Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 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 December 31, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 001-16767
Westfield Financial, Inc.
(Exact name of registrant as specified in its charter)
Massachusetts 73-1627673
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
141 Elm Street, Westfield, Massachusetts 01085
(Address of Principal Executive Offices, including zip code)
(413) 568-1911
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value per share AMEX
-------------------------------------- ----------------------
(Title of Each Class) (Name of Each Exchange
on which Registered)
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent files pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. Large accelerated
filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act). Yes [ ] No [X].
As of March 7, 2006, the registrant had 10,580,000 shares of common stock,
$.01 par value, issued and 9,689,757 shares outstanding. Of such shares
outstanding, 5,607,400 shares were held by Westfield Mutual Holding Company,
the registrant's mutual holding company, and 4,082,357 were held by the
public and directors, officers and employees of the registrant.
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 30, 2005, was $94,547,053. This figure was based on
the closing price as of June 30, 2005 on The American Stock Exchange for a
share of the registrant's common stock, which was $24.24 on June 30, 2005.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III of Form 10-K - Portions of the Proxy Statement for the 2006 Annual
Meeting of Stockholders.
WESTFIELD FINANCIAL, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2005
TABLE OF CONTENTS
ITEM PART I PAGE
1 BUSINESS 2
1A RISK FACTORS 39
1B UNRESOLVED STAFF COMMENTS 42
2 PROPERTIES 43
3 LEGAL PROCEEDINGS 44
4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 44
PART II
5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 44
6 SELECTED FINANCIAL DATA 46
7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 47
7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 72
8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 72
9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 73
9A CONTROLS AND PROCEDURES 73
9B OTHER INFORMATION 74
PART III
10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 75
11 EXECUTIVE COMPENSATION 75
12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 76
13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 76
14 PRINCIPAL ACCOUNTING FEES AND SERVICES 76
PART IV
15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES 77
SIGNATURES 78
FORWARD - LOOKING STATEMENTS
This Annual Report on Form 10-K contains "forward-looking statements"
which may be identified by the use of such words as "believe," "expect,"
"anticipate," "should," "planned," "estimated," and "potential." Examples of
forward-looking statements include, but are not limited to, estimates with
respect to our financial condition and results of operation and business that
are subject to various factors which could cause actual results to differ
materially from these estimates. These factors include, but are not limited
to:
* general and local economic conditions;
* changes in interest rates, deposit flows, demand for mortgages
and other loans, real estate values, and competition;
* changes in accounting principles, policies, or guidelines;
* changes in legislation or regulation; and
* other economic, competitive, governmental, regulatory, and
technological factors affecting our operations, pricing,
products, and services.
Any or all of our forward-looking statements in this Annual Report on
Form 10-K and in any other public statements we make may turn out to be
wrong. They can be affected by inaccurate assumptions we might make or known
or unknown risks and uncertainties. Consequently, no forward-looking
statements can be guaranteed. We disclaim any obligation to subsequently
revise any forward-looking statements to reflect events or circumstances
after the date of such statements, or to reflect the occurrence of
anticipated or unanticipated events.
1
PART I
ITEM 1. BUSINESS
General. Westfield Financial, Inc. ("Westfield Financial," the
"Company," "us," "our," or "we") is a Massachusetts-chartered stock holding
company organized in November 2001 in connection with the reorganization of
Westfield Mutual Holding Company, a federally-chartered mutual holding
company which owns 57.5% of the outstanding common stock of Westfield
Financial. Westfield Financial serves as the holding company for Westfield
Bank, a federally-chartered stock savings bank. Unless the context
otherwise requires, all references herein to Westfield Bank or Westfield
Financial include Westfield Financial and Westfield Bank on a consolidated
basis. In connection with our reorganization, Westfield Financial sold
4,972,600 shares of its common stock to eligible depositors of Westfield
Bank. Net proceeds of the stock offering were $47.7 million. The
reorganization of Westfield Mutual Holding Company and the related stock
offering by Westfield Financial were completed on December 27, 2001. The
common stock of Westfield Financial commenced trading on The American Stock
Exchange under the symbol "WFD" on December 28, 2001.
On July 23, 2004 Westfield Bank and Westfield Mutual Holding Company
completed their conversions from Massachusetts-chartered companies regulated
by the Massachusetts Division of Banks or the Federal Reserve Board to
federally-chartered companies regulated by the Office of Thrift Supervision
(the "OTS").
Westfield Securities Corp., and Elm Street Securities Corporation,
Massachusetts chartered security corporations, were formed by the Company for
the primary purpose of holding qualified investment securities. In the third
quarter of 2005, the Company dissolved Westfield Securities Corporation in
order to streamline operations.
Westfield Bank was formed in 1853 and reorganized into a mutual holding
company structure without a stock offering in 1995. Historically, Westfield
Bank has been a community-oriented provider of banking products and services
to businesses and individuals, including traditional products such as
residential and commercial real estate loans, consumer loans and a variety of
deposit products. In recent years, however, Westfield Bank has developed and
implemented a lending strategy that focuses less on residential real estate
lending and more on servicing commercial customers, including increased
emphasis on commercial and industrial lending and commercial deposit
relationships, extending its branch network and broadening its product lines
and services. Westfield Bank believes that this business strategy is best for
its long term success and viability, and complements its existing commitment
to high quality customer service.
2
Beginning on September 1, 2001, Westfield Bank began referring its
residential real estate loan customers to a third party mortgage company.
Under the program, substantially all of Westfield Bank's residential real
estate loans are underwritten and originated by a third party mortgage
company. In connection with this referral program, Westfield Bank receives
fee income for each of the loans originated by the third party mortgage
company. Westfield Bank may purchase residential real estate loans from the
third party mortgage company depending on market conditions. To date,
Westfield Bank has not purchased a significant amount of loans from the third
party mortgage company.
Westfield Bank's revenues are derived principally from interest on its
loans and interest and dividends on its investment securities. Its primary
sources of funds are deposits, scheduled amortization and prepayments of loan
principal and mortgage-backed securities, maturities and calls of investment
securities, and funds provided by operations.
Market Area. Westfield Bank operates through 10 banking offices in
Agawam, East Longmeadow, Holyoke, Southwick, Springfield, West Springfield
and Westfield, Massachusetts. It also has five free-standing ATM locations in
Agawam, Feeding Hills, Springfield, and Westfield, Massachusetts. Westfield
Bank's primary deposit gathering area is concentrated in the communities
surrounding these locations and its primary lending area includes all of
Hampden County in Western Massachusetts. In addition, Westfield Bank
provides online banking services through its web site
(http://www.westfieldbank.com).
The City of Westfield is largely suburban and is located in the Pioneer
Valley near the intersection of U.S. Interstates 90 (the Massachusetts
Turnpike) and 91. Interstate 90 is the major east-west highway that crosses
Massachusetts. Interstate 91 is the major north-south highway that runs
directly through the heart of New England. Westfield is located
approximately 90 miles west of Boston, Massachusetts, 70 miles southeast of
Albany, New York and 30 miles north of Hartford, Connecticut. Westfield's
2004 population was approximately 41,000 and the estimated 2004 population
for Hampden County was approximately 456,200.
The economy of Westfield Bank's market area historically has been
supported by a variety of industries. Its primary market area has benefited
from the presence of large employers centered in insurance, health care,
warehouse, manufacturing and education. Among the largest employers currently
in its market area are Bay State Health Systems, Big Y Foods, Friendly Ice
Cream Corporation, Hasbro, Mass Mutual Life Insurance Company, Mestek, Noble
Hospital, the University of Massachusetts, Westfield State College, American
International College, and the Sullivan Paper Company. In addition, other
employment and economic activity is provided by a substantial number of small
and medium size businesses in the area.
Westfield Bank's future growth opportunities will be influenced by the
growth and stability of the statewide and regional economies, other
demographic population trends and the competitive environment. Westfield
Bank believes that it has developed lending products and marketing strategies
to address the diverse credit-related needs of the residents in its market
area.
3
As of December 2005, the unemployment rate of Westfield Bank's primary
market area and Massachusetts was 5.4% and 4.9%, respectively, compared to
4.9% and 4.7%, respectively, in December 2004. From June 2004 to June 2005,
the median household income in Westfield Bank's market area increased by
10.6% to $61,500, compared to $55,624 as of June 2004. Despite the increase,
the median household income in Westfield Bank's market area is below state
and national averages.
Competition. Westfield Bank faces intense competition both in making
loans and attracting deposits. Its primary market area is highly competitive
and it faces direct competition from approximately 24 financial institutions,
many with a local, state-wide or regional presence and, in some cases, a
national presence. Many of these financial institutions are significantly
larger than and have greater financial resources than Westfield Bank.
Westfield Bank's competition for loans comes principally from commercial
banks, savings institutions, mortgage banking firms, credit unions, finance
companies, mutual funds, insurance companies and brokerage and investment
banking firms. Historically, Westfield Bank's most direct competition for
deposits has come from savings, co-operative and commercial banks. Westfield
Bank faces additional competition for deposits from short-term money market
funds and other corporate and government securities funds and from brokerage
firms and insurance companies. In Westfield Bank's market area, there were
approximately ten of the foregoing institutions at December 31, 2005.
Lending Activities
Loan Portfolio Composition. Westfield Bank's loan portfolio primarily
consists of residential real estate loans, home equity loans, commercial real
estate loans, commercial and industrial loans and consumer loans.
At December 31, 2005, Westfield Bank had total loans of $383.9 million,
of which 71.8% were adjustable-rate loans and 28.2% were fixed-rate loans.
Commercial real estate loans and commercial and industrial loans totaled
$169.6 million and $100.0 million respectively. The remainder of its loans
at December 31, 2005 consisted of residential mortgage loans, home equity
loans and consumer loans. Residential mortgage and home equity loans
outstanding at December 31, 2005 totaled $106.9 million. Consumer loans
outstanding at December 31, 2005 were $7.4 million.
Westfield Bank's loans are subject to federal law and regulations. The
interest rates Westfield Bank charges on loans are affected principally by
the demand for loans, the supply of money available for lending purposes and
the interest rates offered by its competitors. These factors are, in turn,
affected by general and local economic conditions, monetary policies of the
federal government, including the Federal Reserve Board, legislative tax
policies and governmental budgetary matters. The following table presents the
composition of Westfield Bank's loan portfolio in dollar amounts and in
percentages of the total portfolio at the dates indicated.
4
At December 31,
--------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------------- ------------------- ------------------- ------------------- --------------------
Percent of Percent of Percent of Percent of Percent of
Amount Total Amount Total Amount Total Amount Total Amount Total
------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ -----------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Real estate loans:
Commercial $169,564 44.17% $144,336 38.65% $131,292 37.57% $100,903 27.92% $ 99,425 23.82%
Residential 96,061 25.02 111,646 29.90 100,728 28.83 146,664 40.59 199,710 47.86
Home equity 10,857 2.83 11,176 2.99 9,819 2.81 11,232 3.11 13,041 3.13
-------- ------ -------- ------ -------- ------ -------- ------ -------- -------
Total real estate
loans 276,482 72.02 267,158 71.54 241,839 69.21 258,799 71.62 312,176 74.81
-------- ------ -------- ------ -------- ------ -------- ------ -------- -------
Other loans:
Commercial and
industrial 100,019 26.06 94,726 25.36 85,292 24.41 61,494 17.01 47,012 11.27
Indirect auto 1,745 0.45 5,886 1.58 15,983 4.57 33,848 9.37 52,129 12.49
Consumer, other 5,627 1.47 5,679 1.52 6,327 1.81 7,216 2.00 5,955 1.43
Total other loans 107,391 27.98 106,291 28.46 107,602 30.79 102,558 28.38 105,096 25.19
-------- ------ -------- ------ -------- ------ -------- ------ -------- -------
Total loans 383,873 100.00% 373,449 100.00% 349,441 100.00% 361,357 100.00% 417,272 100.00%
-------- ------ -------- ------ -------- ------ -------- ------ -------- -------
Net deferred loan
origination costs 386 429 181 123 197
Allowance for loan
losses (5,422) (5,277) (4,642) (4,325) (3,923)
-------- -------- -------- -------- --------
Total loans, net $378,837 $368,601 $344,980 $357,155 $413,546
======== ======== ======== ======== ========
5
Loan Maturity and Repricing. The following table shows the repricing
dates or contractual maturity dates as of December 31, 2005. The table does
not reflect prepayments or scheduled principal amortization. Demand loans,
loans having no stated maturity, and overdrafts are shown as due in within
one year.
At December 31, 2005
--------------------------------------------------------------------------
Commercial
Residential Commercial and
Real Estate Home Equity Real Estate Industrial Consumer
Loans Loans Loans Loans Loans Totals
----------- ----------- ----------- ---------- -------- ------
(In thousands)
<s> <c> <c> <c> <c> <c> <c>
Amounts due:
Within one year $13,312 $ 8 $ 30,268 $ 50,331 $ 945 $ 94,864
After one year:
One to three years 7,218 23 47,926 7,425 3,790 66,382
Three to five years 26,370 537 52,454 19,657 2,541 101,559
Five to ten years 14,516 2,750 29,817 22,446 96 69,625
Ten to twenty years 21,859 7,539 8,952 10 - 38,360
Over twenty years 12,786 - 147 150 - 13,083
------- ------- -------- -------- ------ --------
Total due after one year 82,749 10,849 139,296 49,688 6,427 289,009
------- ------- -------- -------- ------ --------
Total amount due: 96,061 10,857 169,564 100,019 7,372 383,873
------- ------- -------- -------- ------ --------
Less:
Net deferred loan
origination costs
(fees), net 172 173 (79) 89 31 386
Allowance for loan losses (319) (36) (2,618) (2,366) (83) (5,422)
------- ------- -------- -------- ------ --------
Loans, net $95,914 $10,994 $166,867 $ 97,742 $7,320 $378,837
======= ======= ======== ======== ====== ========
The following table presents, as of December 31, 2005, the dollar
amount of all loans contractually due or scheduled to reprice after December
31, 2006 and whether such loans have fixed interest rates or adjustable
interest rates.
Due After December 31, 2006
----------------------------------
Fixed Adjustable Total
----- ---------- -----
(In thousands)
<s> <c> <c> <c>
Real Estate Loans
Residential $53,316 $ 29,433 $82,749
Home Equity - 10,849 10,849
Commercial real estate 5,575 133,721 139,296
------- -------- --------
Total real estate loans 58,891 174,003 232,894
------- -------- --------
Other Loans
Commercial and industrial 33,455 16,233 49,688
Consumer 6,427 - 6,427
------- -------- --------
Total other loans 39,882 16,233 56,115
------- -------- --------
Total loans $98,773 $190,236 $289,009
======= ======== ========
6
The following table presents our loan originations, purchases, sales
and principal payments for the years indicated:
For the Year Ended December 31,
------------------------------------
2005 2004 2003
---- ---- ----
(In thousands)
<s> <c> <c> <c>
Loans:
Balance outstanding at beginning of year $373,449 $349,441 $361,357
Originations:
Real estate loans:
Residential 8,607 5,435 4,062
Home equity 4,356 6,390 5,694
Commercial 58,382 31,174 58,978
-------- -------- --------
Total mortgage originations
71,345 42,999 68,734
Commercial and industrial loans 43,465 50,349 67,558
Consumer loans 3,325 3,516 4,676
-------- -------- --------
Total originations 118,135 96,864 140,968
Purchases of one-to-four family
mortgage loans 1,236 34,996 11,352
-------- -------- --------
119,371 131,860 152,320
-------- -------- --------
Less:
Principal repayments, unadvanced funds
and other, net 108,627 107,737 163,803
Loan charge-offs, net 320 115 433
-------- -------- --------
Total deductions 108,947 107,852 164,236
-------- -------- --------
Ending balance $383,873 $373,449 $349,441
======== ======== ========
7
Commercial Real Estate Loans. Westfield Bank originates commercial
real estate loans to finance the purchase of real property, which generally
consists of apartment buildings, business properties, multi-family investment
properties and construction loans to developers of commercial and residential
properties. In underwriting commercial real estate loans, consideration is
given to the property's historic cash flow, current and projected occupancy,
location and physical condition. At December 31, 2005, Westfield Bank's
commercial real estate loan portfolio consisted of 420 loans, totaling $169.6
million, or 44.2% of total loans. Since 2001, commercial real estate loans
have grown by $70.2 million, or 70.6%, from $99.4 million at December 31,
2001 to $169.6 million at December 31, 2005.
The majority of the commercial real estate portfolio consists of loans
which are collateralized by properties in Westfield Bank's normal lending
area. Westfield Bank's commercial real estate loan portfolio is diverse, and
does not have any significant loan concentration by type of property or
borrower. Westfield Bank generally lends up to a maximum loan-to-value ratio
of 85% on commercial properties and generally requires a minimum debt
coverage ratio of 1.15 times. Its largest commercial real estate loan
relationship had an outstanding balance of $13.3 million at December 31, 2005
which was secured by one commercial investment property located in
Massachusetts and two properties in New Hampshire. The loans of this
borrower have performed to contractual terms.
Westfield Bank also offers construction loans to finance the
construction of commercial properties located in its primary market area.
Westfield Bank had $30.1 million in commercial construction loans and
commitments at December 31, 2005.
Commercial real estate lending involves additional risks compared with
one-to-four family residential lending. Payments on loans secured by
commercial real estate properties often depend on the successful management
of the properties, on the amount of rent from the properties, or on the level
of expenses needed to maintain the properties. Repayment of such loans may
therefore be adversely affected by conditions in the real estate market or
the general economy. Also, commercial real estate loans typically involve
large loan balances to single borrowers or groups of related borrowers. In
order to mitigate this risk, Westfield Bank monitors its loan concentration
on a quarterly basis and its loan policies generally limit the amount of
loans to a single borrower or group of borrowers.
Because of increased risks associated with commercial real estate
loans, Westfield Bank's commercial real estate loans generally have higher
rates than residential mortgage loans. Commercial real estate loans
generally have adjustable rates with repricing dates of five years or less
however, occasionally repricing dates may be a long as ten years. Whenever
possible, Westfield Bank's seeks to originate adjustable rate commercial real
estate loans. Borrower activity and market conditions however, may influence
whether the Bank is able to originate adjustable rate loans rather than fixed
rate loans.
8
Commercial and Industrial Loans. Westfield Bank offers commercial and
industrial loan products and services which are designed to give business
owners borrowing opportunities for modernization, inventory, equipment,
construction, consolidation, real estate, working capital, vehicle purchases
and the financing of existing corporate debt. Westfield Bank offers business
installment loans, vehicle and equipment financing, lines of credit,
equipment leasing and other commercial loans. At December 31, 2005,
Westfield Bank's commercial and industrial loan portfolio consisted of 823
loans, totaling $100.0 million or 26.0% of its total loans. Since 2001,
commercial and industrial loans have grown $53.0 million, or 112.8%, from
$47.0 at December 31, 2001 to $100.0 million at December 31, 2005. Westfield
Bank's commercial loan team includes six commercial loan officers, one
business development manager, and four credit analysts. Westfield Bank may
hire additional commercial loan officers on an as needed basis.
As part of Westfield Bank's strategy of increasing its emphasis on
commercial lending, Westfield Bank seeks to attract its business customers'
entire banking relationship. Most commercial borrowers also maintain a
commercial deposit at Westfield Bank. Westfield Bank provides complementary
commercial products and services, including an equipment leasing program with
a third party vendor, a variety of commercial deposit accounts, cash
management services, internet banking, sweep accounts, a broad ATM network
and night deposit services. Commercial loan officers are based in its main
and branch offices, and Westfield Bank views its potential branch expansion
as a means of facilitating these commercial relationships. Westfield Bank
intends to continue to expand the volume of its commercial business products
and services within its current underwriting standards.
Westfield Bank's commercial loan portfolio does not have any
significant loan concentration by type of property or borrower. The largest
concentration of loans was for colleges and universities, which comprise
approximately 3.3% of the total loan portfolio as of December 31, 2005. At
December 31, 2005, Westfield Bank's largest commercial and industrial loan
relationship was $14.3 million to a private New England college. The loans
of this borrower have performed to contractual terms.
Commercial and industrial loans generally have terms of seven years or
less, however on an occasional basis, may have terms of up to ten years.
Among the $100.0 million Westfield Bank has in its commercial and industrial
loan portfolio as of December 31, 2005, $61.2 million have adjustable
interest rates and $38.8 million have fixed interest rates. Whenever
possible, Westfield Bank seeks to originate adjustable rate commercial and
industrial loans. Borrower activity and market conditions however, may
influence whether the Bank is able to originate adjustable rate loans rather
than fixed rate loans. Westfield Bank generally requires the personal
guarantee of the business owner. Interest rates on commercial loans
generally have higher yields than residential or commercial real estate
loans.
Commercial and industrial loans are generally considered to involve a
higher degree of risk than residential or commercial real estate loans
because the collateral may be in the form of intangible assets and/or
inventory subject to market obsolescence. Commercial and industrial loans may
also involve relatively large loan balances to single borrowers or groups of
related borrowers, with the repayment of such loans typically dependent on
the successful operation and income stream of the borrower. These risks can
be significantly affected by economic
9
conditions. In addition, business lending generally requires substantially
greater oversight efforts by Westfield Bank's staff compared to residential
or commercial real estate lending. In order to mitigate this risk, Westfield
Bank monitors its loan concentration and its loan policies generally limit
the amount of loans to a single borrower or group of borrowers. Westfield
Bank also utilizes the services of an outside consultant to conduct on-site
credit quality reviews of the commercial and industrial loan portfolio.
Residential Mortgage Loans and Originations. Beginning in September,
2001, Westfield Bank began referring its residential real estate borrowers to
a third party mortgage company. Residential real estate borrowers submit
applications to Westfield Bank, but the loan is closed on the books of the
mortgage company. Westfield Bank receives a fee for each of these loans
originated by the third party mortgage company. Under the program,
substantially all of Westfield Bank's residential real estate loans are
underwritten and originated by the third party mortgage company. In
addition, depending on market conditions, Westfield Bank may purchase
residential real estate loans from the third party mortgage company. To
date, the Bank has not purchased a significant amount of loans from the third
party mortgage company. Westfield Bank believes that this program
diversifies its loan portfolio and reduces its interest rate risk by reducing
the amount of long-term fixed rate residential mortgages held in Westfield
Bank's loan portfolio.
Even though substantially all residential mortgages are referred to a
third party mortgage company, Westfield Bank still holds residential
mortgages in its loan portfolio. The mortgages held in portfolio consist
primarily of loans originated prior to the commencement of the third party
residential mortgage program. As of December 31, 2005, loans on one-to-four
family residential properties, including home equity lines, accounted for
$106.9 million, or 27.9%, of Westfield Bank's total loan portfolio.
Westfield Bank's residential adjustable-rate mortgage loans generally
are fully amortizing loans with contractual maturities of up to 30 years,
payments due monthly. Its adjustable-rate mortgage loans generally provide
for specified minimum and maximum interest rates, with a lifetime cap and
floor, and a periodic adjustment on the interest rate over the rate in effect
on the date of origination. As a consequence of using caps, the interest
rates on these loans are not generally as rate sensitive as its cost of
funds. The adjustable-rate mortgage loans that Westfield Bank originates
generally are not convertible into fixed-rate loans.
Adjustable-rate mortgage loans generally pose different credit risks
than fixed-rate loans, primarily because as interest rates rise, the
borrower's payments rise, increasing the potential for default. To date,
Westfield Bank has not experienced difficulty with payments for these loans.
At December 31, 2005, its residential mortgage and home equity loan portfolio
included $53.5 million in adjustable-rate loans or, 14.0% of its total loan
portfolio, and $53.4 million in fixed-rate loans, or 13.9% of its total loan
portfolio.
10
Westfield Bank's home equity lines of credit totaled $10.9 million and
comprised 2.8% of its total loan portfolio at December 31, 2005. These loans
may be originated in amounts of the existing first mortgage, or up to 100% of
the value of the property securing the loan. The term to maturity on
Westfield Bank's home equity and home improvement loans may be up to 15
years.
Consumer Loans. Consumer loans are generally originated at higher
interest rates than residential and commercial mortgage loans, but they also
generally tend to have a higher credit risk than residential mortgage loans
because they are usually unsecured or secured by rapidly depreciable assets.
Management, however, believes that offering consumer loan products helps to
expand and create stronger ties to Westfield Bank's existing customer base by
increasing the number of customer relationships and providing cross-marketing
opportunities.
Westfield Bank offers a variety of consumer loans to retail customers
in the communities it serves. Examples of its consumer loans include:
* automobile loans;
* secured passbook loans;
* credit lines tied to deposit accounts to provide overdraft
protection; and
* unsecured personal loans.
At December 31, 2005, the consumer loan portfolio totaled $7.4 million
or 1.9% of total loans. Westfield Bank's consumer lending will allow it to
diversify its loan portfolio while continuing to meet the needs of the
individuals and businesses that it serves.
Automobile loans currently represent the largest portion of its
consumer loan portfolio, totaling $3.6 million, or 0.9% of its total loan
portfolio and 48.6% of its consumer loan portfolio, at December 31, 2005.
Westfield Bank offers fixed-rate automobile loans on a direct basis with
terms of up to 60 months for new and recent model used cars and up to 48
months for older model used cars. Westfield Bank will make such loans up to
100% of the vehicle purchase price on new cars and up to 100% of the NADA
retail value of used cars.
Indirect automobile loans currently represent the second largest
portion of its consumer loan portfolio, totaling $1.7 million, or 0.5% of its
total loan portfolio and 23.0% of its consumer loan portfolio, at December
31, 2005. Management curtailed its indirect lending beginning in fiscal year
2000 and in the fourth quarter of 2003 the Bank ceased writing new loans
under this program.
11
Loans collateralized by rapidly depreciable assets such as automobiles
or that are unsecured entail greater risks than residential mortgage loans.
In such cases, repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding loan balance, since there is
a greater likelihood of damage, loss or depreciation of the underlying
collateral. The remaining deficiency often does not warrant further
substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. Further, collections on these loans are dependent on
the borrower's continuing financial stability and, therefore, are more likely
to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Repossessed collateral relating to consumer loans at December
31, 2005 approximated $34,875. Finally, the application of various federal
and state laws, including federal and state bankruptcy and insolvency laws,
may limit the amount which can be recovered on such loans if a borrower
defaults.
Loan Approval Procedures and Authority. As established by the
Executive Committee of the Board of Directors, Westfield Bank's lending
policies provide that its mortgage underwriting department may review and
approve mortgage loans up to $500,000. Westfield Bank's underwriting
department also may review and approve home equity loans up to $100,000. Any
loan applications, including mortgage loans, that exceed $500,000 or $100,000
for home equity loans require approval of the Executive Committee. For loans
requiring board approval, management is responsible for presenting to the
board information about the creditworthiness of a borrower and the estimated
value of the subject property. Generally, the estimated value of the property
must be supported by an independent appraisal report prepared in accordance
with Westfield Bank's appraisal policy.
The following generally describes Westfield Bank's current lending
procedures. Upon receipt of a completed loan application from a prospective
borrower, Westfield Bank must order a credit report and verify other
information. If necessary, Westfield Bank obtains additional financial or
credit related information. Westfield Bank requires an appraisal for all
mortgage loans. Appraisals for mortgage loans are performed by licensed or
certified third-party appraisal firms and are reviewed by Westfield Bank's
lending department. Appraisals for second mortgages or home equity loans are
not required. Rather, a designated employee of Westfield Bank conducts an
inspection of the property. Westfield Bank requires title insurance on all
first mortgage loans and certain other loans. Westfield Bank requires
borrowers to obtain hazard insurance. Westfield Bank also requires borrowers
to obtain flood insurance, if applicable, prior to closing. In addition,
Westfield Bank makes available to borrowers the option to advance funds on a
monthly basis together with each payment of principal and interest to a
mortgage escrow account from which it makes disbursements for items such as
real estate taxes, flood insurance, and private mortgage insurance premiums.
Beginning on September 1, 2001, Westfield Bank began referring its
residential real estate loans to a third-party mortgage company. Residential
real estate borrowers submit applications to Westfield Bank, but the loan is
closed on the books of the mortgage company.
12
Asset Quality. One of Westfield Bank's key operating objectives has
been and continues to be the achievement of a high level of asset quality.
Westfield Bank maintains a large proportion of loans secured by residential
and commercial properties, sets sound credit standards for new loan
originations and follows careful loan administration procedures. Westfield
Bank also utilizes the services of an outside consultant to conduct on-site
credit quality reviews of Westfield Bank's commercial and industrial loan
portfolio on an annual basis. These practices and relatively favorable
economic and real estate market conditions have resulted in historically low
delinquency ratios and, in recent years, a low level of nonaccrual loans.
Delinquent Loans and Foreclosed Assets. Westfield Bank's policies
require that management continuously monitor the status of the loan portfolio
and report to the Board of Directors on a monthly basis. These reports
include information on delinquent loans and foreclosed real estate, as well
as Westfield Bank's actions and plans to cure the delinquent status of the
loans and to dispose of the foreclosed property.
The following table presents information regarding nonperforming
mortgage, consumer and other loans, and foreclosed real estate as of the
dates indicated. All loans where the interest payment is 90 days or more in
arrears as of the closing date of each month are placed on non-accrual
status. At December 31, 2005, 2004, and 2003, Westfield Bank had $1.9
million, $2.2 million, and $1.8 million, respectively, of non-accrual loans.
If all non-accrual loans had been performing in accordance with their terms,
Westfield Bank would have earned additional interest income of $176,000,
$176,000, and $134,000 for the years ended December 31, 2005, 2004, and 2003,
respectively.
At December 31,
--------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in thousands)
<s> <c> <c> <c> <c> <c>
Non-accrual real estate loans:
Residential $ 411 $ 631 $ 995 $1,323 $1,866
Home equity 18 - 32 30 14
Commercial real estate 1,285 1,341 342 374 536
------ ------ ------ ------ ------
Total non-accrual real estate loans 1,714 1,972 1,369 1,727 2,416
------ ------ ------ ------ ------
Other loans:
Commercial and industrial 173 170 289 530 183
Consumer 32 29 110 126 85
------ ------ ------ ------ ------
Total non-accrual consumer and
other loans 205 199 399 656 268
------ ------ ------ ------ ------
Total nonperforming loans 1,919 2,171 1,768 2,383 2,684
Foreclosed real estate, net - - - - 176
------ ------ ------ ------ ------
Total nonperforming assets $1,919 $2,171 $1,768 $2,383 $2,860
====== ====== ====== ====== ======
Nonperforming loans to total loans 0.50% 0.58% 0.51% 0.66% 0.64%
Nonperforming assets to total assets 0.24 0.27 0.22 0.29 0.37
13
Allowance for Loan Losses. The following table presents the activity
in Westfield Bank's allowance for loan losses and other ratios at or for the
dates indicated.
