the national
economy and in the money markets, it is impossible for the management of the
Company to accurately predict future changes in monetary policy or the effect of
such changes on the business or financial condition of the Company, the Bank or
Broadway National Bank.
State Regulation. The Company is also a "bank holding company" within the
meaning of the Massachusetts bank holding company laws. The prior approval of
the Massachusetts Board of Bank Incorporation is required before the Company may
acquire all or substantially all of the assets of any depository institution (or
holding company thereof) merge with a holding company of a depository
institution or acquire more than 5% of the voting stock of a depository
institution or holding company thereof.
Acquisition of the Holding Company
Federal Regulation. Under the Federal Change in Bank Control Act ("CIBCA"),
a notice must be submitted to the FRB if any person (including a company), or
group acting in concert, seeks to acquire 10% or more of the Company's
outstanding voting stock, unless the FRB has found that the acquisition will not
result in a change in control of the Company. Under the CIBCA, the FRB has 60
days from the filing of a complete notice to act, taking into consideration
certain factors, including the financial and managerial resources of the
acquirer, the convenience and needs of the communities served by the Company and
the Bank, and the anti-trust effects of the acquisition.
Under the BHCA, any company would be required to obtain prior approval from
the FRB before it may obtain "control" of the Company within the meaning of the
BHCA. Control generally is defined to mean the ownership or power to vote 25
percent or more of any class of voting securities of the Company or the ability
to control in any manner the election of a majority of the Company's directors.
An existing bank holding company would be required to obtain the FRB's prior
approval under the BHCA before acquiring more than 5% of the Company's voting
stock. See "Holding Company Regulation." Approval of the Board of Bank
Incorporation may also be required for acquisition of the Company under some
circumstances.
Federal Banking Regulations
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
29
in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMEL financial
institution examination rating system), and, together with the risk-based
capital standard itself, a 4% Tier I risk-based capital standard. Core 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 purchased mortgage servicing rights and credit card relationships.
The OTS regulations also require that, in meeting the tangible, leverage (core)
and risk-based capital standards, institutions must generally deduct investments
in and loans to subsidiaries engaged in activities as a principle not
permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%,
as assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of Tier I (core) capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and the allowance for loan and lease losses limited to a maximum
of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
National Banks are required by OCC regulation to maintain leverage (core)
capital at least equal to 4% (3% for institutions receiving the highest rating
on the CAMEL financial institution examination rating system) and an 8%
risk-based capital ratio. National banks are subject to identical requirements
under the prompt corrective action standards. The OCC's regulations do not
establish a separate interest rate risk component for national bank capital
requirements.
30
The following table presents the Bank's capital position at December 31,
1996 relative to fully phased-in regulatory requirements.
[Enlarge/Download Table]
Capital
Excess ---------------------------------
Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
----------------- ------------- ----------------- -------------- ---------------
(Dollars in thousands)
Tangible............ $53,910 $11,934 $41,976 6.8% 1.5%
Core (Leverage)..... 53,910 23,868 30,042 6.8 3.0%
Risk-based.......... 58,310 35,301 23,009 13.2 8.0%
Prompt Corrective Regulatory Action. Under the prompt corrective action
regulations, the OTS with respect to savings associations and the OCC with
respect to National Banks, are required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a depository institution
is considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the appropriate regulator to
meet a specific capital level. An institution generally is considered
"adequately capitalized" if its ratio of total capital to risk-weighted assets
is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at
least 4%, and its ratio of core capital to total assets is at least 4% (3% if
the institution receives the highest CAMEL rating). An institution that has a
ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier
I (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." An
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 an 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 banking
regulator 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
an 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 appropriate agency 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 and Broadway National Bank is a member of the BIF. Both the SAIF and
the BIF (the deposit insurance fund that covers most commercial bank deposits),
are statutorily required to be capitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying average
deposit insurance premiums of between 24 and 25 basis points. The BIF met the
required reserve in 1995, whereas the SAIF was not expected to meet or exceed
the required level until 2002 at the earliest. This situation was primarily due
to the statutory requirement that SAIF members make payments on bonds
31
issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize
the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted
a new assessment rate schedule of from 0 to 27 basis points under which 92% of
BIF members paid an annual administration fee of only $2,000. With respect to
SAIF member institutions, the FDIC adopted a final rule retaining the previously
existing assessment rate schedule applicable to SAIF member institutions of 23
to 31 basis points. As long as the premium differential continued, it may have
had adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members, such as the Bank were placed at a substantial competitive disadvantage
to BIF members with respect to pricing of loans and deposits and the ability to
achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the "Funds Act") which, among other things, imposed a special
one-time assessment on SAIF member institutions, including the Bank, to
recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a special
assessment of 65.7 basis points on SAIF assessable deposits held as of March 31,
1995, payable November 27, 1996 (the "SAIF Special Assessment"). The SAIF
Special Assessment was recognized by the Bank as an expense in the quarter ended
September 30, 1996 and is generally tax deductible. The SAIF Special Assessment
recorded by the Bank amounted to $2.7 million on a pre-tax basis and $1.6
million on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits,
including those held by the National Bank, will be assessed for a FICO payment
of 1.3 basis points, while SAIF deposits will pay 6.48 basis points. Full pro
rata sharing of the FICO payments between BIF and SAIF members will occur on the
earlier of January 1, 2000 or the date the BIF and SAIF are merged. The Funds
Act specifies that the BIF and SAIF will be merged on January 1, 1999, provided
no savings associations remain as of that time.
