-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q/VPZsAVqIIwRkWnGmfhIkedSpnL2nxNQVHCRq6v6gJiSsV8VKJO0Fdky63d8++A qpQZA73kDPTpUL40S5iSYg== 0000950156-07-000059.txt : 20070129 0000950156-07-000059.hdr.sgml : 20070129 20070129165554 ACCESSION NUMBER: 0000950156-07-000059 CONFORMED SUBMISSION TYPE: 10KSB/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20070129 DATE AS OF CHANGE: 20070129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WESTBOROUGH FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0001087843 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 043504121 STATE OF INCORPORATION: MA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10KSB/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-27997 FILM NUMBER: 07561666 BUSINESS ADDRESS: STREET 1: 100 E MAIN ST CITY: WESTBOROUGH STATE: MA ZIP: 01581 BUSINESS PHONE: 5083664111 MAIL ADDRESS: STREET 1: 100 E MAIN ST CITY: WAWESTBOROUGH STATE: MA ZIP: 01581 10KSB/A 1 wbor-10ksba_66492.txt BODY OF FORM 10-KSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 Form 10-KSB/A [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2006 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to _______________. Commission file No. 000-27997 WESTBOROUGH FINANCIAL SERVICES, INC. (Exact name of small business issuer in its charter) Massachusetts 04-3504121 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 E. Main Street 01581 Westborough, Massachusetts (Address of principal executive offices) (Zip Code) (508) 366-4111 (Issuer's telephone number, including area code) Securities registered under Section 12(b) of the Exchange Act: None. Securities registered under Section 12(g) of the Exchange Act: Common Stock, par value $0.01 per share (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained herein, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB/A or any amendment to this Form 10-KSB/A. [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act). Yes [ ] No [X] The issuer's revenues for the fiscal year ended September 30, 2006 were $15,292,000. The aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average bid and asked prices of the common stock as of December 8, 2006 was $15,864,128. State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. As of December 8, 2006, the registrant had 1,595,774 shares of common stock, par value $0.01 per share, outstanding. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] EXPLANATORY NOTE AS TO THE PURPOSE OF THIS AMENDMENT This Amendment No. 1 on Form 10-KSB/A to the Annual Report on Form 10-KSB of Westborough Financial Services, Inc. (the "Company") for the fiscal year ended September 30, 2006 is being filed for the purpose of providing the information required by Part III of the Annual Report on Form 10-K, which the Company is no longer incorporating by reference to its proxy statement. Part III is hereby amended and restated in its entirety. As required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), new certifications of our principal executive officer and principal financial officer are being filed as exhibits to this Amendment No. 1 on Form 10-KSB/A. Exhibit 23.1 is also being filed herewith. No other information contained in the original filing is amended hereby. This amendment does not modify or update disclosures in the original filing. Furthermore, except for the matters described above, this amendment does not change any previously reported financial results, nor does it reflect events occurring after the date of the original filing.
TABLE OF CONTENTS Page ---- FORWARD LOOKING STATEMENTS (i) PART I ......................................................................................... 1 ITEM 1. DESCRIPTION OF BUSINESS......................................................... 1 ITEM 2. DESCRIPTION OF PROPERTY......................................................... 38 ITEM 3. LEGAL PROCEEDINGS............................................................... 39 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................. 39 PART II ......................................................................................... 39 ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................ 39 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION....................... 39 ITEM 7. FINANCIAL STATEMENTS............................................................ 54 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............................................................ 55 ITEM 8A. CONTROLS AND PROCEDURES......................................................... 55 ITEM 8B. OTHER INFORMATION............................................................... 55 PART III ......................................................................................... 54 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS,CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT................... 54 ITEM 10. EXECUTIVE COMPENSATION.......................................................... 59 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS............................................................. 66 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE....... 69 ITEM 13. EXHIBITS........................................................................ 71 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.......................................... 73 SIGNATURES............................................................................... 74 CERTIFICATIONS
FORWARD LOOKING STATEMENTS Westborough Financial Services, Inc. (the "Company") and The Westborough Bank (the "Bank") may from time to time make written or oral "forward-looking statements" which may be identified by the use of such words as "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions. Forward-looking statements include statements with respect to the Company's and the Bank's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, which are subject to significant risks and uncertainties. The following factors, many of which are subject to change based on various other factors beyond the Company's and the Bank's control, and other factors identified in the Company's filings with the Securities and Exchange Commission and those presented elsewhere by management from time to time, could cause its financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which would cause actual results to differ materially from these estimates. These factors include, but are not limited to: * conditions which effect general and local economies; * changes in interest rates, deposit flows, demand for mortgages and other loans, real estate values and competition; * changes in accounting principles, policies, or guidelines; * changes in legislation or regulation; and * other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services. This list of important factors is not exclusive. The Company and the Bank do not undertake any obligation to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank. i PART I ITEM 1. DESCRIPTION OF BUSINESS General The Company is a Massachusetts chartered mid-tier holding company that completed its initial public offering in February 2000 in connection with the reorganization of The Westborough Bank (the "Bank") from a Massachusetts chartered mutual savings bank into the Massachusetts mutual holding company form of organization. Pursuant to the reorganization, the Bank converted to a Massachusetts chartered stock savings bank as a wholly-owned subsidiary of the Company, which is majority owned by Westborough Bancorp, MHC ("MHC"), a Massachusetts chartered mutual holding company. The Company's common stock is traded on the Over-the-Counter Bulletin Board under the symbol "WFSM.OB." On November 13, 2006, the Company, the Bank and the MHC entered into an agreement and Plan of Merger with Assabet Valley Bancorp, Hudwest Financial Services, Inc., and Hudson Savings Bank. Under the terms of the agreement, the mutual holding company structure of the MHC will be eliminated and the Bank will merge with Hudson Savings Bank. The Company will merge with Hudwest Financial Services, Inc., with the Company as the surviving corporation and a wholly-owned subsidiary of Assabet Valley Bancorp. The Company will eventually be merged into Assabet Valley Bancorp. The stockholders of the Company, other than the MHC, will receive $35.00 in cash in exchange for each share of common stock they own. The transaction is subject to regulatory approval and the approval of the stockholders of the Company and the corporators of the MHC and Assabet Valley Bancorp. It is anticipated that the transaction will be completed in spring of 2007. The Company's principal business is its investment in the Bank. The Bank is headquartered in Westborough, Massachusetts and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the applicable legal limits and by the Deposit Insurance Fund. As a Massachusetts stock savings bank, the Bank is examined by the Division of Banks for the Commonwealth of Massachusetts (the "Division") and the FDIC. The Bank has offices in the towns of Westborough, Northborough and Shrewsbury, Massachusetts. The Bank has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services to meet the needs of the communities it serves. The Bank attracts retail deposits from the general public and invests those funds primarily in loans secured by first mortgages on owner-occupied, one- to four-family residences and, to a lesser extent, in commercial real estate and commercial loans to small businesses. Unless otherwise indicated, the information presented in this Annual Report on Form 10-KSB represents the consolidated activity of the Company and its subsidiary for the year ended September 30, 2006. At September 30, 2006, total assets were $301.0 million, deposits were $211.3 million and total stockholders' equity was $28.4 million. Market Area The Bank is a community- and customer-oriented retail bank offering traditional deposit products, residential and commercial real estate mortgage loans and, to a lesser extent, consumer and commercial loans. The Bank operates four full service-banking offices located in the towns of Westborough, Northborough and Shrewsbury, Massachusetts. The Bank also operates a non-public, self-contained office at the "Willows," a retirement community located in Westborough. Together, these offices serve the Bank's "primary market area" consisting of Westborough, Northborough, Shrewsbury, Grafton, Southborough and Hopkinton, Massachusetts. The Bank's deposits are gathered from the general public in these towns and the surrounding communities. The Bank's lending activities are 1 concentrated primarily in the towns where it has offices, as well as contiguous cities and towns. These cities and towns are located in east central Massachusetts, near the central Route 495 belt. The Bank's market area has grown steadily to achieve a blend of industry, office parks and residences. The town of Westborough is approximately 12 miles east of Worcester and 29 miles west of Boston, located at the junction of major interstate highways constructed in the 1950's and 1960's. The convenient access provided by Routes 20, 9, I-90 and I-495 has contributed to the diverse economic base consisting of a retail and commercial section, and a high-tech manufacturing section. Among the largest industries in the Bank's market area are financial services, health services, high-tech and utilities. Public transportation within the Bank's market area has expanded with the addition of mass transit stations. The Massachusetts Bay Transportation Authority operates stations in the towns of Grafton, Westborough and Southborough. These stations provide direct access to Worcester and Boston for residents in the Bank's market area. Since 1980, the Bank's primary market area has experienced increases in both population and households as individuals and families moved from urban areas surrounding Boston to more outlying areas with lower cost and newer housing stock. The Bank anticipates that its future growth opportunities will be influenced by the growth and stability of the statewide and regional economies, other demographic population trends and the competitive environment. The Bank believes that it has developed lending, deposit and non-deposit investment products and marketing strategies to address the diverse needs of the residents in its market area. Business Strategy In past years, the Bank's primary management strategy has been to offer savings and certificate of deposit accounts and residential mortgage loans in the market area of Westborough, Massachusetts and surrounding communities. The Bank's loan portfolio historically consisted of one- to four-family residential first mortgage loans, with relatively few commercial real estate or commercial loans in its portfolio. In recent years, the Company has adopted a growth-oriented strategy that has focused on expanding its product lines and services and providing expanded electronic and traditional delivery systems for its customers. The Bank believes that this business strategy is best for its long-term success and viability, and complements its existing commitment to high quality customer service. In connection with the Bank's overall growth strategy, it seeks to: o continue to focus on expanding its residential lending and retail banking franchise, and increasing the number of households served within its market area; o expand its commercial banking products and services for small- and medium-sized businesses, as a means to increase the yield and re-pricing characteristics on its loan portfolio and to attract lower cost transaction deposit accounts; o expand its branch network to increase its market share; o increase the use of alternative delivery channels, such as Internet and telephone banking; and o offer a variety of non-deposit investment products (such as mutual funds, insurance, etc.,) and services as a means to compete for an increased share of its customers' financial service business and improve fee-based income. In order to create a platform for the accomplishment of the Company's goals, management has made significant investments in its physical infrastructure and human and technological resources. The Bank is in the process of renovating older sections of its Main Office and other branches to better serve its retail customers. The Bank continues to upgrade its on-line Internet bill payment and other on-line applications. Such investments have been necessary to ensure that adequate resources are in place to offer increased products and services. Management believes that the Company's long-term profitability is enhanced as it realizes the benefits of diversified product lines and market share growth. 2 Lending Activities General. The Bank originates loans primarily through its main office. The principal lending activities of the Bank are the origination and purchase of first mortgage loans for the purpose of purchasing or refinancing owner-occupied, one- to four-family residential properties. To a lesser extent, the Bank also originates commercial real estate loans, commercial and industrial (C&I) loans and consumer loans. The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and percentages at the dates indicated.
