SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from_______to______ Commission File Number 0-23435 Medford Bancorp, Inc. (Exact name of registrant as specified in its charter) Massachusetts 04-3384928 - ------------- ---------- (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification No.) 29 High Street Medford, Massachusetts 02155 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (781) 395-7700 -------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| The number of shares outstanding of Medford Bancorp, Inc.'s common stock, $0.50 par value per share, as of September 30, 2000 was 8,066,768. TABLE OF CONTENTS PART I FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS PAGE Consolidated Balance Sheets 1 Consolidated Statements of Income 2-5 Consolidated Statements of Changes in Stockholders' Equity 6 Consolidated Statements of Cash Flows 7-8 Notes to Consolidated Financial Statements 9 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10-25 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 25 PART II OTHER INFORMATION ITEM 1 - Legal Proceedings 25 ITEM 2 - Changes in Securities and Use of Proceeds 25 ITEM 3 - Defaults Upon Senior Securities 26 ITEM 4 - Submission of Matters to a Vote of Security Holders 26 ITEM 5 - Other Information 26 ITEM 6 - Exhibits and Reports on Form 8-K 26 SIGNATURES 27 Exhibit Index 28 PART I FINANCIAL INFORMATION ITEM 1 Financial Statements MEDFORD BANCORP, INC. CONSOLIDATED BALANCE SHEETS September 30, December 31, 2000 1999 ------------- ------------ (In thousands) ASSETS Cash and due from banks $ 18,422 $ 17,043 Interest-bearing deposits 3,106 3,867 ----------- ----------- Cash and cash equivalents 21,528 20,910 Investment securities available for sale 530,588 520,030 Investment securities held to maturity 33,998 5,000 Restricted equity securities 11,751 10,828 Loans 675,986 633,530 Less allowance for loan losses (6,842) (6,779) ----------- ----------- Loans, net 669,144 626,751 ----------- ----------- Banking premises and equipment, net 10,968 11,566 Accrued interest receivable 10,668 9,162 Goodwill and deposit-based intangibles 2,856 3,679 Other assets 14,940 16,986 ----------- ----------- Total assets $ 1,306,441 $ 1,224,912 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 963,274 $ 911,328 Short-term borrowings 29,838 67,071 Long-term debt 212,117 148,653 Accrued taxes and expenses 2,789 3,920 Other liabilities 2,442 3,070 ----------- ----------- Total liabilities 1,210,460 1,134,042 ----------- ----------- Stockholders' equity: Serial preferred stock, $.50 par value, 5,000,000 shares authorized; none issued -- -- Common stock, 15,000,000 shares authorized; $.50 par value, 9,122,596 shares issued 4,561 4,561 Additional paid-in capital 23,495 24,839 Retained earnings 92,084 85,153 Accumulated other comprehensive loss (5,390) (9,405) Treasury stock at cost (1,055,828 and 739,344 shares, respectively) (18,769) (14,278) ----------- ----------- Total stockholders' equity 95,981 90,870 ----------- ----------- Total liabilities and stockholders' equity $ 1,306,441 $ 1,224,912 =========== =========== See accompanying notes to consolidated financial statements. 1 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME Three Months Ended September 30, -------------------- 2000 1999 -------- -------- (Dollars in thousands, except per share data) Interest and dividend income: Interest and fees on loans $ 12,695 $ 11,308 Interest on debt securities 8,862 8,110 Dividends on equity securities 258 188 Interest on short-term investments 79 59 -------- -------- Total interest and dividend income 21,894 19,665 -------- -------- Interest expense: Interest on deposits 9,474 8,132 Interest on short-term borrowings 462 862 Interest on long-term debt 2,948 1,887 -------- -------- Total interest expense 12,884 10,881 -------- -------- Net interest income 9,010 8,784 Provision for loan losses -- -- -------- -------- Net interest income, after provision for loan losses 9,010 8,784 -------- -------- Other income: Customer service fees 507 457 Loss on sales of investment securities, net (90) (6) Miscellaneous 224 196 -------- -------- Total other income 641 647 -------- -------- Operating expenses: Salaries and employee benefits 2,785 2,730 Occupancy and equipment 638 631 Data processing 392 370 Professional fees 111 103 Amortization of intangibles 273 282 Advertising and marketing 203 156 Other general and administrative 595 505 -------- -------- Total operating expenses 4,997 4,777 -------- -------- Income before income taxes 4,654 4,654 Provision for income taxes 1,638 1,626 -------- -------- Net income $ 3,016 $ 3,028 ======== ======== (continued) 2 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (continued) Three Months Ended September 30, --------------------- 2000 1999 --------- --------- (Dollars in thousands, except per share data) Earnings per share: Basic $ 0.37 $ 0.36 Diluted $ 0.36 $ 0.35 Cash dividends declared per share $ 0.12 $ 0.11 Weighted averages shares outstanding: Basic 8,048,154 8,377,148 Diluted 8,315,642 8,741,568 See accompanying notes to consolidated financial statements. 3 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME Nine Months Ended September 30, -------------------- 2000 1999 -------- -------- (Dollars in thousands, except per share data) Interest and dividend income: Interest and fees on loans $ 37,049 $ 33,387 Interest on debt securities 25,613 23,754 Dividends on equity securities 658 480 Interest on short-term investments 269 246 -------- -------- Total interest and dividend income 63,589 57,867 -------- -------- Interest expense: Interest on deposits 26,782 24,505 Interest on short-term borrowings 1,844 1,549 Interest on long-term debt 7,891 5,914 -------- -------- Total interest expense 36,517 31,968 -------- -------- Net interest income 27,072 25,899 Provision for loan losses 75 -- -------- -------- Net interest income, after provision for loan losses 26,997 25,899 -------- -------- Other income: Customer service fees 1,464 1,376 Gain (loss) on sales of investment securities, net (164) 1,522 Gain on sale of loans -- 3 Pension plan curtailment gains 1,195 -- Miscellaneous 777 626 -------- -------- Total other income 3,272 3,527 -------- -------- Operating expenses: Salaries and employee benefits 8,298 7,959 Occupancy and equipment 1,936 1,879 Data processing 1,139 1,128 Professional fees 331 370 Amortization of intangibles 822 851 Advertising and marketing 521 445 Other general and administrative 1,808 1,560 -------- -------- Total operating expenses 14,855 14,192 -------- -------- Income before income taxes 15,414 15,234 Provision for income taxes 5,561 5,506 -------- -------- Net income $ 9,853 $ 9,728 ======== ======== (continued) 4 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (Continued) Nine Months Ended September 30, --------------------- 2000 1999 --------- --------- (Dollars in thousands, except per share data) Earnings per share: Basic $ 1.21 $ 1.16 Diluted $ 1.17 $ 1.11 Cash dividends declared per share $ 0.36 $ 0.33 Weighted averages shares outstanding: Basic 8,144,345 8,397,677 Diluted 8,427,433 8,790,839 See accompanying notes to consolidated financial statements. 