At or for Years Ended December 31,
------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in thousands)
<s> <c> <c> <c> <c> <c>
Balance at beginning of year $ 5,277 $ 4,642 $ 4,325 $ 3,923 $ 3,434
Charge-offs:
Residential - - (3) (36) (16)
Commercial real estate - - - (29) (17)
Home equity loans - - (31) - -
Commercial and industrial (431) (14) (124) (241) (26)
Consumer (181) (390) (567) (622) (1,784)
-------- -------- -------- -------- --------
Total charge-offs (612) (404) (725) (928) (1,843)
-------- -------- -------- -------- --------
Recoveries:
Residential - - 10 17 -
Commercial real estate 1 - - - -
Home equity loans 3 4 3 - -
Commercial and industrial 9 65 73 16 14
Consumer 279 220 206 363 688
-------- -------- -------- -------- --------
Total recoveries 292 289 292 396 702
-------- -------- -------- -------- --------
Net charge-offs (320) (115) (433) (532) (1,141)
Provision for loan losses 465 750 750 934 1,630
-------- -------- -------- -------- --------
Balance at end of year $ 5,422 $ 5,277 $ 4,642 $ 4,325 $ 3,923
======== ======== ======== ======== ========
Total loans receivable(1) $383,873 $373,449 $349,441 $361,357 $417,272
======== ======== ======== ======== ========
Average loans outstanding $383,436 $366,677 $354,134 $398,555 $443,652
======== ======== ======== ======== ========
Allowance for loan losses as
a percent of total loans
receivable 1.41% 1.41% 1.33% 1.20% 0.94%
Net loans charged off as a
percent of average loans
outstanding 0.08% 0.03% 0.12% 0.13% 0.26%
<FN>
- -------------------
<F1> Does not include deferred fees.
</FN>
Westfield Bank maintains an allowance for loan losses to absorb losses
inherent in the loan portfolio based on ongoing quarterly assessments of the
estimated losses. Westfield Bank's methodology for assessing the
appropriateness of the allowance consists of a review of the components,
which include a specific valuation allowance for identified problem loans and
a formula allowance for current performing loans. Fluctuations in the
balances of impaired loans affect the specific valuation allowance while
fluctuations in volume and concentrations of loans affects the formula
reserve and the allocation of the allowance of the loan losses among loan
types.
14
The specific valuation allowance incorporates the results of measuring
impairment for specifically identified non-homogenous problem loans in
accordance with Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting By Creditors for Impairment of a Loan," and SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures." In accordance with SFAS No. 114 and No. 118, the specific
allowance reduces the carrying amount of the impaired loans to their
estimated fair value. A loan is recognized as impaired when it is probable
that principal and/or interest are not collectible in accordance with the
loan's contractual terms. A loan is not deemed to be impaired if there is a
short delay in receipt of payment or if, during a longer period of delay, the
Westfield Bank expects to collect all amounts due including interest accrued
at the contractual rate during the period of delay. Measurement of
impairment can be based on the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's observable
market price or the fair value of the collateral, if the loan is collateral
dependent. Measurement of impairment does not apply to large groups of
smaller balance homogenous loans that are collectively evaluated for
impairment such as the Westfield Bank portfolios of home equity loans, real
estate mortgages, installment and other loans.
The formula allowance is calculated by applying loss factors to
outstanding loans by type, excluding loans for which a specific allowance has
been determined. As part of this analysis, each quarter Westfield Bank
prepares an allowance for loan losses worksheet which categorizes the loan
portfolio by risk characteristics such as loan type and loan grade. The
formula allowance is inherently subjective as it requires material estimates
that may be susceptible to significant change. There are a number of factors
that are considered when evaluating the appropriate level of the allowance.
These factors include current economic and business conditions that affect
key lending areas of the company, new loan products, collateral values, loan
volumes and concentrations, credit quality trends such as nonperformance
loans, delinquency and loan losses, and specific industry connections within
the portfolio segments that may impact the collectibility of the loan
portfolio. Loss factors are described as follows:
* Classified loan loss factors are set at levels determined to be
appropriate by Westfield Bank. Loss factors are applied to the
outstanding balance of loans internally classified special mention,
substandard and doubtful.
* Pass graded loan loss factors are based on actual losses for the
previous twelve quarters adjusted for qualitative factors, such as
new loan products, credit quality trends (including trends in
nonperforming loans expected to result from existing conditions),
collateral values, loan volumes and concentrations and specific
industry conditions within portfolio segments that exist at the
balance sheet date. The loss factors are applied to outstanding
loans by loan type.
In addition, management employs an independent third party to perform
an annual review of all of Westfield Bank's commercial and industrial loans
and owner occupied commercial real estate loans with balances or commitments
equal or greater than $750,000. The third party also reviews all commercial
investment real estate loans in excess of $750,000, as well as all adversely
rated loans.
15
Westfield Bank's methodologies include several factors that are
intended to reduce the difference between estimated and actual losses. The
loss factors that are used to establish the allowance for pass graded loans
are designated to be self-correcting by taking into account changes in loan
classification, loan concentrations and loan volumes and by permitting
adjustments based on management's judgments of qualitative factors as of the
evaluation date. Similarly, by basing the pass graded loan loss factors on
loss experience over the prior three years, the methodology is designed to
take Westfield Bank's recent loss experience into account.
Westfield Bank's allowance methodology has been applied on a consistent
basis. Based on this methodology, Westfield Bank believes that it has
established and maintained the allowance for loan losses at adequate levels.
Future adjustments to the allowance for loan losses, however, may be
necessary if economic, real estate and other conditions differ substantially
from the current operating environment resulting in estimated and actual
losses differing substantially. Adjustments to the allowance for loan losses
are charged to income through the provision for loan losses.
A summary of the components of the allowance for loan losses is as
follows:
December 31, 2005 December 31, 2004 December 31, 2003
-------------------------- -------------------------- --------------------------
Specific Formula Total Specific Formula Total Specific Formula Total
-------- ------- ----- -------- ------- ----- -------- ------- -----
(In Thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Real estate mortgage
Residential (1) $ - $ 355 $ 355 $ - $ 421 $ 421 $ - $ 517 $ 517
Commercial 218 2,400 2,618 264 2,097 2,361 17 1,994 2,011
Commercial and
Industrial 32 2,334 2,366 236 2,078 2,314 53 1,660 1,713
Consumer - 83 83 - 181 181 - 401 401
---- ------ ------ ---- ------ ------ ---- ------ ------
Total $250 $5,172 $5,422 $500 $4,777 $5,277 $ 70 $4,572 $4,642
==== ====== ====== ==== ====== ====== ==== ====== ======
December 31, 2002 December 31, 2001
-------------------------- --------------------------
Specific Formula Total Specific Formula Total
-------- ------- ----- -------- ------- -----
<s> <c> <c> <c> <c> <c> <c>
Real estate mortgage
Residential $ - $ 713 $ 713 $ - $ 839 $ 839
Commercial 17 1,618 1,635 32 1,435 1,467
Commercial and
Industrial 53 1,408 1,461 53 946 999
Consumer - 516 516 - 618 618
---- ------ ------ ---- ------ ------
Total $ 70 $4,255 $4,325 $ 85 $3,838 $3,923
==== ====== ====== ==== ====== ======
<FN>
- -------------------
<F1> Includes home equity loans
</FN>
16
In addition, the OTS, as an integral part of its examination process,
periodically reviews Westfield Bank's loan and foreclosed real estate
portfolios and the related allowance for loan losses and valuation allowance
for foreclosed real estate. The OTS may require Westfield Bank to adjust the
allowance for loan losses or the valuation allowance for foreclosed real
estate based on their judgments of information available to them at the time
of their examination, thereby adversely affecting Westfield Bank's results of
operations.
For the year ended December 31, 2005, Westfield Bank provided $465,000
to the allowance for loan losses based on its evaluation of the items
discussed above. Westfield Bank believes that the allowance for loan losses
accurately reflects the level of risk in the current loan portfolio as of
December 31, 2005.
17
Allocation of Allowance for Loan Losses. The following tables set
forth the allowance for loan losses allocated by loan category, the total
loan balances by category, and the percent of loans in each category to total
loans indicated.
At December 31,
------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------- -------------------------------- --------------------------------
Percent of Percent of Percent of
Loan Loans in Loan Loans in Loan Loans in
Amount Balances Each Amount Balances Each Amount Balances Each
of Loan by Category to of Loan by Category to of Loan by Category to
Loan Category Loss Category Total Loans Loss Category Total Loans Loss Category Total Loans
- ------------- ------- -------- ----------- ------- -------- ----------- ------- -------- -----------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Real estate - mortgage:
Residential(1) $ 355 $106,918 27.85% $ 421 $122,822 32.89% $ 517 $110,547 31.64%
Commercial 2,618 169,564 44.17 2,361 144,336 38.65 2,011 131,292 37.57
Commercial loans 2,366 100,019 26.06 2,314 94,726 25.36 1,713 85,292 24.41
Consumer loans 83 7,372 1.92 181 11,565 3.10 401 22,310 6.38
------ -------- ------ ------ -------- ------ ------ -------- ------
Total allowance
for loan losses $5,422 $383,873 100.00% $5,277 $373,449 100.00% $4,642 $349,441 100.00%
====== ======== ====== ====== ======== ====== ====== ======== ======
At December 31,
-------------------------------------------------------------------
2002 2001
-------------------------------- --------------------------------
Percent of Percent of
Loan Loans in Loan Loans in
Amount Balances Each Amount Balances Each
of Loan by Category to of Loan by Category to
Loss Category Total Loans Loss Category Total Loans
------- -------- ----------- ------- -------- -----------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c>
Real estate - mortgage:
Residential(1) $ 713 $157,896 43.70% $ 839 $212,751 50.98%
Commercial 1,635 100,903 27.92 1,467 99,425 23.83
Commercial loans 1,461 61,494 17.01 999 47,012 11.27
Consumer loans 516 41,064 11.37 618 58,084 13.92
------ -------- ------ ------ -------- ------
Total allowance
for loan losses $4,325 $361,357 100.00% $3,923 $417,272 100.00%
====== ======== ====== ====== ======== ======
<FN>
- -------------------
<F1> Includes home equity loans.
</FN>
18
Investment Activities. The Board of Directors reviews and approves
Westfield Bank's investment policy on an annual basis. The Chief Executive
Officer and Chief Financial Officer, as authorized by the Board of Directors,
implement this policy based on the established guidelines within the written
policy.
Westfield Bank's investment policy is designed primarily to manage the
interest rate sensitivity of its assets and liabilities, to generate a
favorable return without incurring undue interest rate and credit risk, to
complement its lending activities and to provide and maintain liquidity
within the range established by policy. In determining Westfield Bank's
investment strategies, it considers its interest rate sensitivity, yield,
credit risk factors, maturity and amortization schedules, and other
characteristics of the securities to be held.
Federally chartered savings banks have authority to invest in various
types of assets, including U.S. Treasury obligations, securities of various
government-sponsored enterprises, mortgage-backed securities, certain
certificates of deposit of insured financial institutions, repurchase
agreements, overnight and short term loans to other banks and corporate debt
instruments.
Securities Portfolio. Westfield Financial classifies securities as
held to maturity or available for sale at the date of purchase. Westfield
Financial does not have any securities classified as trading. Held to
maturity securities are reported at cost, adjusted for amortization of
premium and accretion of discount. Available for sale securities are
reported at fair market value. At December 31, 2005, held to maturity
securities totaled $225.4 million, or 63.5% of the total securities
portfolio, and available for sale investments totaled $129.5 million, or
36.5% of Westfield Financial's total securities portfolio. Westfield
Financial classifies U.S. Government securities and government-sponsored
enterprise securities as available for sale and held to maturity. These
securities predominately have maturities of less than five years, although
Westfield Financial also invests in adjustable rate securities with
maturities of up to 15 years. Westfield Financial's mortgage-backed
securities, which are directly or indirectly insured or guaranteed by Freddie
Mac, Ginnie Mae or Fannie Mae or are rated AAA, consist of both fixed rate
and adjustable rate securities primarily with average lives of less than five
years. Westfield Financial also invests in municipal bonds issued by cities
and towns in Massachusetts and are AAA rated by Moody's, Standard and Poor's,
or Fitch. These securities generally have maturities between 7 and 20 years,
however, many have earlier call dates. In addition, Westfield Financial has
investments in Federal Home Loan Bank stock and mutual funds that invest only
in securities allowed by the Office of Thrift Supervision.
19
The following table sets forth the composition of Westfield Bank's
securities portfolio at the dates indicated.
At December 31,
-----------------------------------------------------------------------
2005 2004 2003
--------------------- --------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- ------ --------- ------ --------- ------
(In thousands)
<s> <c> <c> <c> <c> <c> <c>
Securities:
Government-sponsored enterprises $ 65,818 $ 64,944 $ 45,151 $ 45,061 $ 49,737 $ 50,296
Municipal bonds 30,233 30,339 29,147 29,597 21,687 22,041
Corporate debt securities - - 4,909 4,978 8,735 9,017
-------- -------- -------- -------- -------- --------
Total securities 96,051 95,283 79,207 79,636 80,159 81,354
-------- -------- -------- -------- -------- --------
Mortgage-backed and mortgage-
related securities:
Fannie Mae 144,440 141,472 153,271 152,292 163,435 163,557
Freddie Mac 74,775 73,834 62,614 62,501 69,362 69,275
Ginnie Mae 29,894 29,336 29,811 29,718 29,437 29,446
Other pass-through securities 4,726 4,709 - - - -
Collateralized mortgage
obligations 818 804 2,848 2,856 5,413 5,410
-------- -------- -------- -------- -------- --------
Total mortgage-backed and
mortgage-related securities 254,653 250,155 248,544 247,367 267,647 267,688
-------- -------- -------- -------- -------- --------
Marketable equity securities 6,057 5,742 7,301 6,986 14,594 15,455
-------- -------- -------- -------- -------- --------
Total securities $356,761 $351,180 $ 335,052 $333,989 $362,400 $364,497
======== ======== ======== ======== ======== ========
20
Mortgage-Backed Securities and Mortgage-Related Securities. The
following table sets forth the amortized cost and fair value of Westfield
Bank's mortgage-backed and mortgage-related securities, which are classified
as available for sale or held to maturity at the dates indicated.
At December 31,
------------------------------------------------------------------------------------------------
2005 2004 2003
------------------------------- ------------------------------- ------------------------------
Amortized Percent of Market Amortized Percent of Market Amortized Percent of Market
Cost Total Value Cost Total Value Cost Total Value
--------- ---------- ------ --------- ---------- ------ --------- ---------- ------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Mortgage-backed and mortgage-
related securities available
for sale:
Fannie Mae $ 46,078 18.09% $ 45,376 $ 32,676 13.15% $ 32,713 $ 31,627 11.82% $ 31,872
Freddie Mac 38,310 15.04 37,863 22,842 9.19 22,838 18,611 6.95 18,586
Ginnie Mae 12,594 4.95 12,386 15,036 6.05 15,069 20,854 7.79 20,857
Other pass-through
securities 4,726 1.86 4,709 - - - - - -
Collateralized mortgage
obligations 818 0.32 804 2,688 1.08 2,696 4,872 1.82 4,862
-------- ----- -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed and
mortgage related securities
available for sale 102,526 40.26 101,138 73,242 29.47 73,316 75,964 28.38 76,177
-------- ----- -------- -------- ------ -------- -------- ------ --------
Mortgage-backed and mortgage
related securities held
to maturity:
Fannie Mae 98,362 38.63 96,096 120,595 48.52 119,579 131,808 49.25 131,685
Freddie Mac 36,465 14.32 35,971 39,772 16.00 39,663 50,751 18.96 50,689
Ginnie Mae 17,300 6.79 16,950 14,775 5.95 14,649 8,583 3.21 8,589
Collateralized mortgage
obligations - - - 160 0.06 160 541 0.20 548
-------- ----- -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed and
mortgage related securities
held to maturity 152,127 59.74 149,017 175,302 70.53 174,051 191,683 71.62 191,511
-------- ----- -------- -------- ------ -------- -------- ------ --------
Total mortgage-backed and
mortgage related securities $254,653 100.00% $250,155 $248,544 100.00% $247,367 $267,647 100.00% $267,688
======== ===== ======== ======== ====== ======== ======== ====== ========
21
Securities Portfolio Maturities. The composition and maturities of the
securities portfolio (debt securities) and the mortgage-backed securities
portfolio at December 31, 2005 are summarized in the following table.
Maturities are based on the final contractual payment dates, and do not
reflect the impact of prepayments or redemptions that may occur.
More than One Year More than Five Years
One Year or Less Through Five Years Through Ten Years More than Ten Years Total Securities
------------------ ------------------ -------------------- ------------------- ---------------------------
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Market Average
Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield
--------- -------- --------- -------- --------- -------- --------- -------- --------- ------ --------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Securities available
for sale:
Government-sponsored
enterprises $3,008 3.19% $14,730 4.61% $ 4,990 5.03% $ - -% $ 22,728 $ 22,579 4.52%
Mortgage-backed
securities available
for sale:
Ginnie Mae -- -- -- -- -- -- 12,594 3.97 12,594 12,386 3.97
Fannie Mae -- -- -- -- 3,595 4.58 42,483 4.32 46,078 45,376 4.34
Freddie Mac -- -- -- -- -- -- 38,310 4.06 38,310 37,863 4.07
Other pass-through
securities -- -- -- -- -- -- 4,726 4.96 4,726 4,709 4.96
Collateralized
mortgage
obligations -- -- -- -- -- -- 818 2.89 818 804 2.89
------ ------- ------- -------- -------- --------
Total mortgage-
backed
securities -- -- -- -- 3,595 4.58 98,931 4.19 102,526 101,138 4.21
------ ------- ------- -------- -------- --------
Total $3,008 3.19% $14,730 4.61 $ 8,585 4.84 $ 98,931 4.19 $125,254 $123,717 4.27
====== ======= ======= ======== ======== ========
Securities held to
maturity:
Government-sponsored
enterprises $7,997 2.60 $15,096 3.50 $14,997 4.92 $ 5,000 5.88 $ 43,090 $ 42,365 4.10
Municipal bonds -- -- 1,211 3.48 9,551 3.72 19,471 4.34 30,233 30,339 4.11
------ ------- ------- -------- -------- --------
Total investment
securities 7,997 2.60 16,307 3.50 24,548 4.45 24,471 4.65 73,323 72,704 4.10
------ ------- ------- -------- -------- --------
Mortgage-backed
securities held to
maturity:
Ginnie Mae 1 8.00 152 5.22 652 5.08 16,495 3.89 17,300 16,950 3.94
Fannie Mae -- -- 3,170 3.62 15,523 3.75 79,669 4.33 98,362 96,096 4.22
Freddie Mac 14 4.26 3,898 2.71 965 4.96 31,588 4.46 36,465 35,971 4.29
------ ------- ------- -------- -------- --------
Total mortgage-
backed
securities 15 4.51 7,220 3.16 17,140 3.87 127,752 4.31 152,127 149,017 4.20
------ ------- ------- -------- -------- --------
Total $8,012 2.60% $23,527 3.40% $41,688 4.21% $152,223 4.36% $225,450 $221,721 4.17%
====== ======= ======= ======== ======== ========
22
Sources of Funds
General. Deposits, scheduled amortization and prepayments of loan
principal, maturities and calls of investments securities and funds provided
by operations are Westfield Bank's primary sources of funds for use in
lending, investing and for other general purposes. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
Deposits. Westfield Bank offers a variety of deposit accounts having a
range of interest rates and terms. Westfield Bank currently offers regular
savings deposits (consisting of passbook and statement savings accounts), NOW
accounts, noninterest-bearing demand accounts, money market accounts and time
deposits. Westfield Bank has expanded the types of deposit products that it
offers to include jumbo certificates of deposit, tiered money market accounts
and customer repurchase agreements to compliment its increased emphasis on
attracting commercial banking relationships.
Deposit flows are influenced significantly by general and local
economic conditions, changes in prevailing interest rates, pricing of
deposits and competition. Westfield Bank's deposits are primarily obtained
from areas surrounding our offices. Westfield Bank relies primarily on
paying competitive rates, service and long-standing relationships with
customers to attract and retain these deposits. Westfield Bank does not use
brokers to obtain deposits.
When Westfield Bank determines its deposit rates, it considers local
competition, U.S. Treasury securities offerings and the rates charged on
other sources of funds. Core deposits (defined as regular accounts, money
market accounts, NOW accounts and demand accounts) represented 46.2% of total
deposits on December 31, 2005 and 48.9% on December 31, 2004. At December
31, 2005 and December 31, 2004, time deposits with remaining terms to
maturity of less than one year amounted to $227.8 million and $184.5 million,
respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Net Interest and Dividend Income" for
information relating to the average balances and costs of Westfield Bank's
deposit accounts for the years ended December 31, 2005, 2004 and 2003.
23
Deposit Distribution Weighted Average. The following table sets forth
the distribution of Westfield Bank's deposit accounts, by account type, at
the dates indicated.
At December 31,
---------------------------------------------------------------------------------------------
2005 2004 2003
----------------------------- ----------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Amount Percent Rates Amount Percent Rates Amount Percent Rates
------ ------- -------- ------ ------- -------- ------ ------- --------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Demand deposits $ 45,260 7.26% 0.00% $ 48,305 7.88% 0.00% $ 54,620 8.64% 0.00%
NOW accounts 69,137 11.10 0.83 57,050 9.31 0.51 42,465 6.71 0.54
Regular accounts 41,387 6.64 0.50 44,882 7.33 0.50 46,331 7.33 0.50
Money market accounts 132,218 21.22 1.62 149,288 24.37 0.93 154,825 24.48 0.98
-------- ------ -------- ------ -------- ------
Total non-certificate
accounts 288,002 46.22 1.01 299,525 48.89 0.64 298,241 47.16 0.81
-------- ------ -------- ------ -------- ------
Time certificates of deposit
Due within 1 year 227,770 36.56 3.05 184,500 30.12 2.14 234,694 37.11 2.35
Over 1 year through 3 years 85,951 13.80 3.51 103,856 16.95 2.88 90,934 14.38 3.13
Over 3 years 21,322 3.42 4.17 24,740 4.04 3.71 8,562 1.35 3.24
-------- ------ -------- ------ -------- ------
Total certificate accounts 335,043 53.78 3.24 313,096 51.11 2.51 334,190 52.84 2.58
-------- ------ -------- ------ -------- ------
Total $623,045 100.00% 2.21% $612,621 100.00% 1.59% $632,431 100.00% 1.75%
======== ====== ======== ====== ======== ======
C.D. Maturities. At December 31, 2005, Westfield Bank had $71.2
million in time certificates of deposit with balances of $100,000 and over
maturing as follows:
Weighted
Average
Maturity Period Amount Rate
- ------------------------------------- ------ --------
(Dollars in thousands)
<s> <c> <c>
Three months or less $15,500 2.92%
Over three months through six months 13,761 3.25
Over six months through twelve months 18,604 3.64
Over twelve months 23,327 3.69
-------
Total $71,192 3.42%
=======
C.D. Balances by Rates. The following table sets forth, by interest
rate ranges, information concerning Westfield Bank's time certificates of
deposit at the dates indicated.
At December 31, 2005
------------------------------------------------------------------------------------
Period to Maturity
------------------------------------------------------------------------------------
Less than One to Two Two to More than Percent of
One Year Years Three Years Three Years Total Total
--------- ---------- ----------- ----------- ----- ----------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c>
2.00% and under $ 33,389 $ 2,399 $ - $ - $ 35,788 10.68%
2.01% to 3.00% 77,531 15,165 501 - 93,197 27.82
3.01% to 4.00% 82,297 21,103 23,351 1,907 128,658 38.40
4.01% to 5.00% 34,553 11,603 11,829 19,415 77,400 23.10
-------- ------- ------- ------- -------- ------
Total $227,770 $50,270 $35,681 $21,322 $335,043 100.00%
======== ======= ======= ======= ======== ======
24
Borrowings. In addition to deposits, borrowings from the Federal Home
Loan Bank of Boston are available as an additional source of funds to finance
Westfield Bank's lending and investing activities. Westfield Bank
traditionally has not relied upon borrowings from the Federal Home Loan Bank.
Westfield Bank maintained $45.0 million in borrowings in 2005 by replacing
matured advances with new advances.
Westfield Bank offers repurchase agreements to commercial customers and
higher balance retail customers. These agreements are direct obligations of
Westfield Bank to repay at maturity or on demand the purchase price of an
undivided interest in a government-sponsored enterprise owned by Westfield
Bank. Since these agreements are not deposits, they are not insured by the
Federal Deposit Insurance Corporation. At December 31, 2005, such repurchase
agreement borrowings totaled $14.4 million.
Personnel
As of December 31, 2005, Westfield Bank had 127 full-time employees and
24 part-time employees. The employees are not represented by a collective
bargaining unit, and we consider our relationship with our employees to be
excellent.
Federal And State Taxation
Federal
General. For federal income tax purposes, we report income on a
calendar year basis, using the accrual method of accounting, and we are
generally subject to federal income taxation in the same manner as other
corporations. Westfield Bank and Westfield Financial constitute an
affiliated group of corporations and, therefore, are eligible to report their
income on a consolidated basis. Because Westfield Mutual Holding Company owns
less than 80% of the common stock of Westfield Financial, it is not a member
of such affiliated group and therefore, must report its income on a separate
return. Westfield Bank and Westfield Mutual Holding Company are not currently
under audit by the IRS.
Distributions. To the extent that Westfield Bank makes "non-dividend
distributions" to Westfield Financial, such distributions will be considered
to result in distributions from unrecaptured tax bad debt reserves as of
December 31, 1987 (our "base year reserve"), to the extent thereof and then
from supplemental reserves for losses on loans, and an amount based on the
amount distributed will be included in income. Non-dividend distributions
include distributions in excess of current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. Dividends paid out of current or accumulated earnings
and profits will not be included in income.
25
The amount of additional income created from a non-dividend
distribution is equal to the lesser of the base year reserve and supplemental
reserve for losses on loans or an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution.
Thus, in some situations, approximately one and one-half times the non-
dividend distribution would be includible in gross income for federal income
tax purposes, assuming a 34% federal corporate income tax rate. Westfield
Bank does not intend to pay dividends that would result in the recapture of
any portion of the bad debt reserves.
Corporate Alternative Minimum Tax. The alternative minimum tax ("AMT")
rules have been devised to ensure that at least a minimum amount of income
tax is paid by high-income corporate taxpayers who take advantage of
substantial tax savings due to the use of certain tax deductions and
exemptions. In essence, the AMT functions as a recapture mechanism,
reclaiming some of the tax deductions and credits utilized by these taxpayers
when calculating their regular federal income tax liability. In general, a
corporation's alternative minimum taxable income is equal to its regular
taxable income, increased by its preference items for the year and adjusted
by computing certain items under special rules that negate the acceleration
of certain tax benefits which are available under the regular tax rules. The
AMT rate is 20%. Such preference items include adjustments for tax exempt
interest, inside build-up of life insurance policies and accelerated
depreciation deductions. During the past five years, Westfield Financial has
not been subject to AMT and therefore has no AMT net operating losses or
credit to utilize.
Elimination of Dividends; Dividends Received Deduction. Westfield
Financial may exclude from its income 100% of dividends received from
Westfield Bank as a member of the same affiliated group of corporations.
Because Westfield Mutual Holding Company is not a member of such affiliated
group, it does not qualify for such 100% dividends exclusion, but is entitled
to deduct 80% of the dividends it receives from Westfield Financial so long
as it owns more than 20% of the common stock.
State
Westfield Bank files Massachusetts Financial Institution excise tax
returns. Generally, the taxable income of financial institutions in
Massachusetts, which is calculated based on federal taxable income, subject
to certain adjustments, is subject to Massachusetts tax. Westfield Bank is
not currently under audit with respect to its Massachusetts income tax
returns.
Westfield Financial is also required to file a Massachusetts income tax
return and is generally subject to a state income tax rate that is the same
tax rate as the tax rate for financial institutions in Massachusetts.
However, Westfield Securities Corp. (dissolved in the third quarter of 2005),
and Elm Street Securities Corp. are taxed at a rate that is currently lower
than income tax rates for savings institutions in Massachusetts.
26
Massachusetts legislation was signed on March 5, 2003 amending the
corporate tax law affecting the treatment of dividends received from Real
Estate Investment Trusts ("REITs"). Dividends from the REIT subsidiary are
no longer eligible for a dividends-received deduction. As a result of the
enactment of this legislation, Westfield Financial ceased recording the tax
benefits associated with the dividend received deduction effective for the
2003 tax year.
In addition to the effect on 2003, the legislation was retroactive to
1999. Westfield Financial's 2003 results include a charge of $1.45 million
representing the additional state tax liability, including interest, relating
to the deduction for dividends received from the REIT for 2002 and prior
years.
REGULATION
General. Westfield Financial and Westfield Mutual Holding Company are
regulated as savings and loan holding companies by the OTS. Westfield Bank,
as a federal savings bank, is subject to regulation, examination, and
supervision by the OTS and the Federal Deposit Insurance Corporation ("FDIC")
as its deposit insurer. Westfield Bank must file reports with the OTS and
the FDIC concerning its activities and financial condition. Westfield
Financial and Westfield Mutual Holding Company are also required to file
reports with, and otherwise comply with, the rules and regulations of the
OTS. Westfield Financial is also required to file reports with, and
otherwise comply with, the rules and regulations of the Securities and
Exchange Commission (the "SEC") under the federal securities laws.
The following discussion is intended to be a summary of the material
statutes and regulations applicable to savings associations and their holding
companies, and it does not purport to be a comprehensive description of all
such statutes and regulations. The OTS and the FDIC have significant
discretion in connection with their supervisory and enforcement activities
and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such policies, whether by the OTS,
the FDIC, SEC or the United States Congress, could have a material adverse
impact on us, Westfield Bank, and our operations and stockholders.
Regulation of Federal Savings Associations
Business Activities. Westfield Bank derives its lending and investment
powers from the Home Owners' Loan Act, as amended ("HOLA"), and OTS
regulations. Under these laws and regulations, Westfield Bank may invest in
mortgage loans secured by residential and commercial real estate, commercial
and consumer loans, certain types of debt securities, and certain other
assets. Westfield Bank may also establish service corporations that may
engage in activities not otherwise permissible for Westfield Bank, including
certain real estate equity investments and securities and insurance
brokerage. Westfield Bank's authority to invest in certain types of loans or
other investments is limited by federal law and regulation.
27
Loans to One Borrower. Westfield Bank is generally subject to the same
limits on loans to one borrower as is a national bank. With specified
exceptions, Westfield Bank's total loans or extensions of credit to a single
borrower cannot exceed 15% of Westfield Bank's unimpaired capital and
surplus, which does not include accumulated other comprehensive income.
