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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-25251
CENTRAL BANCORP, INC.
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(Exact Name of Registrant as Specified in Its Charter)
MASSACHUSETTS 04-3447594
- -------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
399 HIGHLAND AVENUE, SOMERVILLE, MASSACHUSETTS 02144
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (617) 628-4000
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Securities registered under Section 12(b) of the Act: NONE
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Securities registered under Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $1.00 PER SHARE
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(Title of Class)
STOCK PURCHASE RIGHTS
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(Title of Class)
Indicate by check mark whether the registrant (l) 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 of this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes No X
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The aggregate market value of voting stock held by nonaffiliates of the
registrant at June 20, 2003 was approximately $14.4 million based on the closing
sale price of the registrant's Common Stock as listed on the Nasdaq National
MarketSM as of September 30, 2002 ($28.31 per share). Solely for purposes of
this calculation, directors, executive officers and greater than 5% stockholders
are treated as affiliates.
At June 20, 2003, the registrant had 1,663,133 shares of its Common Stock,
$1.00 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Proxy Statement for the 2003 Annual Meeting of
Stockholders (the "Proxy Statement") are incorporated by reference into Item 10,
Item 11, Item 12 Subparts (a) and (b) and Item 13 of Part III of this Form 10-K.
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CENTRAL BANCORP, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Page
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Item 1. Business......................................................... 3
Item 2. Properties....................................................... 21
Item 3. Legal Proceedings................................................ 22
Item 4. Submission of Matters to a Vote of Security Holders.............. 24
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters.......................................... 24
Item 6. Selected Financial Data......................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...... 32
Item 8. Financial Statements and Supplementary Data..................... 33
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure..................................... 60
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 60
Item 11. Executive Compensation.......................................... 60
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters............................ 60
Item 13. Certain Relationships and Related Transactions.................. 61
Item 14. Controls and Procedures......................................... 61
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K..................................................... 61
PART I
NOTE ON FORWARD-LOOKING STATEMENTS
WHEN USED IN THIS ANNUAL REPORT ON FORM 10-K, THE WORDS OR PHRASES "WILL
LIKELY RESULT," "ARE EXPECTED TO," "WILL CONTINUE," "IS ANTICIPATED,"
"ESTIMATE," "PROJECT" OR SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995. THE COMPANY CAUTIONS READERS NOT TO PLACE UNDUE
RELIANCE ON ANY SUCH FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE
MADE, AND TO ADVISE READERS THAT VARIOUS FACTORS, INCLUDING CHANGES IN REGIONAL
AND NATIONAL ECONOMIC CONDITIONS, UNFAVORABLE JUDICIAL DECISIONS, SUBSTANTIAL
CHANGES IN LEVELS OF MARKET INTEREST RATES, CREDIT AND OTHER RISKS OF LENDING
AND INVESTMENT ACTIVITIES AND COMPETITIVE AND REGULATORY FACTORS, COULD AFFECT
THE COMPANY'S FINANCIAL PERFORMANCE AND COULD CAUSE THE COMPANY'S ACTUAL RESULTS
FOR FUTURE PERIODS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED OR PROJECTED.
THE COMPANY DOES NOT UNDERTAKE AND SPECIFICALLY DISCLAIMS ANY OBLIGATION TO
UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT OCCURRENCE OF ANTICIPATED OR
UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS.
ITEM 1. BUSINESS
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GENERAL
THE COMPANY. Central Bancorp, Inc. (the "Company"), a Massachusetts
corporation, was organized by Central Co-operative Bank (the "Bank") on
September 30, 1998, to acquire all of the capital stock of the Bank as part of
its reorganization into the holding company form of ownership, which was
completed on January 8, 1999. Upon completion of the holding company
reorganization, the Company's common stock, par value $1.00 per share (the
"Common Stock"), became registered under the Securities Exchange Act of 1934, as
amended (the "Act"). The Company is a registered bank holding company subject to
regulation and examination by the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board"). The Company has no significant assets
other than the common stock of the Bank, loans to the Bank's Employee Stock
Ownership Plan ("ESOP") and various other liquid assets in which it invests in
the ordinary course of business. For that reason, substantially all of the
discussion in this Annual Report on Form 10-K relates to the operations of the
Bank and its subsidiaries.
THE BANK. Central Co-operative Bank ("Central" or the "Bank") was organized
as a Massachusetts chartered co-operative bank in 1915 and converted from mutual
to stock form in 1986. The primary business of the Bank is to generate funds in
the form of deposits and use the funds to make mortgage loans for the
construction, purchase and refinancing of residential properties, and to make
loans on commercial real estate in its market area. In addition, the Bank makes
a limited amount of consumer loans including home improvement and secured and
unsecured personal loans, and commercial and industrial loans. The Bank also
maintains an investment portfolio of various types of debt securities, including
corporate bonds and mortgage-backed securities, and a limited amount of equity
securities. In fiscal 2002, the Bank began to offer investment services
(including annuities) to its customers through a third party broker-dealer and
its insurance affiliate.
The Bank is headquartered in Somerville, Massachusetts and its operations
are conducted through eight full-service office facilities located in
Somerville, Arlington, Burlington, Chestnut Hill, Malden, Melrose and Woburn,
Massachusetts, a limited service high school branch in Worburn, Massachusetts,
as well as over the Internet. Each full-service branch office also has a 24-hour
automated teller machine ("ATM"). The Bank is a member of the Federal Home Loan
Bank ("FHLB") of Boston and its deposits are insured to applicable limits by the
Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation
("FDIC").
All Massachusetts chartered co-operative banks are required to be members
of the Share Insurance Fund. The Share Insurance Fund maintains a deposit
insurance fund which insures all deposits in member banks which are not covered
by federal insurance, which in the case of the Bank are its deposits in excess
of $100,000 per insured account. In past years, a premium of 1/24 of 1% of
insured deposits has been assessed annually on member banks such as the Bank for
this deposit insurance. However, no premium has been assessed in recent years.
3
The Company's and Bank's main office is located at 399 Highland Avenue,
Somerville, Massachusetts 02144 and their telephone number is (617) 628-4000.
The Bank also maintains a website at www.centralbk.com.
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The operations of the Bank and savings institutions are generally
influenced by overall economic conditions, the related monetary and fiscal
policies of the federal government, and the regulatory policies of financial
institution regulatory authorities, including the Massachusetts Commissioner of
Banks (the "Commissioner"), the Federal Reserve Board and the FDIC.
MARKET AREA
All of the Bank's offices are located in the northwestern suburbs of
Boston, which are its principal market area for deposits. The majority of the
properties securing the Bank's loans are located in Middlesex County. The Bank's
market area consists of established suburban areas and includes portions of the
Route 128 high-technology corridor.
COMPETITION
The Bank's competition for savings deposits has historically come from
other co-operative banks, savings banks, savings and loan associations and
commercial banks located in Massachusetts generally, and in the Boston
metropolitan area, specifically. With the advent of interstate banking the Bank
also faces competition from out-of-state banking organizations. In the past,
during times of high interest rates, the Bank has also experienced additional
significant competition for investors' funds from short-term money market funds
and other corporate and government securities. The Bank has faced continuing
competition from other financial intermediaries for deposits.
The Bank competes for deposits principally by offering depositors a wide
variety of savings programs, convenient branch locations, 24-hour automated
teller machines, Internet banking, preauthorized payment and withdrawal systems,
tax-deferred retirement programs, and other miscellaneous services such as money
orders, travelers' checks and safe deposit boxes. The Bank does not rely upon
any individual, group or entity for a material portion of its deposits.
The Bank's competition for real estate loans comes principally from
mortgage banking companies, co-operative banks and savings banks, savings and
loan associations, commercial banks, insurance companies and other institutional
lenders. The Bank competes for loan originations primarily through the interest
rates and loan fees it charges and the efficiency and quality of services it
provides borrowers, real estate brokers and builders. The competition for loans
encountered by the Bank, as well as the types of institutions with which the
Bank competes, varies from time to time depending upon certain factors including
the general availability of lendable funds and credit, general and local
economic conditions, current interest rate levels, volatility in the mortgage
markets and other factors which are not readily predictable.
Bank regulation is undergoing significant change with an increased number
of bank mergers and acquisitions, changes in the products and services banks can
offer, and involvement in non-banking activities by bank holding companies.
Recent legislation and regulations have expanded the activities in which
depository institutions may engage and reduced or eliminated some of the
competitive advantages which thrift institutions formerly held over commercial
banks, such as interest rate differentials which permitted thrift institutions
to offer a higher rate of interest to attract deposits. The ability of the Bank
to successfully compete will depend upon how successfully it can respond to the
rapidly evolving competitive, regulatory, technological and demographic
developments affecting its operations.
4
LENDING ACTIVITIES
The Bank offers residential mortgage and home equity loans, commercial real
estate loans, construction loans, commercial and industrial loans, personal,
home improvement, and various other types of consumer loans. For the year ended
March 31, 2003, the Bank originated loans totaling $186.0 million, including
$3.9 million of purchased loans. Of the total loans originated during fiscal
2003, $118.4 million, or 63.7%, were residential mortgage loans and $48.5
million, or 26.1%, were commercial mortgage loans. No loans were sold during
fiscal 2002 and 2001 in the secondary market. During 2003, the Bank sold $35.7
million of current year residential mortgage loan originations. The sale of
loans in the secondary market allows the Bank to continue to make loans during
periods when savings flows decline or funds are not otherwise available for
lending purposes and to manage interest rate risk. The Bank's net loan portfolio
increased by $18.8 million, or 5.1%, to $387.2 million at March 31, 2003 from
$368.4 million at March 31, 2002. The increase occurred, despite the continuing
high level of loan refinancing activity due to an increase in originations of
residential and commercial real estate loans and construction loans.
LOAN PORTFOLIO COMPOSITION. The following table summarizes the composition
of the Bank's loan portfolio by type of loan and the percentage each type
represents of the total loan portfolio at the dates indicated.
AT MARCH 31,
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2003 2002 2001 2000 1999
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AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
------ ----- ------ ----- ------ ----- ------ ----- ------ ---
(DOLLARS IN THOUSANDS)
Mortgage loans:
Residential..................$237,296 60.8% $246,045 66.2% $ 248,459 71.9% $ 243,570 76.1% $ 212,659 75.8%
Commercial................... 107,140 27.4 87,013 23.4 69,949 20.2 54,228 16.9 48,756 17.4
Construction................. 30,294 7.8 20,998 5.6 9,152 2.6 9,765 3.1 5,269 1.9
Second mortgage and
home equity................ 9,128 2.3 9,154 2.5 10,977 3.2 7,403 2.3 7,462 2.7
-------- ----- -------- ----- --------- ----- --------- ----- -------- ----
Total mortgage loans....... 383,858 98.3 363,210 97.7 338,537 97.9 314,966 98.4 274,146 97.8
-------- ----- -------- ----- --------- ----- --------- ----- --------- -----
Other loans:
Commercial and industrial.... 5,319 1.4 6,901 1.9 4,979 1.4 3,349 1.1 4,391 1.6
Consumer..................... 1,287 0.3 1,596 0.4 2,277 0.7 1,698 0.5 1,809 0.6
-------- ----- -------- ---- --------- ---- --------- ---- --------- ----
Total other loans.......... 6,606 1.7 8,497 2.3 7,256 2.1 5,047 1.6 6,200 2.2
-------- ---- -------- ---- --------- ---- --------- ---- --------- ----
Total loans................ 390,464 100.0% 371,707 100.0% 345,793 100.0% 320,013 100.0% 280,346 100.0%
===== ===== ===== ===== =====
Less:
Allowance for loan losses.... 3,284 3,292 3,106 2,993 2,913
-------- -------- --------- --------- ---------
Loans, net.................$387,180 $368,415 $ 342,687 $ 317,020 $ 277,433
======== ======== ========= ========= =========
5
LOAN PORTFOLIO SENSITIVITY. The following table sets forth certain maturity
information as of March 31, 2003 regarding the dollar amount of commercial and
industrial loans as well as construction loans in the Bank's portfolio,
including scheduled repayments of principal, based on contractual terms to
maturity. Demand loans, loans having no schedule of repayments and no stated
maturity and overdrafts are reported as due in one year or less.
DUE AFTER
DUE WITHIN ONE THROUGH DUE AFTER
ONE YEAR FIVE YEARS FIVE YEARS TOTAL
---------- ----------- ---------- -----
(IN THOUSANDS)
Construction loans.................. $ 25,838 $ 2,624 $ 1,832 $ 30,294
Commercial and industrial loans..... 4,485 670 164 5,319
---------- ---------- ---------- ----------
Total.......................... $ 30,323 $ 3,294 $ 1,996 $ 35,613
========== ========== ========== ==========
Of construction loans and commercial and industrial loans maturing more
than one year after March 31, 2003, $3.8 million have fixed rates and $1.5
million, have floating or variable rates.
RESIDENTIAL LENDING. The Bank's residential mortgage loans at March 31,
2003 totaled $237.3 million, or 60.8%, of the total loan portfolio. Fixed-rate
residential mortgages totaled $178.6 million, or 75.3%, of the residential loan
portfolio and adjustable rate loans totaled $58.7 million, or 24.7%, of the
residential loan portfolio.
With the implementation of its mortgage banking initiative in fiscal 2003,
whereby the Bank is seeking to increase its origination of residential mortgage
loans and to generate additional noninterest income via loan sale gains,
management regularly assesses the desirability of holding newly originated
long-term, fixed rate residential mortgage loans in its portfolio. A number of
factors are evaluated to determine whether or not to hold such loans including,
current and projected liquidity, current and projected interest rate risk
profile, projected growth in other interest-earning assets, e.g. commercial real
estate loans, and projected interest rates. In light of these factors, the Bank
sold $35.7 million of 15 and 30 year fixed rate residential mortgage loans in
the secondary market while retaining $68.0 million of fiscal 2003 originations
of such loans in portfolio. With the rate on the 30 year fixed rate residential
mortgage loan reaching a 45-year low in 2003, the Company experienced
significant refinancing activity. Customers who refinanced their mortgages
generally refinanced their existing home loans with either a 15 or 30 year fixed
rate mortgage loan. These market conditions lead to a continuing shift to the
fixed rate component of the Bank's residential mortgage loan portfolio.
The Bank's adjustable-rate residential mortgage loans have a maximum term
of 30 years, and allow for periodic interest rate adjustments. The Bank prices
the initial rate competitively but generally avoids initial deep discounts from
contracted indices and margins. The Bank has adopted the U.S. Treasury
Securities Index, adjusted to a constant maturity of one to five years, as its
primary index. The margin at which adjustable-rate loans are generally set is
2.875 percentage points over the stated index. Interest rate adjustments on
adjustable mortgage loans are capped at two percentage points per adjustment and
six percentage points over the life of the loan.
Residential loans may be granted as construction loans or permanent loans
on residential properties. Construction loans on owner-occupied residential
properties may convert to residential loans at fixed or adjustable rates upon
completion of construction. Loans secured by one- to four-family residential
properties are typically written in amounts up to 80% of the appraised value of
the residential property. The Bank generally requires private mortgage insurance
for loans in excess of 80% of appraised value. The maximum loan-to-value ratio
on owner occupied residential properties is 95%. The maximum loan-to-value ratio
on non-owner occupied residential properties is 80%.
COMMERCIAL REAL ESTATE AND CONSTRUCTION LENDING. The Bank originates
permanent and construction loans on commercial real estate. Commercial real
estate loans are typically secured by income-producing properties such as
apartment buildings, office buildings, industrial buildings and various retail
properties and are written with either fixed or adjustable interest rates.
Commercial real estate loans with fixed interest rates have terms generally
ranging from one to five years. As of March 31, 2003, commercial real estate
loans totaled $107.1 million and constituted 27.4% of the total loan portfolio.
6
Commercial real estate loans may be made for up to 80% of the appraised
value of the property up to $5.0 million, the Bank's "house lending limit" for
an individual borrower. Commercial real estate loans currently offered by the
Bank have terms of one to 20 years. Title insurance, fire, casualty insurance
and flood insurance are required in amounts sufficient to protect the Bank's
interest, where applicable. In some cases, commercial real estate loans were
granted in participation with other lenders.
The Bank's construction loans totaled $30.3 million, or 7.8%, of the Bank's
loan portfolio at March 31, 2003. Construction loans are short-term in nature
and have maturities ranging from six months to two years. The Bank grants loans
to construct residential and commercial real estate, as well as land development
for individual residential lots. Currently, construction loans are made for up
to 80% of the projected value of the completed property, based on independent
appraisals. Funds are disbursed based on a schedule of completed work presented
to the Bank and confirmed by physical inspection of the property by a
construction consultant and only after receipt of title updates.
The Bank also originates loans for the construction of single-family homes
for resale by professional builders. The Bank also lends to individuals for
construction of one- to four-family homes which they intend to occupy. Borrowers
are required to have a firm contract with a qualified builder or developer or to
have demonstrated prior home building experience. Construction loans are
normally made for a term of not more than eighteen months and based on a
completed value of not more than 80%, as determined by an independent certified
and licensed appraiser.
The continuing planned growth in commercial real estate loans and
construction loans in fiscal 2003, which aggregated $29.4 million, or 27.2%, is
attributable to the addition of experienced commercial lenders and expansion of
the credit administration function in 2002. This growth was aided by
opportunities created by the declining rate environment which prevailed during
the year.
SECOND MORTGAGES AND HOME EQUITY LINES OF CREDIT. The Bank offers home
equity lines of credit that are secured by the borrower's equity in their
primary residence and may take the form of a first or second mortgage. Equity
loans are made in amounts up to 80% of the appraised value less any first
mortgage. Payment of interest is required monthly and the rate is adjusted
monthly based on changes in the Prime Rate, as quoted in the Wall Street
Journal. Loans are not contingent upon proceeds being used for home improvement.
The Bank's home equity loans outstanding, and amortizing second mortgages
totaled $9.1 million, or 2.3%, of the Bank's loan portfolio at March 31, 2003.
COMMERCIAL AND INDUSTRIAL, CONSUMER AND OTHER LOANS. The Bank's commercial
and industrial, consumer and other loans totaled $6.6 million, or 1.7%, of the
total loan portfolio on March 31, 2003. The Bank's commercial and industrial
portfolio consists primarily of time, demand and line-of-credit loans to a
variety of local small businesses generally done on a secured basis. The Bank
engages in consumer lending primarily as an accommodation to existing customers.
RISKS OF COMMERCIAL REAL ESTATE, CONSTRUCTION AND COMMERCIAL AND INDUSTRIAL
LENDING. Commercial real estate, construction and commercial and industrial
lending entail significant additional risks compared to residential mortgage
lending. The repayment of loans secured by income-producing properties is
typically dependent on the successful operation of the properties and thus may
be subject to a greater extent to adverse conditions in the local real estate
market or in the economy generally. Construction loans involve additional risks,
because of the uncertainties inherent in estimating construction costs, delays
arising from labor problems, material shortages, and other unpredictable
contingencies, which make it relatively difficult to evaluate accurately the
total loan funds required to complete a project, and related loan-to-value
ratios. Commercial and industrial loans are generally not secured by real estate
and may involve greater risks than other types of lending. Because payments on
such loans are often dependent on the successful operation of the business
involved, repayment of such loans may be subject to a greater extent to adverse
conditions in the economy. For more information see " -- Non-Performing Assets."
ORIGINATION FEES AND OTHER FEES. The Bank currently collects origination
fees on some of the real estate loan products offered. Fees to cover the cost of
appraisals, credit reports, and other direct costs are also collected.
7
Loan origination fees collected vary in proportion to the level of lending
activity as well as competitive and economic conditions.
The Bank imposes late charges on all loans with the exception of equity
lines of credit and loans secured by deposits. The Bank also collects prepayment
premiums and partial release fees on commercial real estate and construction
loans where such items are negotiated as part of the loan agreement.
LOAN SOLICITATION AND PROCESSING. Loan originations come from a number of
sources. Residential real estate loans are attributable to walk-in customers,
existing customers, real estate brokers, third party originators and builders.
The Bank also utilizes both in-house and traveling originators in the
origination of residential real estate loans. Commercial real estate loans are
originated by the Bank's team of five commercial loan officers. Consumer loans
result from walk-in customers and depositors.
Each loan originated by the Bank is underwritten by lending personnel of
the Bank or qualified independent contract underwriters. Individual lending
officers, a committee of loan officers and the Bank's Security Committee have
the authority to approve loans up to various limits. Applications are received
in each of the offices of the Bank. Independent certified and licensed
appraisers are used to appraise the property intended to secure real estate
loans. The Bank's underwriting criteria are designed to minimize the risks of
each loan. There are detailed guidelines concerning the types of loans that may
be made, the nature of the collateral, the information that must be obtained
concerning the loan applicant and follow-up inspections of collateral after the
loan is made.
NON-PERFORMING ASSETS. The Bank notifies a borrower of a delinquency when
any payment becomes 15 days past due. Repeated contacts are made if the loan
remains delinquent for 30 days or more. The Bank will consider working out a
payment schedule with a borrower to clear a delinquency, if necessary. If,
however, a borrower is unwilling or unable to resolve such a default after 60
days, the Bank will generally proceed to foreclose and liquidate the property to
satisfy the debt.
Loans on which the accrual of interest has been discontinued are designated
as non-accrual loans. Accrual of interest on loans and amortization of net
deferred loan fees or costs are discontinued either when reasonable doubt exists
as to the full and timely collection of interest or principal, or when a loan
becomes contractually past due 90 days with respect to interest or principal.
When a loan is placed on non-accrual status, all interest previously accrued but
not collected is reversed against current period interest income. Interest
accruals are resumed on such loans only when they are brought fully current with
respect to interest and principal and when, in the judgment of management, the
loans are estimated to be fully collectable as to both principal and interest.