-------------------------------------------------------------------------------------------------- At September 30, -------------------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 -------------------------------------------------------------------------------------------------- Percent Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total -------------------------------------------------------------------------------------------------- (Dollars in thousands) Real estate loans: Fixed rate mortgages $ 54,169 25.44% $ 57,953 28.31% $ 64,310 38.51% $ 65,170 44.84% $ 47,599 35.01% Variable rate mortgages 100,282 47.09% 100,365 49.04% 64,788 38.81% 48,287 33.23% 54,096 39.78% Commercial 32,853 15.43% 26,979 13.18% 23,313 13.96% 17,290 11.90% 20,092 14.78% Home equity lines-of-credit 19,530 9.17% 15,452 7.55% 11,295 6.77% 10,303 7.09% 8,792 6.47% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total real estate loans 206,834 97.13% 200,749 98.08% 163,706 98.05% 141,050 97.06% 130,579 96.04% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Consumer loans: Personal 265 0.12% 198 0.10% 322 0.19% 564 0.39% 983 0.72% Deposit secured 212 0.10% 312 0.15% 297 0.18% 358 0.24% 509 0.37% Home improvement 40 0.02% 6 0.00% 85 0.05% 68 0.05% 171 0.13% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans 517 0.24% 516 0.25% 704 0.42% 990 0.68% 1,663 1.22% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Commercial loans: Commercial lines-of-credit 1,749 0.82% 870 0.43% 965 0.58% 1,824 1.25% 2,549 1.87% Commercial installment 3,842 1.81% 2,534 1.24% 1,579 0.95% 1,461 1.01% 1,182 0.87% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total commercial loans 5,591 2.63% 3,404 1.67% 2,544 1.53% 3,285 2.26% 3,731 2.74% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans 212,942 100.00% 204,669 100.00% 166,954 100.00% 145,325 100.00% 135,973 100.00% ====== ====== ====== ====== ====== Adjusted by: Due to borrowers on incomplete loans (3,360) (4,287) (1,507) (3,550) (2,866) Net deferred loan costs 721 620 389 223 161 Net premium on purchased loans and indirect lending 221 260 402 470 538 Allowance for loan loss (780) (785) (950) (911) (926) -------- -------- -------- -------- -------- Net loans $209,744 $200,477 $165,288 $141,557 $132,880 ======== ======== ======== ======== ========
3 Residential Mortgage Loans. The Bank's primary emphasis is the origination of first mortgage loans secured by one- to four-family properties that serve as the primary or secondary residence of the owner. As of September 30, 2006, loans on one- to four-family residential properties accounted for 72.5% of the Bank's total loan portfolio. Most of the Bank's loan originations are from internal mortgage specialists, directors and officers, marketing promotions, referrals from mortgage brokers (correspondents), existing or past customers, and members of the Bank's local communities or referrals from local real estate agents, attorneys and builders. The Bank believes that its branch network is a significant source of new loan generation. The Bank has two mortgage loan originators, each of whom have designated call areas. They have extensive training in residential and equity products and are available to meet with customers at the office of a realtor or their homes. The Bank's marketing department provides support in the form of displays, mailings and other materials which are available to the loan specialists to leave in real estate offices. The Bank currently offers loans that conform to underwriting standards specified by Fannie Mae ("conforming loans") and also originates non-conforming loans, as described below. These loans may be fixed-rate one- to four-family mortgage loans or adjustable-rate one- to four-family mortgage loans with maturities of between 5 and 30 years. The non-conforming loans generally follow Fannie Mae guidelines except that the loan amount exceeds Fannie Mae guidelines' maximum limit of $417,000. The average size of the Bank's first mortgage loans originated during the year ended September 30, 2006 and the year ended September 30, 2005 was $243,594 and $282,034, respectively. The average size of the Bank's first mortgage loans was $193,523 and $186,958 at September 30, 2006 and September 30, 2005, respectively. The Bank is an approved seller/servicer for Fannie Mae. The Bank generally sells fixed rate one-to four-family loans in the secondary market. Loan sales were $2.3 million and $8.1 million for years ended September 30, 2006 and September 30, 2005, respectively. Such loans, however, continue to be serviced by the Bank. The Bank's originations of first mortgage loans amounted to $20.0 million in fiscal year 2006, $63.6 million in fiscal year 2005 and $49.9 million in fiscal year 2004. During the latter part of 2004, the Bank entered into correspondent contracts with a number of mortgage brokers and lenders who present prospective customer loan applications to the Bank for consideration. Such loan applications are reviewed by the Bank, and approval is subject to the loan meeting established underwriting conditions and criteria. The Bank offers a variety of adjustable-rate mortgages ("ARM's") and fixed-rate one- to four-family mortgage loans with maximum loan-to-value ratios that depend on the type of property and the size of loan involved. The loan-to-value ratio is the loan amount divided by the appraised value of the property. The loan-to-value ratio is a measure commonly used by financial institutions to determine exposure to risk. The majority of the Bank's loans on owner-occupied one- to four-family homes are originated with a loan-to-value ratio of 80% or less. For first-time home buyers, the Bank has made loans on owner-occupied one- to four-family homes with a loan-to-value ratio of up to 95%. The borrower is required to obtain mortgage insurance if the loan-to-value ratio is over 80%. Subsequently, if the loan-to-value ratio falls to 80% or less, the borrower is not required to continue to have mortgage insurance. The Bank currently offers fixed-rate mortgage loans with terms of 15 to 40 years secured by one- to four-family residences. Fixed rate mortgage loans are priced to be competitive with the offerings of local area banks, reflecting current market trends and conditions. The Bank currently offers a variety of ARM loans secured by one- to four-family residential properties that initially adjust after one year, three years, five years, seven years, or ten years. After the initial adjustment period, ARM loans adjust on an annual basis. The ARM loans that the Bank currently originates have a maximum 30 year amortization period and are subject to the same loan-to-value ratios 4 applicable to fixed-rate mortgage loans described above. The interest rates on ARM loans fluctuate based upon a fixed spread above the average yield on United States treasury securities and generally are subject to a maximum increase of 2% per adjustment period and a limitation on the aggregate adjustment of 6% over the life of the loan. The Bank originated $15.1 million and $46.6 million of one-to-four family ARM loans in the years ended September 30, 2006 and 2005, respectively. At September 30, 2006, 47.1% of the Bank's total loans consisted of ARM loans, down from 49.0% at September 30, 2005. The volume and types of ARM loans the Bank originates are affected by the level of market interest rates, competition, consumer preferences and the availability of funds. Although the Bank will continue to offer ARM loans, it cannot guarantee that it will be able to originate or purchase a volume of ARM loans sufficient to maintain or perhaps increase the proportion these loans represent when compared against the aggregate residential loan portfolio. The Bank encourages growth in its ARM portfolio since ARM loans help reduce its exposure to increases in interest rates. However, ARM loans can pose credit risks different from the risks inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower may rise. This increases the potential for default. The Bank's home equity lines-of-credit, which totaled $19.5 million, or 9.2% of total loans at September 30, 2006, are adjustable-rate loans secured by a first or second mortgage on owner-occupied one- to four-family residences located in the Bank's market area. Interest rates on home equity credit lines are based upon the "prime rate" as published in the "Money Rates" section of the Wall Street Journal (the "index"). The home equity line product is written for a term of 20 years, with a 10 year draw period and a 10 year payback period, with no principal payments required during the draw period. Within the first 10 year draw period, interest only payments are required monthly. The subsequent 10 year period requires a minimum monthly payment of 1/120th of the outstanding principal balance of the loan plus the outstanding interest. The maximum credit line available is equal to (i) the lesser of $250,000 or 80% of the Bank's appraisal of the property, or (ii) 50% of the tax assessment on the property. In each case, these amounts are reduced by the first mortgage balance. Such loans also have a maximum term of 20 years. The underwriting standards applicable to these loans generally are the same as one- to four-family first mortgage loans, except that the combined loan-to-value ratio, including the balance of the first mortgage, cannot exceed 80% of the assessed or appraised value of the property. In conjunction with the Bank's residential mortgage lending, the Bank offers construction loans to the future occupants of single family homes. These loans typically have a term of twelve months and are structured to become permanent loans upon the completion of construction. All such loans are secured by first liens on the property and are subject to a maximum loan-to-value ratio of 80%, which is based upon the "as completed" valuation of the property. During the construction period, the interest rate for construction loans to individuals is equal to the index plus 2%. Loans involving construction financing present a greater risk than loans for the purchase of existing homes since collateral values and construction costs can only be estimated at the time the loan is approved. Commercial Real Estate Loans. At September 30, 2006, commercial real estate mortgage loans totaled $32.9 million, or 15.4% of total loans. These loans are generally secured by office buildings, condominiums, and retail establishments located within the Bank's market area. The Bank's commercial real estate loans are offered on a fixed- and adjustable-rate basis. Typical terms for fixed rate loans provide for a maximum five-year re-pricing term with a 20 year amortization and a market interest rate, based upon the index, as adjusted to reflect inherent risk factors. Typical terms for adjustable-rate loans provide for a maximum note and amortization term of 20 years, with a re-pricing schedule every 1, 3, or 5 years. Price readjustments at each scheduled interval are based on a spread above the index. Loans on commercial properties are also subject to a maximum loan-to- 5 value ratio of 80% for the owner occupied and residential investment property and 75% for commercial property and construction loans. Pursuant to the Bank's underwriting standards, a number of factors are considered before a