5 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Nine Months Ended September 30, 2000 and 1999 Accumulated Common Stock Additional Treasury Stock Other -------------------- Paid-In Retained ---------------------- Comprehensive Shares Dollars Capital Earnings Shares Dollars Income (Loss) Total ---------- -------- ---------- -------- ----------- ---------- -------------- -------- (In thousands) Balance at December 31, 1999 9,122,596 $4,561 $ 24,839 $ 85,153 (739,344) $(14,278) $(9,405) $ 90,870 --------- Comprehensive income: Net income -- -- -- 9,853 -- -- -- 9,853 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- 4,015 4,015 --------- Total comprehensive income 13,868 --------- Cash dividends declared ($.36 per share) -- -- -- (2,922) -- -- -- (2,922) Repurchase of treasury stock -- -- -- -- (423,100) (6,428) -- (6,428) Issuance of common stock under stock option plan and related income tax benefits -- -- (1,344) -- 106,616 1,937 -- 593 --------- ------ -------- -------- ---------- -------- ------- --------- Balance at September 30, 2000 9,122,596 $4,561 $ 23,495 $ 92,084 (1,055,828) $(18,769) $(5,390) $ 95,981 ========= ====== ======== ======== ========== ======== ======= ========= Balance at December 31, 1998 9,122,596 $4,561 $ 26,389 $ 76,770 (412,768) $ (8,511) $ 3,058 $ 102,267 --------- Comprehensive loss: Net income -- -- -- 9,728 -- -- -- 9,728 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- (9,473) (9,473) --------- Total comprehensive loss 255 --------- Cash dividends declared ($.33 per share) -- -- -- (2,760) -- -- -- (2,760) Repurchase of treasury stock -- -- -- -- (425,796) (7,689) -- (7,689) Issuance of common stock under stock option plan -- -- (1,467) -- 94,220 1,826 -- 359 --------- ------ -------- -------- ---------- -------- ------- --------- Balance at September 30, 1999 9,122,596 $4,561 $ 24,922 $ 83,738 (744,344) $(14,374) $(6,415) $ 92,432 ========= ====== ======== ======== ========== ======== ======= ========= See accompanying notes to consolidated financial statements. 6 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, ---------------------- 2000 1999 --------- --------- (In thousands) Cash flows from operating activities: Net income $ 9,853 $ 9,728 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 75 -- Depreciation and amortization, net 1,813 1,978 Loss (gain) on sales of investment securities, net 164 (1,522) Gain on sale of loans -- (3) Decrease (increase) in accrued interest receivable and other assets (1,985) 463 Decrease in accrued taxes and expenses and other liabilities (921) (7) --------- --------- Net cash provided by operating activities 8,999 10,637 --------- --------- Cash flows from investing activities: Activity in investment securities available for sale: Maturities 59,974 40,250 Sales 15,849 104,802 Purchases (102,846) (238,383) Principal amortization of mortgage-backed securities 23,285 40,482 Activity in investment securities held to maturity: Maturities 4,997 18,638 Purchases (35,522) (1,641) Proceeds from sale of loans, net -- 82 Loans originated and purchased, net of amortization and payoffs (42,412) (29,982) Purchases of banking premises and equipment, net (287) (613) Proceeds from sale of foreclosed real estate -- 116 --------- --------- Net cash used in investing activities (76,962) (66,249) --------- --------- (continued) 7 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded) Nine Months Ended September 30, -------------------- 2000 1999 -------- -------- (In thousands) Cash flows from financing activities: Net increase in deposits 51,946 29,976 Increase (decrease) in borrowings with maturities of three months or less (37,233) 30,913 Proceeds from long-term debt 63,464 2,000 Issuance of common stock 298 359 Payments to acquire treasury stock (6,428) (7,689) Cash dividends paid (3,466) (3,583) -------- -------- Net cash provided by financing activities 68,581 51,976 -------- -------- Net change in cash and cash equivalents 618 (3,636) Cash and cash equivalents at beginning of period 20,910 22,002 -------- -------- Cash and cash equivalents at end of period $ 21,528 $ 18,366 ======== ======== See accompanying notes to consolidated financial statements. 8 MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 Note 1. Basis of Presentation The consolidated interim financial statements of Medford Bancorp, Inc. (the "Company") and its wholly-owned subsidiary, Medford Savings Bank (the "Bank") presented herein are intended to be read in conjunction with the consolidated financial statements presented in the Company's annual report for the year ended December 31, 1999. The consolidated financial information for the three and nine months ended September 30, 2000 is unaudited. In the opinion of management, however, the consolidated financial information reflects all adjustments (consisting solely of normal recurring accruals) necessary for a fair presentation in accordance with generally accepted accounting principles. Interim results are not necessarily indicative of results to be expected for the entire year. Note 2. Commitments At September 30, 2000, the Company had outstanding commitments to originate new residential and commercial real estate mortgage loans totaling approximately $9.8 million, which are not reflected on the consolidated balance sheet. Unadvanced funds on equity lines were $23.6 million, unadvanced construction loan funds were $16.5 million, and unadvanced funds on commercial lines of credit were $10.5 million at September 30, 2000. Note 3. Earnings per Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed conversion. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. The assumed conversion of outstanding dilutive stock options would increase the shares outstanding but would not require an adjustment to income as a result of the conversion. Note 4. Defined Benefit Plan Termination On January 26, 2000 the Board of Directors of the Bank voted to amend its employee benefit programs to provide for the cessation of pension benefit accruals effective February 29, 2000 in conjunction with its termination of the Defined Benefit Pension Plan ("Plan") effective March 31, 2000. Final Plan termination is subject to IRS approval. During the first quarter of 2000, the Bank recorded an after-tax gain of $700,000 from the curtailment of its Plan. It is anticipated that the Bank will record an after-tax gain of approximately $1.2 million upon settlement and distribution of the Plan assets during the fourth quarter of 2000. On an on-going basis, a portion of the cost of providing the Plan will be reallocated to enhance 401(k) benefits for employees. 9 ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operation GENERAL This form 10-Q contains certain statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company's actual results could differ materially from those projected in the forward-looking statements as a result, among other factors, of changes in general national or regional economic conditions, changes in loan default and charge-off rates, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in interest rates, changes in the size and nature of the Company's competition, and changes in the assumptions used in making such forward-looking statements. Consolidated net income was $3,016,000, or basic earnings per share of $0.37 ($0.36 diluted basis), for the three months ended September 30, 2000, compared to $3,028,000, or basic earnings per share of $0.36 ($0.35 diluted basis), for the comparable prior year period. Net interest income was $9,010,000 for the quarter ended September 30, 2000, up $226,000 or 2.6% from the comparable 1999 period, and represented a net interest margin of 2.93% which compared to 3.06% for the comparable 1999 period. Net loss on sale of assets was $90,000 for the 2000 third quarter compared to a net loss of $6,000 for the same quarter in 1999. Total operating expenses were $4,997,000 for the quarter ended September 30, 2000, up $220,000 or 4.6% from $4,777,000 during the comparable period in 1999. There was no provision for loan losses recorded for the three-month periods ended September 30, 2000 and 1999. For the third quarter of 2000, the annualized return on assets was 0.94% and the annualized return on equity was 13.04%, compared to 1.00% and 13.26%, respectively, for the comparable period in 1999. Consolidated net income was $9,853,000, or basic earnings per share of $1.21 ($1.17 diluted basis), for the nine months ended September 30, 2000, compared to $9,728,000, or basic earnings per share of $1.16 ($1.11 diluted basis), for the comparable prior year period. Basic and diluted earnings per share have increased 4.3% and 5.4%, respectively, while consolidated net income increased $125,000 or 1.3% for the nine months comparative period. Net interest income was $27,072,000 for the nine months ended September 30, 2000, up $1.2 million or 4.5% from the comparable 1999 period, and represented a net interest margin of 2.96% compared to 3.04% for the nine months ended September 30, 1999. The net loss on sales of assets totaled $164,000 for the first nine months of 2000 compared to a gain of $1,525,000 for the same nine-month period in 1999. During the nine months ended September 30, 2000 there was a $1.2 million pre-tax curtailment gain from the termination of the Company's defined benefit pension plan. 10 Total operating expenses were $14,855,000 for the nine months ended September 30, 2000, up $663,000 or 4.7% from $14,192,000 during the comparable period in 1999. The provision for loan losses recorded for the nine months ended September 30, 2000 was $75,000 compared to zero for the same prior year period. For the first nine months of 2000, the annualized return on assets was 1.05% and the annualized return on equity was 14.75%, compared to 1.10% and 13.83%, respectively, for the comparable period in 1999. Total non-performing assets were $826,000 or 0.06% of total assets at September 30, 2000, compared to $2,500,000 or 0.20%, respectively, at December 31, 1999. The allowance for loan losses at September 30, 2000 was $6,842,000, representing 1.01% of total loans. At December 31, 1999, the allowance for loan losses was $6,779,000, representing 1.07% of total loans. The Company had no foreclosed real estate at September 30, 2000 or December 31, 1999. The Company had total assets of $1.31 billion and capital of $95.9 million at September 30, 2000, representing a capital to assets ratio of 7.35%, exceeding all regulatory requirements. When compared to December 31, 1999, investment securities increased $40.5 million or 7.6% to $576.3 million, total gross loans increased $42.5 million or 6.7% to $676.0 million, deposits increased $51.9 million or 5.7% to $963.3 million, and borrowings increased $26.2 million or 12.2% to $241.9 million. A more detailed discussion and analysis of the Company's financial condition and results of operations follows. INVESMENT SECURITIES Investment securities consist of the following: September 30, December 31, 2000 1999 ------------ ------------ (In thousands) Securities available for sale, at fair value $530,588 $520,030 Securities held to maturity, at amortized cost 33,998 5,000 Restricted equity securities: Federal Home Loan Bank stock 10,606 9,683 Northeast Retirement Services 31 31 Massachusetts Savings Bank Life Insurance stock 1,114 1,114 -------- -------- $576,337 $535,858 ======== ======== 11 The amortized cost and fair value of investment securities, excluding restricted equity securities, at September 30, 2000 and December 31, 1999 with gross unrealized gains and losses, follows: Gross Gross Amortized Unrealized Unrealized Fair September 30, 2000 Cost Gains Losses Value -------- ------- ------- -------- (In thousands) Securities Available for Sale Debt securities: Corporate bonds $283,472 $ 986 $(1,859) $282,599 Mortgage-backed 