As a result of the Funds Act, the FDIC recently voted to effectively lower
SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range
comparable to that of BIF members. SAIF members will also continue to make the
FICO payments described above. The FDIC also lowered the SAIF assessment
schedule for the fourth quarter of 1996 to 18 to 27 basis points. Management
cannot predict the level of FDIC insurance assessments on an on-going basis,
whether the savings association charter will be eliminated or whether the BIF
and SAIF will eventually be merged.
The Bank's assessment rate for fiscal 1996 ranged from 18 to 23 basis
points and the premium paid for this period was $916,000. Broadway National Bank
paid an administrative fee of $2,000 to the FDIC for 1996. A significant
increase in FDIC insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Bank and/or Broadway
National Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the regulators.
The management of the Bank and Broadway National Bank does not know of any
practice, condition or violation that might lead to termination of deposit
insurance.
Thrift Rechartering Legislation. The Funds Act provides that the BIF and
SAIF will merge on January 1, 1999 if there are no more savings associations as
of that date. That legislation also requires
32
that the Department of Treasury submit a report to Congress by March 31, 1997
that makes recommendations regarding a common financial institutions charter,
including whether the separate charters for thrifts and banks should be
abolished. Various proposals to eliminate the federal thrift charter, create a
uniform financial institutions charter and abolish the OTS have been introduced
in Congress. The bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date (January 1,
1998 in one bill, June 30, 1998 in the other) or they would automatically become
national banks. Converted federal thrifts would generally be required to conform
their activities to those permitted for the charter selected and divestiture of
nonconforming assets would be required over a two year period, subject to two
possible one year extensions. State chartered thrifts would become subject to
the same federal regulation as applies to state commercial banks. The Company is
unable to predict whether such legislation would be enacted, the extent to which
the legislation would restrict or disrupt its operations or those of its
subsidiary or whether the BIF and SAIF funds will eventually merge.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the limits on loans to one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of its unimpaired capital,
surplus, and allowable general valuation allowance. An additional amount may be
lent, equal to 10% of unimpaired capital, surplus and allowable general
valuation allowance, if such loan is secured by readily-marketable collateral,
which is defined to include certain financial instruments and bullion.
National banks are generally subject to similar loan to one borrower limits.
At December 31, 1996, the Bank's limit on loans to one borrower was $10.0
million and Broadway National Bank's limit was $2.4 million. At December 31,
1996, the Bank's largest aggregate outstanding balance of loans to one
borrower was $3.8 million and Broadway National Bank's largest aggregate
outstanding balance of loans to one borrower was $1.9 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings and loan association is required to 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 QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
December 31, 1996, the Bank maintained 93.1% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
National banks are not subject to the QTL test.
