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 June 30, 2001 [_] 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 June 30, 2001 was 7,785,064. 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 10-24 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 25 ITEM 4 - Submission of Matters to a Vote of Security Holders 25 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 June 30, December 31, 2001 2000 ----------- ----------- (In thousands) ASSETS Cash and due from banks $ 19,374 $ 16,905 Interest-bearing deposits 32,816 5,353 ----------- ----------- Cash and cash equivalents 52,190 22,258 Securities available for sale 536,360 528,690 Securities held to maturity 56,472 42,854 Federal Home Loan Bank stock, at cost 11,920 11,420 Loans 680,058 675,697 Less allowance for loan losses (6,948) (6,950) ----------- ----------- Loans, net 673,110 668,747 ----------- ----------- Banking premises and equipment, net 11,462 10,884 Accrued interest receivable 9,973 10,211 Goodwill and deposit-based intangibles 2,056 2,588 Other assets 12,438 12,038 ----------- ----------- Total assets $1,365,981 $1,309,690 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $1,036,534 $ 975,857 Short-term borrowings 17,466 20,443 Long-term debt 202,775 203,400 Accrued taxes and expenses 2,201 2,278 Other liabilities 2,388 2,747 ----------- ----------- Total liabilities 1,261,364 1,204,725 ----------- ----------- 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 22,226 22,705 Retained earnings 99,084 94,697 Accumulated other comprehensive income 2,463 424 Treasury stock at cost (1,337,532 and 980,048 shares, respectively) (23,717) (17,422) ----------- ----------- Total stockholders' equity 104,617 104,965 ----------- ----------- Total liabilities and stockholders' equity $1,365,981 $1,309,690 =========== =========== See accompanying notes to consolidated financial statements. 1 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME Three Months Ended June 30, --------------------------------- 2001 2000 ---------- ---------- (Dollars in thousands, except per share data) Interest and dividend income: Interest and fees on loans $ 12,570 $ 12,374 Interest on debt securities 9,342 8,503 Dividends on equity securities 198 207 Interest on short-term investments 220 95 ---------- ---------- Total interest and dividend income 22,330 21,179 ---------- ---------- Interest expense: Interest on deposits 9,703 8,890 Interest on short-term borrowings 249 598 Interest on long-term debt 3,148 2,599 ---------- ---------- Total interest expense 13,100 12,087 ---------- ---------- Net interest income 9,230 9,092 Provision for loan losses -- -- ---------- ---------- Net interest income, after provision for loan losses 9,230 9,092 ---------- ---------- Other income: Customer service fees 571 494 Gain (loss) on sales of securities, net 155 -- Miscellaneous 246 251 ---------- ---------- Total other income 972 745 ---------- ---------- Operating expenses: Salaries and employee benefits 2,961 2,787 Occupancy and equipment 696 631 Data processing 447 376 Professional fees 123 113 Amortization of intangibles 264 273 Advertising and marketing 157 168 Other general and administrative 658 610 ---------- ---------- Total operating expenses 5,306 4,958 ---------- ---------- Income before income taxes 4,896 4,879 Provision for income taxes 1,743 1,749 ---------- ---------- Net income $ 3,153 $ 3,130 ========== ========== (continued) 2 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (Continued) Three Months Ended June 30, -------------------------------- 2001 2000 ---------- ---------- (Dollars in thousands, except per share data) Earnings per share: Basic $ 0.41 $ 0.39 Diluted $ 0.40 $ 0.37 Cash dividends declared per share $ 0.13 $ 0.12 Weighted averages shares outstanding: Basic 7,785,150 8,122,241 Diluted 7,976,723 8,404,267 See accompanying notes to consolidated financial statements. 3 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (Continued) Six Months Ended June 30, -------------------------------- 2001 2000 --------- --------- (Dollars in thousands, except per share data) Interest and dividend income: Interest and fees on loans $ 25,343 $ 24,354 Interest on debt securities 18,510 16,751 Dividends on equity securities 425 400 Interest on short-term investments 441 190 --------- --------- Total interest and dividend income 44,719 41,695 --------- --------- Interest expense: Interest on deposits 19,242 17,308 Interest on short-term borrowings 639 1,382 Interest on long-term debt 6,398 4,943 --------- --------- Total interest expense 26,279 23,633 --------- --------- Net interest income 18,440 18,062 Provision for loan losses -- 75 --------- --------- Net interest income, after provision for loan losses 18,440 17,987 --------- --------- Other income: Customer service fees 1,109 957 Gain (loss) on sales of securities, net 371 (74) Pension plan curtailment gain -- 1,195 