FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended: September 30, 1998
__________________________
Commission File Number 1-13936
__________________________
BOSTONFED BANCORP INC.
________________________________________________________________________________
(Exact name of registrant as specified in its charter)
Delaware 52-1940834
________________________________________________________________________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
17 New England Executive Park, Burlington, Massachusetts 01803
________________________________________________________________________________
(Address of principal executive offices) (Zip Code)
(781) 273-0300
________________________________________________________________________________
(Registrant's telephone number, including area code)
Not Applicable
________________________________________________________________________________
(Former name, former address and former fiscal year,
if changed since last report)
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 ( )
Number of shares of common stock, par value $.01 per share,
outstanding as of October 31, 1998: 5,212,441.
BOSTONFED BANCORP INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
______________________________ ____
Item 1. Financial Statements:
Consolidated Balance Sheets as of
September 30, 1998 (unadudited) and December 31, 1997 2
Consolidated Statements of Operations for the Three
and Nine Months ended September 30, 1998 and 1997 (unaudited) 3
Consolidated Statement of Changes in Stockholders'
Equity for the Nine Months ended
September 30, 1998 (unaudited) 4
Consolidated Statements of Cash Flows for the
Nine Months ended September 30, 1998 and 1997 (unaudited) 5 - 6
Notes to Consolidated Financial Statements 7 - 8
Average Balances and Yield / Costs 9 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 17
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 18 - 19
PART II _ OTHER INFORMATION
___________________________
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
Signature Page 21
1
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
---------------------------
(Dollars in Thousands, Except Per Share Data)
September 30, December 31,
1998 1997
----------- --------------
Assets (Unaudited)
- ------------
Cash and cash equivalents $ 27,611 $ 24,690
Investment securities available for sale
(amortized cost of $51,595 and $31,554 at
September 30, 1998 and December 31, 1997
respectively) 52,267 31,768
Investment securities held to maturity (fair
value of $ 9,396 and $20,630 at September 30,
1998 and December 31, 1997, respectively) 9,301 20,630
Mortgage-backed securities available for sale
(amortized cost of $20,275 and $19,007 at
September 30, 1998 and December 31, 1997,
respectively) 20,476 19,125
Mortgage-backed securities held to maturity (fair
value of $27,960 and $38,903 at September 30,
1998 and December 31, 1997, respectively) 27,421 38,350
Mortgage loans held for sale 27,412 9,817
Loans, net of allowance for loan losses of $7,929
and $6,600 at September 30, 1998 and December 31,
1997, respectively 891,098 791,728
Accrued interest receivable 5,985 5,163
Stock in FHLB of Boston and Federal Reserve Bank 17,802 16,613
Premises and equipment 6,750 6,842
Real estate owned 58 195
Other assets 10,260 9,759
-------- --------
Total assets $1,096,441 $974,680
======== ========
Liabilities and Stockholders' Equity
- ---------------------------------------
Liabilities:
Deposit accounts $676,236 $619,821
Federal Home Loan Bank advances 323,468 256,500
Securities sold under agreements to repurchase 0 7,140
Advance payments by borrowers for taxes
and insurance 3,504 3,133
Other liabilities 9,043 6,475
------- -------
Total liabilities 1,012,251 893,069
------- -------
Commitments and contingencies
Stockholders' equity;
Preferred stock, $.01 par value, 1,000,000 shares
authorized; none issued -- -- -- --
Common stock, $0.01 par value; 17,000,000 shares
authorized; 6,589,617 shares issued (5,368,341 and
5,520,437 shares outstanding, respectively) 66 66
Additional paid-in capital 66,268 65,282
Retained earnings 42,789 38,645
Accumulated other comprehensive income 515 242
Less Treasury Stock, (1,221,276 shares and
1,069,180 shares, respectively), at cost (21,438) (18,146)
Less unallocated ESOP shares (3,174) (3,174)
Less unearned Stock-Based Incentive Plan (836) (1,304)
-------- --------
Total stockholders' equity 84,190 81,611
-------- --------
Total liabilities and stockholders' equity $1,096,441 $974,680
======== ========
See accompanying condensed notes to consolidated financial statements.
2
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In Thousands, except per share amount)
Three Months Ended Nine Months Ended
------------------ ------------------
9/30/98 9/30/97 9/30/98 9/30/97
------------------ ------------------
(Unaudited)
Interest income:
Loans $ 16,876 $ 15,111 $ 48,772 $ 43,583
Mortgage-backed securities 781 1,040 2,578 3,244
Investment securities 1,397 1,391 4,198 3,782
------- ------- ------- -------
Total interest income 19,054 17,542 55,548 50,609
------- ------- ------- -------
Interest expense:
Deposit accounts 6,170 4,970 17,786 13,904
Borrowed funds 4,887 4,630 13,670 13,735
------- ------- ------- -------
Total interest expense 11,057 9,600 31,456 27,639
------- ------- ------- -------
Net interest income 7,997 7,942 24,092 22,970
Provision for loan losses 442 395 1,187 1,275
------- ------- ------- -------
Net interest
income after provision 7,555 7,547 22,905 21,695
Non-interest income:
Loan processing and servicing
fees 191 321 531 918
Gain on sale of loans 704 341 2,130 723
Deposit service fees 419 442 1,242 1,268
Other 192 199 593 570
------- ------- ------- -------
Total non-interest income 1,506 1,303 4,496 3,479
------- ------- ------- -------
Non-interest expense:
Compensation and benefits 3,404 3,429 10,312 10,037
Occupancy and equipment 808 769 2,392 2,311
Federal deposit insurance
premiums 86 74 245 216
Real estate operations (2) (76) (40) (1,186)
Other 1,566 1,441 5,026 4,220
------- ------- ------- -------
Total non-interest expense 5,862 5,637 17,935 15,598
------- ------- ------- -------
Income before income taxes 3,199 3,213 9,466 9,576
Income tax expense 1,281 1,512 3,856 4,256
------- ------- ------- -------
Net income $ 1,918 $ 1,701 $ 5,610 $ 5,320
======= ======= ======= =======
Basic earnings per share $0.38 $0.31 $1.09 $0.95
Diluted earnings
per share $0.36 $0.30 $1.04 $0.91
Basic weighted average shares
outstanding 5,099,921 5,436,453 5,124,218 5,584,322
Common stock equivalents
due to dilutive effect
of stock options 227,953 258,641 272,122 258,641
Diluted total weighted average
shares outstanding 5,327,874 5,695,094 5,396,340 5,842,963
See accompanying condensed notes to consolidated financial statements.