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in
need of more than normal supervision, could, after prior notice but without
obtaining approval of the OTS, make capital distributions during a calendar year
equal to the greater of (i) 100% of its net earnings to date during the calendar
year plus the amount that would reduce by one-half its "surplus capital ratio"
(the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year or (ii) 75% of its net income for the previous
four quarters. Any additional capital distributions would require prior
regulatory approval. In the event the Bank's capital fell below its regulatory
requirements or the
33
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. In December 1994,
the OTS proposed amendments to its capital distribution regulation that would
generally authorize the payment of capital distributions without OTS approval
provided that the payment does not cause the institution to be undercapitalized
within the meaning of the prompt corrective action regulation. However,
institutions in a holding company structure would still have a prior notice
requirement. At December 31, 1996, the Bank was a Tier 1 Bank.
National banks may not pay dividends out of its permanent capital and may
not, without OCC approval, pay dividends in excess of the total of the bank's
retained net income for the year combined with retained net income for the prior
two years. A national bank may not pay a dividend that would cause it to fall
below regulatory capital standards.
Liquidity. 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 5% but may be changed from time to time
by the OTS to any amount within the range of 4% to 10% depending upon economic
conditions and the savings flows of member institutions. OTS regulations also
require each member savings institution to maintain an average daily balance of
short-term liquid assets at a specified percentage (currently 1%) of the total
of its net withdrawable deposit accounts and borrowings payable in one year or
less. Monetary penalties may be imposed for failure to meet these liquidity
requirements. The Bank's liquidity and short-term liquidity ratios for December
31, 1996 were 8.0% and 4.8% respectively, which exceeded the applicable
requirements. The Bank has never been subjected to monetary penalties for
failure to meet its liquidity requirements. Broadway National Bank, under OCC
regulations, is not subject to regulatory liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the
OTS to fund the agency's operations. The general assessments, paid on a
semi-annual basis, are computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
thrift financial report. The assessments paid by the Bank for the fiscal year
ended December 31, 1996 totalled $136,000.
National banks pay assessments to the OCC to fund its operations. Such
assessments for Broadway National Bank amounted to $32,000 for the year ended
December 31, 1996.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
National banks are authorized to establish branches within the state in
which they are headquartered but only to the extent state law allows branching
by state banks. The Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994 (the "Act") provides for interstate branching for national banks,
effective June 1, 1997. Under the Act, interstate branching by merger is
authorized on June 1, 1997 unless the state in which the bank is to branch has
enacted a law opting out of interstate branching or expedites the effective date
by passing legislation. De novo interstate branching will be permitted by
34
the Act to the extent the state into which the bank is to branch has enacted a
law authorizing out-of-state banks to establish de novo branches.
Transactions with Related Parties. The authority of a depository
institution to engage in transactions with related parties or "affiliates"
(e.g., any company that controls or is under common control with an institution,
including the Company) is limited by Sections 23A and 23B of the Federal Reserve
Act ("FRA"). Section 23A limits the aggregate amount of covered transactions
with any individual affiliate to 10% of the capital and surplus of the savings
institution. The aggregate amount of covered transactions with all affiliates is
limited to 20% of the savings institution's capital and surplus. Certain
transactions with affiliates are required to be secured by collateral in an
amount and of a type described in Section 23A and the purchase of low quality
assets from affiliates is generally prohibited. Section 23B generally provides
that certain transactions with affiliates, including loans and asset purchases,
must be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions like the Bank 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 authority of the Bank and Broadway National Bank to extend credit to
executive officers, directors and 10% shareholders ("insiders"), as well as
entities such persons control, is governed by Sections 22(g) and 22(h) of the
FRA and Regulation O thereunder. Among other things, such loans are required to
be made on terms substantially the same as those offered to unaffiliated
individuals and to not involve more than the normal risk of repayment. Recent
legislation created an exception to this requirement for loans made pursuant to
a benefit or compensation program that is widely available to all employees of
the institution and does not give preference to insiders over other employees.