Westfield Bank may lend additional amounts up to 10% of its unimpaired
capital and surplus which does not include accumulated other comprehensive
income, if the loans or extensions of credit are fully-secured by readily-
marketable collateral. Westfield Bank currently complies with applicable
loans-to-one borrower limitations.
QTL Test. The HOLA requires that Westfield Bank, as a savings
association, to comply with the qualified thrift lender ("QTL") test. Under
the QTL test, Westfield Bank is required to maintain at least 65% of its
portfolio assets in certain "qualified thrift investments" for at least nine
months of the most recent twelve-month period. "Portfolio assets" means, in
general, Westfield Bank's total assets less the sum of:
* specified liquid assets up to 20% of total assets;
* goodwill and other intangible assets; and
* the value of property used to conduct Westfield Bank's
business.
Westfield Bank may also satisfy the QTL test by qualifying as a
domestic building and loan association as defined in the Internal Revenue
Code of 1986, as amended (the "Code"). Westfield Bank met the QTL test at
December 31, 2005 and in each of the prior 12 months, and, therefore, is a
"qualified thrift lender." If Westfield Bank fails the QTL test, and is
unable to correct that failure for a period of time, it must either operate
under certain restrictions on its activities or convert to a national
charter.
Capital Requirements. The OTS regulations require Westfield Bank to
meet three minimum capital standards:
(1) a tangible capital ratio requirement of 1.5% of total assets as
adjusted under the OTS regulations;
(2) a leverage ratio requirement of 3% of core capital to such
adjusted total assets, if a savings association has been
assigned the highest composite rating of 1 under the Uniform
Financial Institutions Rating System; and
(3) a risk-based capital ratio requirement of 8% of core and
supplementary capital to total risk-based assets.
28
The minimum leverage capital ratio for any other depository institution
that does not have a composite rating of 1 will be 4%, unless a higher
leverage capital ratio is warranted by the particular circumstances or risk
profile of the depository institution. In determining the amount of risk-
weighted assets for purposes of the risk-based capital requirement, a savings
association must compute its risk-based assets by multiplying its assets and
certain off-balance sheet items by risk-weights, which range from 0% for cash
and obligations issued by the United States Government or its agencies to
100% for consumer and commercial loans, as assigned by the OTS capital
regulation based on the risks found by the OTS to be inherent in the type of
asset.
Tangible capital is defined, generally, as common stockholders' equity
(including retained earnings), certain non-cumulative perpetual preferred
stock and related earnings, minority interests in equity accounts of fully
consolidated subsidiaries, less intangibles (other than certain mortgage
servicing rights), and investments in and loans to subsidiaries engaged in
activities not permissible for a national bank. Core capital is defined
similarly to tangible capital, but core capital also includes certain
qualifying supervisory goodwill and certain purchased credit card
relationships. Supplementary capital currently includes cumulative and other
preferred stock, mandatory convertible debt securities, subordinated debt and
intermediate preferred stock and the allowance for loan and lease losses. In
addition, up to 45% of unrealized gains on available-for-sale equity
securities with a readily determinable fair value may be included in tier 2
capital. The allowance for loan and lease losses includable in supplementary
capital is limited to a maximum of 1.25% of risk-weighted assets, and the
amount of supplementary capital that may be included as total capital cannot
exceed the amount of core capital.
At December 31, 2005, Westfield Bank met each of its capital
requirements, in each case on a fully phased-in basis.
Community Reinvestment. Under the Community Reinvestment Act (the
"CRA"), as implemented by OTS regulations, Westfield Bank has a continuing
and affirmative obligation consistent with its safe and sound operation to
help meet the credit needs of its entire community, including low and
moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that
it believes are best suited to its particular community, consistent with the
CRA. The CRA requires the OTS, in connection with its examination of a
savings association, to assess Westfield Bank's record of meeting the credit
needs of its community and to take such record into account in its evaluation
of certain applications by Westfield Bank. The CRA also requires all
institutions to publicly disclose their CRA ratings. Westfield Bank received
a "Satisfactory" CRA rating in its most recent examination, in January 2005.
The CRA regulations establish an assessment system that bases an
association's rating on its actual performance in meeting community needs.
In particular, the assessment system focuses on three tests:
* a lending test, to evaluate the institution's record of making
loans in its assessment areas;
29
* an investment test, to evaluate the institution's record of
investing in community development projects, affordable
housing, and programs benefiting low or moderate income
individuals and businesses in its assessment area or a broader
area that includes its assessment area; and
* a service test, to evaluate the institution's delivery of
services through its retail banking channels and the extent and
innovativeness of its community development services.
Transactions with Affiliates. Westfield Bank's authority to engage in
transactions with its "affiliates" is limited by the OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act (the "FRA"). In general,
these transactions must be on terms that are as favorable to Westfield Bank
as comparable transactions with non-affiliates. In addition, certain types
of these transactions are restricted to an aggregate percentage of Westfield
Bank's capital. Collateral in specified amounts must usually be provided by
affiliates in order to receive loans from Westfield Bank. In addition, OTS
regulations prohibit a savings association from lending to any of its
affiliates that engage in activities not permissible for bank holding
companies and from purchasing the securities of any affiliate, other than a
subsidiary.
Effective April 1, 2003, the FRB rescinded its interpretations of
Sections 23A and 23B of the FRA and replaced these interpretations with
Regulation W. In addition, Regulation W makes various changes to existing
law regarding Sections 23A and 23B, including expanding the definition of
what constitutes an affiliate subject to Sections 23A and 23B. The Federal
Reserve Board expects each depository institution that is subject to Sections
23A and 23B to implement policies and procedures to ensure compliance with
Regulation W, which Westfield Bank has done.
Loans to Insiders. Westfield Bank's authority to extend credit to its
directors, executive officers and principal stockholders, as well as to
entities controlled by such persons, is currently governed by the
requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the
FRB. Among other things, these provisions require that extensions of credit
to insiders: (i) be made on terms that are substantially the same as, and
follow credit underwriting procedures that are not less stringent than, those
prevailing for comparable transactions with unaffiliated persons and that do
not involve more than the normal risk of repayment or present other
unfavorable features; and (ii) not exceed certain limitations on the amount
of credit extended to such persons, individually and in the aggregate, which
limits are based, in part, on the amount of Westfield Bank= capital. The
regulations allow small discounts on fees on residential mortgages for
directors, officers and employees. In addition, extensions for credit in
excess of certain limits must be approved by Westfield Bank's Board of
Directors.
Enforcement. The OTS has primary enforcement responsibility over
savings associations, including Westfield Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist orders and to remove directors and officers. In
general, these enforcement actions may be initiated in response to violations
of laws and regulations and to unsafe or unsound practices.
30
Standards for Safety and Soundness. Under federal law, the OTS has
adopted a set of guidelines prescribing safety and soundness standards.
These guidelines establish general standards relating to internal controls
and information systems, internal audit systems, loan documentation, credit
underwriting, interest rate risk exposure, asset growth, asset quality,
earnings standards, compensation, fees and benefits. In general, the
guidelines require appropriate systems and practices to identify and manage
the risks and exposures specified in the guidelines.
In addition, the OTS adopted regulations that authorize, but do not
require, the OTS to order an institution that has been given notice that it
is not satisfying these safety and soundness standards to submit a compliance
plan. If, after being notified, an institution fails to submit an acceptable
plan of compliance or fails in any material respect to implement an accepted
plan, the OTS must issue an order directing action to correct the deficiency,
may issue an order directing other actions of the types to which an
undercapitalized association is subject under the "prompt corrective action"
provisions of federal law. If an institution fails to comply with such an
order, the OTS may seek to enforce such order in judicial proceedings and to
impose civil money penalties.
Capital Distributions. The OTS imposes various restrictions or
requirements on Westfield Bank's ability to make capital distributions,
including cash dividends. A savings institution that is the subsidiary of a
savings and loan holding company must file a notice with the OTS at least 30
days before making a capital distribution. Westfield Bank must file an
application for prior approval if the total amount of its capital
distributions, including the proposed distribution, for the applicable
calendar year would exceed an amount equal to Westfield Bank's net income for
that year plus Westfield Bank's retained net income for the previous two
years.
The OTS may disapprove of a notice of application if:
* Westfield Bank would be undercapitalized following the
distribution;
* the proposed capital distribution raises safety and soundness
concerns; or
* the capital distribution would violate a prohibition contained
in any statute, regulation, or agreement.
Liquidity. Westfield Bank is required to maintain a sufficient amount
of liquid assets to ensure its safe and sound operation.
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations, the OTS is required to take certain, and is authorized to take
other, supervisory actions against undercapitalized savings associations.
For this purpose, a savings association would be placed in one of the
following four categories based on the association's capital:
* well-capitalized;
* adequately capitalized;
31
* undercapitalized; or
* critically undercapitalized.
At December 31, 2005, Westfield Bank met the criteria for being
considered "well-capitalized." When appropriate, the OTS can require
corrective action by a savings association holding company under the "prompt
corrective action" provision of federal law.
Insurance of Deposit Accounts. Westfield Bank is a member of the Bank
Insurance Fund (the "BIF"), maintained by the FDIC, and Westfield Bank pays
its deposit insurance assessments to the BIF. The FDIC also maintains
another insurance fund, the Savings Association Insurance Fund (the "SAIF"),
which ordinarily insures the deposits of federal savings associations.
Westfield Bank is a member of the BIF, rather than the SAIF, because it paid
to BIF prior to its conversion from a Massachusetts bank on July 23, 2004,
and continues to do so under Section 10(0) of HOLA.
Under federal law, the FDIC established a risk based assessment system
for determining the deposit insurance assessments to be paid by insured
depository institutions. Under the assessment system, the FDIC assigns an
institution to one of three capital categories based on the institution's
financial information as of the quarter ending three months before the
beginning of the assessment period. An institution's assessment rate depends
on the capital category and supervisory category to which it is assigned.
Under the regulation, there are nine risk assessment classifications (i.e.,
combinations of capital groups and supervisory subgroups) to which different
assessment rates are applied. Assessment rates currently range from 0% of
deposits for an institution in the highest category (i.e., well-capitalized
and financially sound, with no more than a few minor weaknesses) to 0.27% of
deposits for an institution in the lowest category (i.e., undercapitalized
and substantial supervisory concern). The FDIC is authorized to raise the
assessment rates as necessary to maintain the required reserve ratio of
1.25%.
In addition, all FDIC-insured institutions are required to pay
assessments to the FDIC at an annual rate of approximately 0.0168% of insured
deposits to fund interest payments on bonds issued by the Financing
Corporation, an agency of the federal government established to recapitalize
the predecessor to the BIF. These assessments will continue until the
Financing Corporation bonds mature in 2017.
On February 15, 2006, President Bush signed into law legislation
designed, in part, to increase insurance limits for certain accounts,
including individual retirement accounts, merge the BIF and SAIF funds and
grant the FDIC additional flexibility in establishing reserves in the fund.
Pending rulemaking by the FDIC, the legislation is not yet effective.
Federal Home Loan Bank System. Westfield Bank is a member of the
Federal Home Loan Bank (the "FHLB") of Boston, which is one of the regional
FHLBs composing the FHLB System. Each FHLB provides a central credit
facility primarily for its member institutions. Westfield Bank, as a member
of the FHLB of Boston, is required to acquire and hold shares of capital
stock in the FHLB of Boston. While the required percentages of stock
ownership are subject to change by the FHLB, Westfield Bank was in compliance
with this requirement with an
32
investment in FHLB of Boston stock at December 31, 2005 of $4.0 million. Any
advances from a FHLB must be secured by specified types of collateral, and
all long-term advances may be obtained only for the purpose of providing
funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of earnings that the FHLBs can pay as
dividends to their members and could also result in the FHLBs imposing a
higher rate of interest on advances to their members. If dividends were
reduced, or interest on future FHLB advances increased, Westfield Bank's net
interest income would be affected.
Federal Reserve System. Westfield Bank is subject to provisions of the
FRA and the FRB's regulations pursuant to which depositary institutions may
be required to maintain non-interest-earning reserves against their deposit
accounts and certain other liabilities. Currently, reserves must be
maintained against transaction accounts (primarily NOW and regular checking
accounts). The amount of transaction accounts exempt from a reserve
requirement is $7 million. A 3% reserve is required for transaction accounts
from $7 million to $40.6 million. Transaction accounts over $40.6 million
are subject to a 10% reserve requirement. Westfield Bank is in compliance
with the foregoing reserve requirements. Because required reserves must be
maintained in the form of either vault cash, a non-interest-bearing account
at a Federal Reserve Bank, or a pass-through account as defined by the FRB,
the effect of this reserve requirement is to reduce Westfield Bank's
interest-earning assets. The balances maintained to meet the reserve
requirements imposed by the FRB may be used to satisfy liquidity requirements
imposed by the OTS. FHLB System members are also authorized to borrow from
the Federal Reserve discount window, but FRB regulations require such
institutions to exhaust all FHLB sources before borrowing from a Federal
Reserve Bank.
Prohibitions Against Tying Arrangements. Federal savings banks are
subject to prohibitions on certain tying arrangements. A depository
institution is prohibited, subject to some exceptions, from extending credit
or offering any other service, or fixing or varying the consideration for
such extension of credit or service, on the condition that the customer
obtain some additional service from the institution or its affiliates or not
obtain credit or services of a competitor of the institution.
The Bank Secrecy Act. Westfield Bank and Westfield Financial are
subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act, which
gives the federal government powers to address money laundering and terrorist
threats through enhanced domestic security measures, expanded surveillance
powers, and mandatory transaction reporting obligations. By way of example,
the Bank Secrecy Act imposes an affirmative obligation on Westfield Bank to
report currency transactions that exceed certain thresholds and to report
other transactions determined to be suspicious.
33
* Title III of the USA PATRIOT Act takes measures intended to
encourage information sharing among financial institutions,
bank regulatory agencies and law enforcement bodies. Further,
certain provisions of Title III impose affirmative obligations
on a broad range of financial institutions, including banks,
thrifts, brokers, dealers, credit unions, money transfer agents
and parties registered under the Commodity Exchange Act. Among
other requirements, the USA PATRIOT Act imposes the following
obligations on financial institutions:
* financial institutions must establish anti-money laundering
programs that include, at minimum: (i) internal policies,
procedures, and controls, (ii) specific designation of an anti-
money laundering compliance officer, (iii) ongoing employee
training programs, and (iv) an independent audit function to
test the anti-money laundering program;
* financial institutions must establish and meet minimum
standards for customer due diligence, identification and
verification;
* financial institutions that establish, maintain, administer, or
manage private banking accounts or correspondent accounts in
the United States for non-United States persons or their
representatives (including foreign individuals visiting the
United States) must establish appropriate, specific, and, where
necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering through
those accounts;
* financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts
for foreign shell banks (foreign banks that do not have a
physical presence in any country), and are subject to certain
recordkeeping obligations with respect to correspondent accounts
of foreign banks;
* bank regulators are directed to consider a bank's or holding
company's effectiveness in combating money laundering when
ruling on Federal Reserve Act and Bank Merger Act applications.
Office of Foreign Asset Control. Westfield Bank and Westfield
Financial, like all United States companies and individuals, are prohibited
from transacting business with certain individuals and entities named on the
Office of Foreign Asset Control's list of Specially Designated Nationals and
Blocked Persons. Failure to comply may result in fines and other penalties.
Recently, the Office of Foreign Asset Control issued guidance directed at
financial institutions in which it asserted that it may, in its discretion,
examine institutions determined to be high-risk or to be lacking in their
efforts to comply with these prohibitions.
34
Holding Company Regulation
Westfield Financial and Westfield Mutual Holding Company are savings
and loan holding companies regulated by the OTS. As such, Westfield
Financial and Westfield Mutual Holding Company are registered with and are
subject to OTS examination and supervision, as well as certain reporting
requirements. In addition, the OTS has enforcement authority over Westfield
Financial and Westfield Mutual Holding Company and any of their non-savings
institution subsidiaries. Among other things, this authority permits the OTS
to restrict or prohibit activities that are determined to be a serious risk
to the financial safety, soundness or stability of a subsidiary savings
institution. Unlike bank holding companies, federal savings and loan holding
companies are not subject to any regulatory capital requirements or to
supervision by the Federal Reserve System.
Restrictions Applicable to Westfield Financial. Because Westfield
Financial was acquired after May 4, 1999, under the Gramm-Leach-Bliley Act
(the "GLB Act") it is prohibited from engaging in non-financial activities.
Unitary savings and loan associations acquired before this date are
"grandfathered" under the GLB Act and generally have no restrictions on their
business activities. Westfield Financial's activities, however, will be
restricted to:
* furnishing or performing management services for a savings
institution subsidiary of such holding company;
* conducting an insurance agency or escrow business;
* holding, managing, or liquidating assets owned or acquired from
a savings institution subsidiary of such company;
* holding or managing properties used or occupied by a savings
institution subsidiary of such company;
* acting as trustee under a deed of trust;
* any other activity (i) that the FRB, by regulation, has
determined to be permissible for bank holding companies under
Section 4(c) of the Bank Holding Company Act of 1956 (the "BHC
Act"), unless the Director of the OTS, by regulation, prohibits
or limits any such activity for savings and loan holding
companies, or (ii) in which multiple savings and loan holding
companies were authorized by regulation to directly engage in
on March 5, 1987;
* purchasing, holding, or disposing of stock acquired in
connection with a qualified stock issuance if the purchase of
such stock by such holding company is approved by the Director
of the OTS; and
* any activity permissible for financial holding companies under
section 4(k) of the BHC Act.
35
Permissible activities which are deemed to be financial in nature or
incidental thereto under section 4(k) of the BHC Act include:
* lending, exchanging, transferring, investing for others, or
safeguarding money or securities;
* insurance activities or providing and issuing annuities, and
acting as principal, agent, or broker;
* financial, investment, or economic advisory services;
* issuing or selling instruments representing interests in pools
of assets that a bank is permitted to hold directly;
* underwriting, dealing in, or making a market in securities;
* activities previously determined by the FRB to be closely
related to banking;
* activities that bank holding companies are permitted to engage
in outside of the U.S.; and
* portfolio investments made by an insurance company.
In addition, Westfield Financial cannot be acquired or acquire a
company unless the acquirer is engaged solely in financial activities.
Restrictions Applicable to Activities of Mutual Holding Companies.
Under federal law, a mutual holding company may engage only in the following
activities:
* investing in the stock of a savings institution;
* acquiring a mutual association through the merger of such
association into a savings institution subsidiary of such
holding company or an interim savings institution subsidiary of
such holding company;
* merging with or acquiring another holding company, one of whose
subsidiaries is a savings institution;
* investing in a corporation the capital stock of which is
available for purchase by a savings institution under federal
law or under the law of any state where the subsidiary savings
institution or association is located; and
* the permissible activities described above for non-
grandfathered savings and loan holding companies.
36
If a mutual holding company acquires or merges with another holding
company, the holding company acquired or the holding company resulting from
such merger or acquisition may only invest in assets and engage in the
activities listed above, and it has a period of two years to cease any non-
conforming activities and divest any non-conforming investments.
Restrictions Applicable to All Savings and Loan Holding Companies.
Federal law prohibits a savings and loan holding company, including Westfield
Financial and Westfield Mutual Holding Company, directly or indirectly, from
acquiring:
* control (as defined under HOLA) of another savings institution
(or a holding company parent) without prior OTS approval;
* through merger, consolidation, or purchase of assets, another
savings institution or a holding company thereof, or acquiring
all or substantially all of the assets of such institution (or
a holding company) without prior OTS approval; or
* control of any depository institution not insured by the FDIC
(except through a merger with and into the holding company's
savings institution subsidiary that is approved by the OTS).
A savings and loan holding company may not acquire as a separate
subsidiary an insured institution that has a principal office outside of the
state where the principal office of its subsidiary institution is located,
except:
* in the case of certain emergency acquisitions approved by the
FDIC;
* if such holding company controls a savings institution
subsidiary that operated a home or branch office in such
additional state as of March 5, 1987; or
* if the laws of the state in which the savings institution to be
acquired is located specifically authorize a savings
institution chartered by that state to be acquired by a savings
institution chartered by the state where the acquiring savings
institution or savings and loan holding company is located or
by a holding company that controls such a state-chartered
association.
The Sarbanes-Oxley Act. As a public company, we are subject to the
Sarbanes-Oxley Act, which implements a broad range of corporate governance
and accounting measures for public companies designed to promote honesty and
transparency in corporate America and better protect investors from corporate
wrongdoing. The Sarbanes-Oxley Act's principal legislation and the
derivative regulation and rule making promulgated by the SEC includes:
* the creation of an independent accounting oversight board;
* auditor independence provisions that restrict non-audit
services that accountants may provide to their audit clients;
37
* additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and
chief financial officer certify financial statements;
* a requirement that companies establish and maintain a system of
internal control over financial reporting and that a company's
management provide an annual report regarding its assessment of
the effectiveness of such internal control over financial
reporting to the company's independent accountants and that
such accountants provide an attestation report with respect to
management's assessment of the effectiveness of the company's
internal control over financial reporting;
* the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by
directors and senior officers in the twelve month period
following initial publication of any financial statements that
later require restatement;
* an increase in the oversight of, and enhancement of certain
requirements relating to audit committees of public companies
and how they interact with the company's independent auditors;
* the requirement that audit committee members must be
independent and are absolutely barred from accepting
consulting, advisory or other compensatory fees from the
issuer;
* the requirement that companies disclose whether at least one
member of the committee is a "financial expert" (as such term
is defined by the SEC) and if not, why not;
* expanded disclosure requirements for corporate insiders,
including accelerated reporting of stock transactions by
insiders and a prohibition on insider trading during pension
blackout periods;
* a prohibition on personal loans to directors and officers,
except certain loans made by insured financial institutions;
* disclosure of a code of ethics and the requirement of filing of
a Form 8-K for a change or waiver of such code;
* mandatory disclosure by analysts of potential conflicts of
interest; and
* a range of enhanced penalties for fraud and other violations.
Although we anticipate that we will incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, management does not expect that such compliance will have a
material impact on our results of operations or financial condition.
<page> 38
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension
of personal loans to directors and executive officers of issuers (as defined
in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages
advanced by an insured depository institution, such as Westfield Bank, that
are subject to the insider lending restrictions of Section 22(h) of the FRA.
Quotation on AMEX. Our common stock is quoted on the American Stock
Exchange ("AMEX"). In order to maintain such quotation, we are subject to
certain corporate governance requirements, including:
* a majority of our board must be composed of independent
directors;
* we are required to have an audit committee composed of at least
three directors, each of whom is an independent director, as
such term is defined by both AMEX rules as set forth in its
Company Guide and by Exchange Act regulations;
* our nominating committee and compensation committee must also
be composed entirely of independent directors; and
* each of our audit committee and nominating committee must have
a publicly available written charter.
Federal Securities Laws. Our common stock is registered with the SEC
under Section 12(b) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). We are subject to information, proxy solicitation, insider
trading restrictions, and other requirements under the Exchange Act.
ITEM 1A. RISK FACTORS
Our loan portfolio includes loans with a higher risk of loss.
Westfield Bank originates commercial and industrial loans, commercial real
estate loans, consumer loans, and residential mortgage loans primarily within
our market area. In recent years, Westfield Bank has developed and
implemented a lending strategy that focuses less on residential real estate
lending and more on servicing commercial customers, including increased
emphasis on commercial and industrial lending and commercial deposit
relationships. Commercial and industrial loans, commercial real estate
loans, and consumer loans may expose a lender to greater credit risk than
loans secured by residential real estate because the collateral securing
these loans may not be sold as easily as residential real estate. In
addition, commercial real estate and commercial and industrial loans may also
involve relatively large loan balances to individual borrowers or groups of
borrowers. These loans also have greater credit risk than residential real
estate for the following reasons:
* Commercial and Industrial Loans. Repayment is generally
dependent upon the successful operation of the borrower's
business.
* Commercial Real Estate Loans. Repayment is dependent on income
being
39
generated in amounts sufficient to cover operating expenses and
debt service.
* Consumer Loans. Consumer loans (such as indirect automobile
loans) are collateralized, if at all, with assets that may not
provide an adequate source of payment of the loan due to
depreciation, damage or loss.
Any downturn in the real estate market or local economy could adversely
affect the value of the properties securing the loans or revenues from the
borrower's business thereby increasing the risk of non-performing loans.
If our allowance for loan losses is not sufficient to cover actual loan
losses, our earnings could decrease. Our loan customers may not repay their
loans according to their terms and the collateral securing the payment of
these loans may be insufficient to pay any remaining loan balance. We
therefore may experience significant loan losses, which could have a material
adverse effect on our operating results.
Material additions to our allowance for loan losses also would
materially decrease our net income, and the charge-off of loans may cause us
to increase the allowance. We make various assumptions and judgments about
the collectibility of our loan portfolio, including the creditworthiness of
our borrowers and the value of the real estate and other assets serving as
collateral for the repayment of many of our loans. We rely on our loan
quality reviews, our experience and our evaluation of economic conditions,
among other factors, in determining the amount of the allowance for loan
losses. If our assumptions prove to be incorrect, our allowance for loan
losses may not be sufficient to cover losses inherent in our loan portfolio,
resulting in additions to our allowance.
Changes in interest rates could adversely affect our results of
operations and financial condition. Our profitability, like that of most
financial institutions, depends substantially on our net interest income,
which is the difference between the interest income earned on our interest-
earning assets and the interest expense paid on our interest-bearing
liabilities. Increases in interest rates may decrease loan demand and make
it more difficult for borrowers to repay adjustable rate loans. In addition,
as market interest rates rise, we will have competitive pressures to increase
the rates we pay on deposits, which will result in a decrease of our net
interest income.
We also are subject to reinvestment risk associated with changes in
interest rates. Changes in interest rates may affect the average life of
loans and mortgage-related securities. Decreases in interest rates can
result in increased prepayments of loans and mortgage-related securities as
borrowers refinance to reduce borrowing costs. Under these circumstances, we
are subject to reinvestment risk to the extent that we are unable to reinvest
the cash received from such prepayments at rates that are comparable to the
rates on existing loans and securities.
40
Our local economy may affect our future growth possibilities. Our
current market area is principally located in Hamden County, Massachusetts.
Our future growth opportunities depend on the growth and stability of our
regional economy and our ability to expand our market area. A downturn in
our local economy may limit funds available for deposit and may negatively
affect our borrowers' ability to repay their loans on a timely basis, both of
which could have an impact on our profitability.
We depend on our executive officers and key personnel to continue the
implementation of our long-term business strategy and could be harmed by the
loss of their services. We believe that our continued growth and future
success will depend in large part upon the skills of our management team.
The competition for qualified personnel in the financial services industry is
intense, and the loss of our key personnel or an inability to continue to
attract, retain and motivate key personnel could adversely affect our
business. We cannot assure you that we will be able to retain our existing
key personnel or attract additional qualified personnel. Although we have
employment agreements with our Chairman and Chief Executive Officer and our
Chief Financial Officer, the loss of the services of one or more of our
executive officers and key personnel could impair our ability to continue to
develop our business strategy.
We operate in a highly regulated environment, and changes in laws and
regulations to which we are subject may adversely affect our results of
operations. Westfield Bank is subject to extensive regulation, supervision
and examination by the OTS, as its chartering authority, and by the Federal
Deposit Insurance Corporation (the "FDIC")as the insurer of its deposits up
to certain limits. In addition, the OTS regulates and oversees Westfield
Financial and Westfield Mutual Holding Company. We also belong to the
Federal Home Loan Bank System and, as a member of such system, we are subject
to certain limited regulations promulgated by the Federal Home Loan Bank of
Boston. This regulation and supervision limits the activities in which we
may engage. The purpose of regulation and supervision is primarily to
protect our depositors and borrowers and, in the case of FDIC regulation, the
FDIC's insurance fund. Regulatory authorities have extensive discretion in
the exercise of their supervisory and enforcement powers. They may, among
other things, impose restrictions on the operation of a banking institution,
the classification of assets by such institution and such institution's
allowance for loan losses. Regulatory and law enforcement authorities also
have wide discretion and extensive enforcement powers under various consumer
protection and civil rights laws, including the Truth-in-Lending Act, the
Equal Credit Opportunity Act, the Fair Housing Act, and the Real Estate
Settlement Procedures Act. Any change in the laws or regulations applicable
to us, or in banking regulators' supervisory policies or examination
procedures, whether by the OTS, the FDIC, other state or federal regulators,
or the United States Congress could have a material adverse effect on our
business, financial condition, results of operations and cash flows.
Competition in our primary market area may reduce our ability to
attract and retain deposits and originate loans. We operate in a competitive
market for both attracting deposits, which is our primary source of funds,
and originating loans. Historically, our most direct competition for savings
deposits has come from credit unions, community banks, large commercial banks
and thrift institutions in our primary market area. Particularly in times of
extremely low or extremely high interest rates, we have faced additional
significant competition for investors' funds from brokerage firms and other
firms' short-term money market securities and corporate and government
securities. Our competition for loans comes principally from
41
mortgage brokers, commercial banks, other thrift institutions, and insurance
companies. Such competition for the origination of loans may limit our
future growth and earnings prospects. Competition for loan originations and
deposits may limit our future growth and earnings prospects.
Our charter and bylaws may prevent a transaction you may favor or limit
our growth opportunities, which could cause the market price of our common
stock to decline. Certain provisions of our charter and bylaws and
applicable provisions of Massachusetts and federal law and regulations may
delay, inhibit or prevent an organization or person from gaining control of
Westfield Financial though a tender offer, business combination, proxy
context or some other method, even though you might be in favor of the
transaction. In addition, only a majority vote of the Board of Directors of
Westfield Financial may call a special meeting of shareholders. Therefore, as
a shareholder of Westfield Financial, you will not be able to call a special
meeting of shareholders to consider a tender offer, business combination or
other transaction.
We may not be able to pay dividends in the future in accordance with
past practice. We pay a quarterly dividend to stockholders. However, we are
dependent primarily upon Westfield Bank for our earnings and funds to pay
dividends on our common stock. The payment of dividends also is subject to
legal and regulatory restrictions. Any payment of dividends in the future
will depend, in large part, on Westfield Bank's earnings, capital
requirements, financial condition and other factors considered relevant by
our Board of Directors.