3
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands)
Nine Months Ended September 30, 1998
(Unaudited)
Unearned
Accumulated Stock-
Additional other Unallocated Based Total
Common paid-in Retained Treasury Comprehensive ESOP Incentive stockholders'
stock capital earnings Stock income shares Plan equity
------ -------- --------- -------- ---------- ----------- ---------- ------------
Balance at December 31, 1997 $ 66 65,282 38,645 (18,146) 242 (3,174) (1,304) 81,611
Net income - - - - 1,889 - - - - - - - - 1,889
Change in net unrealized gain/(loss)
on investments available for sale
(net of tax benefit of $89) - - - - - - - - (204) - - - - (204)
--------
Total comprehensive income - - - - - - - - - - - - - - 1,685
Cash dividends declared and
paid ($0.07 per share) - - - - (387) - - - - - - - - (387)
Common Stock repurchased
(98,200 shares at an average
price of $21.27 per share) - - - - - - (2,089) - - - - - - (2,089)
Allocation relating to earned
portion of Stock-Based
Incentive Plan - - - - - - - - - - - - 197 197
Options exercised - - (2) - - 7 - - - - - - 5
Appreciation in fair value of
shares charged to expense for
compensation plans - - 217 - - - - - - - - - - 217
------- ------- -------- --------- --------- -------- --------- --------
Balance at March 31, 1998 $ 66 65,497 40,147 (20,228) 38 (3,174) (1,107) 81,239
------- ------- -------- --------- --------- -------- --------- --------
Net income - - - - 1,803 - - - - - - - - 1,803
Change in net unrealized gain/(loss)
on investments available for sale
(net of tax of $51) - - - - - - - - 36 - - - - 36
--------
Total comprehensive income - - - - - - - - - - - - - - 1,839
Cash dividends declared and
paid ($0.10 per share) - - - - (542) - - - - - - - - (542)
Common Stock repurchased
(30,000 shares at an average
price of $24.05 per share) - - - - - - (721) - - - - - - (721)
Allocation relating to earned
portion of Stock-Based
Incentive Plan - - - - - - - - - - - - 148 148
Options exercised - - 1 - - 8 - - - - - - 9
Tax benefit of stock
distributed relating to the
stock-based incentive plan - - 317 - - - - - - - - - - 317
Appreciation in fair value of
shares charged to expense for
compensation plans - - 265 - - - - - - - - - - 265
------- ------- -------- --------- --------- -------- --------- --------
Balance at June 30, 1998 $ 66 66,080 41,408 (20,941) 74 (3,174) (959) 82,554
------- ------- -------- --------- --------- -------- --------- --------
Net income - - - - 1,918 - - - - - - - - 1,918
Change in net unrealized gain/(loss)
on investments available for sale
(net of tax of $361) - - - - - - - - 441 - - - - 441
--------
Total comprehensive income - - - - - - - - - - - - - - 2,359
Cash dividends declared and
paid ($0.10 per share) - - - - (537) - - - - - - - - (537)
Common Stock repurchased
(24,796 shares at an average
price of $20.00 per share) - - - - - - (497) - - - - - - (497)
Allocation relating to earned
portion of Stock-Based
Incentive Plan - - - - - - - - - - - - 123 123
Appreciation in fair value of
shares charged to expense for
compensation plans - - 188 - - - - - - - - - - 188
------- ------- -------- --------- --------- -------- --------- --------
Balance at September 30, 1998 $ 66 66,268 42,789 (21,438) 515 (3,174) (836) 84,190
------- ------- -------- --------- --------- -------- --------- --------
See accompanying condensed notes to consolidated financial statements.
4
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
For the Nine Months Ended
September 30,
1998 1997
------- -------
(Unaudited)
Net cash flows from operating activities:
Net income $ 5,610 $ 5,320
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation, amortization and
accretion, net 1,010 843
Earned SIP shares 468 806
Appreciation in fair value of shares
charged to expense for compensation plans 670 844
Provision for loan losses 1,187 1,275
Loans originated for sale (258,979) (88,431)
Proceeds from sale of loans 243,514 76,125
Provision for valuation allowance
for real estate owned - 57
Gain on sale of real estate held
for development - (898)
Gain on sale of real estate
acquired through foreclosure (35) (539)
Gain on sale of investment securities - (7)
Gain on sale of loans (2,130) (723)
Increase in accrued interest receivable (822) (325)
Decrease(increase) in prepaid expenses
and other assets, net (343) 3,692
Increase (Decrease) in accrued expenses and
other liabilities, net 2,299 (140)
-------- -------
Net cash used in
operating activities (7,551) (2,101)
-------- -------
Cash flows from investing activities:
Net cash of acquired institution - 11,908
Proceeds from sale of investment securities
available for sale - 9,008
Proceeds from sale of mortgage-backed
securities available for sale - 1,084
Proceeds from maturities of investment
securities held to maturity 12,350 5,850
Proceeds from maturities of investment
securities available for sale 5,000 4,000
Purchase of investment securities
available for sale (24,993) (13,013)
Purchase of investment securities
held to maturity (1,000) (4,900)
Purchase of mortgage-backed securities
available for sale (7,392) -
Principal payments on mortgage-backed
securities available for sale 6,067 2,560
Principal payments on mortgage-
backed securities held to maturity 10,906 3,478
Increase in loans, net (100,557) (21,669)
Purchases of premises and equipment (748) (676)
Proceeds from sale of real estate owned 172 3,283
Additional investment in real estate owned - (2)
Proceeds from sale of real estate held for
development - 2,102
Purchase of FHLB and Federal Reserve Stock (1,189) -
------- -------
Net cash provided by (used in)
investing activities (101,384) 3,013
------- ---------
-Continued on next page-
5
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
For the Nine Months Ended
September 30,
1998 1997
------- -------
(Unaudited)
Cash flows from financing activities:
Increase in deposit accounts 56,415 16,324
Repayments of securities sold under
agreement to repurchase (7,140) (33,685)
Proceeds from securities sold under
agreements to repurchase - 38,651
Repayments of Federal Home Loan
Bank advances (348,948) (241,200)
Proceeds from Federal Home Loan
Bank advances 415,916 236,200
Cash dividends paid (1,466) (1,146)
Common stock repurchased (3,307) (10,766)
Options exercised 15 -
Increase in advance payments by
borrowers for taxes and insurance 371 807
-------- -------
Net cash provided by
financing activities 111,856 5,185
------- -------
Net increase
in cash and cash equivalents 2,921 6,097
Cash and cash equivalents at January 1 24,690 18,278
------- -------
Cash and cash equivalents at September 30 $ 27,611 $ 24,375
======= =======
Supplemental disclosure of cash flow
information:
Payments during
the Nine months ended September 30, for:
Interest $ 30,204 $ 27,144
======= =======
Taxes $ 3,276 $ 4,097
======= =======
Supplemental schedule of non-cash
investing activities:
Transfers of mortgage
loans to real estate owned $ - $ 401
======= =======
See accompanying condensed notes to consolidated financial statements.