The Bank has instituted additional procedures to closely monitor loans and
bring potential problems to management's attention early in the collection
process. The Bank prepares a monthly watch list of potential problem loans
including currently performing loans. The Senior Loan Officer reviews
delinquencies with the Security Committee of the Board of Directors at least
monthly. Due to the high priority given to monitoring asset quality, Senior
Management is involved in the early detection and resolution of problem loans.
8
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
AT MARCH 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- ------- -------- --------
(DOLLARS IN THOUSANDS)
Loans accounted for on a non-accrual basis,
non-performing loans...................... $ -- $ -- $ -- $ 235 $ 419
Restructured loans........................... -- -- -- -- --
Real estate acquired by foreclosure.......... -- -- -- -- --
------- ------- -------- -------- ------
Non-performing assets..................... $ -- $ -- $ -- $ 235 $ 419
======= ======= ======== ======== ======
Impaired loans, accruing..................... $ -- $ -- $ -- $ -- $ --
Non-performing loans to total loans.......... 0.00% 0.00% 0.00% 0.07% 0.15%
Non-performing assets to total assets........ 0.00% 0.00% 0.00% 0.06% 0.12%
At March 31, 2003, there were no loans where known information about
possible credit problems of borrowers caused management to have serious doubts
as to the ability of such borrowers to comply with present loan repayment terms.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained at a
level which management considers adequate to provide for probable losses based
on an evaluation of known and inherent risks in the portfolio. Such evaluation
for each of the periods reported includes identification of adverse situations
which may affect the ability of certain borrowers to repay, a review of overall
portfolio size, quality, composition and an assessment of existing and
anticipated economic conditions. Regular reviews of the loan portfolio are
performed to identify loans for which specific allowance allocations are
considered prudent. Specific allocations are made based on the risk
classification assigned to individual loans. Additionally, general risk
allocations are determined by formula whereby the loan portfolio is stratified
by loan type and by risk rating category. Loss factors are then applied to each
strata based on various considerations including historical loss experience,
delinquency trends, current economic conditions, industry standards and
regulatory guidelines. While management uses available information in
establishing the allowance for loan losses, future adjustments to the allowance
may be necessary if economic conditions differ substantially from the
assumptions used in making the evaluations. Additions to the allowance are
charged to earnings and realized losses, net of recoveries, are charged to the
allowance.
Various regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan losses. Such agencies
may require the Bank to recognize additions to the allowance based on their
judgment of information available to them at their examination date.
9
The following table presents activity in the allowance for loan losses
during the years indicated.
YEARS ENDED MARCH 31,
--------------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- -------
(DOLLARS IN THOUSANDS)
Balance at beginning of year................. $ 3,292 $ 3,106 $ 2,993 $ 2,913 $ 2,886
-------- --------- ---------- ---------- ----------
Charge-offs:
Residential mortgage....................... -- -- -- -- (88)
Commercial mortgage........................ -- -- -- -- --
Other loans................................ (21) (4) (4) (9) (11)
-------- --------- ----------- ---------- ----------
Total charge-offs........................ (21) (4) (4) (9) (99)
-------- --------- ----------- ---------- ----------
Recoveries:
Residential mortgage....................... -- 80 60 9 78
Commercial mortgage........................ -- 103 48 36 36
Other loans................................ 13 7 9 44 12
-------- --------- ---------- ---------- ----------
Total recoveries......................... 13 190 117 89 126
-------- --------- ---------- ---------- ----------
Net (charge-offs) recoveries................. (8) 186 113 80 27
Provision.................................... -- -- -- -- --
-------- --------- ---------- ---------- ----------
Balance at end of year....................... $ 3,284 $ 3,292 $ 3,106 $ 2,993 $ 2,913
======== ========= ========== ========== ==========
Average loans outstanding during the year.... $378,502 $ 335,271 $ 341,732 $ 300,089 $ 287,513
Ratio of net charge-offs to average loans.... nm n/a n/a n/a n/a
Total loans outstanding at end of year....... $390,464 $ 371,707 $ 345,793 $ 320,013 $ 280,346
Ratio of allowance for loan
losses to loans at end of year............. 0.84% 0.89% 0.90% 0.94% 1.04%
The allowance for loan losses is available for offsetting credit losses in
connection with any loan, but is internally allocated among loan categories as
part of the process for evaluating the adequacy of the allowance for loan
losses. The following table presents the allocation of the Bank's allowance for
loan losses, by type of loan, at the dates indicated.
AT MARCH 31,
--------------------------------------------------------------------------------
2003 2002 2001
---------------------- --------------------- ----------------------
% OF % OF % OF
LOANS TO LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
Mortgage loans:
Residential mortgage...... $ 583 60.8% $ 636 66.2% $ 1,637 71.9%
Commercial mortgage....... 2,009 27.4 1,956 23.4 1,058 20.2
Construction.............. 457 7.8 462 5.6 169 2.6
Second mortgage and
home equity............. 94 2.3 98 2.5 163 3.2
-------- ---- -------- ---- ------- ----
Total mortgage loans.... 3,143 98.3 3,152 97.7 3,027 97.9
Other loans................. 141 1.7 140 2.3 79 2.1
-------- ---- -------- ---- ------- ----
Total................... $ 3,284 100.0% $ 3,292 100.0% $ 3,106 100.0%
======== ===== ======== ===== ======= =====
10
AT MARCH 31,
--------------------------------------------------
2000 1999
---------------------- ---------------------
% OF % OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
Mortgage loans:
Residential mortgage...... $ 1,333 76.1% $ 1,120 75.8%
Commercial mortgage....... 1,202 16.9 1,556 17.4
Construction.............. 198 3.1 92 1.9
Second mortgage and
home equity............. 178 2.3 58 2.7
-------- ---- -------- ----
Total mortgage loans.... 2,911 98.4 2,826 97.8
Other loans................. 82 1.6 87 2.2
-------- ---- -------- ----
Total................... $ 2,993 100.0% $ 2,913 100.0%
======== ===== ======== =====
INVESTMENT ACTIVITIES
The primary objectives of the investment portfolio are to achieve a
competitive rate of return over a reasonable period of time and to provide
liquidity. As a Massachusetts-chartered bank, the Bank is authorized to invest
in various obligations of federal and state governmental agencies, corporate
bonds and other obligations and, within certain limits, marketable equity
securities. The Bank's investment policy requires that corporate debt securities
be rated as "investment grade" at the time of purchase. The Bank's investment in
marketable equity securities is generally limited to large, well known
corporations whose shares are actively traded. The size of the Bank's holdings
in an individual company's stock is also limited by policy. A portion of the
Bank's investment portfolio consists of mortgage-backed securities which
represent interests in pools of residential mortgages. Such securities include
securities issued and guaranteed by the Federal National Mortgage Association
("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), and the Government
National Mortgage Association ("GNMA") as well as collateralized mortgage
obligations ("CMOs") issued primarily by FNMA and FHLMC.
Investments are classified as either held to maturity, available for sale
or trading. Investments classified as trading securities are reported at fair
value with unrealized gains and losses included in earnings. Investments
classified as available for sale are reported at fair value, with unrealized
gains and losses reported as a separate component of stockholders' equity.
Securities held to maturity are carried at amortized cost. At March 31, 2003,
all of the Bank's marketable investments were classified as available for sale.
The following table sets forth a summary of the Bank's investment
securities, as well as the percentage such investments comprise of the Bank's
total assets, at the dates indicated.
AT MARCH 31,
--------------------------------------------------
2003 2002 2001
----- ------ ----
(DOLLARS IN THOUSANDS)
U. S. Government and agency obligations................. $ 8,247 $ 13,996 $ 19,051
Corporate bonds......................................... 38,727 38,568 5,245
Mortgage-backed securities.............................. 12,056 18,340 19,314
Marketable equity securities............................ 2,081 2,980 5,778
---------- ---------- ----------
Total investment securities......................... $ 61,111 $ 73,884 $ 49,388
========== ========== ==========
Percentage of total assets.......................... 12.8% 15.8% 11.0%
==== ==== ====
11
At March 31, 2003, the Bank owned securities issued by several companies having
a book value that exceeded 10% of the Company's stockholders' equity. Such
securities consisted primarily of debt obligations. The following table
summarizes the aggregate book and market value of the Bank's holdings of each
issuer.
ISSUER BOOK VALUE MARKET VALUE
------ ---------- ------------
(DOLLARS IN THOUSANDS)
AT&T $ 5,216.3 $ 5,417.5
Ford Motor Credit 5,082.9 4,930.0
GMAC 5,143.8 5,267.9
Boeing Capital Corp. 5,034.7 5,235.6
Hewlett Packard 4,982.2 5,445.8
DaimlerChrysler 4,015.8 4,265.2
The following table sets forth the scheduled maturities, amortized cost,
market values and average yields for the Bank's debt securities at March 31,
2003.
ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS MORE THAN TEN YEARS
------------------ ------------------ ------------------ -------------------
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD COST YIELD
--------- ------- --------- ------- --------- ------- --------- -------
(DOLLARS IN THOUSANDS)
U.S. government and agency
securities................ $ -- -- % $ 2,000 6.10% $ 6,000 6.27% $ -- -- %
Corporate bonds............. 501 6.57 31,248 6.89 5,163 7.80 -- --
Mortgage-backed securities.. -- -- 666 6.89 1,586 7.87 9,588 6.30
------ ------- ------- -------
Total................ $ 501 $33,914 $12,749 $ 9,588
====== ======= ======= ========
TOTAL INVESTMENT PORTFOLIO
---------------------------
AMORTIZED MARKET AVERAGE
COST VALUE YIELD
--------- ------ ------
(DOLLARS IN THOUSANDS)
U.S. government and agency
securities................ $ 8,000 $ 8,247 6.23%
Corporate bonds............. 36,912 38,727 7.01
Mortgage-backed securities.. 11,840 12,056 6.55
-------- --------
Total................ $ 56,752 $ 59,030
======== ========
12
DEPOSITS AND BORROWED FUNDS
GENERAL. Savings accounts and other types of deposits have traditionally
been an important source of the Bank's funds for use in lending and for other
general business purposes. In addition to deposits, the Bank derives funds from
loan repayments, loan sales, borrowings and from other operations. The
availability of funds is influenced by the general level of interest rates and
other market conditions. Scheduled loan repayments are a relatively stable
source of funds while deposit inflows and outflows vary widely and are
influenced by prevailing interest rates and money market conditions. Borrowings
may be used on a short-term basis to compensate for reductions in deposits or
deposit inflows at less than projected levels and may be used on a longer term
basis to support expanded lending activities.
DEPOSITS. Consumer deposits are attracted principally from within the
Bank's market area through the offering of a broad selection of deposit
instruments including demand deposit accounts, NOW and Preferred NOW accounts,
money market deposit accounts, regular savings accounts, term deposit accounts
and retirement savings plans. The Bank has historically not actively solicited
or advertised for deposits outside of its market area or solicited brokered
deposits. During fiscal 2003, the Bank did enter into a retail CD brokerage
agreement with a major brokerage firm and considers this arrangement to be a
secondary source of liquidity. The Bank attracts deposits through its branch
office network, automated teller machines, the Internet and by paying rates
competitive with other Massachusetts financial institutions.
DEPOSIT ACCOUNTS. The following table shows the distribution of the Bank's
deposit accounts at the dates indicated and the weighted average rate paid for
each category of account for the years indicated.
YEARS ENDED MARCH 31,
----------------------------------------------------------------
2003 2002
----------------------------- -----------------------------
AVERAGE AVERAGE
AVERAGE % OF RATE AVERAGE % OF RATE
BALANCE DEPOSITS PAID BALANCE DEPOSITS PAID
------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Demand deposit accounts............. $ 29,586 10.7% -- % $ 24,535 9.0% --%
NOW accounts........................ 37,271 13.4 .64 36,177 13.2 1.12
Passbook and other savings
accounts........................ 70,489 25.4 1.10 67,322 24.7 1.32
Money market deposit accounts....... 33,695 12.1 1.83 16,869 6.2 1.75
Term deposit certificates........... 106,572 38.4 3.72 127,906 46.9 5.13
--------- ----- --------- -----
Total deposits.................. $ 277,613 100.0% 2.02% $ 272,809 100.0% 2.98%
========= ===== ========= =====
YEARS ENDED MARCH 31,
--------------------------
2001
--------------------------
AVERAGE
AVERAGE % OF RATE
BALANCE DEPOSITS PAID
------- -------- -------
(DOLLARS IN THOUSANDS)
Demand deposit accounts............. $ 20,382 7.5% --%
NOW accounts........................ 32,312 12.0 1.29
Passbook and other savings
accounts........................ 62,018 22.9 2.03
Money market deposit accounts....... 17,200 6.4 2.22
Term deposit certificates........... 138,223 51.2 5.81
-------- ----
Total deposits.................. $270,135 100.0% 3.73%
======== =====
13
TIME DEPOSITS IN EXCESS OF $100,000. The following table indicates the
amount of the Bank's time deposits of $100,000 or more by time remaining until
maturity as of March 31, 2003 (in thousands).
Maturity Period:
Three months or less.................... $ 4,055
Three through six months................ 7,584
Six through twelve months............... 8,696
Over twelve months...................... 5,924
---------
Total............................. $ 26,259
=========
BORROWINGS. From time to time the Bank borrows funds from the FHLB of
Boston. All advances from the FHLB of Boston are secured by a blanket lien on
residential first mortgage loans, certain investment securities and all the
Bank's stock in the FHLB of Boston. At March 31, 2003, the Bank had advances
outstanding from the FHLB of Boston of $144.4 million. Proceeds from these
advances were primarily used to fund the Bank's loan growth. Additional sources
of borrowed funds include The Co-operative Central Bank Reserve Fund and the
Federal Reserve System.
The following table sets forth certain information regarding borrowings
from the FHLB of Boston, including short-term borrowings under a line of credit,
at the dates and for the periods indicated.
AT OR FOR THE
YEARS ENDED MARCH 31,
-------------------------------------------------
2003 2002 2001
--------- --------- --------
(DOLLARS IN THOUSANDS)
Amounts outstanding at end of period......................... $ 144,400 $ 164,000 $121,000
Weighted average rate at end of period....................... 4.81% 4.39% 5.84%
Maximum amount of borrowings outstanding
at any month end........................................... $ 165,500 $ 164,000 $121,000
Approximate average amounts outstanding...................... $ 155,590 $ 124,680 $111,980
Approximate weighted average rate during the year............ 4.67% 5.41% 6.18%
SUBSIDIARIES
In April 1998, the Bank established Central Securities Corporation, a
Massachusetts corporation, as a wholly owned subsidiary of the Bank for the
purpose of engaging exclusively in buying, selling and holding, on its own
behalf, securities that may be held directly by the Bank. This subsidiary
corporation holds U.S. Treasury notes, Government agency obligations, corporate
bonds and mortgage-backed securities and qualifies under Section 38B of Chapter
63 of the Massachusetts General Laws as a Massachusetts security corporation.
In July 1999, the Bank established Central Preferred Capital Corporation
("CPCC"), a Massachusetts corporation which has elected to be taxed as a real
estate investment trust ("REIT") for federal and Massachusetts tax purposes.
CPCC holds mortgage loans which were previously originated by the Bank. For
additional information, see Note 8 of Notes to Consolidated Financial Statements
under "Item 8. Financial Statements and Supplementary Data."
14
REGULATION AND SUPERVISION
REGULATION AND SUPERVISION OF THE COMPANY
GENERAL. The Company is a bank holding company subject to regulation by the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended
(the "BHCA"). As a result, the activities of the Company are subject to certain
limitations, which are described below. In addition, as a bank holding company,
the Company is required to file annual and quarterly reports with the Federal
Reserve Board and to furnish such additional information as the Federal Reserve
Board may require pursuant to the BHCA. The Company is also subject to regular
examination by the Federal Reserve Board.
ACTIVITIES. With certain exceptions, the BHCA prohibits a bank holding
company from acquiring direct or indirect ownership or control of more than 5%
of the voting shares of a company that is not a bank or a bank holding company,
or from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve Board regulation or
order, have been identified as activities closely related to the business of
banking. The activities of the Company are subject to these legal and regulatory
limitations under the BHCA and the related Federal Reserve Board regulations.
Notwithstanding the Federal Reserve Board's prior approval of specific
nonbanking activities, the Federal Reserve Board has the power to order a
holding company or its subsidiaries to terminate any activity, or to terminate
its ownership or control of any subsidiary, when it has reasonable cause to
believe that the continuation of such activity or such ownership or control
constitutes a serious risk to the financial safety, soundness or stability of
any bank subsidiary of that holding company.
Effective with the enactment of the Gramm-Leach-Bliley Act (the "G-L-B
Act") on November 12, 1999, bank holding companies whose financial institution
subsidiaries are well capitalized and well managed and have satisfactory
Community Reinvestment Act ("CRA") records can elect to become "financial
holding companies" which are permitted to engage in a broader range of financial
activities than are permitted to bank holding companies. Financial holding
companies are authorized to engage in, directly or indirectly, financial
activities. A financial activity is an activity that is: (i) financial in
nature; (ii) incidental to an activity that is financial in nature; or (iii)
complementary to a financial activity and that does not pose a safety and
soundness risk. The G-L-B Act includes a list of activities that are deemed to
be financial in nature. Other activities also may be decided by the Federal
Reserve Board to be financial in nature or incidental thereto if they meet
specified criteria. A financial holding company that intends to engage in a new
activity or to acquire a company to engage in such an activity is required to
give prior notice to the Federal Reserve Board. If the activity is not either
specified in the G-L-B Act as being a financial activity or one that the Federal
Reserve Board has determined by rule or regulation to be financial in nature,
the prior approval of the Federal Reserve Board is required.
ACQUISITIONS. Under the BHCA, a bank holding company must obtain the prior
approval of the Federal Reserve Board before (1) acquiring direct or indirect
ownership or control of any voting shares of any bank or bank holding company
if, after such acquisition, the bank holding company would directly or
indirectly own or control more than 5% of such shares; (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or (3)
merging or consolidating with another bank holding company. Satisfactory
financial condition, particularly with regard to capital adequacy, and
satisfactory CRA ratings generally are prerequisites to obtaining federal
regulatory approval to make acquisitions.
Under the BHCA, any company must obtain approval of the Federal Reserve
Board prior to acquiring control of the Company or the Bank. For purposes of the
BHCA, "control" is defined as ownership of more than 25% of any class of voting
securities of the Company or the Bank, the ability to control the election of a
majority of the directors, or the exercise of a controlling influence over
management or policies of the Company or the Bank. In addition, the Change in
Bank Control Act and the related regulations of the Federal Reserve Board
require any person or persons acting in concert (except for companies required
to make application under the BHCA), to file a written notice with the Federal
Reserve Board before such person or persons may acquire control of the Company
or the Bank. The Change in Bank Control Act defines "control" as the power,
directly or indirectly, to vote 25% or more of any voting securities or to
direct the management or policies of a bank holding company or an insured bank.
15
Under Massachusetts banking law, prior approval of the Massachusetts
Division of Banks is also required before any person may acquire control of a
Massachusetts bank or bank holding company. Massachusetts law generally
prohibits a bank holding company from acquiring control of an additional bank if
the bank to be acquired has been in existence for less than three years or, if
after such acquisition, the bank holding company would control more than 30% of
the FDIC-insured deposits in the Commonwealth of Massachusetts.
CAPITAL REQUIREMENTS. The Federal Reserve Board has adopted guidelines
regarding the capital adequacy of bank holding companies, which require bank
holding companies to maintain specified minimum ratios of capital to total
assets and capital to risk-weighted assets. See "Regulation and Supervision of
the Bank -- Capital Requirements."
DIVIDENDS. The Federal Reserve Board has the power to prohibit dividends by
bank holding companies if their actions constitute unsafe or unsound practices.
The Federal Reserve Board has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the Federal Reserve Board's
view that a bank holding company should pay cash dividends only to the extent
that the company's net income for the past year is sufficient to cover both the
cash dividends and a rate of earnings retention that is consistent with the
company's capital needs, asset quality, and overall financial condition. The
Federal Reserve Board also indicated that it would be inappropriate for a bank
holding company experiencing serious financial problems to borrow funds to pay
dividends. Under the prompt corrective action regulations adopted by the Federal
Reserve Board pursuant to the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"), the Federal Reserve Board may prohibit a bank holding
company from paying any dividends if the holding company's bank subsidiary is
classified as "undercapitalized." See "Regulation and Supervision of the Bank --
Prompt Corrective Regulatory Action."
STOCK REPURCHASES. As a bank holding company, the Company is required to
give the Federal Reserve Board prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption, when combined with the net consideration paid for
all such purchases or redemptions during the preceding 12 months, is equal to
10% or more of the Company's consolidated net worth. The Federal Reserve Board
may disapprove such a purchase or redemption if it determines that the proposal
would violate any law, regulation, Federal Reserve Board order, directive, or
any condition imposed by, or written agreement with, the Federal Reserve Board.
This requirement does not apply to bank holding companies that are
"well-capitalized," received one of the two highest examination ratings at their
last examination and are not the subject of any unresolved supervisory issues.