commercial real estate loan is made. The Bank evaluates qualifications and financial condition of the borrower, including credit history, profitability and managerial experience, as well as the appraised value and condition of the underlying property. Factors that the Bank considers in evaluating the underlying property include the net operating income of the mortgaged property before debt service, interest/expense, and depreciation, the debt service coverage ratio (the ratio of operating income to debt service) and, as noted above, the ratio of the loan amount to the appraised value of the property. Loans secured by commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family owner occupied residential mortgage loans. Such loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project decreases, or if leases are not obtained or renewed, the borrower's ability to repay the loan may be impaired. The Bank's real estate loan portfolio also includes construction loans to builders and developers of properties within the Bank's market area. Construction loans to builders typically are in amounts equal to 70-75% of the completed appraised value. Construction loans generally have up to twelve months with a fixed or floating interest rate based upon the index plus a margin. In addition to securing the loan with the property under construction, the Bank generally obtains personal guarantees from the borrower. The proceeds of such loans are disbursed only after certification by in-house personnel or Bank retained inspection firms that confirm specified stages of construction have been completed. Construction lending is generally considered to carry a higher level of risk than permanent mortgage financing because of the uncertainty of the value of the collateral upon completion. Repayment of such loans is also dependent upon the successful completion of the project and can be adversely affected by market conditions and other factors not within the control of the Bank or the borrower. The Bank seeks to control such risks by tying the amount of the loan advanced to a predetermined construction schedule, with appropriate inspections by Bank personnel or Bank retained inspection firms, in order to ensure that loan proceeds are applied appropriately. Consumer Loans. At September 30, 2006, $517 thousand, or 0.24 % of the Bank's total loans, consisted of consumer loans such as personal, deposit secured and fixed-rate home improvement loans. Consumer loans generally have shorter terms to maturity, which reduces the Bank's exposure to changes in interest rates. Consumer loans also carry higher rates of interest than do one- to four-family residential mortgage loans. The Bank believes that offering consumer loan products helps to expand and create stronger ties to the Bank's existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities. The Bank's personal loans consist of unsecured loans to individuals and secured loans for the purchase of new and used automobiles. The Bank's unsecured loans have a maximum term of 48 months. The terms of the Bank's automobile loans generally are determined by the age and condition of the vehicle. At September 30, 2006, the Bank's personal loans totaled $265 thousand, or 0.12% of total loans. The Bank also makes loans secured by deposit accounts up to 90% of the amount of the depositor's savings account balance. The rate for such loans is 2.0% higher than the rate paid on regular savings accounts and 3.0% higher than the rate paid on term deposits. For loans secured by term deposits, the maturity date for the loan is the lesser of 36 months, or the maturity of the deposit instrument. For loans secured by regular savings deposit accounts, the term is the lesser of 36 months or 6 the term desired by the regular savings account customer. Deposit secured loans totaled $212 thousand, or 0.10% of total loans at September 30, 2006. Commercial Loans. The Bank has made a commitment to small business lending by developing certain products and services for the small- and medium-sized businesses located in the Bank's market area. Such services are designed to give business owners borrowing opportunities for, among other things, modernization, inventory, equipment, consolidation and working capital. In addition, the Bank has tailored certain products and services, such as its business checking accounts and treasury, tax and loan service, to better serve the needs of local businesses. The Bank also is an approved lender of the Small Business Administration. At September 30, 2006, $5.6 million, or 2.63%, of the Bank's total loans consisted of commercial loans. The Bank expects that commercial loans will comprise a growing portion of its total loan portfolio in the future. Commercial loans generally are limited to terms of five to seven years or less. Commercial loans have fixed or variable interest rates tied to the index. Where applicable, the Bank collateralizes these loans with a lien on business assets and equipment and the personal guarantees of the borrower's principal officers (a lien may also be placed on the guarantors' primary residence for additional collateral or to secure the guaranty). The Bank's commercial services are administered by the Bank's loan department. The Bank has two experienced commercial lending officers with considerable commercial lending expertise, including many years of banking experience in Massachusetts and in the Bank's market area. Also, the Bank has a commercial loan assistant and a senior credit analyst both with extensive banking experience. Commercial loans generally are considered to involve a higher degree of risk than residential mortgage loans because the primary collateral may be in the form of accounts receivable and/or inventory and other fixed assets subject to market obsolescence. Commercial loans also may involve relatively large loan balances to single borrowers or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation and income stream of the borrower. Such risks can be significantly affected by economic conditions. In addition, commercial lending ordinarily requires substantially greater oversight efforts compared to residential real estate lending. To minimize these risks, the Bank conducts periodic reviews of the commercial loan portfolio to ensure adherence to underwriting standards and policy requirements. Origination of Loans. The Bank's lending activities are conducted through its main and branch offices. The Bank's ability to originate loans is dependent upon the relative customer demand for fixed-rate or adjustable-rate mortgage loans, which is affected by the current and expected future levels of interest rates. The following table sets forth information with respect to originations, sales of loans and principal payments for the periods indicated. 7
------------------------------------------------------------ For the Year Ended September 30, ------------------------------------------------------------ 2006 2005 2004 2003 2002 ------------------------------------------------------------ Loans, net: Balance outstanding beginning of year $200,477 $165,288 $141,557 $132,880 $134,957 -------- -------- -------- -------- -------- Originations and Purchased Loans: Mortgage loans: Residential 19,896 63,612 49,850 53,729 30,003 Commercial 7,010 5,109 8,890 1,164 8,866 Home equity lines-of-credit 18,750 15,290 10,032 9,488 8,658 -------- -------- -------- -------- -------- Total mortgage originations 45,656 84,011 68,772 64,381 47,527 Commercial loans 8,898 6,552 7,552 2,728 1,704 Consumer loans 474 807 656 1,453 2,123 -------- -------- -------- -------- -------- Total originations 55,028 91,370 76,980 68,562 51,354 -------- -------- -------- -------- -------- Less: Principal repayments, unadvanced funds and other, net (43,469) (48,213) (47,688) (55,835) (53,421) Sale of mortgage loans, principal balance (2,297) (8,133) (5,522) (4,065) 0 Credit (provision) for loan losses 0 173 (70) 0 (8) Net loan charge-offs (recoveries) 5 (8) 31 15 (2) Transfers to foreclosed real estate 0 0 0 0 0 -------- -------- -------- -------- -------- Total deductions (45,761) (56,181) (53,249) (59,885) (53,431) -------- -------- -------- -------- -------- Net loan activity 9,267 35,189 23,731 8,677 (2,077) -------- -------- -------- -------- -------- Loans, net, end of year $209,744 $200,477 $165,288 $141,557 $132,880 ======== ======== ======== ======== ========
8 The following table presents, as of September 30, 2006, the dollar amount of all loans due after September 30, 2007, and whether such loans have fixed or adjustable interest rates. ----------------------------------- Due After September 30, 2007 ----------------------------------- Fixed Adjustable Total ----------------------------------- (In Thousands) Mortgage loans $53,009 $ 96,153 $149,162 Commercial mortgages loans 22,548 4,055 26,603 Home equity loans 4,110 - 4,110 Consumer loans 320 - 320 Commercial loans 3,625 - 3,625 ------- -------- -------- $83,612 $100,208 $183,820 ======= ======== ======== 9 Loan Commitments. The Bank generally makes loan commitments to borrowers not exceeding 45 days. At September 30, 2006, the Bank had $4.7 million in loan commitments outstanding, primarily for the origination of one- to four-family residential real estate loans, commercial loans and commercial real estate loans. Unadvanced funds on home equity lines-of-credit and commercial lines-of-credit at September 30, 2006 represented $16.9 million and $1.9 million, respectively. Loan Solicitation. Loan originations are derived from a number of sources, including the Bank's existing customers, referrals, realtors, mortgage companies, advertising and "walk-in" customers at the Bank's offices. The Bank also employs two full-time "on the road" loan originators who are available to meet with customers at their convenience. During the latter part of 2004, the Bank entered into correspondent contracts with a number of mortgage brokers and lenders who present prospective customer loan applications to the Bank for consideration. Such loan applications are reviewed by the Bank, and approval is subject to the loan meeting established underwriting conditions and criteria. Loan Approval and Administrative Procedures. On an annual basis the Board of Directors approves the Bank's lending policies, procedures, loan approval limits, and outside, independent firms (such as appraisers), that may be retained during the underwriting process. Depending on the type and size of the requested loan, coupled with the borrower's aggregate loan balances with the Bank, loans may be approved by individual loan officers, the loan management committee or the executive committee. Residential mortgage loan requests for one-to four-family homes in amounts up to $1.0 million may be approved by the loan committee. One-to four-family mortgage requests greater than $1.0 million require approval by the executive committee. Commercial loan (Commercial Real Estate, Term loans, Lines-of-credit, etc.) requests up to $1.0 million may be approved by the loan committee. Commercial loan requests exceeding $1.0 million require approval of the executive committee. The Bank requires that all prospective borrowers complete a loan application and sign documentation authorizing the release of financial information to the Bank such as credit