210,444 72 (6,631) 203,885 U.S. Government and federal agency obligations 43,198 -- (1,129) 42,069 -------- ------- ------- -------- Total debt securities 537,114 1,058 (9,619) 528,553 Marketable equity securities 2,306 (271) -- 2,035 -------- ------- ------- -------- Total securities available for sale $539,420 $ 787 $(9,619) $530,588 ======== ======= ======= ======== Securities Held to Maturity Debt securities: Mortgage-backed $ 29,208 $ 322 $ -- 29,530 U.S. Government and federal agency obligations 4,790 113 -- 4,903 -------- ------- ------- -------- Total securities held to maturity $ 33,998 $ 435 $ -- $ 34,433 ======== ======= ======= ======== Gross Gross Amortized Unrealized Unrealized Fair December 31, 1999 Cost Gains Losses Value -------- ------- ------- -------- (In thousands) Securities Available for Sale Debt securities: Corporate bonds $250,078 $ 42 $ (3,353) $246,767 Mortgage-backed 224,083 -- (9,627) 214,456 U.S. Government and federal agency obligations 59,144 -- (2,017) 57,127 -------- ------- -------- -------- Total debt securities 533,305 42 (14,997) 518,350 Marketable equity securities 2,097 6 (423) 1,680 -------- ------- -------- -------- Total securities available for sale $535,402 $ 48 $(15,420) $520,030 ======== ======= ======== ======== Securities Held to Maturity U.S. Government obligations $ 5,000 $ 6 $ -- $ 5,006 ======== ======= ======== ======== 12 The amortized cost and fair value of debt securities by contractual maturity at September 30, 2000 are as follows: Available for Sale Held to Maturity --------------------------- --------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ------------ ------------ ------------ ------------ (In thousands) Within 1 year $ 76,317 $ 75,984 $ -- $ -- After 1 year through 5 years 245,009 243,778 4,790 4,903 After 5 years through 10 years 5,344 4,906 -- -- ------------ ------------ ------------ ------------ 326,670 324,668 4,790 4,903 Mortgage-backed securities 210,444 203,885 29,208 29,530 ------------ ------------ ------------ ------------ $ 537,114 $ 528,553 $ 33,998 $ 34,433 ============ ============ ============ ============ The amortized cost and fair value of debt securities by contractual maturity at December 31, 1999 are as follows: Available for Sale Held to Maturity --------------------------- --------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ------------ ------------ ------------ ------------ (In thousands) Within 1 year $ 64,996 $ 64,987 $ 5,000 $ 5,006 After 1 year through 5 years 238,848 234,204 -- -- After 5 years through 10 years 5,378 4,703 -- -- ------------ ------------ ------------ ------------ 309,222 303,894 5,000 5,006 Mortgage-backed securities 224,083 214,456 -- -- ------------ ------------ ------------ ------------ $ 533,305 $ 518,350 $ 5,000 $ 5,006 ============ ============ ============ ============ Investment securities increased $40.5 million from $535.8 million at December 31, 1999 to $576.3 million at September 30, 2000. At September 30, 2000 the securities portfolio classified as "available for sale" reflected a net unrealized pre-tax loss of $8.8 million as a result of the ongoing changes in market interest rates as compared to an unrealized pre-tax loss of $15.4 million at December 31, 1999. In accordance with the Company's asset-liability strategies, purchases of mortgage-backed securities are primarily in fifteen year mortgages with weighted-average lives of six years and other investment securities are generally short-term with maturities of five years or less. Sales of debt securities produced a loss of $90,000 during the 2000 third quarter and a loss of $154,000 for the nine months ended September 30, 2000 compared to losses of $6,000 and gains of $1,483,000 for the third quarter and nine months ended September 30, 1999, respectively. Sales of equities produced losses of $10,000 during the nine months ended September 30, 2000 compared to gains of $39,000 for the nine months ended September 30, 1999. There were no sales of equities recorded in either of the quarterly periods ended September 30, 2000 and 1999. 13 LOANS A summary of the Company's outstanding loan balances as of the dates indicated as follows: September 30, December 31, 2000 1999 ------------ ----------- (In thousands) Mortgage loans on real estate: Residential 1 - 4 family $ 490,323 $ 465,420 Commercial 125,589 112,050 Construction 34,092 25,239 Second mortgages 729 774 Equity lines of credit 21,210 19,394 --------- --------- 671,943 622,877 Less: Unadvanced loan funds (16,478) (11,735) --------- --------- 655,465 611,142 --------- --------- Other loans: Commercial 16,335 18,124 Personal 2,016 2,071 Other 838 841 --------- --------- 19,189 21,036 --------- --------- Add: Net premium on loans acquired 157 198 Net deferred loan origination costs 1,175 1,154 --------- --------- Total loans 675,986 633,530 Less allowance for loan losses (6,842) (6,779) --------- --------- Loans, net $ 669,144 $ 626,751 ========= ========= Total gross loans outstanding at September 30, 2000 increased $42.5 million to $675.9 million when compared to the December 31, 1999 level. The increase in gross loans can be principally explained by the growth in residential 1-4 family real estate mortgage loans of $24.9 million, commercial real estate loans of $13.5 million and construction real estate loans of $8.9 million from the December 31, 1999 levels. Changes in all other loan categories during the three months ended September 30, 2000 are representative of net activity in new loan originations and amortization and payoffs. NON-PERFORMING ASSETS Total non-performing assets were $826,000 and $2.5 million at September 30, 2000 and December 31, 1999, respectively. There were no foreclosed assets at September 30, 2000 or December 31, 1999. As a percentage of total assets, nonperforming assets equaled 0.06% and 0.20% at September 30, 2000 and December 31, 1999, respectively. Fluctuations in total nonperforming assets occur from quarter to quarter but remain at historically low levels. It is the Company's general policy to place loans on a non-accrual status when such loans become 90 days contractually delinquent or when the collectibility of principal or interest payments becomes doubtful. When a loan is placed on non-accrual status, its interest income accrual ceases and all income previously accrued but unpaid is reversed. 