Miscellaneous 574 553 --------- --------- Total other income 2,054 2,631 --------- --------- Operating expenses: Salaries and employee benefits 5,865 5,513 Occupancy and equipment 1,457 1,300 Data processing 870 747 Professional fees 228 220 Amortization of intangibles 532 550 Advertising and marketing 305 318 Other general and administrative 1,258 1,210 --------- --------- Total operating expenses 10,515 9,858 --------- --------- Income before income taxes 9,979 10,760 Provision for income taxes 3,567 3,923 --------- --------- Net income $ 6,412 $ 6,837 ========= ========= (continued) 4 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (Concluded) Six Months Ended June 30, ------------------------------------ 2001 2000 ---------- ---------- (Dollars in thousands, except per share data) Earnings per share: Basic $ 0.82 $ 0.83 Diluted $ 0.80 $ 0.81 Cash dividends declared per share $ 0.26 $ 0.24 Weighted averages shares outstanding: Basic 7,848,441 8,192,440 Diluted 8,042,781 8,483,334 See accompanying notes to consolidated financial statements. 5 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Six Months Ended June 30, 2001 and 2000 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, 2000 9,122,596 $ 4,561 $ 22,705 $ 94,697 (980,048) $ (17,422) $ 424 $104,965 -------- Comprehensive income: Net income -- -- -- 6,412 -- -- -- 6,412 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- 2,039 2,039 -------- Total comprehensive income 8,451 -------- Cash dividends declared ($.26 per share) -- -- -- (2,025) -- -- -- (2,025) Repurchase of treasury stock -- -- -- -- (401,048) (7,066) -- (7,066) Issuance of common stock under stock option plan -- -- (479) -- 43,564 771 -- 292 --------- ------- -------- -------- ---------- --------- -------- -------- Balance at June 30, 2001 9,122,596 $ 4,561 $ 22,226 $ 99,084 (1,337,532) $ (23,717) $ 2,463 $104,617 ========= ======= ======== ======== ========== ========= ======== ======== 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 -- -- -- 6,837 -- -- -- 6,837 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- (46) (46) -------- Total comprehensive income 6,791 -------- Cash dividends declared ($.24 per share) -- -- -- (1,958) -- -- -- (1,958) Repurchase of treasury stock -- -- -- -- (358,000) (5,419) -- (5,419) Issuance of common stock under stock option plan -- -- (798) -- 51,176 951 -- 153 --------- ------- -------- -------- ---------- --------- -------- --------- Balance at June 30, 2000 9,122,596 $ 4,561 $ 24,041 $ 90,032 (1,046,168) $ (18,746) $ (9,451) $ 90,437 ========= ======= ======== ======== ========== ========= ======== ======== See accompanying notes to consolidated financial statements. 6 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, --------------------- 2001 2000 --------- -------- (In thousands) Cash flows from operating activities: Net income $ 6,412 $ 6,837 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses -- 75 Depreciation and amortization, net 786 1,307 Loss (gain) on sales of securities, net (371) 74 Increase in accrued interest receivable and other assets (1,171) (910) Decrease in accrued taxes and expenses and other liabilities (148) (663) --------- -------- Net cash provided by operating activities 5,508 6,720 --------- -------- Cash flows from investing activities: Activity in securities available for sale: Maturities 42,293 44,324 Sales 46,667 5,964 Purchases (115,638) (80,971) Principal amortization of mortgage-backed securities 29,568 14,172 Activity in securities held to maturity: Maturities -- 4,997 Purchases (21,067) (15,119) Loans originated and purchased, net of amortization and payoffs (4,192) (24,629) Additions to banking premises and equipment, net (1,191) (128) --------- -------- Net cash used in investing activities (23,560) (51,390) --------- -------- (continued) 7 MEDFORD BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded) Six Months Ended June 30, --------------------- 2001 2000 --------- -------- (In thousands) Cash flows from financing activities: Net increase in deposits 60,677 59,790 Decrease in borrowings with maturities of three months or less (2,977) (26,745) Repayment of/ proceeds from long-term debt (625) 23,464 Issuance of common stock 292 153 Payments to acquire treasury stock (7,066) (5,419) Cash dividends paid (2,317) (2,496) --------- -------- Net cash provided by financing activities 47,984 48,747 --------- -------- Net change in cash and cash equivalents 29,932 4,077 Cash and cash equivalents at beginning of period 22,258 20,910 --------- -------- Cash and cash equivalents at end of period $ 52,190 $ 24,987 ========= ======== See accompanying notes to consolidated financial statements. 