Regulation O also places individual and aggregate limits on the amount of loans
that institutions may make to insiders based, in part, on the institution's
capital position and requires certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions, the OCC has primary enforcement
authority over national banks and both agencies have the authority to bring
actions against the respective institutions and all institution-affiliated
parties, including stockholders, and any attorneys, appraisers and accountants
who knowingly or recklessly participate in wrongful action likely to have an
adverse effect on an insured institution. Formal enforcement action may range
from the issuance of a capital directive or cease and desist order to removal of
officers and/or directors to institution of receivership, conservatorship or
termination of deposit insurance. Civil penalties cover a wide range of
violations and can amount to $25,000 per day, or even $1 million per day in
especially egregious cases. Under the FDI Act, the FDIC has the authority to
recommend to OTS that enforcement action be taken with respect to a particular
savings institution or the OCC with respect to a national bank. If action is not
taken by the agency, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
The FRB has similar enforcement authority with respect to the Company.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address
35
internal controls and information systems; internal audit system; credit
underwriting; loan documentation; interest rate risk exposure; asset growth; and
compensation, fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
Guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard, as required by the FDI
Act. The final rule establishes deadlines for the submission and review of such
safety and soundness compliance plans when such plans are required.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). During fiscal 1996, the Federal
Reserve Board regulations generally required that reserves be maintained against
aggregate transaction accounts as follows: for accounts aggregating $52.0
million or less (subject to adjustment by the Federal Reserve Board) the reserve
requirement is 3%; and for accounts aggregating greater than $52.0 million, the
reserve requirement is $1.6 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 $52.0 million. The first $4.3 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) were exempted from the reserve requirements. The Bank and Broadway
National Bank maintained compliance with the foregoing requirements during
fiscal 1996.
Federal Securities Laws
The Company's common stock is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to
the information and proxy solicitation requirements, insider trading
restrictions, and other requirements under the Exchange Act.
Shares of the common stock purchased by persons who are not affiliates of
the Company may be resold without registration. Shares purchased by an affiliate
of the Company will be subject to the resale restrictions of Rule 144 under the
Securities Act. If the Company meets the current public information requirements
of Rule 144 under the Securities Act, each affiliate of the Company who complies
with the other conditions of Rule 144 (including those that require the
affiliate's sale to be aggregated with those of certain other persons) would be
able to sell in the public market, without registration, a number of shares not
to exceed in any three-month period the greater of (i) 1% of the outstanding
shares of the Company or (ii) the average weekly volume of trading in such
shares during the preceding four calendar weeks. Provision may be made in the
future by the Company to permit affiliates to have their shares registered for
sale under the Securities Act under certain circumstances.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their federal income on a
consolidated basis and the accrual method of accounting, and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. Broadway National Bank will also report its income on a consolidated
basis with the Company and Bank effective February 8, 1997. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Bank or the
Company. The Bank was audited by the IRS during 1996, and covered the tax years
1991, 1992 and 1993. For its 1996 taxable year, the Bank 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, requires savings institutions to recapture (i.e.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. Thrift institutions that would be treated as
small banks are allowed to utilize the Experience Method applicable to such
institutions, while thrift institutions that are treated as large banks (those
generally exceeding $500 million in assets) are required to use only the
36
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
the residential loan requirement.
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 current 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.
Under the 1996 Act, for its current and future taxable years, the Bank is
not permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i.e., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
other than its supplemental reserve for losses on loans, if any over the balance
of such reserves as of December 31, 1987. The Company has previously recorded a
deferred tax liability equal to the bad debt recapture and as such, the new
rules will have no effect on net income or income tax expense.
Distributions. Under the 1996 Act, if 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 34% 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. 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
37
be phased-in over a five year period whereby the rates are 12.13% for 1995,
11.72% for 1996, 11.32% for 1997, 10.91% for 1998 and 10.50% for 1999. Net
income for years beginning before January 1, 1999 includes gross income as
defined under the provisions of the Internal Revenue Code, plus interest from
bonds, notes and evidences of indebtedness of any state, including
Massachusetts, less the deductions, excluding the deductions for dividends
received, state taxes, and losses sustained in other taxable years, as defined
under the provisions of the Internal Revenue Code. For taxable years beginning
on or after January 1, 1999, the definition of state taxable income is modified
to allow a deduction for ninety-five percent of dividends received from stock
where the Bank owns fifteen percent or more of the voting stock of the
institution paying the dividend and to allow deductions from certain expenses
allocated to federally tax exempt obligations. Subsidiary corporations of the
Bank 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 1995. The net worth or tangible
property of such subsidiaries is taxed at a rate of 0.26%. Such subsidiaries may
file consolidated tax returns on the net earnings portion of the corporate tax.