6
BOSTONFED BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of BostonFed Bancorp, Inc., ("BostonFed" or the "Company") and its
wholly-owned subsidiaries, Boston Federal Savings Bank ("BFS") and BF Funding
Corporation as of September 30, 1998 and December 31, 1997 and for the three-
and nine-month periods ended September 30, 1998 and 1997, and the accounts of
its wholly-owned subsidiary, Broadway National Bank ("BNB") effective at close
of business February 7, 1997 through September 30, 1998. Broadway Capital
Corporation, the former holding company of Broadway National Bank, was merged
into BostonFed effective May 28, 1997.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management all necessary adjustments,
consisting only of normal recurring accruals necessary for a fair presentation,
have been included. The results of operations for the three- and nine-month
periods ended September 30, 1998 and 1997 are not necessarily indicative of the
results that may be expected for the entire fiscal year.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which sets accounting and
reporting standards for derivative instruments and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measure those instruments at fair value.
This Statement is effective for years beginning January 1, 2000. The impact of
adoption is not expected to be material to the Company.
NOTE 2: COMMITMENTS, CONTINGENCIES AND CONTRACTS
At September 30, 1998, the Company had commitments of $81.5 million to
originate mortgage loans and $5.1 million to purchase loans from correspondent
lenders. Of these $86.6 million commitments, $49.6 million were adjustable rate
mortgage loans at rates ranging from 5.88% to 9.50% and $37 million were
fixed rate mortgage loans with interest rates ranging from 5.88% to 9.00%. The
Company also had commitments to sell $54.6 million of mortgage loans.
At September 30, 1998, the Company was servicing first mortgage loans of
approximately $621.9 million, which are either partially or wholly-owned by
others.
7
NOTE 3: LEGISLATIVE MATTERS
The proposed legislation regarding elimination of the federal thrift
charter and related issues remains pending before Congress. The Company is
unable to predict whether such legislation will be enacted, the extent to which
the legislation would restrict or disrupt its operations or whether the BIF and
SAIF funds will eventually merge. See Form 10-K for the fiscal year ended
December 31, 1997 for a discussion of the proposed legislation.
NOTE 4: ACQUISITIONS
On February 7, 1997 the Company acquired BNB, headquartered in Chelsea,
Massachusetts. The purchase price was $22 million and was accounted for using
the purchase method of accounting. The results of operations include the effect
of the purchase beginning February 8, 1997. In connection with the acquisition,
the fair value of assets acquired and liabilities assumed were as follows:
February 7, 1997
----------------
(in thousands)
Assets acquired:
Cash and cash equivalents $ 5,758
Fed Funds 28,150
Investments available for sale 35,352
Investment securities 4,646
Loans, net 66,093
Premises and equipment 1,972
Other assets 4,192
---------
Total assets acquired 146,163
Liabilities assumed:
Deposits 125,022
Borrowed funds -
Other liabilities 2,318
--------
Total liabilities assumed 127,340
--------
Assets in excess of liabilities 18,823
Cash paid to Broadway shareholders 22,000
--------
Goodwill $ 3,177
========
The following condensed consolidated pro-forma results of the Company were
prepared as if the acquisition had taken place on January 1 of the respective
year. The pro-forma results are not necessarily indicative of the actual results
of operations had the Company's acquisition of BNB actually occurred on January
1 of the respective year.
Nine Months Ended
9/30/97
------------------
(In thousands except per share amounts)
Total interest and dividend
income and total
non-interest income $ 55,029
Net income $ 5,471
Net income per share $ 0.94
8
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Average Balances and Yields / Costs
(Unaudited)
For the quarter ended September 30: 1998 1997
------------------------------------- ------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
---------- ---------- --------- --------- ---------- ---------
(Dollars in thousands)
Assets:
Interest-earning assets:
Investment securities (1) $ 91,293 $ 1,397 6.12% $ 91,999 $ 1,391 6.05%
Loan, net and mortgage loans held for sale (2) 894,643 16,876 7.55% 772,189 15,111 7.83%
Mortgage-backed securities (3) 47,100 781 6.63% 60,994 1,040 6.82%
---------- --------- --------- --------- ---------- ---------
Total interest-earning assets 1,033,036 19,054 7.38% 925,182 17,542 7.58%
--------- --------- ---------- ---------
Non-interest-earning assets 41,524 39,850
---------- ---------
Total assets $ 1,074,560 $ 965,032
========== =========
Liabilities and Stockholders' Equity:
Interest-bearing Liabilities:
Money market deposit accounts $ 62,844 461 2.93% $ 63,264 462 2.92%
Savings accounts 121,499 782 2.57% 119,765 728 2.43%
NOW accounts 103,625 280 1.08% 99,678 268 1.08%
Certificate accounts 320,809 4,647 5.79% 243,138 3,512 5.78%
---------- --------- --------- --------- ---------- ---------
Total 608,777 6,170 4.05% 525,845 4,970 3.78%
Borrowed Funds (4) 318,976 4,887 6.13% 303,101 4,630 6.11%
---------- --------- --------- --------- ---------- ---------
Total interest-bearing liabilities 927,753 11,057 4.77% 828,946 9,600 4.63%
--------- --------- ---------- ---------
Non-interest-bearing liabilities 61,450 50,103
---------- ---------
Total liabilities 989,203 879,049
---------- ---------
Stockholders' equity 85,357 85,983
---------- ---------
Total liabilities and
stockholders' equity $ 1,074,560 $ 965,032
========== =========
Net interest rate spread (5) $ 7,997 2.61% $ 7,942 2.95%
========= ========= ========== =========
Net interest margin (6) 3.10% 3.43%
========= =========
Ratio of interest-earning assets to
interest-bearing liabilities 111.35% 111.61%
========= =========
<FN>
(1) Includes investment securities available for sale and held to maturity,
short-term investments, stock in FHLB-Boston and daily federal funds sold.
(2) Amount is net of deferred loan origination costs, construction loans in
process, net unearned discount on loans purchased and allowance for loan
losses and includes non-performing loans.
(3) Includes mortgage-backed securities available for sale and held to maturity.
(4) Interest paid on borrowed funds for the periods presented includes
interest expense on FNMA deposits held in escrow accounts with the
Company related to the Company's FNMA servicing, which, if such interest
expense was excluded, would result in an average cost of borrowed funds
of 6.01% and 6.08% for the three months ended September 30, 1998 and
September 30, 1997, respectively.
(5) 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.