14 In accordance with SFAS No. 114, a loan is considered impaired when, based on current information and events, it is probable that the borrower will be unable to meet principal or interest payments as agreed in the original loan contract. The principal balance of impaired loans at September 30, 2000 was $814,000, all of which were included in the $826,000 non-performing assets referenced in the preceding paragraph. The loan loss allowance allocated to these impaired loans was $114,000 at September 30, 2000. ALLOWANCE FOR LOAN LOSSES A summary of the activity in the allowance for loan losses follows: Nine Months Ended September 30, ------------------ 2000 1999 ------- ------- (In thousands) Balance at beginning of period $ 6,779 $ 6,876 Provision for loan losses 75 -- Recoveries 46 49 Loans charged-off (58) (153) ------- ------- Balance at end of period $ 6,842 $ 6,772 ======= ======= The allowance for loan losses is established through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the collectibility of the loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, known inherent risks in the nature and volume of the loan portfolio, levels of non-performing loans, adverse situations that may affect the borrowers' ability to repay, trends in delinquencies and charge-offs, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision, as more information becomes available. Ultimate losses may vary from current estimates and future additions to the allowance may be necessary. The allowance for loan losses was $6.8 million at September 30, 2000, a reserve coverage of 1.01% of total loans. At December 31, 1999, the allowance for loan losses was $6.8 million, representing 1.07% of total loans. 15 DEPOSITS Total deposits increased $51.9 million from December 31, 1999 to $963.3 million at September 30, 2000. Generally, the Company's strategy is to maintain stable deposit rates and to increase deposit levels through selective core deposit and term deposit promotions. To retain core deposits, the Company continues to promote its "ComboPlus" account, which combines a statement savings and a demand account. This "ComboPlus" account has contributed to an increase in both its related savings and demand deposits. The following table indicates the balances in various deposit accounts at the dates indicated. September 30, December 31, 2000 1999 ------------- ------------ (In thousands) Demand $ 65,051 $ 51,202 NOW 59,607 60,811 Savings and money market accounts 391,338 382,970 Term certificates 447,278 416,345 -------- -------- Total deposits $963,274 $911,328 ======== ======== BORROWED FUNDS Historically, the Company has selectively engaged in long-term borrowings to fund loans and has entered into short-term repurchase agreements to fund investment securities purchases. At September 30, 2000, the Company's long-term borrowings increased by $63.5 million to $212.1 million from $148.6 million at December 31, 1999 while its short-term borrowings decreased by $37.2 million to $29.8 million from $67.1 million at year-end. At September 30, 2000, borrowed funds totaled $241.9 million, increasing $26.3 million from the $215.7 million reported at December 31, 1999. STOCKHOLDERS' EQUITY The Company's capital to assets ratio was 7.35% and 7.42% at September 30, 2000 and December 31, 1999, respectively. The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and/or the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Holding companies, such as the Company, are not subject to prompt corrective action provisions. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. 16 Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to average assets (as defined). As of December 31, 1999, the Company and the Bank met all capital adequacy requirements to be categorized as well capitalized. No conditions or events occurred during the first nine months of 2000 that management believes have changed the Company's or the Bank's category. Therefore, management believes as of September 30, 2000 that the Company and the Bank met all capital adequacy requirements to continue to be categorized as well capitalized. The Company's book value at September 30, 2000 was $11.90 per share, compared with $10.84 per share at December 31, 1999. 17 RESULTS OF OPERATIONS QUARTER ENDED SEPTEMBER 30, 2000 VS QUARTER ENDED SEPTEMBER 30, 1999 NET INTEREST INCOME Interest and dividend income from loans and investments increased $2.2 million or 11.3% to $21.9 million for the 2000 third quarter when compared to the same quarter in 1999. For the 2000 third quarter, average earning assets totaled $1.248 billion, an increase of $82.1 million or 7.1% over the comparable average for 1999, with $26.4 million of that increase attributed to short and long-term investment securities and $55.7 million attributed to loans. The annualized yields on earning assets were 7.03% and 6.76% for the third quarters in 2000 and 1999, respectively. The yield on investment securities was 6.33% for the third quarter 2000 as compared 6.04% for the third quarter 1999. Short and long-term investments contributed $821,000 of additional interest and dividend income when comparing the third quarter of 2000 to the third quarter of 1999, primarily as a result of higher average balances. The increase in the average balance on loans and an increase in the yield, from 7.43% to 7.65%, caused interest income on loans to increase by $1,387,000 from its 1999 third quarter level. Total interest expense for the three months ended September 30, 2000 was $12.9 million, reflecting an increase of $2.0 million or 18.4% over the same period in 1999. At September 30, 2000 average interest-bearing liabilities were $1.12 billion, an increase of $66.5 million or 5.9% over the comparable prior year period. This period-to-period increase can be attributed to average deposit growth of $46.4 million and average borrowed funds increasing $20.1 million. Overall, interest expense on deposits increased $1.3 million to $9.5 million as a result of the increase in average deposits and in rates paid from 3.77% to 4.17% for the quarters ended September 30, 1999 and 2000, respectively. Interest expense on borrowed funds increased $661,000 as the average balances increased and the rates paid on borrowed funds increased 68 basis points to 6.12% in the