Because Westfield Mutual Holding Company owns a majority of our common
stock, Westfield Mutual Holding Company may prevent transactions you may
like. Westfield Mutual Holding Company owns at least a majority of our
common stock. The same directors and officers who manage Westfield Bank also
manage Westfield Financial and Westfield Mutual Holding Company. The board
of trustees of Westfield Mutual Holding Company will control the outcome of
most matters put to a vote of stockholders of Westfield Financial. As a
federally-chartered mutual holding company, the board of Westfield Mutual
Holding Company must ensure that interests of depositors of the Bank are
represented and considered in matters put to a vote of stockholders of
Westfield Financial. Therefore, we cannot assure you that the votes cast by
Westfield Mutual Holding Company will be in your personal best interests as a
stockholder.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
42
ITEM 2. PROPERTIES
Properties
Westfield Bank currently conducts its business through its ten banking
offices and five off-site ATMs. As of December 31, 2005, the properties and
leasehold improvements owned by us had an aggregate net book value of $11.0
million.
Location Ownership Year Opened Year of Lease or
License Expiration
- -------------------- --------- ----------- ------------------
Main Office:
<s> <c> <c> <c>
141 Elm St.
Westfield, MA Owned 1964 N/A
Branch Offices:
206 Park St.
W. Springfield, MA Owned 1957 N/A
655 Main St.
Agawam, MA Owned 1968 N/A
26 Arnold St.
Westfield, MA Owned 1976 N/A
300 Southampton Rd.
Westfield, MA Owned 1987 N/A
462 College Highway
Southwick, MA Owned 1990 N/A
382 N. Main St.
E. Longmeadow, MA Leased 1997 2007(1)
1341 Main St.
Springfield, MA Leased 1999 2009(2)
1642 Northampton St.
Holyoke, MA Owned 2001 N/A
1342 Liberty St.
Springfield, MA Owned 2001 N/A
ATMs:
337 N. Westfield St.
Feeding Hills, MA Leased 1988 2013
830 Suffield St.
Agawam, MA Tenant at will 1997 N/A
516 Carew St.
Springfield, MA Tenant at will 2002 N/A
1000 State St.
Springfield, MA Tenant at will 2003 N/A
115 West Silver St.
Westfield, MA Tenant at will 2005 N/A
<FN>
- -------------------
<F1> Does not include one additional five-year option.
<F2> Does not include two additional five-year options.
</FN>
43
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any pending legal proceeding other than routine
legal proceedings occurring in the ordinary course of business. In the
opinion of management, no legal proceedings will have a material effect on
the Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on The American Stock Exchange under the
symbol "WFD." Westfield Mutual Holding Company owns 5,607,400 shares, or
57.5% of our outstanding common stock. At December 31, 2005, there were
9,754,757 shares of common stock issued and outstanding, and there were
approximately 1,384 holders of record.
The table below shows the high and low sales price during the periods
indicated as well as dividends declared per share. The information set forth
in the table below was provided by the American Stock Exchange.
Price Range Dividends
----------------- ---------
For the Year Ended December 31, 2005 High Low
------------------------------------ ---- ---
<s> <c> <c> <c>
Fourth Quarter ended December 31, 2005 $24.53 $22.12 $0.40
Third Quarter ended September 30, 2005 25.58 23.48 0.10
Second Quarter ended June 30, 2005 25.03 23.15 0.30
First Quarter ended March 31, 2005 25.40 23.20 0.10
Price Range Dividends
----------------- ---------
For the Year Ended December 31, 2004 High Low
------------------------------------ ---- ---
<s> <c> <c> <c>
Fourth Quarter ended December 31, 2004 $26.00 $23.50 $0.10
Third Quarter ended September 30, 2004 23.60 19.76 0.10
Second Quarter ended June 30, 2004 24.87 19.45 0.05
First Quarter ended March 31, 2004 25.07 23.15 0.05
A quarterly cash dividend of $0.10 per share was declared on January
25, April 26, and July 26, and $0.15 per share was declared on October 26,
2005 by the Board of Directors. In addition, the Board of Directors declared
special cash dividends of $0.20 per share on April 26, and $0.25 per share on
October 25, 2005. The continued payment of dividends depends upon our debt
and equity structure, earnings, financial condition, need for capital in
connection with possible future acquisitions and other factors, including
economic conditions, regulatory restrictions and tax considerations. We
cannot guarantee that we will pay dividends or that, if paid, that we will
not reduce or eliminate dividends in the future.
44
The only funds available for the payment of dividends on the capital
stock of Westfield Financial will be cash and cash equivalents held by
Westfield Financial, dividends paid by Westfield Bank to Westfield Financial,
and borrowings. Westfield Bank will be prohibited from paying cash dividends
to Westfield Financial to the extent that any such payment would reduce
Westfield Bank's capital below required capital levels or would impair the
liquidation account to be established for the benefit of the Westfield Bank's
eligible account holders and supplemental eligible account holders at the
time of the reorganization and stock offering.
The following table sets forth information with respect to purchase
made by the Company of it's common stock during the quarter ended December
31, 2005:
Maximum
Total number number of
of shares shares that
purchased as may yet be
Total number Average part of publicly purchased
of shares price paid announced under the
Period purchased per share ($) programs program
------ ------------ ------------- ---------------- -----------
<s> <c> <c> <c> <c>
October 1 - 31, 2005 - - -
November 1 - 30, 2005 85,000 24.08 85,000
December 1 - 31, 2005 - - -
------ ----- ------
Total 85,000 24.08 85,000 164,862
In July 2004, the Company announced that the Board of Directors had
approved a share repurchasing program ("Repurchase Program 2") which
authorized the repurchase of up to 502,550 shares. The Repurchase Program
will continue until it is completed.
There were no sales by the Company of unregistered securities during
the quarter ended December 31, 2005.
45
ITEM 6. SELECTED FINANCIAL DATA
The summary information presented below at or for each of the years
presented is derived in part from the consolidated financial statements of
Westfield Financial. The following information is only a summary, and you
should read it in conjunction with our consolidated financial statements and
notes beginning on page F-1.
At December 31,
------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In thousands)
<s> <c> <c> <c> <c> <c>
Selected Financial Condition Data:
Total assets $805,095 $796,903 $795,216 $812,980 $782,732
Loans, net(1) 378,837 368,601 344,980 357,155 413,546
Securities available for sale 28,321 14,968 25,806 79,842 74,184
Securities held to maturity 73,323 71,298 69,927 45,960 45,614
Mortgage backed securities
available for sale 101,138 73,316 76,177 90,468 87,150
Mortgage backed securities
held to maturity 152,127 175,302 191,683 159,339 81,007
Deposits 623,045 612,621 632,431 656,065 637,109
Customer repurchase agreements 14,441 14,615 12,135 8,724 6,061
Federal Home Loan Bank advances 45,000 45,000 20,000 15,000 -
Total equity 115,842 118,051 124,804 126,699 131,317
Allowance for loan losses 5,422 5,277 4,642 4,325 3,923
Nonperforming loans 1,919 2,171 1,768 2,383 2,684
For the Years Ended
December 31,
------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In thousands, except per share data)
<s> <c> <c> <c> <c> <c>
Selected Operating Data:
Interest and dividend income $ 37,306 $ 34,428 $ 35,635 $ 43,013 $ 47,543
Interest expense 13,597 10,913 13,858 18,775 25,002
-------- -------- -------- -------- --------
Net interest and dividend income 23,709 23,515 21,777 24,238 22,541
Provision for loan losses 465 750 750 934 1,630
-------- -------- -------- -------- --------
Net interest and dividend income
after provision for loan losses 23,244 22,765 21,027 23,304 20,911
Total noninterest income (loss) 3,372 3,896 3,074 (362) 2,517
Total noninterest expense 18,464 17,776 17,630 16,659 15,899
-------- -------- -------- -------- --------
Income before income taxes 8,152 8,885 6,471 6,283 7,529
Income taxes 1,933 2,562 2,820 2,239 2,512
-------- -------- -------- -------- --------
Net income $ 6,219 $ 6,323 $ 3,651 $ 4,044 $ 5,017
======== ======== ======== ======== ========
Basic earnings per share $ 0.66 $ 0.65 $ 0.36 $ 0.39 N/A
Diluted earnings per share $ 0.64 $ 0.64 $ 0.36 $ 0.38 N/A
Dividends per share paid $ 0.90 $ 0.30 $ 0.20 $ 0.15 N/A
<FN>
- -------------------
<F1> Loans are shown net of deferred loan fees, allowance for loan losses
and unadvanced loan funds.
</FN>
46
At or for the Years Ended December 31,
-------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
<s> <c> <c> <c> <c> <c>
Selected Financial Ratios and
Other Data(1)
Performance Ratios:
Return on average assets 0.77% 0.79% 0.45% 0.51% 0.70%
Return on average equity 5.27 5.24 2.94 3.14 6.16
Average equity to average assets 14.66 15.14 15.33 16.23 11.32
Equity to total assets at end of year 14.39 14.83 15.69 15.58 16.78
Average interest rate spread 2.78 2.83 2.47 2.54 2.75
Net interest margin(2) 3.13 3.13 2.86 3.18 3.33
Average interest earning assets to
average interest earning liabilities 119.22 121.47 121.49 125.76 115.77
Total noninterest expense to
average assets 2.29 2.24 2.18 2.10 2.21
Efficiency ratio(3) 68.23 66.99 72.13 65.01 65.62
Regulatory Capital Ratios:
Regulatory tier 1 leverage capital 14.48 14.69 15.31 15.65 17.27
Tier 1 risk-based capital 24.54 25.75 28.46 28.77 28.09
Total risk-based capital 25.68 26.90 29.63 29.78 28.98
Asset Quality Ratios:
Nonperforming loans as a percent of
total loans 0.50 0.58 0.51 0.66 0.64
Nonperforming assets as a percent of
total assets 0.24 0.27 0.22 0.29 0.37
Allowance for loan losses as a percent of
total loans 1.41 1.41 1.33 1.20 0.94
Allowance for loan losses as a percent of
nonperforming assets 283 243 263 181 137
Number of:
Banking offices 10 10 10 10 10
Full-time equivalent employees 142 144 152 146 159
<FN>
- -------------------
<F1> Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios.
<F2> Net interest margin represents net interest and dividend income as a
percentage of average interest earning assets.
<F3> The efficiency ratio represents the ratio of operating expenses
divided by the sum of net interest and dividend income and
noninterest income less gain on sale of securities.
</FN>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Westfield Financial strives to remain a leader in meeting the financial
service needs of the local community and to provide quality service to the
individuals and businesses in the market areas that it has served since 1853.
Historically, Westfield Bank has been a community-oriented provider of
traditional banking products and services to business organizations and
individuals, including products such as residential and commercial real
estate loans, consumer loans and a variety of deposit products. Westfield
Bank meets the needs of its local community through a community-based and
service-oriented approach to banking.
In recent years, in addition to real estate lending, we have adopted a
growth-oriented strategy that has focused on increased emphasis on commercial
lending. Our strategy also calls for increasing deposit relationships and
broadening our product lines and services. We believe that this business
strategy is best for our long term success and viability, and complements our
existing commitment to high quality customer service. In connection with our
overall growth strategy, Westfield Bank seeks to:
47
* continue to grow its commercial loan portfolio as a means to
increase the yield on and diversify its loan portfolio and
build transactional deposit account relationships;
* focus on expanding its retail banking franchise, and increasing
the number of households served within its market area; and
* depending on market conditions, refer substantially all of the
fixed-rate residential real estate loans to a third party
mortgage company which underwrites, originates and services
these loans in order to diversify its loan portfolio, increase
fee income and reduce interest rate risk.
You should read our financial results for the year ended December 31,
2005 in the context of this strategy.
* Net income for the year ended December 31, 2005 was $6.2
million, or $0.64 per diluted share, compared to $6.3 million,
or $0.64 per diluted share for the year ended December 31,
2004. The 2004 results included net gains from the sale of
securities of $877,000 for the year ended December 31, 2004.
This was primarily the result of the Company selling its common
stock portfolio in 2004. Net gains from sales of securities
for the year ended December 31, 2005 were $19,000.
* Net interest and dividend income increased $194,000 to $23.7
million for the year ended December 31, 2005, compared to $23.5
million for the same period in 2004. The net interest margin
was 3.13% for the both years ended December 31, 2005, and 2004.
The yield on earning assets increased 32 basis points to 4.92%
for the year ended December 31, 2005, compared to the same
period in 2004. The cost of paying liabilities, however,
increased 37 basis points to 2.14% for the year ended December
31, 2005, compared to the same period in 2004.
* Commercial real estate and commercial and industrial loans
increased $30.5 million, to $269.6 million at December 31,
2005. This is consistent with Westfield Bank's strategic plan,
which emphasizes commercial lending. The continued success of
Westfield Bank's commercial lending is primarily dependent on
the local and national economy.
* Residential real estate loans decreased $15.9 million to $107.3
million at December 31, 2005 from $123.2 million at December
31, 2004. Westfield Bank refers its residential real estate
borrowers to a third party mortgage company and substantially
all of Westfield Bank's residential real estate loans are
underwritten, originated and serviced by a third party mortgage
company. Westfield Bank receives a fee from each of these
loans originated. Westfield Bank believes that this program
has diversified its loan portfolio and continues to reduce
interest rate risk by reducing the amount of long-term fixed
rate residential mortgages held in Westfield Bank's loan
portfolio.
48
* Securities, including mortgage-backed securities increased
$20.0 million to $354.9 million at December 31, 2005, compared
to $334.9 million at December 31, 2004. The largest segment of
the securities portfolio is mortgage-backed securities, the
majority of which are adjustable rate instruments. Management
feels that investing funds in adjustable rate mortgage backed
securities has helped provide cash flow and in addition, helped
reduce interest rate risk.
* Total deposits increased $10.4 million to $623.0 million at
December 31, 2005 from $612.6 million at December 31, 2004.
Time deposits increased $21.9 million to $335.0 million at
December 31, 2005, while regular savings and money market
accounts decreased $20.6 million. As the rates paid on term
deposits increased throughout 2005, some customers have shifted
funds out of lower yielding core deposits, and into higher
yielding term deposits. Management feels that in a period of
rising rates, the more rate sensitive customers will continue
to move funds into term deposits, resulting in a higher cost of
deposits. Checking accounts increased $9.0 million to $114.4
million at December 31, 2005. The increase is primarily due to
a new checking account product which pays higher rates to
customers who maintain large balances.
* Fees received from the third party mortgage company were
$107,000 for the year ended December 31, 2005, compared to
$100,000 for the same period in 2004. Fee income from the
third party mortgage company in the future may be affected by
borrower activity, which generally decreases in a rising
interest rate environment.
* Checking account processing fees increased $148,000 for the
twelve months ended December 31, 2005, compared to the same
period in 2004. This was as a result of Westfield Bank's
overdraft privilege program offered to checking account
customers. The overdraft privilege program commenced in the
second quarter of 2004, therefore the 2004 results reflect only
a partial year under the program. In 2005, the overdraft
privilege program was in effect for the entire year.
* Nonperforming loans decreased $252,000 to $1.9 million at
December 31, 2005 from $2.2 million at December 31, 2004. This
was primarily the result of payments in full received on
nonperforming loans.
* Gross charge-offs increased by $208,000 to $612,000 for the
twelve months ended December 31, 2005, compared to the same
period in 2004. This was the result of an increase of $417,000
in charge-offs on commercial and industrial loans, partially
offset by a decrease of $209,000 in consumer loan charge-offs.
* The allowance for loans as a percent of total loans receivable
was 1.41% as of both December 31, 2005 and December 31, 2004.
Westfield Bank had steadily increased this ratio in prior years
to compensate for growth in commercial loans, which typically
have higher risks than residential loans. As Westfield Bank
emphasizes the origination of commercial real estate loans and
commercial and industrial loans for its loan portfolio,
increased allowance requirements may continue. Due to
Westfield
49
Bank's third party mortgage program and the discontinuation of
its indirect automobile lending, the balances of both
residential mortgages and consumer loans decreased during 2005.
This resulted in a decrease in the allowance requirement for
residential mortgages and consumer loans.
* Stockholders' equity at December 31, 2005 and December 31, 2004
was $115.8 million and $118.1 million, respectively,
representing 14.4% and 14.8% of total assets. The change is
comprised of net income of $6.2 million for the year ended
December 31, 2005, the net repurchase of 199,755 shares of
common stock for $4.9 million, and the declaration by the Board
of Directors of four quarterly and two special dividends
aggregating $3.6 million.
General
Westfield Financial's consolidated results of operations are comprised
of earnings on investments and the net income recorded by its principal
operating subsidiary, Westfield Bank. Westfield Bank's consolidated results
of operations depend primarily on net interest and dividend income. Net
interest and dividend income is the difference between the interest income
earned on interest-earning assets and the interest paid on interest-bearing
liabilities. Interest-earning assets consist primarily of residential
mortgage loans, commercial mortgage loans, commercial loans, consumer loans,
mortgage-backed securities and investment securities. Interest-bearing
liabilities consist primarily of certificates of deposit, savings, money
market and NOW account deposits, and borrowings from the Federal Home Loan
Bank of Boston. The consolidated results of operations also depend on
provision for loan losses, noninterest income, and noninterest expense.
Noninterest expense includes salaries and employee benefits, occupancy
expenses and other general and administrative expenses. Noninterest income
includes service fees and charges, income on bank owned life insurance, and
gains (losses) on sales of securities and securities writedowns.
The consolidated results of operations may also be affected
significantly by economic and competitive conditions in the market area and
elsewhere, including those conditions that influence market interest rates,
government policies and the actions of regulatory authorities. Future
changes in applicable laws, regulations or government policies may materially
affect the results of operations. Furthermore, because Westfield Bank's
lending activity is concentrated in loans secured by residential and
commercial real estate located in Hampden County, Massachusetts, downturns in
this regional economy could have a negative impact on its earnings.
Critical Accounting Policies
Westfield Financial's accounting policies are disclosed in Note 1 to
the Consolidated Financial Statements. The more critical policies given
Westfield Financial's current business strategy and asset/liability structure
are accounting for nonperforming loans, the allowance for loan losses and
provision for loan losses, the classification of securities as either held to
maturity or available for sale, other than temporary impairment of
securities, and discount rate assumptions used for benefit liabilities. In
addition to the informational disclosure in the Notes
50
to the Consolidated Financial Statements, Westfield Financial's policy on
each of these accounting policies is described in detail in the applicable
sections of Management's Discussion and Analysis of Financial Condition and
Results of Operations. Senior management has discussed the development and
selection of these accounting estimates and the related disclosures with the
Audit Committee of Westfield Financial's Board of Directors.
On a quarterly basis, Westfield Financial's reviews available for sale
investment securities with unrealized depreciation on a judgmental basis to
assess whether the decline in fair value is temporary or other than
temporary. Declines in the fair value of held to maturity and available for
sale securities below their cost that are deemed to be other than temporary
are reflected in earnings as realized losses. In estimating other than
temporary impairment losses, management considers (1) the length of time and
the extent to which the fair value has been less than cost, (2) the financial
condition and near-term prospects of the issuer, and (3) the intent and
ability of the corporation to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair
value.
Securities, including mortgage-backed securities, which management has
the positive intent and ability to hold until maturity are classified as held
to maturity and are carried at amortized cost. Securities, including
mortgage-backed securities, which have been identified as assets for which
there is not a positive intent to hold to maturity are classified as
available for sale and are carried at fair value with unrealized gains and
losses, net of income taxes, reported as a separate component of equity.
Accordingly, a misclassification would have a direct effect on stockholders'
equity. Sales or reclassification as available for sale (except for certain
permitted reasons) of held to maturity securities may result in the
reclassification of all such securities to available for sale. Westfield
Financial has never sold held to maturity securities or reclassified such
securities to available for sale other than in specifically permitted
circumstances. Westfield Financial does not acquire securities or mortgage-
backed securities for purposes of engaging in trading activities.
Westfield Financial's general policy is to discontinue the accrual of
interest when principal or interest payments are delinquent 90 days or more,
or earlier if the loan is considered impaired. Any unpaid amounts previously
accrued on these loans are reversed from income. Subsequent cash receipts are
applied to the outstanding principal balance or to interest income if, in the
judgment of management, collection of principal balance is not in question.
Loans are returned to accrual status when they become current as to both
principal and interest and when subsequent performance reduces the concern as
to the collectibility of principal and interest. Loan fees and certain direct
loan origination costs are deferred, and the net fee or cost is recognized as
an adjustment to interest income over the estimated average lives of the
related loans.
51
The process of evaluating the loan portfolio, classifying loans and
determining the allowance and provision is described in detail in "Business-
Asset Quality-Allowance for Loan Losses" above. Westfield Financial's
methodology for assessing the appropriations of the allowance consists of two
key components, which are a specific allowance for identified problems or
impaired loans and a formula allowance for the remainder of the portfolio.
Measurement of impairment can be based on present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
observable market price or the fair value of the collateral, if the loan is
collateral dependent. This evaluation is inherently subjective as it requires
material estimates that may be susceptible to significant change. The
appropriations of the allowance is also reviewed by management based upon its
evaluation of then-existing economic and business conditions affecting the
key lending areas of Westfield Financial and other conditions, such as new
loan products, credit quality trends (including trends in nonperforming loans
expected to result from existing conditions), collateral values, loan volumes
and concentrations, specific industry conditions within portfolio segments
that existed as of the balance sheet date and the impact that such conditions
were believed to have had on the collectibility of the loan portfolio.
Although management believes it has established and maintained the allowance
for loan losses at adequate levels, future adjustments may be necessary if
economic, real estate and other conditions differ substantially from the
current operating environment.
52
AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST AND DIVIDEND INCOME
The following tables set forth information relating to our financial
condition and net interest and dividend income for the years ended December
31, 2005, 2004 and 2003 and reflect the average yield on assets and average
cost of liabilities for the years indicated. The yields and costs were
derived by dividing income or expense by the average balance of interest-
earning assets or interest-bearing liabilities, respectively, for the years
shown. Average balances were derived from actual daily balances over the
years indicated. Interest income includes fees earned from making changes in
loan rates or terms, and fees earned when commercial real estate loans were
prepaid or refinanced.
For the Year Ended December 31,
---------------------------------------------------------------------------------------------
2005 2004 2003
----------------------------- ----------------------------- -----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- -------- ------- ------- -------- -------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
ASSETS:
Interest-earning assets:
Short term investments(1) $ 30,141 $ 788 2.61% $ 20,866 $ 290 1.39% $ 17,648 $ 170 0.96%
Securities 344,618 13,577 3.94 361,253 13,195 3.65 389,333 13,189 3.39
Loans(2) 383,436 22,941 5.98 366,677 20,943 5.71 354,134 22,276 6.29
-------- ------- -------- ------- -------- -------
Total interest-earning
assets 758,195 37,306 4.92 748,796 34,428 4.60 761,115 35,635 4.68
------- ------- -------
Total noninterest-earning
assets 47,226 46,135 48,693
-------- -------- --------
Total assets $805,421 $794,931 $809,808
======== ======== ========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
NOW accounts 60,150 326 0.54 48,004 249 0.52 42,783 347 0.81
Savings accounts 43,250 215 0.50 47,728 232 0.49 46,771 371 0.79
Money market deposit accounts 144,629 2,117 1.46 152,855 1,419 0.93 152,863 1,860 1.22
Time certificates of deposit 325,050 9,155 2.82 317,563 7,724 2.43 353,967 10,544 2.98
-------- ------- -------- ------- -------- -------
Total interest-bearing
deposits 573,079 11,813 566,150 9,624 596,384 13,122
Customer repurchase agreements
and other borrowings 62,209 1,784 2.87 50,309 1,289 2.56 30,123 736 2.44
-------- ------- -------- ------- -------- -------
Interest-bearing liabilities 635,977 13,597 2.14 616,459 10,913 1.77 626,507 13,858 2.21
-------- ------- -------- ------- -------- -------
Noninterest-bearing deposits 44,590 52,631 54,119
Other noninterest-bearing
liabilities 6,819 5,488 5,020
-------- -------- --------
Total noninterest-bearing
liabilities 52,098 58,119 59,139
-------- -------- --------
Total liabilities 687,386 674,578 685,646
Total equity 118,035 120,353 124,162
-------- -------- --------
Total liabilities and
equity $805,421 $794,931 $809,808
======== ======== ========
Net interest and dividend income $23,709 $23,515 $21,777
======= ======= =======
Net interest rate spread(3) 2.78 2.83 2.47
Net interest margin(4) 3.13% 3.13% 2.86%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 119.2x 121.5x 121.5x
<FN>
- -------------------
<F1> Short term investments include Federal funds sold.
<F2> Loans, including non-accrual loans, are net of deferred loan
origination costs (fees), and unadvanced funds.
<F3> Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost
of interest-bearing liabilities.
<F4> Net interest margin represents net interest and dividend income as a
percentage of average interest earning assets.
</FN>
53
Rate/Volume Analysis. The following table shows how changes in
interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected our interest and dividend income
and interest expense during the periods indicated. Information is provided
in each category with respect to:
(1) interest income changes attributable to changes in volume
(changes in volume multiplied by prior rate);
(2) interest income changes attributable to changes in rate (changes
in rate multiplied by prior volume); and
(3) the net change.
The changes attributable to the combined impact of volume and rate have
been allocated proportionately to the changes due to volume and the changes
due to rate.
Year Ended December 31, 2005 Year Ended December 31, 2004
Compared to Year Ended Compared to Year Ended
December 31, 2004 December 31, 2003
Increase/(Decrease) Increase/(Decrease)
---------------------------- ----------------------------
Due to Due to
----------------- -------------------
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
(In thousands)
<s> <c> <c> <c> <c> <c> <c>
Interest earning assets:
Short term investments $ 129 $ 369 $ 498 $ 31 $ 89 $ 120
Investment securities (608) 990 382 (951) 957 6
Loans 957 1,041 1,998 789 (2,122) (1,333)
----- ------ ------ ------- ------- -------
Total interest-earning assets 478 2,400 2,878 (131) (1,076) (1,207)
----- ------ ------ ------- ------- -------
Interest bearing liabilities:
NOW accounts 67 10 77 42 (140) (98)
Savings accounts (22) 5 (17) 8 (147) (139)
Money market deposit accounts (76) 774 698 0 (441) (441)
Time certificates of deposit 182 1,249 1,431 (1,084) (1,736) (2,820)
Customer repurchase agreements
and other borrowings 305 190 495 493 60 553
----- ------ ------ ------- ------- -------
Total interest bearing
liabilities 456 2,228 2,684 (541) (2,404) (2,945)
----- ------ ------ ------- ------- -------
Change in net interest and
dividend income $ 22 $ 172 $ 194 $ 410 $ 1,328 $ 1,738
===== ====== ====== ======= ======= =======
54
Comparison of Financial Condition at December 31, 2005 and December 31, 2004
Consolidated assets increased $8.2 million, or 1.0%, to $805.1 million
at December 31, 2005 from $796.9 million at December 31, 2004. Cash and cash
equivalents decreased $24.6 million to $26.4 million at December 31, 2005
from $51.0 million at December 31, 2004. This was primarily the result of a
$26.9 million decrease in Federal funds sold.
Net loans during this period increased by $10.2 million, or 2.7%, to
$378.8 million at December 31, 2005, from $368.6 million at December 31,
2004.
Commercial real estate loans increased $25.2 million, or 17.5%, to
$169.5 million at December 31, 2005 from $144.3 million at December 31, 2004.
Commercial and industrial loans increased $5.3 million, or 5.6%, to $100.1
million at December 31, 2005 from $94.8 million at December 31, 2004.
Westfield Bank's strategic plan calls for emphasis on commercial lending.
The success of the plan to grow commercial loans is primarily dependent upon
the health of the local and national economy.
Residential real estate loans decreased $15.9 million to $107.3 million
at December 31, 2005 from $123.2 million at December 31, 2004. Westfield
Bank refers its residential real estate borrowers to a third party mortgage
company and substantially all of Westfield Bank's residential real estate
loans are underwritten, originated and serviced by a third party mortgage
company. Westfield Bank receives a fee from each of these loans originated.
Westfield Bank believes that this program has diversified its loan portfolio
and continues to reduce interest rate risk by reducing the amount of long-
term fixed rate residential mortgages held in Westfield Bank's loan
portfolio.
Securities, including mortgage-backed securities increased $20.0
million to $354.9 million at December 31, 2005 as compared to $334.9 million
at December 31, 2004. The largest segment of the securities portfolio is
mortgage-backed securities, the majority of which are adjustable rate
instruments. Management feels that investing funds in adjustable rate
mortgage backed securities has helped provide cash flow and in addition,
helped reduce interest rate risk.
Total deposits increased $10.4 million to $623.0 million December 31,
2005 from $612.6 million at December 31, 2004. Time deposits increased $21.9
million to $335.0 million at December 31, 2005, while regular savings and
money market accounts decreased $20.6 million. As the rates paid on term
deposits increased throughout 2005, some customers have shifted funds out of
lower yielding core deposits, and into higher yielding term deposits.
Management feels that in a period of rising rates, the more rate sensitive
customers will continue to move funds into term deposits, resulting in a
higher cost of deposits. Checking accounts increased $9.0 million to $114.3
million at December 21, 2005. The increase is primarily due to a new
checking account product which pays higher rates to customers who maintain
large balances.
Federal Home Loan Bank borrowings were $45.0 million at both December
31, 2005 and December 31, 2004. Customer repurchase agreements decreased
$174,000 to $14.4 million at December 31, 2005. A customer repurchase
agreement is an agreement by Westfield Bank to sell to and repurchase from
the customer an interest in specific securities issued by government-
sponsored enterprises. This transaction settles immediately on a same day
basis in
55
immediately available funds. Interest paid is commensurate with other
products of equal interest and credit risk. All the customer repurchase
agreements are held by Westfield Bank's commercial loan customers. The
increase in customer repurchase agreements is consistent with Westfield
Bank's strategy to emphasize commercial customer relationships.
Stockholders' equity at December 31, 2005 and December 31, 2004 was
$115.8 million and $118.1 million, respectively, representing 14.4% and 14.8%
of total assets. The change is comprised of net income of $6.2 million for
the year ended December 31, 2005, the net repurchase of 199,755 shares of
common stock for $4.9 million, and the declaration by the Board of Directors
of four quarterly and two special dividends aggregating $3.6 million.
Comparison of Operating Results for Years Ended December 31, 2005 and 2004
General
Net income for the year ended December 31, 2005 and $6.2 million, or
$0.64 per diluted share, compared to $6.3 million, or $0.64 per diluted share
for the year ended December 31, 2004. The 2004 results included net gains
from the sale of securities of $877,000 for the year ended December 31, 2004.
This was primarily the result of the Company selling its common stock
portfolio in 2004. Net gains from sales of securities for the year ended
December 31, 2005 were $19,000.
Interest and Dividend Income
Total interest and dividend income increased $2.9 million or 8.4% to
$37.3 million for the year ended December 31, 2005, compared to $34.4 million
for the same period in 2004.