(6) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
</FN>
9
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Average Balances and Yields / Costs
(Unaudited)
For the nine months ended September 30: 1998 1997
------------------------------------- ------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
---------- ---------- --------- --------- ---------- ---------
(Dollars in thousands)
Assets:
Interest-earning assets:
Investment securities (1) $ 90,626 $ 4,198 6.17% $ 84,068 $ 3,782 6.00%
Loan, net and mortgage loans held for sale (2) 856,036 48,772 7.59% 750,769 43,583 7.74%
Mortgage-backed securities (3) 51,497 2,578 6.67% 63,426 3,244 6.82%
---------- --------- --------- --------- ---------- ---------
Total interest-earning assets 998,159 55,548 7.42% 898,263 50,609 7.51%
--------- --------- ---------- ---------
Non-interest-earning assets 41,628 39,733
---------- ---------
Total assets $ 1,039,787 $ 937,996
========== =========
Liabilities and Stockholders' Equity:
Interest-bearing Liabilities:
Money market deposit accounts $ 63,235 1,398 2.95% $ 61,422 1,354 2.94%
Savings accounts 118,420 2,230 2.51% 116,078 2,142 2.46%
NOW accounts 103,983 876 1.12% 94,933 786 1.10%
Certificate accounts 305,190 13,282 5.80% 227,561 9,622 5.64%
---------- --------- --------- --------- ---------- ---------
Total 590,828 17,786 4.01% 499,994 13,904 3.71%
Borrowed Funds (4) 303,122 13,670 6.01% 306,543 13,735 5.97%
---------- --------- --------- --------- ---------- ---------
Total interest-bearing liabilities 893,950 31,456 4.69% 806,537 27,639 4.57%
--------- --------- ---------- ---------
Non-interest-bearing liabilities 61,609 44,816
---------- ---------
Total liabilities 955,559 851,353
---------- ---------
Stockholders' equity 84,228 86,643
---------- ---------
Total liabilities and
stockholders' equity $ 1,039,787 $ 937,996
========== =========
Net interest rate spread (5) $24,092 2.73% $22,970 2.94%
========= ========= ========== =========
Net interest margin (6) 3.22% 3.41%
========= =========
Ratio of interest-earning assets to
interest-bearing liabilities 111.66% 111.37%
========= =========
<FN>
(1) Includes investment securities available for sale and held to maturity,
short-term investments, stock in FHLB-Boston and daily federal funds sold.
(2) Amount is net of deferred loan origination costs, construction loans in
process, net unearned discount on loans purchased and allowance for loan
losses and includes non-performing loans.
(3) Includes mortgage-backed securities available for sale and held to maturity.
(4) Interest paid on borrowed funds for the periods presented includes
interest expense on FNMA deposits held in escrow accounts with the
Company related to the Company's FNMA servicing, which, if such interest
expense was excluded, would result in an average cost of borrowed funds
of 5.96% and 5.96% for the nine months ended September 30, 1998 and
September 30, 1997, respectively.
(5) 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.
(6) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
</FN>
10
BOSTONFED BANCORP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
A. GENERAL
The Company is the holding company for two banking subsidiaries, Boston
Federal Savings Bank, a federally chartered community savings bank and Broadway
National Bank, a nationally chartered commercial bank. On February 7, 1997, the
Company acquired BNB and as a result of the acquisition, the Company became a
bank holding company subject to regulation by the Federal Reserve Bank ("FRB").
Boston Federal Savings Bank is regulated by the Office of Thrift Supervision and
Broadway National Bank is regulated by the Office of the Comptroller of the
Currency. Substantially all of the Company's business is coordinated through its
subsidiary banks and references herein to "Company" include the banks as
appropriate. The Company's principal business has been and continues to be
attracting retail deposits from the general public in the areas surrounding its
branch offices and investing those deposits, together with funds generated from
operations and borrowings, primarily in one- to four-family residential mortgage
loans. To a lesser extent, the Company invests in multi-family mortgage,
commercial real estate, construction and land, consumer loans, business loans,
and investment securities. The Company originates loans for investment and loans
for sale in the secondary market, generally retaining the servicing rights for
loans sold. Loan sales are made from loans held in the Company's portfolio
designated as being held for sale or originated for sale during the period. The
Company's revenues are derived principally from interest on its mortgage loans,
and to a lesser extent, interest and dividends on its investment and
mortgage-backed securities, fees, gains on sale of loans and loan servicing
income. The Company's primary sources of funds are deposits, principal and
interest payments on loans and mortgage-backed securities, FHLB advances,
repurchase agreements and proceeds from the sale of loans. Since the acquisition
of BNB was consummated at the close of business on February 7, 1997, the
financial statements of the Company and the following discussion regarding the
Company's financial condition at Sept 30, 1998 and December 31, 1997, and the
results of operations for the three- and nine- months ended September 30, 1998
and 1997 includes information and data of BNB from February 8, 1997 through
September 30, 1998.
B. YEAR 2000 ISSUE
Included in other non-interest expenses for the three- and nine-month
periods ended September 30, 1998 and 1997 are charges incurred in connection
with the modification or replacement of software or hardware in order for the
Company's computer and related systems to properly recognize dates beyond
December 31, 1999.
The impact of computer systems ability to process dates beyond 1999, the
Year 2000 issue, creates a significant business challenge for the Company. The
Company is addressing this issue as it affects all of its software, hardware and
other systems to insure the Company is Year 2000 compliant. The Company has
developed a plan that is based upon the FFIEC (Federal Financial Institutions
Examination Council) recommended phases and time frames for insuring Year 2000
compliance. These phases include awareness, assessment, renovation, validation
and implementation.
The Company has completed the awareness phase through development of a Year
2000 committee and reporting structure. The assessment phase has been completed
with a review of all software, hardware and business systems including an
evaluation of the critical nature and year 2000 business risk that each
application presents. The Company primarily utilizes third-party vendors for the
processing of its critical data processing applications. The Company is working
closely with these critical vendors to monitor renovation and validation efforts
to insure that the time frames set out in the Company's plan are met. Based upon
information currently available, the Company estimates that 72% of critical
applications are renovated at September 30, 1998. It is expected that
substantially all renovations will be completed by December 31, 1998. The
Company has created an internal Year 2000 testing environment and has developed
test scripts incorporating typical transactions in order to test the modified
systems. Testing with critical application vendors will begin in the fourth
quarter of 1998 and is expected to be completed by March 31, 1999. The target
date for completion of the implementation phase is June 30, 1999, a date prior
to any anticipated impact on operating systems.
In the event that the Company's third-party vendors do not successfully or
timely achieve Year 2000 compliance, the Company's operations could be adversely
effected. The Company is developing contingency plans in the event that one or
all of these significant vendors fails to meet Year 2000 operating requirements.
