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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
Commission File No.: 1-13936
BOSTONFED BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1940834
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
17 NEW ENGLAND EXECUTIVE PARK, BURLINGTON, MASSACHUSETTS 01803
(Address of principal executive offices)
Registrant's telephone number, including area code: (781) 273-0300
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK PAR VALUE $0.01 PER SHARE
(Title of class)
Securities registered pursuant to Section 12(g) of the Act: None
THE AMERICAN STOCK EXCHANGE
(Name of exchange on which registered)
The registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes X No .
-------- -------
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ---------
The aggregate market value of the voting and non-voting stock held by
non-affiliates of the registrant, i.e., persons other than directors and
executive officers of the registrant is $104.8 million and is based upon the
last sales price as quoted on the American Stock Exchange for March 6, 1998.
The number of shares of Common Stock outstanding as of March 6, 1998 is
5,492,637.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED
DECEMBER 31, 1997 ARE INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-K.
PORTIONS OF THE PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF
STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K.
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INDEX
PART I PAGE
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Item 1. Business............................................. 3
Item 2. Properties........................................... 41
Item 3. Legal Proceedings.................................... 41
Item 4. Submission of Matters to a Vote Security Holders..... 41
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholders Matters................................. 42
Item 6. Selected Financial Data.............................. 42
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 42
Item 7A. Quantitative and Qualitative Disclosure About
Market Risks......................................... 42
Item 8. Financial Statements and Supplementary Data ......... 42
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.................. 42
PART III
Item 10. Directors and Executive Officers of the Registrant... 42
Item 11. Executive Compensation............................... 43
Item 12. Security Ownership of Certain Beneficial Owners
and Management....................................... 43
Item 13. Certain Relationships and Related Transactions....... 43
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K.................................. 43
SIGNATURES ..................................................... 45
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PART I
ITEM 1. BUSINESS.
GENERAL
BostonFed Bancorp, Inc. (also referred to as the "Company" or "Registrant")
was incorporated under Delaware law on July 11, 1995, and subsequently became
the holding company for Boston Federal Savings Bank ("BFS"). On October 24,
1995, BFS completed its conversion from a mutual savings bank to a stock form of
ownership, while simultaneously, the Company issued 6,589,617 shares of common
stock utilizing a portion of the proceeds to acquire all of the stock of BFS. On
February 7, 1997, the Company acquired Broadway National Bank ("BNB"), using the
purchase method of accounting, at a cost of approximately $22 million.
The Company's business is conducted primarily through its ownership of BFS
and BNB (collectively, the "Banks"). BFS's administrative branch office is
located in Burlington, Massachusetts and its seven other branch offices are
located in Arlington, Bedford, Billerica, Boston, Lexington, Peabody and
Wellesley, all of which are in the greater Boston metropolitan area. As the
result of its acquisition of BNB, the Company added two banking offices (Chelsea
and Revere) to its franchise in the greater Boston metropolitan area. As a
result of the acquisition of BNB, a nationally chartered commercial bank, the
Company became a multi-bank holding company subject to regulation by the Federal
Reserve Bank ("FRB"). Prior to its acquisition of BNB, the Company was a savings
and loan holding company regulated by the Office of Thrift Supervision ("OTS")
and, as a result, was not subject to any significant restrictions on the types
of business activities in which it could engage. As a bank holding company, the
Company is subject to certain restrictions and requirements imposed by the FRB
on the activities in which the Company may engage and the assets in which the
Company may invest. The Company also remains subject to regulations of the
Office of Thrift Supervision ("OTS") for the first three years following the
initial public offering. See "Regulation and Supervision Holding Company
Regulation." 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 and results of
operations at and for the years ended December 31, 1997, include information and
data related to BNB only from February 8, 1997 to December 31, 1997.
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 commercial real estate,
construction and land, multi-family mortgage, equity lines of credit and
consumer loans. The Company originates loans for investment and loans for sale
in the secondary market, generally retaining the servicing rights for loans
sold. Loan sales are made from loans held in the Company's portfolio designated
as being held for sale or originated for sale during the period. The Company's
revenues are derived principally from interest on its mortgage loans, and to a
lesser extent, interest and dividends on its investment and mortgage-backed
securities, fees and loan servicing income. The Company's primary sources of
funds are retail deposits, wholesale brokered deposits, principal and interest
payments on loans, investments and mortgage-backed securities, Federal Home Loan
Bank-Boston ("FHLB") advances, repurchase agreements and proceeds from the sale
of loans.
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MARKET AREA AND COMPETITION
The Company has been, and intends to continue to be, a community-oriented
financial institution offering a variety of financial products and services to
meet the needs of the communities it serves. The Company's deposit gathering is
concentrated in the communities surrounding its offices while its lending base
extends throughout eastern Massachusetts and, to a lesser extent, other areas of
New England.
The Company faces significant competition both in generating loans and in
attracting deposits. The Boston metropolitan area is a highly competitive
market. The Company's share of deposits and loan originations in eastern
Massachusetts amounts to less than one percent. The Company faces direct
competition from a significant number of financial institutions operating in its
market area, many with a state-wide or regional presence and, in some cases, a
national presence. Many of these financial institutions are significantly larger
and have greater financial resources than the Company. The Company's competition
for loans comes principally from commercial banks, savings banks, mortgage
banking companies, credit unions and insurance companies. Its most direct
competition for deposits has historically come from savings and commercial
banks. In addition, the Company faces increasing competition for deposits from
non-bank institutions such as brokerage firms and insurance companies in such
instruments as short-term money market funds, corporate and government
securities funds, mutual funds and annuities.
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION. The Company's loan portfolio consists primarily
of first mortgage loans secured by one- to four-family residences. At December
31, 1997, the Company had total loans outstanding, including mortgage loans held
for sale, of $815.3 million, of which $702.1 million were one- to four-family,
residential mortgage loans, or 86.1% of the Company's total loans. At such date,
the remainder of the loan portfolio consisted of: $18.9 million of multi-family
residential loans, or 2.3% of total loans; $36.4 million of commercial real
estate loans, or 4.5% of total loans; $20.5 million of construction and land
loans, or 2.5% of total loans; and other loans, primarily home equity lines of
credit, of $37.5 million or 4.6% of total loans. The Company had $9.8 million of
mortgage loans held for sale at December 31, 1997 consisting of one- to
four-family fixed and variable-rate mortgage loans. At that same date, 75.9% of
the Company's mortgage loans had adjustable interest rates, most of which are
indexed to the one-year Constant Maturity Treasury ("CMT") Index.
The types of loans that the Company may originate are subject to federal
and state laws and regulations. Interest rates charged by the Company on loans
are affected by the demand for such loans and the supply of money available for
lending purposes and the rates offered by competitors. These factors are, in
turn, affected by, among other things, economic conditions, monetary policies of
the federal government, including the Federal Reserve Board, and legislative tax
policies.
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The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
AT DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------------------------
Mortgage Loans:
Residential:
One- to four-family (1).... $702,102 86.11% $607,792 88.00% $447,033 85.44% $427,716 84.77%
Multi-family............... 18,874 2.32 21,381 3.10 27,986 5.35 29,212 5.79
Commercial real estate....... 36,400 4.46 28,136 4.07 26,412 5.05 28,714 5.69
Construction and land........ 20,497 2.51 12,532 1.81 3,435 .66 3,450 0.68
Other loans2................... 37,465 4.60 20,850 3.02 18,343 3.50 15,504 3.07
-------- ------ ------- ------ -------- ------ ------- ------
Total loans.............. 815,338 100.00% 690,691 100.00% 523,209 100.00% 504,596 100.00%
====== ====== ====== ======
Less:
Allowance for loan losses.... (6,600) (4,400) (4,275) (3,700)
Construction loans in
process.................... (8,527) (6,936) (805) (1,076)
Net unearned discount on
loans purchased............ (114) (163) (262) (525)
Deferred loan origination
(fees) costs............... 1,448 1,448 560 96
-------- -------- -------- --------
Loans, net and mortgage
loans held for sale...... $801,545 $680,640 $518,427 $499,389
======== ======== ======== ========
- ---------------
1993
- ------------------------------------------------------------
PERCENT
AMOUNT OF TOTAL
- ------------------------------------------------------------
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------
Mortgage Loans:
Residential:
One- to four-family1....... $340,584 81.57%
Multi-family............... 30,418 7.28
Commercial real estate....... 24,548 5.88
Construction and land........ 4,704 1.13
Other loans2................... 17,276 4.14
------- ------
Total loans.............. 417,530 100.00%
======
Less:
Allowance for loan losses.... (4,450)
Construction loans in (1,175)
process....................
Net unearned discount on (489)
loans purchased............
Deferred loan origination 150
(fees) costs............... -------
Loans, net and mortgage $411,566
loans held for sale..... ========
- -----------------------------------
1 Includes mortgage loans held for sale of $9.8 million, $4.0 million, $8.9
million, $316,000 and $25.9 million at December 31, 1997, 1996, 1995, 1994
and 1993, respectively.
2 These loans primarily consist of one- to four-family lines of credit
secured by mostly second mortgages which amounted to $28.1 million, $17.4
million, $14.9 million, $12.8 million and $12.0 million at December 31,
1997, 1996, 1995, 1994 and 1993, respectively.
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LOAN MATURITY. The following table shows the remaining contractual maturity
of the Company's loans at December 31, 1997. There were $9.8 million of mortgage
loans held for sale at December 31, 1997. The table does not include the effect
of future principal prepayments. Principal prepayments on total loans were
$167.2 million, $95.4 million and $57.8 million for the years ended December 31,
1997, 1996 and 1995, respectively.
At December 31, 1997
- ----------------------------------------------------------------------------------------------------------------------------------
ONE- TO
FOUR- MULTI- COMMERCIAL CONSTRUCTION OTHER TOTAL
FAMILY FAMILY REAL ESTATE AND LAND LOANS LOANS
- ----------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Amounts due:
One year or less............................... $ 1,991 $ 61 $ 997 $12,185 $ 2,707 $ 17,941
After one year:
More than one year to three years........... 9,582 327 1,092 7,761 5,315 24,077
More than three years to five years......... 13,129 290 338 -- 4,772 18,529
More than five years to 10 years............ 57,900 1,480 537 -- 22,921 82,838
More than 10 years to 20 years.............. 108,605 4,820 13,593 111 1,338 128,467
More than 20 years.......................... 510,895 11,896 19,843 440 412 543,486
-------- ------- ------- ------- ------- -------
Total due after one year.................... 700,111 18,813 35,403 8,312 34,758 797,397
-------- ------- ------- ------- ------- -------
Total amount due............................ $702,102 $18,874 $36,400 $20,497 $37,465 815,338
======== ======= ======= ======= =======
Less:
Allowance for loan losses............ (6,600)
Construction loans in process........ (8,527)
Net unearned discount on loans
purchased .................... (114)
Deferred loan origination costs...... 1,448
--------
Loans, net, and mortgage loans held for sale 801,545
Mortgage loans held for sale................ (9,817)
--------
Loans, net.................................. $791,728
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The following table sets forth at December 31, 1997 the dollar amount of
loans contractually due after December 31, 1998, and whether such loans have
fixed interest rates or adjustable interest rates.
DUE AFTER DECEMBER 31, 1998
----------------------------------------
FIXED ADJUSTABLE TOTAL
--------- ---------- ---------
(IN THOUSANDS)
Mortgage loans:
Residential:
One- to four-family........... $169,923 $530,188 $700,111
Multi-family.................. 1,700 17,113 18,813
Commercial real estate.......... 2,089 33,314 35,403
Construction and land........... 183 8,129 8,312
Other loans........................ 4,574 30,184 34,758
-------- -------- --------
Total loans ................ $178,469 $618,928 $797,397
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ORIGINATION, SALE, SERVICING AND PURCHASE OF LOANS. The Company's mortgage
lending activities are conducted primarily by its commissioned loan personnel,
through its ten branch offices, and through wholesale brokers and other
financial institutions approved by the Company. All loans originated by the
Company, either through internal sources or through wholesale brokers or other
correspondent financial institutions are underwritten by the Company pursuant to
the Company's policies and procedures. The Company originates both
adjustable-rate and fixed-rate mortgage loans. The Company's ability to
originate loans is dependent upon the relative customer demand for fixed-rate or
adjustable-rate loans, which is affected by the current and expected future
level of interest rates. While the Company has in the past, from time to time,
sold adjustable-rate one- to four-family loans, it is currently the general
policy of the Company to sell a substantial majority of the one- to four-family
fixed-rate mortgage loans with maturities over ten years that it originates and
to retain a substantial majority of adjustable-rate and fixed-rate loans with
maturities of ten years or less of the one- to four-family mortgage loans which
it originates. The Company retains the servicing of loans sold in most cases. At
December 31, 1997, the Company serviced $549.4 million of loans for others. The
Company recognizes, at the time of sale, the cash gain or loss on the sale of
the loans based on the difference between the net cash proceeds received and the
carrying value of the loans sold. See "- Lending Activities - Loan Servicing."