The increase in interest income was primarily the result of a $2.0
million increase in interest income on loans. Interest income from
commercial real estate loans and commercial and industrial loans increased
$2.9 million for the year ended December 31, 2005 from the year ended
December 31, 2004. In accordance with Westfield Bank's strategic plan, the
average balance of commercial real estate loans and commercial industrial
loans increased $28.2 million to $259.3 million for the year ended December
31, 2005, compared to $231.1 million for the same period in 2004.
Interest income from residential real estate loans decreased $336,000
to $6.5 million for the year ended December 31, 2005, compared to the same
period in 2004. The average balance of residential real estate loans
decreased $4.4 million for the year ended December 31, 2005 from $119.6
million for the year ended December 31, 2004 due to our residential real
estate loan program with a third party mortgage company. In addition,
interest on consumer loans decreased $581,000 to $631,000 for the year ended
December 31, 2005, compared to $1.2 million for the same period in 2004.
This was primarily the result of a decrease in average balance of consumer
loans from $16.0 million for 2004 to $9.0 million for 2005 due to
management's decision to discontinue indirect automobile loan originations in
2003 and allow the portfolio to paydown.
56
Interest and dividends on securities was $13.6 million for the years
ended December 31, 2005 and $13.2 million for the same period in 2004. The
average yield on securities increased from 3.65% for the year 2004 to 3.94%
for the same period in 2005. This change was offset by a $16.7 million
decrease in the average balance of securities from $361.3 million for 2004 to
$344.6 million for 2005. Market interest rates increased during 2005. As
lower yielding investments purchased in a higher rate environment matured,
were called, or paid down in 2005, the funds were reinvested at higher rates.
In addition, the interest rate on adjustable rate securities repriced upward
in the rising interest rate environment.
Interest Expense
Interest expense for the year ended December 31, 2005 increased $2.7
million to $13.6 million from the comparable 2004 period. This was
attributable to an increase in the average cost of interest-bearing
liabilities increasing 37 basis points to 2.14% for the year ended December
31, 2005 from 1.77% for the same period in 2004. In addition, the average
balance of total interest-bearing liabilities increased $19.5 million to
$636.0 million for the year ended December 31, 2005 from $616.5 million for
the same period in 2004.
As the rates paid on term deposits increased throughout 2005, some
customers have shifted funds out of lower yielding core deposits, and into
higher yielding term deposits. Management feels that in a period of rising
rates, the more rate sensitive customers will continue to move funds into
term deposits, resulting in a higher cost of deposits.
Net Interest and Dividend Income
Net interest and dividend income increased $194,000 to $23.7 million
for the twelve months ended December 31, 2005 as compared to $23.5 million
for the same period in 2004. The net interest margin was 3.13% for both the
twelve months ended December 31, 2005 and 2004.
The increase in income from interest-earning assets was mostly offset
by an increase in interest expense from interest-bearing liabilities. The
average cost of interest-bearing liabilities increased 37 basis points to
2.14% for the twelve months ended December 31, 2005 from 1.77% for same
period in 2004. The yield on interest-earning assets increased 32 basis
points to 4.92% for the twelve months ended December 31, 2005 from 4.60% for
same period in 2004.
Westfield Bank's net interest margin may be affected by the slope of
the yield curve. A flat or inverted yield curve may result in a decrease in
the net interest margin. Customer migration into term deposits, as discussed
previously, and increased local competition for deposits may lead to higher
deposit costs, which may also contribute to a decrease to the net interest
margin.
57
Provision for Loan Losses
During 2005, Westfield Bank provided $465,000 for loans losses,
compared to $750,000 during 2004. The provision for loan losses brings
Westfield Bank's allowance for loan losses to a level determined appropriate
by management based on the methodology discussed under "Allowance for Loan
Losses." The allocation of the provision for loan losses among loan types
and between the specific and formula components of the allowance for loan
losses is also determined based on the methodology discussed under "Allowance
for Loan Losses." The following factors were used to determine the provision
for 2005.
* Loan concentrations - Commercial real estate loans and commercial
and industrial loans increased $30.5 million, or 12.8%, to $269.6
million as of December 31, 2005 as compared to 2004. Westfield
Bank considers these types of loans to contain more risk than
conventional residential mortgages. These increases resulted in
an increase in the allowance requirements for commercial real
estate and commercial and industrial loans. As Westfield Bank
emphasizes increasing its commercial real estate loans and
commercial and industrial loans, increased allowance requirements
may continue.
Residential real estate loans decreased $15.9 million to $107.3
million at December 31, 2005, resulting in a decrease in the
allowance requirement for residential loans. Westfield Bank
refers it residential real estate borrowers to a third party
mortgage company and substantially all of Westfield Bank's
residential real estate loans are underwritten, originated and
serviced by a third party mortgage company. Consumer loans
decreased $4.3 million to $7.3 million, resulting in decreases
in the allowance requirements for consumer loans. Due to
Westfield Bank's discontinuation of its indirect auto lending,
the balance of consumer loans is expected to continue to
decrease. Decreased future allowances for consumer loans may
result.
* Credit quality - Actual loss experience on loans increased with
charge-offs totaling $612,000 in 2005 as compared to $404,000 in
2004. Net loans charged off as a percent of average loans
outstanding increased from 0.03% in 2004 to 0.08% in 2005.
Nonperforming loans decreased $252,000 from $2.2 million at
December 31, 2004 to $1.9 million at December 31, 2005. The
decrease was mainly due to payments in full received on
nonperforming loans.
As a result of the detailed allowance for loan loss methodology and
consideration of the above factors, management determined that a provision of
$465,000 was appropriate in 2005. The allowance for loan losses was 1.41% of
total loans at the end of 2005 and also the end of 2004.
58
Noninterest Income
Noninterest income decreased $524,000 to $3.4 million in 2005 from $3.9
million for 2004. Net gains from sales and writedowns of securities were
$19,000 for the year ended December 31, 2005, compared to $877,000 for the
same period in 2004. This is primarily the result of the company selling its
common stock portfolio in 2004 to comply with OTS regulations. Income on
bank owned life insurance was $758,000 for the period ended December 31,
2005, compared to $741,000 for the same period in 2004.
Fees received from the third party mortgage company were $107,000 for
the year ended December 31, 2005, compared to $100,000 for the same period in
2004. Fee income from the third party mortgage company in the future may be
affected by borrower activity, which generally decreases in a rising interest
rate environment.
Checking account processing fees increased $148,000 for the twelve
months ended December 31, 2005, compared to the same period in 2004. This
was a result of Westfield Bank's overdraft privilege program offered to
checking account customers. The overdraft privilege program commenced in the
second quarter of 2004, therefore the 2004 results reflect only a partial
year under the program. In 2005, the overdraft privilege program was in
effect for the entire year.
Noninterest Expense
Noninterest expense for the twelve months ended December 31, 2005 was
$18.5 million as compared to $17.8 million for the same period in 2004.
Salaries and benefits increased $402,000 for the year ended December 31,
2005, compared to the same period in 2004. This was primarily the result of
normal increases in salaries and health care costs along with an increase in
stock based benefit plan expenses of $176,000.
Advertising and marketing expenses increased $195,000 for the twelve
months ended December 31, 2005, compared to the same period in 2004. This
was the result of management's decision to increase spending on advertising
and marketing to promote the Bank's products and services.
Income Taxes
Income taxes decreased $629,000 to $1.9 million in 2005. The effective
tax rate was 23.7% in 2005 compared to 28.8% for 2004. This was primarily
the result of an increase in income from tax-exempt assets. The effective
tax rates for 2005 and 2004 also reflect the utilization of Westfield
Securities Corporation (dissolved in the third quarter of 2005), and Elm
Street Securities Corporation, both Massachusetts qualified securities
corporations.
59
Comparison of Financial Condition at December 31, 2004 and December 31, 2003
Consolidated assets increased $1.7 million, or 0.2%, to $796.9 million
at December 31, 2004 from $795.2 million at December 31, 2003. Securities
decreased $28.7 million, or 7.9%, to $334.9 million at December 31, 2004 from
$363.6 million at December 31, 2003. Cash received from maturities, calls,
and paydowns of securities was primarily used to fund loan demand. Cash and
cash equivalents increased $5.4 million to $51.0 million at December 31, 2004
from $45.7 million at December 31, 2003.
Net loans during this period increased by $23.6 million, or 6.8%, to
$368.6 million at December 31, 2004, from $345.0 million at December 31,
2003.
Commercial real estate loans increased $13.0 million, or 9.9%, to
$144.3 million at December 31, 2004 from $131.3 million at December 31, 2003.
Commercial and industrial loans increased $9.5 million, or 11.1%, to $94.8
million at December 31, 2004 from $85.3 million at December 31, 2003.
Westfield Bank's strategic plan calls for emphasis on commercial lending.
The success of the plan to grow commercial loans is primarily dependent upon
the improvement of the local and national economy.
Residential real estate loans increased $12.7 million to $123.2 million
at December 31, 2004 from $110.5 million at December 31, 2003. The increase
was primarily the result of Westfield Bank's purchase of $35.3 million in
adjustable rate mortgage loans, which are serviced by the originating
institutions. This was offset by principal payments and payoffs of other
residential real estate loans. Westfield Bank refers its residential real
estate borrowers to a third party mortgage company and substantially all of
Westfield Bank's residential real estate loans are underwritten, originated
and serviced by a third party mortgage company. Westfield Bank receives a
fee from each of these loans originated.
Indirect automobile loans decreased $10.1 million, or 63.1%, to $5.9
million on December 31, 2004 as compared to $16.0 million on December 31,
2003. Management curtailed its indirect lending beginning in fiscal year
2000 and in the fourth quarter of 2003, the Bank ceased writing loans under
this program.
Total deposits decreased $19.8 million to $612.6 million at December
31, 2004. The decrease in deposits was primarily due to a decrease of $21.1
million in time deposits for the year ended December 31, 2004. Management
believes that the decrease in time deposits was a result of a pricing
strategy whereby less emphasis was placed on attracting term deposits, which
generally have higher interest rates than core deposits. This led to an
increase in net interest income.
60
Core deposits, which include checking, NOW, savings and money market
accounts, increased $1.3 million to $299.5 million at December 31, 2004.
Westfield Bank's strategy is to emphasize core deposits in order to maintain
long-term relationships with customers and to reduce the cost of funds.
Management believes, however, that a percentage of the growth in core
deposits over the last three years was due to the low rate environment, i.e.
no incentive for customers to lock up funds in time deposits. In a period of
rising interest rates, the more rate sensitive customers may shift funds back
into time deposits, resulting in a higher cost of funds.
The decrease in deposits was offset by increases in Federal Home Loan
Bank borrowings and customer repurchase agreements. Federal Home Loan Bank
borrowings increased $25.0 million to $45.0 million at December 31, 2004 to
take advantage of the current interest rate environment. Customer repurchase
agreements increased $2.5 million to $14.6 million at December 31, 2004. A
customer repurchase agreement is an agreement by Westfield Bank to sell to
and repurchase from the customer an interest in specific securities issued by
government-sponsored enterprises. This transaction settles immediately on a
same day basis in immediately available funds. Interest paid is commensurate
with other products of equal interest and credit risk. All the customer
repurchase agreements are held by Westfield Bank's commercial loan customers.
The increase customer repurchase agreements is consistent with Westfield
Bank's strategy to emphasize commercial customer relationships.
Stockholders' equity at December 31, 2004 and December 31, 2003 was
$118.1 million and $124.8 million, respectively. The change is comprised of
net income of $6.3 million for the year ended December 31, 2004, the net
repurchase of 567,788 shares of common stock for $12.0 million, and the
declaration by the Board of Directors of quarterly cash dividends aggregating
$1.7 million.
Comparison of Operating Results for Years Ended December 31, 2004 and
2003
General
Westfield Financial reported net income of $6.3 million or $0.64 per
diluted share for the year ended December 31, 2004 compared to net income of
$3.7 million or $0.36 per diluted share for the same period in 2003.
Interest and dividend income increased by $1.2 million and interest expense
decreased by $2.9 million resulting in an increase in net interest income of
$1.7 million. Noninterest income increased by $822,000 and income tax
expense decreased by $258,000.
Westfield Financial's 2003 results included a charge of $1.45 million
representing the additional state tax liability, including interest, relating
to the deduction for dividends received from Westfield Bank's real estate
investment trust subsidiary for 2002 and prior years. Total income taxes
were $2.6 million for the year ended December 31, 2004, compared to $2.8
million for the same period in 2003.
61
Interest and Dividend Income
Total interest and dividend income decreased $1.2 million or 3.4% to
$34.4 million for the year ended December 31, 2004 compared to $35.6 million
for the same period in 2003.
The decrease in interest income was primarily the result of a $1.3
million decrease in interest income on loans. Interest income from
residential real estate loans decreased $1.6 million to $7.8 million for the
year ended December 31, 2004, compared to the same period in 2003. The
average balance of residential real estate loans decreased to $119.6 million
for the year ended December 31, 2004 from $131.4 million for the year ended
December 31, 2003 due to our residential real estate loan program with a
third party mortgage company. In addition, interest on consumer loans
decreased $1.2 million to $1.2 million for the year ended December 31, 2004
as compared to $2.4 million for the same period in 2003. This was primarily
the result of a decrease in average balance of consumer loans from $31.2
million for 2003 to $16.0 million for 2004 due to management's decision to
discontinue indirect automobile loan originations.
The decrease is interest income from residential real estate loans and
consumer loans was partially offset by increases in income from commercial
real estate loans and commercial and industrial loans. Interest income from
commercial real estate loans and commercial and industrial loans increased
$1.5 million for the year ended December 31, 2004 from the year ended
December 31, 2003. In accordance with Westfield Bank's strategic plan, the
average balance of commercial real estate loans and commercial industrial
loans increased $39.6 million to $231.1 million for the year ended December
31, 2004, compared to $191.5 million for the same period in 2003
Interest and dividends on securities was $13.2 million for both the
years ended December 31, 2004 and 2003. The average yield on securities
increased from 3.39% for the year 2003 to 3.65% for the same period in 2004.
This change was offset by a $28.0 million decrease in the average balance of
securities from $389.3 million for 2003 to $361.3 million for 2004. Market
interest rates increased during 2004. As lower yielding investments
purchased in a higher rate environment matured, were called, or paid down in
2004, the funds were reinvested at higher rates. In addition, the interest
rate on adjustable rate securities repriced upward in the rising interest
rate environment.
Interest Expense
Interest expense for the year ended December 31, 2004 decreased $3.0
million to $10.9 million from the comparable 2003 period. This was
attributable to a decrease in the average cost of interest-bearing
liabilities of 44 basis points to 1.77% for the year ended December 31, 2004
from 2.21% for the same period in 2003. In addition, the average balance of
total interest-bearing liabilities decreased $10.0 million to $616.5 million
for the year ended December 31, 2004 from $626.5 million for the same period
in 2003.
62
The decrease in both the average balance and average cost of interest-
bearing liabilities was the result of a pricing strategy whereby less
emphasis was placed on attracting term deposits, which generally have higher
interest rates than core deposits.
Net Interest and Dividend Income
Net interest and dividend income increased $1.7 million to $23.5
million for the twelve months ended December 31, 2004, compared to $21.8
million for the same period in 2003. The net interest margin was 3.13% for
the twelve months ended December 31, 2004, compared to 2.86% for the same
period in 2003.
The increase in the net interest margin was primarily the result of
lower funding costs. The average cost of interest-bearing liabilities
decreased 44 basis points to 1.77% for the twelve months ended December 31,
2004 from 2.21% for same period in 2003. The yield on interest-earning
assets decreased 8 basis points to 4.60% for the twelve months ended December
31, 2004 from 4.68% for same period in 2003. Westfield Financial expects net
interest and dividend income to generally increase in future periods as it
continues to emphasize higher yielding commercial real estate loans and
commercial and industrial loans, while referring residential mortgage loans
to a third party mortgage company.
In addition, Westfield Bank continues to emphasize core deposits over
time deposits. The average balance of core deposits, which are checking,
NOW, savings and money market accounts, increased $4.7 million to $301.2
million for the twelve months ended December 31, 2004 from $296.5 million for
the same period in 2003. The average balance of time deposits decreased
$36.4 million to $317.6 million for the twelve months ended December 31, 2004
from $354.0 million for the same period in 2003. The decrease in time
deposits was partially offset by an increase in Federal Home Loan Bank
borrowings. The average balance of Federal Home Loan Bank borrowings
increased $17.5 million to $34.4 million for the twelve months ended December
31, 2004 from $16.9 million for the same period in 2003.
The use of a pricing strategy whereby less emphasis was placed on
attracting term deposits, which generally have higher interest rates than
core deposits, and the shift in Westfield Bank's funding mix contributed to
the decrease in funding costs. Management believes, however, that a
percentage of the growth in core deposits over the last three years is due to
the low rate environment, i.e. no incentive for customers to lock up funds in
time deposits. In a period of rising interest rates, the more rate sensitive
customers may shift funds back into time deposits, resulting in a higher cost
of deposits.
63
Provision for Loan Losses
Westfield Bank provided $750,000 for loans losses, during both 2004 and
2003. The provision for loan losses brings Westfield Bank's allowance for
loan losses to a level determined appropriate by management based on the
methodology discussed under "Allowance for Loan Losses." The allocation of
the provision for loan losses among loan types and between the specific and
formula components of the allowance for loan losses is also determined based
on the methodology discussed under "Allowance for Loan Losses." The following
factors were used to determine the provision for 2004.
* Loan concentrations - Commercial real estate loans and commercial
and industrial loans increased $22.5 million or 10.4% during
2004, compared to 2003. Westfield Bank considers these types of
loans to contain more risk than conventional residential
mortgages. These increases resulted in an increase in the
allowance requirements for commercial real estate and commercial
and industrial loans. As Westfield Bank emphasizes increasing
its commercial real estate loans and commercial and industrial
loans, increased allowance requirements may continue.
Residential real estate loans increased $12.7 million to $123.2
million at December 31, 2004. This was the result of Westfield
Bank purchasing $35.0 million of adjustable rate mortgage loans
in 2004. The increases in residential real estate loans and
commercial loans were partially offset by a decrease in consumer
loans of $10.8 million to $11.6 million, resulting in decreases
in the allowance requirements for consumer loans, respectively.
Due to Westfield Bank's discontinuation of its indirect auto
lending, the balance of consumer loans is expected to continue
to decrease. Decreased future allowances for consumer loans may
result.
* Credit quality - Actual loss experience on loans decreased with
charge-offs totaling $404,000 in 2004 as compared to $725,000 in
2003. Net loans charged off as a percent of average loans
outstanding decreased from 0.12% in 2003 to 0.03% in 2004.
Nonperforming loans increased $403,000 from $1.8 million at
December 31, 2003 to $2.2 million at December 31, 2004. This was
primarily due to a single commercial real estate loan
relationship of $1.4 million. The loan is fully collateralized
based on the estimated fair market value of the property. This
was offset primarily by payments in full received on other
nonperforming loans.
As a result of the detailed allowance for loan loss methodology and
consideration of the above factors, management determined that a provision of
$750,000 was appropriate in 2004.
The allowance for loan losses at the end of 2004 was 1.41% of total
loans compared with 1.33% at the end of 2003. The increase in the coverage
ratio reflects the changes in the loan portfolio described above.
64
Noninterest Income
Noninterest income increased $822,000 to $3.9 million in 2004 from $3.1
million for 2003. Fees received from the third party mortgage company were
$100,000 for the year ended December 31, 2004, compared to $340,000 for the
same period in 2003. Higher interest rates resulted in fewer referrals to
the third party mortgage company. Fee income from the third party mortgage
company in the future may be affected by borrower activity, which generally
decreases in a rising interest rate environment.
Checking account processing fees increased $617,000 for the year ended
December 31, 2004, compared to the same period in 2003. This was a result of
new products and services provided by Westfield Bank to its checking account
customers commencing in the third quarter of 2004.
Net gains from sales and writedowns of securities were $877,000 for the
year ended December 31, 2004, compared to $409,000 for the same period in
2003. This is primarily the result of the company selling its common stock
portfolio in 2004 to comply with OTS regulations. Income on bank owned life
insurance was $741,000 for the period ended December 31, 2004, compared to
$806,000 for the same period in 2003.
Noninterest Expense
Noninterest expense for the twelve months ended December 31, 2004 was
$17.8 million, compared to $17.6 million for the same period in 2003. The
2003 results included a net charge of $153,000 for tax-related interest and
penalties regarding the Commonwealth of Massachusetts' REIT legislation.
Salaries and benefits increased $1.1 million for the year ended December 31,
2004, compared to the same period in 2003. This was primarily the result of
normal increases in salaries and health care costs along with an increase in
stock based benefit plan expenses of $65,000. Expenses associated with
indirect auto loan processing decreased by $153,000 for the year ended
December 31, 2004, compared to the same period in 2003. This was a result of
discontinuing the indirect auto loan program.
Advertising and marketing expenses decreased $124,000 for the twelve
months ended December 31, 2004, compared to the same period in 2003. This
was the result of additional expenses incurred in 2003 to promote the 150th
anniversary of Westfield Bank.
Income Taxes
Income taxes decreased $258,000 to $2.6 million in 2004. The effective
tax rate was 28.8% in 2004 compared to 43.6% for 2003. The effective tax
rates for 2004 and 2003 also reflect the utilization of Westfield Securities
Corporation and Elm Street Securities Corporation, both Massachusetts
qualified securities corporations. The effective tax rate for 2003 also
includes Elm Street Real Estate Investments, Inc., a wholly-owned subsidiary
of Westfield Bank, as a real estate investment trust.
65
The 2003 income taxes were affected by Massachusetts legislation signed
on March 5, 2003 amending the corporate tax law affecting the treatment of
dividends received from REITs. Dividends from the REIT subsidiary are no
longer eligible for a dividends-received deduction. As a result of the
enactment of this legislation, the Company ceased recording the tax benefits
associated with the dividend received deduction effective for the 2003 tax
year.
In addition to the effect on 2003, the legislation was retroactive to
1999. The Company's 2003 results included a charge of $1.45 million
representing the additional state tax liability, including interest, relating
to the deduction for dividends received from the REIT for 2002 and prior
years.
Liquidity and Capital Resources
The term "liquidity" refers to our ability to generate adequate amounts
of cash to fund loan originations, loan purchases, deposit withdrawals and
operating expenses. Our primary sources of liquidity are deposits, scheduled
amortization and prepayments of loan principal and mortgage-backed
securities, maturities and calls of investment securities and funds provided
by our operations. Westfield Bank also can borrow funds from the Federal
Home Loan Bank based on eligible collateral of loans and securities.
Outstanding borrowings from the Federal Home Loan Bank were $45.0 million at
December 31, 2005 and 2004. At December 31, 2005, Westfield Bank's maximum
borrowing capacity from the Federal Home Loan Bank was approximately $12.8
million, net of any outstanding borrowings. In addition, we may enter into
reverse repurchase agreements with approved broker-dealers. Reverse
repurchase agreements are agreements that allow us to borrow money using our
securities as collateral.
Westfield Bank also has outstanding at any time, a significant number
of commitments to extend credit and provide financial guarantees to third
parties. These arrangements are subject to strict credit control
assessments. Guarantees specify limits to Westfield Bank's obligations.
Because many commitments and almost all guarantees expire without being
funded in whole or in part, the contract amounts are not estimates of future
cash flows. Westfield Bank is also obligated under agreements with the
Federal Home Loan Bank to repay borrowed funds and is obligated under leases
for certain of its branches and equipment. A summary of lease obligations,
borrowings, and credit commitments at December 31, 2005 follows:
66
After 1 Year After 3 Years
Within but Within but Within After
1 Year 3 Years 5 Years 5 Years Total
------ ------------ ------------- ------- -----
(In thousands)
<s> <c> <c> <c> <c> <c>
Lease Obligations
Operating lease obligations $ 254 $ 317 $ 176 $ 314 $ 1,061
======= ======= ====== ======= ========
Borrowings
Federal Home Loan Bank $10,000 $30,000 $5,000 $ - $ 45,000
======= ======= ====== ======= ========
Credit Commitments
Available lines of credit $49,137 $ - $ - $12,916 $ 62,053
Other loan commitments 27,163 2,890 - - 30,053
Letters of Credits 4,995 - - 941 5,936
------- ------- ------ ------- --------
Total $91,549 $33,207 $5,176 $14,171 $144,103
======= ======= ====== ======= ========
Maturing investment securities are a relatively predictable source of
funds. However, deposit flows, calls of securities and prepayments of loans
and mortgage-backed securities are strongly influenced by interest rates,
general and local economic conditions and competition in the marketplace.
These factors reduce the predictability of the timing of these sources of
funds.
Our primary investing activities are the origination of commercial real
estate, commercial and industrial and consumer loans, and the purchase of
mortgage-backed and other investment securities. During the year ended
December 31, 2005, Westfield Bank originated loans of approximately $118.1
million, and during the comparable period of 2004, Westfield Bank originated
loans of approximately $96.9 million. Under Westfield Bank's residential
real estate loan program, Westfield Bank refers its residential real estate
borrowers to a third party mortgage company and substantially all of
Westfield Bank's residential real estate loans are underwritten, originated
and serviced by a third party mortgage company. Purchases of securities
totaled $125.9 million for the year ended December 31, 2005 and $104.2
million for the year ended December 31, 2004. At December 31, 2005,
Westfield Bank had loan commitments to borrowers of approximately $36.0
million, and available home equity and unadvanced lines of credit of
approximately $62.0 million.
Deposit flows are affected by the level of interest rates, by the
interest rates and products offered by competitors and by other factors.
Total deposits increased $10.4 million during the year ended December 31,
2005 and decreased $19.8 million during the year ended December 31, 2004.
Time deposit accounts scheduled to mature within one year were $227.8 million
at December 31, 2005. Based on Westfield Bank's deposit retention experience
and current pricing strategy, it anticipates that a significant portion of
these certificates of deposit will remain on deposit. Westfield Bank
monitors its liquidity position frequently and anticipates that it will have
sufficient funds to meet its current funding commitments.
67
At December 31, 2005, Westfield Bank exceeded each of the applicable
regulatory capital requirements. Westfield Bank's tier 1 leverage capital
was $116.8 million, or 14.5% to adjusted total assets. Westfield Bank's tier
1 capital to risk weighted assets was $116.8 million or 24.5%. Westfield
Bank had total capital to risk weighted assets of $122.2 million or 25.7%.
We do not anticipate any material capital expenditures during calendar
year 2006, nor do we have any balloon or other payments due on any long-term
obligations or any off-balance sheet items other than the commitments and
unused lines of credit noted above.
Off-Balance Sheet Arrangement
We do not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that is
material to investors.
Management of Market Risk
As a financial institution, our primary market risk is interest rate
risk since substantially all transactions are denominated in U.S. dollars
with no direct foreign exchange or changes in commodity price exposure.
Fluctuations in interest rates will affect both our level of income and
expense on a large portion of our assets and liabilities. Fluctuations in
interest rates will also affect the market value of all interest-earning
assets.
The primary goal of our interest rate management strategy is to limit
fluctuations in net interest income as interest rates vary up or down and
control variations in the market value of assets, liabilities and net worth
as interest rates vary. We seek to coordinate asset and liability decisions
so that, under changing interest rate scenarios, net interest income will
remain within an acceptable range.
To achieve the objectives of managing interest rate risk, Westfield
Bank's Asset and Liability Management Committee meets monthly to discuss and
monitor the market interest rate environment relative to interest rates that
are offered on its products. The Asset and Liability Management Committee
presents periodic reports to the Board of Directors of Westfield Bank and
Westfield Financial, Inc. at their regular meetings.
In recent years, Westfield Bank's lending activities have emphasized
commercial real estate and commercial and industrial loans. Commercial real
estate loans have grown $38.3 million or 29.2% since December 31, 2003.
Commercial and industrial loans have grown $14.7 million or 17.3% since
December 31, 2003. Consumer loans decreased $14.9 million, or 67.0%, since
December 31, 2003. Management curtailed its indirect lending beginning in
fiscal year 2000 and in the fourth quarter of 2003 the program was
discontinued. We believe that Westfield Bank's increased emphasis on
commercial lending has allowed it to diversify its loan portfolio while
continuing to meet the needs of the businesses and individuals that it
serves.
68
Westfield Bank's primary source of funds has been deposits, consisting
primarily of time deposits, money market accounts, savings accounts, demand
accounts and NOW accounts, which have shorter terms to maturity than the loan
portfolio. Several strategies have been employed to manage the interest rate
risk inherent in the asset/liability mix, including but not limited to:
* maintaining the diversity of our existing loan portfolio through
the origination of commercial loans and commercial real estate
loans which typically have variable rates and shorter terms than
residential mortgages; and
* emphasizing investments with an expected average duration of five
years or less.
In addition, emphasis on commercial loans has reduced the average
maturity of Westfield Bank's loan portfolio. Moreover, the actual amount of
time before loans are repaid can be significantly affected by changes in
market interest rates. Prepayment rates will also vary due to a number of
other factors, including the regional economy in the area where the loans
were originated, seasonal factors, demographic variables and the assumability
of the loans. However, the major factors affecting prepayment rates are
prevailing interest rates, related financing opportunities and competition.
We monitor interest rate sensitivity so that we can adjust our asset and
liability mix in a timely manner and minimize the negative effects of
changing rates.
Each of Westfield Bank's sources of liquidity is vulnerable to various
uncertainties beyond the control of Westfield Bank. Scheduled loan and
security payments are a relatively stable source of funds, while loan and
security prepayments and calls, and deposit flows vary widely in reaction to
market conditions, primarily prevailing interest rates. Asset sales are
influenced by pledging activities, general market interest rates and
unforeseen market conditions. Westfield Bank's financial condition is
affected by its ability to borrow at attractive rates, retain deposits at
market rates and other market conditions. Management considers Westfield
Bank's sources of liquidity to be adequate to meet expected funding needs and
also to be responsive to changing interest rate markets.
Net Interest and Dividend Income Simulation. We use a simulation model
to monitor interest rate risk. This model reports the net interest income at
risk primarily under seven different interest rate environments.
Specifically, net interest income is measured in one scenario that assumes no
change in interest rates, and six scenarios where interest rates increase
100, 200, 300, and 400 basis points, and decrease 100 and 200 basis points,
respectively, from current rates over the one year time period following the
current consolidated financial statements.
The changes in interest income and interest expense due to changes in
interest rates reflect the rate sensitivity of our interest earning assets
and interest bearing liabilities. For example, in a rising interest rate
environment, the interest income from an adjustable rate loan is likely to
increase depending on its repricing characteristics while the interest income
from a fixed rate loan would not increase until the funds were repaid and
loaned out at a higher interest rate.
69
The tables below set forth as of December 31, 2005 the estimated
changes in net interest and dividend income that would result from
incremental changes in interest rates over the applicable twelve-month
period.