Contingency plans for unexpected Year 2000 related business interruption will be
completed after testing of modified systems, but prior to June 30, 1999.
Further, the Company will seek alternative vendors should one of the critical
vendors fail to achieve satisfactory Year 2000 compliance. In the event the
Company's current third party data processing vendors were not to achieve Year
2000 compliance and the Company could not engage alternative vendors in a timely
manner, the Company's operations would be adversely impacted.
The total cost of the Year 2000 project is estimated at $300,000 to
$500,000 which includes estimated costs and time associated with third-party
Year 2000 issues, based on information currently available. Through September
30, 1998 the Company has expensed approximately $100,000 to date toward the Year
2000 remediation efforts. A significant portion of the costs associated with the
year 2000 project are not expected to be incremental to the Company, but rather
represent a reprioritization of existing internal systems technology resources.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based upon management's best estimates,
which are derived utilizing numerous assumptions of future events, including the
continued availability of certain resources, third-party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.
11
C. FINANCIAL CONDITION
Total assets at September 30, 1998 were $1.1 billion, compared to $974.7
million at December 31, 1997, an increase of $121.8 million or 12.5%. The major
components of asset growth included investment securities available for sale,
mortgage loans held for sale and loans, net of allowance for loan losses.
Investment securities available for sale increased to $52.3 million at September
30, 1998 from $31.8 million at December 31, 1997 due primarily to an investment
in two mutual funds that invest mainly in government agency mortgage-backed
securities. Mortgage loans held for sale increased from $9.8 million at December
31, 1997 to $27.4 million at September 30, 1998 due to the increased activity in
the secondary market resulting from heavy volume of fixed- and adjustable-rate
loan originations for sale. Loans, net of allowance for loan losses, increased
by $99.4 million, or 12.6%, from a balance of $791.7 million at December 31,
1997 to $891.1 million at September 30, 1998, primarily due to growth in BFS's
loan portfolio. These increases were partially offset by decreases in investment
securities held to maturity and mortgage-backed securities held to maturity of
$11.3 million and $10.9 million, respectively, compared to the balances at
December 31, 1997. Deposit accounts increased by $56.4 million from a balance of
$619.8 million at December 31, 1997 to a balance of $676.2 million at September
30, 1998. The increase is mainly attributable to the successful roll-out of a
new 15-month retail certificate of deposit acquisition program initiated by BFS.
BNB's deposits also grew by $2.7 million during the nine-months ended September
30, 1998. Federal Home Loan Bank advances increased by $67.0 million, to a
balance of $323.5 million at September 30, 1998 from a balance of $256.5 million
at December 31, 1997. These advances were used to fund the increase in
investments available for sale and mortgage loans held for sale and loans, net.
Other borrowed money (repurchase agreements), which amounted to $7.1 million at
December 31, 1997, were repaid during the nine-months ended September 30, 1998.
12
D. LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are deposits, (including brokered
deposits), principal and interest payments on loans, investments,
mortgage-backed and related securities and loan sales, FHLB advances and
repurchase agreements. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and competition. The
Company has maintained in excess of the required minimum levels of liquid assets
at BFS as defined by OTS regulations. This requirement, which may be varied at
the direction of the OTS depending upon economic conditions and deposit flows,
is based upon a percentage of the BFS's deposits and short-term borrowings.
BFS's current required liquidity ratio is 4%. At September 30, 1998 and December
31, 1997 BFS's liquidity ratio was 4.7% and 5.7% respectively. Management has
maintained liquidity as close as possible to the minimum requirement so that it
may invest any excess liquidity in higher yielding interest-earning assets or
use such funds to repay higher cost FHLB advances. The OCC does not have
specific guidance for liquidity ratios for BNB, but does require banks to
maintain reasonable and prudent liquidity levels. Management believes such
levels have been maintained since the acquisition date.
The Company's most liquid assets are cash, overnight federal funds sold,
and loans and investments available for sale. The levels of these assets are
dependent on the Company's operating, financing, lending and investing
activities during any given period. At September 30, 1998, BFS' cash, loans and
investments available for sale totaled $84.1 million or 8.8% of BFS's total
assets. While not all of these liquid assets qualify for BFS's regulatory
liquidity requirements, other assets in the held to maturity category qualify
for regulatory liquidity requirements.
The Company has other sources of liquidity if a need for additional funds
arises, including FHLB advances. At September 30, 1998, BFS had $323.5 million
in advances outstanding from the FHLB. The Company generally does not pay the
highest deposit rates in its market and accordingly utilizes alternative sources
of funds such as FHLB advances and repurchase agreements to supplement cash flow
needs.
At September 30, 1998, the Company had commitments to originate loans and
unused outstanding lines of credit totaling $148.0 million. The Company
anticipates that it will have sufficient funds available to meet its current
loan origination commitments. Certificate accounts which are scheduled to mature
in less than one year from September 30, 1998, totaled $166.8 million.
At September 30, 1998, the consolidated stockholders' equity to total
assets ratio was 7.7%. As of September 30, 1998, the Company, BFS and BNB
exceeded all of their regulatory capital requirements. The Company's
consolidated Tier 1 capital, total capital and Tier 1 leverage ratios were
13.7%, 14.9% and 7.5%, respectively. BFS's tier 1, total risk-based, tier 1
risk-based and tangible equity capital ratios were 5.2%, 10.4%, 9.2% and 5.2%,
respectively. BNB's respective capital ratios were 9.9%, 16.6%, 15.5%, and 7.6%.
13
E. COMPARISON OF THREE- AND NINE-MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
General
Earnings for the quarter ended September 30, 1998 were $1.9 million, or
$.38 basic earnings per share, $.36 per share on a diluted basis, compared to
earnings of $1.7 million, or $.31 basic and $.30 diluted earnings per share for
the third quarter of 1997. Earnings for the nine-months ended September 30, 1998
were $5.6 million or $1.09 basic earnings per share, $1.04 per share on a
diluted basis, compared to earnings of $5.3 million or $.95 basic earnings per
share, $.91 per share on a diluted basis during the nine-months ended September
30, 1997. Earnings for the nine-months ended September 30, 1998 were enhanced by
gain on sale of loans of $2.1 million (before income taxes) compared to last
year's first nine months gain on sale of loans totaling $723,000 (before income
tax).Earnings for the first nine months of 1997 were also enhanced by earnings
of $1.1 million (before income taxes) from real estate operations, which
included a gain of $891,000 (before income taxes), from the sale of a land
sub-division owned by a subsidiary of BFS. The Company's annualized return on
average assets was .72% and the annualized return on average stockholders'
equity was 8.88% during the nine-months ended September 30, 1998, compared to
.76% and 8.18%, respectively, for the nine-months ended September 30, 1997
(annualized). Comments regarding the components of net income are detailed in
the following paragraphs.