At December 31, 1997, the Company had $9.8 million of mortgage loans held for
sale consisting of fixed and adjustable-rate one- to four-family loans. The
Company has, in the past, from time to time, purchased loans or participations
of loans, primarily one- to four-family mortgage loans, and had $7.3 million of
purchased loans at December 31, 1997. With the exception of purchases of loans
from correspondent financial institutions, which are underwritten pursuant to
the Company's policies and closed in the name of the correspondent financial
institution but immediately purchased by the Company for its mortgage banking
activities, the Company currently does not purchase loans or participate in
loans.
The Company engages in certain hedging activities to facilitate the sale of
its originated and purchased mortgage loans in an attempt to minimize interest
rate risk from the time the loan commitments are made to the time until the
loans are securitized or packaged and sold. The Company currently utilizes
forward loan sale commitment contracts with Fannie Mae ("FNMA"), Freddie Mac
("FHLMC"), and other
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approved investors as its method of hedging loan sales in an attempt to protect
the Company from fluctuations in market interest rates. Generally, the Company
will enter into contracts to deliver loans or agency mortgage-backed securities
to purchasers at a future date for a specified price while the Company
simultaneously processes and closes loans, thereby protecting the price of
currently processed loans from interest rate fluctuations that may occur from
the time the interest rate on the loan is fixed to the time of sale. As loans
are closed and funded, they may also be pooled to create mortgage-backed
securities which will be delivered to fulfill the forward commitment contracts.
The amount of forward coverage of the "pipeline" of mortgages is set on a
day-to-day basis by an operating officer, within policy guidelines, based on the
Company's assessment of the general direction of interest rates and levels of
mortgage-origination activity. For the year ended December 31, 1997, the Company
had $1.1 million in net gains attributable to the sale of loans. These gains
were primarily the result of implementation of FASB 122, "Accounting for
Mortgage Servicing Rights."
The following table sets forth the Company's loan originations, purchases,
sales and principal repayments for the periods indicated:
For the Year Ended December 31,
------------------------------------
1997 1996 1995
---------- -------- --------
(In thousands)
Net loans:
Beginning balance.................................... $ 676,670 $509,496 $499,073
Loans originated:
One- to four-family........................... 321,039 362,534 146,303
Multi-family.................................. 869 4,204 440
Commercial real estate........................ 7,294 5,942 906
Construction and land......................... 16,870 11,638 5,728
Other(1)...................................... 34,055 16,124 11,356
---------- -------- --------
Total loans originated........................ 380,127 400,442 164,733
Loans purchased2................................. 17,013 46,208 6,356
Loans from BNB acquisition....................... 66,093 -- --
---------- -------- --------
Total..................................... 1,139,903 956,146 670,162
Less:
Principal repayments and other, net.............. (226,143) (122,346) (77,937)
Loan charge-offs, net............................ (116) (1,169) (3,039)
Sale of mortgage loans........................... (111,566) (148,025) (69,426)
Transfer of mortgage loans to real estate owned.. (533) (3,966) (1,333)
---------- -------- --------
Loans, net and mortgage loans held for sale.......... 801,545 680,640 518,427
Mortgage loans held for sale..................... (9,817) (3,970) (8,931)
---------- -------- --------
Loans, net .......................................... $ 791,728 $676,670 $509,496
========== ======== ========
- ---------------------------
1 Other loans primarily consist of one- to four-family lines of credit
secured by mortgages. The amounts indicated primarily include new amounts
drawn on such home-equity lines of credit during the periods presented.
2 Includes loans purchased from correspondent financial institutions which
are underwritten pursuant to the Company's policies and closed in the name
of the financial institution but immediately purchased by the Company for
its mortgage banking activities.
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The Company offers both fixed-rate
and adjustable-rate mortgage loans secured by one- to four-family residences
located in the Company's primary market area, with maturities of up to thirty
years. Substantially all of such loans are secured by property located in the
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Company's primary market area. Loan originations are obtained at the Company's
branch offices and from the Company's commissioned loan representatives,
correspondent banking relationships and wholesale brokers and their contacts
with the local real estate industry, existing or past customers, and members of
the local communities.
At December 31, 1997, the Company's total loans outstanding were $815.3
million, of which $702.1 million, or 86.1%, were one- to four-family residential
mortgage loans, most of which were primarily owner-occupied properties. Of the
one- to four-family residential mortgage loans outstanding at that date, 25.5%
were fixed-rate loans, and 74.5% were adjustable-rate mortgage loans. The
interest rates for the majority of the Company's adjustable-rate mortgage loans
are indexed to the Constant Maturity Treasury Index (the "CMT Index"). The
Company currently offers fixed-rate mortgage loans with amortization periods of
five to thirty years. The Company currently offers a number of adjustable-rate
mortgage loan programs with interest rates which adjust annually with
amortization schedules of ten to thirty years. The Company's adjustable-rate
mortgage loans are originated with interest rates which are fixed for an initial
period of one, three, five or seven years and at the end of such period will
adjust thereafter either annually or a greater period according to their terms.
The Company's one- to four-family adjustable-rate loan products generally
reprice based on a margin, currently 287 to 325 basis points, over the CMT Index
for the Treasury security of a maturity which is comparable to the interest
adjustment period for the loan. Generally, all of the Company's adjustable-rate
mortgage loans provide for periodic (generally 2%) and overall caps (generally
6%) on the increase or decrease in interest rate at any adjustment date and over
the life of the loan. Included in the Company's adjustable-rate mortgage loan
portfolio is a type of adjustable-rate loan which was originated at an interest
rate below the fully-indexed rate and which limits the adjustment of the
interest rate to 1% annually and 6% over the life of the loan. The Company also
offers a single-family loan product which has been popular with its customers
consisting of a fixed-rate loan up to the conforming FNMA/FHLMC limit of
$227,000 coupled with a second mortgage adjustable-rate loan for the amount of
the loan in excess of the FNMA/FHLMC limit. After origination, the Company will
typically sell the fixed-rate portion of the loan (to FNMA/FHLMC) and retain the
adjustable-rate second mortgage portion of the loan for its portfolio. During
1997, the Company's retained portion of this loan product was $4.1 million, or
1.1% of total originations.
The Company generally originates one- to four-family residential mortgage
loans in amounts up to 80% of the lower of the appraised value or the selling
price of the property securing the loan and up to 95% of the appraised value or
selling price if private mortgage insurance is obtained on the portion of the
loan in excess of 75% of the lesser of the appraised value or selling price.
However, the Company may originate single-family owner-occupied mortgage loans
in amounts up to 85% of the lesser of the appraised value or selling price
without private mortgage insurance. Mortgage loans originated by the Company
generally include due-on-sale clauses which provide the Company with the
contractual right to deem the loan immediately due and payable in the event the
borrower transfers ownership of the property without the Company's consent.
Due-on-sale clauses are an important means of adjusting the rates on the
Company's fixed-rate mortgage loan portfolio and the Company has generally
exercised its rights under these clauses.
MULTI-FAMILY MORTGAGE LENDING. The Company originates multi-family mortgage
loans generally secured by 5 to 120 unit apartment buildings located in the
Company's primary market area. The Company currently originates multi-family
loans on a limited and selective basis. In reaching its decision on whether to
make a multi-family loan, the Company considers the value of the underlying
property as well as the qualifications of the borrower. Other factors relating
to the property to be considered are: the net operating income of the mortgaged
premises before debt service and depreciation; the debt service ratio (the ratio
of earnings before debt service to debt service); and the ratio of loan amount
to appraised value. The Company generally requires a debt service ratio of 115%
or greater. Pursuant to the Company's current underwriting policies, a
multi-family mortgage loan may only be made in an amount up to 85% of the
appraised value of the underlying property to a maximum amount of $4.0 million.
However, generally loans are not granted
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which exceed 80% of the appraised value. Generally, all multi-family loans made
to corporations, partnerships and other business entities require personal
guarantees by the principal borrowers. On an exception basis, the Company may
not require a personal guarantee on such loans depending on the creditworthiness
of the borrower and amount of the down payment.
When evaluating the qualifications of the borrower for a multi-family loan,
the Company considers the financial resources and income level of the borrower,
the borrower's experience in owning or managing similar property, and the
Company's lending experience with the borrower. The Company's underwriting
guidelines require that the borrower be able to demonstrate strong management
skills and the ability to maintain the property from current rental income. The
borrower is required to present evidence of the ability to repay the mortgage
and a history of making mortgage payments on a timely basis. In making its
assessment of the creditworthiness of the borrower, the Company generally
reviews the financial statements, employment and credit history of the borrower,
as well as other related documentation. The Company's multi-family loan
portfolio at December 31, 1997, totalled $18.9 million or 2.3% of total loans.
The Company's largest multi-family loan at December 31, 1997, was a $3.4 million
performing loan secured by a 118 unit apartment complex located in Malden,
Massachusetts.
Loans secured by apartment buildings and other multi-family residential
properties are generally larger and involve a greater degree of risk than one-
to four-family residential mortgage loans. Because payments on loans secured by
multi-family properties are often dependent on successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to the then prevailing conditions in the real estate market or
the economy. The Company seeks to minimize these risks through its underwriting
policies.
COMMERCIAL REAL ESTATE LENDING. The Company originates commercial real
estate loans that are secured by properties generally used for business purposes
such as small office buildings or retail facilities located in the Company's
primary market area. The Company's underwriting procedures provide that
commercial real estate loans may be made in amounts up to the lesser of 85% of
the appraised value of the property, or the Company's current loan limit which
is $4.0 million. However, generally loans are not granted which exceed 80% of
the appraised value. The Company currently originates commercial real estate
loans with terms of up to thirty years the majority of which contain
adjustable-rates and are indexed to the CMT Index. The Company's underwriting
standards and procedures are similar to those applicable to its multi-family
loans, whereby the Company considers the net operating income of the property
and the borrower's expertise, credit history and profitability. The Company has
generally required that the properties securing commercial real estate loans
have debt service coverage ratios of at least 115%. Generally, all commercial
real estate loans made to corporations, partnerships and other business entities
require personal guarantees by the principal borrowers. On an exception basis,
the Company may not require a personal guarantee on such loans depending on the
creditworthiness of the borrowers and the amount of the down payment. The
Company's commercial real estate loan portfolio at December 31, 1997 was $36.4
million, or 4.5% of total loans. The largest commercial real estate loan in the
Company's portfolio at December 31, 1997 was a $2.8 million performing loan
secured by an office building located in Watertown, Massachusetts.
Loans secured by commercial real estate properties are generally larger and
involve a greater degree of risk than one- to four-family residential mortgage
loans. Because payments on loans secured by commercial real estate properties
are often dependent on successful operation or management of the properties,
repayment of such loans may be subject to a greater extent to the then
prevailing conditions in the real estate market or the economy. The Company
seeks to minimize these risks through its underwriting standards.
CONSTRUCTION AND LAND LENDING. The Company originates loans for the
acquisition and development of property to licensed and experienced contractors
in its primary market area. The Company's
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construction loans primarily have been made to finance the construction of one-
to four-family, owner-occupied residential properties. While the Company
originates loans secured by raw land, the Company generally does not originate
such loans unless the borrower has also secured financing with the Company for
the construction of structures on the property. These loans are primarily
adjustable-rate loans with maturities of less than two years. Construction and
land mortgage loans are originated in amounts up to 75% of the lesser of the
appraised value of the property, as improved, or sales price, unless such loan
is for the construction of a residential property which cannot exceed an 80%
loan to value ("LTV") ratio. Proceeds of such loans are dispersed as phases of
the construction are completed. Generally, if the borrower is a corporation,
partnership or other business entity, personal guarantees by the principal
borrowers are required. However, personal guarantees may not be required on such
loans depending on the creditworthiness of the borrower and amount of the down
payment. The Company's current loan limit is $4.0 million. The Company's largest
construction and land loan at December 31, 1997 was a performing loan with a
$4.0 million revolving line of credit with a carrying balance of $2.0 million
and secured by the remaining 60 lots in a 70 unit residential subdivision in
Southborough, Massachusetts. At December 31, 1997, the Company had $20.5 million
of construction and land loans which amounted to 2.5% of the Company's total
loan portfolio. Working with experienced land developers in the local community,
the Company will continue to expand this area of its lending business.