SARBANES-OXLEY ACT OF 2002. On July 30, 2002, the Sarbanes-Oxley Act of
2002 ("SOX") was signed into law which mandated a variety of reforms intended to
address corporate and accounting fraud. SOX contained provisions which amend the
Securities Exchange Act of 1934, as amended (the "Act") and provisions which
directed the SEC to promulgate rules. The resultant law and regulations under
the Act as of the time of this annual report is set forth in the following
paragraphs. SOX provides for the establishment of a new Public Company
Accounting Oversight Board ("PCAOB"), which will enforce auditing, quality
control and independence standards for firms that audit Securities and Exchange
Commission ("SEC")-reporting companies and will be funded by fees from all
SEC-reporting companies. SOX imposed higher standards for auditor independence
and restricts provision of consulting services by auditing firms to companies
they audit. Any non-audit services being provided to an audit client will
require preapproval by the Company's audit committee members. In addition,
certain audit partners must be rotated periodically. SOX requires chief
executive officers and chief financial officers, or their equivalent, to certify
to the accuracy of periodic reports filed with the SEC, subject to civil and
criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under SOX, counsel will be required to report evidence
of a material violation of the securities laws or a breach of fiduciary duty by
a company to its chief executive officer or its chief legal officer, and, if
such officer does not appropriately respond, to report such evidence to the
audit committee or other similar committee of the board of directors or the
board itself.
Longer prison terms will also be applied to corporate executives who
violate federal securities laws, the period during which certain types of suits
can be brought against a company or its officers has been extended, and bonuses
issued to top executives prior to restatement of a company's financial
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from trading during
retirement plan "blackout" periods, and loans to company executives are
restricted. In addition, a provision directs that civil penalties levied by the
SEC as a result of any judicial or administrative action under the Act be
16
deposited in a fund for the benefit of harmed investors. Directors and executive
officers must also report most changes in their ownership of a company's
securities within two business days of the change, and as of the end of June
2003, all ownership reports must be electronically filed.
SOX also increases the oversight and authority of audit committees of
publicly traded companies. Audit committee members must be independent and are
barred from accepting consulting, advisory or other compensatory fees from the
issuer. In addition, all SEC-reporting companies must disclose whether at least
one member of the committee is an audit committee "financial expert" (as such
term is defined by the SEC rules) and if not, why not. Audit committees of
publicly traded companies will have authority to retain their own counsel and
other advisors funded by the company. Audit committees must establish procedures
for the receipt, retention and treatment of complaints regarding accounting and
auditing matters and procedures for confidential, anonymous submission of
employee concerns regarding questionable accounting or auditing matters. It is
the responsibility of the audit committee to hire, oversee and work on
disagreements with the Company's independent auditor.
Beginning six months after the SEC determines that the PCAOB is able to
carry out its functions, it will be unlawful for any person that is not a
registered public accounting firm ("RPAF") to audit an SEC-reporting company.
Under the Act, a RPAF is prohibited from performing statutorily mandated audit
services for a company if such company's chief executive officer, chief
financial officer, comptroller, chief accounting officer or any person serving
in equivalent positions has been employed by such firm and participated in the
audit of such company during the one-year period preceding the audit initiation
date. SOX also prohibits any officer or director of a company or any other
person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the Company's financial statements for the
purpose of rendering the financial statement's materially misleading. The SEC
has prescribed rules requiring inclusion of an internal control report and
assessment by management in the annual report to shareholders. SOX requires the
RPAF that issues the audit report to attest to and report on management's
assessment of the Company's internal controls. In addition, SOX requires that
each financial report required to be prepared in accordance with (or reconciled
to) generally accepted accounting principles and filed with the SEC reflect all
material correcting adjustments that are identified by a RPAF in accordance with
generally accepted accounting principles and the rules and regulations of the
SEC.
Although the Company anticipates it will incur additional expense in
complying with the provisions of the Act and the related rules, management does
not expect that such compliance will have a material impact on the Company's
financial condition or results of operations.
REGULATION AND SUPERVISION OF THE BANK
GENERAL. The Bank is subject to extensive regulation by the Commissioner
and the FDIC. The lending activities and other investments of the Bank must
comply with various regulatory requirements. The Commissioner and FDIC
periodically examine the Bank for compliance with these requirements. The Bank
must file reports with the Commissioner and the FDIC describing its activities
and financial condition. The Bank is also subject to certain reserve
requirements promulgated by the Federal Reserve Board. This supervision and
regulation is intended primarily for the protection of depositors. Certain of
these regulatory requirements are referred to below or appear elsewhere herein.
CAPITAL REQUIREMENTS. Under FDIC regulations, state-chartered banks that
are not members of the Federal Reserve System are required to maintain a minimum
leverage capital requirement consisting of a ratio of Tier 1 capital to total
assets of 3% if the FDIC determines that the institution is not anticipating or
experiencing significant growth and has well-diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high liquidity, good
earnings and in general a strong banking organization, rated composite 1 under
the Uniform Financial Institutions Rating System (the CAMELS rating system)
established by the Federal Financial Institutions Examination Council. For all
but the most highly rated institutions meeting the conditions set forth above,
the minimum leverage capital ratio is 3% plus an additional "cushion" amount of
at least 100 to 200 basis points with a minimum leverage capital requirement of
not less than 4%. Tier 1 capital is the sum of common stockholders' equity,
noncumulative perpetual preferred stock (including any related surplus) and
minority interests in consolidated subsidiaries, minus all intangible assets
(other than certain mortgage and non-mortgage servicing
17
assets, purchased credit card relationships and qualifying supervisory goodwill)
minus identified losses, disallowed deferred tax assets and investments in
financial subsidiaries and certain non-financial equity investments.
In addition to the leverage ratio (the ratio of Tier 1 capital to total
assets), state-chartered nonmember banks must maintain a minimum ratio of
qualifying total capital to risk-weighted assets of at least 8% of which at
least four percentage points must be Tier 1 capital. Qualifying total capital
consists of Tier 1 capital plus Tier 2 or supplementary capital items. Tier 2
capital items include allowances for loan losses in an amount of up to 1.25% of
risk-weighted assets, cumulative preferred stock and preferred stock with a
maturity of over 20 years, certain other capital instruments and up to 45% of
pretax net unrealized holding gains on equity securities. The includable amount
of Tier 2 capital cannot exceed the institution's Tier 1 capital. Qualifying
total capital is further reduced by the amount of the bank's investments in
banking and finance subsidiaries that are not consolidated for regulatory
capital purposes, reciprocal cross-holdings of capital securities issued by
other banks, most intangible assets and certain other deductions. Under the FDIC
risk-weighting system, all of a bank's balance sheet assets and the credit
equivalent amounts of certain off-balance sheet items are assigned to one of
four broad risk weight categories from 0% to 100%, based on the risks inherent
in the type of assets or item. The aggregate dollar amount of each category is
multiplied by the risk weight assigned to that category. The sum of these
weighted values equals the bank's risk-weighted assets.
At March 31, 2003, the Bank's ratio of Tier 1 capital to average assets was
6.77%, its ratio of Tier 1 capital to risk-weighted assets was 10.07% and its
ratio of total risk-based capital to risk-weighted assets was 11.08%.
DIVIDEND LIMITATIONS. The Bank may not pay dividends on its capital stock
if its regulatory capital would thereby be reduced below the amount then
required for the liquidation account established for the benefit of certain
depositors of the Bank at the time of its conversion to stock form.
Earnings of the Bank appropriated to bad debt reserves and deducted for
Federal income tax purposes are not available for payment of cash dividends or
other distributions to stockholders without payment of taxes at the then current
tax rate by the Bank on the amount of earnings removed from the reserves for
such distributions. The Bank intends to make full use of this favorable tax
treatment and does not contemplate use of any earnings in a manner which would
limit the Bank's bad debt deduction or create federal tax liabilities.
Under FDIC regulations, the Bank is prohibited from making any capital
distributions if after making the distribution, the Bank would have: (i) a total
risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital
ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
DEPOSIT INSURANCE. The Bank is required to pay assessments to the FDIC for
insurance of its deposits by the BIF based on a percentage of its insured
deposits. Under the Federal Deposit Insurance Act, the FDIC is required to set
semi-annual assessments for BIF-insured institutions at a rate determined by the
FDIC to be necessary to maintain the designated reserve ratio of the BIF at
1.25% of estimated insured deposits or at a higher percentage of insured
deposits that the FDIC determines to be justified for that year by circumstances
raising a significant risk of substantial future losses to the BIF. In the event
the BIF should fail to meet the statutory reserve ratio, the FDIC would be
required to set semi-annual assessments for BIF members that are sufficient to
increase the reserve ratio to 1.25% within one year or in accordance with such
other schedule that the FDIC adopts by regulation to restore the reserve ratio
in not more than 15 years.
The assessment rate for an insured depository institution is determined by
the assessment risk classification assigned to the institution by the FDIC based
on the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for date closest to the last day of the fourth month
preceding the semi-annual assessment period, institutions are assigned to one of
three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund.
18
The FDIC has adopted an assessment schedule for BIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings have been reduced to zero and institutions in the
worst risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. At March 31, 2003, the Bank is considered well capitalized. In
addition, FDIC-insured institutions are required to pay assessments to the FDIC
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO"), an agency of the federal government established to finance
takeovers of insolvent thrifts. Until December 31, 1999, BIF-insured
institutions were required to pay FICO assessments at one-fifth the rate at
which Savings Association Insurance Fund ("SAIF") members were assessed. After
December 31, 1999, both BIF and SAIF members have been assessed at the same rate
for FICO payments.
The FDIC has announced that the BIF reserve ratio had fallen below 1.25% as
of March 31, 2003. The FDIC has further indicated that in the event the BIF
reserve ratio is expected to remain below the designated reserve ratio when the
FDIC establishes the assessment rate for the first half of 2003 this fall, it
will require BIF-insured banks to begin paying a premium for deposit insurance.
All Massachusetts chartered co-operative banks are required to be members
of the Share Insurance Fund. The Share Insurance Fund maintains a deposit
insurance fund which insures all deposits in member banks which are not covered
by federal insurance, which in the case of the Bank are its deposits in excess
of $100,000 per insured account. In past years, a premium of 1/24 of 1% of
insured deposits has been assessed annually on member banks such as the Bank for
this deposit insurance. However, no premium has been assessed in recent years.
PROMPT CORRECTIVE REGULATORY ACTION. Federal banking regulators are
required to take prompt corrective action if an insured depository institution
fails to satisfy certain minimum capital requirements, including a leverage
limit, a risk-based capital requirement, and any other measure deemed
appropriate by the federal banking regulators for measuring the capital adequacy
of an insured depository institution. All institutions, regardless of their
capital levels, are restricted from making any capital distribution or paying
any management fees if the institution would thereafter fail to satisfy the
minimum levels for any of its capital requirements. An institution that fails to
meet the minimum level for any relevant capital measure (an "undercapitalized
institution") may be: (i) subject to increased monitoring by the appropriate
federal banking regulator; (ii) required to submit an acceptable capital
restoration plan within 45 days; (iii) subject to asset growth limits; and (iv)
required to obtain prior regulatory approval for acquisitions, branching and new
lines of businesses. The capital restoration plan must include a guarantee by
the institution's holding company that the institution will comply with the plan
until it has been adequately capitalized on average for four consecutive
quarters, under which the holding company would be liable up to the lesser of 5%
of the institution's total assets or the amount necessary to bring the
institution into capital compliance as of the date it failed to comply with its
capital restoration plan. A "significantly undercapitalized" institution, as
well as any undercapitalized institution that does not submit an acceptable
capital restoration plan, may be subject to regulatory demands for
recapitalization, broader application of restrictions on transactions with
affiliates, limitations on interest rates paid on deposits, asset growth and
other activities, possible replacement of directors and officers, and
restrictions on capital distributions by any bank holding company controlling
the institution. Any company controlling the institution may also be required to
divest the institution or the institution could be required to divest
subsidiaries. The senior executive officers of a significantly undercapitalized
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt. In their discretion, the federal banking
regulators may also impose the foregoing sanctions on an undercapitalized
institution if the regulators determine that such actions are necessary to carry
out the purposes of the prompt corrective provisions. If an institution's ratio
of tangible capital to total assets falls below the "critical capital level"
established by the appropriate federal banking regulator, the institution will
be subject to conservatorship or receivership within specified time periods.
19
Under the implementing regulations, the federal banking regulators
generally measure an institution's capital adequacy on the basis of its total
risk-based capital ratio (the ratio of its total capital to risk-weighted
assets), Tier 1 risk-based capital ratio (the ratio of its core capital to
risk-weighted assets) and leverage ratio (the ratio of its core capital to
adjusted total assets). The following table shows the capital ratios required
for the various prompt corrective action categories.
ADEQUATELY SIGNIFICANTLY
WELL CAPITALIZED CAPITALIZED UNDERCAPITALIZED UNDERCAPITALIZED
---------------- ----------- ---------------- ----------------
Total risk-based
capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0%
Tier 1 risk-based
capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0%
Leverage ratio 5.0% or more 4.0% or more * Less than 4.0% * Less than 3.0%
<FN>
- -----------
* 3.0% if institution has a composite 1 CAMELS rating.
</FN>
A "critically undercapitalized" institution is defined as an institution that
has a ratio of "tangible equity" to total assets of less than 2.0%. Tangible
equity is defined as core capital plus cumulative perpetual preferred stock (and
related surplus) less all intangible assets other than qualifying supervisory
goodwill and certain purchased mortgage servicing rights. The FDIC may
reclassify a well capitalized depository institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically undercapitalized) if the FDIC determines, after notice
and an opportunity for a hearing, that the savings institution is in an unsafe
or unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category.
PATRIOT ACT. The Patriot Act is intended to strengthen U.S. law
enforcement's and the intelligence communities' abilities to work cohesively to
combat terrorism on a variety of fronts. The potential impact of the Patriot Act
on financial institutions of all kinds is significant and wide ranging. The
Patriot Act contains sweeping anti-money laundering and financial transparency
laws and imposes various regulations including standards for verifying client
identification at account opening, and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
LOANS TO EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS. Loans to
directors, executive officers and principal stockholders of a state non-member
bank like the Bank must be made on substantially the same terms as those
prevailing for comparable transactions with persons who are not executive
officers, directors, principal stockholders or employees of the Bank unless the
loan is made pursuant to a compensation or benefit plan that is widely available
to employees and does not favor insiders. Loans to any executive officer,
director and principal stockholder together with all other outstanding loans to
such person and affiliated interests generally may not exceed 15% of the bank's
unimpaired capital and surplus and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Loans to directors,
executive officers and principal stockholders, and their respective affiliates,
in excess of the greater of $25,000 or 5% of capital and surplus (up to
$500,000) must be approved in advance by a majority of the board of directors of
the bank with any "interested" director not participating in the voting. State
non-member banks are prohibited from paying the overdrafts of any of their
executive officers or directors unless payment is made pursuant to a written,
pre-authorized interest-bearing extension of credit plan that specifies a method
of repayment or transfer of funds from another account at the bank. Loans to
executive officers may not be made on terms more favorable than those afforded
other borrowers and are restricted as to type, amount and terms of credit. In
addition, Section 106 of the BHCA prohibits extensions of credit to executive
officers, directors, and greater than 10% stockholders of a depository
institution by any other institution which has a correspondent banking
relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
TRANSACTIONS WITH AFFILIATES. A state non-member bank or its subsidiaries
may not engage in "covered transactions" with any one affiliate in an amount
greater than 10% of such bank's capital stock and surplus, and for all such
transactions with all affiliates a state non-member bank is limited to an amount
equal to 20% of capital
20
stock and surplus. All such transactions must also be on terms substantially the
same, or at least as favorable, to the bank or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. An affiliate of a state non-member bank is any company or entity
which controls or is under common control with the state non-member bank and,
for purposes of the aggregate limit on transactions with affiliates, any
subsidiary that would be deemed a financial subsidiary of a national bank. In a
holding company context, the parent holding company of a state non-member bank
(such as the Company) and any companies which are controlled by such parent
holding company are affiliates of the state non-member bank. The BHCA and
Regulation W further prohibit a depository institution from extending credit to
or offering any other services, or fixing or varying the consideration for such
extension of credit or service, on the condition that the customer obtain some
additional service from the institution or certain of its affiliates or not
obtain services of a competitor of the institution, subject to certain limited
exceptions.
MASSACHUSETTS STATE LAW. As a Massachusetts-chartered co-operative bank,
the Bank is subject to the applicable provisions of Massachusetts law and the
regulations of the Commissioner adopted thereunder. The Bank derives its lending
and investment powers from these laws, and is subject to periodic examination
and reporting requirements by and of the Commissioner. In addition, the Bank is
required to make periodic reports to the Co-operative Central Bank. In 1990,
legislation was enacted permitting banks nationwide to enter the Bank's market
area and compete for deposits and loan originations. The approval of the
Massachusetts Commissioner of Banks is required prior to any merger or
consolidation, or the establishment or relocation of any office facility.
EMPLOYEES
At March 31, 2003, the Company and the Bank employed 94 full-time and 36
part-time employees. The Company's and Bank's employees are not represented by
any collective bargaining agreement. Management of the Company and Bank
considers its relations with its employees to be good.
ITEM 2. PROPERTIES
- -------------------
The Bank owns all its offices, except the Burlington and Malden branch
offices, and the loan and operations centers located in Somerville. Net book
value includes the cost of land, buildings and improvements as well as leasehold
improvements, net of depreciation and/or amortization. At March 31, 2003, all of
the Bank's offices were in reasonable condition and met the business needs of
the Bank. The following table sets forth the location of the Bank's offices, as
well as certain information relating to these offices as of March 31, 2003
(dollars in thousands):
NET BOOK
YEAR VALUE AT
OFFICE LOCATION OPENED MARCH 31, 2003
--------------- ------ --------------
MAIN OFFICE
399 Highland Avenue
Somerville, MA............................................. 1974 $ 273
BRANCH OFFICES:
175 Broadway
Arlington, MA.............................................. 1982 123
85 Wilmington Road
Burlington, MA............................................. 1978(a) 2
1192 Boylston Street
Chestnut Hill (Brookline), MA.............................. 1954 127
137 Pleasant Street
Malden, MA................................................. 1975(b) 22
846 Main Street
Melrose, MA................................................ 1994 163
21
NET BOOK
YEAR VALUE AT
OFFICE LOCATION OPENED MARCH 31, 2003
--------------- ------ --------------
275 Main Street
Woburn, MA................................................. 1980 $ 459
198 Lexington Street
Woburn, MA................................................. 1974 163
Woburn High School
Woburn, MA................................................. 2002(c) 37
OPERATIONS CENTER
17 Inner Belt Road
Somerville, MA............................................. 1994(d) 8
COMMERCIAL LOAN CENTER
401 Highland Avenue........................................ 2002(e) 51
Somerville, MA
RESIDENTIAL LOAN CENTER
403 Highland Avenue
Somerville, MA............................................. 2002(f) 51
<FN>
_______________
(a) The lease for the Burlington branch expires in 2007 with no renewal option.
(b) The lease for the Malden branch expires in 2005 with an option to extend
the lease for one ten-year term.
(c) The lease for the Woburn High School branch is for one year, renewable
annually.
(d) The lease for the Operations Center expires in 2005 with no renewal option.
(e) The lease for the Commercial Loan Center expires in 2006 with an option to
extend for one three-year term.
(f) The lease for the Residential Loan Center expires in 2005 with an option to
extend for one three-year term.
</FN>
At March 31, 2003, the net book value of the Bank's premises and equipment
was $1.9 million.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
The Bank from time to time is involved as plaintiff or defendant in various
legal actions incident to its business. Except as described herein, none of
these actions are believed to be material, either individually or collectively,
to the results of operations and financial condition of the Company or any
subsidiary.
The Bank has been named as defendant in a civil suit filed March 28, 2002
in Middlesex Superior Court under the caption Yi v. Central Bank in which it is
------------------
alleged, inter alia, that the Bank committed an unfair or deceptive trade
----- ----
practice by failing to pay surplus foreclosure proceeds to a junior lien holder
in 1994. The plaintiff seeks damages of $165,000 plus statutory interest of
approximately $175,000 and has applied for a multiple damage award under Chapter
93A of the Massachusetts General Laws which provides for up to treble damages if
a violation is found to be willful or knowing. While the Bank believes that it
has meritorious defenses to all such claims and intends to vigorously defend
against them, a settlement offer has been made to the plaintiffs' counsel,
however, no response has been received.
The Company and certain present and former directors have been named in
related federal and state court lawsuits brought by PL Capital, LLC and
affiliates ("PL Capital") and also by Lawrence B. Seidman and affiliates
("Seidman"), respectively, current and former stockholders, in which PL Capital
has challenged actions by the directors including, among other things, a
decision on setting the date for closing of the polls for voting at the 2002
Annual Meeting and the directors' decision following that Annual Meeting not to
seek the sale of the Company. PL Capital and Seidman have challenged the
directors' determination that PL Capital and Seidman secretly acted in concert
in violation of the Company's Shareholder Rights Agreement ("Rights Plan").
22
After a review and recommendation by a Special Committee of the Board of
Directors, the Board of Directors determined on January 28, 2003 that PL
Capital, which owned 9.8% of Central Bancorp shares, had secretly coordinated a
November 4, 2002 block trade to place 8.3% of Company's common stock in the
hands of Seidman, Joseph Stilwell ("Stilwell") and Robert Reichenbach
("Reichenbach"), thereby exceeding the 10% ownership limit set by the
Shareholder Rights Plan. As a result, the Special Committee and Board of
Directors determined that PL Capital, Seidman, Stilwell and Reichenbach
(collectively, the "PL Capital-Seidman Group") constitute an Acquiring Person
under the Rights Plan. Seidman and PL Capital immediately commenced actions in
the Massachusetts Superior Court for Suffolk County to enjoin implementation of
the Rights Plan, which once implemented would provide an issuance of one
additional share of common stock for each share presently owned to all of the
Company's shareholders other than the PL Capital-Seidman Group. The
Massachusetts Superior Court entered an ex parte temporary restraining order,
-- -----
later extended to a preliminary injunction, enjoining the Company and its Board
of Directors from implementing the Rights Plan pending trial on the merits.