Interest Income
Total interest income on interest-earning assets for the quarter ended
September 30, 1998 increased by $1.5 million, or 8.6%, to $19.1 million,
compared to the quarter ended September 30, 1997. The increase in interest
income was primarily attributable to a $107.9 million increase in average
interest-earning assets, offset by a 20 basis point decrease in the average
yield. The average yield on interest-earning assets decreased to 7.38% for the
three months ended September 30, 1998 from 7.58% for the three months ended
September 30, 1997. For the first nine months of 1998, total interest income was
$55.5 million, compared to $50.6 million for the same period in 1997. The major
reason for the increase was also the increased average balances of
interest-earning assets which were $998.2 million during the nine-months ended
September 30, 1998, compared to $898.3 million during the comparable period in
1997. The average yields during the nine-months ending September 30, 1998 and
1997 were 7.42% and 7.51%, respectively.
Interest income on loans, net, for the quarter ended September 30, 1998
increased by $1.8 million, or 11.7%, to $16.9 million compared to $15.1 million
for the same quarter in 1997. On a year to date basis, interest income on loans.
net, increased $5.2 million to $48.8 million from the $43.6 million earned
during the first nine months of 1997. The increase in interest income from
loans, net, for the quarter and nine months ended September 30, 1998, compared
to the same periods last year, was primarily attributable to increases in
average balances of $122.5 million and $105.3 million, respectively. The
earnings impact of higher balances of loans, net was partially offset by
declines in the average yield on loans, net which decreased by 28 basis points
to 7.55% during the quarter ended September 30, 1998, compared to 7.83% during
the quarter ended September 30, 1997. On a year to date basis, the yield on
loans, net, decreased from 7.74% for the nine months ended September 30, 1997,
to 7.59% during the current year period. Interest on mortgage-backed securities
for the quarter ended September 30, 1998 decreased by $259,000 to $781,000,
compared to $1.0 million for the same quarter in 1997. This decrease in income
was due primarily to the $13.9 million lower average balance during the quarter
ended September 30, 1998, compared to the quarter ended September 30, 1997.
Additionally, the average yield declined by 19 basis points to an average of
6.63% during the September 30, 1998 quarter, compared to the same quarter last
year. On a year to date basis, interest on mortgage-backed securities was $2.6
million, compared to last year's comparable period total of $3.2 million, also
due to declines in average balances and yields. The average balance of
mortgage-backed securities declined by $11.9 million to $51.5 million for the
nine-months ended September 30, 1998 compared to the prior year period average
balance of $63.4 million. Average yields were also lower by 15 basis points
during the current period.
Income from investment securities was $1.4 million for each of the quarters
ending September 30, 1998 and 1997. On a year to date basis, income from
investment securities was $4.2 million and $3.8 million, respectively for the
nine-months ended September 30, 1998 and 1997. The average yield on investment
securities increased by 7 and 17 basis points, respectively, in the current
three- and nine-month periods, compared to last year's periods due to the higher
yields received by BFS on the two mutual funds it invested in January, 1998. The
average balance decreased by $706,000 to an average of $91.3 million during the
quarter ended September 30, 1998, compared to an average balance of $92.0
million for the quarter ended September 30, 1997. For the nine-months ended
September 30, 1998, the average investment securities balance was $90.6 million,
compared to $84.1 for the prior period. The increase in the average balance also
is primarily due to BFS's investment in the mutual funds previously mentioned.
14
Interest Expense
Total interest expense on interest-bearing liabilities for the quarter
ended September 30, 1998 increased by $1.5 million or 15.6%, to $11.1 million
compared to the quarter ended September 30, 1997. The increase in interest
expense for the quarter ended September 30, 1998 was due primarily to an
increase of $98.8 million in the average balance of interest-bearing liabilities
which averaged $927.8 million during the current quarter, compared to an average
balance of $828.9 million during the quarter ended September 30, 1997. A 14
basis point increase in the average cost of interest-bearing liabilities also
contributed to the increase in interest expense. The average cost of
interest-bearing liabilities increased to 4.77% during the quarter ended
September 30, 1998, compared to 4.63% for last year's comparable quarter. On a
year to date basis, interest expense on interest-bearing liabilities totaled
$31.5 million, compared to last year's to date total of $27.6 million, a 14.1%
increase. The increase was caused by the combined effects of an 12 basis point
increase in the average cost of funds and an increase of $87.4 million in
average balances during the nine months ended September 30, 1998, compared to
the prior year period.
Interest expense on deposit accounts was $6.2 million for the quarter ended
September 30, 1998, an increase of $1.2 million from the $5.0 million for the
quarter ended September 30, 1997. The increase in the expense was due to higher
average deposit account balances of $82.9 million and a 27 basis point increase
in the average cost of funds during the quarter ended September 30, 1998,
compared to the quarter ended September 30, 1997. A major reason for the higher
cost of funds is due to the Company's use of wholesale brokered certificates of
deposit, which at September 30, 1998 amounted to $82.7 million compared to $35
million at September 30, 1997. The average balance of deposit accounts increased
from $525.8 million for the quarter ending September 30, 1997 to an average
balance of $608.8 million for the quarter ending September 30, 1998, mostly due
to the successful roll-out of a new 15 month retail certificate of deposit
acquisition program initiated by BFS during 1998. For the nine-months ended
September 30, 1998, interest expense on deposit accounts was $17.8 million,
compared $13.9 million for the prior year period, an increase of $3.9 million or
28.1%. The increase was caused by the combined effects of higher average deposit
account balances that averaged $590.8 million during the nine-months ended
September 30, 1998, compared to $500.0 million in the prior year period.
Additionally, a 30 basis point increase in the average cost of deposit accounts
also contributed to the increase in interest expense. Interest expense on
borrowed funds increased from $4.6 million for the quarter ended September 30,
1997 to $4.9 million for the current quarter. The average cost of borrowed funds
increased from 6.11% during the quarter ended September 30, 1997 to an average
of 6.13% during the current quarter. The average balance increased from $303.1
million during the third quarter of 1997 to an average balance of $319.0 million
during the third quarter of 1998. For the nine-months ended September 30, 1998
and 1997, interest expense on borrowed funds was $13.7 million. The average cost
of borrowed funds increased by four basis points from 5.97% for the nine-months
ended September 30, 1997 to 6.01% for the current nine months. The impact of
this increase was offset by a reduction in the average balance of borrowed money
from an average balance of $306.5 million for the nine-month period ended
September 30, 1997 to an average balance of $303.1 million during the current
period.