8 MEDFORD BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000 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, 2000 The consolidated financial information for the three and six months ended June 30, 2001 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 accounting principles generally accepted in the United States of America. Interim results are not necessarily indicative of results to be expected for the entire year. Note 2. Commitments At June 30, 2001, the Company had outstanding commitments to originate new residential and commercial real estate mortgage loans totaling approximately $19.4 million, which are not reflected on the consolidated balance sheet. Unadvanced funds on equity lines were $23.0 million, unadvanced construction loan funds were $12.7 million, and unadvanced funds on commercial lines of credit were $14.0 million at June 30, 2001. 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. 9 ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operation GENERAL The discussions set forth below and elsewhere herein contain certain statements that may be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. The company may make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to stockholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," "intend," "estimate," "assume," "will," "should," and other expression which predict or indicate future events or trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Company. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Company to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements. Some of the factors that might cause these differences include the following: 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 laws and regulations; changes in size and nature of the Company's competition; and changes in the assumptions used in making such forward-looking statements. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences, including, among others, the factors listed under "Risk Factors and Factors Affecting Forward Looking Statements," as found in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. Readers should carefully review the factors described under "Risk Factors and Factors Affecting Forward Looking Statements" and should not place undue reliance on our forward-looking statements. These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. Consolidated net income was $3,153,000, or basic earnings per share of $0.41 ($0.40 diluted basis), for the three months ended June 30, 2001, compared to $3,130,000, or basic earnings per share of $0.39 ($0.37 diluted basis), for the comparable prior year period. Net interest income was $9,230,000 for the quarter ended June 30, 2001, up $138,000 or 1.5% from the comparable 2000 period, and represented a net interest margin of 2.86%, which compared to 2.97% for the comparable 2000 period. Net gain on sale of assets was $155,000 for the 2001 second quarter compared to zero for the same quarter in 2000. Total operating expenses were $5,306,000 for the quarter ended June 30, 2001, up $348,000 or 7.0% from $4,958,000 during the comparable period in 2000. There was no provision for loan losses recorded for the three-month periods ended June 30, 2001 and 2000. For the second quarter of 2001, the annualized return on assets was 0.95% and the annualized return on equity was 12.16%, compared to 1.01% and 14.40%, respectively, for the comparable period in 2000. 10 Consolidated net income was $6,412,000, or basic earnings per share of $.82 ($.80 diluted basis), for the six months ended June 30, 2001, compared to $6,837,000, or basic earnings per share of $.83 ($.81 diluted basis), for the comparable prior year period. Basic and diluted earnings per share have both decreased 1.2% while consolidated net income decreased $425,000 or 6.2% for the six months comparative period. Net interest income was $18,440,000 for the six months ended June 30, 2001, up $378,000 or 2.1% from the comparable 2000 period, and represented a net interest margin of 2.86% compared to 2.97% for the six months ended June 30, 2000. The net gain on sales of assets totaled $371,000 for the first six months of 2001 compared to a net loss of $74,000 for the same six-month period in 2000. During the six months ended June 30, 2000 there was a $1.2 million pre-tax curtailment gain from the termination of the Company's defined benefit pension plan. Total operating expenses were $10,515,000 for the six months ended June 30, 2001, up $657,000 or 6.7% from $9,858,000 during the comparable period in 2000. There was no provision for loan losses recorded for the six months ended June 30, 2001 compared to $75,000 for the same prior year period. For the first six months of 2001, the annualized return on assets was 0.98% and the annualized return on equity was 12.46%, compared to 1.11% and 15.66%, respectively, for the comparable period in 2000. Total non-performing assets were $2,100,000 or 0.15% of total assets at June 30, 2001, compared to $1,047,000 or 0.08%, respectively, at December 31, 2000. The allowance for loan losses at June 30, 2001 was $6,948,000, representing 1.02% of total loans. At