Following expedited proceedings in Massachusetts federal and state courts, the
parties have asked for rulings on the legal standard applicable to the
directors' decisions challenged by PL Capital and Seidman and on whether PL
Capital and Seidman can avoid application of the Rights Plan to them by virtue
of Seidman's sale of all of his shares in the Company. Seidman sold those shares
immediately after his motion for summary judgment in the federal court was
denied and contemporaneously with the federal court's order that the legal
standard on the applicable Rights Plan claims be determined by the state court
and that trial then proceed as scheduled in the state court. (On February 11 and
February 26, 2003, respectively, the Company and its directors entered into
settlement agreements with Stilwell and Reichenbach (and their respective
affiliates) and the litigation was subsequently dismissed with respect to those
parties only.)
PL Capital's initial complaint was filed on October 1, 2002 in the United
States District Court for the District of Massachusetts and amended on November
12, 2002, challenging, respectively, the decisions of the Company's Board of
Directors concerning setting a date for closing the polls on voting for
directors at the 2002 Annual Meeting and the Board of Directors' decision not to
seek sale of the Company. (PL Capital's amended complaint also challenged the
directors' decision to re-elect Marat E. Santini and John F. Gilgun, Jr. rather
than PL Capital's nominees to the Board of the Bank and the Company's
reimbursement of legal fees for Joseph and John Doherty, and alleged unfair and
deceptive trade practices within the meaning of Chapter 93A of the Massachusetts
General Laws.) PL Capital's requests for relief were opposed by the Company and
its directors and were denied by the court and dismissed on November 13, 2002.
PL Capital and Seidman subsequently filed complaints in the Massachusetts
Superior Court for Suffolk County on January 30 and 31, 2003 challenging the
directors' Rights Plan decision of January 28, 2003, but the state court found
that PL Capital and Seidman had apparently failed to inform the Court that PL
Capital had filed related action in federal court (see above) and was already a
party there to identical claims concerning the Rights Plan. (The Special
Committee had filed in federal court on January 28, 2003, seeking a declaratory
judgment that its decision under the Rights Plan complied with applicable
Massachusetts law, to prevent such circumvention by PL Capital or Seidman.)
Acccordingly, PL Capital and Seidman were ordered by the state court to proceed
in federal court, where PL Capital had initiated action in October 2002.
PL Capital and Seidman have filed additional claims in the federal court
challenging other decisions made by the Company's directors. PL Capital's claims
in the federal court against the Company, its directors, the Central Cooperative
Bank Employee Stock Ownership Plan Trust (the "ESOP") and the Joseph R. Doherty
Family Limited Partnership, L.P. also challenge the directors' approval of a
loan from the Company to the ESOP and allege interference with PL Capital's
voting rights as a result of the ESOP's purchase of Reichenbach's shares of the
Company's common stock (in connection with Reichenbach's decision to settle out
of the litigation). PL Capital further alleges that John Doherty, Joseph
Doherty, the Joseph R. Doherty Family Limited Partnership, L.P. and the ESOP
(and its trustees) violated Section 13(d) of the Securities Exchange Act of 1934
("Exchange Act") by allegedly failing to disclose certain relationships and
purported motives in connection with their ownership of the Company's stock. PL
Capital also seeks a declaratory judgment that former director Garrett Goodbody
and director Richard Fates are entitled to indemnification from the Company with
respect to the litigation. PL Capital seeks declaratory and injunctive relief,
money damages and attorneys' fees. Seidman has also alleged in the federal
court, in addition to claims concerning the directors' Rights Plan
determination, claims similar to PL Capital's alleging violation of Section
13(d) of the Exchange Act by John Doherty and Joseph Doherty and interference
with Seidman's voting rights by virtue of the ESOP's purchase of Reichenbach's
shares of the Company's common stock. Seidman seeks declaratory relief and
attorneys' fees. The Company has also sought a declaratory judgment from both
the state and federal courts seeking to resolve those litigations (and, in the
federal court, the Company has
23
also alleged that PL Capital and Seidman violated Section 13(d) of the Exchange
Act by failing to disclose to the Company, its shareholders and the investing
public their coordinated ownership of the Company's stock).
The Company believes that all of PL Capital's and Seidman's claims are without
merit and intends to defend them vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
- --------------------------------------------------------------------------------
The Company's common stock is quoted on the Nasdaq National MarketSM under
the symbol "CEBK." At March 31, 2003, there were 1,662,433 shares of the common
stock outstanding and approximately 249 holders of record. The foregoing number
of holders does not reflect the number of persons or entities who held the stock
in nominee or "street name" through various brokerage firms. In October 1996,
the Company established a quarterly cash dividend policy and made its first
dividend distribution on November 15, 1996; it has paid cash dividends on a
quarterly basis since initiating the dividend program.
The following tables list the high and low prices for the Common Stock
during each quarter of fiscal 2003 and fiscal 2002 as reported by the Nasdaq
National MarketSM, and the amounts and payable dates of the cash dividends paid
during each quarter of fiscal 2003 and fiscal 2002. The stock quotations
constitute interdealer prices without retail markups, markdowns or commissions,
and may not necessarily represent actual transactions.
COMMON STOCK PRICES CASH DIVIDENDS (PAYABLE DATES)
Fiscal 2003 High Low Fiscal 2003 Amount
-------------------------------------------------------- -----------------------
6/30/02 $31.95 $26.50 5/17/02 $0.10
9/30/02 33.50 28.05 8/16/02 0.10
12/31/02 31.50 28.31 11/15/02 0.12
3/31/03 36.55 30.11 2/14/03 0.12
Fiscal 2002 High Low Fiscal 2002 Amount
-------------------------------------------------------- ------------------------
6/30/01 $26.00 $17.50 5/18/01 $0.10
9/30/01 27.75 21.50 8/17/01 0.10
12/31/01 26.99 21.00 11/16/01 0.10
3/31/02 29.75 25.00 2/15/02 0.10
24
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
AT OR FOR THE YEAR ENDED MARCH 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET
Total assets................................ $ 477,208 $ 468,219 $ 449,337 $ 409,557 $ 364,696
Total loans................................. 390,464 371,707 345,793 320,013 280,346
Investments:
Available for sale...................... 61,111 73,884 49,388 68,316 68,881
Held to maturity........................ -- -- -- -- --
Deposits.................................... 287,959 261,907 287,167 258,339 266,463
Borrowings.................................. 144,576 164,000 121,000 111,000 57,000
Total stockholders' equity.................. 39,443 38,954 38,212 37,397 38,742
Shares outstanding.......................... 1,662 1,633 1,684 1,810 1,967
STATEMENTS OF OPERATIONS
Net interest and dividend income............ $ 17,257 $ 14,413 $ 13,914 $ 13,375 $ 11,947
Provision for loan losses................... -- -- -- -- --
Net gain (loss) from sale and write-down of
investment securities................... (308) (150) 680 1,013 580
Gain on sale of loans....................... 796 -- -- -- --
Other non-interest income................... 917 838 608 656 788
Total non-interest expenses................. 13,877 10,464 10,330 9,345 8,773
Income before cumulative effect of
accounting change....................... 2,187 2,860 3,109 3,567 2,682
Net income.................................. 2,187 2,860 3,109 3,333 2,682
Earnings per common share after cumulative
effect of accounting change - diluted... 1.37 1.72 1.81 1.77 1.38
SELECTED RATIOS
Interest rate spread........................ 3.29% 2.85% 2.80% 3.11% 2.97%
Net yield on interest-earning assets........ 3.71 3.36 3.38 3.64 3.29
Equity-to-assets............................ 8.27 8.32 8.50 9.13 10.62
Return on average assets before
cumulative effect of change in
accounting principle.................... 0.46 0.65 0.74 0.94 0.72
Return on average stockholders' equity
before cumulative effect of change in
accounting principle.................... 5.52 7.62 8.11 9.49 7.12
Dividend payout ratio....................... 33.24 23.39 22.42 20.67 23.45
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
GENERAL
The operations of the Company and its subsidiary, the Bank, are generally
influenced by overall economic conditions, the related monetary and fiscal
policies of the federal government and the regulatory policies of financial
institution regulatory authorities, including the Commissioner, the Federal
Reserve Board and the FDIC.
The Bank monitors its exposure to earnings fluctuations resulting from
market interest rate changes. Historically the Bank's earnings have been
vulnerable to changing interest rates due to differences in the terms to
maturity or repricing of its assets and liabilities. For example, in a rising
interest rate environment, the Bank's net interest income and net income could
be negatively affected as interest-sensitive liabilities (deposits and
borrowings) could adjust more quickly to rising interest rates than the Bank's
interest-sensitive assets (loans and investments).
The following is a discussion and analysis of the Company's results of
operations for the last three fiscal years and its financial condition at the
end of fiscal years 2003 and 2002. Management's discussion and analysis of
financial condition and results of operations should be read in conjunction with
the consolidated financial statements and accompanying notes.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of the Company's financial condition
and results of operations are based on the consolidated financial statements
which are prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of such financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. On an ongoing basis, management evaluates its
estimates, including those related to the allowance for loan losses. Management
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis in making judgments about the carrying values of assets that are
not readily apparent from other sources. Actual results could differ from the
amount derived from management's estimates and assumptions under different
assumptions or conditions.
Management believes the allowance for loan losses policy is a critical
accounting policy that required the most significant estimates and assumptions
used in the preparation of the consolidated financial statements. The allowance
for loan losses is based on management's evaluation of the level of the
allowance required in relation to the estimated loss exposure in the loan
portfolio. Management believes the allowance for loan losses is a significant
estimate and therefore regularly evaluates it for adequacy by taking into
consideration factors such as prior loan loss experience, the character and size
of the loan portfolio, business and economic conditions and management's
estimation of future losses. The use of different estimates or assumptions could
produce different provisions for loan losses. Refer to the discussion of
Allowance for Loan Losses in the Business Section and Notes 1 and 4 to
Consolidated Financial Statements for a detailed description of management's
estimation process and methodology related to the allowance for loan losses.
RESULTS OF OPERATIONS
The Company reported net income of $2.2 million or $1.37 per diluted share
for fiscal 2003, as compared to $2.9 million, or $1.72 per diluted share for
fiscal 2002 and $3.1 million or $1.81 per diluted share for fiscal 2001.
The Company's earnings in fiscal 2003 were adversely affected by two
significant items, namely, state legislation (the "REIT legislation") passed in
March 2003 that retroactively eliminated the dividends received deduction on
dividends received from the Bank's REIT subsidiary and legal fees incurred in
connection with litigation with certain of the Company's shareholders.
26
The REIT legislation resulted in an increase in the Company's provision for
income taxes of $835 thousand in the fourth quarter of fiscal 2003. In June
2003, a group of banks negotiated a settlement with the Massachusetts Department
of Revenue ("DOR") and, as a result, the Bank will recognize in the first
quarter of fiscal 2004 a reduction in the Company's provision for income taxes
of $374 thousand.
The legal fees associated with the litigation with certain shareholders,
who initially filed suit against the Company in October 2002 following the
annual meeting of shareholders, totaled approximately $875 thousand, net of
taxes. The Company has coverage under its directors' and officers' liability
insurance policy for reimbursement of legal fees, subject to limitations,
incurred in connection with this litigation. The extent of coverage is currently
being resolved with the insurance carrier. At March 31, 2003, the Company had
not received any insurance reimbursement and, accordingly, net income was
reduced to the extent of legal fees incurred.
The Company's earnings decrease for fiscal 2002 compared with fiscal 2001
was primarily due to write-downs of $642 thousand in certain equity securities
which had experienced a decline in fair value judged by management to be other
than temporary, partially offset by higher net interest income.
INTEREST RATE SPREAD. The Company's and the Bank's operating results are
significantly affected by its net interest spread, which is the difference
between the yield on loans and investments and the interest cost of deposits and
borrowings. The interest spread is affected by economic conditions and market
factors that influence interest rates, loan demand and deposit flows. The
following table present average balances, interest income and expense and yields
earned or rates paid on all interest-earning assets and interest-bearing
liabilities for the years indicated.
YEARS ENDED MARCH 31,
-----------------------------------------------------------------
2003 2002
------------------------------- ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------ ------- -------- ------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans................. $370,505 $24,952 6.73% $ 327,743 $23,567 7.19%
Other loans.................... 7,997 586 7.33 7,528 670 8.90
-------- ------- --------- -------
Total loans................ 378,502 25,538 6.75 335,271 24,237 7.23
Short-term investments......... 7,620 125 1.64 22,076 866 3.92
Investment securities.......... 78,928 4,466 5.66 71,427 4,170 5.84
-------- ------- --------- -------
Total investments.......... 86,548 4,591 5.30 93,503 5,036 5.39
-------- ------- --------- -------
Total interest-earning
assets................... 465,050 30,129 6.48 428,774 29,273 6.83
------- -------
Allowance for loan losses ....... (3,287) (3,234)
Non-interest-earning assets...... 14,406 14,951
-------- ---------
Total assets.............. $476,169 $ 440,491
======== =========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Deposits....................... $248,027 $ 5,601 2.26 $ 248,274 8,119 3.27
Short-term borrowings.......... 505 9 1.78 477 10 2.10
Advances from FHLB of Boston... 155,085 7,262 4.68 124,203 6,731 5.42
-------- ------- --------- -------
Total interest-bearing
liabilities............. 403,617 12,872 3.19 372,954 14,860 3.98
------- ---- ------- ----
Non-interest-bearing deposits.... 29,586 24,535
Other liabilities................ 3,371 4,481
-------- ---------
Total liabilities......... 436,574 401,970
Stockholders' equity............. 39,595 38,521
-------- ---------
Total liabilities and
stockholders' equity.... $476,169 $ 440,491
======== =========
Net interest and dividend income. $17,257 $14,413
======= =======
Interest rate spread............. 3.29% 2.85%
==== ====
Net yield on interest-earning
assets......................... 3.71% 3.36%
==== ====
YEARS ENDED MARCH 31,
-----------------------------
2001
-----------------------------
AVERAGE YIELD/
BALANCE INTEREST COST
------- -------- ------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Mortgage loans................. $ 334,513 $ 25,613 7.66%
Other loans.................... 7,219 716 9.92
--------- ---------
Total loans................ 341,732 26,329 7.70
Short-term investments......... 7,457 487 6.53
Investment securities.......... 62,998 4,101 6.51
--------- ---------
Total investments.......... 70,455 4,588 6.51
--------- ---------
Total interest-earning
assets................... 412,187 30,917 7.50
---------
Allowance for loan losses ....... (3,042)
Non-interest-earning assets...... 13,676
---------
Total assets.............. $ 422,821
=========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Deposits....................... $ 249,753 10,087 4.04
Short-term borrowings.......... 874 58 6.64
Advances from FHLB of Boston... 111,106 6,858 6.17
--------- ---------
Total interest-bearing
liabilities............. 361,733 17,003 4.70
--------- ----
Non-interest-bearing deposits.... 20,382
Other liabilities................ 2,383
---------
Total liabilities......... 384,498
Stockholders' equity............. 38,323
---------
Total liabilities and
stockholders' equity.... $ 422,821
=========
Net interest and dividend income. $ 13,914
=========
Interest rate spread............. 2.80%
====
Net yield on interest-earning
assets......................... 3.38%
====
27
RATE/VOLUME ANALYSIS. The effect on net interest income of changes in
interest rates and changes in the amounts of interest-earning assets and
interest-bearing liabilities is shown in the following table. Information is
provided on changes for the fiscal years indicated attributable to changes in
interest rates and changes in volume. Changes due to combined changes in
interest rates and volume are allocated between changes in rate and changes in
volume proportionally to the change due to volume and the change due to rate.
2003 VS. 2002 2002 VS. 2001
----------------------------- -----------------------------
CHANGES DUE TO CHANGES DUE TO
INCREASE (DECREASE) IN: INCREASE (DECREASE) IN:
----------------------------- -----------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
(IN THOUSANDS)
Interest income:
Mortgage loans....................... $ 2,953 $(1,568) $ 1,385 $ (508) $(1,538) $(2,046)
Other loans.......................... 40 (124) (84) 30 (76) (46)
------- ------- -------- ------- ------- -------
Total income from loans.......... 2,993 (1,692) 1,301 (478) (1,614) (2,092)
------- ------- -------- ------- ------- -------
Short-term investments............... (393) (348) (741) 639 (260) 379
Investment securities................ 428 (132) 296 516 (447) 69
------- ------- -------- ------- ------- -------
Total income from investments.... 35 (480) (445) 1,155 (707) 448
------- ------- -------- ------- ------- -------
Total interest and dividend
income......................... 3,028 (2,172) 856 677 (2,321) (1,644)
------- ------- -------- ------- ------- -------
Interest expense:
Deposits............................. (8) (2,510) (2,518) (60) (1,908) (1,968)
Short-term borrowings................ 1 (2) (1) (19) (29) (48)
Advances from FHLB of Boston......... 1,529 (998) 531 758 (885) (127)
------- ------- -------- ------- ------- -------
Total interest expense........... 1,522 (3,510) (1,988) 679 (2,822) (2,143)
------- ------- -------- ------- ------- -------
Net interest and dividend income....... $ 1,506 $ 1,338 $ 2,844 $ (2) $ 501 $ 499
======= ======= ======== ======= ======= =======
INTEREST AND DIVIDEND INCOME. The Company experienced a $2.8 million
overall increase in net interest and dividend income for the year ended March
31, 2003 compared to fiscal 2002. Interest income on loans increased by $1.3
million to $25.5 million due to a $43.2 million increase in average loan
balances partially offset by a 48 basis point decline in the average rate
earned. During fiscal 2003, the Bank commenced its mortgage banking initiative
and sought to increase its origination of residential mortgage loans and to
eliminate the purchase of such loans. With the continuing decline of interest
rates which reached a forty-year low in fiscal 2003, the Bank was able to double
its origination of such loans to $118.4 million of which $35.7 million were sold
in the secondary market. The Bank has continued to emphasize commercial real
estate lending in order to diversify the loan portfolio and improve overall
portfolio yield. Interest and dividend income on investments decreased by $445
thousand in fiscal 2003 due primarily to a 9 basis point decrease in the rate
earned on investments and a $7.0 million decrease in the average balance of
investments. The overall total average balance of interest-earning assets
increased by $36.3 million from fiscal 2002 to fiscal 2003, and the average
yield on all interest-earning assets decreased by 35 basis points between the
two fiscal years.
The Bank experienced a $499 thousand overall increase in net interest and
dividend income for the year ended March 31, 2002 compared to fiscal 2001.
Interest income on loans decreased by $2.1 million to $24.2 million due to a
$6.5 million decrease in average loan balances and a 47 basis point decline in
the average rate earned. During fiscal year 2002, the Bank originated and
purchased new loans amounting to $157.9 million, including $84.0 million during
the fourth quarter of the year. With declining interest rates, management had
decided to slow down the origination of fixed-rate residential loans during the
first half of the year. During the second half of the year, the Bank priced its
residential loans more competitively which increased origination volume.
Additionally, interest and dividend income on investments increased by $448
thousand in fiscal 2002 due primarily to an $23.0 million increase in average
total balances of investments partially offset by a 112 basis point decrease in
the rate earned on investments. The overall total average balance of
interest-earning assets increased by $16.6 million from fiscal 2001 to fiscal
2002, and the average yield on all interest-earning assets decreased by 67 basis
points between the two fiscal years.
28
INTEREST EXPENSE. For fiscal 2003, interest expense on deposits decreased
by $2.5 million from $8.1 million in fiscal 2002 to $5.6 million in fiscal 2003.
The decrease can be attributed primarily to a 101 basis point reduction in the
cost of deposits in fiscal 2003 reflecting the series of reductions in interest
rates initiated by the Federal Reserve Board beginning in January 2001. Interest
expense on borrowings increased $530 thousand as the average balance of
borrowings rose to $155.6 million during fiscal 2003 from $124.7 million during
fiscal 2002, which was partially offset by a decrease of 74 basis points in the
rate paid on these borrowings to 4.67% in fiscal 2003 from 5.41% in fiscal 2002.
There was an overall increase in the average balance of interest-bearing
liabilities of $30.7 million during fiscal 2003 compared to fiscal 2002.
For fiscal 2002, interest expense on deposits decreased by $2.0 million
from $10.1 million in fiscal 2001 to $8.1 million in fiscal 2002. The decrease
can be attributed primarily to a 77 basis point reduction in the cost of
deposits in fiscal 2002 reflecting the series of reductions in interest rates
initiated by the Federal Reserve Board beginning in January 2001 and the
repricing of nearly 70% of certificates of deposit outstanding at March 31, 2001
in fiscal 2002. Interest expense on borrowings decreased $175 thousand as the
average balance of borrowings rose to $124.7 million during fiscal 2002 from
$112.0 million during fiscal 2001, which was more than offset by a decrease of
77 basis points in the rate paid on these borrowings to 5.41% in fiscal 2002
from 6.18% in fiscal 2001. There was an overall increase in the average balance
of interest-bearing liabilities of $11.2 million during fiscal 2002 compared to
fiscal 2001.
PROVISION FOR LOAN LOSSES. Due to the high level of asset quality, as
measured by low delinquency rates and the absence of non-performing assets
during the past two years, the Bank made no provision for loan losses during
fiscal 2003, 2002 and 2001. At March 31, 2003 and 2002, the Bank had no
non-performing loans.
NON-INTEREST INCOME. Total non-interest income for fiscal 2003 was $1.4
million, compared to $688 thousand during fiscal 2002. During the second half of
fiscal 2003, the Bank commenced its mortgage banking initiative and sold $35.7
million of fixed rate residential mortgage loans in the secondary market. These
loans were sold on a servicing released basis. The Bank realized a gain of $796
thousand on the sale of these loans. Non-interest income in fiscal 2003 was
adversely affected by the additional write-down of $803 thousand in certain
equity securities, which had experienced a decline in fair value judged to be
other than temporary.