third quarter of 2000 compared to the third quarter in 1999. The overall cost of interest bearing liabilities increased to 4.56% from 4.08% when comparing the two quarters. Net interest income increased 2.6% or $226,000 to $9.0 million when comparing the third quarter in 2000 to the same quarter in 1999 even as the weighted average rate spread decreased by 21 basis points to 2.47% while the net interest margin decreased 13 basis points to 2.93%. The increase in net interest income is primarily due to increased levels of earning assets while the basis point declines in spread and margin reflect the changing mix of earning assets and interest bearing liabilities. The yield on earning assets increased 27 basis points to 7.03% in the third quarter 2000 as compared to the same quarter in 1999, while the cost of interest-bearing liabilities increased by 48 basis points to 4.56%. This resulted in an interest rate spread and a net interest margin of 2.47% and 2.93%, respectively, for the three months ended September 30, 2000. 18 MEDFORD BANCORP, INC. INTEREST RATE SPREAD Three Months Ended September 30, ------------------ 2000 1999 ------- ------- Weighted average yield earned on: Short-term investments 6.27% 5.02% Investment securities 6.33 6.04 Loans 7.65 7.43 ----- ----- All earning assets 7.03% 6.76% ----- ----- Weighted average rate paid on: Deposits 4.17% 3.77% Borrowed funds 6.12 5.44 ----- ----- All interest-bearing liabilities 4.56% 4.08% ----- ----- Weighted average rate spread 2.47% 2.68% ===== ===== Net interest margin 2.93% 3.06% ===== ===== 19 PROVISION FOR LOAN LOSSES The provision for loan losses represents a charge against current earnings and an addition to the allowance for loan losses. The provision is determined by management on the basis of many factors, including the quality of specific loans, risk characteristics of the loan portfolio generally, the level of non performing loans, current economic conditions, trends in delinquency and charge-offs, and value of the underlying collateral. Management considers the allowance for loan losses to be adequate at September 30, 2000, although there can be no assurance that the allowance is adequate or that additional provisions to the allowance for loan losses will not be necessary. Growth in the loan portfolio was offset by the reduced allocation associated with non-performing loans and the Company recorded no provision for loan losses for the third quarter of 2000 and 1999. The Company recorded net loan recoveries of $26,000 for the three months ended September 30, 2000 compared to net loan charge-offs of $75,000 for the same period in 1999. OTHER INCOME Other income, including customer service fees and gains and losses on sales of assets equaled $641,000 in the third quarter of 2000 as compared to $647,000 in the third quarter of 1999, representing a decrease of $6,000 or 0.93%. The increase in losses on sales of securities when comparing the third quarter of 2000 to the third quarter of 1999 principally accounts for the decrease in other income. See related discussions under "Investment Securities" included in "Management's Discussion and Analysis" in Item 2 of Part 1 of this report. OPERATING EXPENSES Operating expenses increased $220,000 or 4.6% to $4,997,000 for the three months ended September 30, 2000 when compared to the same period in 1999. Salaries and employee benefits increased $55,000, when comparing the third quarter of 2000 to 1999. Other general and administrative expenses increased $93,000 when comparing the three months ended September 30, 2000 and the same period in 1999. The Company's annualized expense ratio, which is the ratio of non-interest expense to average assets, was 1.59% for the three months ended September 30, 2000, as compared to 1.58% for the prior year comparable period. The Company continues to focus on cost containment with the intent to be a low cost provider of high quality banking products and services. PROVISION FOR INCOME TAXES The Company's effective tax rate for three months ended September 30, 2000 was 35.2% as compared to 34.9% for the period ended September 30, 1999. 20 NINE MONTHS ENDED SEPTEMBER 30, 2000 VS NINE MONTHS ENDED SEPTEMBER 30, 1999 NET INTEREST INCOME Interest and dividend income from loans and investments increased $5.7 million or 9.9% to $63.6 million for the first nine months of 2000 when compared to 1999. Over the first half of 2000 average earning assets totaled $1.2 billion, an increase of $86.2 million or 7.6% over the comparable average for 1999, with $29.2 million of that increase attributed to short and long-term investment securities and $57.0 million attributed to loans. The annualized yields on earning assets were 6.93% and 6.78% for the nine months ended September 30, 2000 and 1999, respectively. The yield on investment securities was 6.19% for the first half of 2000, an increase of 16 basis points from 6.03% for the same period in 1999. Short and long-term investments contributed $2,059,000 of additional interest and dividend income when comparing the first nine months of 2000 to the first nine months of 1999, primarily as a result of higher average balances. The increase in the average balance on loans and yield from 7.48% to 7.58% caused interest income on loans to increase by $3,662,000 from the 1999 nine-month period. Total interest expense for the nine months ended September 30, 2000 was $36.5 million, reflecting an increase of $4.5 million or 14.2% over the same period in 1999. At September 30, 2000 average interest-bearing liabilities were $1.103 billion, an increase of $72.9 million or 6.6% over the comparable prior year period. This period-to-period increase can be attributed to average deposit growth of $37.9 million and average borrowed funds increasing $35.0 million. Deposit growth occurred as rates paid increased from 3.86% to 4.03% for the nine months ended September 30, 1999 and 2000, respectively. Overall, interest expense on deposits increased $2.3 million to $26.8 million due to increases in both average deposits and rates paid. Interest expense on borrowed funds increased $2.3 million as the average balances increased and the rates paid on borrowed funds increased 48 basis points to 5.93% in the first nine months of 2000 compared to the first nine months of 1999. The overall cost of interest bearing liabilities increased to 4.40% from 4.14% when comparing the two periods. Net interest income increased 4.5% or $1.2 million to $27.1 million when comparing the nine months in 2000 to the same period in 1999 even as the weighted average rate spread and the net interest margin decreased by 11 and 8 basis points, respectively. The increase in net interest income is primarily due to increased levels of earning assets while the basis point declines in spread and margin reflect the changing mix of earning assets and interest bearing liabilities. The yield on earning assets increased 15 basis points to 6.93% in the first nine months of 2000 as compared to the first nine months of 1999, while the cost of interest bearing liabilities increased by 26 basis points to 4.40%. This resulted in an interest rate spread and a net interest margin of 2.53% and 2.96%, respectively, for the nine months ended September 30, 2000. 