Construction and land financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development compared to the estimated cost (including interest)
of construction. If the estimate of value proves to be inaccurate, the Company
may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
OTHER LENDING. Other loans at December 31, 1997, amounting to $37.5 million
or 4.6% of the Company's total loan portfolio, consisted primarily of home
equity and improvement loans, and, to a significantly lesser extent, new and
used automobile loans originated by the Company, personal loans, student loans,
business loans and loans secured by savings accounts. Such loans are generally
originated in the Company's primary market area and generally are secured by
real estate, personal property, savings accounts and automobiles. These loans
are shorter term and generally contain higher interest rates than residential
mortgage loans.
Substantially all of the Company's home equity lines of credit are
primarily secured by second mortgages on one- to two-family residences located
in the Company's primary market area. At December 31, 1997, these loans totalled
$28.1 million, or 3.4% of the Company's total loans and 74.9% of other loans.
Generally, under the terms of the Company's home equity lines of credit,
borrowers have the ability to draw on such lines and repay outstanding principal
and interest on a monthly basis on a certain percentage of the outstanding
principal over a period of up to ten years and, thereafter, the outstanding
balance drawn on such lines is converted to an adjustable-rate loan with terms
of up to ten years. The underwriting standards employed by the Company for these
loans include a determination of the applicant's credit history and an
assessment of the applicant's ability to meet existing obligations and payments
on the proposed loan and the value of the collateral securing the loan. The
stability of the applicant's monthly income may be determined by verification of
gross monthly income from primary employment and, additionally, from any
verifiable secondary income. Creditworthiness of the applicant is of primary
consideration.
Loans secured by rapidly depreciable assets such as automobiles or that are
unsecured entail greater risks than one- to four-family residential mortgage
loans. In such cases, repossessed collateral for a defaulted loan may not
provide an adequate source of repayment of the outstanding loan balance, since
there is a greater likelihood of damage, loss or depreciation of the underlying
collateral. Further, consumer loan collections on these loans are dependent on
the borrower's continuing financial stability and, therefore, are
11
12
more likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Finally, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans in the event of a default.
LOAN APPROVAL PROCEDURES AND AUTHORITY. The Board of Directors establishes
the lending policies and loan approval limits of the Bank. Such limits are
included in a matrix with the corresponding level of authority requirements. At
BFS, Board of Directors' approval is required on all one- to four-family loans
in excess of $1.5 million and on all commercial real estate, multi-family and
non-owner occupied construction loans in excess of $2.0 million. At BNB, a
similar matrix has been established and Board of Directors' approval is required
on all loans in excess of $400,000.
Pursuant to OTS and Office of the Comptroller of the Currency ("OCC")
regulations, loans to one borrower cannot, subject to certain exceptions, exceed
15% of the Bank's unimpaired capital and surplus. At December 31, 1997, the
loans to one borrower limit was $8.3 million and $1.9 million for BFS and BNB,
respectively.
LOAN SERVICING. The Company also services mortgage loans for others.
Loan servicing includes collecting and remitting loan payments, accounting for
principal and interest, making inspections as required of mortgaged premises,
contacting delinquent mortgagors, supervising foreclosures and property
dispositions in the event of unremedied defaults, making certain insurance and
tax payments on behalf of the borrowers and generally administering the loans.
All of the loans currently being serviced for others are loans which have been
sold by the Company. At December 31, 1997, the Company was servicing $549.4
million of loans for others. The gross servicing fee income from loans
originated and purchased is generally .25% to .38% of the total balance of the
loan serviced. The Company currently does not purchase servicing rights related
to mortgage loans originated by other institutions. The Company recognizes the
present value of the servicing income, net of servicing expenses, attributable
to servicing rights upon sale of the loan. The Company amortizes the capitalized
mortgage servicing rights using a method which approximates the level yield
method in proportion to, and over the period of, estimated net servicing income.
The Company reviews prepayment activity on its serviced loans at least quarterly
and adjusts its capitalized mortgage servicing rights amortization schedule
accordingly. As of December 31, 1997, the Company had $1.8 million of
capitalized mortgage servicing rights.
NONPERFORMING AND PROBLEM ASSETS.
CLASSIFIED ASSETS. Federal regulations and the Company's Asset
Classification Policy require that the Company utilize an internal asset
classification system as a means of reporting problem and potential problem
assets. The Company has incorporated the OTS and OCC internal asset
classifications for BFS and BNB, respectively, as a part of its credit
monitoring system. The Company currently classifies problem and potential
problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is
considered "Substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "Doubtful" have all of the weaknesses
inherent in those classified "Substandard" with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." Assets classified as "Loss" are those considered "uncollectible"
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted. Assets which do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are required to be designated "Special Mention."
12
13
When an insured institution classifies one or more assets, or portions
thereof, as "Substandard" or "Doubtful," it is required to establish a general
valuation allowance for loan losses in an amount deemed prudent by management.
General valuation allowances represent loss allowances which have been
established to recognize the inherent risk associated with lending activities,
but which, unlike specific allowances, have not been allocated to particular
problem assets. When an insured institution classifies one or more assets, or
portions thereof, as "Loss," it is required either to establish a specific
allowance for losses equal to 100% of the amount of the asset so classified or
to charge off such amount.
BFS's and BNB's determination as to the classification of its assets and
the amount of its valuation allowances is subject to review by the OTS and OCC,
respectively, which can order the establishment of additional general or
specific loss allowances. The OTS and OCC, in conjunction with the other federal
banking agencies, have adopted an interagency policy statement on the allowance
for loan and lease losses. The policy statement provides guidance for financial
institutions on both the responsibilities of management for the assessment and
establishment of adequate allowances and guidance for banking agency examiners
to use in determining the adequacy of general valuation guidelines. Generally,
the policy statement recommends that institutions have effective systems and
controls to identify, monitor and address asset quality problems; that
management has analyzed all significant factors that affect the collectibility
of the portfolio in a reasonable manner; and that management has established
acceptable allowance evaluation processes that meet the objectives set forth in
the policy statement. As a result of the declines in local and regional real
estate market values and the significant losses experienced by many financial
institutions just a few years ago, there has been a greater level of scrutiny by
regulatory authorities of the loan portfolios of financial institutions
undertaken as part of the examination of institutions by the OTS, OCC and the
Federal Deposit Insurance Corporation ("FDIC"). While the Company believes that
it has established an adequate allowance for loan losses, there can be no
assurance that regulators, in reviewing the Company's loan portfolio, will not
request the Company to materially increase its allowance for loan losses,
thereby negatively affecting the Company's financial condition and earnings at
that time. Although management believes that, based on information currently
available to it, its allowance for loan losses is adequate, actual losses are
dependent upon future events and, as such, further additions to the level of
allowances for loan losses may become necessary.
BFS's Asset Classification Committee reviews and classifies assets on a
quarterly basis and reports the results of its review to the Board of Directors.
BNB's assets are reviewed by a non-lending officer who reports classifications
to the BNB Board on a quarterly basis. The Company classifies assets in
accordance with the management guidelines described above. At December 31, 1997,
the Company had, on a consolidated basis, $3.6 million of assets designated as
"Special Mention," $5.8 million of assets designated as "Substandard," no assets
designated as "Doubtful" and $2.2 million of assets designated as "Loss." All
assets classified as "Loss" have been charged off for financial statement
purposes. Included in these amounts was $1.4 million in non-performing loans at
December 31, 1997. In the opinion of management, the remaining special mention
and "Substandard" loans of $8.0 million evidence one or more weaknesses or
potential weaknesses and, depending on the regional economy and other factors,
may become non-performing assets in future periods.
13
14
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996
- -----------------------------------------------------------------------------------------------------------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
- -----------------------------------------------------------------------------------------------------------------------------------
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
- -----------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Residential:
One- to four-family..... 36 $3,313 14 $865 15 $1,481 24 $1,463
Multi-family............ -- -- -- -- 1 60 -- --
Commercial real estate....... -- -- 3 21 -- -- -- --
Construction and land........ -- -- -- -- -- -- -- --
Other loans.................. 6 139 3 6 4 56 3 14
-- ------ -- ---- -- ------ -- ------
Total........................ 42 $3,452 20 $892 20 $1,597 27 $1,477
== ====== == ==== == ====== == ======
Delinquent loans to loans,
net and mortgage loans
held for sale........... 0.43% 0.11% 0.23% 0.22%
AT DECEMBER 31, 1995
- -----------------------------------------------------------------------------------------
60-89 DAYS 90 DAYS OR MORE
- -----------------------------------------------------------------------------------------
PRINCIPAL PRINCIPAL
NUMBER BALANCE NUMBER BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS
- -----------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
- -----------------------------------------------------------------------------------------
Residential:
One- to four-family........ 11 $ 923 23 $1,178
Multi-family............... -- -- 1 720
Commercial real estate.......... 1 202 4 2,693
Construction and land........... -- -- -- --
Other loans..................... -- -- -- --
-- ------ -- ------
Total........................... 12 $1,125 28 $4,591
== ====== == ======
Delinquent loans to loans, net
and mortgage loans held
for sale .................. 0.22% 0.89%
14
15
NON-PERFORMING ASSETS AND RESTRUCTURED LOANS. The following table sets
forth information regarding non-accrual loans, restructured loans and real
estate owned ("REO"). At December 31, 1997, restructured loans totalled
$369,000, consisting of 3 loans, and REO, net, totalled $195,000, consisting of
6 properties. It is the policy of the Company to cease accruing interest on
loans 90 days or more past due and charging off all accrued interest. For the
years ended December 31, 1997, 1996, 1995, 1994 and 1993, the amount of
additional interest income that would have been recognized on non-accrual loans
if such loans had continued to perform in accordance with their contractual
terms was $146,000, $103,000, $303,000, $281,000 and $421,000, respectively. For
the same periods, the difference between the amount of interest income which
would have been recognized on restructured loans if such loans were performing
in accordance with their regular terms and amounts recognized was $1,000,
$73,000, $77,000, $294,000 and $461,000, respectively.
AT DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Non-accrual loans:
Residential real estate:
One- to four-family...................... $ 941 $1,463 $1,195 $ 848 $ 2,088
Multi-family............................. -- -- 745 546 --
Construction and land...................... -- -- -- -- 738
Commercial real estate..................... 458 25 3,312 2,126 --
Other loans................................ 6 14 -- 51 14
------ ------ ------ ------ -------
Total.................................... 1,405 1,502 5,252 3,571 2,840
Real estate owned, net (1)................... 195 2,668 971 387 3,103
------ ------ ------ ------ -------
Total non-performing assets.............. 1,600 4,170 6,223 3,958 5,943
Restructured loans........................... 369 2,489 2,941 4,834 4,668
------ ------ ------ ------ -------
Total risk elements.......................... $1,969 $6,659 $9,164 $8,792 $10,611
====== ====== ====== ====== =======
Allowance for loan losses as a percent
of loans(2)................................ 0.82% 0.64% 0.82% 0.74% 1.07%
Allowance for loan losses as a percent
of non-performing loans (3)................ 469.75 293.02 81.40 103.61 156.69
Non-performing loans as a percent 0.17
of loans (2,3)............................. 0.22 1.00 0.71 0.68
Non-performing assets as a percent 0.16
of total assets4........................... 0.51 0.97 0.68 1.19
- ------------------------------------------------------
1 Loans includes loans, net and mortgage loans held for sale, excluding
allowance for loan losses.
2 Non-performing loans consist of all 90 days or more past due and other
loans which have been identified by the Company as presenting uncertainty
with respect to the collectability of interest or principal.