Total non-interest income for fiscal 2002 was $688 thousand, compared to
$1.3 million during fiscal 2001. The primary reason for the $600 thousand
decline in fiscal 2002 was the write-down of $642 thousand in certain equity
securities which had experienced a decline in fair value judged to be other than
temporary and a decrease in gains on the sale of securities. Partially
offsetting this decrease was an increase in deposit service charges attributable
to an increase in core deposit accounts and, for the first time, brokerage
income from the Bank's new offering of investment products through a third
party.
NON-INTEREST EXPENSES. Non-interest expenses increased $3.4 million during
fiscal 2003, as compared to the year ended March 31, 2002. This increase is due
to increases in salaries and employee benefits ($1.3 million), data processing
expenses ($170 thousand), professional fees ($1.4 million), advertising ($133
thousand) and other non-interest expenses ($726 thousand), partially offset by
the elimination of goodwill amortization ($288 thousand).
Salaries and employee benefits increased by $1.3 million, or 23.4%, in
fiscal 2003 as compared to fiscal 2002 due to several factors including
additional lending personnel in both the residential and commercial real estate
areas, an overall salary increase of approximately 4%, additional ESOP expense
associated with shares acquired during the year and bonuses earned in connection
with the Bank's management incentive compensation plan (no bonuses were earned
in fiscal 2002).
Data processing expenses increased by $170 thousand, or 17.6%, in fiscal
2003 as compared to fiscal 2002 due primarily to volume related charges for both
data processing and item processing.
Professional fees increased by $1.4 million in fiscal 2003 as compared to
fiscal 2002 due primarily to legal fees associated with pending litigation with
certain of the Company's shareholders and, to a lesser extent, legal and other
professional fees incurred in connection with the contested election of
directors at the 2002 annual meeting of stockholders. Professional fees incurred
for such activities aggregated approximately $1.65 million in fiscal 2003.
29
Exclusive of such costs, professional fees would have been approximately $758
thousand in fiscal 2003. Future legal fees associated with this litigation are
likely to be significant.
As previously noted, the Company has coverage under its directors' and
officers' liability insurance policy for reimbursement of legal fees, subject to
limitations, incurred in connection with the shareholder litigation. No
reimbursement of legal fees was received in fiscal 2003. Management is currently
working with its insurance carrier to ensure that the Company receives full
reimbursement of all legal fees to which it is entitled. At this time, no
estimate of any future insurance recovery is available.
Advertising expense increased by $133 thousand, or 51.0%, in fiscal 2003 as
compared to fiscal 2002 due to increased promotion of the Bank's expanded
residential and commercial real estate lending programs. During fiscal 2002, the
Bank had reduced its use of advertising to promote certificates of deposit.
Other non-interest expenses increased by $726 thousand, or 59.9%, in fiscal
2003 as compared to fiscal 2002. Such increase was due to several factors
including the accrual for the Bank's portion of the estimated cost of resolution
of a commercial claim filed in 2002, as well as increases in ATM expense,
memberships and contributions, communication costs and directors fees.
Non-interest expense increased $134 thousand during fiscal 2002, as
compared to the year ended March 31, 2001. Such increase is primarily due to
increases in professional fees of $294 thousand and data processing service fees
of $119 thousand, partially offset by decreases in advertising of $285 thousand
and occupancy and equipment expenses of $68 thousand. Salaries and employee
benefits, the largest component of non-interest expenses was virtually unchanged
during fiscal 2002.
The increase in professional fees of $294 thousand in fiscal 2002 compared
to fiscal 2001 was primarily due to increased legal and consulting costs. The
increase in data processing service fees was due to the change, in November
2000, to a new data processing system more suitable to the Bank's needs. The
decrease in advertising of $285 thousand occurred as the Bank curtailed its
regular promotion of certificates of deposit.
Salaries and employee benefits expense decreased approximately $9 thousand
during fiscal 2002 despite a $175 thousand increase in ESOP expenses due to the
initial application of the fair value method of accounting for the allocation of
ESOP shares to employees. Prior to fiscal 2002, compensation expense was
recognized as shares were allocated to ESOP participants' accounts based on the
cost of such shares to the ESOP. In future periods, compensation expense
relating to the ESOP may be significantly affected by the market value of the
Company's common stock.
INCOME TAXES. The effective rates of income tax expense for the years ended
March 31, 2003, 2002 and 2001 were 54.3%, 38.3% and 36.2%, respectively.
Exclusive of the impact of an additional state tax provision, as described
below, necessitated by recent tax legislation, the effective tax rate in 2003
would have been 36.8%.
The Governor of Massachusetts signed legislation on March 5, 2003, which
expressly disallows deductions for dividends received from a REIT, resulting in
such dividends being subject to state taxation. In addition, the legislation
applies retroactively to tax years ending on or after December 31, 1999. In the
fourth quarter of 2003, the Company provided additional income taxes of $835
thousand as a result of this legislation. Beginning in May 2002, the DOR had
sent assessment notices and, later, demand notices to Massachusetts financial
institutions with REIT subsidiaries asserting that the state statute providing
for a 95% dividends received deduction on certain distributions did not apply to
dividends received from a REIT subsidiary. With the passage of the
aforementioned legislation, the focus of this disputed matter was changed from
an interpretation of tax law to the constitutionality of a retroactive change in
the law.
Given the significant financial impact of this issue on numerous
Massachusetts financial institutions and the considerable uncertainty of the
constitutionality of the retroactive provisions of the legislation, a settlement
was reached in June 2003 among the DOR and the majority of affected financial
institutions. This settlement provides that 50% of all dividends received by the
Bank from its REIT subsidiary from 1999 through December 2002 are subject to
state income taxes. In addition, interest on the related taxes is to be
assessed. In settlement of this matter,
30
the Bank paid $431 thousand in June 2003 and also recognized a reduction in its
accrued tax liabilities of $374 thousand, which will increase net income by the
same amount in the first quarter of fiscal 2004.
As a result of this legislation, the Company's effective tax rate is likely
to increase closer to the effective statutory rate for Massachusetts financial
institutions of approximately 40.9%.
FINANCIAL CONDITION
Total assets at March 31, 2003 amounted to $477.2 million, an increase of
$9.0 million from $468.2 million at March 31, 2002. Total assets at March 31,
2002 amounted to $468.2 million, an increase of $18.9 million from $449.3
million at March 31, 2001. During fiscal 2003, increases in the Bank's core
deposits were used to repay FHLB advances, which contributed to the modest asset
growth in fiscal 2003.
Net loans increased $18.8 million to $387.2 million at March 31, 2003 from
$368.4 million at March 31, 2002. At March 31, 2003, mortgage loans were $383.9
million, a $20.6 million increase from March 31, 2002. The increase in mortgage
loans was entirely attributable to increases in commercial real estate and
construction loans which increased $20.1 million and $9.3 million, respectively.
The growth in commercial real estate loans and construction loans is
attributable to the addition of experienced commercial lenders and expansion of
the credit administration function in recent years. Residential mortgage loans
decreased $8.7 million during fiscal 2003 and represented 60.8% of loans at
March 31, 2003 compared to 66.2% at March 31, 2002. During fiscal 2003, the Bank
commenced operation of its mortgage banking initiative, which resulted in the
sale of $35.7 million in fixed rate residential mortgage loans.
Total deposits at March 31, 2003 were $288.0 million, a $26.1 million
increase from $261.9 million one year earlier. This increase is attributable to
core deposit growth of $31.3 million, or 20.5%, partially offset by a decrease
in certificates of deposit of $5.2 million. The majority of core deposit growth
was in money market accounts, the highest paying core deposit account. This
growth has been aided by the introduction and promotion of the Bank's Community
Package Account product, low interest rates and the continuing uncertainty in
the stock market.
Advances from the FHLB of Boston decreased to $144.4 million at March 31,
2003 from $161.0 million at March 31, 2002. The Bank decreased its borrowings
from the FHLB of Boston in fiscal 2003 consistent with its intent of reducing
the utilization of FHLB advances.
Stockholders' equity increased to $39.4 million at March 31, 2003 from
$39.0 million at March 31, 2002 due to $3.8 million in comprehensive income,
$516 thousand in proceeds from option exercises and $429 thousand in
amortization of unearned ESOP compensation. The increases in these equity
accounts were substantially offset by $3.6 million in ESOP stock purchases and
$727 thousand in dividends paid.
LIQUIDITY
The Company's primary sources of liquidity are dividends from its bank
subsidiary and repayments of the ESOP loans. In addition, the Company has access
to the capital markets to raise additional equity.
The Bank's principal sources of liquidity are customer deposits,
amortization and repayments of loan and mortgage-backed security principal, FHLB
of Boston advances and maturities of various other investments. These various
sources of liquidity, as well as the Bank's ability to sell residential mortgage
loans in the secondary market, are used to fund deposit withdrawals, loan
originations and investments.
Deposits have been a relatively stable source of funds for the Bank despite
significant competition. During fiscal 2003, deposit balances increased by $26.1
million to $288.0 million from $261.9 million at March 31, 2002. The mix of
deposits changed significantly during fiscal 2003 with term deposit certificates
decreasing $5.2 million while core deposit accounts increased $31.3 million.
This shift occurred due to several factors including the low interest rate
environment that prevailed throughout the year, the Bank's emphasis of its core
deposit products and less aggressive pricing of term deposits.
31
The Bank is a member of the FHLB of Boston and has the ability to borrow
from the FHLB of Boston for any sound business purpose for which the Bank has
legal authority, subject to such regulations and limitations as may be
prescribed. At March 31, 2003 and 2002, the Bank had outstanding FHLB of Boston
advances of $144.4 million and $161.0 million, respectively. The FHLB of Boston
advances are secured by a blanket lien on residential first mortgage loans, U.S.
Government and agency securities and all stock in the FHLB of Boston. At March
31, 2003, the Bank had approximately $26.0 million in unused borrowing capacity
at the FHLB of Boston.
The Bank also may obtain funds from the Federal Reserve Bank of Boston by
pledging certain of the Bank's notes and drafts and is party to a retail CD
brokerage agreement with a major brokerage firm. The Bank views these borrowing
facilities as secondary sources of liquidity and has had no need to use them.
At March 31, 2003, outstanding commitments to originate mortgage loans
totaled $33.3 million, and commitments for unadvanced funds on home equity,
commercial and construction loans totaled $23.4 million. At March 31, 2003, the
Bank also had $4.8 million in commitments to sell residential mortgage loans.
Management believes that the Bank has adequate sources of liquidity to fund
these commitments.
CAPITAL RESOURCES
The Company and the Bank are required to maintain minimum capital ratios
pursuant to federal banking regulations. The first standard establishes a
risk-adjusted ratio relating capital to different categories of balance sheet
assets and off-balance sheet obligations. Two categories of capital are defined:
Tier 1 or core capital (stockholders' equity) and Tier 2 or supplementary
capital. Total capital is the sum of both Tier 1 and Tier 2 capital. According
to the standards, Tier 1 capital must represent at least 50% of qualifying total
capital. At March 31, 2003, the minimum total risk-based capital ratio required
was 8.00%. The Company's and the Bank's risk-based total capital ratios at March
31, 2003 were 12.05% and 11.08%, respectively.
To complement the risk-based standards, the FDIC adopted a leverage ratio
(adjusted stockholders' equity divided by total average assets) of 3% for the
most highly rated banks and 4%-5% for all others. The leverage ratio is to be
used in tandem with the risk-based capital ratios as the minimum standards for
banks. The Company's and the Bank's leverage ratios were 7.41% and 6.77%,
respectively, at March 31, 2003.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
The Bank's earnings are largely dependent on its net interest income, which
is the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities. The Bank seeks to reduce its exposure to changes
in interest rate, or market risk, through active monitoring and management of
its interest-rate risk exposure. The policies and procedures for managing both
on- and off-balance sheet activities are established by the Bank's
asset/liability management committee ("ALCO"). The Board of Directors reviews
and approves the ALCO policy annually and monitors related activities on an
ongoing basis.
Market risk is the risk of loss from adverse changes in market prices and
rates. The Bank's market risk arises primarily from interest rate risk inherent
in its lending, borrowing and deposit taking activities.
The main objective in managing interest rate risk is to minimize the
adverse impact of changes in interest rates on the Bank's net interest income
and preserve capital, while adjusting the Bank's asset/liability structure to
control interest-rate risk. However, a sudden and substantial increase or
decrease in interest rates may adversely impact earnings to the extent that the
interest rates borne by assets and liabilities do not change at the same speed,
to the same extent, or on the same basis.
The Bank quantifies its interest-rate risk exposure using a sophisticated
simulation model. Simulation analysis is used to measure the exposure of net
interest income to changes in interest rates over a specific time horizon.
Simulation analysis involves projecting future interest income and expense under
various rate scenarios. The simulation is based on actual cash flows and
assumptions of management about the future changes in interest rates and levels
of activity (loan originations, loan prepayments, deposit flows, etc). The
assumptions are inherently uncertain and, therefore, actual results will differ
from simulated results due to timing, magnitude and frequency of
32
interest rate changes as well as changes in market conditions and strategies.
The net interest income projection resulting from use of actual cash flows and
management's assumptions is compared to net interest income projections based on
an immediate shift of 300 basis points upward and 100 basis points downward (150
basis points for 2002). The 2003 rate was lowered due to the continuing decline
in interest rates. Internal guidelines on interest rate risk state that for
every 100 basis points immediate shift in interest rates, estimated net interest
income over the next twelve months should decline by no more than 5%.
The following table indicates the estimated exposure, as a percentage of
estimated net interest income, for the twelve month period following the date
indicated assuming an immediate and parallel shift for all market rates with
other rates adjusting to varying degrees in each scenario based on both
historical and expected spread relationships:
March 31,
-----------------
2003 2002
------ -------
300 basis point increase in rates ..................... (7.6)% (12.9)%
100 basis point decrease in rates (2003 only) ......... (2.0)%
150 basis point decrease in rates (2002 only) ......... 0.5%
For each one percentage point change in net interest income in the 2003
projections, the effect on net income would be $105 thousand assuming a 40% tax
rate.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
Page
----
Consolidated Balance Sheets............................................... 34
Consolidated Statements of Income......................................... 35
Consolidated Statement of Changes in Stockholders' Equity................. 36
Consolidated Statement of Cash Flows...................................... 38
Notes to Consolidated Financial Statements................................ 39
Independent Auditors' Report.............................................. 59
33
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(Dollars in thousands)
MARCH 31,
---------------------------------
2003 2002
---- ----
ASSETS
Cash and due from banks $ 5,996 $ 5,109
Short-term investments 5,226 2,455
----------- -----------
Cash and cash equivalents 11,222 7,564
----------- -----------
Investment securities available for sale (amortized cost of $59,500
in 2003 and $74,935 in 2002) (note 2) 61,111 73,884
Stock in Federal Home Loan Bank of Boston, at cost (notes 2 and 7) 8,300 8,300
The Co-operative Central Bank Reserve Fund (note 2) 1,576 1,576
----------- -----------
Total investments 70,987 83,760
----------- -----------
Loans (note 3) 390,464 371,707
Less allowance for loan losses (note 4) 3,284 3,292
----------- -----------
Net loans 387,180 368,415
----------- -----------
Accrued interest receivable 2,380 2,530
Banking premises and equipment, net (note 5) 1,869 1,836
Deferred tax asset, net (note 8) 719 1,289
Goodwill, net (note 1) 2,232 2,232
Other assets 619 593
----------- -----------
Total assets $ 477,208 $ 468,219
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (note 6) $ 287,959 $ 261,907
Federal Home Loan Bank advances (notes 2 and 7) 144,400 161,000
Short-term borrowings 176 3,000
Advance payments by borrowers for taxes and insurance 999 1,111
Accrued expenses and other liabilities 4,231 2,247
----------- -----------
Total liabilities 437,765 429,265
----------- -----------
Commitments and Contingencies (notes 8, 9 and 12) Stockholders' equity (note
10):
Preferred stock $1.00 par value; authorized 5,000,000 shares; none issued -- --
Common stock $1.00 par value; authorized 15,000,000 shares;
2,027,727 shares issued at March 31, 2003 and
1,999,588 shares issued at March 31, 2002 2,028 2,000
Additional paid-in capital 12,751 11,934
Retained income 34,601 33,141
Treasury stock (365,294 shares at March 31, 2003 and
2002), at cost (7,249) (7,189)
Accumulated other comprehensive income (loss) 1,002 (626)
Unearned compensation - ESOP (note 11) (3,690) (306)
----------- -----------
Total stockholders' equity 39,443 38,954
----------- -----------
Total liabilities and stockholders' equity $ 477,208 $ 468,219
=========== ===========
See accompanying notes to consolidated financial statements.
34
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
YEARS ENDED MARCH 31,
---------------------------------------------
2003 2002 2001
---------- ---------- ----------
Interest and dividend income:
Mortgage loans $ 24,952 $ 23,567 $ 25,613
Other loans 586 670 716
Short-term investments 125 866 487
Investments 4,466 4,170 4,101
---------- ---------- ---------
Total interest and dividend income 30,129 29,273 30,917
---------- ---------- ---------
Interest expense:
Deposits 5,601 8,119 10,087
Advances from Federal Home Loan Bank of Boston 7,262 6,731 6,858
Short-term borrowings 9 10 58
---------- ---------- ---------
Total interest expense 12,872 14,860 17,003
---------- ---------- ---------
Net interest and dividend income 17,257 14,413 13,914
Provision for loan losses (note 4) -- -- --
---------- ---------- ---------
Net interest and dividend income after
provision for loan losses 17,257 14,413 13,914
---------- ---------- ---------
Non-interest income:
Deposit service charges 571 492 428
Net gains (losses) from sales and write-downs
of investment securities (note 2) (308) (150) 680
Gain on sale of loans 796 -- --
Brokerage income 94 100 --
Other income 252 246 180
---------- ---------- ---------
Total non-interest income 1,405 688 1,288
---------- ---------- ---------
Non-interest expenses:
Salaries and employee benefits (note 11) 6,862 5,562 5,571
Occupancy and equipment (note 5) 1,137 1,124 1,192
Data processing service fees 1,136 966 847
Professional fees 2,410 1,051 757
Advertising 394 261 546
Goodwill amortization (note 1) -- 288 288
Other expenses 1,938 1,212 1,129
---------- ---------- ---------
Total non-interest expenses 13,877 10,464 10,330
---------- ---------- ---------
Income before income taxes 4,785 4,637 4,872
Provision for income taxes (note 8) 2,598 1,777 1,763
---------- ---------- ---------
Net income $ 2,187 $ 2,860 $ 3,109
========== ========== =========
Earnings per common share (note 1)
Basic $ 1.38 $ 1.73 $ 1.81
========== ========== =========
Diluted $ 1.37 $ 1.72 $ 1.81
========== ========== =========
Weighted average common shares outstanding - basic 1,584 1,650 1,717
Weighted average common and equivalent shares
outstanding - diluted 1,599 1,665 1,719
See accompanying notes to consolidated financial statements.
35
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands, Except Per Share Data)
ADDITIONAL
COMMON PAID-IN RETAINED TREASURY
STOCK CAPITAL INCOME STOCK
----- ---------- -------- --------
Balance at March 31, 2000 $ 1,970 $ 11,190 $ 28,538 $ (3,043)
Net income -- -- 3,109 --
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- -- -- --
Comprehensive income
Purchase of treasury stock -- -- -- (2,187)
Dividends paid ($.40 per share) -- -- (697) --
Amortization of unearned compensation - ESOP -- -- --
------- -------- -------- --------
Balance at March 31, 2001 $ 1,970 $ 11,190 $ 30,950 $ (5,230)
Net income -- -- 2,860 --
Other comprehensive income net of tax:
Unrealized (loss) on securities, net
of reclassification adjustment -- -- -- --
Comprehensive income
Purchase of shares by ESOP (note 11) -- -- -- --
Purchase of treasury stock -- -- -- (1,924)
Dividends paid ($.40 per share) -- -- (669) --
Proceeds from exercise of stock options 30 462 -- --
Amortization of unearned compensation - ESOP -- 175 -- --
Other equity transactions -- 107 -- (35)
------- -------- -------- --------
Balance at March 31, 2002 $ 2,000 $ 11,934 $ 33,141 $ (7,189)
Net income -- -- 2,187 --
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment -- -- -- --
Comprehensive income
Purchase of shares by ESOP (note 11) -- -- -- --
Proceeds from exercise of stock options 28 488 -- --
Tax benefit of stock options -- 66 -- --
Director deferred compensation transactions -- 45 -- (60)
Dividends paid ($.44 per share) -- -- (727) --
Amortization of unearned compensation - ESOP -- 218 -- --
------- ------- -------- --------
Balance at March 31, 2003 $ 2,028 $ 12,751 $ 34,601 $ (7,249)
======= ======== ======== ========
ACCUMULATED
OTHER UNEARNED TOTAL
OMPREHENSIVE COMPENSATION STOCKHOLDERS'
INCOME (LOSS) ESOP EQUITY
------------- ------------ -------------
Balance at March 31, 2000 $ (825) $ (433) $37,397
Net income -- -- 3,109
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment 394 -- 394
-------
Comprehensive income 3,503
-------
Purchase of treasury stock -- -- (2,187)
Dividends paid ($.40 per share) -- -- (697)
Amortization of unearned compensation - ESOP -- 196 196
------- -------- -------
Balance at March 31, 2001 $ (431) $ (237) $38,212
Net income -- -- 2,860
Other comprehensive income net of tax:
Unrealized (loss) on securities, net
of reclassification adjustment (195) -- (195)
-------
Comprehensive income 2,665
-------
Purchase of shares by ESOP (note 11) -- (199) (199)
Purchase of treasury stock -- -- (1,924)
Dividends paid ($.40 per share) -- -- (669)
Proceeds from exercise of stock options -- -- 492
Amortization of unearned compensation - ESOP -- 130 305
Other equity transactions -- -- 72
------- -------- -------
Balance at March 31, 2002 $ (626) $ (306) $38,954
Net income -- -- 2,187
Other comprehensive income net of tax:
Unrealized gain on securities, net
of reclassification adjustment 1,628 -- 1,628
-------
Comprehensive income 3,815
-------
Purchase of shares by ESOP (note 11) -- (3,595) (3,595)
Proceeds from exercise of stock options -- -- 516
Tax benefit of stock options -- -- 66
Director deferred compensation transactions -- -- (15)
Dividends paid ($.44 per share) -- -- (727)
Amortization of unearned compensation - ESOP -- 211 429
------- -------- -------
Balance at March 31, 2003 $ 1,002 $ (3,690) $39,443
======= ======== =======
See accompanying notes to consolidated financial statements.