reports, personal financial statements, individual/corporate tax returns, financial statements and other necessary information. Upon receipt of the information, the Bank will proceed with the underwriting process. If necessary, the Bank may require additional financial or credit related information from the applicant. The Bank requires an appraisal for commercial and residential mortgage loans, except in some cases where existing mortgages are being refinanced. Appraisals are performed by licensed or certified third-party appraisal firms and are reviewed by the Bank's lending department. The Bank requires title insurance on all mortgage loans, except for home equity credit lines and fixed-rate home improvement loans. For those exceptions, the Bank requires evidence of previous title insurance. The Bank requires borrowers to obtain hazard insurance and may require borrowers to obtain flood insurance prior to closing. For properties with a private sewage disposal system, the Bank also requires evidence of compliance with applicable laws. Further, if requested by the Bank, some borrowers are required to deposit funds on a monthly basis to an escrow account for the future payment of real estate taxes, and premium payments for flood insurance and private mortgage insurance. Interest rates charged by the Bank on all loans are primarily determined by competitive loan rates offered in its market area and interest rate costs of the source of funding for the loan. The Bank may charge a fixed origination fee on new residential mortgage loans or a percentage fee on new commercial loans. The origination fees, net of direct origination costs, are deferred and amortized into income over the life of the loan. At September 30, 2006, the amount of net deferred loan origination costs was $721 thousand. Loan Maturity and Re-pricing. The following table sets forth certain information as of September 30, 2006 regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Adjustable and floating rate loans are included in the period in which interest rates are next scheduled to adjust rather than the period in which they contractually mature, and fixed-rate loans are included in the period in which the final contractual repayment is due. This table does not include prepayments on scheduled principal amortizations. 10
--------------------------------------------------------------------------------------------- At September 30, 2006 --------------------------------------------------------------------------------------------- Mortgage Loans --------------------------------------- Home Variable Commercial Equity Fixed Rate Rate Mortgage Lines-of Consumer Commercial Total Mortgages Mortgages Loans -Credit Loans Loans Loans --------------------------------------------------------------------------------------------- (In thousands) Amounts due: Within one year $ 1,160 $ 4,129 $ 6,250 $15,420 $221 $1,942 $ 29,122 One to three years 48 15,756 7,160 0 51 270 23,285 Over three to five years 206 27,101 4,163 0 151 959 32,580 Over five to ten years 3,872 51,022 13,986 0 94 2,384 71,358 Over ten to twenty years 33,927 0 1,294 1,111 0 0 36,332 Over twenty years 14,956 2,274 0 2,999 0 36 20,265 ------- -------- ------- ------- ---- ------ ------- Loans, gross $54,169 $100,282 $32,853 $19,530 $517 $5,591 212,942 ======= ======== ======= ======= ==== ====== Due to borrowers on Incomplete loans (3,360) Net deferred loan origination costs 721 Net premium on purchased loans and indirect lending 221 Allowance for loan losses (780) -------- Loans, net $209,744 ========
Non-Performing Assets, Asset Classification and Allowances for Losses. The Senior Lending Officer or designee, working with other members of the loan committee, continually monitors the status of all delinquent loans. On a monthly basis, the Senior Lending Officer presents an update of the status of loans to both the Bank's executive committee and board of directors. One of the Bank's primary tools utilized to manage and control delinquent and problem loans is the Watched Asset List. This report identifies all loans or commitments that are considered to have inherent collateral or cash flow deficiencies that could result in a potential loss to the Bank if not properly supervised. The subject loans are managed by the loan committee, which, together with the executive committee, may meet more frequently to discuss the status of particular loans and to add or delete loans from the Watched Asset List, as is deemed appropriate. At September 30, 2006, the Bank had 7 loans which were 90 days or more past due which totaled $416 thousand. The Bank also had $1.1 million in assets classified as substandard and $43 thousand classified as special mention at September 30, 2006. No assets were classified as doubtful or loss. The Bank had $416 thousand and $175 thousand non-performing assets at September 30, 2006 and 2005, respectively. 11 The following table presents information regarding non-accrual mortgage and consumer and other loans, accruing loans delinquent 90 days or more, and foreclosed real estate as of the dates indicated:
--------------------------------------------- At September 30, --------------------------------------------- 2006 2005 2004 2003 2002 --------------------------------------------- (Dollars in thousands) Non-accrual first mortgage loans $42 $154 $42 $204 $140 Non-accrual commercial and other loans 374 21 79 430 0 Accruing loans delinquent 90 days or more 0 0 0 0 0 ----- ----- ----- ----- ----- Total non-performing and delinquent loans 416 175 121 634 140 Foreclosed real estate, net 0 0 0 0 0 ----- ----- ----- ----- ----- Total non-performing assets and delinquent loans $416 $175 $121 $634 $140 ===== ===== ===== ===== ===== Non-performing and delinquent loans to total loans 0.20% 0.09% 0.07% 0.45% 0.11% Non-performing assets and delinquent loans to total assets 0.14% 0.06% 0.05% 0.25% 0.06%
Loans are placed on non-accrual status when they are 90 days past due or, in the opinion of management, the collection of principal and interest is doubtful. When the Bank designates loans as non-accrual loans, it reverses outstanding interest that it previously recognized to income. The Bank may recognize income in the period that interest is collected, and when the full return of principal balances are no longer in doubt. A loan can be returned to accrual status once there is no longer principal and interest past due, or in circumstances where an abundance of additional collateral has been obtained and the loan is in a "positive" state of collection. Impaired loans generally are individually assessed to determine whether a loan's carrying value is not in excess of the fair value of the collateral or the present value of the loan's cash flows. Groups of smaller balance loans, however, are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer loans for impairment disclosures. The Bank had $416 thousand of loans classified as impaired at September 30, 2006. There were $175 thousand of loans classified as impaired at September 30, 2005 and $300 thousand at September 30, 2004. Troubled debt restructuring generally involves a modification of terms of a borrower's debt and can affect the carrying value of a loan. At September 30, 2006, 2005 and 2004, the Bank had no loans classified as troubled debt restructuring. Foreclosed real estate consists of property the Bank acquired through foreclosure or deed in lieu of foreclosure. Foreclosed real estate properties are initially recorded at the lower of the investment in the loan or fair value. Thereafter, the Bank carries foreclosed real estate at fair value less estimated selling costs, net of a valuation allowance account established through provisions charged to income, which result from the ongoing periodic valuations of foreclosed real estate properties. The Bank had no foreclosed real estate at September 30, 2006, 2005 and 2004. 12 Allowance for Loan Losses. The following table presents the activity in the Bank's allowance for loan losses at or for the dates indicated:
------------------------------------------------------- At or for the Years Ended September 30, ------------------------------------------------------- 2006 2005 2004 2003 2002 ------------------------------------------------------- (Dollars in thousands) Balance at beginning of year $785 $950 $911 $926 $916 ------- ------- ------- ------- ------- (Credit) provision for loan losses 0 (173) 70 0 8 ------- ------- ------- ------- ------- Charge-off: Mortgage loans 0 0 0 0 0 Commercial Loans (5) 0 (33) 0 0 Consumer loans 0 0 (2) (19) (11) ------- ------- ------- ------- ------- Total charge-offs (5) 0 (35) (19) (11) Recoveries 0 8 4 4 13 ------- ------- ------- ------- ------- Balance at end of year $780 $785 $950 $911 $926 ======= ======= ======= ======= ======= Net charge-offs/(recoveries) for the year $5 ($8) $31 $15 ($2) Ratio of net charge-offs/(recoveries) to average loans outstanding during the year 0.002% -0.004% 0.021% 0.011% -0.001% Allowance for loan losses as a percent of total loans before the allowance for loan losses 0.37% 0.39% 0.57% 0.64% 0.69% Allowance for loan losses as a percent of non-performing loans 187.50% 448.57% 785.12% 143.69% 661.43%
The allowance for loan losses is a valuation account that reflects the Bank's evaluation of the losses inherent in its loan portfolio. The Bank maintains the allowance through provisions for loan losses that it charges to income. The Bank charges losses on loans against the allowance for loan losses when it believes the collection of loan principal is unlikely. 13 The following table presents the Bank's allocation of the allowance for loan losses by loan category and the percentage of loans in each category to total loans at the dates indicated.
------------------------------------------------------------------------------------------------------------ At September 30, ------------------------------------------------------------------------------------------------------------ 2006 2005 2004 2003 2002 ------------------------------------------------------------------------------------------------------------ Percent of Percent of Percent of Percent of Percent of Loans in Loans in Loans in Loans in Loans in Category Category Category Category Category Dollar to Total Dollar to Total Dollar to Total Dollar to Total Dollar to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ----------------------------------------------------------------------------------------------------------- (Dollars in thousands) Real estate-mortgage: Residential (1) $368 81.70% $369 84.90% $280 84.09% $159 85.16% $133 81.25% Commercial 125 15.43% 102 13.18% 89 13.96% 138 11.90% 41 14.78% Commercial 270 2.63% 292 1.66% 434 1.52% 487 2.26% 643 2.74% Consumer 7 0.24% 3 0.25% 4 0.42% 18 0.68% 24 1.22% Unallocated 10 0.00% 19 0.00% 143 0.00% 109 0.00% 85 0.00% -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- Total Allowance for loan losses $780 100.00% $785 100.00% $950 100.00% $911 100.00% $926 100.00% ======== ======= ======== ======= ======== ======= ======== ======= ======== ======= Net loans before the allowance for loan losses $210,524 $201,262 $166,238 $142,468 $133,806 Allowance as % of Gross Loans 0.37% 0.39% 0.57% 0.64% 0.69% - -------------------- Includes home equity lines of credit and construction loans.