December 31, 2000, the allowance for loan losses was $6,950,000, representing 1.03% of total loans. The Company had no foreclosed real estate at June 30, 2001 or December 31, 2000. The Company had total assets of $1.37 billion and capital of $104.6 million at June 30, 2001, representing a capital to assets ratio of 7.66%, exceeding all regulatory requirements. When compared to December 31, 2000, securities increased $21.8 million or 3.7% to $604.8 million, total gross loans increased $4.4 million or 0.65% to $680.1 million, deposits increased $60.7 million or 6.2% to $1,037 million, and borrowings decreased $3.6 million or 1.61% to $220.2 million. A more detailed discussion and analysis of the Company's financial condition and results of operations follows. 11 SECURITIES The amortized cost and fair value of investment securities, excluding restricted equity securities, at June 30, 2001 and December 31, 2000 with gross unrealized gains and losses, follows: Gross Gross Amortized Unrealized Unrealized Fair June 30, 2001 Cost Gains Losses Value - ------------------------------------------------- --------- ----------- ----------- -------- (In thousands) Securities Available for Sale - ----------------------------- Debt securities: Corporate bonds $296,028 $ 5,906 $ (185) $301,749 Federal agency obligations 5,000 -- -- 5,000 Mortgage-backed 230,142 845 (2,482) 228,505 -------- -------- -------- -------- Total debt securities 531,170 6,751 (2,667) 535,254 Marketable equity securities 1,261 60 (215) 1,106 -------- -------- -------- -------- Total securities available for sale $532,431 $ 6,811 $ (2,882) $536,360 ======== ======== ======== ======== Securities Held to Maturity - --------------------------- Debt securities: Federal agency obligations $ 4,847 $ 252 $ -- $ 5,099 Mortgage-backed 51,625 899 (175) 52,349 -------- -------- -------- -------- Total securities held to maturity $ 56,472 $ 1,151 $ (175) $ 57,448 ======== ======== ======== ======== Gross Gross Amortized Unrealized Unrealized Fair December 31, 2000 Cost Gains Losses Value - ------------------------------------------------- --------- ----------- ----------- -------- (In thousands) Securities Available for Sale - ----------------------------- Debt securities: Corporate bonds $310,165 $ 2,628 $ (478) $312,315 Federal agency obligations 3,000 -- (3) 2,997 Mortgage-backed 212,589 668 (1,850) 211,407 -------- -------- -------- -------- Total debt securities 525,754 3,296 (2,331) 526,719 Marketable equity securities 2,285 81 (395) 1,971 -------- -------- -------- -------- Total securities available for sale $528,039 $ 3,377 $ (2,726) $528,690 ======== ======== ======== ======== Securities Held to Maturity - ----------------------------- Debt securities: Federal agency obligations $ 4,809 $ 210 $ -- $ 5,019 Mortgage-backed 38,045 871 -- 38,916 -------- -------- -------- -------- Total securities held to maturity $ 42,854 $ 1,081 $ -- $ 43,935 ======== ======== ======== ======== 12 The amortized cost and fair value of debt securities by contractual maturity at June 30, 2001 are as follows: Available for Sale Held to Maturity --------------------- -------------------- Amortized Fair Amortized Fair Cost Value Cost Value --------- -------- --------- -------- (In thousands) Within 1 year $ 70,848 $ 71,568 $ -- $ -- After 1 year through 5 years 230,180 235,181 4,847 5,099 -------- -------- -------- -------- 301,028 306,749 4,847 5,099 Mortgage-backed securities 230,142 228,505 51,625 52,349 -------- -------- -------- -------- $531,170 $535,254 $ 56,472 $ 57,448 ======== ======== ======== ======== Securities increased $21.8 million from $583.0 million at December 31, 2000 to $604.8 million at June 30, 2001. At June 30, 2001, the securities portfolio classified as "available for sale" reflected a $3.9 million appreciation in market value as a result of the ongoing changes in market interest rates as compared to $651,000 at December 31, 2000. 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 securities are generally short-term with maturities of five years or less. Sales of debt securities produced gains of $155,000 during the 2001 second quarter and gains of $311,000 for the six months ended June 30, 2001 compared to losses of $64,000 for the six months ended June 30, 2000. Sales of equities produced gains of $60,000 during the six months ended June 30, 2001 compared to losses of $10,000 for the six months ended June 30, 2000. There were no sales of equities recorded in either of the quarterly periods ended June 30, 2001 and 2000. 