36
The Bank's other comprehensive income (loss) and related tax effect for the
years ended March 31 are as follows:
2003
-----------------------------------------
BEFORE-TAX TAX (BENEFIT) AFTER-TAX
in thousands AMOUNT EXPENSE AMOUNT
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized gains (losses) on securities:
Unrealized net holding gains during period $ 2,306 $ 901 $ 1,405
Less reclassification adjustment for net losses included in net income 308 85 223
----------------------------------------
Other comprehensive income $ 2,614 $ 986 $ 1,628
========================================
2002
-----------------------------------------
BEFORE-TAX TAX (BENEFIT) AFTER-TAX
in thousands AMOUNT EXPENSE AMOUNT
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized gains (losses) on securities:
Unrealized net holding gains during period $ (451) $ (163) $ (288)
Less reclassification adjustment for net losses included in net income 150 57 93
----------------------------------------
Other comprehensive income $ (301) $ (106) $ (195)
========================================
2001
-----------------------------------------
BEFORE-TAX TAX (BENEFIT) AFTER-TAX
in thousands AMOUNT EXPENSE AMOUNT
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized gains (losses) on securities:
Unrealized net holding gains during period $ 1,188) $ 360 $ 828
Less reclassification adjustment for net losses included in net income (680) (246) (434)
----------------------------------------
Other comprehensive income $ 508 $ 114 $ 394
========================================
See accompanying notes to consolidated financial statements.
37
CENTRAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(In Thousands, Except Per Share Data)
YEARS ENDED MARCH 31,
---------------------------------------------
2003 2002 2001
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 2,187 $ 2,860 $ 3,109
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization 314 372 438
Amortization of premiums and discounts 269 176 86
Amortization of goodwill -- 288 288
Stock-based compensation 429 305 196
Decrease (increase) in deferred tax assets, net (462) (380) 270
Net (gains) losses from sales and write-downs of
investment securities 308 150 (680)
Gain on sale of loans (796) -- --
Originations of loans held for sale (36,364) -- --
Proceeds from the sale of loans originated for sale 36,513 -- --
(Increase) decrease in accrued interest receivable 150 (104) (390)
(Increase) decrease in other assets (26) 109 (507)
Increase (decrease) in advance payments by borrowers for
taxes and insurance (112) (109) 167
Increase (decrease) in accrued expenses and other
liabilities 2,043 509 (30)
--------- ---------- ---------
Net cash provided by operating activities 4,453 4,176 2,947
--------- ---------- ---------
Cash flows from investing activities:
Net increase in loans (18,110) (25,728) (25,667)
Principal payments on mortgage-backed securities 7,426 7,246 4,069
Purchases of investment securities (6,210) (61,256) (6,170)
Proceeds from sales of investment securities 7,638 2,885 3,955
Maturities and redemptions of investment securities 6,000 26,000 4,000
Purchase of stock in FHLB of Boston -- (2,150) (350)
Purchase of banking premises and equipment, net (346) (190) (238)
--------- ---------- ---------
Net cash used in investing activities (3,602) (53,193) (20,401)
--------- ---------- ---------
Cash flows from financing activities:
Net increase (decrease) in deposits 26,052 (25,260) 28,828
Proceeds from FHLB advances 39,000 65,000 152,000
Repayments of FHLB advances (55,600) (25,000) (142,000)
Net increase (decrease) in short-term borrowings (2,824) 3,000 --
Proceeds from exercise of stock options 516 492 --
Purchase of treasury stock -- (1,924) (2,187)
Payments of dividends (727) (669) (697)
Purchase of stock by ESOP (3,595) (199) --
Other equity transactions (15) 72 --
--------- ---------- ---------
Net cash provided by financing activities 2,807 15,512 35,944
--------- ---------- ---------
Net increase (decrease) in cash and cash equivalents 3,658 (33,505) (18,490)
Cash and cash equivalents at beginning of year 7,564 41,069 22,579
--------- ---------- ---------
Cash and cash equivalents at end of year $ 11,222 $ 7,564 $ 41,069
========= ========== =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 12,938 $ 14,883 $ 16,937
Income taxes $ 2,820 $ 1,715 $ 1,850
See accompanying notes to consolidated financial statements.
38
CENTRAL BANCORP, INC AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2003
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of
Central Bancorp, Inc. (the "Company"), a Massachusetts corporation, and its
wholly-owned subsidiary, Central Co-operative Bank (the "Bank").
The Bank was organized as a Massachusetts chartered co-operative bank in
1915 and converted from mutual to stock form in 1986. The primary business of
the Bank is to generate funds in the form of deposits and use the funds to make
mortgage loans for the construction, purchase and refinancing of residential
properties, and to make loans on commercial real estate in its market area. The
Bank is subject to competition from other financial institutions. The Company is
subject to the regulations of, and periodic examinations by, the Federal Reserve
Bank ("FRB"). The Bank is also subject to the regulations of, and periodic
examination by, the Federal Deposit Insurance Corporation ("FDIC") and the
Massachusetts Division of Banks. The Bank's deposits are insured by the Bank
Insurance Fund of the FDIC for deposits up to $100,000 and the Share Insurance
Fund ("SIF") for deposits in excess of $100,000.
The Company conducts its business through one operating segment, the Bank.
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America. All significant intercompany balances and transactions have been
eliminated in consolidation. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and income and expenses for the year. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change relate
to the determination of the allowance for loan losses.
Certain prior year amounts have been reclassified to conform to the current
year's presentation. The following is a summary of the more significant
accounting policies adopted by the Bank.
Cash and Due from Banks
The Bank is required to maintain cash and reserve balances with the Federal
Reserve Bank. Such reserves are calculated based upon deposit levels and
amounted to approximately $3,241,000 at March 31, 2003.
Investments
Investments are classified as either held to maturity, available for sale
or trading. Investments classified as trading securities are reported at fair
value, with unrealized gains and losses included in earnings. Investments
classified as available for sale are reported at fair value, with unrealized
gains and losses reported as other comprehensive income (loss) within
stockholders' equity. Securities that the Bank has the positive intent and
ability to hold to maturity are classified as held to maturity and reported at
amortized cost.
Gains and losses on sales of securities are recognized when realized with
the cost basis of investments sold determined on a specific-identification
basis. Premiums and discounts on investment and mortgage-backed securities are
amortized or accreted to interest income over the actual or expected lives of
the securities using the level-yield method.
If a decline in fair value below the amortized cost basis of an investment
is judged to be other than temporary, the cost basis of the investment is
written down to fair value as a new cost basis and the amount of the write-down
is included in the results of operations.
Loans
Loans are reported at the principal amount outstanding, adjusted by
unamortized discounts, premiums, and net deferred loan origination costs and
fees. Loans classified as held for sale are stated at the lower of aggregate
cost or market value. The Company enters into forward commitments to sell loans
in order to reduce market risk associated with the origination of loans held for
sale. Market value is estimated based on outstanding investor
39
commitments or, in the absence of cash commitments, current investor yield
requirements. Net unrealized losses, if any, are provided for in a valuation
allowance by charges to operations.
Loans on which the accrual of interest has been discontinued are designated
as non-accrual loans. Accrual of interest on loans and amortization of net
deferred loan fees or costs are discontinued either when reasonable doubt exists
as to the full and timely collection of interest or principal, or when a loan
becomes contractually past due 90 days with respect to interest or principal.
The accrual on some loans, however, may continue even though they are more than
90 days past due if management deems it appropriate, provided that the loans are
well secured and in the process of collection. When a loan is placed on
non-accrual status, all interest previously accrued but not collected is
reversed against current period interest income. Interest accruals are resumed
on such loans only when they are brought fully current with respect to interest
and principal and when, in the judgment of management, the loans are estimated
to be fully collectible as to both principal and interest. The Bank records
interest income on non-accrual and impaired loans on the cash basis of
accounting.
Loan origination fees, net of certain direct loan origination costs, are
considered adjustments of interest-rate yield and are amortized into interest
income over the contractual loan term using the level-yield method. At March 31,
2003 and 2002, the Bank had net deferred loan fees of $781,000 and $692,000,
respectively.
Loans are classified as impaired when it is probable that the Bank will not
be able to collect all amounts due in accordance with the contractual terms of
the loan agreement. Impaired loans, except those loans that are accounted for at
fair value or at lower of cost or fair value, are accounted for at the present
value of the expected future cash flows discounted at the loan's effective
interest rate or as a practical expedient in the case of collateral dependent
loans, the lower of the fair value of the collateral or the recorded amount of
the loan. Management considers the payment status, net worth and earnings
potential of the borrower, and the value and cash flow of the collateral as
factors to determine if a loan will be paid in accordance with its contractual
terms. Management does not set any minimum delay of payments as a factor in
reviewing for impaired classification. Impaired loans are charged off when
management believes that the collectibility of the loan's principal is remote.
Management considers non-accrual loans, except for smaller balance, homogeneous
residential mortgage loans, to be impaired.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level determined to be
adequate by management to absorb future charge-offs of loans deemed
uncollectible. This allowance is increased by provisions charged to operating
expense and by recoveries on loans previously charged off, and reduced by
charge-offs on loans.
Arriving at an appropriate level of allowance for loan losses necessarily
involves a high degree of judgment. The allowance for loan losses is evaluated
on a regular basis by management and is based upon management's systematic
periodic review of the collectibility of the loans. Primary considerations in
this evaluation are prior loan loss experience, the character and size of the
loan portfolio, business and economic conditions and management's estimation of
future losses. The Bank evaluates specific loan status reports on certain
commercial and commercial real estate loans rated "substandard" or worse.
Estimated reserves for each of these credits is determined by reviewing current
collateral value, financial information, cash flow, payment history and trends
and other relevant facts surrounding the particular credit. The remaining
commercial and commercial real estate loans are provided for as part of pools of
similar loans based on a combination of historical loss experience and
qualitative adjustments. Smaller balance, homogeneous loans, including
residential real estate loans and consumer loans, are evaluated as a group by
applying estimated charge off and recovery percentages, based on historical
experience and certain qualitative factors, to the current outstanding balance
in each category. Based on these analyses, the resulting allowance is deemed
adequate to absorb all probable credit losses in the portfolio.
Although management uses available information to establish the appropriate
level of the allowance for loan losses, future additions to the allowance may be
necessary based on estimates that are susceptible to change as a result of a
changes in economic conditions and other factors. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize adjustments to the allowance based on their
judgments about information available to them at the time of their examination.
Changes in estimates are provided currently in earnings.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the accounting basis and the
tax basis of the Bank's assets and liabilities. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
realized or settled. The Bank's deferred tax asset is reviewed periodically and
40
adjustments to such asset are recognized as deferred income tax expense or
benefit based on management's judgments relating to the realizability of such
asset.
Banking Premises and Equipment
Land is stated at cost. Buildings, leasehold improvements and equipment are
stated at cost, less allowances for depreciation and amortization. Depreciation
and amortization are computed on the straight-line method over the estimated
useful lives of the assets or terms of the leases, if shorter.
Goodwill
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142") which is effective for fiscal years beginning after December 15,
2001. The Company adopted SFAS 142 as of April 1, 2002. SFAS 142 addresses the
method of identifying and measuring goodwill and other intangible assets having
indefinite lives acquired in a business combination, eliminates further
amortization of goodwill, and requires periodic impairment evaluations of
goodwill using a fair value methodology prescribed in the statement. As a result
of adopting SFAS 142, the Company no longer amortizes the goodwill balance of
$2,232,000, which reduced goodwill amortization and increased net income by
$288,000 in 2003. An initial impairment test was performed during 2003 and
another impairment test was completed at year-end and in each analysis, it was
determined that an impairment charge was not required. Impairment testing is
required at least annually or more frequently as a result of an event or change
in circumstances (e.g. recurring operating losses by the acquired entity) that
would indicate an impairment adjustment may be necessary.
The following table sets forth the reconciliation of net income and
earnings per share excluding goodwill amortization for the years ended March 31,
2002 and 2001 (Dollars in thousands, except per share data):
2002 2001
--------- ---------
Reported net income......................................... $ 2,860 $ 3,109
Add back:
Goodwill amortization.............................. 288 288
--------- --------
Adjusted net income......................................... $ 3,148 $ 3,397
========= ========
Basic earnings per share:
Reported net income......................................... $ 1.73 $ 1.81
Add back:
Goodwill amortization.............................. 0.18 0.17
--------- --------
Adjusted net income......................................... $ 1.91 $ 1.98
========= ========
Diluted earnings per share:
Reported net income......................................... $ 1.72 $ 1.81
Add back:
Goodwill amortization.............................. 0.17 0.17
--------- --------
Adjusted net income......................................... $ 1.89 $ 1.98
========= ========
Pension Benefits
The Bank provides pension benefits for its employees in a multi-employer
pension plan through membership in the Co-operative Banks Employees Retirement
Association. Pension costs are funded as they are accrued and are accounted for
on a defined contribution plan basis.
Stock-Based Compensation
The Company follows the intrinsic value method set forth in APB Opinion No.
25 "Accounting for Stock Issued to Employees" (APB No. 25) under which there is
generally no charge to earnings for stock option grants. Companies that elect to
use this method are required to disclose the pro forma effect of using the fair
value method of accounting for stock-based compensation that is encouraged by
SFAS No. 123.
41
No options were granted during fiscal 2003 and 2002 and forfeitures during
these years were insignificant. Consequently, no material difference in net
income occurred in fiscal 2003 and 2002 as a result of the Company's use of the
intrinsic value method rather than the fair value method of accounting for
stock-based compensation. Had the Company determined compensation expense based
on the fair value at the grant date for its stock options, the Company's net
income and earnings per share for fiscal 2001 would have been as follows:
EARNINGS PER SHARE
------------------------
NET INCOME BASIC DILUTED
---------- ----- -------
As reported $ 3,109 $1.81 $1.81
Pro Forma 2,934 1.71 1.71
The per share weighted average fair value of stock options granted during
2001 was $5.39 on the date of grant. This fair value was determined using the
Black Scholes option pricing model with the following weighted average
assumptions:
Expected dividend yield 2.00%
Risk-free interest rate 5.20
Expected volatility 31.00
Expected life in years 6.00
Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing income available
to common stockholders by the weighted-average number of common shares
outstanding for the period. Unallocated ESOP shares are not considered
outstanding in computing basic EPS. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock, such as
stock options, were exercised or converted into common stock.
Recent Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS Statement
No. 123, to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
Companies are able to eliminate a "ramp-up" effect that the SFAS No. 123
transition rule creates in the year of adoption. Companies can choose to elect a
method that will provide for comparability amongst years reported. In addition,
this Statement amends the disclosure requirement of Statement 123 to require
prominent disclosures in both annual compensation and the effect of the method
used on reported results. The amendments to SFAS No. 123 are effective for
financial statements for fiscal years ending after December 15, 2002. The
Company is not currently considering the adoption of fair value based
compensation of stock options.
NOTE 2. INVESTMENTS (Dollars in Thousands)
The amortized cost and fair value of investments securities available for
sale are summarized as follows:
MARCH 31, 2003
---------------------------------------------------------------
AMORTIZED GROSS UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- -------- --------
U.S. Government and agency obligations $ 8,000 $ 247 $ -- $ 8,247
Corporate bonds 36,912 2,006 (191) 38,727
Mortgage-backed securities 11,840 298 (82) 12,056
--------- ---------- ------- --------
Total debt securities 56,752 2,551 (273) 59,030
Marketable equity securities 2,748 32 (699) 2,081
--------- ---------- ------- --------
Total $ 59,500 $ 2,583 $ (972) $ 61,111
========= ========== ======= ========
42
MARCH 31, 2002
---------------------------------------------------------------
AMORTIZED GROSS UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- -------- --------
U.S. Government and agency obligations $ 13,995 $ 73 $ (72) $ 13,996
Corporate bonds 39,012 231 (675) 38,568
Mortgage-backed securities 18,377 168 (205) 18,340
-------- ------ -------- --------
Total debt securities 71,384 472 (952) 70,904
Marketable equity securities 3,551 17 (588) 2,980
-------- ------ -------- --------
Total $ 74,935 $ 489 $ (1,540) $ 73,884
======== ====== ======== ========
The maturity distribution (based on contractual maturities) and annual
yields of debt securities at March 31, 2003 are as follows:
AMORTIZED FAIR ANNUAL
COST VALUE YIELD
--------- --------- ------
Due within one year $ 501 $ 516 6.57%
Due after one year but within five years 33,914 35,257 6.84
Due after five years but within ten years 12,749 13,573 7.09
Due after ten years 9,588 9,684 6.30
--------- ---------
$ 56,752 $ 59,030 6.80
========= =========
Mortgage-backed securities are shown at their contractual maturity dates
but actual maturities may differ as borrowers have the right to prepay
obligations without incurring prepayment penalties.
Proceeds from sales of investment securities and related gains and losses
for the years ended March 31, 2003, 2002, and 2001 (all classified as available
for sale) were as follows:
2003 2002 2001
---- ---- ----
Proceeds from sales $ 7,638 $2,885 $ 3,955
Gross gains 495 546 694
Gross losses -- 54 14
During the years ended March 31, 2003 and 2002, the Bank recognized
write-downs in certain equity securities totaling $803 and $642, respectively,
as a result of declines in the fair value of such securities judged to be other
than temporary. These write-downs are not included in the preceding table.
A mortgage-backed security pool with an amortized cost of $2,566 and fair
value of $2,642 at March 31, 2003, was pledged to provide collateral for
customers. In addition, investment securities carried at $3,628 were pledged
under a blanket lien to partially secure the Bank's advances from the Federal
Home Loan Bank of Boston ("FHLB of Boston").
As a member of the FHLB of Boston, the Bank is required to invest in stock
of the FHLB of Boston in an amount equal to 1% of its outstanding home loans or
1/20th of its outstanding advances from the FHLB of Boston, whichever is higher.
If such stock is redeemed, the Bank will receive from the FHLB of Boston an
amount equal to the par value of the stock.
The Co-operative Central Bank Reserve Fund (the "Fund") was established for
liquidity purposes and consists of deposits required of all insured co-operative
banks in Massachusetts. The Fund is used by The Co-operative Central Bank to
advance funds to member banks or to make other investments.
43
NOTE 3. LOANS (In Thousands)
Loans as of March 31, 2003 and 2002 are summarized below:
2003 2002
-------- --------
Real estate loans:
Residential real estate $ 237,296 $ 246,045
Commercial real estate 107,140 87,013
Construction 30,294 20,998
Second mortgage and home equity lines of credit 9,128 9,154
--------- ---------
Total real estate loans 383,858 363,210
--------- ---------
Commercial loans 5,319 6,901
Consumer loans 1,287 1,596
--------- ---------
Total loans 390,464 371,707
Less: allowance for loan losses (3,284) (3,292)
--------- ---------
Total loans, net $ 387,180 $ 368,415
========= =========
Included in residential real estate loans at March 31, 2003, were $647 in
loans held for sale.
The Bank had no non-accrual loans at March 31, 2003 and 2002. During the
years ended March 31, 2003 2002 and 2001, there were no impaired loans. The Bank
follows the same policy for recognition of income on impaired loans as it does
for all other loans.
Mortgage loans serviced by the Bank for others amounted to $1,361 and
$2,616 at March 31, 2003 and 2002, respectively.
The Bank's lending activities are conducted principally in communities in
the suburban Boston area. The Bank grants mortgage loans on residential
property, commercial real estate, construction of residential homes, second
mortgages, home equity and other loans. Substantially all loans granted by the
Bank are secured by real estate collateral. The ability and willingness of
residential mortgage borrowers to honor their repayment commitments are
generally impacted by the level of overall economic activity within the
borrowers' geographic areas and real estate values. The ability and willingness
of commercial real estate and construction loan borrowers to honor their
repayment commitments are generally impacted by the health of the real estate
market in the borrowers' geographic area and the general economy.
The following summarizes the activity with respect to loans made to
directors and officers and their related interests for the years ended March 31:
2003 2002
------ -----
Balance at beginning of year $ 865 $ 580
New loans 444 434
New officers with loans outstanding -- 66
Repayment of principal (390) (215)
----- -----
Balance at end of year $ 919 $ 865
===== =====
Loans included above were made in the Bank's ordinary course of business,
on substantially the same terms, including interest rates and collateral
requirements, as those prevailing at the time for comparable transactions with
unrelated persons. All loans included above are performing in accordance with
the terms of the respective loan.