Corporations which qualify as "securities corporations," as defined by the
Massachusetts tax code, are taxed at a special rate of 0.33% of their gross
income if they qualify as a "bank-holding company" under the Massachusetts tax
code. The Company has applied for and received approval to be taxed at this
reduced tax rate as long as it is exclusively engaged in activities of a
"securities corporation." The Company believes it will continue to qualify as a
securities corporation because a separate subsidiary was formed to make the loan
to the Bank's Employee Stock Ownership Plan and the Company's other activities
qualify as activities permissible for a securities corporation. If the Company
fails to so qualify, however, it will be taxed as a financial institution at a
rate of 10.50%, rather than at the phased-in rates, beginning with fiscal 1995.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities ("SFAS 125"). SFAS 125
establishes, among other things, new criteria for determining whether a transfer
of financial assets in exchange for cash or other consideration should be
accounted for as a sale or as a pledge of collateral in a secured borrowing.
SFAS 125 also establishes new accounting requirements for pledged collateral.
SFAS 125 is effective for most transactions occurring after December 31, 1996
and must be applied prospectively. However, SFAS 127, Deferral of the Effective
Date of Certain Provisions of SFAS 125, requires the deferral of implementation
as it relates to repurchase agreements, dollar-rolls, securities lending and
similar transactions in the years beginning after December 31, 1997. The Company
has determined that the adoption of SFAS 125 will not have a material impact on
its consolidated financial statements.
38
Item 2. Properties.
The Company conducts its business through an administrative and full
service office located in Burlington and seven other full service branch
offices. The Company believes it's current facilities are adequate to meet the
present and immediately foreseeable needs of the Company.
[Enlarge/Download Table]
Original Net Book Value
Year of Property or
Leased Leased Date of Leasehold
or or Lease Improvements at
Location Owned Acquired Expiration December 31, 1996
--------------------------------------- ---------- ------------ ----------------------- ------------------------
(In thousands)
Administrative/Branch/Home
Office:
17 New England Executive Park Leased 1988 November 1998 (1) $1,496
Burlington, MA 01803
Branch Offices:
980 Massachusetts Avenue Owned 1976 -- 482
Arlington, MA 02174
60 The Great Road Owned 1971 -- 450
Bedford, MA 01730
459 Boston Road Owned 1972 -- 427
Billerica, MA 01821
75 Federal Street Leased 1988 September 1998 (1) 185
Boston, MA 02110
1840 Massachusetts Avenue Owned 1960 -- 1,164
Lexington, MA 02173
31 Cross Street Owned 1971 -- 563
Peabody, MA 01960
200 Linden Street Leased 1973 November 1998 (1) 212
-----
Wellesley, MA 02181
Total............................ $4,979
======
----------
(1) The Company has options to renew these leases which range from 5 to 15
years.
Item 3. Legal Proceedings.
The Company is not involved in any pending material legal proceedings other
than routine legal proceedings occurring in the ordinary course of business.
Such routine legal proceedings, in the aggregate, are believed by management to
be immaterial to the Company's financial condition or results of operations.
39
In 1993, the Company foreclosed on and took possession of a 35 unit
multi-family residential complex located in Lowell, Massachusetts. Subsequent
thereto, the Company instituted an action in the Superior Court for Middlesex
County (C.A. No. 94-4127) to recover a $735,000 deficiency against the borrower
whereafter the borrower countersued the Company and two of its officers. The
borrower sought damages against the Company and the two members of management
claiming, among other things, $2.9 million in damages for a breach of an oral
agreement to forbear. On February 24, 1996, the court granted summary judgment
for the Company and its two officers. The defendant has appealed the summary
judgment. The Company has been advised by its counsel that there is little
possibility that the borrower will prevail on his counterclaims against the
Company.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Information relating to the market for Registrant's common equity and
related stockholder matters appears under "Shareholder Information" in the
Registrant's 1996 Annual Report to Stockholders on page 64 and is incorporated
herein by reference.
Item 6. Selected Financial Data.
The above-captioned information appears under "Selected Financial Data" of
the Corporation in the Registrant's 1996 Annual Report to Stockholders on pages
6 and 7 is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The above-captioned information appears under Management Discussion and
Analysis of Financial Condition and Results of Operation in the Registrant's
1996 Annual Report to Stockholders on pages 9 through 22 and is incorporated
herein by reference.
Item 8. Financial Statements and Supplementary Data.