The allowance for loan loss was $780 thousand at September 30, 2006 as compared to $785 thousand at September 30, 2005. With regard to determining how the allowance for loan loss is allocated to various categories of loans, specific individual loans selected to appear on the Bank's Watched Asset List have been identified by the line officer (relationship manager) and reviewed by management as having a defined weakness, such as insufficient cash flow, inadequate collateral, irregular payment history, etc., which could jeopardize the contractual repayment of the loan. Potential loss factors are quantified utilizing a "discount factor" against the collateral held for a specific loan or a related group of loans. All substandard loan factors are decided by the line officer that has intimate knowledge of the loan relationship and the collateral supporting the obligation. The discounts can range from 0% to 100%, depending on the nature of the collateral and the circumstances behind the loan classification. The discounted collateral value is then compared with the outstanding loan balance to determine the adequacy of the specific allowance for loan loss allocated. The remaining loans not subject to individual review, are evaluated as related, homogeneous, groups according to specific loan categories. Residential real estate mortgage loans generally fall into this category of homogeneous groups. Loss factors are assigned to each related, homogeneous, group according to factors such as historical losses, delinquency trends, peer group comparisons, industry and economic data and loss percentages generally used by banking regulators for similarly graded loans. The allowance for loan loss allocated to residential real estate mortgage loans decreased by $1 thousand to $368 thousand at September 30, 2006 as compared to $369 thousand at September 30, 2005. The slight decrease in the allocation is mainly due to the aggregate balances of homogeneous loans in this group remaining consistent. Most of the $211 million increase in residential real estate mortgage loans was in the variable-rate mortgage loans and home equity lines-of-credit categories which, during the periods of generally rising interest rates, have a higher inherent repayment risk, due to the effect that higher mortgage payments have upon a borrower's capacity to pay debt. Such loss characteristics, which 14 exist throughout the long-term life of such loans, are less obvious in generally favorable economic conditions. The allowance for loan loss allocated to commercial real estate mortgage loans increased by $23 thousand to $125 thousand at September 30, 2006 as compared to an allowance for loan loss of $102 thousand at September 30, 2005. The increase in the allowance for loan losses in this category was due primarily to the $5.9 million increase in the balance of loans in this category. Primarily due to an improvement in portfolio risk characteristics, the allowance for loan losses allocated to commercial loans declined by $22 thousand, to $270 thousand at September 30, 2006. The balance of loans in this homogenous group increased slightly to $5.6 million at September 30, 2006 from $3.4 million at September 30, 2005, however specifically allocated losses within the commercial loans have decreased as certain classified loans have paid-off during the year. The allowance for loan loss allocated to consumer loans increased slightly from September 30, 2005 to September 30, 2006 and primarily reflects a slight increase in the balance of consumer loans. At September 30, 2006, the balance of consumer loans was $517 thousand, as compared to $516 thousand at September 30, 2005. The allowance designated as unallocated was $10 thousand at September 30, 2006 as compared to an unallocated balance of $19 thousand at September 30, 2005. The unallocated component of the allowance is maintained to cover uncertainties that could affect management's estimate of probable losses and also reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the loan portfolio. The Bank has no established range into which the unallocated portion of the allowance should fall. The amount of the unallocated allowance at September 30, 2006 is considered by management to be reasonable. Although the management of the Bank believes that it has established and maintained the allowance for loan losses at adequate levels, future additions may be necessary if economic and other conditions in the future differ substantially from the current operating environment. Management believes its policies with respect to the methodology for its determination of the allowance for loan losses involve a higher degree of complexity and require management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. This critical policy and its application are periodically reviewed with the Audit Committee and our Board of Directors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The FDIC, in conjunction with the other federal banking agencies, has adopted an inter-agency policy statement on allowance for loan losses and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for their assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Investment Activities The Company's Board of Directors reviews and approves the investment policy on an annual basis. The President and Chief Executive Officer, and the Senior Vice President and Treasurer, as authorized by the Board, implement this policy. Management reports securities transactions to the Board for review and approval on a monthly basis. The investment policy is designed primarily to manage the interest rate sensitivity of the Bank's assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement the Bank's lending activities and to provide and maintain liquidity within established guidelines. In establishing investment strategies, the Bank considers its interest rate sensitivity, the types 15 of securities to be held, liquidity and other factors. Massachusetts-chartered savings banks have authority to invest in various types of assets, including U.S. Treasury obligations, securities of various federal agencies, mortgage-backed securities, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements, loans of federal funds, and, subject to certain limits, corporate debt and equity securities, commercial paper and mutual funds. At September 30, 2006, with the exception of securities of the government-sponsored enterprises, the Company had no securities of any issuer where the aggregate market and book value of the securities of such issuer, exceeded 10 percent of stockholders' equity. At September 30, 2006 and September 30, 2005, the Bank's liquidity ratio was 111.9% and 80.7%, respectively. The increase in the liquidity percentage was due primarily to an increase in the liquidity of the investment portfolio. For information regarding the carrying values, yields and maturities of the Bank's securities, see "Carrying Values, Yields and Maturities" further on in this section. At September 30, 2006, the fair value of the government-sponsored enterprise obligations portfolio totaled $31.0 million, or 109.2% of stockholders' equity. This portfolio consists primarily of securities with maturities of one to five years. Some of the debentures are callable and call provisions vary following a minimum holding period. The Bank generally does not purchase structured notes, and at September 30, 2006, there were no structured notes in the Bank's portfolio. At September 30, 2006, the portfolio of other debt obligations, excluding mortgage-backed securities, totaled $7.4 million. The Bank's policy generally requires that investment in corporate debt obligations be limited to corporate bonds with an "A" rating or better by at least one nationally recognized rating service at the time of purchase. At September 30, 2006, the Bank's mortgage-backed securities, all of which were classified as available for sale, totaled $24.0 million, or 8.0% of total assets. The Bank generally purchases mortgage-backed securities as a means to deploy excess liquidity at more favorable yields than other investment alternatives. In addition, mortgage-backed securities generate positive interest rate spreads with minimal administrative expense and lower the Bank's overall credit risk due to the fact that they are directly or indirectly insured or guaranteed. Purchases of mortgage-backed securities have declined as the Bank continues to experience an increase in loans. Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees or credit enhancements that reduce credit risk. However, mortgage-backed securities are more liquid than individual mortgage loans and may be used to collateralize the Bank's borrowings. In general, mortgage-backed securities issued or guaranteed by Fannie Mae, Freddie Mac and GNMA are weighted at no more than 20% for risk-based capital purposes, compared to the 50% risk-weighting assigned to most non-securitized residential mortgage loans. While mortgage-backed securities carry a reduced credit risk as compared to whole loans, they remain subject to the risk of a fluctuating interest rate environment. Along with other factors, such as the geographic distribution of the underlying mortgage loans, changes in interest rates may alter the prepayment rate of those mortgage loans and affect both the prepayment rates and value of mortgage-backed securities. Under the Bank's investment policy, the aggregate amount of common stock that it may purchase may not exceed 13% of its total securities portfolio. The Bank's policy also has limitations against acquiring concentrations of such securities in any one issuer or industry. The Bank purchases marketable equity securities as growth investments that can provide the opportunity for capital appreciation that is taxed on a more favorable basis than operating income. There can be no assurance that investment in marketable equity securities will appreciate in value and, therefore, such investments involve higher risk than U.S. Government or government-sponsored enterprise securities. Unless otherwise noted with respect to certain securities or required by regulators or accounting standards, the Bank classifies securities available for sale at the date of purchase. Available for sale 16 securities are reported at fair market value. The Bank currently has no securities classified as trading or held to maturity. The following table presents activity in the Bank's securities portfolio, including FHLB stock for the years indicated: --------------------------------- For the Year Ended September 30, --------------------------------- 2006 2005 2004 --------------------------------- (Dollars In Thousands) Beginning balance $ 66,906 $75,001 $ 88,840 Purchases 18,112 7,208 32,029 Maturities (12,600) (3,700) (6,790) Sales and calls (830) (4,259) (30,525) Principal repayments (5,586) (5,634) (6,285) Premium and (discount) amortization, net (268) (399) (522) Change in net unrealized gains/(losses) 84 (1,311) (1,746) Write-down 0 0 0 -------- ------- -------- Ending balance $ 65,818 $66,906 $ 75,001 ======== ======= ======== The following table sets forth certain information regarding the amortized cost and fair value of the Bank's securities at the dates indicated.
------------------------------------------------------------------------- At September 30, ------------------------------------------------------------------------- 2006 2005 2004 ------------------------------------------------------------------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value ------------------------------------------------------------------------- (Dollars in thousands) Debt securities: Government-sponsored enterprise obligations $31,323 $31,038 $27,917 $27,474 $21,549 $21,514 Banking and finance obligations 6,119 6,115 7,801 7,726 12,442 12,645 Other bonds and obligations 1,261 1,261 3,711 3,721 5,299 5,433 ------- ------- ------- ------- ------- ------- Total debt securities 38,704 38,414 39,429 38,921 39,290 39,592 ------- ------- ------- ------- ------- ------- Mortgage-backed and mortgage- related securities: FHLMC 7,624 7,373 8,079 7,866 9,866 9,816 FNMA 16,034 15,576 16,218 15,866 21,620 21,602 GNMA 246 243 319 316 427 423 Other 837 836 981 971 1,122 1,119 ------- ------- ------- ------- ------- ------- Total mortgage-backed and mortgage-related securities 24,741 24,028 25,597 25,019 33,035 32,960 ------- ------- ------- ------- ------- ------- Marketable equity securities 1 0 1 0 410 407 FHLB stock 3,376 3,376 2,966 2,966 2,042 2,042 ------- ------- ------- ------- ------- ------- Total securities $66,822 $65,818 $67,993 $66,906 $74,777 $75,001 ======= ======= ======= ======= ======= =======
17 The following table sets forth the amortized cost and fair value of the Bank's mortgage-backed and mortgage-related securities, all of which were classified as available for sale at the dates indicated.
------------------------------------------------------------------------------------------------- At September 30, ------------------------------------------------------------------------------------------------- 2006 2005 2004 ------------------------------------------------------------------------------------------------- Amortized Percent of Fair Amortized Percent of Fair Amortized Percent of Fair Cost Total (1) Value Cost Total (1) Value Cost Total (1) Value ------------------------------------------------------------------------------------------------- (Dollars in thousands) Mortgage-backed and mortgage- related securities: FHLMC $7,624 30.82% $7,373 $7,866 31.44% $8,079 $8,079 31.44% $7,866 FNMA 16,034 64.81% 15,576 15,866 63.42% 16,218 16,218 63.42% 15,866 GNMA 246 0.99% 243 316 1.26% 319 319 1.26% 316 Other 837 3.38% 836 971 3.88% 981 981 3.88% 971 ------- ------- ------- ------- ------- ------- ------- ------- ------- Total mortgage-backed and mortgage-related securities $24,741 100.00% $24,028 $25,019 100.00% $25,597 $25,597 100.00% $25,019 ======= ======= ======= ======= ======= ======= ======= ======= ======= Based on amortized cost
Carrying Values, Yields and Maturities. The table below presents information regarding the carrying values, weighted average yields and contractual maturities of debt securities at September 30, 2006. Mortgage-backed securities are presented by issuer. Yields on tax exempt obligations were not computed on a tax equivalent basis.