44
NOTE 4. ALLOWANCE FOR LOAN LOSSES (In Thousands)
A summary of changes in the allowance for loan losses follows:
YEARS ENDED MARCH 31,
--------------------------------------------
2003 2002 2001
--------- -------- ---------
Balance at beginning of year $ 3,292 $ 3,106 $ 2,993
Provision charged to expense -- -- --
Amounts charged-off (21) (4) (4)
Recoveries on accounts previously charged-off 13 190 117
--------- -------- ---------
Balance at end of year $ 3,284 $ 3,292 $ 3,106
========= ======== =========
NOTE 5. BANKING PREMISES AND EQUIPMENT (In Thousands)
A summary of cost, accumulated depreciation and amortization of banking
premises and equipment at March 31 follows:
ESTIMATED
2003 2002 USEFUL LIVES
---------- ---------- ------------
Land $ 589 $ 589
Buildings and improvements 2,401 2,339 50 years
Furniture and fixtures 5,876 5,744 3-5 years
Leasehold improvements 635 482 5-6 years
--------- --------
9,501 9,154
Less accumulated depreciation and amortization (7,632) (7,318)
--------- --------
Total $ 1,869 $ 1,836
========= ========
Depreciation and amortization for the years ended March 31, 2003, 2002 and
2001 amounted to $314, $372 and $438, respectively, and is included in occupancy
and equipment expense in the accompanying consolidated statements of income.
A summary of minimum rentals of banking premises for future periods under
non-cancelable operating leases follows:
YEARS ENDING MARCH 31,
2004 $ 133
2005 133
2006 80
2007 64
2008 40
Certain leases contain renewal options the potential impact of which is not
included above. Rental expense for the years ended March 31, 2003, 2002 and 2001
was $145, $133 and $125, respectively, and is included in occupancy and
equipment expense in the accompanying consolidated statements of income.
45
NOTE 6. DEPOSITS (Dollars in Thousands)
Deposits at March 31 are summarized as follows:
2003 2002
---- ----
Demand deposit accounts $ 31,523 $ 25,370
NOW accounts 38,047 36,277
Passbook and other savings accounts 71,629 72,944
Money market deposit accounts 42,687 17,997
-------- --------
Total non certificate accounts 183,886 152,588
-------- --------
Term deposit certificates
Certificates of $100 and above 26,259 27,233
Certificates less than $100 77,814 82,086
-------- --------
Total term deposit certificates 104,073 109,319
-------- --------
$287,959 $261,907
======== ========
Contractual maturities of term deposit certificates with weighted average
interest rates at March 31, 2003 are as follows:
AMOUNT RATE
------ ----
Within 1 year $ 56,958 2.83%
Over 1 to 3 years 32,637 3.87
Over 3 years 14,478 4.64
--------
$104,073 3.41
========
NOTE 7. ADVANCES FROM FEDERAL HOME LOAN BANK OF BOSTON (Dollars in Thousands)
A summary of the maturity distribution of FHLB of Boston advances (based on
final maturity dates) with weighted average interest rates at March 31 follows:
2003 2002
------------------------ -------------------------
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
Within 1 year $ 5,300 3.61% $ 55,600 2.61%
Over 1 to 5 years 54,100 4.64 21,400 4.83
Over 5 to 10 years 83,000 4.98 82,000 5.52
Over 10 years 2,000 5.49 2,000 5.49
--------- ----------
$ 144,400 4.81 $ 161,000 4.39
========= ==========
At March 31, 2003, advances totaling $102,000 were callable prior to the
scheduled maturity of the advances of which $84,000 were callable during fiscal
2004. The Bank is subject to a substantial penalty in the event it elects to
prepay any of its FHLB of Boston advances.
The FHLB of Boston is authorized to make advances to its members subject to
such regulations and limitations as the Federal Home Loan Bank Board may
prescribe. The advances are secured by FHLB of Boston stock and a blanket lien
on certain qualified collateral, defined principally as 90% of the fair value of
U.S. Government and federal agency obligations and 75% of the carrying value of
first mortgage loans on owner-occupied residential property. The Bank's unused
borrowing capacity with the FHLB of Boston was approximately $26,000 at March
31, 2003.
46
NOTE 8. INCOME TAXES (Dollars in Thousands)
The components of the provision for income taxes for the years indicted
are as follows:
YEARS ENDED MARCH 31,
--------------------------------------
2003 2002 2001
------- ------- -------
Current
Federal $ 1,708 $ 1,930 $ 1,555
State 1,352 229 52
------- ------- -------
Total current provision 3,060 2,159 1,607
Deferred (prepaid) (462) (382) 156
------- ------- -------
$ 2,598 $ 1,777 $ 1,763
======= ======= =======
The provision for income taxes for the periods presented is different
from the amounts computed by applying the statutory Federal income tax rate to
income before income taxes. The differences between expected tax rates and
effective tax rates are as follows:
YEARS ENDED MARCH 31,
--------------------------------------
2003 2002 2001
---------- ----------- ----------
Statutory Federal tax rate 34.0% 34.0% 34.0%
Items affecting Federal income tax rate:
Dividends received deduction (0.3) (0.4) (0.6)
Goodwill amortization -- 2.1 2.0
State income taxes, net of Federal benefit 2.7 2.6 1.2
Retroactive REIT legislation,
net of Federal benefit 16.1 -- --
Non-Deductible portion of ESOP expense 1.5 1.3 --
Other 0.3 (1.3) (0.4)
----- ---- ----
Effective tax rate 54.3% 38.3% 36.2%
==== ==== ====
During 2002, the Massachusetts Department of Revenue ("DOR") issued notices
of intent to assess additional state excise taxes to numerous financial
institutions in Massachusetts that have formed a real estate investment trust
(REIT) subsidiary. The DOR contends that dividends received by the banks from
such subsidiaries are fully taxable in Massachusetts. The Company believes that
the state statutes that provide for a 95% dividends received deduction on
certain dividend distributions apply to dividends received from its REIT
subsidiary.
The Governor of Massachusetts signed legislation on March 5, 2003, which
expressly disallows deductions for dividends received from a REIT, resulting in
such dividends being subject to state taxation. In addition, this law applies
retroactively to tax years ending on or after December 31, 1999. In the fourth
quarter of fiscal 2003, the Company provided additional state taxes, including
interest, net of the related federal tax benefit, of $835.
In June 2003, a settlement of this matter was reached between the DOR and
the majority of affected financial institutions. The settlement provides that
50% of all dividends received from REIT subsidiaries from 1999 through 2002 are
subject to state taxation. Interest on such additional taxes is also to be
assessed. Payment of such taxes and interest totaling $431 was made in June
2003. As a result of this settlement, the Bank recognized a reduction of $374 in
its accrued tax liabilities, which will increase net income by the same amount
in the first quarter of fiscal 2004.
47
The components of gross deferred tax assets and gross deferred tax
liabilities that have been recognized as of March 31 are as follows:
2003 2002
------ ------
Deferred tax assets:
Allowance for loan losses $ 549 $ 549
Deferred loan origination fees 42 53
Depreciation 324 298
Post-employee retirement
benefit accrual 239 241
Unrealized loss on securities, net -- 425
Write-down of investments securities 460 218
Deferred expenses 524 --
Other 65 59
------ ------
Gross deferred tax asset 2,203 1,843
------- ------
Deferred tax liabilities:
Unrealized gain on securities, net 607 --
Accrued dividend receivable 27 30
Deferred loan origination costs 219 285
Deferred income 631 239
------ ------
Gross deferred tax liability 1,484 554
------ ------
Net deferred tax asset $ 719 $1,289
====== ======
Based on the Bank's historical and current pretax earnings, management
believes it is more likely than not that the Bank will realize the net deferred
tax asset existing at March 31, 2003. Further, management believes the existing
net deductible temporary differences will reverse during periods in which the
Bank generates net taxable income. At March 31, 2003, recoverable income taxes,
plus estimated taxes for fiscal 2004, exceed the amount of the net deferred tax
asset. There can be no assurance, however, that the Bank will generate any
earnings or any specific level of continuing earnings.
The unrecaptured base year tax bad debt reserves will not be subject to
recapture as long as the Bank continues to carry on the business of banking. In
addition, the balance of the pre-1988 bad debt reserves continues to be subject
to provision of present law that requires recapture in the case of certain
excess distributions to shareholders. The tax effect of pre-1988 bad debt
reserves subject to recapture in the case of certain excess distributions is
approximately $1,300.
NOTE 9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (In Thousands)
The Bank is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include unused lines of credit, unadvanced portions
of commercial and construction loans, and commitments to originate loans. The
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the balance sheets. The amounts of
those instruments reflect the extent of the Bank's involvement in particular
classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to its financial instruments is represented by the contractual
amount of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
48
Financial instruments with off-balance sheet risks as of March 31,
included the following:
2003 2002
-------- --------
Unused lines of credit $15,153 $11,035
Unadvanced portions of construction loans 9,260 4,574
Unadvanced portions of commercial loans 925 1,574
Commitments to originate commercial mortgage loans 18,526 13,674
Commitments to originate residential mortgage loans 12,850 11,468
Commitments to sell residential mortgage loans 4,810 --
Commitments to originate loans, unused lines of credit and unadvanced
portions of commercial and construction loans are agreements to lend to a
customer, provided there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments may
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on management's credit
evaluation of the borrower.
NOTE 10. STOCKHOLDERS' EQUITY (Dollars in Thousands, except per share amount)
The Company and the Bank may not declare or pay cash dividends on their
stock if the effect thereof would cause capital to be reduced below regulatory
requirements, or if such declaration and payment would otherwise violate
regulatory requirements.
In October 1991, the Bank adopted a Shareholder Rights Plan. The plan
entitles each shareholder to purchase the Company's stock at a discount price in
the event any person or group of persons exceeds predetermined ownership
limitations of the Company's outstanding common stock and, in certain
circumstances, engages in specific activities deemed adverse to the interests of
the Company's shareholders. This plan was due to expire in October 2001 but was
renewed by the Board of Directors during fiscal 2002 and is now scheduled to
expire in October 2011.
Beginning in April 1999, the Board of Directors authorized a series of four
separate 5% stock repurchase programs under which the Company has acquired
365,294 shares of its stock at an average cost of $19.56 per share. The latest
repurchase program was completed in March 2002.
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulations that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. The minimum core (leverage) capital ratio
required for banks with the highest overall rating from bank regulatory agencies
is 3.00% and is 4.00%-5.00% for all others. The Bank must also have a minimum
total risk-based capital ratio of 8.00% (of which 4.00% must be Tier I capital,
consisting of common stockholders' equity). As of March 31, 2003, the Bank met
all capital adequacy requirements to which it is subject.
49
The most recent notification from the FDIC categorized the Bank as "well
capitalized" under the regulatory framework for prompt corrective action. To be
categorized as "well capitalized," the Bank must maintain minimum risk-weighted
capital, Tier 1 capital and tangible capital ratios as set forth in the table.
There are no conditions or events, since that notification, that management
believes would cause a change in the Bank's categorization. No deduction was
taken from capital for interest-rate risk. The Company's and the Bank's Tier
1/leverage, Tier 1 risk-based and total risk-based capital ratios together with
related regulatory minimum requirements are summarized below:
TO BE WELL
FOR CAPITAL CAPITALIZED UNDER
ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
--------------------- -------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- -------- -------- ------- -------- -----
As of March 31, 2003:
COMPANY (CONSOLIDATED)
Total capital $39,076 12.05% 25,950 =>8.00% N/A N/A
Tier 1 capital 35,792 11.03 12,975 =>4.00 N/A N/A
Tier 1 leverage capital 35,792 7.41 19,299 =>4.00 N/A N/A
BANK
Total capital 35,949 11.08 25,950 =>8.00 $32,437 =>10.00%
Tier 1 capital 32,665 10.07 12,975 =>4.00 19,462 => 6.00
Tier 1 leverage capital 32,665 6.77 19,299 =>4.00 24,124 => 5.00
As of March 31, 2002:
COMPANY (CONSOLIDATED)
Total capital 40,303 13.06 24,694 =>8.00 N/A N/A
Tier 1 capital 37,011 11.99 12,347 =>4.00 N/A N/A
Tier 1 leverage capital 37,011 8.09 18,304 =>4.00 N/A N/A
BANK
Total capital 38,134 12.35 24,700 =>8.00 30,875 =>10.00
Tier 1 capital 34,842 11.28 12,350 =>4.00 18,525 => 6.00
Tier 1 leverage capital 34,842 7.61 18,304 =>4.00 22,880 => 5.00
=> Means equal to or greater than.
NOTE 11. EMPLOYEE BENEFITS (Dollars in Thousands, Except Per Share Data)
PENSION AND SAVINGS PLANS
As a participating employer in the Co-operative Banks Employees' Retirement
Association ("CBERA"), a multi-employer plan, the Bank has in effect a
noncontributory defined benefit plan ("Pension Plan") and a defined contribution
plan ("Savings Plan") covering substantially all eligible employees.
Benefits under the Pension Plan are determined at the rate of 1% and 1.5%,
respectively, of certain elements of final average pay times years of credited
service and are generally provided at age 65 based on years of service and the
average of the participants' three highest consecutive years of compensation
from the Bank. Employee contributions are made to a Savings Plan which qualifies
under section 401(k) of the Internal Revenue Code of 1986, as amended. The Bank
matches 50% of an eligible deferral contribution on the first 5% of the deferral
amount subject to the maximum allowable under federal regulations. Pension
benefits and employer contributions to the Savings Plan become vested over six
years.
Expenses for the Pension Plan and the Savings Plan were $319, $289 and $269
for the years ended March 31, 2003, 2002 and 2001, respectively. Forfeitures are
used to reduce expenses of the plans.
50
EMPLOYEE STOCK OWNERSHIP PLAN
During fiscal 1991, the Bank established an Employee Stock Ownership Plan
("ESOP") that is authorized to purchase shares of outstanding common stock of
the Company from time to time in the open market or in negotiated transactions.
The ESOP is a tax-qualified defined contribution plan established for the
exclusive benefit of the Bank's employees.
During fiscal 2002, the Company's Board of Directors authorized a loan to
the ESOP to acquire up to an additional 5% of outstanding shares of Company
stock. During fiscal 2003, a loan to purchase up to an additional $3,200 in
shares for the ESOP was authorized. During fiscal 2003 and 2002, 114,864 and
7,222 shares, respectively, were purchased at a purchase price of $3,595 and
$199, respectively. The ESOP is repaying its loans to the Company with funds
from the Bank's contributions to the ESOP and earnings from the ESOP's assets.
These loans have terms of up to 20 years.
Prior to fiscal 2002, compensation expense was recognized as the shares
were allocated to ESOP participants based upon the cost of the shares to the
ESOP. Beginning in fiscal 2002, compensation expense was recognized as the
shares were allocated to participants based upon the fair value of the shares at
the time they were allocated. Consequently, changes in market value of the
Company's stock have an effect on the Company's results of operations but have
no effect on stockholders' equity. ESOP expense for fiscal 2003, 2002 and 2001
amounted to $429, $305 and $130, respectively.
STOCK OPTION PLAN
The Company has adopted two qualified Stock Option Plans for the benefit of
officers and other employees under which an aggregate of 281,500 shares had been
reserved for issuance. One of these plans terminated in 1997.
Stock option activity is as follows for the years indicated:
NUMBER OF WEIGHTED AVERAGE
SHARES SHARES EXERCISE PRICE
--------- ---------------------
Balance March 31, 2000 57,499 18.511
Granted 32,501 16.625
--------
Balance March 31, 2001 90,000 17.830
Forfeited (799) 16.625
Exercised (29,588) 16.617
--------
Balance March 31, 2002 59,613 18.448
Exercised (28,139) 18.308
-------
Balance March 31, 2003 31,474 18.572
=======
The exercise price of an option will not be less than the fair market value
of the common stock on the date of grant of the option. At March 31, 2003,
33,299 shares were reserved for issuance under the remaining plan.
51
All stock options are fully vested and exercisable at the time of grant.
The range of exercise prices and weighted average remaining contractual life of
outstanding stock options at March 31, 2003 are as follows:
Exercise Number Remaining
Price Outstanding Life
--------- ----------- ---------
$16.625 14,565 7.7 years
20.250 16,909 6.7 years
------
31,474
======
OTHER POST-RETIREMENT BENEFITS
The Bank maintains a post-retirement medical insurance plan and life
insurance plan for certain individuals. The following tables summarize the
funded status and the actuarial benefit obligations of these plans for fiscal
2003 and 2002.
2003 2002
-------------------- --------------------
LIFE MEDICAL LIFE MEDICAL
---- ------- ---- -------
Actuarial present value of benefits obligation:
Retirees $ (229) $ (357) $ (220) $ (614)
Fully eligible participants (14) (57) (12) (132)
------- ------- ------- -------
Total $ (243) $ (414) $ (232) $ (746)
======= ======= ======= =======
Change in projected benefit obligation:
Accumulated benefit obligations at
prior year-end $ (232) $ (746) $ (266) $ (720)
Service cost less expense component -- -- -- --
Interest cost (16) (27) (16) (51)
Actuarial gain (loss) 4 330 45 (12)
Assumptions (9) (29) (5) (13)
Benefits paid 10 58 10 50
------- ------- ------- -------
Accumulated benefit obligations
at year-end $ (243) $ (414) $ (232) $ (746)
======= ======= ======= =======
Change in plan assets:
Fair value of plan assets at prior year-end $ -- $ -- $ -- $ --
Actual return on plan assets -- -- -- --
Employer contribution 10 58 10 50
Benefits paid end expenses (10) (58) (10) (50)
------- ------- ------- -------
Fair value of plan assets at current
year-end $ -- $ -- $ -- $ --
======= ======= ======= =======
Funded $ (243) $ (414) $ (232) $ (746)
Unrecognized net obligation 86 248 95 273
Unrecognized prior year service -- -- -- --
Unrecognized net (loss) gain (72) (180) (82) 102
------- ------- ------- -------
$ (229) $ (346) $ (219) $ (371)
======= ======= ======= =======
Reconciliation of (accrual) prepaid:
(Accrued) prepaid pension cost at beginning
of year $ (219) $ (371) $ (211) $ (343)
Minus net periodic cost (20) (33) (18) (78)
Plus employer contributions, net 10 58 10 50
------- ------- ------- -------
(Accrued) prepaid cost at end of year $ (229) $ (346) $ (219) $ (371)
======= ======= ======= =======
Benefit obligation weighted average assumption as
of fiscal year-end:
Discount rate 6.50% 6.50% 7.00% 7.00%
Expected return on plan assets 6.50 6.50 7.00% 7.00%
Rate of compensation increase -- -- -- --
52
1 PERCENTAGE POINT INCREASE
------------------------------------
2003 2002
----------------- ----------------
LIFE MEDICAL LIFE MEDICAL
---- ------- ---- -------
Impact of 1% change in health care trend rates:
Effect on total service and interest cost components N/A $ (2) N/A $ (4)
Effect on the post retirement benefit obligations N/A 27 N/A 55
Components of net periodic benefit obligations:
Service cost $ -- $ -- $ -- $ --
Interest cost 16 27 16 51
Expected return on plan assets -- -- -- --
Amortization of prior service cost 9 25 9 25
Recognized actuarial (gain) loss (5) (19) (6) 2
---- ---- ----- ----
Net periodic benefit cost for fiscal year ending $ 20 $ 33 $ 19 $ 78
==== ==== ===== ====
Periodic benefit cost weighted average assumptions:
Discount rate 7.25% 7.00% 7.25% 7.25%
Expected return on plan assets 7.25% 7.00% 7.25% 7.25%
Rate of compensation increase -- -- -- --
For measurement purposes, a 15.0% annual rate of increase in the per capita
cost of covered health care benefits was assumed for the fiscal year ended March
31, 2002. The rate was assumed to decrease to 5.5% for the fiscal year ending
March 31, 2003 and remain at that level thereafter.
NOTE 12. LEGAL PROCEEDINGS
The Bank from time to time is involved as plaintiff or defendant in various
legal actions incident to its business. Except as described herein, none of
these actions are believed to be material, either individually or collectively,
to the results of operations and financial condition of the Company or any
subsidiary.
The Bank has been named as defendant in a civil suit filed March 28, 2002
in Middlesex Superior Court under the caption Yi v. Central Bank in which it is
------------------
alleged, inter alia, that the Bank committed an unfair or deceptive trade
----- ----
practice by failing to pay surplus foreclosure proceeds to a junior lien holder
in 1994. The plaintiff seeks damages of $165,000 plus statutory interest of
approximately $175,000 and has applied for a multiple damage award under Chapter
93A of the Massachusetts General Laws which provides for up to treble damages if
a violation is found to be willful or knowing. While the Bank believes that it
has meritorious defenses to all such claims and intends to vigorously defend
against them, a settlement offer has been made to the plaintiffs' counsel,
however, no response has been received.
The Company and certain present and former directors have been named in
related federal and state court lawsuits brought by PL Capital, LLC and
affiliates ("PL Capital") and also by Lawrence B. Seidman and affiliates
("Seidman"), respectively, current and former stockholders, in which PL Capital
has challenged actions by the directors including, among other things, a
decision on setting the date for closing of the polls for voting at the 2002
Annual Meeting and the directors' decision following that Annual Meeting not to
seek the sale of the Company. PL Capital and Seidman have challenged the
directors' determination that PL Capital and Seidman secretly acted in concert
in violation of the Company's Shareholder Rights Agreement ("Rights Plan").
After a review and recommendation by a Special Committee of the Board of
Directors, the Board of Directors determined on January 28, 2003 that PL
Capital, which owned 9.8% of Central Bancorp shares, had secretly coordinated a
November 4, 2002 block trade to place 8.3% of Company's common stock in the
hands of Seidman, Joseph Stilwell ("Stilwell") and Robert Reichenbach
("Reichenbach"), thereby exceeding the 10% ownership limit set by the
Shareholder Rights Plan. As a result, the Special Committee and Board of
Directors determined that PL Capital, Seidman, Stilwell and Reichenbach
(collectively, the "PL Capital-Seidman Group") constitute an Acquiring Person
under the Rights Plan. Seidman and PL Capital immediately commenced actions in
the Massachusetts Superior Court for Suffolk County to enjoin implementation of
the Rights Plan, which once implemented would provide an issuance of one
additional share of common stock for each share presently owned to all of the
Company's shareholders other than the PL Capital-Seidman Group. The
Massachusetts Superior Court entered an ex parte temporary restraining order,
-- -----
later extended to a preliminary injunction, enjoining the Company and its Board
of Directors from implementing the Rights Plan pending trial on the merits.