The Consolidated Financial Statements of BostonFed Bancorp, Inc. and its
subsidiaries, together with the report thereon by KPMG Peat Marwick LLP appears
in the Registrant's 1996 Annual Report to Stockholders on pages 23 through 62
and are incorporated herein by reference.
Item 9. Change In and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
40
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on April 28, 1997 at
pages 5 through 7.
Item 11. Executive Compensation.
The information relating to executive compensation is incorporated
herein by reference to the Registrant's Proxy Statement for the Annual Meeting
of Stockholders to be held on April 28, 1997 at pages 13 through 18.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on April 28, 1997,
at pages 3 through 7.
Item 13. Certain Relationships and Related Transactions.
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on April 28, 1997, at page 19.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company are incorporated
by reference to the following indicated pages of the 1996 Annual
Report to Stockholders:
PAGE
Independent Auditors' Report.......................................... 23
Consolidated Balance Sheets as of
December 31, 1996 and 1995.......................................... 24
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1995 and 1994.................................... 26
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1996, 1995 and 1994.................... 27
41
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1996, 1995 and 1994.............................. 29
Notes to Consolidated Financial Statements............................ 31
The remaining information appearing in the Annual Report to Stockholder is
not deemed to be filed as part of this report, except as expressly provided
herein.
(2) All schedules are omitted because they are not required or applicable,
or the required information is shown in the consolidated financial
statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
3.1 Restated Certificate of Incorporation of BostonFed
Bancorp, Inc.* 3.2 Bylaws of BostonFed Bancorp, Inc.*
4.0 Stock Certificate of BostonFed Bancorp, Inc.*
10.1 Employment Agreement between the Bank and David F.
Holland and Employment Agreement between the Company and
David F. Holland*
10.2 Employment Agreement between Bank and David P. Conley
and Employment Agreement between the Company and David
P. Conley*
10.3 Employment Agreement between Bank and John A. Simas and
Employment Agreement between the Company and John A.
Simas*
10.4 Form of Change in Control Agreement between the Bank and
Executive and between the Company and Executive*
10.5 Boston Federal Savings Bank Employee Severance
Compensation Plan*
10.6 Employee Stock Ownership Plan and Trust*
10.7 BostonFed Bancorp, Inc. 1996 Stock-Based Incentive
Plan**
10.8 BostonFed Bancorp, Inc. 1997 Stock Incentive Plan***
13.0 1996 Annual Report to Stockholders (filed herewith)
21.0 Subsidiary information is incorporated herein by
reference to "Part I - Subsidiaries"
23.0 Consent of KPMG Peat Marwick LLP
27.0 Financial Data Schedule (filed herewith)
----------
* Incorporated herein by reference into this document from the
Exhibits to Form S-1, Registration Statement, and any
amendments thereto, filed on July 21, 1995, Registration No.
33-94860
** Incorporated herein by reference into this document from the
Proxy Statement for the 1996 Annual Meeting of Stockholders
dated March 20, 1996.
*** Incorporated herein by reference into this document from the
Proxy Statement for the 1997 Annual Meeting of Stockholders
dated March 28, 1997.
(b) Reports on Form 8-K.
None.
42
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
BOSTONFED BANCORP, INC.
By: /s/ David F. Holland
-----------------------------
David F. Holland
President and Chief Executive Officer
DATED: 3/31/97
----------------------
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.
Name Title Date
---- ----- ----
/s/ David F. Holland President and Chief 3/31/97
---------------------- Executive Officer
David F. Holland and Chairman of the Board
/s/ David P. Conley Director, Executive 3/31/97
---------------------- Vice President,
David P. Conley Assistant Treasurer
and Assistant Secretary
/s/ John A. Simas Senior Vice President, 3/31/97
---------------------- Treasurer, Corporate
John A. Simas Secretary and Chief Financial
Officer (Principal
Accounting Officer)
/s/ Edward P. Callahan Director 3/31/97
----------------------
Edward P. Callahan
/s/ Richard J. Dennis, Sr. Director 3/31/97
----------------------
Richard J. Dennis, Sr.
/s/ Charles R. Kent Director 3/31/97
----------------------
Charles R. Kent
/s/ W. Robert Mill Director 3/31/97
----------------------
W. Robert Mill
/s/ Irwin W. Sizer Director 3/31/97
----------------------
Irwin W. Sizer
43
Dates Referenced Herein and Documents Incorporated by Reference
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