Net Interest Income
Net interest income during the third quarter of 1998 was $8.0 million,
compared to $7.9 million for the third quarter of 1997 as industry-wide margin
shrinkage was offset by net interest income earned from asset growth. On a year
to date basis, net interest income was $24.1 million, compared to $23.0 million
for the prior year to date. The net interest margin, at 3.10% for the quarter
ended September 30, 1998 was 33 basis points lower than last year's comparable
quarter. On a year to date basis, the net interest margin of 3.22% was 19 basis
points lower than last year to date. The net interest margin was compressed due
to the effects of a continuation of the relatively flat interest rate yield
curve.
15
Provision for Loan Losses
The Company's provision for loan losses amounted to $442,000 for the
quarter ended September 30, 1998, compared to the $395,000 loan loss provision
for the comparable quarter last year. For the nine-months ended September 30,
1998 and 1997, the provision was $1.2 million and $1.3 million, respectively.
The allowance for loan losses increased from $6.6 million at December 31, 1997
to $7.9 million at September 30, 1998 due to the year-to-date provision and net
recoveries.
The Company establishes provisions for loan losses, which are charged to
operations, in order to maintain the allowance for loan losses at a level which
is deemed to be appropriate based upon management's assessment of the risk
inherent in its loan portfolio in light of current economic conditions, actual
loss experience, industry trends and other factors which may affect the real
estate values in the Company's market area. In addition various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses. Such agencies may require the Company
to make additional provisions for estimated loan losses based upon judgements
different from those of management. While management believes the current
allowance for loan losses is adequate, actual losses are dependent upon future
events, and as such, future provisions for loan losses may be necessary. As part
of the Company's determination of the adequacy of the allowance for loan losses,
the Company monitors its loan portfolio through its Asset Classification
Committee. The Committee classifies loans depending on risk of loss
characteristics. The most severe classification before a charge-off is required
is "sub-standard." At September 30, 1998, the Company classified $5.4 million of
loans ($4.5 million at BFS and $891,000 at BNB) as sub-standard compared to $5.8
million ($4.3 million of BFS and $1.5 million of BNB) at December 31, 1997. The
Asset Classification Committee, which meets quarterly, determines the adequacy
of the allowance for loan losses through ongoing analysis of historical loss
experience, the composition of the loan portfolios, delinquency levels,
underlying collateral values, cash flow values and state of the real estate
economy. Utilizing these procedures, management believes that the allowance for
loan losses at September 30, 1998 was sufficient to provide for anticipated
losses inherent in the loan portfolio.
The Company's allowance for loan losses at September 30, 1998 was $7.9
million, which represented 779.7% of non-performing loans or .86% of total
loans, compared to $6.6 million at December 31, 1997, or 469.8% of
non-performing loans and .82% of total loans.
Non-performing loans at September 30, 1998 amounted to $1.0 million or .11%
of total loans, compared to $1.4 million, or .17% of total loans, at December
31, 1997.
The amount of interest income on non-performing loans that would have been
recorded had these loans been current in accordance with their original terms,
was $67,000 and $137,000 for the nine-month periods ended September 30, 1998 and
1997, respectively. The amount of interest income that was recorded on these
loans was $33,000 and $36,000 for the nine-month periods ended September 30,
1998 and 1997, respectively.
At September 30, 1998, loans characterized as impaired, (which include all
non-performing loans and some other sub-standard assets), pursuant to SFAS No.
114, "Accounting by Creditors for Impairment of a Loan", ("SFAS 114") and SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition
and Disclosure", ("SFAS 118") totaled $1.5 million. All of the impaired loans
have been measured using the fair value of the collateral method. During the
nine-months ended September 30, 1998, the average recorded value of impaired
loans was $1.5 million, $75,000 interest income was recognized and $110,000 of
interest income would have been recognized under the loans' original terms.
At September 30, 1998 and at December 31, 1997, the Company had $58,000 and
$195,000 in real estate owned, respectively. Further, at September 30, 1998 the
Company also had restructured real estate loans amounting to $214,000 for which
interest is being recorded in accordance with the loans' restructured terms. The
amount of the interest income lost on these restructured loans is not material
to the Company's financial statements.
16
Non-Interest Income
Total non-interest income in the third quarter of 1998 increased by
$203,000, or 15.4%, to $1.5 million from $1.3 million for the three months ended
September 30, 1997. The largest component of non-interest income was gain on
sale of loans, which increased to $704,000 during the quarter ended September
30, 1998, compared to $341,000 for the comparable quarter last year. For the
nine-months ended September 30, 1998, gain on sale of loans was $2.1 million,
compared to $723,000 for the comparable period in the prior year. The reason for
the increases were due to increased volume of fixed-rate loans originated and
sold during the current quarter and year to date period. Generally lower market
interest rates and the position of the interest rate yield curve have provided
many borrowers an opportunity to re-finance their mortgages to lower, and
generally fixed interest rates. The Company sells the majority of fixed-rate
loans it originates. The continuation of a strong housing market and economy
also contributed to increased volume for financing of home purchases. Loan
processing and servicing fees were $191,000 and $531,000 for the third quarter
and year to date, respectively, compared to $321,000 and $918,000, respectively,
for the comparable periods last year. The primary reasons for the declines were
due to decreasing balances of loans serviced that were sold before originated
mortgage servicing rights ("omsr") were recorded, and adjustments to the omsr of
$24,000 and $205,000, respectively, for the three- and nine-months ending
September 30, 1998 due to more rapid loan prepayments than previously estimated.
These conditions are expected to continue in the foreseeable future.
Non-Interest Expense
Total non-interest expense was $5.9 million for the quarter ended September
30, 1998 compared to $5.6 million for the comparable quarter in 1997. On a year
to date basis, total non-interest expense was $17.9 million for the nine-months
ended September 30, 1998 and $15.6 million for the prior year comparable period.
Compensation and benefits increased by $275,000, or 2.7%, from $10.0 million for
the nine-months ended September 30, 1997 to $10.3 million for the nine-months
ended September 30, 1998 due to normal year over year increases. Increased ESOP
expenses were offset by decreases in the cost of the stock-based incentive plan.
For the nine-months ended September 30, 1998, real estate operations earned
$40,000 compared to earnings of $1.2 million for the nine-months ended September
30, 1997. Approximately $891,000 of the $1.2 million was due to the sale of a
land sub-division by a subsidiary of BFS during the first quarter of 1997. Other
non-interest expenses increased to $5.0 million during the nine-months ended
September 30, 1998 from $4.2 million during the comparable quarter last year.
The major reasons for the increase were consulting and legal costs incurred to
assist in the implementation of certain tax planning strategies and the
inclusion of a full nine months of BNB's expenses for the current period.