Following expedited
53
proceedings in Massachusetts federal and state courts, the parties have asked
for rulings on the legal standard applicable to the directors' decisions
challenged by PL Capital and Seidman and on whether PL Capital and Seidman can
avoid application of the Rights Plan to them by virtue of Seidman's sale of all
of his shares in the Company. Seidman sold those shares immediately after his
motion for summary judgment in the federal court was denied and
contemporaneously with the federal court's order that the legal standard on the
applicable Rights Plan claims be determined by the state court and that trial
then proceed as scheduled in the state court. (On February 11 and February 26,
2003, respectively, the Company and its directors entered into settlement
agreements with Stilwell and Reichenbach (and their respective affiliates) and
the litigation was subsequently dismissed with respect to those parties only.)
PL Capital's initial complaint was filed on October 1, 2002 in the United
States District Court for the District of Massachusetts and amended on November
12, 2002, challenging, respectively, the decisions of the Company's Board of
Directors concerning setting a date for closing the polls on voting for
directors at the 2002 Annual Meeting and the Board of Directors' decision not to
seek sale of the Company. (PL Capital's amended complaint also challenged the
directors' decision to re-elect Marat E. Santini and John F. Gilgun, Jr. rather
than PL Capital's nominees to the Board of the Bank and the Company's
reimbursement of legal fees for Joseph and John Doherty, and alleged unfair and
deceptive trade practices within the meaning of Chapter 93A of the Massachusetts
General Laws.) PL Capital's requests for relief were opposed by the Company and
its directors and were denied by the court and dismissed on November 13, 2002.
PL Capital and Seidman subsequently filed complaints in the Massachusetts
Superior Court for Suffolk County on January 30 and 31, 2003 challenging the
directors' Rights Plan decision of January 28, 2003, but the state court found
that PL Capital and Seidman had apparently failed to inform the Court that PL
Capital had filed related action in federal court (see above) and was already a
party there to identical claims concerning the Rights Plan. (The Special
Committee had filed in federal court on January 28, 2003, seeking a declaratory
judgment that its decision under the Rights Plan complied with applicable
Massachusetts law, to prevent such circumvention by PL Capital or Seidman.)
Acccordingly, PL Capital and Seidman were ordered by the state court to proceed
in federal court, where PL Capital had initiated action in October 2002.
PL Capital and Seidman have filed additional claims in the federal court
challenging other decisions made by the Company's directors. PL Capital's claims
in the federal court against the Company, its directors, the Central Cooperative
Bank Employee Stock Ownership Plan Trust (the "ESOP") and the Joseph R. Doherty
Family Limited Partnership, L.P. also challenge the directors' approval of a
loan from the Company to the ESOP and allege interference with PL Capital's
voting rights as a result of the ESOP's purchase of Reichenbach's shares of the
Company's common stock (in connection with Reichenbach's decision to settle out
of the litigation). PL Capital further alleges that John Doherty, Joseph
Doherty, the Joseph R. Doherty Family Limited Partnership, L.P. and the ESOP
(and its trustees) violated Section 13(d) of the Securities Exchange Act of 1934
("Exchange Act") by allegedly failing to disclose certain relationships and
purported motives in connection with their ownership of the Company's stock. PL
Capital also seeks a declaratory judgment that former director Garrett Goodbody
and director Richard Fates are entitled to indemnification from the Company with
respect to the litigation. PL Capital seeks declaratory and injunctive relief,
money damages and attorneys' fees. Seidman has also alleged in the federal
court, in addition to claims concerning the directors' Rights Plan
determination, claims similar to PL Capital's alleging violation of Section
13(d) of the Exchange Act by John Doherty and Joseph Doherty and interference
with Seidman's voting rights by virtue of the ESOP's purchase of Reichenbach's
shares of the Company's common stock. Seidman seeks declaratory relief and
attorneys' fees. The Company has also sought a declaratory judgment from both
the state and federal courts seeking to resolve those litigations (and, in the
federal court, the Company has also alleged that PL Capital and Seidman violated
Section 13(d) of the Exchange Act by failing to disclose to the Company, its
shareholders and the investing public their coordinated ownership of the
Company's stock).
The Company believes that all of PL Capital's and Seidman's claims are
without merit and intends to defend them vigorously.
NOTE 13. FAIR VALUES OF FINANCIAL INSTRUMENTS (In Thousands)
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Significant assets and liabilities that are not
considered financial assets or liabilities include the intangible value inherent
in deposit relationships (i.e. core deposits) and banking premises and
equipment. In addition, the tax ramifications related to the realization of the
unrealized gains and losses can have a
54
significant effect on fair values and have not been considered in any of the
estimates. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Bank.
The following methods and assumptions were used by the Bank in estimating
fair values of its financial instruments:
CASH AND DUE FROM BANKS
The carrying values reported in the balance sheet for cash and due from
banks approximate their fair value because of the short maturity of these
instruments.
SHORT-TERM INVESTMENTS
The carrying values reported in the balance sheet for short-term
investments approximate fair value because of the short maturity of these
investments.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
The fair values presented for investment and mortgage-backed securities are
based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
LOANS
The fair values of loans are estimated using discounted cash flow analysis,
using interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. The incremental credit risk for
nonperforming loans has been considered in the determination of the fair value
of loans.
ACCRUED INTEREST RECEIVABLE
The carrying value reported in the balance sheet for accrued interest
receivable approximates its fair value because of the short maturity of these
accounts.
STOCK IN FHLB OF BOSTON
The carrying amount reported in the balance sheet for FHLB stock
approximates its fair value. If redeemed, the Bank will receive an amount equal
to the par value of the stock.
THE CO-OPERATIVE CENTRAL BANK RESERVE FUND
The carrying amount reported in the balance sheet for the Co-operative
Central Bank Reserve Fund approximates its fair value.
DEPOSITS
The fair values of deposits (excluding term deposit certificates) are, by
definition, equal to the amount payable on demand at the reporting date. Fair
values for term deposit certificates are estimated using a discounted cash flow
technique that applies interest rates currently being offered on certificates to
a schedule of aggregated monthly maturities on time deposits with similar
remaining maturities.
ADVANCES FROM FHLB OF BOSTON
Fair values of non-callable advances from the FHLB of Boston are estimated
using a discounted cash flow technique that applies interest rates currently
being offered on advances to a schedule of aggregated monthly maturities on FHLB
advances. Fair values of callable advances from the FHLB of Boston are estimated
using the prepayment fee payable to the FHLB of Boston assuming all such
advances were prepaid on the reporting date.
SHORT-TERM BORROWINGS, ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND
INSURANCE AND ACCRUED INTEREST PAYABLE
The carrying values reported in the balance sheet for short-term
borrowings, advance payments by borrowers for taxes and insurance and accrued
interest payable approximate their fair value because of the short maturity of
these accounts.
OFF-BALANCE SHEET INSTRUMENTS
The Bank's commitments for unused lines of credit and unadvanced portions
of loans are at floating rates, which approximate current market rates, and,
therefore, no fair value adjustment has been made.
55
The estimated carrying amounts and fair values of the Bank's financial
instruments are as follows:
MARCH 31, 2003 MARCH 31, 2002
----------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
ASSETS
Cash and due from banks $ 5,996 $ 5,996 $ 5,109 $ 5,109
Short-term investments 5,226 5,226 2,455 2,455
Investment securities 61,111 61,111 73,884 73,884
Net loans 387,180 393,347 368,415 367,893
Stock in Federal Home Loan Bank of Boston, at cost 8,300 8,300 8,300 8,300
The Co-operative Central Bank Reserve Fund 1,576 1,576 1,576 1,576
Accrued interest receivable 2,380 2,380 2,530 2,530
LIABILITIES
Deposits $287,959 $290,325 $261,907 $262,810
Advances from Federal Home Loan Bank of Boston 144,400 160,104 161,000 166,896
Short-term borrowings 176 176 3,000 3,000
Advance payments by borrowers for taxes and insurance 999 999 1,111 1,111
Accrued interest payable 606 606 618 618
NOTE 14. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS (In Thousands)
The following are the condensed financial statements for Central Bancorp,
Inc. (the "Parent Company") only:
MARCH 31,
-------------------------
BALANCE SHEETS 2003 2002
----------------------------------------------------------------------------------------------------------------
ASSETS
Cash deposit in subsidiary bank $ 93 $ 1,970
Investment in subsidiary 36,326 36,785
ESOP loan 3,660 199
Other assets 394 --
--------- --------
Total assets $ 40,473 $ 38,954
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued taxes and other liabilities $ 1,030 $ --
Total stockholders' equity 39,443 38,954
--------- --------
Total liabilities and stockholders' equity $ 40,473 $ 38,954
========= ========
YEARS ENDED MARCH 31,
------------------------------------
STATEMENTS OF INCOME 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------
Dividends from subsidiary $ 2,437 $ 2,500 $ 4,000
Interest income 92 -- --
Non-interest expenses 2,006 466 266
------- ------- -------
Income before income taxes 523 2,034 3,734
Income tax benefit (650) (154) (87)
------- ------- -------
Income before equity in undistributed net income of subsidiary 1,173 2,188 3,821
Equity in undistributed net income of subsidiary 1,014 672 (712)
------- ------- --------
Net income $ 2,187 $ 2,860 $ 3,109
======= ======= =======
56
YEARS ENDED MARCH 31,
----------------------------------
STATEMENTS OF CASH FLOWS 2003 2002 2001
---------------------------------------- ------------ -------------------------------------------------------------
Cash flows from operating activities
Net income $ 2,187 $ 2,860 $ 3,109
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in undistributed net income of subsidiary (1,014) (672) 712
Decrease (increase) in other assets (394) -- 100
Increase (decrease) in accrued taxes and other liabilities 1,030 (71) 70
------- -------- -------
Net cash provided by operating activities 1,809 2,117 3,991
------- -------- ---------
Cash flows from investing activities:
ESOP loans, net of repayment (3,461) (199) --
------- -------- ---------
Cash flows from financing activities:
Proceeds from exercise of stock options 516 492 --
Purchase of treasury stock -- (1,924) (2,187)
Cash dividends paid (727) (669) (697)
Other, net (14) -- --
------- -------- -------
Net cash used by financing activities (225) (2,101) (2,884)
------- -------- -------
Net increase (decrease) in cash in subsidiary bank (1,877) (183) 1,107
Cash in subsidiary bank at beginning of year 1,970 2,153 1,046
------- -------- -------
Cash in subsidiary bank at end of year $ 93 $ 1,970 $ 2,153
======= ======== =======
NOTE 15. QUARTERLY RESULTS OF OPERATIONS (Unaudited) (In Thousands, Except Per
Share Data)
The following tables summarize the operating results on a quarterly basis
for the years ended March 31, 2003 and 2002.
2003
-----------------------------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- -------
Interest and dividend income....................... $ 7,563 $ 7,450 $ 7,600 $ 7,516
Interest expense................................... 3,283 3,334 3,248 3,007
-----------------------------------------------------
Net interest and dividend income.............. 4,280 4,116 4,352 4,509
Non-interest income................................ 223 58 306 818
Non-interest expenses.............................. 2,891 3,132 3,200 4,654
-----------------------------------------------------
Income before income taxes.................... 1,612 1,042 1,458 673
Income tax......................................... 585 374 548 1,091
-----------------------------------------------------
Net income (loss)............................. $ 1,027 $ 668 $ 910 $ (418)
=====================================================
Earnings (loss) per common share -- basic.......... $ 0.64 $ 0.42 $ 0.58 $ (0.27)
======================================================
Earnings (loss) per common share -- diluted........ $ 0.63 $ 0.42 $ 0.58 $ (0.27)
======================================================
2002
-----------------------------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- -------
Interest and dividend income....................... $ 7,599 $ 7,180 $ 7,052 $ 7,442
Interest expense................................... 4,364 3,820 3,344 3,332
-----------------------------------------------------
Net interest and dividend income.............. 3,235 3,360 3,708 4,110
Non-interest income................................ 409 337 244 (302)
Non-interest expenses.............................. 2,811 2,806 2,467 2,380
-----------------------------------------------------
Income before income taxes.................... 833 891 1,485 1,428
Income tax......................................... 303 327 536 611
-----------------------------------------------------
Net income.................................... $ 530 $ 564 $ 949 $ 817
=====================================================
Earnings per common share -- basic................. $ 0.32 $ 0.34 $ 0.57 $ 0.50
=====================================================
Earnings per common share -- diluted............... $ 0.32 $ 0.34 $ 0.57 $ 0.50
=====================================================
57
During the quarter ended March 31, 2003, the Bank recognized gains on the
sales of loans of $768. During the quarters ended March 31, 2003 and 2002, the
Bank recognized write-downs of $115 and $457, respectively, for certain
marketable equity securities which had experienced a decline in fair value which
was judged to be other than temporary.
As more fully described in Note 8 to the accompanying consolidated
financial statements, the Bank provided additional income taxes of $835 in the
quarter ended March 31, 2003 as a result of legislation affecting the taxation
of dividends received by the Bank from its REIT subsidiary. In addition,
included in non-interest expenses for the quarter ended March 31, 2003, are an
accrual for the Bank's portion of the estimated cost of resolution of a
commercial claim filed in 2002 and legal fees incurred in the pending dispute
with certain of the Company's shareholders that, together, amounted to $1,426.
58
[LETTERHEAD OF KPMG LLP]
Independent Auditors' Report
The Board of Directors and Stockholders
Central Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Central Bancorp,
Inc. and subsidiary (the Company) as of March 31, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended March 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Central Bancorp,
Inc. and subsidiary as of March 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended March 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 1 to the Consolidated Financial Statements, effective April
1, 2002, the Company adopted Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets."
/s/ KPMG LLP
Boston, Massachusetts
April 25, 2003, except as to the fifth paragraph
of Note 8, which is as of June 23, 2003.
59
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the sections titled "Proposal I -- Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement.
The Company has adopted a Code of Ethics which applies to its senior
executive and financial officers. The Code of Ethics is included as Exhibit 14
to this Annual Report.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Executive Compensation and Other Benefits" in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- --------------------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS
- ---------------------------
(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and Principal
Holders Thereof" in the Proxy Statement.
(b) SECURITY OWNERSHIP OF MANAGEMENT
The information required by this item is incorporated herein by
reference to the section captioned "Proposal I - Election of Directors
-- Security Ownership of Management" in the Proxy Statement.
(c) CHANGES IN CONTROL
Not applicable.
(d) EQUITY COMPENSATION PLANS
The Company has adopted the 1999 Stock Option and Incentive Plan
pursuant to which equity may be awarded to participants. This plan has
been approved by stockholders.
60
The following table sets forth certain information with respect to the
Company's equity compensation plans as of March 31, 2003.
(a) (b) (c)
NUMBER OF SECURITIES REMAINING
NUMBER OF SECURITIES TO BE AVAILABLE FOR FUTURE ISSUANCE
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE UNDER EQUITY COMPENSATION
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING PLANS (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS & RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
- ------------- -------------------------- ---------------------------- ------------------------------
Equity compensation plans 31,474 $18.572 33,299
approved by security holders
Equity compensation plans not 0 0 0
approved by security holders
Total (1) 31,474 $18.572 33,299
<FN>
_________
(1) The 1999 Stock Option and Incentive Plan provides for a proportionate
adjustment to the number of shares reserved thereunder in the event of
a stock split, stock dividend reclassification or similar event.
</FN>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Certain Transactions" in the Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES.
- ---------------------------------
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of its principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on this evaluation, the Company's principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
required to be included in the Company's periodic SEC reports.
There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect those controls subsequent to
the date of their last evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) The following documents are filed as part of this Annual Report on Form
10-K.
(1) FINANCIAL STATEMENTS
--------------------
For the Financial Statements filed as part of this Annual Report on
Form 10-K, reference is made to "Item 8 -- Financial Statements and
Supplementary Data".
61
(2) FINANCIAL STATEMENT SCHEDULES
-----------------------------
All financial statement schedules have been omitted as not applicable
or not required or because they are included in the financial
statements appearing at Item 8.
(3) EXHIBITS REQUIRED BY PARAGRAPH (C) OF ITEM 14
---------------------------------------------
See "Item 14(c) -- Exhibits"
(b) REPORTS ON FORM 8-K -- The Registrant filed the following Current Reports
-------------------
on Form 8-K during the fourth quarter of the fiscal year ended March 31,
2003:
DATE OF REPORT ITEM(S) REPORTED FINANCIAL STATEMENTS FILED
-------------- ---------------- --------------------------
January 28, 2003 7, 9 N/A
February 24, 2003 5 N/A
March 7, 2003 5, 7 N/A
(c) EXHIBITS
--------
The following exhibits are filed as exhibits to this report.
EXHIBIT NO. DESCRIPTION
---------- -----------
3.1* Articles of Organization of Central Bancorp, Inc.
3.2* Bylaws of Central Bancorp, Inc.
4.1 Shareholder Rights Agreement, dated as of October 11, 2001, by and between the Central
Bancorp, Inc. and Registrar and Transfer Company, as Rights Agent, as amended and
restated as of January 29, 2003, and as amended on February 11, 2003 and May 22, 2003
10.1* Employment Agreement between the Bank and John D. Doherty, dated October 24, 1986 +
10.2* First Amendment to Employment Agreement between the Bank and John D. Doherty, dated March
31, 1992 +
10.3* Second Amendment to Employment Agreement between the Bank and John D. Doherty, dated June
8, 1995 +
10.4* Third Amendment to the Employment Agreement between the Bank and
John D. Doherty, dated January 8, 1999 +
10.5* Termination Agreement, dated March 31, 1992, by and between the Bank and Joseph R. Doherty +
10.6* Consulting Agreement, dated March 31, 1992, by and between the Bank and Joseph R. Doherty +
10.7* Amendment to Consulting Agreement between the Bank and Joseph R. Doherty, dated August 11,
1994 +
10.8* Severance Agreement between the Bank and William P. Morrissey, dated December 14, 1994 +
10.9* Severance Agreement between the Bank and David W. Kearn, dated December 14, 1994 +
10.10* Severance Agreement between the Bank and Paul S. Feeley, dated May 14, 1998 +
10.11* Amendments to Severance Agreements between the Bank and Messrs. Feeley, Kearn
and Morrissey, dated January 8, 1999. +
10.12** 1999 Stock Option and Incentive Plan +
10.13*** Deferred Compensation Plan for Non-Employee Directors +
62
10.14 Management Incentive Plan, as amended +
10.15**** Severance Agreement between the Bank and Michael K. Devlin, dated February 25, 2002. +
10.16 Termination of Consulting Agreement between the Bank and Joseph R. Doherty, dated July 30, 2002 +
14 Code of Ethics for Senior Executive and Financial Officers
21 Subsidiaries of Registrant
23 Consent of KPMG LLP
99 Certification of Chief Executive Officer and Chief Financial Officer pursuant to
Section 906 of Sarbanes-Oxley Act of 2002
<FN>
______________
+ Management contract or compensatory plan.
* Incorporated herein by reference to the Form 10-K for the fiscal year ended
March 31, 1999, filed with the SEC on June 28, 1999.
** Incorporated by reference to the Registration Statement on Form S-8 (File
No. 333-87005) filed on September 13, 1999.
*** Incorporated by reference to the Registration Statement on Form S-8 (File
No. 333-49264) filed on November 3, 2000.
**** Incorporated by reference to the Annual Report on Form 10-K for the
fiscal year ended March 31, 2002 filed with the SEC on June 28, 2002.
</FN>
63
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CENTRAL BANCORP, INC.
Date: June 27, 2003 By: /s/ John D. Doherty
----------------------------------------------
John D. Doherty
Chairman, President, & Chief Executive Officer
(Duly Authorized Representative)
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
By: /s/ John D. Doherty Date: June 27, 2003
-------------------------------------------------
John D. Doherty
Chairman, President and Chief Executive Officer
By: /s/ Michael K. Devlin Date: June 27, 2003
-------------------------------------------------
Michael K. Devlin
Senior Vice President, Treasurer
and Chief Financial Officer
(Principal Financial and Accounting Officer )
By: /s/ Joseph R. Doherty Date: June 27, 2003
-------------------------------------------------
Joseph R. Doherty
Director
By: /s/ Terence D. Kenney Date: June 27, 2003
-------------------------------------------------
Terence D. Kenney
Director
By: /s/ James F. Linnehan Date: June 27, 2003
-------------------------------------------------
James F. Linnehan
Director
By: /s/ Paul E. Bulman Date: June 27, 2003
-------------------------------------------------
Paul E. Bulman
Director
By: /s/ Richard J. Fates Date: June 27, 2003
-------------------------------------------------
Richard J. Fates
Director
By: /s/ Nancy D. Neri Date: June 27, 2003
-------------------------------------------------
Nancy D. Neri
Director
By: /s/ Gregory W. Boulos Date: June 27, 2003
-------------------------------------------------
Gregory W. Boulos
Director
CERTIFICATION
I, John D. Doherty, Chairman, President and Chief Executive Officer of
Central Bancorp, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Central Bancorp,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: June 27, 2003
/s/ John D. Doherty
----------------------------------------
John D. Doherty
Chairman, President and Chief Executive
Officer
CERTIFICATION
I, Michael K. Devlin, Senior Vice President, Treasurer and Chief Financial
Officer of Central Bancorp, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Central Bancorp,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: June 27, 2003
/s/ Michael K. Devlin
-------------------------------------------------
Michael K. Devlin
Senior Vice President, Treasurer and Chief
Financial Officer