3 REO balances are shown net of related valuation allowances.
4 Non-performing assets consist of non-performing loans and REO.
15
16
The Company adopted a new accounting method for measuring loan impairment
on January 1, 1995. Adoption of this accounting standard did not have a material
effect on the comparability of the above tables. At December 31, 1997, loans
which were characterized as impaired pursuant to SFAS 114 and 118 totalled $2.1
million. All of the $2.1 million in impaired loans have been measured using the
fair value of the collateral method. During the year ended December 31, 1997,
the average recorded value of impaired loans was $3.8 million, $139,000 of
interest income was recognized, all of which was recorded on a cash basis, and
$286,000 of interest income would have been recognized under original terms.
AT DECEMBER 31,
- -------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------
(IN THOUSANDS)
Impaired loans:
Residential real estate:
One- to four-family $ 999 $1,763 $2,828
Multi-family 316 2,271 1,367
Construction and land -- -- --
Commercial real estate 677 246 4,062
Other loans 99 112 99
Impaired loan valuation allowance -- -- (618)
------ ------ ------
Total $2,091 $4,392 $7,738
====== ====== ======
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to cover
estimated losses in loans receivable which are deemed probable and estimable
based on information currently known to management. Amounts provided for fiscal
years 1997, 1996, 1995, 1994 and 1993 were $1.7 million, $1.3 million, $3.6
million, $283,000 and $3.9 million, respectively. During the year ended 1997,
there were recoveries of $399,000 and charge-offs of $515,000 made against this
allowance. The allowance is based upon a number of factors, including current
economic conditions, actual loss experience and industry trends. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to make additional provisions for estimated loan losses
based upon judgments different from those of management. As of December 31,
1997, the Company's allowance for loan losses was 0.82% of total loans as
compared to 0.64% as of December 31, 1996. Management believes this increased
coverage ratio is prudent due to the balance increase in the combined total of
construction and land, commercial real estate, home equity and improvement and
consumer loans. These combined total balances increased from $59.8 million at
December 31, 1996 to $91.5 million at December 31, 1997, an increase of 53% due
in large part to the inclusion of BNB's balances. The Company had non-accrual
loans of $1.4 million and $1.5 million at December 31, 1997 and December 31,
1996, respectively. The Company will continue to monitor and modify its
allowance for loan losses as conditions dictate. While management believes the
Company's allowance for loan losses is sufficient to cover losses inherent in
its loan portfolio at this time, no assurances can be given that the Company's
level of allowance for loan losses will be sufficient to cover future loan
losses incurred by the Company or that future adjustments to the allowance for
loan losses will not be necessary if economic and other conditions differ
substantially from the economic and other conditions used by management to
determine the current level of the allowance for loan losses.
16
17
The following table sets forth activity in the Company's allowance for
loan losses for the periods set forth in the following table.
AT OR FOR THE YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Balance at beginning of period.............. $4,400 $4,275 $3,700 $4,450 $4,381
BNB allowance for loan losses
at acquisition date...................... 620 -- -- -- --
Provision for loan losses................... 1,696 1,294 3,614 283 3,918
Charge-offs:
Real estate loans:
Residential:
One- to four-family..................... 370 387 550 711 2,114
Multi-family............................ 84 263 483 251 1,114
Commercial................................ 45 664 2,297 200 805
Construction and land..................... -- -- -- -- 4
Other..................................... 16 198 194 56 17
------ ------ ------ ------ ------
Total.................................. 515 1,512 3,524 1,218 4,054
Recoveries.................................. 399 343 485 185 205
------ ------ ------ ------ ------
Balance at end of period.................... $6,600 $4,400 $4,275 $3,700 $4,450
====== ====== ====== ====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period............. 0.02% 0.19% 0.60% 0.23% 0.94%
==== ==== ==== ==== ====
17
18
The following tables set forth the Company's percent of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated.
AT DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------------
1997 1996
- ------------------------------------------------------------------------------------------------------------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
ALLOWANCE LOANS IN ALLOWANCE LOANS IN
TO TOTAL EACH CATEGORY TO TOTAL EACH CATEGORY
AMOUNT ALLOWANCE TO TOTAL LOANS AMOUNT ALLOWANCE TO TOTAL LOANS
- ------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------------
Residential:
One- to four-family. $1,997 30.26% 86.11% $1,899 43.16% 88.00%
Multi-family........ 206 3.12 2.32 274 6.23 3.10
Commercial real estate 369 5.59 4.46 451 10.25 4.07
Construction and land. 152 2.30 2.51 463 10.52 1.81
Other loans........... 266 4.03 4.60 61 1.39 3.02
Unallocated........... 3,610 54.70 -- 1,252 28.45 --
------ ------ ------- ------ ------- ------
Total allowance
for loan losses. $6,600 100.00% 100.00% $4,400 100.00% 100.00%
====== ====== ======= ====== ======= ======
AT DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------
1995 1994 1993
- --------------------------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF LOANS OF OF LOANS OF OF LOANS
ALLOWANCE IN EACH ALLOWANCE IN EACH ALLOWANCE IN EACH
TO CATEGORY TO CATEGORY TO CATEGORY
TOTAL TO TOTAL TOTAL TO TOTAL TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------------------------------------------
Residential:
One- to four family $1,974 46.18% 85.44% $1,309 35.38% 84.77% $1,467 32.97% 81.57%
Multi-family........ 373 8.72 5.35 393 10.62 5.79 369 8.29 7.28
Commercial real
estate.............. 1,285 30.06 5.05 655 17.70 5.69 646 14.52 5.88
Construction and land 580 13.57 0.66 416 11.24 0.68 594 13.35 1.13
Other loans.......... 47 1.10 3.50 92 2.49 3.07 98 2.20 4.14
Unallocated.......... 16 0.37 -- 835 22.57 -- 1,276 28.67 --
------ ------- ------ ----- ------ ----- ------ ------ ------
Total allowance
for loan losses.. $4,275 100.00% 100.00% $3,700 100.00% 100.00% $4,450 100.00% 100.00%
====== ======= ====== ====== ====== ====== ====== ====== ======
18
19
REAL ESTATE OWNED
At December 31, 1997, the Company had $195,000 of real estate owned, net of
valuation allowances. When the Company acquires property through foreclosure or
deed in lieu of foreclosure, it is initially recorded at the lower of the
recorded investment in the corresponding loan or the fair value of the related
assets at the date of foreclosure, less costs to sell. Thereafter, if there is a
further deterioration in value, the Company provides for a specific valuation
allowance and charges operations for the diminution in value. It is the policy
of the Company to have obtained an appraisal on all real estate subject to
foreclosure proceedings prior to the time of foreclosure. It is the Company's
policy to require appraisals on a periodic basis on foreclosed properties and
conduct periodic inspections on foreclosed properties.
INVESTMENT ACTIVITIES
The investment policy of the Company, as approved by the Board of
Directors, requires management to maintain adequate liquidity, generate a
favorable return on investments without incurring undue interest rate and credit
risk and to complement the Company's lending activities. Generally, the
Company's investment policy is more restrictive than the OTS and OCC regulations
allow and, accordingly, the Company has invested primarily in U.S. Government
and Agency securities, FDIC insured certificates of deposit, mutual funds which
qualify as liquid assets under the OTS regulations, federal funds and U.S.
government sponsored agency issued mortgage-backed securities. As required by
SFAS 115, the Company has established an investment portfolio of securities that
are categorized as held to maturity, available for sale or held for trading. The
Company does not currently maintain a portfolio of securities categorized as
held for trading. The substantial majority of the Company's investment and
mortgage-backed securities are purchased for the held to maturity portfolio
which such portfolio totalled $59.0 million, or 6.1% of assets. At December 31,
1997, the available for sale portfolio totalled $50.9 million or 5.2% of the
Company's assets. The investment policy provides different management levels of
approval, from the investment officer up to and including the Board of
Directors, depending on the size of purchase or sale and monthly cumulative
purchase or sale amounts. Generally, pursuant to the Company's policies, the
Board must provide prior approval for all individual securities investments over
$10.0 million and approval for all monthly purchases which aggregate $25.0
million or more.BFS's Investment Committee and BNB's Board are provided with
summaries of the held to maturity and available for sale investment portfolios
of BFS and BNB, respectively, on a quarterly basis.
At December 31, 1997, the Company had invested $57.5 million in
mortgage-backed securities, or 5.9% of total assets, which were guaranteed by
GNMA, insured by either FNMA or FHLMC or privately issued. Of the $57.5 million,
$33.0 million were GNMA securities, of which $29.2 million were adjustable-rate
with 1% maximum annual rate adjustments and lifetime maximum interest rates of
10% to 13%. Investments in mortgage-backed securities involve a risk that actual
prepayments will be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby reducing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities or in the event such securities are redeemed by
the issuer. In addition, the market value of such securities may be adversely
affected by changes in interest rates. At December 31, 1997, mortgage-backed
securities available for sale and held-to-maturity amounted to $19.1 million and
$38.4 million, respectively.
19
20
The following table sets forth the composition of the Company's
mortgage-backed securities portfolio in dollar amounts and in percentages of the
respective portfolios at the dates indicated.
AT DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities:
GNMA (1, 2)................................ $33,106 57.60% $40,321 60.53% $44,385 75.24%
FHLMC (3, 4)............................... 9,544 16.60 11,239 16.87 13,092 22.20
FNMA............................ .......... 894 1.56 1,147 1.72 1,512 2.56
Privately issued collateralized
mortgage obligations ................... 13,931 24.24 13,905 20.88 -- --
------- ------ ------- ------ ------ ------
Total mortgage-backed securities........ 57,475 100.00% 66,612 100.00% 58,989 100.00%
====== ====== ======
Less:
Mortgage-backed securities available for
sale - GNMA (3)............................ 10,681 13,710 12,605
Mortgage-backed securities available
for sale - FHLMC (4)....................... 8,444 9,883 11,268
------ ------ ------
Mortgage-backed securities
held to maturity........................ $38,350 $43,019 $35,116
======= ======= =======
- --------------------
1 Includes $213,000, $341,000 and $527,000 of unamortized premiums related to
GNMA securities as of December 31, 1997, 1996 and 1995, respectively.
2 Is net of unrealized gain of $128,000 at December 31, 1997.
3 Includes $144,000, $187,000 and $234,000 of unamortized premiums related to
FHLMC securities as of December 31, 1997, 1996 and 1995, respectively.
4 Is net of unrealized loss of $10,000 at December 31, 1997.
20
21
The following tables set forth the Company's mortgage-backed securities
activities for the periods indicated:
FOR THE YEAR
ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------------------
(IN THOUSANDS)
Beginning balance .................................... $66,612 $58,989 $39,801
Mortgage-backed securities purchased:
Available for sale............................... -- 10,666 23,873
Held to maturity................................. -- 13,891 --
Less:
Sale of mortgage-backed securities
available for sale ............................ (1,084) (10,614) --
Principal repayments ............................ (8,448) (5,934) (4,586)
Change in unrealized gains (losses).............. 440 (322) --
Accretion of premium, net of discount............ (45) (64) (99)
------- ------- -------
Ending balance........................................ $57,475 $66,612 $58,989
======= ======== =======
The following table sets forth certain information regarding the carrying
amount and fair values of the Company's mortgage-backed securities at the dates
indicated:
AT DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
- -------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Mortgage-backed securities:
Held to maturity:
FNMA.......................... $ 894 $ 902 $ 1,147 $ 1,129 $ 1,512 $ 1,531
FHLMC......................... 1,100 1,108 1,356 1,330 1,824 1,830
GNMA.......................... 22,425 22,858 26,611 26,696 31,780 32,286
Privately issued collateralized
mortgage obligations........ 13,931 14,035 13,905 13,878 -- --
------- ------ ------ ------ ------ -------
Total held to maturity...... 38,350 38,903 43,019 43,033 35,116 35,647
------- ------ ------ ------ ------ -------
Available for sale:
GNMA.......................... 10,681 10,681 13,710 13,710 12,605 12,605
FHLMC......................... 8,444 8,444 9,883 9,883 11,268 11,268
------- ------ ------ ------ ------ -------
Total available for sale.... 19,125 19,125 23,593 23,593 23,873 23,873
------- ------ ------ ------ ------ -------
Total mortgage-backed
securities.................. $57,475 $58,028 $66,612 $66,626 $58,989 $59,520
======= ======= ======= ======= ======= =======
The following table sets forth certain information regarding the carrying
amount and fair values of the Company's short-term investments and investment
securities at the dates indicated:
21
22
AT DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
- --------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Overnight federal funds sold and short-term
investments................................. $ 3,448 $ 3,448 $ 2,943 $ 2,943 $10,460 $10,460
Investment securities:
Held to maturity:
Certificates of deposit................. -- -- 250 250 495 495
U.S. Government obligations, federal
agency obligations, and other
obligations........................... 20,630 20,630 18,920 18,795 16,309 16,411
------- ------- ------- ------- ------- -------
Total held to maturity...................... 20,630 20,630 19,170 19,045 16,804 16,906
------- ------- ------- ------- ------- -------
Available for sale:
U.S. Government obligations, federal
agency obligations, and other
obligations.......................... 30,617 30,617 -- -- -- --
Cash management fund1.................. 1,150 1,150 1,085 1,085 1,022 1,022
------- ------- ------- ------- ------- -------
Total available for sale............. 31,767 31,767 1,085 1,085 1,022 1,022
------- ------- ------- ------- ------- -------
Total investment securities................. $55,845 $55,845 $23,198 $23,073 $28,286 $28,388
======= ======= ======= ======= ======= =======
- ------------------------
1 Consists of securities issued by an institutional mutual fund which primarily
invests in short-term U.S. Government securities.