13 LOANS A summary of the Company's outstanding loan balances as of the dates indicated as follows: June 30, December 31, 2001 2000 --------- ------------ (In thousands) Mortgage loans on real estate: Residential 1 - 4 family $ 484,840 $ 487,964 Commercial 133,124 124,201 Construction 19,237 19,913 Second mortgages 633 699 Equity lines of credit 22,727 21,609 --------- --------- 660,561 654,386 Other loans: Commercial 15,468 17,219 Personal 2,864 2,925 --------- --------- 18,332 20,144 --------- --------- Net deferred loan origination costs 1,165 1,167 --------- --------- Total loans 680,058 675,697 Less allowance for loan losses (6,948) (6,950) --------- --------- Loans, net $ 673,110 $ 668,747 ========= ========= Total gross loans outstanding at June 30, 2001 increased $4.4 million to $680.1 million when compared to the December 31, 2000 level. As residential mortgage rates decreased during the first six months of 2001, refinancing activity increased contributing to the decline in residential 1-4 family real estate mortgage loans of $3.1 million. Construction real estate and commercial and industrial loans also declined by $0.7 million and $1.8 million, respectively from December 31, 2000 levels. Offsetting these decreases, the Company's commitment to rebuild its commercial real estate portfolio continues to make gains as they grew $8.9 million during the six months ended June 30, 2001. NON-PERFORMING ASSETS Total non-performing assets were $2.1 million and $1.0 million at June 30, 2001 and December 31, 2000, respectively. There were no foreclosed assets at June 30, 2001 or December 31, 2000. As a percentage of total assets, nonperforming assets equaled 0.15% and 0.08% at June 30, 2001 and December 31, 2000, respectively. Fluctuations in total non-performing 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. 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 June 30, 2001 was $2.1 million all of which were included in the $2.1 million non-performing assets referenced in the preceding paragraph. 14 ALLOWANCE FOR LOAN LOSSES A summary of the activity in the allowance for loan losses follows: Six Months Ended June 30, ------------------------ 2001 2000 ------- ------- (In thousands) Balance at beginning of period $ 6,950 $ 6,779 Provision for loan losses -- 75 Recoveries 46 12 Loans charged-off (48) (50) ------- ------- Balance at end of period $ 6,948 $ 6,816 ------- ------- 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 of $6.9 million at June 30, 2001 represented a reserve coverage of 1.02% of total loans. At December 31, 2000, the allowance for loan losses was $6.8 million, representing 1.03% of total loans. DEPOSITS Total deposits increased $60.7 million from December 31, 2000 to $1,037 million at June 30, 2001. Demand deposits increased $10.8 million from year-end levels. During the first half of 2001, savings and money market accounts increased $71.2 million as retail depositors sought alternative banking relationships, in a consolidating market, and municipalities shifted from certificates of deposits to money market accounts for increased liquidity. The shift in municipal deposits contributed to the $20 million decrease in term certificates from $459.0 million at December 31, 2000 to $439.0 million at June 30, 2001. 15 June 30, December 31, 2001 2000 ---------- ------------ (In thousands) Demand $ 73,925 $ 63,122 NOW 63,703 65,106 Savings and money market accounts 459,870 388,655 Term certificates 439,036 458,974 ---------- ---------- Total deposits $1,036,534 $ 975,857 ========== ========== BORROWED FUNDS At June 30, 2001, the Company's long-term borrowings decreased by $625,000 to $202.8 million from $203.4 million at December 31, 2000. Short-term borrowings decreased by $2.9 million to $17.5 million from $20.4 million at year-end. At June 30, 2001, borrowed funds totaled $220.2 million, decreasing $3.6 million from the $223.8 million reported at December 31, 2000 as the Company experienced strong deposit growth. STOCKHOLDERS' EQUITY The Company's capital to assets ratio was 7.66% and 8.01% at June 30, 2001 and December 31, 2000, 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. 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). Management believes as of June 30, 2001 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 June 30, 2001 was $13.44 per share, compared with $12.89 per share at December 31, 2000. 16 RESULTS OF OPERATIONS QUARTER ENDED JUNE 30, 2001 VS QUARTER ENDED JUNE 30, 2000 NET INTEREST INCOME Interest and dividend income from loans and investments increased $1.2 million or 5.4% to $22.3 million for the 2001 second quarter when compared to the same quarter in 2000. For the 2001 second quarter, average earning assets totaled $1.292 billion, an increase of $69.0 million or 5.6% over the comparable average for 2000, with $48.6 million of that increase attributed to short and long-term securities and $20.4 million attributed to loans. The annualized yields on earning assets were 6.91% and 6.93% for the second quarters in 2001 and 2000, respectively. The yield on investment securities was 6.37% for the second quarter 2001 as compared 6.17% for the second quarter 2000. Short and long-term investments contributed $954,000 of additional interest and dividend income