Income Tax Expense
Income tax expense for the quarter ended September 30, 1998 was $1.3
million, compared to $1.5 million for the quarter ended September 30, 1997. The
effective income tax rate was 40.0% during the current quarter, compared to
47.1% for the quarter ended September 30, 1997. On a year to date basis, income
tax expense was $3.9 million, for an effective rate of 40.7%, compared to $4.3
million for an effective rate of 44.4% for the nine months ended September 30,
1997. As with the current quarter, the reason for the decreased tax expense and
effective tax rates during the current nine-months period was due to the
implementation of tax saving strategies.
17
Item 3. MARKET RISK AND MANAGEMENT OF INTEREST RATE RISK
The principal market risk affecting the Company is interest rate risk. The
objective of the Company's interest rate risk management function is to evaluate
the interest rate risk included in certain balance sheet accounts, determine the
level of risk appropriate given the Company's business strategy, operating
environment, capital and liquidity requirements and performance objectives, and
manage the risk consistent with Board of Directors' approved guidelines. Through
such management, the Company seeks to reduce the vulnerability of its operations
to changes in interest rates. The Company monitors its interest rate risk as
such risk relates to its operating strategies. The Company's Board of Directors
has established a management Asset/Liability Committee that is responsible for
reviewing the Company's asset/ liability policies and interest rate risk
position. The Committee reports trends and interest rate risk position to the
Board of Directors on a quarterly basis. The extent of the movement of interest
rates is an uncertainty that could have a negative impact on the earnings of the
Company.
In recent years, the Company has utilized the following strategies to
manage interest rate risk: (1) emphasizing the origination and retention of
adjustable-rate, one- to four-family mortgage loans; (2) generally selling in
the secondary market substantially all fixed-rate mortgage loans originated with
terms greater than 15 years while generally retaining the servicing rights
thereof; (3) primarily investing in investment securities or mortgage- backed
securities with adjustable interest rates; and (4) attempting to reduce the
overall interest rate sensitivity of liabilities by emphasizing longer-term
deposits and utilizing FHLB advances to replace rate sensitive deposits. The
volatile and generally rising rate environment of 1996 allowed the Company to
originate record loan volume, the majority of loans originated were
adjustable-rate loans, which were primarily retained for BFS's portfolio. Many
of these loans, however, do not reprice until the third or fifth year of their
term. As interest rates generally fell during the second half of 1997 and have
continued to fall during 1998, customer preference shifted to longer-term fixed
rate mortgages, many of which were sold in the secondary market.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring the Company's interest rate sensitivity "gap." An asset or liability
is said to be interest rate sensitive within a specific time period if it will
mature or reprice within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. These differences are
a primary component of the risk to net interest income. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. A gap is considered negative when the
amount of interest rate sensitive liabilities exceeds the amount of interest
rate sensitive assets. Accordingly, during a period of rising interest rates, an
institution with a positive gap position would be in a better position to invest
in higher yielding assets which, consequently, may result in the yield on its
assets increasing at a pace more closely matching the increase in the cost of
its interest-bearing liabilities than if it had a negative gap. During a period
of falling interest rates, an institution with a positive gap would tend to have
its assets repricing at a faster rate than one with a negative gap which,
consequently, may tend to restrain the growth of its net interest income.
Certain shortcomings are inherent in gap analysis. For example, although
certain assets and liabilities may have similar maturities or periods to
repricing, they may react in different degrees to changes in market interest
rates. Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Additionally, certain
assets, such as adjustable-rate loans, have features which restrict changes in
interest rates both on a short-term basis and over the life of the asset.
Further, in the event of change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in
calculating the table. Finally, the ability of many borrowers to service their
adjustable-rate loans may decrease in the event of an interest rate increase.
At September 30, 1998, the Company's one year gap was a positive 13.2% of
total assets, compared to a positive 10.2% of total assets at December 31, 1997.
The Company's interest rate sensitivity is also monitored by management
through the use of a model which internally generates estimates of the change in
net portfolio value (NPV") over a range of interest rate change scenarios. NPV
is the present value of expected cash flows from assets, liabilities, and
off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is
defined as the NPV in that scenario divided by the market value of assets in the
same scenario.
18
As in the case with the gap analysis, certain shortcomings are inherent in
the methodology used in the above interest rate risk measurements. Modeling
changes in NPV require the making of certain assumptions which may or may not
reflect the manner in which actual yields and costs respond to changes in market
interest rates. In this regard, the NPV model used assumes that the composition
of the Company's interest sensitive assets and liabilities existing at the
beginning of a period remains constant over the period being measured and also
assumes that a particular change in interest rates is reflected uniformly across
the yield curve regardless of the duration to maturity or repricing of specific
assets and liabilities. Accordingly, although the NPV measurements and net
interest income models provide an indication of the Company's interest rate risk
exposure at a particular point in time, such measurements are not intended to
and do not provide a precise forecast of the effect of changes in market
interest rates on the Company's net interest income and will differ from actual
results. See the Company's Form 10-K for the year ended December 31, 1997 for a
detail of the GAP and NPV tables. There have been no material changes in the net
portfolio value since December 31, 1997.
In addition to historical information, this 10-Q includes certain
forward-looking statements based on current management expectations. Generally,
verbs in the future tense and the words, "believe", "expect", "anticipate",
"intends", "opinion", "potential", and similar expressions identify
forward-looking statements. Examples of this forward-looking information can be
found in, but are not limited to, the allowance for losses discussion, Year 2000
issues and any quantitative and qualitative disclosur e about market risk. The
Company's actual results could differ materially from those management
expectations. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulations of
federal, state and local tax authorities, changes in interest rates, deposit
flows, the cost of funds, demand for loan products, demand for financial
services, competition, changes in the quality or composition of the Company'
loan and investment portfolios, changes in accounting principles, policies or
guidelines, and other economic, competitive, governmental and technological
factors (including Year 2000 problems) affecting the Company's operations,
markets, products, services and prices.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not involved in any pending material legal proceedings other
than routine legal proceedings occurring in the ordinary course of business.
Such routine legal proceedings, in the aggregate, are believed by management to
be immaterial to the Company's financial condition or results of operations.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
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Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Certificate of Incorporation*
3.2 Bylaws*
27 Financial Data Schedule
* Incorporated herein to the Company's Registration Statement on Form S-1,
as amended, (SEC No. 33-94860) originally filed on July 21, 1995
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BOSTONFED BANCORP, INC.
(Registrant)
Date: November 16, 1998 By: /s/ David F. Holland
__________________________________
David F. Holland
President and
Chief Executive Officer
Date: November 16, 1998 By: /s/ John A. Simas
__________________________________
John A. Simas
Executive Vice President,
Chief Financial Officer
and Corporate Secretary
21