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23
The table below sets forth certain information regarding the carrying
amount, weighted average yields and contractual maturities of the Company's
short-term investments, investment securities and mortgage-backed securities as
of December 31, 1997.
AT DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- ---------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Overnight federal funds sold and short-term
investments. $ 3,448 5.30% $ -- --% $ -- --%
Held to maturity:
U.S. Government obligations, federal agency
obligations, and other obligations.......... 5,939 5.67 13,691 6.38 1,000 7.01
------- ------
Total held to maturity..................... 5,939 5.67 13,691 6.38 1,000 7.01
------ ------
Available for sale:
U.S. Government obligations, federal agency
obligations, and other obligations........... 7,994 5.87 22,623 6.32 -- --
Cash management fund (1)....................... 1,150 5.93 -- -- -- --
------ ------ ------
Total available for sale..................... 9,144 5.88 22,623 6.32 -- --
------ ------ ------
Total investment securities......................... $18,531 5.70% $36,314 6.34% $1,000 7.01%
======= ===== ======= ===== ======
Mortgage-backed securities:
Held to maturity:
FNMA........................................... $ -- --% $ 813 7.0% $ -- --%
GNMA........................................... -- -- 137 6.50 3,126 8.19
FHLMC.......................................... -- -- 1,100 7.0 -- --
Privately issued collateralized -- -- -- -- -- --
mortgage obligation..........................
------ ------ ------
Total held to maturity....................... -- -- 2,050 6.97 3,126 8.19
------ ------ ------
Available for sale:
GNMA........................................... -- -- -- -- -- --
FHLMC.......................................... -- -- -- -- -- --
-------- ------ -----
Total held for sale.......................... -- -- -- -- -- --
-------- ------
Total mortgage-backed securities.................... $ -- --% $2,050 6.97% $3,126 8.19%
======== ===== ====== ==== ====== ====
AT DECEMBER 31, 1997
- ------------------------------------------------------------------------------------------------------
MORE THAN TEN YEARS TOTAL
- ------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE
AMOUNT YIELD AMOUNT YIELD
- --------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Daily federal funds sold and short-term investments. $ -- --% $ 3,448 5.30%
Held to maturity:
U.S. Government obligations, federal agency
obligations, and other obligations.......... -- -- 20,630 6.19
------- -------
Total held to maturity..................... -- -- 20,630 6.19
------- ------
Available for sale:
U.S. Government obligations, federal agency
obligations, and other obligations........... -- -- 30,617 6.19
Cash management fund (1)....................... -- -- 1,150 5.93
------- ------
Total available for sale..................... -- -- 31,767 6.18
------- ------
Total investment securities......................... $ -- --% $55,845 6.13%
======= === ======= ====
Mortgage-backed securities:
Held to maturity:
FNMA........................................... $ 81 7.61% $ 894 7.06%
GNMA........................................... 19,162 6.96 22,425 7.13
FHLMC.......................................... -- -- 1,100 7.00
Privately issued collateralized
mortgage obligation.......................... 13,931 7.16 13,931 7.16
------- ------
Total held to maturity....................... 33,174 7.05 38,350 7.14
------ ------
Available for sale:
GNMA........................................... 10,681 6.34 10,681 6.34
FHLMC.......................................... 8,444 7.00 8,444 7.00
------ ------
Total held for sale.......................... 19,125 6.63 19,125 6.63
------ ------
Total mortgage-backed securities.................... $52,299 6.89% $57,475 6.97%
======= ==== ======= ====
- ---------------------------------
1 Consists of securities issued by an institutional mutual fund which primarily
invests in short-term U.S. Government securities.
23
24
SOURCES OF FUNDS
GENERAL. Retail deposits, wholesale brokered deposits, loan repayments and
prepayments, proceeds from sales of loans, cash flows generated from operations
and FHLB advances are the primary sources of the Company's funds for use in
lending, investing and for other general purposes.
DEPOSITS. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposits consist of savings, NOW
accounts, checking accounts, money market accounts and certificate accounts. For
the year ended December 31, 1997, core deposits represented 57.7% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Company's deposits are obtained predominantly from the
areas in which its branch offices are located. The Company relies primarily on
customer service and long-standing relationships with customers to attract and
retain these deposits; however, market interest rates and rates offered by
competing financial institutions significantly affect the Company's ability to
attract and retain deposits. The Company uses traditional means of advertising
its deposit products, including radio and print media and generally does not
solicit deposits from outside its market area except through the use of
wholesale brokered deposits which provided $75 million of deposits during 1997
for terms of two to three years.
The following table presents the deposit activity of the Company for
the periods indicated:
FOR THE YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Net deposits (withdrawals)........................... $47,355 $(6,425) $ (9,179)
Interest credited on deposit accounts................ 18,626 16,139 15,119
Deposits acquired from BNB acquisition............... 125,022 -- --
-------- ------- --------
Total increase (decrease) in deposit accounts........ $191,003 $9,714 $ 5,940
======== ======= ========
At December 31, 1997, the Company had $19.0 million in certificate
accounts in amounts of $100,000 or more (excluding wholesale deposits) maturing
as follows:
WEIGHTED
MATURITY PERIOD AMOUNT AVERAGE RATE
- ----------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Three months or less............................... % 6,428 5.27%
Over 3 through 6 months............................ 4,345 5.60
Over 6 through 12 months........................... 3,499 5.42
Over 12 months..................................... 4,688 5.80
------- -----
Total.............................................. $18,960 5.51%
======= =====
24
25
The following table sets forth the distribution of the Company's average
deposit accounts for the periods indicated and the weighted average rates on
each category of deposits presented.
FOR THE YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------
PERCENT WEIGHTED PERCENT WEIGHTED PERCENT WEIGHTED
OF TOTAL AVERAGE OF TOTAL AVERAGE OF TOTAL AVERAGE
AVERAGE AVERAGE NOMINAL AVERAGE AVERAGE NOMINAL AVERAGE AVERAGE NOMINAL
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
- ----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Money market deposit
accounts................... $61,800 11.18% 2.95% $46,540 11.10% 3.00% $49,693 11.89% 2.96%
Savings accounts........... 116,247 21.03 2.43 90,763 21.63 2.44 99,498 23.81 2.50
NOW accounts............... 96,590 17.47 1.11 66,336 15.82 1.34 65,661 15.71 1.42
Non-interest-bearing
accounts................... 41,017 7.42 -- 16,177 3.86 -- 14,016 3.35 --
-------- ----- ------- ----- ------- -----
Total................. 315,654 57.10 1.81 219,816 52.41 2.05 228,868 54.76 2.14
-------- ----- ------- ----- ------- -----
Certificate accounts:
Less than six months...... 33,573 6.07 5.16 23,748 5.66 4.97 16,682 3.99 4.75
Over six through 12 months. 54,876 9.93 5.41 49,259 11.74 5.49 41,343 9.89 5.50
Over 12 through 36 months.. 94,157 17.04 5.99 70,849 16.90 5.78 75,445 18.05 5.38
Over 36 months............ 6,859 1.24 5.43 6,973 1.66 5.41 6,670 1.60 5.38
IRA/KEOGH................. 47,650 8.62 5.78 48,769 11.63 5.82 48,940 11.71 5.61
-------- ----- ------- ----- ------- -----
Total certificate accounts 237,115 42.90 199,598 47.59 5.61 189,080 45.24 5.41
-------- ----- ------- ----- ---- ------- -----
Total average deposits... $552,769 100.00% 3.47% $419,414 100.00% 3.74% $417,948 100.00% 3.62%
======== ====== ======== ====== ======== ======
Note: Average balances for 1997 and 1996 are calculated on a daily basis, while
average balances for 1995 are based on average monthly balances.
25
26
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1997.
PERIOD TO MATURITY FROM DECEMBER 31, 1997 AT DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------
LESS THAN ONE TO TWO TO THREE TO FOUR TO
ONE YEAR TWO YEARS THREE YEARS FOUR YEARS FIVE YEARS 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Certificate accounts:
0 to 4.00%............ $ 1,367 $ -- $ -- $ -- $ -- $ 1,367 $ 1,486 $ 1,977
4.01 to 5.00%......... 1,521 364 -- -- -- 1,885 1,630 16,130
5.01 to 6.00%......... 128,058 37,397 17,243 20,681 102 203,481 151,893 101,060
6.01 to 7.00%......... 6,223 14,029 52,236 2,829 1,485 76,802 45,021 76,878
7.01 to 8.00%......... -- 94 -- -- -- 94 94 129
-------- ------- ------- ------ ------ --------- -------- --------
Total.............. $137,169 $51,884 $69,479 $23,510 $1,587 $283,629 $200,124 $196,174
======== ======= ======= ======= ====== ======== ======== ========
BORROWINGS. The Company utilizes advances from the FHLB as an alternative
to retail deposits to fund its operations and may do so in the future as part of
its operating strategy. These FHLB advances are collateralized primarily by
certain of the Company's mortgage loans and mortgage-backed securities and
secondarily by the Company's investment in capital stock of the FHLB. FHLB
advances are made pursuant to several different credit programs, each of which
has its own interest rate and range of maturities. The maximum amount that the
FHLB will advance to member institutions, including the Company, fluctuates from
time to time in accordance with the policies of the OTS, OCC and the FHLB. See
"Regulation - Federal Home Loan Bank System." During the year ended December 31,
1997, the Company repaid net of borrowings $40.0 million from the FHLB. At
December 31, 1997, the Company had $256.5 million in outstanding advances from
the FHLB and $7.1 million in repurchase agreements.
26
27
The following tables set forth certain information regarding the Company's
borrowed funds and repurchase agreements at or for the periods ended on the
dates indicated:
AT OR FOR THE YEAR
ENDED DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
FHLB advances:
Average balance outstanding............................ $287,128 $217,628 $133,268
Maximum amount outstanding at
any month-end during the period..................... $310,792 $303,374 $148,274
Balance outstanding at end of period................... $256,500 $296,500 $119,909
Weighted average interest rate
during the period................................... 6.00% 5.86% 6.30%
Weighted average interest rate at end
of period.......................................... 5.96 5.88% 5.95%
AT OR FOR THE YEAR
ENDED DECEMBER 31,
- --------------------------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Securities sold under agreements to repurchase:
Average balance outstanding............................ $11,948 $7,496
Maximum amount outstanding at
any month-end during the period..................... $21,861 $10,016
Balance outstanding at end of period................... $7,140 $ 3,500
Weighted average interest rate
during the period................................... 5.62% 5.53%
Weighted average interest rate at end
of period.......................................... 5.98% 5.45%
SUBSIDIARY ACTIVITIES
Leader Corporation ("Leader Corp.") and BFS Service Corp., both
incorporated under Massachusetts law, are wholly owned subsidiaries of BFS while
Aygro Corp., also incorporated under Massachusetts law, is a wholly owned
subsidiary of BNB. Leader Corporation owns Connelly Hill Limited Partnership,
which sold its only parcel of land to a developer on January 31, 1997. The sale
resulted in a gain of approximately $800,000.
In 1994, BFS, through Leader Corp., permitted Liberty Financial, a third
party securities broker, to offer various uninsured investment products to BFS's
customers. Leader Corp. entered into a contract with
27
28
such third party brokerage concern to perform brokerage services in segregated
areas of BFS's branches. Under this contract, Liberty Financial leases space
from BFS at three of BFS's branch locations, pays rent and a percentage of sales
to Leader Corp.