----------------------------------------------------------------------------------------------------- September 30, 2006 ----------------------------------------------------------------------------------------------------- More than One Year More than Five Years One Year or Less to Five Years to Ten Years More than Ten Years Total ----------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield ----------------------------------------------------------------------------------------------------- (Dollars in thousands) Debt securities: Government-sponsored enterprise obligations $12,194 3.52% $18,844 4.48% $ - 0.00% $ - 0.00% $31,038 4.11% Banking and finance obligations 3,619 4.70% 2,496 4.88% - 0.00% - 0.00% 6,615 4.77% Other bonds and obligations 1,261 5.63% - 0.00% - 0.00% - 0.00% 1,261 5.63% ------- ------- ------ ------- ------- Total debt securities 17,074 3.90% 21,340 4.53% - 0.00% - 0.00% 38,414 4.25% ------- ------- ------ ------- ------- Mortgage-backed and mortgage-related securities: FHLMC 81 5.00% 59 6.00% 1,352 4.28% 5,881 4.25% 7,373 4.28% FNMA - 0.00% 2,620 4.29% 862 5.77% 12,094 4.55% 15,576 4.57% GNMA - 0.00% - 0.00% - 0.00% 243 3.51% 243 3.51% Other - 0.00% - 0.00% - 0.00% 836 4.99% 836 4.99% ------- ------- ------ ------- ------- Total mortgage-backed and mortgage-related securities 81 0.00% 2,679 4.33% 2,214 4.86% 19,054 4.46% 24,028 4.49% ------- ------- ------ ------- ------- Total $17,155 3.88% $24,019 4.51% $2,214 4.86% $19,054 4.46% $62,442 4.34% ======= ======= ====== ======= =======
18 Deposit Activity and Other Sources of Funds General. Deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of securities and funds provided by operations are the Bank's primary sources of funds for use in lending, investing and for other general purposes. The Bank, most recently, has been utilizing borrowed funds from the Federal Home Loan Bank ("FHLB") in order to fund loans and in connection with the Bank's management of the interest rate sensitivity of its assets and liabilities. Deposits. The Bank offers a variety of deposit accounts having a range of interest rates and terms. The Bank currently offers regular savings deposits, NOW accounts, personal and business demand accounts, money market accounts and certificates of deposit. The Bank also offers Individual Retirement Accounts ("IRA's"), which at September 30, 2006 totaled $12.4 million. Deposit flows are influenced significantly by general and local economic conditions, changes in prevailing interest rates, pricing of deposits and competition. The Bank's deposits are primarily obtained from areas surrounding its offices, and the Bank relies primarily on paying competitive rates, service and long-standing relationships with customers to attract and retain these deposits. The Bank has developed deposit products to attract and retain individual and commercial depositors. Some programs involve the introduction of commercial deposit products tailored to small-and medium-sized businesses, such as the Bank's business and commercial checking accounts. The Bank does not use brokers to obtain deposits. When the Bank determines its deposit rates, it considers local and Internet-based competition, U.S. Treasury securities offerings and the rates charged on other sources of funds. Core deposits (defined as total savings accounts, NOW accounts, money market accounts and demand accounts) represented 63.7% of total deposits at September 30, 2006. Certificates of deposit with remaining terms to maturity of less than one year represented 28.3% of total deposits at September 30, 2006. The following table presents the Bank's deposit activity for the years indicated.
---------------------------------- For the Years Ended September 30, ---------------------------------- 2006 2005 2004 ---------------------------------- (Dollars In Thousands) Beginning balance $210,281 $211,710 $215,898 Net deposits (3,627) (4,407) (6,512) Interest paid on deposit accounts 4,623 2,978 2,324 -------- -------- -------- Ending Balance $211,277 $210,281 $211,710 ======== ======== ======== Total (decrease) increase in deposit accounts $ 996 $ (1,429) $ (4,188) Percentage (decrease) increase 0.47% -0.67% -1.94%
19 At September 30, 2006, the Bank had $24.1 million in certificates of deposit with balances of $100,000 and over maturing as follows: ------------------------ At September 30, 2006 ------------------------ Weighted Average Amount Rate ------------------------ (Dollars in thousands) Maturity Period: Three months or less $ 6,258 3.86% Over three months through six months 3,004 2.90% Over six months through 12 months 8,254 5.22% Over 12 months 6,594 4.51% ------- Total $24,110 4.38% ======= The following table presents the distribution of the Bank's deposit accounts at the dates indicated by dollar amount and percent of portfolio, and the weighted average interest rate on each category of deposits.
------------------------------------------------------------------------------------------------- At September 30, ------------------------------------------------------------------------------------------------- 2006 2005 2004 ------------------------------------------------------------------------------------------------- Percent Weighted Percent Weighted Percent Weighted of Average of Average of Average total Nominal total Nominal total Nominal Amount deposits Rate Amount deposits Rate Amount deposits Rate ------------------------------------------------------------------------------------------------- (Dollars in thousands) Non-interest bearing accounts $ 21,962 10.39% 0.00% $ 22,245 10.58% 0.00% $ 25,131 11.87% 0.00% NOW accounts 15,547 7.36% 0.13% 17,800 8.46% 0.13% 20,044 9.47% 0.10% Savings accounts: Regular 26,989 12.77% 0.40% 35,735 16.99% 0.40% 39,932 18.86% 0.40% Tiered-rate 37,808 17.90% 1.97% 66,091 31.44% 1.99% 72,242 34.12% 1.55% -------- ------- -------- ------- -------- ------- Total savings accounts 64,797 30.68% 1.32% 101,826 48.43% 1.43% 112,174 52.99% 1.14% -------- ------- -------- ------- -------- ------- Money market deposit accounts 32,207 15.24% 3.35% 5,161 2.45% 3.19% 6,139 2.90% 1.00% -------- ------- -------- ------- -------- ------- Total non-certificate accounts 134,513 63.67% 1.45% 147,032 69.92% 1.12% 163,488 77.22% 0.83% -------- ------- -------- ------- -------- ------- Certificates of deposit accounts: Due within 1 year 59,798 28.30% 4.28% 44,371 21.10% 2.97% 34,183 16.15% 1.84% Over 1 year through 3 years 14,380 6.81% 4.21% 17,831 8.48% 3.46% 12,090 5.71% 2.63% Over 3 years 2,586 1.22% 5.18% 1,047 0.50% 4.05% 1,949 0.92% 3.28% -------- ------- -------- ------- -------- ------- Total certificate accounts 76,764 36.33% 4.29% 63,249 30.08% 3.12% 48,222 22.78% 2.08% -------- ------- -------- ------- -------- ------- Total deposits $211,277 100.00% 2.48% $210,281 100.00% 1.72% $211,710 100.00% 1.12% ======== ======= ======== ======= ======== =======
20 Borrowings. The Bank borrows funds from the FHLB for use in connection with its management of liquidity, interest rate sensitivity of its assets and liabilities, as well as to fund loan growth and for other general purposes. Over the past two years, the Bank has increased its advances from the FHLB in response to a decline in deposit sources of funds and increased lending activity. The advances are collateralized by certain of the Bank's mortgage loans and by its investment in stock of the FHLB. The maximum amount the FHLB will advance to its members, including the Bank, fluctuates from time to time in accordance with FHLB policies. At September 30, 2006, the Bank had outstanding advances from the FHLB of $57.5 million and had the capacity to increase outstanding advances to $102.1 million based on the Bank's qualified collateral available to the FHLB. The Bank expects to continue to borrow from the FHLB. The following table presents certain information regarding the Bank's borrowed funds at or for the years ended on the dates indicated. --------------------------------------- At or for the Years Ended September 30, --------------------------------------- 2006 2005 2004 --------------------------------------- (Dollars in thousands) Federal Home Loan Bank advances: Average balance outstanding $52,762 $32,125 $16,215 Maximum amount outstanding at any month-end during the year $57,500 $50,000 $31,000 Balance outstanding at end of year $57,500 $50,000 $21,500 Weighted average interest rate during the year 4.20% 3.71% 3.94% Weighted average interest rate end of year 4.33% 4.02% 3.37% There were no short-term advances with original maturities of less than ninety days at September 30, 2006. The average balance outstanding was $3.6 million, the maximum balance outstanding at any month-end during the year was $6.9 million and the weighted average interest rate during the year was 5.01%. 21 Selected Financial Ratios and Other Data The following information in the table are selected financial ratios and other data for the Company for the years indicated:
--------------------------------------- At or for the Years Ended September 30, --------------------------------------- Selected Financial Ratios and Other Data (1) 2006 2005 2004 --------------------------------------- Performance Ratios: Return (loss) on average assets -0.01% 0.32% 0.46% Return (loss) on average stockholders' equity -0.15% 3.11% 4.14% Average stockholders' equity to average assets 9.47% 10.43% 11.10% Stockholders' equity to assets at end of year 9.43% 9.81% 10.87% Net interest rate spread (2) 2.38% 2.99% 3.32% Net interest margin (3) 2.72% 3.25% 3.53% Average interest-earning assets to average interest-bearing liabilities 113.91% 116.44% 117.19% Operating expenses as a percent of average assets 2.88% 3.02% 3.05% Efficiency ratio (4) 102.05% 90.45% 83.81% Regulatory Capital Ratios: (5) Total risk-based capital 17.92% 19.51% 20.97% Tier 1 risk-based capital 17.44% 19.00% 20.29% Regulatory tier 1 leverage capital 9.46% 10.18% 10.79% Asset Quality Ratios: Non-performing loans as a percent of loans 0.20% 0.09% 0.07% Non-performing assets as a percent of total assets 0.14% 0.06% 0.05% Allowance for loan losses as a percent of total loans before the allowance for loan losses 0.37% 0.39% 0.57% Number of: Full-service offices (6) 4 4 4 Full-time equivalent employees 69 71 68 Share Data: Basic number of weighted average shares outstanding 1,562,323 1,554,853 1,541,927 Dilutive number of weighted average shares outstanding 1,562,323 1,571,204 1,563,727 Basic earnings (loss) per share ($0.03) $0.58 $0.77 Dilutive earnings (loss) per share ($0.03) $0.57 $0.76 Dividends declared per share $0.24 $0.24 $0.20 - -------------------- Asset Quality and Regulatory Capital Ratios are end of year ratios. Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-earning assets. Efficiency ratio represents total operating expenses divided by the sum of net interest income, customer service fees and miscellaneous income. Ratios are based on consolidation. The number of full service offices does not include the Bank's branch at the Willows retirement community.