For the Twelve Months Ending December 31, 2005
(Dollars in thousands)
----------------------------------------------
Changes in Net Interest
Interest Rates and Dividend
(Basis Points) Income % Change
-------------- ------------ --------
<s> <c> <c>
400 25,175 -3.0%
300 25,357 -2.3%
200 25,709 -1.0%
100 25,944 -0.1%
0 25,963 0.0%
-100 26,110 0.6%
-200 25,615 -1.3%
Market rates were assumed to increase 100, 200, 300 and 400 basis
points and decrease 100 and 200 basis points, in even increments over the
twelve month period. The repricing and/or new rates of assets and
liabilities moved in tandem with market rates. However, in certain deposit
products, the use of data from a historical analysis indicated that the rates
on these products would move only a fraction of the rate change amount.
Management believes that a percentage of the growth in core deposits
over the last three years was due to the low rate environment, i.e. no
incentive for customers to lock up funds in time deposits. Management
believes that in a rising rate environment, Westfield Bank will experience a
shift, by some customers, out of core deposits and back into term deposits.
Based upon analysis, Management has estimated what is believed to be the rate
sensitive portion of the funds currently in core deposits. In scenarios that
assume a rising rate environment of 100 basis points or more, this shift is
incorporated into the balance sheet forecasts.
We have developed consolidated balance sheet growth projections for the
twelve month period. The same product mix and growth strategy was used for
all rate change simulations, except for the shift into term deposits in
certain scenarios as described in the previous paragraph. Income from tax-
exempt assets is calculated on a fully taxable equivalent basis.
Pertinent data from each loan account, deposit account and investment
security was used to calculate future cash flows. The data included such
items as maturity date, payment amount, next repricing date, repricing
frequency, repricing index and spread. Prepayment speed assumptions were
based upon the difference between the account rate and the current market
rate.
70
The income simulation analysis was based upon a variety of assumptions.
These assumptions include but are not limited to balance sheet growth, asset
mix, prepayment speeds, the timing and level of interest rates, and the shape
of the yield curve. As market conditions vary from the assumptions in the
income simulation analysis, actual results will differ. As a result, the
income simulation analysis does not serve as a forecast of net interest
income, nor do the calculations represent any actions that management may
undertake in response to changes in interest rates.
Recent Accounting Pronouncements
Share-Based Payments. In December 2004, the Financial Accounting
Standards Board ("FASB") published Statement No. 123 (R) (revised 2004),
Share-Based Payment ("SFAS 123 (R)" or the "Statement"). SFAS 123 (R)
requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. That cost will be
measured based on the fair value of the equity or liability instruments
issued. SFAS 123 (R) covers a wide range of share-based compensation
arrangements including stock options, restricted share plans, performance-
based awards, share appreciation rights, and employee share purchase plans.
SFAS 123 (R) is a replacement of SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued
to Employees, and its related interpretive guidance. The effect of the
Statement will be to require entities to measure the cost of employee
services received in exchange for stock options based on the grant-date fair
value of the award, and to recognize the cost over the period the employee is
required to provide services for the award. SFAS 123 (R) permits entities
to use any option-pricing model that meets the fair value objective in the
Statement.
For public entities, SFAS 123 (R) is effective for fiscal years
beginning on or after June 15, 2005, and is applicable to all employee awards
vested, granted, modified, or settled after the effective date. For public
entities that file as small business issuers and non-public entities, the
effective date of implementation is for fiscal years beginning on or after
December 15, 2005. As of the effective date, compensation cost related to
the non-vested portion of awards outstanding as of that date would be based
on the grant-date fair value of those awards as calculated under the original
provisions of Statement No. 123; that is, an entity would not re-measure the
grant-date fair value estimate of the unvested portion of awards granted
prior to the effective date of SFAS 123 (R). This Statement is not expected
to have a material impact on the Company's consolidated financial statements.
Westfield Financial intends to recognize compensation expense under the
fair value based method beginning January 1, 2006. While the Company is
still in the process of analyzing the cost of stock options under SFAS 123R,
the preliminary estimate of the expense, using the Black-Scholes model for
the year ended December 31, 2006 is approximately $234,000, net of taxes.
71
Servicing Rights. In August 2005, the FASB issued an exposure draft
which would amend FASB Statement No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, with
respect to the accounting for servicing of financial assets. This proposed
Statement would require that all separately recognized servicing rights be
initially measured at fair value, if practicable. For each class of
separately recognized service assets and liabilities, this proposed Statement
would permit an entity to choose either of the following subsequent
measurement methods (1) amortize servicing assets or liabilities in
proportion to and over the period of estimated net servicing income or net
servicing loss or (2) report servicing assets or liabilities at fair value at
each reporting date and report changes in fair value in earnings in the
period in which the changes occur. This proposed Statement also would
require additional disclosures for all separately recognized servicing
rights. This proposed Statement would be effective for new transactions
occurring and for subsequent measurement in the earlier of the first fiscal
year that begins after December 15, 2005, or fiscal years beginning during
the fiscal quarter in which the final Statement is issued. At this time, the
Company is uncertain how the application of this statement will impact the
Company's consolidated financial statements.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and accompanying Notes of
Westfield Financial have been prepared in accordance with Accounting
Principles Generally Accepted in the United States of America ("GAAP"). GAAP
generally requires the measurement of financial position and operating
results in terms of historical dollars without consideration for changes in
the relative purchasing power of money over time due to inflation. The
impact of inflation is reflected in the increased cost of our operations.
Unlike industrial companies, our assets and liabilities are primarily
monetary in nature. As a result, changes in market interest rates have a
greater impact on performance than do the effects of inflation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, Management of Market Risk, pages 64 -
67, for a discussion of Quantitative and Qualitative Disclosures About Market
Risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Westfield Financial may be found on
pages F-1 through F-40 of this report.
72
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Effective June 15, 2004, the Audit Committee of the Board of Directors
voted not to reengage Deloitte & Touche LLP as Westfield Financial's
independent registered public accounting firm, effective immediately. On the
same date, the Audit Committee of the Board of Directors recommended,
approved and appointed Wolf & Company, P.C. as the Westfield Financial's
independent registered public accounting firm for the purpose of auditing
Westfield Financial's consolidated financial statements for the years ended
December 31, 2004 and 2005.
The audit report of Deloitte & Touche LLP on the consolidated financial
statements of Westfield Financial for the year ended December 31, 2003 did
not contain an adverse opinion or disclaimer of opinion and was not qualified
or modified as to uncertainty, audit scope, or accounting principles. During
2003 and any subsequent interim periods through June 15, 2004, there were no
disagreements with Deloitte & Touche LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedures, which disagreements, if not resolved to Deloitte & Touche's
satisfaction, would have caused it to make reference in connection with its
report to the subject matter of the disagreement. We requested Deloitte &
Touche LLP to furnish a letter addressed to the Securities and Exchange
Commission stating whether it agrees with these statements made by us and, if
not, stating the respects in which it does not agree. A copy of this letter,
dated March 31, 2004, was attached as an exhibit to the Form 8-K filed with
the SEC on June 21, 2004 and is hereby incorporated by reference.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including Westfield Financial's President and Chief
Executive Officer and Chief Financial Officer and Treasurer, has evaluated
the effectiveness of Westfield Financial's disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of
the period covered by this report. Based upon that evaluation, Westfield
Financial's President and Chief Executive Officer and Chief Financial Officer
and Treasurer concluded that the disclosure controls and procedures were
effective to ensure that information required to be disclosed in the reports
Westfield Financial files and submits under the Exchange Act (i) is recorded,
processed, summarized and reported as and when required and (ii) accumulated
and communicated to Westfield Financial's management including the Chief
Executive Officer and Chief Financial Officer and Treasurer, as appropriate
to allow timely discussion regarding required disclosure.
There have been no changes in Westfield Financial's internal control
over financial reporting identified in connection with the evaluation that
occurred during Westfield Financial's last fiscal quarter that has materially
affected, or that is reasonably likely to materially affect, Westfield
Financial's internal control over financial reporting.
73
Management Report on Internal Control Over Financial Reporting
* The management of Westfield Financial, Inc. is responsible for
establishing and maintaining adequate internal control over financial
reporting. Westfield Financial Inc.'s internal control system is a
process designed to provide reasonable assurance to the company's
management and board of directors regarding the preparation and fair
presentation of published financial statements.
* Our internal control over financial reporting includes policies and
procedures that pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect transactions and
dispositions of assets; provide reasonable assurances that transactions
are recorded as necessary to permit preparation of financial statements
in accordance with accounting principles generally accepted in the
United States of America, and that receipts and expenditures are being
made only in accordance with authorizations of management and the
directors of Westfield Financial Inc.; and provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition,
use or disposition of Westfield Financial Inc.'s assets that could have
a material effect on our financial statements.
* Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
* Westfield Financial, Inc.'s management assessed the effectiveness of
the company's internal control over financial reporting as of December
31, 2005. In making this assessment, we used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control-Integrated Framework. Based on our assessment we
believe that, as of December 31, 2005, the company's internal control
over financial reporting is effective based on those criteria.
* Westfield Financial Inc.'s Independent Registered Public Accounting
Firm has issued an audit report on our assessment of, and the effective
operation of, the company's internal control over financial reporting
as of December 31, 2005. This report appears on pages F-39 and F-40.
ITEM 9B. OTHER INFORMATION
None
74
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included in the Company's Proxy Statement for
the 2005 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference: "Election of Directors," Nominees for
Election as Director," "Continuing Directors," "Executive Officers," and
"Section 16(a) Beneficial Ownership Reporting Compliance.
Code of Ethics
Westfield Financial has adopted a Conflict of Interest Policy and Code
of Conduct, which applies to all employees and officers of Westfield
Financial and Westfield Bank. Westfield Financial has also adopted a Code of
Ethics for Senior Financial Officers of Westfield Financial, Inc., which
applies to Westfield Financial's principal executive officer, principal
financial officer, principal accounting officer or controller or person
performing similar functions for Westfield Financial and Westfield Bank, and
which requires compliance with the Conflict of Interest Policy and Code of
Conduct. The Code of Ethics for Senior Financial Officers of Westfield
Financial meets the requirements of a "code of ethics" as defined by Item 406
of Regulation S-K. The Code of Ethics for Senior Financial Officers was
filed as exhibit 14.1 to the Form 10-K filed with the SEC on March 15, 2003
and is hereby incorporated by reference. There have been no amendments to
the Code of Ethics since that time.
ITEM 11. EXECUTIVE COMPENSATION
The following information included in the Proxy Statement is
incorporated herein by reference: "Management Salary Compensation Committee
Report on Executive Compensation," "Compensation Committee Interlocks and
Insider Participation," "Performance Graph," "Directors' Compensation,"
"Executive Compensation," "Employment Agreements," and "Benefits."
75
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included in the Proxy Statement is
incorporated herein by reference: "Security Ownership of Certain Beneficial
Owners and Management.
Number of securities
Number of securities remaining available for
To be issued Weighted-average future issuance under
Upon exercise of exercise price of equity compensation plans
Outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
- ------------- -------------------- -------------------- -------------------------
(a) (b) (c)
<s> <c> <c> <c>
Equity compensation
plans approved by
security holders 410,055 $14.52 118,424
Equity compensation
plans not approved by
security holders - - -
------- ------ -------
Total 410,055 $14.52 118,424(1)
======= ====== =======
<FN>
- -------------------
<F1> Reflects 45,760 shares reserved for future grant under the Westfield
Financial, Inc. 2002 Stock Option Plan, 65,560 shares subject to current
restricted stock awards under the Westfield Financial, Inc. 2002
Recognition and Retention Plan ("RRP") and 7,104 shares reserved for
future awards under the RRP.
</FN>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included in the Proxy Statement is
incorporated herein by reference: "Compensation of Directors and Executive
Officers - Transactions with Certain Related Persons."
ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES
The following information included in the Proxy Statement is
incorporated herein by reference: "Principal Accountants Fees and Services."
76
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a. Financial Statements
Reference is made to the Consolidated Financial Statements included in
Item 8 of Part II hereof.
b. Exhibits
Exhibit Description
2.1 Plan of Reorganization and Minority Stock Issuance of
Westfield Mutual Holding Company, as amended. (1)
3.1 Articles of Organization of Westfield Financial, Inc.(1)
3.2 Bylaws of Westfield Financial, Inc. (1)
3.3 Amended and Restated Charter of Westfield Mutual Holding
Company (1)
3.4 Amended and Restated Bylaws of Westfield Mutual Holding
Company (1)
4.1 Articles of Organization of Westfield Financial, Inc.
(See Exhibit 3.1)
4.2 Bylaws of Westfield Financial, Inc. (See Exhibit 3.2)
4.3 Form of Stock Certificate of Westfield Financial, Inc. (1)
10.1 Form of Employee Stock Ownership Plan of
Westfield Financial, Inc. (1)
10.2 Form of the Benefit Restoration Plan of
Westfield Financial, Inc. (5)
10.3 Form of Employment Agreement between Donald A. Williams and
Westfield Financial, Inc. (1)
10.4 Form of Employment Agreement between Victor J. Carra and
Westfield Financial, Inc. (1)
10.5 Form of Employment Agreement between Michael J. Janosco, Jr.
and Westfield Financial, Inc. (1)
10.6 Form of One Year Change in Control Agreement by and among
certain officers and Westfield Financial, Inc. and
Westfield Bank (1)
10.7 Form of Directors' Deferred Compensation Plan (5)
10.8 The SBERA 401(k) Plan adopted by Westfield Bank (2)
10.9 Amendments to the Employee Stock Ownership Plan of
Westfield Financial, Inc. (4) (6)
10.10 Form of Amended and Restated Deferred Compensation Agreement
with Donald A. Williams.
14.1 Code of Ethics (3)
16.1 Letter regarding change on certifying accountants (4)
21.1 Subsidiaries of the Registrant (1)
23.1 Consent of Wolf & Company, P.C.
23.2 Consent of Deloitte & Touche LLP
31.1 Rule 13a - 14(a)/15d - 14(a) Certifications
32.1 Section 1350 Certifications
77
(1) Incorporated herein by reference to the Registration Statement
No. 333-68550, on Form S-1 of Westfield Financial filed with
the SEC on August 28, 2001, as amended.
(2) Incorporated herein by reference to the Registration Statement
No. 333-73132, on Form S-8, filed with the SEC on November 9,
2001, as amended.
(3) Incorporated by reference to the Annual Report on Form 10-K for
the year ended December 31, 2002 as filed with the SEC on
March 31, 2003.
(4) Incorporated by reference to the Form 8-K filed with the SEC on
June 21, 2004.
(5) Incorporated by reference to the Form 8-K filed with the SEC on
December 22, 2005.
(6) Incorporated by reference to the Form 8-K filed with the SEC on
August 25, 2005.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, on March 15,
2006.
Westfield Financial, Inc.
By: /s/ Donald A. Williams
--------------------------
Donald A. Williams
Chairman of the Board of Directors
and Chief Executive Officer
78
Pursuant to the requirements of the Securities Act of 1933, as amended,
and any rules and regulations promulgated thereunder, this Annual Report on
Form 10-K, has been signed by the following persons in the capacities and on
the dates indicated.
Name Title Date
---- ----- ----
<s> <c> <c>
/s/ Donald A. Williams Chairman of the Board of Directors
- ------------------------------ and Chief Executive Officer March 15, 2006
Donald A. Williams (Principal Executive Officer)
/s/ Michael J. Janosco, Jr. Chief Financial Officer and Treasurer March 15, 2006
- ------------------------------ (Principal Accounting Officer)
Michael J. Janosco, Jr.
/s/ Victor J. Carra Director March 15, 2006
- ------------------------------
Victor J. Carra
/s/ David C. Colton, Jr. Director March 15, 2006
- ------------------------------
David C. Colton, Jr.
/s/ Robert T. Crowley, Jr. Director March 15, 2006
- ------------------------------
Robert T. Crowley, Jr.
/s/ Harry C. Lane Director March 15, 2006
- ------------------------------
Harry C. Lane
Director March 15, 2006
- ------------------------------
William H. McClure
/s/ Mary C. O'Neil Director March 15, 2006
- ------------------------------
Mary C. O'Neil
/s/ Richard C. Placek Director March 15, 2006
- ------------------------------
Richard C. Placek
/s/ Paul R. Pohl Director March 15, 2006
- ------------------------------
Paul R. Pohl
/s/ Charles E. Sullivan Director March 15, 2006
- ------------------------------
Charles E. Sullivan
Director March 15, 2006
- ------------------------------
Thomas C. Sullivan
79
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Westfield Financial, Inc.
We have audited the accompanying consolidated balance sheets of Westfield
Financial, Inc. and subsidiaries (the "Company") as of December 31, 2005
and 2004, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for the years then ended. 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. The consolidated
financial statements for the year ended December 31, 2003 were audited by
other auditors whose report, dated March 10, 2004, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance
about whether 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 audit provides a reasonable basis for
our opinion.
In our opinion, the 2005 and 2004 consolidated financial statements
referred to above present fairly, in all material respects, the financial
position of Westfield Financial, Inc. and subsidiaries as of December 31,
2005 and 2004, and the results of their operations and their cash flows for
the years then ended in conformity with accounting principles generally
accepted in the United States of America.
We also have audited, in accordance with the standards of the Public
Accounting Oversight Board (United States), the effectiveness of Westfield
Financial, Inc. and subsidiaries' internal control over financial reporting
as of December 31, 2005 based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) and our report dated March 10, 2006 expressed
an unqualified opinion on management's assessment of the effectiveness of
Westfield Financial, Inc.'s internal control over financial reporting and
an unqualified opinion on the effectiveness of Westfield Financial, Inc.'s
internal control over financial reporting.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts
March 10, 2006
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Westfield Financial, Inc.
We have audited the accompanying consolidated statements of income, changes
in stockholders' equity, and cash flows of Westfield Financial, Inc. and
subsidiaries (the "Company") for the year ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for
our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the results of operations and cash flows of
Westfield Financial, Inc. and subsidiaries for the year ended December 31,
2003 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Deloitte & Touche LLP
Hartford, Connecticut
March 10, 2004
F-2
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
December 31,
----------------------
2005 2004
---- ----
<s> <c> <c>
ASSETS
CASH AND DUE FROM BANKS $ 18,136 $ 13,961
FEDERAL FUNDS SOLD 5,090 31,964
INTEREST-BEARING DEPOSITS AND OTHER SHORT TERM INVESTMENTS 3,230 5,122
-------- --------
CASH AND CASH EQUIVALENTS 26,456 51,047
-------- --------
SECURITIES:
Available for Sale - at estimated fair value 28,321 14,968
Held to Maturity - at amortized cost (estimated fair value of
$72,704 in 2005 and $71,654 in 2004) 73,323 71,298
MORTGAGE BACKED SECURITIES:
Available for Sale - at estimated fair value 101,138 73,316
Held to Maturity - at amortized cost (estimated fair value of
$149,017 in 2005 and $174,051 in 2004) 152,127 175,302
FEDERAL HOME LOAN BANK OF BOSTON AND OTHER STOCK AT COST 4,237 4,237
LOANS - Net of allowance for loan losses of $5,422 in 2005 and
$5,277 in 2004 378,837 368,601
PREMISES AND EQUIPMENT - Net 11,048 11,505
ACCRUED INTEREST RECEIVABLE 3,853 3,551
BANK-OWNED LIFE INSURANCE 19,819 17,248
OTHER ASSETS 5,936 5,830
-------- --------
TOTAL ASSETS $805,095 $796,903
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
DEPOSITS:
Noninterest-bearing $ 45,260 $ 48,305
Interest-bearing 577,785 564,316
-------- --------
Total deposits 623,045 612,621
-------- --------
CUSTOMER REPURCHASE AGREEMENTS 14,441 14,615
FEDERAL HOME LOAN BANK OF BOSTON ADVANCES 45,000 45,000
OTHER LIABILITIES 6,767 6,616
-------- --------
TOTAL LIABILITIES 689,253 678,852
-------- --------
COMMITMENTS AND CONTINGENCIES (NOTE 16)
STOCKHOLDERS' EQUITY:
Preferred stock - $.01 par value, 5,000,000 shares authorized,
none outstanding at December 31, 2005 and 2004 - -
Common stock - $.01 par value, 25,000,000 shares authorized,
10,580,000 shares issued, 9,754,757 and 9,954,512 shares
outstanding at December 31, 2005 and December 31, 2004, respectively 106 106
Additional paid-in capital 48,020 47,659
Unallocated Common Stock of Employee Stock Ownership Plan (5,127) (5,427)
Unearned compensation (861) (1,543)
Retained earnings 92,789 90,399
Accumulated other comprehensive loss (1,177) (122)
Treasury stock, at cost (825,243 shares at December 31, 2005
and 625,488 at December 31, 2004) (17,908) (13,021)
-------- --------
Total stockholders' equity 115,842 118,051
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $805,095 $796,903
======== ========
See notes to consolidated financial statements.
F-3
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
Years Ended December 31,
---------------------------------
2005 2004 2003
---- ---- ----
<s> <c> <c> <c>
INTEREST AND DIVIDEND INCOME:
Residential and commercial real estate loans $15,901 $ 4,644 $15,834
Debt securities, taxable 11,829 11,660 11,645
Debt securities, tax-exempt 1,200 1,065 714
Consumer loans 631 1,212 2,440
Commercial and industrial loans 6,409 5,087 4,002
Federal funds sold 788 288 170
Marketable equity securities 404 355 526
Interest-bearing deposits and other short term investments 144 117 304
------- ------- -------
Total interest and dividend income 37,306 34,428 35,635
------- ------- -------
INTEREST EXPENSE:
Deposits 11,813 9,625 13,122
Customer repurchase agreements 312 195 211
Other borrowings 1,472 1,093 525
------- ------- -------
Total interest expense 13,597 10,913 13,858
------- ------- -------
Net interest and dividend income 23,709 23,515 21,777
PROVISION FOR LOAN LOSSES 465 750 750
------- ------- -------
Net interest and dividend income after
Provision for loan losses 23,244 22,765 21,027
------- ------- -------
NONINTEREST INCOME:
Income from bank-owned life insurance 758 741 806
Service charges and fees 2,595 2,278 1,859
Gains on sales and writedowns of securities, net 19 877 409
------- ------- -------
Total noninterest income 3,372 3,896 3,074
------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits 11,155 10,753 9,685
Occupancy 1,927 1,808 1,802
Computer operations 1,557 1,582 1,667
Stationery, supplies and postage 522 530 560
Other 3,303 3,103 3,916
------- ------- -------
Total noninterest expense 18,464 17,776 17,630
------- ------- -------
INCOME BEFORE INCOME TAXES 8,152 8,885 6,471
INCOME TAXES 1,933 2,562 2,820
------- ------- -------
NET INCOME $ 6,219 $ 6,323 $ 3,651
======= ======= =======
EARNINGS PER COMMON SHARE:
Basic $ 0.66 $ 0.65 $ 0.36
Diluted $ 0.64 $ 0.64 $ 0.36
See notes to consolidated financial statements.
F-4
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
Accumulated
Restricted Other
Stock Compre-
Additional Unallo- Unearned hensive
Common Stock Paid-In cated Compen- Retained (Loss) Treasury Stock
Shares Amount Capital ESOP sation Earnings Income Shares Amount Total
------ ------ ---------- ------- ---------- -------- ----------- ------ ------ -----
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
BALANCE, JANUARY 1, 2003 10,580,000 $106 $49,463 $(5,621) $(2,731) $84,264 $ 1,218 - $ - $126,699
Comprehensive income:
Net income - - - - - 3,651 - - - 3,651
Unrealized losses on
securities arising
during the year, net
of tax benefit of $92 - - - - - - (167) - - (167)
Reclassification for
gains included in net
income, net of taxes
of $146 - - - - - - (263) - - (263)
Comprehensive income - - - - - - - - - 3,221
Activity related to
common stock issued
as employee incentives - - (2,320) (216) 637 - - - - (1,899)
Treasury stock purchased - - - - - - - (59,700) (1,134) (1,134)
Reissuance of treasury
shares in connection
with stock option
exercises - - - - - (8) - 2,000 38 30
Cash dividends declared
($0.20 per share) - - - - - (2,113) - - - (2,113)
---------- ---- ------- ------- ------- ------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2003 10,580,000 106 47,143 (5,837) (2,094) 85,794 788 (57,700) (1,096) 124,804
Comprehensive income:
Net income - - - - - 6,323 - - - 6,323
Unrealized losses on
securities arising
during the year, net
of tax benefit of $161 - - - - - - (324) - - (324)
Reclassification for
gains included in net
income, net of taxes
of $291 - - - - - - (586) - - (586)
Comprehensive income - - - - - - - - - 5,413
Activity related to
common stock issued
as employee incentives - - 516 410 551 - - - - 1,477
Treasury stock purchased - - - - - - - (569, 588) (11,956) (11,956)
Reissuance of treasury
shares in connection
with stock option
exercises - - - - - (5) - 1,800 31 26
Cash dividends declared
($0.30 per share) - - - - - (1,713) - - - (1,713)
---------- ---- ------- ------- ------- ------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2004 10,580,000 106 47,659 (5,427) (1,543) 90,399 (122) (625,488) (13,021) 118,051
Comprehensive income:
Net income - - - - - 6,219 - - - 6,219
Unrealized losses on
securities arising
during the year, net
of tax benefit of $622 - - - - - - (1,043) - - (1,043)
Reclassification for
gains included in net
income, net of taxes
of $7 - - - - - - (12) - - (12)
Comprehensive income - - - - - - - - - 5,164
Activity related to
common stock issued
as employee incentives - - 361 300 682 - - - - 1,343
Treasury stock purchased - - - - - - - (237,400) (5,699) (5,699)
Reissuance of treasury
shares in connection
with stock option exercises - - - - - (271) - 37,645 812 541
Cash dividends declared
($0.90 per share) - - - - - (3,558) - - - (3,558)
---------- ---- ------- ------- ------- ------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 2005 10,580,000 $106 $48,020 $(5,127) $ (861) $92,789 $(1,177) (825,243) $(17,908) $115,842
========== ==== ======= ======= ======= ======= ======= ======== ======== ========
See notes to consolidated financial statements.
F-5
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
----------------------------------
2005 2004 2003
---- ---- ----
<s> <c> <c> <c>
OPERATING ACTIVITIES:
Net Income $ 6,219 $ 6,323 $ 3,651
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses 465 750 750
Other than temporary write-down of securities - - 85
Depreciation and amortization of premises and equipment 950 1,003 1,080
Net amortization of premiums and discounts on securities,
mortgage backed securities and mortgage loans 1,080 1,452 3,273
Amortization of unearned compensation 1,678 1,962 769
Gain on sale of fixed assets - - (50)
Net realized securities gains (19) (877) (494)
Deferred income tax benefit (334) (615) (992)
Increase in cash surrender value of bank-owned life insurance (758) (741) (806)
Changes in assets and liabilities:
Accrued interest receivable (302) 4 382
Other assets 857 748 (708)
Other liabilities 151 155 (646)
-------- -------- ---------
Net cash provided by operating activities 9,987 10,164 6,294
-------- -------- ---------
INVESTING ACTIVITIES:
Securities, held to maturity:
Purchases (11,131) (18,473) (61,941)
Proceeds from maturities and principal collections 9,000 17,000 37,980
Securities, available for sale:
Purchases (17,982) (5,332) (19,883)
Proceeds from sales 3,833 11,891 34,595
Proceeds from calls, maturities and principal collections 548 4,155 40,610
Mortgage backed securities, held to maturity:
Purchases (24,979) (39,255) (127,681)
Principal collections 47,528 54,687 93,000
Mortgage backed securities, available for sale:
Purchases (71,791) (41,110) (43,383)
Proceeds from sales 16,962 20,325 8,104
Principal collections 25,305 22,943 47,111
Purchase of Federal Home Loan Bank of Boston and other stock - - (304)
Purchase of residential mortgages (1,236) (35,294) (11,462)
Net (increase) decrease in loans (9,528) 10,864 22,821
Purchases of premises and equipment (493) (734) (452)
Proceeds from sale of fixed assets - - 499
Purchase of bank-owned life insurance (1,813) - (15,701)
-------- -------- ---------
Net cash (used in) provided by investing activities (35,777) 1,667 3,913
-------- -------- ---------
FINANCING ACTIVITIES:
Increase (decrease) in deposits 10,424 (19,810) (23,634)
(Decrease) increase in customer repurchase agreements (174) 2,480 3,411
Repayment of Federal Home Loan Bank of Boston advances (5,000) - -
Federal Home Loan Bank of Boston advances 5,000 25,000 5,000
Purchase of common stock in connection with employee benefit program (335) (485) (2,668)
Cash dividends paid (3,558) (1,713) (2,113)
Treasury stock purchased (5,699) (11,956) (1,134)
Reissuance of treasury shares in connection with stock
option exercises 541 26 30
-------- -------- ---------
Net cash provided by (used in) financing activities 1,199 (6,458) (21,108)
-------- -------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS: (24,591) 5,373 (10,901)
Beginning of year 51,047 45,674 56,575
-------- -------- ---------
End of year $ 26,456 $ 51,047 $ 45,674
======== ======== =========
See notes to consolidated financial statements
F-6
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Basis of Presentation - Westfield Financial, Inc.
(the "Company") is a Massachusetts corporation. The Company has a
federally-chartered stock savings bank subsidiary called Westfield Bank
(the "Bank"). The Bank's deposits are insured to the limits specified by
the Federal Deposit Insurance Corporation ("FDIC"). The Bank operates 10
branches in Western Massachusetts. The Bank's primary source of revenue is
earned from loans to small and middle-market businesses and to residential
property homeowners.
Westfield Securities Corp., and Elm Street Securities Corporation,
Massachusetts chartered security corporations, were formed by the Company
for the primary purpose of holding qualified investment securities. In the
third quarter of 2005, the Company dissolved Westfield Securities
Corporation in order to streamline operations.
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company, the Bank, and Elm Street Securities
Corporation, as well as Westfield Securities Corp., prior to its
dissolution. All material intercompany balances and transactions have been
eliminated in consolidation.
Estimates - The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of income and expenses for
each. Actual results could differ from those estimates. Estimates that
are particularly susceptible to significant change in the near-term relate
to the determination of the allowance for loan losses and other than
temporary impairment of investment securities.
Cash and Cash Equivalents - The Company defines cash on hand, cash due from
banks, federal funds sold and interest bearing deposits having an original
maturity of 90 days or less as cash and cash equivalents. Cash and due
from banks at December 31, 2005 and 2004 includes partially restricted cash
of approximately $291,000, and $347,000 respectively, for Federal Reserve
Bank of Boston cash reserve requirements.