when comparing the second quarter of 2001 to the second quarter of 2000, primarily as a result of higher average balances and yield. The increase in the average balance on loans and a decrease in the yield, from 7.58% to 7.47%, caused interest income on loans to only increase $196,000 from its 2000 second quarter level. Total interest expense for the three months ended June 30, 2001 was $13.1 million, reflecting an increase of $1.01 million or 8.4% over the same period in 2000. At June 30, 2001 average interest-bearing liabilities were $1.16 billion, an increase of $60.0 million or 5.4% over the comparable prior year period. This period-to-period increase can be attributed to average deposit growth of $52.6 million and average borrowed funds increasing $7.4 million. Overall, interest expense on deposits increased $814,000 to $9.7 million as a result of the increase in average deposits and in rates paid from 4.02% to 4.13% for the quarters ended June 30, 2001 and 2000, respectively. Interest expense on borrowed funds increased $199,000 as the average balances increased and the rates paid on borrowed funds increased 16 basis points to 6.09% in the second quarter of 2001 compared to the second quarter in 2000. The overall cost of interest bearing liabilities increased to 4.51% from 4.39% when comparing the two quarters. Net interest income increased 1.5% or $138,000 to $9.2 million when comparing the second quarter in 2001 to the same quarter in 2000 even as the weighted average rate spread decreased by 14 basis points to 2.40% while the net interest margin decreased 11 basis points to 2.86%. 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 decreased 2 basis points to 6.91% in the second quarter 2001 as compared to the same quarter in 2000, while the cost of interest-bearing liabilities increased by 12 basis points to 4.51%. This resulted in an interest rate spread and a net interest margin of 2.40% and 2.86%, respectively, for the three months ended June 30, 2001. 17 MEDFORD BANCORP, INC. INTEREST RATE SPREAD Three Months Ended June 30, ------------------ 2001 2000 ---- ---- Weighted average yield earned on: Short-term investments 4.27% 6.15% Securities 6.37 6.17 Loans 7.47 7.58 ---- ---- All earning assets 6.91% 6.93% ---- ---- Weighted average rate paid on: Deposits 4.13% 4.02% Borrowed funds 6.09 5.93 ---- ---- All interest-bearing liabilities 4.51% 4.39% ---- ---- Weighted average rate spread 2.40% 2.54% ==== ==== Net interest margin 2.86% 2.97% ==== ==== 18 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 June 30, 2001, 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. The Company recorded no provision for loan losses for the second quarter of 2001 and 2000. The Company recorded net loan charge-offs of $13,000 and $11,000 for the three months ended June 30, 2001 and June 30, 2000. OTHER INCOME Other income, including customer service fees and gains and losses on sales of assets equaled $972,000 for the second quarter of 2001 as compared to $745,000 in the second quarter of 2000, representing a increase of $227,000 or 30.5%. When comparing the second quarter of 2001 with the second quarter of 2000, the increase in securities gains and customer service fees of $155,000 and $77,000, respectively, principally account for the increase in other income. See related discussions under "Securities" included in "Management's Discussion and Analysis" in Item 2 of Part 1 of this report. OPERATING EXPENSES Operating expenses increased $348,000 or 7.0% to $5,306,000 for the three months ended June 30, 2001 when compared to the same period in 2000. Salaries and employee benefits increased $174,000, when comparing the second quarter of 2001 to the second quarter of 2000. Occupancy, equipment and data processing expenses increased $65,000 and $71,000, respectively, when compared to the second quarter of 2000 as a result of additional operating expenses associated with the opening of our Somerville and Arlington Center branch sites. The Company's annualized expense ratio, which is the ratio of non-interest expense to average assets, was 1.60% for the three months ended June 30, 2001, as compared to 1.59% for the prior year comparable period. PROVISION FOR INCOME TAXES The Company's effective tax rate for three months ended June 30, 2001 was 35.6% as compared to 35.8% for the period ended June 30, 2000. 