22 Competition The Bank faces significant competition both in making loans and attracting deposits. The Bank's service area of central Massachusetts has a high concentration of financial institutions, many of which are branches of large money center and regional banks that have resulted from the consolidation of the banking industry in Massachusetts and surrounding states. Some of these competitors have greater resources than the Bank does and may offer services that the Bank does not provide. The Bank's competition for loans comes principally from commercial banks, savings institutions, mortgage companies, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. The Bank's most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions. The Bank faces additional competition for deposits from short-term money market funds, corporate and government securities funds, brokerage firms, Internet banks and insurance companies. The Bank expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the industry. Employees At September 30, 2006, the Bank had 64 full-time and 9 part-time employees. None of the Bank's employees is represented by a collective bargaining agreement. Management of the Bank believes that it enjoys excellent relations with its personnel. Subsidiary Activities Eli Whitney Security Corporation. Eli Whitney Security Corporation is a wholly-owned subsidiary of the Bank. Eli Whitney was established in 1995 as a Massachusetts security corporation for the purpose of buying, selling and holding securities on its own behalf and not as a broker. The income earned on Eli Whitney's securities is subject to a significantly lower rate of state tax than that assessed on income earned on securities maintained by the Bank. At September 30, 2006, Eli Whitney had total assets of $45.8 million, virtually all of which were in securities. The Hundredth Corporation. The Hundredth Corporation is a wholly-owned subsidiary of the Bank. The Hundredth Corporation was established in 1991 for the investment in real or personal property. At September 30, 2006, The Hundredth Corporation had total assets of $992 thousand. Its largest investment consists of $958 thousand of land on which the Bank constructed its expanded Maple Avenue, Shrewsbury Branch office. 23 FEDERAL AND STATE TAXATION Federal Taxation General. The following discussion is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank, the MHC or the Company. For federal income tax purposes, the Bank reports income on the basis of a taxable year ending September 30, using the accrual method of accounting, and the Bank is generally subject to federal income taxation in the same manner as other corporations. The Bank and the Company constitute an affiliated group of corporations and, therefore, are eligible to report their income on a consolidated basis. Because the MHC owns less than 80% of the common stock of the Company, it is not a member of such affiliated group and reports its income on a separate return. The Bank is not currently under audit by the Internal Revenue Service and its federal income tax returns have not been audited for the past five years. Bad Debt Reserves. The Bank, as a "small bank" (one with assets having an adjusted tax basis of $500 million or less) is permitted to maintain a reserve for bad debts and to make, within specified formula limits, annual additions to the reserve which are deductible for purposes of computing its taxable income. Distributions. To the extent that the Bank makes non-dividend distributions to shareholders, such distributions will be considered to result in distributions from the Bank's base year reserve, i.e., its reserve as of October 31, 1988, to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in the Bank's taxable income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not constitute non-dividend distributions and, therefore, will not be included in the Bank's taxable income. The amount of additional taxable income created from a non-dividend distribution is equal to the lesser of the Bank's base year reserve and supplemental reserve for losses on loans or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in certain situations, approximately one and one-half times the non-dividend distribution would be includible in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in the recapture of any portion of its bad debt reserves. Elimination of Dividends; Dividends Received Deduction. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. Because the MHC is not be a member of such affiliated group, it does not qualify for such 100% dividends exclusion, but is entitled to deduct 80% of the dividends it receives from the Company so long as it owns more than 20% of the Company's common stock. State Taxation The Bank files Massachusetts Savings Institution income tax returns. Generally, the income of savings institutions in Massachusetts, which is calculated based on federal taxable income, subject to certain adjustments, is subject to Massachusetts tax. The Bank is not currently under audit with respect to its Massachusetts income tax returns and its state tax returns have not been audited for the past five years. The Company is required to file a Massachusetts income tax return and is generally subject to a state income tax rate that is the same tax rate as the tax rate for savings institutions in Massachusetts. However, if the Company meets certain requirements, it may be eligible to elect to be taxed as a 24 Massachusetts Security Corporation, which would allow the Company to be taxed at a rate that is currently lower than income tax rates for savings institutions in Massachusetts. REGULATION General The Bank is a Massachusetts-chartered stock savings bank, and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is subject to extensive regulation, examination and supervision by the Commonwealth of Massachusetts Division of Banks (the "Division") as its primary corporate regulator, and by the FDIC as the deposit insurer. The Bank must file reports with the Division and the FDIC concerning its activities and financial condition, and it must obtain regulatory approval prior to entering into certain transactions, such as mergers with, or acquisitions of, other depository institutions and opening or acquiring branch offices. The Division and the FDIC conduct periodic examinations to assess the Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which a savings bank can engage and is intended primarily for the protection of the deposit insurance fund and depositors. The Bank is also a member of the Federal Home Loan Bank (the "FHLB") and is subject to certain regulation by the Board of the Federal Reserve System. The MHC and the Company, as bank holding companies controlling the Bank are subject to the Bank Holding Company Act of 1956, as amended (the "BHCA"), and the rules and regulations of the Federal Reserve Board (the "FRB") under the BHCA and to the provisions of the Massachusetts General Laws applicable to savings banks and other depository institutions and their holding companies (the "Massachusetts banking laws") and the regulations of the Division under the Massachusetts banking laws applicable to bank holding companies. The MHC and the Company are required to file reports with, and otherwise comply with the rules and regulations of the FRB and the Division. The Company is required to file certain reports with, and otherwise comply with, the rules and regulations of the Securities and Exchange Commission under the federal securities laws. Any change in such laws and regulations, whether by regulatory action or through legislation, could have a material adverse impact on the MHC, the Company and the Bank, and their operations and stockholders. The following references to the laws and regulations under which the Bank, the MHC and the Company are regulated are brief summaries thereof, do not purport to be complete, and are qualified in their entirety to reference to such laws and regulations. Massachusetts Banking Regulation Activity Powers. The Bank derives its lending, investment and other activity powers primarily from the applicable provisions of the Massachusetts banking laws and its related regulations. Under these laws and regulations, savings banks, including the Bank, generally may, invest in (a) real estate mortgages; (b) consumer and commercial loans; (c) specific types of debt securities, including certain corporate debt securities and obligations of federal, state and local governments and agencies; (d) certain types of corporate equity securities; and (e) certain other assets. A savings bank may also invest pursuant to a "leeway" power that permits investments not otherwise permitted by the Massachusetts banking laws. "Leeway" investments must comply with a number of limitations on the individual and aggregate amounts of "leeway" investments. A savings bank may also exercise trust powers upon approval of the Division. Massachusetts savings banks may also exercise any power and engage in any activity permissible for national banks in accordance with regulations adopted by the Division with respect to such power or activity . The exercise of lending, investment and activity powers are limited by federal law and the related regulations. See "Federal Banking Regulation" below. 25 Massachusetts Community Reinvestment Act. The Bank is also subject to provisions of the Massachusetts banking laws that, like the provisions of the federal Community Reinvestment Act ("CRA"), impose continuing and affirmative obligations upon a banking institution organized in Massachusetts to serve the credit needs of its local communities ("Massachusetts CRA"). The obligations of the Massachusetts CRA are similar to those imposed by the CRA, with the exception of the assigned exam ratings. Massachusetts banking law provides for an additional exam rating of "high satisfactory" in addition to the federal CRA ratings of "outstanding," "satisfactory," "needs to improve" and "substantial noncompliance." The Division has adopted regulations to implement the Massachusetts CRA that are based on the CRA. See "Federal Banking Regulation - Federal Community Reinvestment Act." The Division is required to consider a bank's Massachusetts CRA rating when reviewing the bank's application to engage in certain transactions, including mergers, asset purchases and the establishment of branch offices or automated teller machines, and provides that such assessment may serve as a basis for the denial of any such application. The Massachusetts CRA requires the Division to assess a bank's compliance with the Massachusetts CRA and to make such assessment available to the public. The Bank's most recent Massachusetts CRA rating dated February 20, 2003, from the Division was a rating of "Satisfactory." Loans-to-One-Borrower Limitations. With specified exceptions, the total obligations of a single borrower to a Massachusetts-chartered savings bank may not exceed 20% of the savings bank's surplus account. A savings bank may lend additional amounts up to 100% of the bank's surplus account if secured by collateral meeting the requirements of the Massachusetts banking laws. The Bank currently complies with applicable loans-to-one-borrower limitations. Loans to a Bank's Insiders. Provisions of the Massachusetts banking laws prohibit a savings bank from making a loan or otherwise extending credit to any of its officers and directors or trustees and prohibits any such officer, director or trustee from borrowing, otherwise becoming indebted, or becoming liable for a loan or other extension of credit by such bank to any other person except for any of the following loans after approval by a majority of the members of the Bank's Executive Committee, excluding any member involved in such loan or extension of credit: (a) loan or extension of credit, secured or unsecured, to an officer of the bank in an amount not exceeding $35,000; (b) loan or extension of credit intended or secured for educational purposes to an officer of the bank in an amount not exceeding $150,000; (c) loan or extension of credit secured by a mortgage on residential real estate to be occupied in whole or in part by the officer to whom the loan or extension of credit is made, in an amount not exceeding $500,000; or (d) loan or extension of credit to a director or trustee of the bank who is not also an officer of the bank in an amount permissible under the bank's loan-to-one borrower limit. See "Massachusetts Banking Regulation - Loans-to-One Borrower Limitations" above. No such loan may be granted with an interest rate or on other terms that are preferential in comparison to loans granted to persons not affiliated with the savings bank. Dividends. Under the Massachusetts banking laws, a stock savings bank may, subject to several limitations, declare and pay a dividend on its capital stock, which is the bank's common stock and any preferred stock, out of the bank's net profits. A dividend may not be declared, credited or paid by a stock savings bank so long as there is any impairment of capital stock. No dividend may be declared on the bank's common stock for any period other than for which dividends are declared upon preferred stock, except as authorized by the Commissioner of Banks of the Commonwealth of Massachusetts (the "Commissioner"). The approval of the Commissioner is also required for a stock savings bank to declare a dividend, if the total of all dividends declared by the savings bank in any calendar year shall exceed the total of its net profits for that year combined with its retained net profits of the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. In addition, federal law may also limit the amount of dividends that may be paid by the Bank. See "Federal Banking Regulation - Prompt Corrective Action" below. Examination and Enforcement. The Division is required to periodically examine savings banks at least once every calendar year or at least once each 18 month period if the savings bank qualifies as 26 well capitalized under the prompt corrective action provisions of the Federal Deposit Insurance Act. See " -- Federal Banking Regulation -- Prompt Corrective Action" below. The Division may also examine a savings bank whenever the Division deems an examination expedient. If the Division finds, after an inquiry, that any trustee, director or officer of a savings bank has, among other things, violated any law related to such bank or has conducted the business of such bank in an unsafe or unsound manner, the Division may take various actions that could result in the suspension or removal of such person as an officer, director or trustee of the savings bank. If the Division determines that, among other things, a savings bank has violated its charter or any Massachusetts law or is conducting its business in an unsafe or unsound manner or is in an unsafe or unsound condition to transact its banking business, the Division may take possession of the property and business of the savings bank and may, if the facts warrant, initiate the liquidation of the bank. Federal Banking Regulation Capital Requirements. FDIC regulations require insured banks, such as the Bank, to maintain minimum levels of capital. The FDIC regulations define two tiers, or classes, of capital. Tier 1 capital is comprised of the sum of common stockholders' equity (excluding the unrealized appreciation or depreciation, net of tax, from available-for-sale securities), non-cumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets (other than qualifying servicing rights) and any net unrealized loss on marketable equity securities. The components of Tier 2 capital currently include cumulative perpetual preferred stock, certain perpetual preferred stock for which the dividend rate may be reset periodically, mandatory convertible securities, subordinated debt, intermediate preferred stock, allowance for possible loan losses and up to 45% of pretax net unrealized holding gains on available for sale equity securities with readily determinable market values. Allowance for possible loan losses includible in Tier 2 capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital that may be included in total capital cannot exceed 100% of Tier 1 capital. The FDIC regulations establish a minimum leverage capital requirement for banks in the strongest financial and managerial condition, with a rating of 1 (the highest examination rating of the FDIC for banks) under the Uniform Financial Institutions Rating System, of not less than a ratio of 3.0% of Tier 1 capital to total assets. For all other banks, the minimum leverage capital requirement is 4.0%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. The FDIC regulations also require that savings banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of a ratio of total capital (which is defined as the sum of Tier 1 capital and Tier 2 capital) to risk-weighted assets of at least 8% and a ratio of Tier 1 capital to risk-weighted assets of at least 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The federal banking agencies, including the FDIC, have also adopted regulations to require an assessment of an institution's exposure to declines in the economic value of a bank's capital due to changes in interest rates when assessing the bank's capital adequacy. Under such a risk assessment, examiners will evaluate a bank's capital for interest rate risk on a case-by-case basis, with consideration of both quantitative and qualitative factors. According to the agencies, applicable considerations include the quality of the bank's interest rate risk management process, the overall financial condition of the bank and the level of other risks at the bank for which capital is needed. Institutions with significant interest rate risk may be required to hold additional capital. The agencies also issued a joint policy 27 statement providing guidance on interest rate risk management, including a discussion of the critical factors affecting the agencies' evaluation of interest rate risk in connection with capital adequacy. The following table shows the Leverage, Tier 1 risk-based capital, and Total risk-based capital ratios, for the Bank and consolidated Company, at September 30, 2006:
--------------------------------------------------------------------------- As of September 30, 2006 --------------------------------------------------------------------------- Minimum to be Well Minimum for Capital Capitalized under Prompt Actual Adequacy Purposes Corrective Action Provisions --------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio --------------------------------------------------------------------------- (Dollars in thousands) Total risk-based capital Company $29,014 17.92% $12,952 8.00% N/A N/A Bank $28,627 17.78% $12,878 8.00% $16,097 10.00% Tier 1 risk-based capital Company $28,228 17.44% $ 6,476 4.00% N/A N/A Bank $27,841 17.30% $ 6,439 4.00% $ 9,658 6.00% Tier 1 leverage capital Company $28,228 9.46% $11,937 4.00% N/A N/A Bank $27,841 9.38% $11,869 4.00% $14,836 5.00% For purposes of calculating Total risk-based capital and Tier 1 risk-based capital, assets are based on total risk-weighted assets. In calculating Tier 1 leverage capital, assets are based on adjusted total average assets.