At December 31, 1997, Leader Corp. had a retained deficit of $637,000 and
for the years ended December 31, 1997 and 1996 had net income of $753,000 and a
net loss of $38,000, respectively.
During 1997, BFS Service Corp. and Aygro Corp. were activated in order to
establish BFS Preferred Capital Corp. ("BFSPCC") and BNB Preferred Capital Corp.
("BNBPCC"), respectively. BFSPCC and BNBPCC are real estate investment trusts
organized under Massachusetts law and satisfy the requirements of Section 856 of
the Internal Revenue Code of 1986, as amended.
PERSONNEL
As of December 31, 1997, the Company had 231 authorized full-time employee
positions and 70 authorized part-time employee positions, for a total of
approximately 261 full time equivalents. The employees are not represented by a
collective bargaining unit and the Company considers its relationship with its
employees to be good.
REGULATION AND SUPERVISION
GENERAL
As a result of the Company's acquisition of BNB in February 1997, the
Company became a bank holding company and ceased to be a savings and loan
holding company. The Company, as a bank holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
Federal Reserve Board ("FRB") under the Bank Holding Company Act of 1956, as
amended ("BHCA"). In addition, the activities of savings institutions, such as
BFS, are governed by the Home Owner=s Loan Act ("HOLA") and the Federal Deposit
Insurance Act ("FDI Act"). The activities of national banks are generally
governed by the National Bank Act and the FDI Act.
BFS is subject to extensive regulation, examination and supervision by the
OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. BFS
is a member of the Federal Home Loan Bank System and its deposit accounts are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF") managed by the FDIC. BFS must file reports with the OTS and the FDIC
concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with or acquisitions of other institutions. BNB is subject to extensive
regulation, examination and supervision by and reporting with the OCC, as its
primary federal regulator, and the FDIC, as the deposit insurer. BNB is a member
of the Bank Insurance Fund ("BIF") managed by the FDIC. The OTS and/or the FDIC
conduct periodic examinations to test BFS's safety and soundness and compliance
with various regulatory requirements and the OCC and/or FDIC conduct similar
examinations of BNB. This regulation and supervision establishes a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulatory requirements and policies, whether by the OTS, the
OCC, the FDIC or the Congress, could have a material adverse impact on the
Company, BFS and/or BNB and their operations. Certain of the regulatory
requirements applicable to BFS, BNB and to the Company are referred to below or
elsewhere herein. The description of statutory provisions and regulations
applicable to depository
28
29
institutions and their holding companies set forth in this Form 10-K does not
purport to be a complete description of such statutes and regulations and their
effects on BFS, BNB and the Company.
HOLDING COMPANY REGULATION
FEDERAL REGULATION. Due to its control of BNB, the Company is subject to
examination, regulation, and periodic reporting under the BHCA, as administered
by the FRB.
The Company is required to obtain the prior approval of the FRB to acquire
all, or substantially all, of the assets of any bank or bank holding company or
merge with another bank holding company. Prior FRB approval will also be
required for the Company to acquire direct or indirect ownership or control of
any voting securities of any bank or bank holding company if, after giving
effect to such acquisition, the Company would, directly or indirectly, own or
control more than 5% of any class of voting shares of such bank or bank holding
company. In evaluating such transactions, the FRB considers such matters as the
financial and managerial resources of and future prospects of the companies
involved, competitive factors and the convenience and needs of the communities
to be served. Bank holding companies may acquire additional banks in any state,
subject to certain restrictions such as deposit concentration limits. In
addition to the approval of the FRB, before any bank acquisition can be
completed, prior approval may also be required to be obtained from other
agencies having supervisory jurisdiction over BFS to be acquired.
A bank holding company is generally prohibited from engaging in, or
acquiring direct or indirect control of more than 5% of the voting securities of
any company engaged in, non-banking activities. One of the principal exceptions
to this prohibition is for activities found by the FRB to be so closely related
to banking or managing or controlling banks to be a proper incident thereto.
Some of the principal activities that the FRB has determined by regulation to be
closely related to banking are: (i) making or servicing loans; (ii) performing
certain data processing services; (iii) providing discount brokerage services;
(iv) acting as fiduciary, investment or financial advisor; (v) finance leasing
personal or real property; (vi) making investments in corporations or projects
designed primarily to promote community welfare; and (vii) acquiring a savings
association, like BFS, provided that the savings association only engages in
activities permitted bank holding companies. The FRB has adopted capital
adequacy guidelines for bank holding companies (on a consolidated basis)
substantially similar to those of the OTS for BFS and the OCC for BNB. See
"Capital Requirements." The Company's total and Tier 1 capital exceeds these
requirements.
Bank holding companies are generally required to give the FRB prior written
notice of any purchase or redemption of its outstanding equity securities if the
gross consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the Company's consolidated net worth. The FRB
may disapprove such a purchase or redemption if it determines that the proposal
would constitute an unsafe and unsound practice, or would violate any law,
regulation, FRB order or directive, or any condition imposed by, or written
agreement with, the FRB. The FRB has now adopted an exception to this approval
requirement for well-capitalized bank holding companies that meet certain other
conditions.
The FRB has issued a policy statement regarding the payment of dividends by
bank holding companies. In general, the FRB's policies provide that dividends
should be paid only out of current earnings and only if the prospective rate of
earnings retention by the Bank holding company appears consistent with the
organization's capital needs, asset quality, and overall financial condition.
The FRB's policies also require that a bank holding company serve as a source of
financial strength to its subsidiary banks by standing ready to use available
resources to provide adequate capital funds to those banks during periods of
financial stress or adversity and by maintaining the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks where necessary. These regulatory policies could affect the
ability of the Company to pay dividends or otherwise engage in capital
distributions.
29
30
The status of the Company as a registered bank holding company under the
BHCA does not exempt it from certain Federal and state laws and regulations
applicable to corporations generally, including, without limitation, certain
provisions of the Federal securities laws.
Under the FDI Act, depository institutions are potentially liable to the
FDIC for losses suffered or anticipated by the FDIC in connection with the
default of a commonly controlled depository institution or any assistance
provided by the FDIC to such an institution in danger of default. This applies
to depository institutions controlled by the same bank holding company.
The Company and its subsidiaries will be affected by the monetary and
fiscal policies of various agencies of the United States Government, including
the Federal Reserve System. In view of changing conditions in the national
economy and in the money markets, it is impossible for the management of the
Company to accurately predict future changes in monetary policy or the effect of
such changes on the business or financial condition of the Company, BFS or BNB.
STATE REGULATION. The Company is also a "bank holding company" within the
meaning of the Massachusetts bank holding company laws. The prior approval of
the Massachusetts Board of Bank Incorporation is required before the Company may
acquire all or substantially all of the assets of any depository institution (or
holding company thereof), merge with a holding company of a depository
institution or acquire more than 5% of the voting stock of a depository
institution or holding company thereof.
ACQUISITION OF THE HOLDING COMPANY
FEDERAL REGULATION. Under the Federal Change in Bank Control Act ("CIBCA"),
a notice must be submitted to the FRB if any person (including a company), or
group acting in concert, seeks to acquire 10% or more of the Company's
outstanding voting stock, unless the FRB has found that the acquisition will not
result in a change in control of the Company. Under the CIBCA, the FRB has 60
days from the filing of a complete notice to act, taking into consideration
certain factors, including the financial and managerial resources of the
acquirer and the anti-trust effects of the acquisition.
Under the BHCA, any company would be required to obtain prior approval from
the FRB before it may obtain "control" of the Company within the meaning of the
BHCA. Control generally is defined to mean the ownership or power to vote 25
percent or more of any class of voting securities of the Company or the ability
to control in any manner the election of a majority of the Company's directors.
An existing bank holding company would be required to obtain the FRB's prior
approval under the BHCA before acquiring more than 5% of the Company's voting
stock. See "Holding Company Regulation." Approval of the Board of Bank
Incorporation may also be required for acquisition of the Company under some
circumstances.
FEDERAL BANKING REGULATIONS
CAPITAL REQUIREMENTS. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below establish, in
effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMELS financial
institution examination rating system), and, together with the risk-based
capital standard itself, a 4% Tier I risk-based capital standard. Core (or Tier
1) capital is defined as common stockholders' equity (including retained
earnings), certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships. The OTS regulations also require that, in meeting the tangible,
leverage (core) and risk-based capital standards, institutions must generally
30
31
deduct investments in and loans to subsidiaries engaged in activities as a
principle not permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%,
as assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of Tier I (core) capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and the allowance for loan and lease losses limited to a maximum
of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
National Banks are required by OCC regulation to maintain leverage (core)
capital at least equal to 4% (3% for institutions receiving the highest rating
on the CAMELS financial institution examination rating system) and an 8%
risk-based capital ratio. National banks are subject to identical requirements
as savings institutions under the prompt corrective action standards. Both the
OTS and the OCC have the discretion to establish higher capital requirements on
a case-by-case basis where deemed appropriate in the circumstances of a
particular institution.
The Company is subject to consolidated capital requirements pursuant to the
regulations of the FRB. Generally, a bank holding company must have a
consolidated ratio of core (Tier 1) capital to total assets of at least 3% if it
receives the FRB's highest examination rating and 4% otherwise. A bank holding
company also must maintain a total capital to risk-based assets ratio of at
least 8% and a Tier 1 (core) capital to risk-based assets ratio of at least 4%.
31
32
The following table presents BFS's and BNB's capital position at December
31, 1997 relative to fully phased-in regulatory requirements.
FOR CAPITAL
ADEQUACY TO BE WELL
ACTUAL PURPOSES CAPITALIZED
- --------------------------------------------------------------------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
As of December 31, 1997:
Risk-based Total Capital:
BFS.................................... $54,731 11.9% $36,758 8.0% $45,948 10.0%
BNB.................................... 9,477 16.4 4,618 8.0 5,772 10.0
Core Capital:
BFS.................................... 48,987 5.9 24,952 3.0 41,586 5.0
BNB.................................... 8,799 7.4 4,753 4.0 5,941 5.0
Risk-based Tier I Capital:
BFS....................................
BNB.................................... 8,799 15.2 2,309 4.0 3,463 6.0
Tangible Capital:
BFS.................................... 48,987 5.9 12,476 1.5 41,586 5.0
As of December 31, 1996 (BFS only):
Risk-weighted capital.................... 58,310 13.2 35,301 8.0 44,060 10.0
Core capital............................. 53,910 6.8 23,868 3.0 39,780 5.0
Tangible capital......................... 53,910 6.8 11,934 1.5 39,780 5.0
The Company's regulatory capital ratios at December 31, 1997 were 8.2%,
15.2% and 16.5% for Tier 1 leverage ratio, Tier 1 risk-based capital ratio and
total capital ratio, respectively.
PROMPT CORRECTIVE REGULATORY ACTION. Under the prompt corrective action
regulations, the OTS with respect to savings associations and the OCC with
respect to national banks, are required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a depository institution
is considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the appropriate regulator to
meet a specific capital level. An institution generally is considered
"adequately capitalized" if its ratio of total capital to risk-weighted assets
is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at
least 4%, and its ratio of core capital to total assets is at least 4% (3% if
the institution receives the highest CAMELS rating). An institution that has a
ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier
I (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." An
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and an institution that has a
tangible capital to assets ratio equal to or less than 2% is deemed to be
"critically undercapitalized." Subject to a narrow exception, the Banking
regulator is required to appoint a receiver or conservator for an institution
that is "critically undercapitalized." The regulation also provides that a
capital restoration plan must be filed with and approved by the applicable
regulatory agency within 45 days of the date an institution receives notice that
it is "undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Compliance with the plan must be
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guaranteed by any parent holding company. In addition, numerous mandatory
supervisory actions become immediately applicable to an undercapitalized
institution, including, but not limited to, increased monitoring by regulators
and restrictions on growth, capital distributions and expansion. The appropriate
agency could also take any one of a number of discretionary supervisory actions,
including the issuance of a capital directive and the replacement of senior
executive officers and directors.