19 SIX MONTHS ENDED JUNE 30, 2001 VS SIX MONTHS ENDED JUNE 30, 2000 NET INTEREST INCOME Interest and dividend income from loans and investments increased $3.0 million or 7.3% to $44.7 million for the first six months of 2001 when compared to 2000. Over the first half of 2001 average earning assets totaled $1.3 billion, an increase of $67.6 million or 5.6% over the comparable average for 2000, with $41.0 million of that increase attributed to short and long-term investment securities and $26.6 million attributed to loans. The annualized yields on earning assets were 6.98% and 6.87% for the six months ended June 30, 2001 and 2000, respectively. The yield on investment securities was 6.42% for the first half of 2001, an increase of 30 basis points from 6.12% for the same period in 2000. Short and long-term investments contributed $2,035,000 of additional interest and dividend income when comparing the first six months of 2001 to the first six months of 2000, primarily as a result of higher average balances and yield. The increase in the average balance of loans and no change in yield caused interest income on loans only to increase $989,000 from its 2000 six month level. Total interest expense for the six months ended June 30, 2001 was $26.3 million, reflecting an increase of $2.6 million or 11.2% over the same period in 2000. At June 30, 2001 average interest-bearing liabilities were $1.151 billion, an increase of $57.2 million or 5.2% over the comparable prior year period. This period-to-period increase can be attributed to average deposit growth of $46.0 million and average borrowed funds increasing $11.2 million. Deposit growth occurred as rates paid increased from 3.96% to 4.20% for the six months ended June 30, 2001 and 2000, respectively. Overall, interest expense on deposits increased $1.9 million to $19.2 million due to increases in both average deposits and rates paid. Interest expense on borrowed funds increased $712,000 as the average balances increased and the rates paid on borrowed funds increased 37 basis points to 6.18% in the first six months of 2001 compared to the first six months of 2000. The overall cost of interest bearing liabilities increased to 4.59% from 4.32% when comparing the two periods. Net interest income increased 2.1% or $378,000 to $18.4 million when comparing the six months in 2001 to the same period in 2000 even as the weighted average rate spread decreased by 16 basis points to 2.39% while net interest margin decreased 11 basis points to 2.86%. 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 11 basis points to 6.98% in the first six months of 2001 as compared to the first six months of 2000, while the cost of interest bearing liabilities increased by 27 basis points to 4.59%. This resulted in an interest rate spread and a net interest margin of 2.39% and 2.86%, respectively, for the six months ended June 30, 2001. 20 MEDFORD BANCORP, INC. INTEREST RATE SPREAD Six Months Ended June 30, ------------------ 2001 2000 ---- ---- Weighted average yield earned on: Short-term investments 4.77% 5.82% Securities 6.42 6.12 Loans 7.54 7.54 ---- ---- All earning assets 6.98% 6.87% ---- ---- Weighted average rate paid on: Deposits 4.20% 3.96% Borrowed funds 6.18 5.81 ---- ---- All interest-bearing liabilities 4.59% 4.32% ---- ---- Weighted average rate spread 2.39% 2.55% ==== ==== Net interest margin 2.86% 2.97% ==== ==== 21 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 June 30, 2001, 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. The Company recorded no provision for loan losses for the first six months of 2001 as compared to $75,000 for the same period in 2000. The Company recorded net loan charge-offs of $2,000 for the first half of 2001 compared to net charge-offs of $38,000 for the six months ended June 30, 2000. OTHER INCOME Other income, including customer service fees and gains and losses on sales of assets equaled $2.1 million in the first six months of 2001 as compared to $2.6 million in the first six months of 2000, representing a decrease of $577,000 or 21.9%. When comparing the first quarter 2001 with 2000, this decrease is primarily due to the pre-tax gain of $1.195 million from the curtailment of the Company's defined benefit pension plan recorded in the first quarter of 2000 partially offset by the net change in securities gains and losses of $445,000. See related discussions under "Securities" included in "Management's Discussion and Analysis" in Item 2 of Part 1 of this report. OPERATING EXPENSES Operating expenses increased $657,000 or 6.7% to $10,515,000 for the six months ended June 30, 2001 when compared to the same period in 2000. Salaries and employee benefits increased $352,000, when comparing the first six months of 2001 to the first six months of 2000. Occupancy, equipment and data processing expenses increased $157,000 and $123,000, respectively, when compared to the first half of 2000 as a result of additional operating expenses associated with the opening of our Somerville and Arlington Center branch sites. The Company's annualized expense ratio, which is the ratio of non-interest expense to average assets, was 1.60% for the six months ended June 30, 2000 and 2001. PROVISION FOR INCOME TAXES The Company's effective tax rate for the six months ended June 30, 2001 was 35.7% as compared to 36.5% for the six months ended June 30, 2000. 