F-7
Securities and Mortgage Backed Securities - Securities, including mortgage
backed securities, which management has the positive intent and ability to
hold until maturity are classified as held to maturity and are carried at
amortized cost. Securities, including mortgage backed securities, which
have been identified as assets for which there is not a positive intent to
hold to maturity are classified as available for sale and are carried at
fair value with unrealized gains and losses, net of income taxes, reported
as a separate component of stockholders' equity. The Company does not
acquire securities and mortgage backed securities for purposes of engaging
in trading activities.
Realized gains and losses on sales of securities and mortgage backed
securities are computed using the specific identification method and are
included in noninterest income. The amortization of premiums and accretion
of discounts is determined by using the level yield method to the maturity
date.
Other than Temporary Impairment of Securities - On a quarterly basis, the
Company reviews investment securities with unrealized depreciation on a
judgmental basis to assess whether the decline in fair value is temporary
or other than temporary. Declines in the fair value of held to maturity
and available for sale securities below their cost that are deemed to be
other than temporary are reflected in earnings as realized losses. In
estimating other than temporary impairment losses, management considers (1)
the length of time and the extent to which the fair value has been less
than cost, (2) the financial condition and near-term prospects of the
issuer, and (3) the intent and ability of the corporation to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.
Loans - Loans are recorded at the principal amount outstanding. Interest
on loans is calculated using the effective yield method on daily balances
of the principal amount outstanding and is credited to income on the
accrual basis to the extent it is deemed collectible. The Company's
general policy is to discontinue the accrual of interest when principal or
interest payments are delinquent 90 days or more, or earlier if the loan is
considered impaired. Any unpaid amounts previously accrued on these loans
are reversed from income. Subsequent cash receipts are applied to the
outstanding principal balance or to interest income if, in the judgment of
management, collection of the principal balance is not in question. Loans
are returned to accrual status when they become current as to both
principal and interest and when subsequent performance reduces the concern
as to the collectibility of principal and interest. Loan fees and certain
direct loan origination costs are deferred, and the net fee or cost is
recognized as an adjustment to interest income over the estimated average
lives of the related loans. Compensation to an auto dealer is normally
based upon a spread that a dealer adds on the loan base rate set by the
Company. The compensation is paid to an automobile dealer shortly after
the loan is originated. The Company records the amount as a deferred cost
that is amortized over the life of the loans in relation to the interest
paid by the customer.
Allowance for Loan Losses - The allowance for loan losses is established
through provisions for loan losses charged to expense. Loans are charged
off against the allowance when management believes that the collectibility
of the principal is unlikely. Recoveries of amounts previously charged-off
are credited to the allowance.
The Bank maintains an allowance for loan losses to absorb losses inherent
in the loan portfolio based on ongoing quarterly assessments of the
estimated losses. The Bank's methodology for assessing the appropriateness
of the allowance consists of two key components, which are a specific
allowance for identified problem loans and a formula allowance for the
remainder of the portfolio. The specific allowance incorporates the results
of measuring impaired loans as provided in Statement of Financial
Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for
Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan -
F-8
Income Recognition and Disclosures." These accounting standards prescribe
the measurement methods, income recognition and disclosures related to
impaired loans. The formula allowance is calculated by applying loss
factors to outstanding loans by type, excluding loans for which a specific
allowance has been determined. In determining the loss factors to apply to
each loan category, the Company considers historical losses, peer group
comparisons, industry data and loss percentages used by banking regulators
for similarly graded loans. Loss factors may be adjusted for qualitative
factors that, in management's judgment, affect the collectibility of the
portfolio as of the evaluation date.
A loan is recognized as impaired when it is probable that principal and/or
interest are not collectible in accordance with the loan's contractual
terms. A loan is not deemed to be impaired if there is a short delay in
receipt of payment or if, during a longer period of delay, the Company
expects to collect all amounts due including interest accrued at the
contractual rate during the period of delay. Measurement of impairment can
be based on present value of expected future cash flows discounted at the
loan's effective interest rate, the loan's observable market price or the
fair value of the collateral, if the loan is collateral dependent. This
evaluation is inherently subjective as it requires material estimates that
may be susceptible to significant change. If the fair value of the
impaired loan is less than the related recorded amount, a specific
valuation allowance is established within the allowance for loan losses or
a writedown is charged against the allowance for loan losses if the
impairment is considered to be permanent. Measurement of impairment
does not apply to large groups of smaller balance homogeneous loans that
are collectively evaluated for impairment such as the Company's portfolios
of consumer and residential real estate loans.
The Company's methodology for assessing the appropriateness of the
allowance consists of two key components, which are a specific allowance
for identified problem or impaired loans and a formula allowance for the
remainder of the portfolio. Measurement of impairment can be based on the
present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's observable market price or the fair
value of the collateral, if the loan is collateral dependent. This
evaluation is inherently subjective as it requires material estimates that
may be susceptible to significant change. The appropriateness of the
allowance is also reviewed by management based upon its evaluation of then-
existing economic and business conditions affecting the key lending areas
of the Company and other conditions, such as new loan products, credit
quality trends (including trends in nonperforming loans expected to result
from existing conditions), collateral values, loan volumes and
concentrations, specific industry conditions within portfolio segments that
existed as of the balance sheet date and the impact that such conditions
were believed to have had on the collectibility of the loan portfolio.
Although management believes it has established and maintained the
allowance for loan losses at appropriate levels, future adjustments may be
necessary if economic, real estate and other conditions differ
substantially from the current operating environment.
In addition, the Office of Thrift Supervision, as an integral part of its
examination process, periodically review the loan and foreclosed real
estate portfolios and the related allowance for loan losses and valuation
allowance for foreclosed real estate. The Office of Thrift Supervision may
require adjustment to the allowance for loan losses based on their
judgments of information available to them at the time of their
examination, thereby adversely affecting results of operations.
Management believes that the allowance for loan losses accurately reflects
estimated credit losses for specifically identified loans, as well as
probable credit losses inherent in the remainder of the portfolio as of the
end of the years presented.
F-9
Transfers and Servicing of Financial Assets - Transfers of financial assets
are accounted for as sales, when control over the assets has been
surrendered. Control over transferred assets is deemed to be surrendered
when (1) the assets have been isolated from the Company, (2) the transferee
obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and
(3) the Company does not maintain effective control over the transferred
assets through an agreement to repurchase them before their maturity.
Premises and Equipment - Land is carried at cost. Buildings and equipment
are stated at cost, less accumulated depreciation, computed on either the
straight-line or accelerated methods over the estimated useful lives of the
assets, or the expected lease term, if shorter. Expected terms include
lease option periods to the extent that the exercise of such options is
reasonably assured.
The cost of maintenance and repairs is charged to expense when incurred.
Major expenditures for betterments are capitalized and depreciated.
Other Real Estate Owned - Other real estate owned represents property
acquired through foreclosure or deeded to the Company in lieu of
foreclosure. Other real estate owned is recorded at the lower of the
carrying value of the related loan, or the estimated fair value of the real
estate acquired, net of estimated selling costs. Initial write-downs are
charged to the allowance for loan losses at the time the loan is
transferred to other real estate owned. Subsequent valuations are
periodically performed by management and the carrying value is adjusted by
a charge to expense to reflect any subsequent declines in the estimated
fair value. Operating costs associated with other real estate owned are
expensed as incurred.
Retirement Plans and Employee Benefits - The Company provides a defined
benefit pension plan for eligible employees through membership in the
Savings Banks Employees Retirement Association ("SBERA"). The Company's
policy is to fund pension cost as accrued. Employees are also eligible to
participate in a 401(k) plan through SBERA. The Company makes matching
contributions to this plan at 50% of up to 6% of the employees' eligible
compensation.
The Company currently offers postretirement life insurance benefits to
retired employees. Such postretirement benefits represent a form of
deferred compensation which requires that the cost and obligations of such
benefits are recognized in the period in which services are rendered.
Income Taxes - The Company uses the asset and liability method for income
tax accounting, whereby, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates applied to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
Earnings per Share - Basic earnings per share represents income available
to common stockholders divided by the weighted-average number of common
shares outstanding during the period. Diluted earnings per share reflects
additional common shares that would have been outstanding if dilutive
potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common
shares that may be issued by the Company relate solely to outstanding stock
awards and options and are determined using the treasury stock method.
F-10
Earnings per common share for the years ended December 31, have been
computed based on the following:
2005 2004 2003
---- ---- ----
(In thousands, except per share data)
<s> <c> <c> <c>
Net income available to common stockholders $6,219 $6,323 $ 3,651
====== ====== =======
Weighted average number of common shares outstanding 9,467 9,706 10,037
Effect of dilutive stock awards and options 231 224 176
------ ------ -------
Adjusted weighted average number of common shares
outstanding used to calculate diluted earnings per
common shares 9,698 9,930 10,213
====== ====== =======
Basic earnings per share $ 0.66 $ 0.65 $ 0.36
Diluted earnings per share $ 0.64 $ 0.64 $ 0.36
Reclassifications - Certain amounts in the prior year financial statements
have been reclassified to conform to the current year presentation.
Stock Options - The Company applies APB Opinion No. 25 and related
Interpretations in accounting for stock options. Accordingly, no
compensation cost has been recognized. Had compensation cost for the
Company's stock options been determined based on the fair value at the
grant dates for awards under the plan consistent with the method prescribed
by SFAS No. 123, the Company's net income and earnings per share would have
been adjusted to the pro forma amounts indicated below:
For the years ended December 31,
2005 2004 2003
---- ---- ----
(In thousands, except per share data)
<s> <c> <c> <c>
Net income as reported $6,219 $6,323 $3,651
Less: Compensation expense
determined under fair value
based method for all awards,
net of tax effects (333) (272) (254)
------ ------ ------
Pro forma net income $5,886 $6,051 $3,397
====== ====== ======
Net income per share
Basic as reported $ 0.66 $ 0.65 $ 0.36
Basic pro forma 0.62 0.62 0.34
Diluted as reported 0.64 0.64 0.36
Diluted pro forma 0.61 0.61 0.33
F-11
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
Years Ended
December 31,
------------------------
2005 2004
---- ----
<s> <c> <c>
Dividend yield 1.70% 1.02%
Expected life in years 10 years 10 years
Expected volatility 21% 17%
Risk-free interest rate 4.14% 4.16%
No options were granted in 2003.
Comprehensive Income (Loss)
Accounting principles generally require that recognized revenue, expenses,
gains and losses be included in net income. Although certain changes in
assets and liabilities, such as unrealized gains and losses on available
for sale securities, are reported as a separate component of the equity
section of the balance sheet, such items, along with net income, are
components of comprehensive income.
The components of other comprehensive income (loss) and related tax effects
are as follows:
Years Ended December 31,
-----------------------------
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
Unrealized holding losses on available for sale $(1,665) $ (485) $(259)
Securities
Reclassification adjustment for losses (gains)
realized in income (19) (877) (409)
------- ------- -----
Net unrealized losses (1,684) (1,362) (668)
Tax effect 629 452 238
------- ------- -----
Net of tax amount $(1,055) $ (910) $(430)
======= ======= =====
Recent accounting pronouncements
Share-Based Payments
In December 2004, the Financial Accounting Standards Board ("FASB")
published Statement No. 123 (R) (revised 2004), Share-Based Payment ("SFAS
123 (R)" or the "Statement"). SFAS 123 (R) requires that the compensation
cost relating to share-based payment transactions be recognized in
financial statements. That cost will be measured based on the fair value
of the equity or liability instruments issued. SFAS 123 (R) covers a wide
range of share-based compensation arrangements including stock options,
restricted share plans, performance-based awards, share appreciation
rights, and employee share purchase plans. SFAS 123 (R) is a replacement
of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees, and its
related interpretive guidance. The effect of the Statement will be to
require entities to measure the cost of employee services received in
exchange for stock options based on the grant-date fair value of the award,
and to recognize the cost over the period the employee is required to
provide services for the award. SFAS 123 (R) permits entities to use any
option-pricing model that meets the fair value objective in the Statement.
F-12
For public entities, SFAS 123 (R) is effective for fiscal years beginning
on or after June 15, 2005, and is applicable to all employee awards vested,
granted, modified, or settled after the effective date. For public
entities that file as small business issuers and non-public entities, the
effective date of implementation is for fiscal years beginning on or after
December 15, 2005. As of the effective date, compensation cost related to
the non-vested portion of awards outstanding as of that date would be based
on the grant-date fair value of those awards as calculated under the
original provisions of Statement No. 123; that is, an entity would not re-
measure the grant-date fair value estimate of the unvested portion of
awards granted prior to the effective date of SFAS 123 (R). This Statement
is not expected to have a material impact on the Company's consolidated
financial statements.
The Company intends to recognize compensation expense under the fair value
based method beginning January 1, 2006. While the Company is still in the
process of analyzing the cost of stock options under SFAS 123R, the
preliminary estimate of the expense, using the Black-Scholes model for the
year ended December 31, 2006 is approximately $234,000, net of taxes.
Servicing Rights
In August 2005, the FASB issued an exposure draft which would amend FASB
Statement No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, with respect to the accounting
for servicing of financial assets. This proposed Statement would require
that all separately recognized servicing rights be initially measured at
fair value, if practicable. For each class of separately recognized
service assets and liabilities, this proposed Statement would permit an
entity to choose either of the following subsequent measurement methods (1)
amortize servicing assets or liabilities in proportion to and over the
period of estimated net servicing income or net servicing loss or (2)
report servicing assets or liabilities at fair value at each reporting date
and report changes in fair value in earnings in the period in which the
changes occur. This proposed Statement also would require additional
disclosures for all separately recognized servicing rights. This proposed
Statement would be effective for new transactions occurring and for
subsequent measurement in the earlier of the first fiscal year that begins
after December 15, 2005, or fiscal years beginning during the fiscal
quarter in which the final Statement is issued. At this time, the Company
is uncertain how the application of this Statement will impact the
Company's consolidated financial statements.
F-13
2. SECURITIES
Securities are summarized as follows:
December 31, 2005
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
<s> <c> <c> <c> <c>
Held to maturity:
Government-sponsored enterprises $ 43,090 $ 6 $ 731 $ 42,365
Municipal bonds 30,233 289 183 30,339
-------- ---- ------ --------
Total held to maturity 73,323 295 914 72,704
-------- ---- ------ --------
Available for sale:
Equity securities 6,057 - 315 5,742
Government-sponsored enterprises 22,728 4 153 22,579
-------- ---- ------ --------
Total available for sale 28,785 4 468 28,321
-------- ---- ------ --------
Total Securities $102,108 $299 $1,382 $101,025
======== ==== ====== ========
December 31, 2004
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
<s> <c> <c> <c> <c>
Held to maturity:
Government-sponsored enterprises $ 38,160 $117 $ 266 $38,011
Municipal bonds 29,147 520 70 29,597
Corporate debt securities 3,991 55 - 4,046
-------- ---- ------ --------
Total held to maturity 71,298 692 336 71,654
-------- ---- ------ --------
Available for sale:
Equity securities 7,301 - 315 6,986
Government-sponsored enterprises 6,991 63 4 7,050
Corporate debt securities 918 14 - 932
-------- ---- ------ --------
Total available for sale 15,210 77 319 14,968
-------- ---- ------ --------
Total Securities $ 86,508 $769 $ 655 $86,622
======== ==== ====== =======
F-14
Information pertaining to securities with gross unrealized losses at
December 31, 2005 and 2004, aggregated by investment category and length of
time that individual securities have been in a continuous loss position,
follows:
December 31, 2005
--------------------------------------------
Less than Twelve Months Over Twelve Months
----------------------- ------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
(In Thousands)
<s> <c> <c> <c> <c>
Held to maturity:
Government-sponsored enterprises $222 $14,792 $509 $22,567
Municipal bonds 78 8,586 105 2,748
---- ------- ---- -------
Total held to maturity 300 23,378 614 25,315
---- ------- ---- -------
Available for sale:
Equity securities - - 315 5,264
Government-sponsored enterprises 153 17,575 - -
---- ------- ---- -------
Total available for sale 153 17,575 315 5,264
---- ------- ---- -------
Total temporarily impaired securities $453 $40,953 $929 $30,579
==== ======= ==== =======
December 31, 2004
--------------------------------------------
Less than Twelve Months Over Twelve Months
----------------------- ------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
(In Thousands)
<s> <c> <c> <c> <c>
Held to maturity:
Government-sponsored enterprises $266 $22,894 $ - $ -
Municipal bonds 70 6,110 - -
---- ------- ---- -------
Total held to maturity 336 29,004 - -
---- ------- ---- -------
Available for sale:
Equity securities 75 4,330 240 760
Government-sponsored enterprises 4 943 - -
---- ------- ---- -------
Total available for sale 79 5,273 240 760
---- ------- ---- -------
Total temporarily impaired securities $415 $34,277 $240 $ 760
==== ======= ==== =======
F-15
At December 31, 2005, nineteen debt securities have gross unrealized losses
of 1.1% from the Bank's amortized cost basis of temporarily impaired debt
securities which existed for less than twelve months. Because these losses
relate to government-sponsored enterprises and highly rated municipal
obligations, are the result of fluctuations in interest rates, and
management has the intent and ability to hold these securities for the
foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2005, eight debt securities have gross unrealized losses of
2.4% from the Bank's amortized cost basis of temporarily impaired debt
securities which existed for greater than twelve months. Because these
losses relate to government-sponsored enterprises and highly rated
municipal obligations, are the result of fluctuations in interest rates,
and management has the intent and ability to hold these securities for the
foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2005, three equity securities have an unrealized loss of
3.4% from the Bank's amortized cost basis which existed for greater than
twelve months and is principally related to fluctuations in interest rates.
These losses relate to mutual funds which invest primarily in short term
debt instruments and adjustable rate mortgage-backed securities. Because
these losses are the result of fluctuations in interest rates, and
management has the intent and ability to hold these securities for the
foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2005, one equity security has an unrealized loss of 15.7%
from the Bank's amortized cost basis which existed for greater than twelve
months. Because the security is an adjustable rate preferred stock issued
by a government-sponsored enterprise, the unrealized loss is principally
related to fluctuations in interest rates, and management has the intent
and ability to hold these securities for the foreseeable future, the
decline is not deemed to be other than temporary.
December 31, 2005
-----------------------
Amortized Estimated
Cost Fair Value
--------- ----------
(In Thousands)
<s> <c> <c>
Held to maturity:
Due in one year or less $ 7,997 $ 7,887
Due after one year through five years 16,307 16,010
Due after five years through ten years 24,548 24,117
Due after ten years 24,471 24,690
------- -------
Total held to maturity $73,323 $72,704
======= =======
Available for sale:
Due in one year or less $ 3,008 $ 3,003
Due after one year through five years 14,730 14,652
Due after five years through ten years 4,990 4,924
------- -------
Total available for sale $22,728 $22,579
======= =======
Gross gains of $34,000, $1,130,000, and $771,000, and gross losses $1,000,
$39,000, and $333,000 were recorded on securities during the years ended
December 31, 2005, 2004, and 2003, respectively. During 2003, the Company
recorded losses of $85,000 for other than temporary impairments in value.
There were no impairment losses recognized during 2005 and 2004.
Securities with a carrying value of $35 million and $37 million were
pledged as collateral to the Federal Reserve Bank of Boston at December 31,
2005 and 2004, respectively.
Unrealized losses on securities available for sale, net of tax were
$283,000 and $176,000 at December 31, 2005 and 2004, respectively.
F-16
3. MORTGAGE BACKED SECURITIES
Mortgage backed securities are summarized as follows:
December 31, 2005
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
<s> <c> <c> <c> <c>
Held to maturity:
Fannie Mae $ 98,362 $ 34 $2,300 $ 96,096
Freddie Mac 36,465 78 572 35,971
Ginnie Mae 17,300 4 354 16,950
-------- ---- ------ --------
Total held to maturity 152,127 116 3,226 149,017
-------- ---- ------ --------
Available for sale:
Fannie Mae 46,078 40 742 45,376
Freddie Mac 38,310 12 459 37,863
Ginnie Mae 12,594 22 230 12,386
Other pass-through securities 4,726 - 17 4,709
Collateralized Mortgage Obligations 818 - 14 804
-------- ---- ------ --------
Total available for sale 102,526 74 1,462 101,138
-------- ---- ------ --------
Total Mortgage Backed Securities $254,653 $190 $4,688 $250,155
======== ==== ====== ========
December 31, 2004
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
<s> <c> <c> <c> <c>
Held to maturity:
Fannie Mae $120,595 $234 $1,250 $119,579
Freddie Mac 39,772 171 280 39,663
Ginnie Mae 14,775 33 159 14,649
Collateralized Mortgage Obligations 160 - - 160
-------- ---- ------ --------
Total held to maturity 175,302 438 1,689 174,051
-------- ---- ------ --------
Available for sale:
Fannie Mae 32,676 178 141 32,713
Freddie Mac 22,842 66 70 22,838
Ginnie Mae 15,036 58 25 15,069
Collateralized Mortgage Obligations 2,688 51 43 2,696
-------- ---- ------ --------
Total available for sale 73,242 353 279 73,316
-------- ---- ------ --------
Total Mortgage Backed Securities $248,544 $791 $1,968 $247,367
======== ==== ====== ========
F-17
Collateralized Mortgage Obligations include tranches of AAA investment
grade and consist of high quality mortgage obligations.
Gross gains of $27,000, $135,000 and $56,000 and gross losses of $41,000,
$349,000, and $ - 0 - were recorded on mortgage backed securities during
the years ended December 31, 2005, 2004, and 2003, respectively.
Unrealized losses on mortgage backed securities available for sale, net of
tax were $894,000 and unrealized gains, net of tax were $54,000 at December
31, 2005 and 2004, respectively.
Information pertaining to securities with gross unrealized losses at
December 31, 2005 and 2004, aggregated by investment category and length of
time that individual securities have been in a continuous loss position,
follows:
December 31, 2005
------------------------------------------------
Less than Twelve Months Over Twelve Months
----------------------- ---------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
<s> <c> <c> <c> <c>
Held to maturity:
Fannie Mae $ 452 $ 26,869 $1,848 $ 64,076
Freddie Mac 25 5,120 547 16,954
Ginnie Mae 178 8,424 176 7,772
------ -------- ------ --------
Total held to maturity 655 40,413 2,571 88,802
------ -------- ------ --------
Available for sale:
Fannie Mae 691 40,327 51 3,935
Freddie Mac 376 28,952 83 5,707
Ginnie Mae 214 8,020 16 836
Other pass-through securities 17 4,709 - -
Collateralized Mortgage Obligations - - 14 804
------ -------- ------ --------
Total available for sale 1,298 82,008 164 11,282
------ -------- ------ --------
Total Temporarily Impaired Securities $1,953 $122,421 $2,735 $100,084
====== ======== ====== ========
F-18
December 31, 2004
------------------------------------------------
Less than Twelve Months Over Twelve Months
----------------------- ---------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
<s> <c> <c> <c> <c>
Held to maturity:
Fannie Mae $ 573 $ 57,204 $677 $36,727
Freddie Mac 260 19,887 20 1,559
Ginnie Mae 159 10,580 - -
------ -------- ---- -------
Total held to maturity 992 87,671 697 38,286
------ -------- ---- -------
Available for sale:
Fannie Mae 141 13,414 - -
Freddie Mac 70 8,202 - -
Ginnie Mae 23 4,563 2 1,262
Collateralized Mortgage Obligations - - 43 1,624
------ -------- ---- -------
Total available for sale 234 26,179 45 2,886
------ -------- ---- -------
Total Temporarily Impaired Securities $1,226 $113,850 $742 $41,172
====== ======== ==== =======
At December 31, 2005, fifty mortgage backed securities have gross
unrealized losses of 1.6% from the Bank's amortized cost basis which
existed for less than twelve months. Because these losses relate to
mortgage-backed securities, which were primarily issued by government-
sponsored enterprises, are the result of fluctuations in interest rates,
and management has the intent and ability to hold these securities for the
foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2005, fifty-six mortgage backed securities have gross
unrealized losses of 2.7% from the Bank's amortized cost basis which
existed for greater than twelve months. Because these losses relate to
mortgage-backed securities, which were primarily issued by government-
sponsored enterprises, are the result of fluctuations in interest rates,
and management has the intent and ability to hold these securities for the
foreseeable future, no declines are deemed to be other than temporary.
4. LOANS
Loans consisted of the following amounts:
December 31,
---------------------
2005 2004
---------------------
(In Thousands)
<s> <c> <c>
Residential real estate $106,918 $122,822
Commercial and industrial 100,019 94,726
Commercial real estate 169,564 144,336
Consumer 7,372 11,565
-------- --------
Total Loans 383,873 373,449
Unearned premiums and deferred loan fees and costs, net 386 429
Allowance for loan losses (5,422) (5,277)
-------- --------
$378,837 $368,601
======== ========
F-19
The following table summarizes information regarding impaired loans:
December 31,
----------------
2005 2004
----------------
(In Thousands)
<s> <c> <c>
Recorded investment in impaired loans $1,641 $1,826
Specific allowance for impaired loans 250 500
Impaired loans on nonaccrual status 1,641 1,663
Years Ended
December 31,
--------------------------
2005 2004 2003
--------------------------
(In Thousands)
<s> <c> <c> <c>
Average recorded investment in impaired loans $1,532 $1,787 $1,970
Income recorded during the period for impaired loans - 11 126
Income recorded on cash basis during the period for impaired loans - 12 127
There were no restructured loans during the years ended December 31, 2005,
2004 and 2003.
Nonaccrual loans at December 31, 2005, December 31, 2004 and 2003 and
related interest income are summarized as follows:
At or For the Years Ended
December 31,
--------------------------
2005 2004 2003
--------------------------
(In Thousands)
<s> <c> <c> <c>
Amount $1,919 $2,171 $1,768
Interest income that would have been
recorded under the original contract terms 176 176 134
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid balances of these loans totaled
$16.3 million and $21.7 million at December 31, 2005 and 2004,
respectively. Net service fee income (expense) of $24,000, $30,000, and
($46,000) was recorded for the years ended December 31, 2005, 2004, and
2003, respectively.
The Company's servicing assets are recorded at fair value at the time the
asset is acquired. The fair value is based upon the net present value of
future cash flows of the net servicing revenue. Assumptions used in
determining fair value include service fee revenue, float revenue, escrow
revenue, servicing expense, and estimated life of the underlying loans. The
fair value of the asset is recalculated quarterly to determine possible
impairment. At December 31, 2005 and 2004, the Company's servicing assets
had a fair value of $93,000 and $71,000 and a carrying value in other
assets of $35,000 and $52,000, respectively. There were no impairment
losses on servicing assets in 2005. The servicing asset is amortized in
proportion to the estimated net servicing revenue of the loans.
No amounts of mortgage servicing assets were capitalized during 2005, 2004,
and 2003. Amortization expense on the Company's mortgage servicing assets
for the years ended December 31, 2005, 2004, and 2003 totaled $17,000,
$24,000, and $106,000, respectively.
F-20
5. ALLOWANCE FOR LOAN LOSSES
An analysis of changes in the allowance for loan losses is as follows:
Years Ended
December 31,
----------------------------
2005 2004 2003
----------------------------
(In Thousands)
<s> <c> <c> <c>
Balance, beginning of year $5,277 $4,642 $4,325
Provision 465 750 750
Charge-offs (612) (404) (725)
Recoveries 292 289 292
------ ------ ------
Balance, end of year $5,422 $5,277 $4,642
====== ====== ======
6. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
December 31,
-------------------
2005 2004
-------------------
(In Thousands)
<s> <c> <c>
Land $ 2,201 $ 2,201
Buildings 9,949 9,915
Leasehold improvements 883 743
Furniture and equipment 5,614 6,338
------- -------
Total 18,647 19,197
Accumulated depreciation and amortization (7,599) (7,692)
------- -------
Premises and equipment, net $11,048 $11,505
======= =======
Depreciation and amortization expense for the years ended December 31,
2005, 2004, and 2003 amounted to $950,000, $1,003,000, and $1,080,000,
respectively.
F-21
7. DEPOSITS
Deposit accounts by type and weighted average rates are summarized as
follows:
Years Ended December 31,
-------------------------------------
2005 Rate 2004 Rate
-------------------------------------
(Dollars in Thousands)
<s> <c> <c> <c> <c>
Demand and Now:
Now accounts $ 69,137 0.83% $ 57,050 0.51%
Demand accounts 45,260 - 48,305 -
Savings:
Regular accounts 41,387 0.50 44,882 0.50
Money market accounts 132,218 1.62 149,288 0.93
Time certificates of deposit 335,043 3.24 313,096 2.51
-------- --------
Total Deposits $623,045 $612,621
======== ========
Time deposits of $100,000 or more totaled approximately $71.2 million and
$63.9 million at December 31, 2005 and 2004, respectively. Interest
expense on such deposits totaled $2.0 million, $1.6 million and
$2.3 million for the years ended December 31, 2005, 2004, and 2003
respectively.
Cash paid for interest was:
Years Ended
December 31,
-----------------------------
2005 2004 2003
-----------------------------
(In Thousands)
<s> <c> <c> <c>
Deposits $11,807 $ 9,615 $13,130
Customer repurchase agreements 312 195 211
Federal Home Loan Bank of Boston advances 1,462 1,093 525
------- ------- -------
Total $13,581 $10,903 $13,866
======= ======= =======
At December 31, 2005 and 2004, the scheduled maturities of time
certificates of deposit are as follows:
2005 2004
---- ----
Amount Rate Amount Rate
---------------- ----------------
(Dollars in Thousands)
<s> <c> <c> <c> <c>
Within 1 year $227,770 3.05% $184,500 2.14%
Over 1 year to 3 years 85,951 3.51 103,856 2.88
Over 3 years to 5 years 21,322 4.17 24,740 3.71
-------- --------
Total certificates of deposits $335,043 3.24% $313,096 2.51%
======== ========
F-22
Interest expense on deposits for the years ended December 31, 2005, 2004,
and 2003 is summarized as follows:
December 31,
----------------------------
2005 2004 2003
----------------------------
(In Thousands)
<s> <c> <c> <c>
Savings $ 217 $ 234 $ 371
Money market accounts 2,117 1,419 1,860
Time certificates of deposit 9,154 7,723 10,544
Other interest bearing 325 249 347
------- ------ -------
$11,813 $9,625 $13,122
======= ====== =======
8. CUSTOMER REPURCHASE AGREEMENTS
The following table summarizes information regarding repurchase agreements:
Years Ended
December 31,
----------------------
2005 2004
----------------------
(Dollars in Thousands)
<s> <c> <c>
Balance outstanding, end of year $14,441 $14,615
Maximum amount outstanding at any month end during year 18,116 16,439
Average amount outstanding during year 16,907 15,934
Weighted average interest rate 2.16% 1.23%
Book value of collateral pledged end of year 35,424 36,701
Fair value of collateral pledged end of year 34,821 36,562
9. FEDERAL HOME LOAN BANK OF BOSTON ADVANCES
The following fixed rate advances are collateralized by a blanket lien on
the Company's residential real estate loans and certain mortgage backed
securities.