21 MEDFORD BANCORP, INC. INTEREST RATE SPREAD Nine Months Ended September 30, ------------------ 2000 1999 ------- ------- Weighted average yield earned on: Short-term investments 5.95% 4.74% Investment securities 6.19 6.03 Loans 7.58 7.48 ----- ----- All earning assets 6.93% 6.78% ----- ----- Weighted average rate paid on: Deposits 4.03% 3.86% Borrowed funds 5.93 5.45 ----- ----- All interest-bearing liabilities 4.40% 4.14% ----- ----- Weighted average rate spread 2.53% 2.64% ===== ===== Net interest margin 2.96% 3.04% ===== ===== 22 PROVISION FOR LOAN LOSSES The provision for loan losses represents a charge against current earnings and an addition to the allowance for loan losses. The provision is determined by management on the basis of many factors, including the quality of specific loans, risk characteristics of the loan portfolio generally, the level of non performing loans, current economic conditions, trends in delinquency and charge-offs, and value of the underlying collateral. Management considers the allowance for loan losses to be adequate at September 30, 2000, although there can be no assurance that the allowance is adequate or that additional provisions to the allowance for loan losses will not be necessary. Due to growth in the loan portfolio, the Company recorded a $75,000 provision for loan losses for the first nine months of 2000. No provision for loan losses was recorded for the first nine months of 1999. The Company recorded net loan charge-offs of $12,000 for the nine months ended September 30, 2000 compared to net loan charge-offs of $104,000 for the same period in 1999. OTHER INCOME Other income, including customer service fees and gains and losses on sales of assets equaled $3.3 million in the first nine months of 2000 as compared to $3.5 million in the first nine months of 1999, representing a decrease of $255,000 or 7.2%. The $1.7 million decrease in combined gains on sales of securities and loans, when comparing the first nine months of 2000 to 1999, was partially offset by a $1.2 million pre-tax curtailment of the Company's defined benefit pension plan. See related discussions under "Investment Securities" included in "Management's Discussion and Analysis" in Item 2 of Part I and "Note 4. Defined Benefit Pension Plan Termination" in Item 1 of Part I of this report. OPERATING EXPENSES Operating expenses increased $663,000 or 4.7% to $14,855,000 for the nine months ended September 30, 2000 when compared to the same period in 1999. Salaries and employee benefits rose $339,000 during the first nine months of 2000 when compared to 1999, reflecting combined effects of increased staffing and wage pressures in a tight labor market. Other general and administrative expenses increased $248,000 when comparing the nine months ended September 30, 2000 and the same period in 1999. The Company's annualized expense ratio, which is the ratio of non-interest expense to average assets, was 1.58% for the nine months ended September 30, 2000, as compared to 1.63% for the prior year comparable period. The Company continues to focus on cost containment with the intent to be a low cost provider of high quality banking products and services. PROVISION FOR INCOME TAXES The Company's effective tax rate for both the nine months ended September 30, 2000 and the comparable 1999 period was 36.1%. 23 LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of funds are customer deposits, amortization and payoff of existing loan principal and sales or maturities of various investment securities. The Company is a voluntary member of the Federal Home Loan Bank of Boston ("FHLBB"), and as such may take advantage of the FHLBB's borrowing programs to enhance liquidity and leverage its favorable capital position. The Company also may draw on lines of credit at the FHLBB and a large commercial bank, and it may pledge U.S. Government securities to borrow from certain investment firms and the Mutual Savings Central Fund of Massachusetts. These various sources of liquidity are used to fund withdrawals, new loans, and investments. Management seeks to promote deposit growth while controlling the Company's cost of funds. Sales oriented programs to attract new depositors and the cross-selling of various products to its existing customer base are currently in place. Management reviews, on an ongoing basis, possible new products, with particular attention to products and services that will assist retention of the Company's base of lower-costing deposits. Maturities and sales of investment securities provide significant liquidity to the Company. The Company's policy of purchasing shorter-term debt securities reduces market risk in the bond portfolio while providing significant cash flow. For the nine months ended September 30, 2000 cash flow from maturities and sales of securities was $80.8 million compared to $163.7 million for the nine months ended September 30, 1999. Principal payments received on mortgage-backed investments during the nine months ended September 30, 2000 and 1999 totaled $23.3 million and $40.5 million, respectively. During periods of high interest rates, maturities in the bond portfolio could provide liquidity at a lower cost than borrowings. Amortization and payoffs of the loan portfolio also contribute significant liquidity to the Company. Traditionally, the amortization and payoffs have been reinvested into loans. When payoff rates exceed