INSURANCE OF DEPOSIT ACCOUNTS. Deposits of BFS are presently insured by the
SAIF and BNB is a member of the BIF. Both the SAIF and the BIF are statutorily
required to be capitalized to a 1.25% of insured reserve deposits ratio. Until
recently, members of the SAIF and BIF were paying average deposit insurance
premiums of between 24 and 25 basis points. The BIF met the required reserve in
1995, whereas the SAIF was not expected to meet or exceed the required level
until 2002 at the earliest. This situation was primarily due to the statutory
requirement that SAIF members make payments on bonds issued in the late 1980s by
the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted
a new assessment rate schedule of from 0 to 27 basis points under which 92% of
BIF members paid an annual administration fee of only $2,000. With respect to
SAIF member institutions, the FDIC adopted a final rule retaining the previously
existing assessment rate schedule applicable to SAIF member institutions of 23
to 31 basis points. As long as the premium differential continued, it may have
had adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members, such as BFS were placed at a substantial competitive disadvantage to
BIF members with respect to pricing of loans and deposits and the ability to
achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the "Funds Act") which, among other things, imposed a special
one-time assessment on SAIF member institutions, including BFS, to recapitalize
the SAIF. As required by the Funds Act, the FDIC imposed a special assessment of
65.7 basis points on SAIF assessable deposits held as of March 31, 1995, payable
November 27, 1996 (the "SAIF Special Assessment"). The SAIF Special Assessment
was recognized by BFS as an expense in the quarter ended September 30, 1996 and
was tax deductible. The SAIF Special Assessment recorded by BFS amounted to $2.7
million on a pre-tax basis and approximately $1.6 million on an after-tax basis.
The Funds Act also spread the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits,
including those held by BNB, were assessed for a FICO payment of 1.3 basis
points, while SAIF deposits pay 6.48 basis points. Full pro rata sharing of the
FICO payments between BIF and SAIF members will occur on the earlier of January
1, 2000 or the date the BIF and SAIF are merged. The Funds Act specifies that
the BIF and SAIF will be merged on January 1, 1999, provided no savings
associations remain as of that time. See "Thrift Rechartering Legislation" which
is discussed elsewhere herein.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to
that of BIF members. SAIF members will also continue to make the FICO payments
described above. Management cannot predict the level of FDIC insurance
assessments on an on-going basis, whether the savings association charter will
be eliminated or whether the BIF and SAIF will eventually be merged.
BFS's assessment rate for fiscal 1997 ranged from 6 to 7 basis points and
the premium paid for this period was $283,000. BNB paid $13,000 to the FDIC for
1997. A significant increase in FDIC insurance
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premiums would likely have an adverse effect on the operating expenses and
results of operations of BFS and/or BNB.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the regulators.
The management of BFS and BNB does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
THRIFT RECHARTERING LEGISLATION. The Funds Act provides that the BIF and
SAIF will merge on January 1, 1999 if there are no more savings associations as
of that date. That legislation also requires that the Department of Treasury
submit a report to Congress by March 31, 1997 that makes recommendations
regarding a common financial institutions charter, including whether the
separate charters for thrifts and banks should be abolished. Various proposals
to eliminate the federal thrift charter, create a uniform financial institutions
charter and merge the OTS with the OCC have been introduced in Congress. The
Company is unable to predict whether such legislation will be enacted, the
extent to which the legislation will restrict or disrupt its operations or those
of its subsidiaries or whether the BIF and SAIF funds will eventually merge.
LOANS TO ONE BORROWER. Under the HOLA, savings institutions are generally
subject to limits on loans to one borrower. Generally, savings institutions may
not make a loan or extend credit to a single or related group of borrowers in
excess of 15% of its unimpaired capital, surplus, and allowable general
valuation allowance. An additional amount may be lent, equal to 10% of
unimpaired capital and surplus, if such loan is secured by readily-marketable
collateral, which is defined to include certain financial instruments and
bullion. National banks are generally subject to similar loan to one borrower
limits. At December 31, 1997, BFS's limit on loans to one borrower was $8.3
million and BNB's limit was $1.9 million. At December 31, 1997, BFS's largest
aggregate outstanding balance of loans to one borrower was $4.0 million and
BNB's largest aggregate outstanding balance of loans to one borrower was $1.3
million.
QTL TEST. The HOLA requires savings institutions to meet a QTL test.
Under the QTL test, a savings and loan association is required to either meet
the definition of a "domestic building and loan association," as that term is
defined in the Internal Revenue Code or maintain at least 65% of its "portfolio
assets" (total assets less: (i) specified liquid assets up to 20% of total
assets; (ii) intangibles, including goodwill; and (iii) the value of property
used to conduct business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
securities) in at least 9 months out of each 12 month period. Recent legislation
has increased the extent to which credit card loans, education loans and small
business loans qualify as "qualified thrift investments."
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
December 31, 1997, BFS maintained in excess of 65% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
National banks are not subject to the QTL test.
LIMITATION ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after
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a proposed capital distribution ("Tier 1 Bank") and has not been advised by the
OTS that it is in need of more than normal supervision, could, after prior
notice but without obtaining approval of the OTS, make capital distributions
during a calendar year equal to the greater of (i) 100% of its net earnings to
date during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year or (ii) 75% of its net
income for the previous four quarters. Any additional capital distributions
would require prior regulatory approval. In the event BFS's capital fell below
its regulatory requirements or the OTS notified it that it was in need of more
than normal supervision, BFS's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice. At December 31, 1997, BFS was a Tier 1 Bank.
National banks may not pay dividends out of their permanent capital and may
not, without OCC approval, pay dividends in excess of the total of the Bank's
retained net income for the year combined with retained net income for the prior
two years. A national bank may not pay a dividend that would cause it to fall
below regulatory capital standards.
LIQUIDITY. BFS is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage of its net withdrawable deposit accounts plus short-term borrowings.
This liquidity requirement is currently 4% but may be changed from time to time
by the OTS to any amount within the range of 4% to 10% depending upon economic
conditions and the savings flows of member institutions. Monetary penalties may
be imposed for failure to meet these liquidity requirements. BFS's liquidity
ratio for December 31, 1997 was 5.7%, which exceeded the applicable
requirement. BFS has never been subjected to monetary penalties for failure to
meet its liquidity requirements. BNB, under OCC regulations, is not subject to
separate regulatory liquidity requirements.
ASSESSMENTS. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessments, paid on a
semi-annual basis, are computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in BFS's latest quarterly
thrift financial report. The assessments paid by BFS for the fiscal year ended
December 31, 1997 totalled $166,000.
National banks pay semi-annual assessments to the OCC to fund its
operations based on asset size. Such assessments for BNB amounted to $45,000 for
the year ended December 31, 1997.
BRANCHING. OTS regulations permit nationwide branching by federally
chartered savings institutions. This permits federal savings institutions to
establish interstate networks and to geographically diversify their loan
portfolios and lines of business. The OTS authority preempts any state law
purporting to regulate branching by federal savings institutions.
National banks are authorized to establish branches within the state in
which they are headquartered to the extent state law allows branching by state
banks. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Act") provides for interstate branching for national banks, effective June
1, 1997. Under the Act, interstate branching by merger was authorized on June 1,
1997 unless the state in which the Bank is to branch has enacted a law opting
out of interstate branching. De novo interstate branching is permitted by the
Act to the extent the state into which BFS is to branch has enacted a law
authorizing out-of-state banks to establish de novo branches.
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TRANSACTIONS WITH RELATED PARTIES. The authority of a depository
institution to engage in transactions with related parties or "affiliates"
(e.g., any company that controls or is under common control with an institution,
including the Company) is limited by Sections 23A and 23B of the Federal Reserve
Act ("FRA"). Section 23A limits the aggregate amount of covered transactions
with any individual affiliate to 10% of the capital and surplus of the savings
institution. The aggregate amount of covered transactions with all affiliates is
limited to 20% of the savings institution's capital and surplus. Certain
transactions with affiliates are required to be secured by collateral in an
amount and of a type described in Section 23A and the purchase of low quality
assets from affiliates is generally prohibited. Section 23B generally provides
that certain transactions with affiliates, including loans and asset purchases,
must be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions like BFS are prohibited from
lending to any affiliate that is engaged in activities that are not permissible
for bank holding companies and no savings institution may purchase the
securities of any affiliate other than a subsidiary. Certain transaction between
sister institutions in a holding company are exempt from these requirements.
The authority of BFS and BNB to extend credit to executive officers,
directors and 10% shareholders ("insiders"), as well as entities such persons
control, is governed by Sections 22(g) and 22(h) of the FRA and Regulation O
thereunder. Among other things, such loans are required to be made on terms
substantially the same as those offered to unaffiliated individuals and to not
involve more than the normal risk of repayment. Recent legislation created an
exception to this requirement for loans made pursuant to a benefit or
compensation program that is widely available to all employees of the
institution and does not give preference to insiders over other employees.
Regulation O also places individual and aggregate limits on the amount of loans
that institutions may make to insiders based, in part, on the institution's
capital position and requires certain board approval procedures to be followed.
ENFORCEMENT. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions, the OCC has primary enforcement
authority over national banks and both agencies have the authority to bring
actions against the respective institutions and all institution-affiliated
parties, including stockholders, and any attorneys, appraisers and accountants
who knowingly or recklessly participate in wrongful action likely to have an
adverse effect on an insured institution. Formal enforcement action may range
from the issuance of a capital directive or cease and desist order to removal of
officers and/or directors to institution of receivership, conservatorship or
termination of deposit insurance. Civil penalties cover a wide range of
violations and can amount to $25,000 per day, or even $1 million per day in
especially egregious cases. Under the FDI Act, the FDIC has the authority to
recommend to OTS that enforcement action be taken with respect to a particular
savings institution or the OCC with respect to a national bank. If action is not
taken by the agency, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
The FRB has similar enforcement authority with respect to the Company.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; and compensation, fees and benefits.
If the appropriate federal banking agency determines that an institution fails
to meet any standard prescribed by the Guidelines, the
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agency may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final rule
establishes deadlines for the submission and review of such safety and soundness
compliance plans when such plans are required.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require depository institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). During fiscal 1997, the Federal
Reserve Board regulations generally required that reserves be maintained against
aggregate transaction accounts as follows: for accounts aggregating $49.3
million or less (subject to adjustment by the Federal Reserve Board) the reserve
requirement is 3%; and for accounts aggregating greater than $49.3 million, the
reserve requirement is $1.6 million plus 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $52.0 million. The first $4.3 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) are exempted from the reserve requirements. The Company is in compliance
with the foregoing requirements. Effective December 16, 1997, the Federal
Reserve amended the Reserve Requirements as follows: the amount of transaction
accounts subject to a reserve requirement ratio of 3% decreased from $49.3
million to $47.8 million and the amount of reservable liabilities that is
exempted from reserve requirements will increase from $4.4 million to $4.7
million. The balances maintained to meet the reserve requirements imposed by the
Federal Reserve Board may be used to satisfy liquidity requirements imposed on
savings institutions by the OTS. BFS and BNB are also in compliance with these
requirements.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Banks report their federal income on a
consolidated basis and the accrual method of accounting, and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly BFS's reserve for bad debts discussed below.
BNB also reports its income on a consolidated basis with the Company and BFS
effective February 8, 1997. The following discussion of tax matters is intended
only as a summary and does not purport to be a comprehensive description of the
tax rules applicable to the Banks or the Company. BFS was audited by the IRS
during 1996, and covered the tax years 1991, 1992 and 1993. For its 1997 taxable
year, the Company is subject to a maximum federal income tax rate of 35%.
BAD DEBT RESERVES. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
Under the Small Business Job Protection Act of 1996 (the "1996 Act"), for
its current and future taxable years, BFS is not permitted to make additions to
its tax bad debt reserves. In addition, BFS is required to recapture (i.e., take
into income) over a six year period the excess of the balance of its tax bad
debt reserves as of December 31, 1995 other than its supplemental reserve for
losses on loans, if any over the balance of such reserves as of December 31,
1987. The Company has previously recorded a deferred tax
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liability equal to the bad debt recapture and as such, the new rules will have
no effect on net income or income tax expense.