December 31,
December 31, Weighted Average
Amount Rate
------------------ ----------------
2005 2004 2005 2004
------------------ ----------------
Year (Dollars in Thousands)
----
<s> <c> <c> <c> <c>
2005 $ - $ 5,000 -% 2.4%
2006 10,000 10,000 3.0 3.0
2007 20,000 20,000 3.1 3.1
2008 10,000 5,000 4.2 3.9
2009 5,000 5,000 3.3 3.3
------- -------
Total advances $45,000 $45,000 3.4% 3.1%
======= =======
F-23
10. LINE OF CREDIT
The Company has an "Ideal Way" line of credit with the Federal Home Loan
Bank of Boston for $9,541,000 for the years ended December 31, 2005 and
2004. Interest on this line of credit is payable at a rate determined and
reset by the Federal Home Loan Bank on a daily basis. The outstanding
principal shall be due daily but that portion not repaid will be
automatically renewed. No amounts were outstanding under this line at
December 31, 2005 and 2004.
11. STOCK PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN
Stock Options
Under the Company's Stock Option Plan, the Company may grant options to its
directors, officers and employees for up to 497,260 shares of common stock.
Both incentive stock options and non-statutory stock options may be granted
under the plan. The exercise price of each option equals the market price
of the Company's stock on the date of grant with a maximum term of ten
years. All options currently outstanding vest at 20% per year.
A summary of the status of the Company's stock options for the years ended
December 31, 2005 and 2004 is presented below:
Weighted Average
Shares Exercise Price
------ ----------------
<s> <c> <c>
Balance at December 31, 2003 444,500 $14.39
Granted 2,500 25.00
Exercised (1,800) 14.39
-------
Balance at December 31, 2004 445,200 14.45
Granted 2,500 24.66
Exercised (37,645) 14.39
-------
Balance at December 31, 2005 410,055 14.52
=======
The weighted average fair value of the options granted in 2005 and 2004
using the Black-Scholes option pricing model were $7.68 per share and $7.93
per share, respectively. No options were granted in 2003.
Information pertaining to options outstanding at December 31, 2005 is as
follows:
Weighted Average
Exercise Number Remaining Number
Price Outstanding Contractual Life Exercisable
-------- ----------- ---------------- -----------
<s> <c> <c> <c>
$14.39 405,055 6.6 Years 255,255
24.66 2,500 9.1 Years 500
25.00 2,500 8.1 Years 1,000
------- -------
410,055 256,755
======= =======
F-24
Stock Awards
Under the Company's Recognition and Retention Plan dated November 1, 2002,
the Company may grant stock awards to its directors, officers and employees
for up to 198,904 shares of common stock. The Company applies APB Opinion
No. 25 and related Interpretations in accounting for stock awards. The
stock allocations, based on the market price at the date of grant, is
recorded as unearned compensation. Unearned compensation is amortized over
the vesting period to be benefited. The Company recorded compensation cost
related to the stock awards of approximately $706,000 in 2005, $551,000 in
2004 and $544,000 in 2003.
Stock awards for 1,000 shares, having a fair value of $25.00 per share,
were granted in 2004. Stock awards for 1,000 shares, having a fair value
of $24.66 per share, were granted in 2005. No stock awards were granted in
2003.
Employee Stock Ownership Plan
In January 2002, the Company established an Employee Stock Ownership Plan
(the ESOP) for the benefit of each employee that has reached the age of 21
and has completed at least 1,000 hours of service in the previous twelve-
month period. As part of the conversion, the Company provided a loan to
the Westfield Financial Employee Stock Ownership Plan Trust which was used
to purchase 8%, or 397,808 shares, of the Company's outstanding stock in
the open market. The loan bears interest equal to 8.0% and provides for
annual payments of interest and principal.
At December 31, 2005 the remaining principal balance is payable as follows:
Years Ending
December 31 (In thousands)
------------ --------------
<s> <c>
2006 $ 201
2007 201
2008 201
2009 201
2010 201
Thereafter 4,233
------
$5,238
======
The Bank has committed to make contributions to the ESOP sufficient to
support the debt service of the loan. The loan is secured by the shares
purchased, which are held in a suspense account for allocation among the
participants as the loan is paid. Total compensation expense applicable to
the ESOP amounted to $458,000, $440,000 and $225,000 for the years ended
December 31, 2005, 2004, and 2003, respectively.
Shares held by the ESOP include the following at December 31, 2005 and
2004.
2005 2004
---- ----
<s> <c> <c>
Allocated 50,863 33,216
Committed to be allocated 18,988 19,135
Unallocated 324,961 343,949
------- -------
394,812 396,300
======= =======
Cash dividends received on allocated shares are allocated to participants
and cash dividends received on shares held in suspense are applied to repay
the outstanding debt of the ESOP. The fair value of these shares was
approximately $7.8 million and $8.9 million at December 31, 2005 and 2004,
respectively.
F-25
ESOP shares are considered outstanding for earnings per share calculations
based on the number of shares allocated. Unallocated ESOP shares are
excluded from earnings per share calculations. Dividends declared on
allocated ESOP shares are charged to retained earnings. The value of
unearned shares to be allocated to ESOP participants for future services
not yet performed is reflected as a reduction of stockholders' equity.
12. RETIREMENT PLANS AND EMPLOYEE BENEFITS
Pension Plan - The Company provides basic and supplemental pension benefits
for eligible employees through the Savings Banks Employees Retirement
Association Pension Plan (the "Plan"). Employees must work a minimum of
1,000 hours per year to be eligible for the Plan. Eligible employees
become vested in the Plan after five years of service.
The following table provides information for the Plan at December 31:
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
Change in benefit obligation:
Benefit obligation, beginning of year $ 8,805 $7,410 $6,515
Service cost 625 548 504
Interest 506 463 439
Actuarial loss 648 570 80
Benefits paid (154) (186) (128)
------- ------ ------
Benefit obligation, end of year 10,430 8,805 7,410
------- ------ ------
Change in plan assets:
Fair value of plan assets, beginning of year 6,536 5,658 4,498
Actual return on plan assets 595 607 708
Employer contribution 475 457 580
Benefits paid (154) (186) (128)
------- ------ ------
Fair value of plan assets, end of year 7,452 6,536 5,658
------- ------ ------
Funded status (benefit obligation less
fair value of plan assets) 2,978 2,269 1,752
Unrecognized net actuarial loss (1,127) (574) (165)
Transition liability 104 115 127
------- ------ ------
Accrued benefit cost $ 1,955 $1,810 $1,714
======= ====== ======
Accumulated benefit obligation $ 5,313 $4,635 $4,263
======= ====== ======
Net pension cost includes the following components for the years ended
December 31:
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
Service cost $ 625 $ 548 $ 504
Interest cost 506 463 439
Expected return on assets (523) (452) (360)
Actuarial loss 22 7 19
Transition obligation (11) (12) (12)
----- ----- -----
Net periodic pension cost $ 619 $ 554 $ 590
===== ===== =====
F-26
The following actuarial assumptions were used for the years ended December
31:
2005 2004 2003
---- ---- ----
<s> <c> <c> <c>
Weighted-average assumptions:
Discount rate 5.75% 6.25% 6.75%
Expected return on plan assets 8.00% 8.00% 8.00%
Rate of compensation increase 5.00% 5.00% 5.00%
The expected long term rate of return on plan assets is based on prevailing
yields of high quality fixed income investments increased by a premium of
3% to 5% for equity investments. The Company expects to contribute
$580,000 to its pension plan in 2006.
The Company's pension plan asset allocation at December 31, 2005 and 2004
are as follows:
Percentage of Plan
Assets
at December 31
------------------
Asset Category 2005 2004
- -------------- ---- ----
<s> <c> <c>
Fixed Income Securities (including money market) 35.1% 34.2%
Domestic Equity 50.5 51.5
International Equity 14.4 14.3
----- -----
100.0% 100.0%
===== =====
The target allocation mix for the pension plan for 2005 was an equity-based
investment deployment range from 55% to 75% of total portfolio assets. The
remainder of the portfolio is allocated to fixed income.
Trustees of the Savings Bank Employees Retirement Association ("SBERA")
select investment managers for the portfolio and a special investment
advisory firm is retained to provide allocation analysis. The overall
investment objective is to diversify equity investments across a spectrum
of types, small cap, large cap and international, along with investment
styles such as growth and value.
The Company estimates that the benefits to be paid from the pension plan
for years ended December 31, are as follows:
Benefit Payments to
Year Participants
---- -------------------
(In Thousands)
<s> <c>
2006 $1,523
2007 64
2008 18
2009 995
2010 16
In Aggregate for 2011 - 2015 3,364
------
$5,980
======
Postretirement Benefits - The Company provides postretirement life
insurance benefits to employees based on the employee's salary at time of
retirement. The accrual of postretirement benefits other than pension
expense is made during the years an employee provides service. The
following sets forth the funded status:
December 31,
----------------
2005 2004
---- ----
(In Thousands)
<s> <c> <c>
Benefits obligation and funded status $(820) $(730)
Transitional obligation 260 232
----- -----
Accrued benefit costs $(560) $(498)
===== =====
F-27
Actuarial assumptions used in accounting for the postretirement benefit
plan were:
December 31,
---------------
2005 2004
---- ----
(In Thousands)
<s> <c> <c>
Assumed average salary compensation increase 5.00% 5.00%
Discount rate 5.75% 6.25%
Benefit cost $ 81 $ 71
Benefit paid 18 17
Net periodic benefit cost for:
Years Ended December 31,
------------------------
2005 2004 2003
---- ---- ----
<s> <c> <c> <c>
Assumed average salary compensation increase 5.00% 5.00% 5.00%
Discount Rate 5.75 6.25 6.75
Expected long-term rate of return on assets 8.00 8.00 8.00
Supplemental Retirement Benefits - The Company provides supplemental
retirement benefits to certain key officers. At December 31, 2005 and
2004, the Company had accrued $2.2 million and $2.0 million, respectively,
relating to these benefits. Amounts charged to expense were $389,000,
$289,000, and $180,000 for the years ended December 31, 2005, 2004 and
2003, respectively.
401(k) - Employees are eligible to participate in a 401(k) plan through
SBERA. The Company makes a matching contribution of 50% with respect to the
first 6% of each participant's annual earnings contributed to the plan.
The Company's contributions to the plan were $150,000, $134,000 and
$150,000, for the years ended December 31, 2005, 2004 and 2003,
respectively.
13. REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered
by the Office of Thrift Supervision. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a
direct material effect on the Bank's consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of assets, liabilities, and certain off-
balance sheet items as calculated under regulatory accounting practices.
The capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors. Prompt corrective action provisions are not applicable to savings
and loan holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as
defined) to average assets (as defined). Management believes, as of
December 31, 2005 and 2004, that the Bank met all capital adequacy
requirements to which it is subject.
As of December 31, 2005, the most recent notification from The Office of
Thrift Supervision categorized the Bank as "well capitalized" under the
regulatory framework for prompt corrective action. To be categorized as
"well capitalized" the Bank must maintain minimum total risk-based, Tier 1
risk based and Tier 1 leverage ratios as set forth in the following. There
are no conditions or events since that notification that management
believes have changed the Bank's category. The Company's and the Bank's
actual capital ratios as of December 31, 2005 and 2004 are also presented
in the table.
F-28
Minimum
To Be Well
Minimum Capitalized
For Capital Under Prompt
Adequacy Corrective
Actual Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<s> <c> <c> <c> <c> <c> <c>
December 31, 2005
Total Capital (to Risk Weighted Assets):
Consolidated $122,241 25.68% $38,086 8.00% N/A -
Bank 105,516 22.31 37,833 8.00 $47,291 10.00%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated 116,819 24.54 19,043 4.00 N/A -
Bank 100,151 21.18 18,917 4.00 28,375 6.00
Tier 1 Capital (to Adjusted Total Assets):
Consolidated 116,819 14.48 32,261 4.00 N/A -
Bank 100,151 12.67 31,624 4.00 39,530 5.00
Minimum
To Be Well
Minimum Capitalized
For Capital Under Prompt
Adequacy Corrective
Actual Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<s> <c> <c> <c> <c> <c> <c>
December 31, 2004
Total Capital (to Risk Weighted Assets):
Consolidated $123,222 26.90% $ 36,650 8.00% N/A -
Bank 87,916 19.49 36,091 8.00 $45,114 10.00%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated 117,945 25.75 18,325 4.00 N/A -
Bank 82,639 18.32 18,046 4.00 27,069 6.00
Tier 1 Capital (to Adjusted Total Assets):
Consolidated 117,945 14.69 32,125 4.00 N/A -
Bank 82,639 10.85 30,452 4.00 38,065 5.00
In July 2004, the Company announced that the Board of Directors had
approved a share repurchase program ("Repurchase Program 2") which
authorized the repurchase of up to 502,550 shares or five percent of its
outstanding shares of common stock, continuing until its completion. At
December 31, 2005, the Company had 164,862 shares remaining to be purchased
under this program.
The Company and the Bank are subject to dividend restrictions imposed by
various regulators, including a limitation on the total of all dividends
that the Bank may pay to the Company in any calendar year, to an amount
that shall not exceed the Bank's net income for the current year, plus the
Bank's net income retained for the two previous years, without regulatory
approval. In addition, the Bank may not declare or pay dividends on, and
the Company may not repurchase, any of its shares of common stock if the
effect thereof would cause stockholders' equity to be reduced below
applicable regulatory capital maintenance requirements or if such
declaration, payment or repurchase would otherwise violate regulatory
requirements.
The only funds available for the payment of dividends on the capital stock
of Westfield Financial will be cash and cash equivalents held by Westfield
Financial, dividends paid from Westfield Bank to Westfield Financial, and
borrowings. Westfield Bank will be prohibited from paying cash dividends to
Westfield Financial to the extent that any such payment would reduce
Westfield Bank's capital below required capital levels or would impair the
liquidation account established for the benefit of Westfield Bank's eligible
account holders and supplemental eligible account holders at the time of the
reorganization and stock offering.
F-29
The following is a reconciliation of the Company's GAAP capital to
regulatory Tier 1 capital:
December 31,
-------------------
2005 2004
---- ----
(In Thousands)
<s> <c> <c>
Consolidated GAAP capital $115,842 $118,051
Less: Unrealized losses (gains) on certain available-for-sale securities,
net of tax 977 (106)
-------- --------
Tier 1 Capital 116,819 117,945
Plus: Allowance for loan losses 5,422 5,277
-------- --------
Total Regulatory Capital $122,241 $123,222
======== ========
14. INCOME TAXES
Income taxes consist of the following:
Years Ended December 31,
----------------------------
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
Current tax provision:
Federal $2,131 $2,883 $2,106
State 136 294 1,706
----------------------------
Total 2,267 3,177 3,812
----------------------------
Deferred tax provision (benefit):
Federal (335) (616) (992)
State 1 1 -
----------------------------
Total (334) (615) (992)
----------------------------
Total $1,933 $2,562 $2,820
============================
The reasons for the differences between the statutory federal income tax
rate and the effective rates are summarized below:
Years Ended December 31,
------------------------
2005 2004 2003
---- ---- ----
<s> <c> <c> <c>
Statutory federal income tax rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 1.1 2.2 17.4
Tax exempt income (6.5) (5.6) (5.5)
Bank owned life insurance (3.4) (3.0) (4.2)
Dividends received deduction (0.1) (0.1) (0.5)
Other, net (1.4) 1.3 2.3
------------------------
Effective tax rate 23.7% 28.8% 43.5%
========================
Cash paid for income taxes for the years ended December 31, 2005, 2004, and
2003 was $1.4 million, $2.3 million and $7.2 million, respectively.
F-30
The tax effects of each item that gives rise to deferred taxes, included in
other assets, are as follows:
December 31,
-----------------
2005 2004
---- ----
(In Thousands)
<s> <c> <c>
Net unrealized loss on securities
available for sale $ 675 $ 46
Depreciation (126) (66)
Allowance for loan losses 1,843 1,794
Employee benefit plans 1,779 1,525
Other 412 321
-----------------
Net deferred tax asset $4,583 $3,620
=================
A summary of the change in the net deferred tax asset is as follows:
December 31,
----------------
2005 2004
---- ----
(In Thousands)
<s> <c> <c>
Balance at beginning of year $3,620 $2,553
Deferred tax benefit 334 615
Net unrealized gain/loss
on securities available for sale 629 452
----------------
Balance at end of year $4,583 $3,620
================
The federal income tax reserve for loan losses at the Bank's base year is
$5.8 million. If any portion of the reserve is used for purposes other
than to absorb loan losses, approximately 150% of the amount actually used,
limited to the amount of the reserve, would be subject to taxation in the
fiscal year in which used. As the Bank intends to use the reserve solely
to absorb loan losses, a deferred tax liability of $2.4 million has not
been provided.
F-31
15. TRANSACTIONS WITH DIRECTORS
The Company has had, and expects to have in the future, loans with its
directors and executive officers. Such loans, in the opinion of management
do not include more than the normal risk of collectibility or other
unfavorable features. Following is a summary of activity for such loans:
Years Ended
December 31,
------------------------------
2005 2004 2003
------------------------------
(In Thousands)
<s> <c> <c> <c>
Balance, beginning of year $13,467 $ 7,175 $2,453
New loans granted 6,266 10,532 4,911
Repayments of principal (6,195) (4,240) (189)
------- ------- ------
Balance, end of year $13,538 $13,467 $7,175
======= ======= ======
16. COMMITMENTS AND CONTINGENCIES
In the normal course of business, various commitments and contingent
liabilities are outstanding, such as standby letters of credit and
commitments to extend credit with off-balance-sheet risk that are not
reflected in the consolidated financial statements. Financial instruments
with off-balance-sheet risk involve elements of credit, interest rate,
liquidity and market risk.
Management does not anticipate any significant losses as a result of these
transactions. The following summarizes these financial instruments and
other commitments and contingent liabilities at their contract amounts:
December 31,
------------------
2005 2004
---- ----
(In Thousands)
<s> <c> <c>
Commitment to extend credit:
Unused lines of credit $62,053 $59,444
Other unused commitments 28,617 32,237
Mortgage commitments 451 116
Existing loan agreements 985 3,123
Standby letters of credit 5,936 5,297
The Company uses the same credit policies in making commitments and
conditional obligations as it does for on balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since some commitments expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral
held varies but may include accounts receivable, inventory, property, plant
and equipment, and income-producing commercial properties.
F-32
Standby letters of credit are written conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to
customers.
At December 31, 2005, outstanding commitments to extend credit totaled
$98.0 million, with $1.6 million in fixed rate commitments and $96.4
million in variable rate commitments.
In the ordinary course of business, the Company is party to various legal
proceedings, none of which, in the opinion of management, will have a
material effect on the Company's consolidated financial position or results
of operations.
The Company leases facilities and certain equipment under cancelable and
noncancelable leases expiring in various years through the year 2016.
Certain of the leases provide for renewal periods for up to fifteen years
at the discretion of the Company. Rent expense under operating leases was
$197,000, $199,000, and $172,000 for the years ended December 31, 2005,
2004, and 2003, respectively.
Aggregate future minimum rental payments under the terms of the operating
leases at December 31, 2005, are as follows:
Years Ending (In Thousands)
------------ --------------
<s> <c>
2006 $ 254
2007 165
2008 152
2009 110
2010 66
Thereafter 314
------
$1,061
======
17. CONCENTRATIONS OF CREDIT RISK
Most of the Company's loans consist of residential and commercial real
estate loans located in Western Massachusetts. As of December 31, 2005 and
2004, the Company's residential and commercial related real estate loans
represented 72% of total loans. The Company's policy for collateral
requires that the amount of the loan may not exceed 95% and 80% of the
appraised value of the property for residential and commercial real estate,
respectively, at the date the loan is granted. For residential loans, in
cases where the loan exceeds 80%, private mortgage insurance is typically
obtained for that portion of the loan in excess of 80% of the appraised
value of the property.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
Methods and assumptions for valuing the Company's financial instruments are
set forth below for financial instruments that have fair values different
than their carrying values. Estimated fair values are calculated based on
the value without regard to any premium or discount that may result from
concentrations of ownership of a financial instrument, possible tax
ramifications or estimated transaction costs.
Cash and Cash Equivalents and Accrued Interest Receivable and Accrued
Interest Payable - The carrying amounts of these items are considered to be
a reasonable estimate of fair value due to their short-term nature.
Securities and Mortgage Backed Securities - The estimated fair values for
securities and mortgage backed securities, except certain state and
municipal securities, are based on quoted market prices or dealer
quotations.
Federal Home Loan Bank and Other Stock - These investments are carried at
cost which approximates fair value.
F-33
Loans - Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type, net of the
applicable portion of the allowance for loan losses, such as commercial and
industrial, commercial real estate, residential mortgage, and consumer.
Each loan category is further segmented into fixed and adjustable rate
interest terms and by performing and nonperforming categories.
The fair value of performing loans, except residential mortgage loans, is
calculated by discounting scheduled cash flows through the estimated
maturity using estimated market discount rates that reflect the credit and
interest rate risk inherent in the loan. The estimate of maturity is based
on the Company's historical experience with repayments for each loan
classification, modified, as required, by an estimate of the effect of
current economic and lending conditions. For performing residential
mortgage loans, fair value is estimated by discounting contractual cash
flows adjusted for prepayment estimates using discount rates based on
secondary market sources adjusted to reflect differences in servicing and
credit costs.
Estimated fair value for impaired loans is based on recent external
appraisals if the loan is collateral dependent. Assumptions regarding
credit risk cash flows and discount rates are judgmentally determined using
available market information and specific borrower information.
Management has made estimates of fair value discount rates that it believes
to be reasonable.
Deposits - The estimated fair value of deposits with no stated maturity,
such as noninterest-bearing demand deposits, savings and NOW accounts, and
money market and checking accounts, is equal to the amount payable on
demand. The estimated fair value of certificates of deposit is based on
the discounted value of contractual cash flows. The discount rate is
estimated using the rates currently offered for deposits of similar
remaining maturities.
Customer Repurchase Agreements - The fair value of these agreements is
estimated based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered.
Borrowings - The estimated fair value of borrowings is based upon the
discounted value of contractual cash flows. The discount rate is estimated
using Federal Home Loan Bank of Boston advance rates currently offered for
borrowings with similar maturities.
Commitments to Extend Credit - The stated value of commitments to extend
credit approximates fair value as the current interest rates for similar
commitments do not differ significantly. For fixed-rate loan commitments,
fair value also considers the difference between current levels of interest
rates and the committed rates. Such differences are not considered
significant.
F-34
The estimated fair values of the Company's financial instruments at
December 31 are as follows:
2005 2004
------------------------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
------------------------------------------------
(In Thousands)
<s> <c> <c> <c> <c>
ASSETS:
Cash and cash equivalents $ 26,456 $ 26,456 $ 51,047 $ 51,047
Securities:
Available for sale 28,321 28,321 14,968 14,968
Held to maturity 73,323 72,704 71,298 71,654
Mortgage backed securities:
Available for sale 101,138 101,138 73,316 73,316
Held to maturity 152,127 149,017 175,302 174,051
Federal Home Loan Bank and
other stock 4,237 4,237 4,237 4,237
Loans - net 378,837 379,384 368,601 371,377
Accrued interest receivable 3,853 3,853 3,551 3,551
LIABILITIES:
Deposits 623,045 617,837 612,621 612,216
Customer repurchase agreements 14,441 14,441 14,615 14,615
Federal Home Loan Bank advances 45,000 43,969 45,000 44,380
Accrued interest payable 156 156 140 140
Limitations - Fair value estimates are made at a specific point in time,
based on relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time the Company's entire
holdings of a particular financial instrument. Where quoted market prices
are not available, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment. Changes in assumptions could significantly affect
the estimates.
19. SEGMENT INFORMATION
The Company has one reportable segment, "Community Banking." All of the
Company's activities are interrelated, and each activity is dependent and
assessed based on how each of the activities of the Company supports the
others. For example, commercial lending is dependent upon the ability of
the Bank to fund itself with retail deposits and other borrowings and to
manage interest rate and credit risk. This situation is also similar for
consumer and residential mortgage lending. Accordingly, all significant
operating decisions are based upon analysis of the Company as one operating
segment or unit.
The Company operates only in the U.S. domestic market, primarily in Western
Massachusetts. For the years ended December 31, 2005, 2004, and 2003,
there is no customer that accounted for more than 10% of the Company's
revenue.
F-35
20. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The condensed balance sheets of the Parent Company are as follows:
December 31,
--------------------------------
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
ASSETS:
Due from banks $ 18 $ 25 $ 7,204
Federal funds sold 2,910 987 -
Securities HTM 10,833 - -
Mortgage Backed HTM 2,029 - -
Investment in subsidiaries 99,192 115,810 117,345
Other assets 905 1,271 500
-------- -------- --------
TOTAL ASSETS $115,887 $118,093 $125,049
======== ======== ========
LIABILITIES AND EQUITY:
Liabilities $ 45 $ 42 $ 245
Equity 115,842 118,051 124,804
-------- -------- --------
TOTAL LIABILITIES AND EQUITY $115,887 $118,093 $125,049
======== ======== ========
The condensed statements of income for the Parent Company are as follows:
December 31,
-------------------------------
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
INTEREST AND DIVIDEND INCOME:
Securities $ 280 $ - $ 34
Interest-bearing deposits - 23 35
Federal funds sold 91 6 -
Other Income 7 - -
------- ------- -------
Total interest income 378 29 69
------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits 1,189 1,019 786
Other 194 183 294
------- ------- -------
Total noninterest expense 1,383 1,202 1,080
------- ------- -------
LOSS BEFORE EQUITY IN UNDISTRIBUTED INCOME
OF SUBSIDIARIES AND BENEFIT FOR INCOME TAX (1,005) (1,173) (1,011)
EQUITY IN UNDISTRIBUTED INCOME
OF SUBSIDIARIES 6,736 7,016 4,248
INCOME TAX BENEFIT (488) (480) (414)
------- ------- -------
NET INCOME $ 6,219 $ 6,323 $ 3,651
======= ======= =======
F-36
The condensed statement of cash flows of the Company are as follows:
December 31,
----------------------------------
2005 2004 2003
---- ---- ----
(In Thousands)
<s> <c> <c> <c>
OPERATING ACTIVITIES:
Net Income $ 6,219 $ 6,323 $ 3,651
Equity in undistributed earnings of subsidiaries (6,736) (7,016) (4,248)
Net amortization of premiums and discounts on securities 9 - -
Change in other liabilities 3 (204) 25
Change in other assets 347 (771) (500)
Net transfers from subsidiaries 10,090 7,641 -
Other, net 1,006 694 637
-------- -------- --------
Net cash provided by (used in) operating activities 10,938 6,667 (435)
-------- -------- --------
INVESTING ACTIVITIES:
Purchase of securities - - (34)
Proceeds from principal collections 430 - -
Sale of securities - - 15,266
Other, net - - (2,500)
-------- -------- --------
Net cash (used in) provided by investing activities 430 - 12,732
-------- -------- --------
FINANCING ACTIVITIES:
Cash dividends paid (3,558) (1,713) (2,113)
Treasury stock purchased (5,699) (11,956) (1,134)
Other, net (195) 810 (2,506)
-------- -------- --------
Net cash used in financing activities (9,452) (12,859) (5,753)
-------- -------- --------
NET CHANGE IN CASH AND CASH 1,916 (6,192) 6,544
EQUIVALENTS
CASH AND CASH EQUIVALENTS:
Beginning of year 1,012 7,204 660
-------- -------- --------
End of year $ 2,928 $ 1,012 $ 7,204
======== ======== ========
Supplemental cash flow information:
Transfer of securities from Westfield Securities Corp. $ 24,584 - -
Transfer of securities to Westfield Bank (11,283) - -
21. OTHER NONINTEREST EXPENSE
There is no item that as a component of other noninterest expense, exceeds
1% of the aggregate of total interest income and noninterest income for the
years ended December 31, 2005, 2004, and 2003 respectively.
<page> F-37
22. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2005
------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
(Dollars in thousands, except per share amounts)
<s> <c> <c> <c> <c>
Interest and dividend income $8,878 $9,176 $9,504 $9,748
Interest expense 2,963 3,279 3,554 3,801
------ ------ ------ ------
Net interest and dividend income 5,915 5,897 5,950 5,947
------ ------ ------ ------
Provision for loan losses 140 125 100 100
Noninterest income 748 793 915 897
Gains on sales and writedowns
of securities, net 0 18 0 1
Noninterest expense 4,582 4,798 4,617 4,467
------ ------ ------ ------
Income before income taxes 1,941 1,785 2,148 2,278
Income taxes 430 373 553 577
------ ------ ------ ------
Net income $1,511 $1,412 $1,595 $1,701
====== ====== ====== ======
Basic earnings per share $ 0.16 $ 0.15 $ 0.17 $ 0.18
Diluted earnings per share $ 0.16 $ 0.15 $ 0.16 $ 0.17
2004
------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
(Dollars in thousands, except per share amounts)
<s> <c> <c> <c> <c>
Interest and dividend income $8,621 $8,372 $8,577 $8,858
Interest expense 2,751 2,684 2,688 2,790
------ ------ ------ ------
Net interest and dividend income 5,870 5,688 5,889 6,068
------ ------ ------ ------
Provision for loan losses 150 125 200 275
Noninterest income 586 888 778 767
Gains on sales and writedowns
of securities, net 478 389 0 10
Noninterest expense 4,483 4,480 4,286 4,527
------ ------ ------ ------
Income before income taxes 2,301 2,360 2,181 2,043
Income taxes 694 727 627 514
------ ------ ------ ------
Net income $1,607 $1,633 $1,554 $1,529
====== ====== ====== ======
Basic earnings per share $ 0.16 $ 0.17 $ 0.16 $ 0.16
Diluted earnings per share $ 0.16 $ 0.16 $ 0.16 $ 0.16
F-38
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Westfield Financial, Inc.
We have audited management's assessment, included in Management's Annual
Report on Internal Control Over Financial Reporting, that Westfield
Financial, Inc. maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Westfield Financial
Inc.'s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to
express an opinion on management's assessment and an opinion on the
effectiveness of the company's internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance
about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as
we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. A company's
internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being
made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may
deteriorate.
F-39
In our opinion, management's assessment that Westfield Financial, Inc.
maintained effective internal control over financial reporting as of
December 31, 2005, is fairly stated, in all material respects, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Also in our opinion, Westfield Financial, Inc. maintained, in all material
respects, effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated
financial statements of Westfield Financial, Inc. and our report dated
March 10, 2006 expressed an unqualified opinion.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts
March 10, 2006
F-40