22 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 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 six months ended June 30, 2001, cash flow from maturities and sales of securities was $89.0 million compared to $55.3 million for the six months ended June 30, 2000. Principal payments received on mortgage-backed securities during the six months ended June 30, 2001 and 2000 totaled $29.6 million and $14.2 million, respectively. During periods of high interest rates, maturities in the bond portfolio could provide significant 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 June 30, 2001, the Company's outstanding borrowings from the FHLBB were $217.7 million and $223.4 million at December 31, 2000. The Company also utilizes repurchase agreements as a source of funding when management deems market conditions to be conducive to such activities. Commitments to originate residential and commercial real estate mortgage loans at June 30, 2001, excluding unadvanced construction funds of $12.7 million, were $19.4 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 six months ended June 30, 2001 totaled $136.7 million, consisting of debt instruments generally maturing in less than five years. This compares with purchases of $96.1 million for the six months ended June 30, 2000. Residential and commercial real estate mortgage loan originations for the six months ended June 30, 2001 totaled $66.3 million, compared with $77.9 million for the six months ended June 30, 2000. The Company's capital position (total stockholders' equity) was $104.6 million or 7.66% of total assets at June 30, 2001 compared with $105.0 million or 8.01% of total assets at December 31, 2000. During the six months ended June 30, 2001, the Company completed its stock repurchase program acquiring 401,048 shares of its common stock. The Company's capital position exceeds all regulatory requirements. 23 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. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. These Statements change the accounting for business combinations and goodwill and intangible assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method is prohibited. SFAS No. 142, which is effective January 1, 2002, changes the accounting for goodwill from an amortization method to an impairment-only approach. In addition, this Statement requires that acquired intangible assets, as defined, be amortized over their useful lives. Management is currently evaluating the impact of adopting this Statement on consolidated financial statements. 24 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, 2000 (the "2000 Annual Report"). For quantitative information about market risk, see Item 7A of Part II of the Company's 2000 Annual Report. There have been no material changes in the quantitative and qualitative disclosures about market risk as of June 30, 2001 from those presented in the Company's 2000 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 The Company's annual meeting of stockholders was held on April 24, 2001 (the "Annual Meeting"). The presence, in person or by proxy, of a least a majority of the total number of issued and outstanding shares of the Company's common stock. $.50 par value per share (the "Common Stock") was necessary to constitute a quorum for the transaction of business at the Annual Meeting. There were 7,856,770.682 shares of Common Stock issued, outstanding and eligible to vote as of March 5, 2001. A total of 6,554,778.850 shares of Common Stock were present in person or by proxy at the Annual Meeting, constituting a quorum. At the Annual Meeting, the stockholders elected the following three individuals as Directors of the Company to serve until the 2004 annual meting of stockholders, with the following votes cast: Nominee For Withheld Paul J. Crowley 6,489,036.119 65,742.731 Edward J. Gaffey 6,496,251.913 58,526.937 Andrew D. Guthrie, Jr. 6,489,839.210 64,939.640 The following additional Directors of the Company continued as Directors after the Annual Meeting: Edward D. Brickley, David L. Burke, Deborah Burke-Santoro, Mary Lou Doherty, Robert A. Havern III, Arthur H. Meehan, Francis D. Pizzella and Eugene R. Murray. 25 ITEM 5 - Other Information None. ITEM 6 - Exhibits and Reports on Form 8-K (a) Exhibit Description Exhibit index (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the three-month period ended June 30, 2001. 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: August 14, 2001 /s/ Arthur H. Meehan --------------------------------------------------------------- Arthur H. Meehan Chairman, President and Chief Executive Officer Date: August 14, 2001 /s/ Phillip W. Wong --------------------------------------------------------------- Phillip W. Wong Executive Vice President, Treasurer and Chief Financial Officer 27 EXHIBITS TO FORM 10-Q MEDFORD BANCORP, INC. EXHIBIT INDEX EXHIBIT NO. DESCRIPTION OF EXHIBIT - ----------- ---------------------- 10.14 Special Termination Agreement with William L. Marshall 28