DISTRIBUTIONS. Under the 1996 Act, if BFS makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from BFS's unrecaptured tax bad debt reserves (including the balance
of its reserves as of December 31, 1987) to the extent thereof, and then from
its supplemental reserve for losses on loans, to the extent thereof, and an
amount based on the amount distributed (but not in excess of the amount of such
reserves) will be included in BFS's income. Non-dividend distributions include
distributions in excess of BFS's current and accumulated earnings and profits,
as calculated for federal income tax purposes, distributions in redemption of
stock, and distributions in partial or complete liquidation. Dividends paid out
of BFS's current or accumulated earnings and profits will not be so included in
BFS's income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if BFS makes a non-dividend distribution to
the Company, approximately one and one-half times the amount of such
distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. BFS does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves. The bad debt
reserves subject to recapture amount to $13.3 million for which no deferred
taxes have been provided.
SAIF RECAPITALIZATION ASSESSMENT. The Funds Act levied a 65.7-cent fee on
every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
STATE AND LOCAL TAXATION
COMMONWEALTH OF MASSACHUSETTS. On July 27, 1995, the Governor of
Massachusetts approved legislation to reduce the tax rate applicable to
financial institutions, including savings banks, from 12.54% on their net income
to 10.50% on their net income apportioned to Massachusetts. The reduced rate is
to be phased-in over a five year period whereby the rates are 12.13% for 1995,
11.72% for 1996, 11.32% for 1997, 10.91% for 1998 and 10.50% for 1999. Net
income for years beginning before January 1, 1999 includes gross income as
defined under the provisions of the Internal Revenue Code, plus interest from
bonds, notes and evidences of indebtedness of any state, including
Massachusetts, less the deductions, excluding the deductions for dividends
received, state taxes, and losses sustained in other taxable years, as defined
under the provisions of the Internal Revenue Code. For taxable years beginning
on or after January 1, 1999, the definition of state taxable income is modified
to allow a deduction for ninety-five percent of dividends received from stock
where a bank owns fifteen percent or more of the voting stock of the institution
paying the dividend and to allow deductions from certain expenses allocated to
federally tax exempt obligations. Subsidiary corporations of BFS conducting
business in Massachusetts must file separate Massachusetts state tax returns and
are taxed as financial institutions, with certain modifications and
grandfathering for taxable years before 1995. The net worth or tangible property
of such subsidiaries is taxed at a rate of 0.26%. Such subsidiaries may file
consolidated tax returns on the net earnings portion of the corporate tax.
Corporations which qualify as "securities corporations," as defined by the
Massachusetts tax code, are taxed at a special rate of 0.33% of their gross
income if they qualify as a "bank-holding company" under the Massachusetts tax
code. The Company has applied for and received approval to be taxed at this
reduced
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tax rate as long as it is exclusively engaged in activities of a "securities
corporation." The Company believes it will continue to qualify as a securities
corporation because a separate subsidiary was formed to make the loan to BFS's
Employee Stock Ownership Plan and the Company's other activities qualify as
activities permissible for a securities corporation. If the Company fails to so
qualify, however, it will be taxed as a financial institution at a rate of
10.50%, rather than at the phased-in rates, beginning with fiscal 1995.
DELAWARE TAXATION. As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS
125"). SFAS 125 establishes, among other things, new criteria for determining
whether a transfer of financial assets in exchange for cash or other
consideration should be accounted for as a sale or as a pledge of collateral in
a secured borrowing. SFAS 125 also establishes new accounting requirements for
pledged collateral. SFAS 125 is effective for most transactions occurring after
December 31, 1996 and must be applied prospectively. However, SFAS 127, Deferral
of the Effective Date of Certain Provisions of SFAS 125, requires the deferral
of implementation as it relates to repurchase agreements, dollar-rolls,
securities lending and similar transactions in the years beginning after
December 31, 1997. The adoption of SFAS 125 did not have a material impact on
the consolidated financial statements. The adoption of SFAS 127 is not expected
to have a material impact on the consolidated financial statements.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 129, "Disclosure of Information about Capital Structure", which is
effective for 1997 financial statements. The Company's disclosures currently
comply with the provisions of this statement.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for the reporting and displaying comprehensive income, which is
defined as all changes to equity except investments by and distributions to
shareholders. Net income is a component of comprehensive income with all other
components referred to in the aggregate as other comprehensive income. This
statement is effective for 1998 financial statements.
Also in June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS 131"), which establishes standards for reporting information
about operating segments. An operating segment is defined as a component of a
business for which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to allocate
resources and evaluate performance. SFAS 131 requires a company to disclose
certain income statement and balance sheet information by operating segment, as
well as provide a reconciliation of operating segment information to the
Company's consolidated balances. SFAS 131 is effective for the 1998 annual
financial statements.
FEDERAL SECURITIES LAWS
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The Company's common stock is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to
the information and proxy solicitation requirements, insider trading
restrictions, and other requirements under the Exchange Act.
Shares of the common stock purchased by persons who are not affiliates of
the Company may be resold without registration. Shares purchased by an affiliate
of the Company will be subject to the resale restrictions of Rule 144 under the
Securities Act. If the Company meets the current public information requirements
of Rule 144 under the Securities Act, each affiliate of the Company who complies
with the other conditions of Rule 144 (including those that require the
affiliate's sale to be aggregated with those of certain other persons) would be
able to sell in the public market, without registration, a number of shares not
to exceed in any three-month period the greater of (i) 1% of the outstanding
shares of the Company or (ii) the average weekly volume of trading in such
shares during the preceding four calendar weeks. Provision may be made in the
future by the Company to permit affiliates to have their shares registered for
sale under the Securities Act under certain circumstances.
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ITEM 2. PROPERTIES.
The Company conducts its business through an administrative and full
service office located in Burlington and 9 other full service branch offices.
The Company believes its current facilities are adequate to meet the present and
immediately foreseeable needs of the Company.
ORIGINAL NET BOOK VALUE OF
LEASED YEAR DATE OF PROPERTY OR LEASEHOLD
OR LEASED OR LEASE IMPROVEMENTS AT
LOCATION OWNED ACQUIRED EXPIRATION DECEMBER 31, 1997
- -------------------------------------------------------------------------------------------------------------------
ADMINISTRATIVE/BRANCH/HOME OFFICE:
17 New England Executive Park Leased 1988 November 1998 (1) $1,578
Burlington, MA 01803
BRANCH OFFICES:
980 Massachusetts Avenue Owned 1976 -- 515
Arlington, MA 02174
60 The Great Road Owned 1971 -- 434
Bedford, MA 01730
459 Boston Road Owned 1972 -- 410
Billerica, MA 01821
75 Federal Street Leased 1988 September 1998 (1) 121
Boston, MA 02110
457 Broadway Owned 1969 697
Chelsea, MA 02150
1840 Massachusetts Avenue Owned 1960 -- 1,185
Lexington, MA 02173
31 Cross Street Owned 1971 -- 540
Peabody, MA 01960
411 Broadway Owned 1977 -- 1,154
Revere, MA 02150
200 Linden Street Leased 1973 November 1998 (1) 208
Wellesley, MA 02181
------
Total............................. $6,842
======
- --------------------
1 The Company has options to renew these leases which range from 5 to 15
years.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any pending material legal proceedings other
than routine legal proceedings occurring in the ordinary course of business.
Such routine legal proceedings, in the aggregate, are believed by management to
be immaterial to the Company's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Information relating to the market for Registrant's common equity and
related stockholder matters appears under "Shareholder Information" in the
Registrant's 1997 Annual Report to Stockholders on pages 63 - 64 and is
incorporated herein by reference. Information relating to dividend restrictions
for Registrant's common stock appears under "Regulation and Supervision."
ITEM 6. SELECTED FINANCIAL DATA.
The above-captioned information appears under "Selected Financial Data" of
the Corporation in the Registrant's 1997 Annual Report to Stockholders on pages
6 and 7 is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The above-captioned information appears under "Management Discussion and
Analysis of Financial Condition and Results of Operation" in the Registrant's
1997 Annual Report to Stockholders on pages 9 through 22 and is incorporated
herein by reference.
ITEMS 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS.
The above captioned information appears under the heading AMarket Risk and
Management of Interest Rate Risk in the Registrant's 1997 Annual Report to
Stockholders on pages 11 through 13 and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements of BostonFed Bancorp, Inc. and its
subsidiaries, together with the report thereon by KPMG Peat Marwick LLP appears
in the Registrant's 1997 Annual Report to Stockholders on pages 23 through 62
and are incorporated herein by reference.
Item 9. Change In and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on April 29, 1998 at
pages 4 through 6.
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ITEM 11. EXECUTIVE COMPENSATION.
The information relating to executive compensation is incorporated herein
by reference to the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on April 29, 1998 at pages 7 through 14.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on April 29, 1998,
at pages 2 through 5.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on April 29, 1998, at page 14.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company are
incorporated by reference to the following indicated pages of
the 1997 Annual Report to Stockholders:
PAGE
Independent Auditors' Report.................................... 23
Consolidated Balance Sheets as of
December 31, 1997 and 1996.................................... 24
Consolidated Statements of Income for the Years Ended
December 31, 1997, 1996 and 1995.............................. 25
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1997, 1996 and 1995.............. 26-28
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1997, 1996 and 1995........................ 29-30
Notes to Consolidated Financial Statements...................... 31-62
The remaining information appearing in the Annual Report to Stockholder is
not deemed to be filed as part of this report, except as expressly provided
herein.
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(2) All schedules are omitted because they are not required or applicable,
or the required information is shown in the consolidated financial
statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
3.1 Restated Certificate of Incorporation of BostonFed Bancorp, Inc.*
3.2 Bylaws of BostonFed Bancorp, Inc.*
4.0 Stock Certificate of BostonFed Bancorp, Inc.*
10.1 Employment Agreement between BFS and David F. Holland and
Employment Agreement between the Company and David F. Holland*
10.2 Employment Agreement between Bank and David P. Conley and
Employment Agreement between the Company and David P. Conley*
10.3 Employment Agreement between Bank and John A. Simas and
Employment Agreement between the Company and John A. Simas*
10.4 Form of Change in Control Agreement between BFS and Executive
and between the Company and Executive*
10.5 Boston Federal Savings Bank Employee Severance Compensation Plan*
10.6 Employee Stock Ownership Plan and Trust*
10.7 BostonFed Bancorp, Inc. 1996 Stock-Based Incentive Plan**
10.8 BostonFed Bancorp, Inc. 1997 Stock Option Plan***
11.0 Computation of earnings per share (see consolidated statement of
Income on page 25 of Annual Report)
13.0 1997 Annual Report to Stockholders (filed herewith)
21.0 Subsidiary information is incorporated herein by reference to
"Part I - Subsidiaries"
23.0 Consent of Independent Accountant (filed herewith)
27.0 Financial Data Schedule (filed herewith)
99.0 Proxy Statement for 1998 Annual Meeting (previously filed on
March 27, 1998)
-----------------------------
* Incorporated herein by reference into this document from the
Exhibits to Form S-1, Registration Statement, and any amendments
thereto, originally filed on July 21, 1995, as amended and declared
effective on September 11, 1995. Registration No. 33-94860.
** Incorporated herein by reference into this document from the Proxy
Statement for the 1996 Annual Meeting of Stockholders dated March
20, 1996.
*** Incorporated herein by reference into this document from the Proxy
Statement for the 1997 Annual Meeting of Stockholders dated March
28, 1997.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company in the last
quarter of 1997.
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SIGNATURES Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
BOSTONFED BANCORP, INC.
By:/s/ David F. Holland
------------------------
David F. Holland
President and Chief Executive Officer
DATED: 3/30/98
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.
Name Title Date
- ---- ----- ----
3/30/98
/s/ David F. Holland President, Chief Executive Officer ---------------
- ------------------------- and Chairman of the Board
David F. Holland
3/30/98
/s/ David P. Conley Director, Executive Vice President, ---------------
- ------------------------- Assistant Treasurer and Assistant Secretary
David P. Conley
3/30/98
/s/ John A. Simas Executive Vice President, ---------------
- ------------------------- Corporate Secretary and Chief Financial
John A. Simas Officer (Principal accounting officer)
3/30/98
/s/ Edward P. Callahan Director ---------------
- -------------------------
Edward P. Callahan
3/30/98
/s/ Richard J. Dennis, Sr. Director ---------------
- -------------------------
Richard J. Dennis, Sr.
3/30/98
/s/ Charles R. Kent Director ---------------
- ------------------------
Charles R. Kent
3/30/98
/s/ W. Robert Mill Director ---------------
- ------------------------
W. Robert Mill
3/30/98
/s/ Irwin W. Sizer Director ---------------
- ------------------------
Irwin W. Sizer
45