origination rates, excess liquidity from loan payoffs is shifted into the investment portfolio. The Company also uses borrowed funds as a source of liquidity. These borrowings generally contribute toward funding over-all loan growth as well as purchases of mortgage-backed securities. At September 30, 2000 the Company's outstanding borrowings from the FHLBB were $212.1 million, as compared to $193.6 million at December 31, 1999. The Company also utilizes repurchase agreements as a source of funding when management deems market conditions to be conducive to such activities. Repurchase agreements totaled $29.1 million at September 30, 2000 as compared to $21.2 million at December 31, 1999. Commitments to originate residential and commercial real estate mortgage loans at September 30, 2000, excluding unadvanced construction funds of $5.6 million, were $4.2 million. Management believes that adequate liquidity is available to fund loan commitments utilizing deposits, loan amortization, maturities of securities, or borrowings. Purchases of securities during the nine months ended September 30, 2000 totaled $138.4 million, consisting of debt instruments generally maturing in less than five years and equities. This compares with purchases of $240.0 million for the nine months ended September 30, 1999. Residential and commercial real estate mortgage loan originations for the nine months ended September 30, 2000 totaled $120 million, compared with $113.9 million for the nine months ended September 30, 1999. 24 The Company's capital position (total stockholders' equity) was $95.9 million or 7.35% of total assets at September 30, 2000 compared with $90.8 million or 7.42% of total assets at December 31, 1999. During the nine months ended September 30, 2000 the Company purchased 423,100 shares of its common stock in accordance with a previously announced stock purchase program. The Company's capital position exceeds all regulatory requirements ASSET-LIABILITY MANAGEMENT Through the Company's Asset-Liability Management Committee ("ALCO"), which is comprised of certain senior and middle management personnel, the Company monitors the level and general mix of interest rate-sensitive assets and liabilities. The primary objective of the Company's ALCO program is to manage the assets and liabilities of the Company to provide for optimum profitability and capital at prudent levels of liquidity and interest rate, credit, and market risk. It is ALCO's general policy to closely match the maturity or rate sensitivity of its assets and liabilities. In accordance with this policy, certain strategies have been implemented to improve the match between interest rate sensitive assets and liabilities. These strategies include, but are not limited to: daily monitoring of the Company's changing cash requirements, with particular concentration on investment in short term securities; originating adjustable and fixed rate mortgage loans for the Company's own portfolio; managing the cost and structure of deposits; and generally using matched borrowings to fund specific purchases of loan packages and large loan origination. Occasionally, management may choose to deviate from specific matching of maturities of assets and liabilities, if an attractive opportunity to enhance yields becomes available. The Company actively manages its liability portfolio in order to effectively plan and manage growth and maturities of deposits. Management recognizes the need for strict attention to all deposits. Accordingly, plans for growth of all deposit types are reviewed regularly. Programs are in place which are designed to build multiple relationships with customers and to enhance the Company's ability to retain deposits at controlled rates of interest, and management has adopted a policy of reviewing interest rates on an ongoing basis on all deposit accounts in order to control deposit growth and interest costs. In addition to attracting deposits, the Company has selectively borrowed funds using advances from the FHLBB and, upon occasion, reverse repurchase agreements. These funds have generally been used to fund loans typically having a matched repricing date as well as purchases of mortgage-backed securities. IMPACT OF INFLATION The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and results of operations in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all assets of a financial institution are monetary in nature. As a result, interest rates have a more significant effect on a financial institution's performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. 25 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk For a discussion of the Company's management of market risk exposure, see "Asset-Liability Management" in Item 2 of Part I of this report and Item 7A of Part II of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (the "1999 Annual Report"). For quantitative information about market risk, see Item 7A of Part II of the Company's 1999 Annual Report. There have been no material changes in the quantitative and qualitative disclosures about market risk as of September 30, 2000 from those presented in the Company's 1999 Annual Report. PART II - OTHER INFORMATION ITEM 1 - Legal Proceedings There are no material legal proceedings to which the Company is a party or to which any of its property is subject, although the Company is a party to ordinary routine litigation incidental to its business. ITEM 2 - Changes in Securities and Use of Proceeds Not applicable. ITEM 3 - Defaults Upon Senior Securities Not applicable. ITEM 4 - Submission of Matters to a Vote of Security Holders None ITEM 5 - Other Information None. ITEM 6 - Exhibits and Reports on Form 8-K (a) Exhibit Description ------- ----------- Exhibit 27 Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the three month period ended September 30, 2000. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MEDFORD BANCORP, INC. Date: November 14, 2000 /s/ Arthur H. Meehan ----------------------------------------------- Arthur H. Meehan Chairman, President and Chief Executive Officer Date: November 14, 2000 /s/ Phillip W. Wong ----------------------------------------------- Phillip W. Wong Executive Vice President, Treasurer and Chief Financial Officer 27 EXHIBIT INDEX Exhibit Description - ------- ----------- 27 Financial Data Schedule 28