At September 30, 2006, the Bank was considered "well capitalized" under FDIC guidelines. Enforcement. The FDIC has extensive enforcement authority over insured savings banks, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices. The FDIC has authority under Federal law to appoint a conservator or receiver for an insured bank under certain circumstances. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state bank if that bank is "critically undercapitalized." For this purpose, "critically undercapitalized" means having a ratio of tangible capital to total assets of less than 2%. The FDIC may also appoint a conservator or receiver for a state bank on the basis of the institution's financial condition or upon the occurrence of certain events, including: (a) insolvency (whereby the assets of the bank are less than its liabilities to depositors and others); (b) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (c) existence of an unsafe or unsound condition to transact business; (d) likelihood that the bank will be unable to meet the demands of its depositors or to pay its obligations in the normal course of business; and (e) insufficient capital or the incurring or likely incurring of losses that will deplete substantially all of the institution's capital with no reasonable prospect of replenishment of capital without federal assistance. Deposit Insurance. The FDIC merged the Bank Insurance Fund and the Savings Association Insurance Fund to form the Deposit Insurance Fund (the "DIF") on March 31, 2006. The Bank is a member of the DIF and pays its deposit insurance assessments to the DIF. Effective January 1, 2007, the FDIC established a risk-based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. Under the assessment system, the FDIC assigns an institution to one of four risk categories, with the first category having two sub- 28 categories based on the institution's most recent supervisory and capital evaluations, designed to measure risk. Assessment rates currently range from 0.05% of deposits for an institution in the highest sub-category of the highest category to 0.43% of deposits for an institution in the lowest category. The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%. The FDIC allows the use of credits for assessments previously paid. We believe that we have credits that will offset certain of these assessments. In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately 0.0124% of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019. Transactions with Affiliates of the Bank. Transactions between an insured bank, such as the Bank, and any of its affiliates is governed by Sections 23A and 23B of the Federal Reserve Act (the "FRA"). An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. Currently, a subsidiary of a bank that is not also a depository institution is not treated as an affiliate of the bank for purposes of Sections 23A and 23B. Sections 23A and 23B (1) limit the extent to which the bank or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such bank's capital stock and retained earnings, and limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and retained earnings, and (2) require that all such transactions be on terms that are consistent with safe and sound banking practices. The term "covered transaction" includes the making of loans, purchase of assets, issuance of guarantees and other similar types of transactions. Further, most loans by a bank to any of its affiliates must be secured by collateral in amounts ranging from 100 to 130 percent of the loan amounts. In addition, any covered transaction by a bank with an affiliate and any purchase of assets or services by a bank from an affiliate must be on terms that are substantially the same, or at least as favorable, to the bank as those that would be provided to a non-affiliate. Prohibitions Against Tying Arrangements. Banks are subject to the prohibitions of 12 U.S.C. 1972 on certain tying arrangements. A depository institution is prohibited, subject to certain exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or certain of its affiliates or not obtain services of a competitor of the institution. Real Estate Lending Policies. FDIC regulations require that state-chartered non-member banks adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to-value limits that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. We believe the Bank's real estate lending policies reflect the Interagency Guidelines for Real Estate Lending Policies that have been adopted by the federal bank regulators. Federal Community Reinvestment Act. Under the Community Reinvestment Act (the "CRA"), any insured depository institution, including the Bank, has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the FDIC, in connection with its examination of a savings bank, to assess the depository institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications for additional branches and acquisitions. 29 Among other things, the current CRA evaluation system focuses on three tests: (1) a lending test, to evaluate the institution's record of making loans in its service areas; (2) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (3) a service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices. For a small bank, which is a bank with less than $250 million in assets in the year prior to the CRA examination, such as the Bank, the CRA assessment will be based on: (a) the bank's loan-to-deposit ratio; (b) the percentage of the bank's loans and any other appropriate lending related activities located in the bank's assessment areas; (c) the bank's record of lending to, and other appropriate lending related activities for borrowers of different income levels and businesses and farms of different sizes; (d) the geographic distribution of the bank's loans; and (e) the bank's record in acting in response to written complaints about the bank's performance in helping to meet the credit needs of its assessment areas. The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system and requires public disclosure of an institution's CRA rating. The Bank received a "satisfactory" rating in its CRA examination conducted by the FDIC on March 22, 2004. Safety and Soundness Standards. Pursuant to the requirements of FDICIA, each federal banking agency, including the FDIC, has adopted guidelines establishing general standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal stockholder. In addition, the FDIC adopted regulations to require a bank that is given notice by the FDIC that it is not satisfying any of such safety and soundness standards to submit a compliance plan to the FDIC. If, after being so notified, a bank fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the FDIC may issue an order directing corrective and other actions of the types to which a significantly undercapitalized institution is subject under the "prompt corrective action" provisions. If a bank fails to comply with such an order, the FDIC may seek to enforce such an order in judicial proceedings and to impose civil monetary penalties. Prompt Corrective Action. FDICIA also established a system of prompt corrective action to resolve the problems of undercapitalized institutions. The FDIC, as well as the other federal banking regulators, adopted regulations governing the supervisory actions that may be taken against undercapitalized institutions. The regulations establish five categories, consisting of "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Generally, an institution will be treated as "well capitalized" if its ratio of total capital to risk-weighted assets is at least 10%, its ratio of Tier 1 capital to risk-weighted assets is at least 6%, its ratio of Tier 1 capital to total assets is at least 5%, and it is not subject to any order or directive by the FDIC to meet a specific capital level. An institution will be treated as "adequately capitalized" if its ratio of total capital to risk-weighted assets is at least 8%, its ratio of Tier 1 capital to risk-weighted assets is at least 4%, and its ratio of Tier 1 capital to total assets is at least 4% (3% if the bank receives the highest rating under the Uniform Financial Institutions Rating System) and it is not a well-capitalized institution. An institution that has total risk-based capital of less than 8%, Tier 1 risk-based-capital of less than 4% or a leverage ratio that is less than 4% (or less than 3% if the institution is rated a composite "1" under the Uniform Financial Institutions Rating System) will be treated as "undercapitalized." An institution that has total risk-based capital of less than 6%, Tier 1 capital of less than 3% or a leverage ratio that is less than 3% will be treated as "significantly undercapitalized," and an institution that has a tangible capital to assets ratio equal to or less than 2% would be deemed to be "critically undercapitalized." 30 The severity of the action authorized or required to be taken under the prompt corrective action regulations increases as a bank's capital decreases within the three undercapitalized categories. All banks are prohibited from paying dividends or other capital distributions or paying management fees to any controlling person if, following such distribution, the bank would be undercapitalized. The FDIC is required to monitor closely the condition of an undercapitalized bank and to restrict the growth of its assets. An undercapitalized bank is required to file a capital restoration plan within 45 days of the date the bank receives notice that it is within any of the three undercapitalized categories, and the plan must be guaranteed by any parent holding company. The aggregate liability of a parent holding company is limited to the lesser of: (a) an amount equal to five percent of the bank's total assets at the time it became "undercapitalized," and (b) the amount that is necessary (or would have been necessary) to bring the bank into compliance with all capital standards applicable with respect to such bank as of the time it fails to comply with the plan. If a bank fails to submit an acceptable plan, it is treated as if it were "significantly undercapitalized." Banks that are significantly or critically undercapitalized are subject to a wider range of regulatory requirements and restrictions. Loans to a Bank's Insiders. A bank's loans to its executive officers, directors, any owner of 10% or more of its stock (each, an "insider") and any of certain entities affiliated to any such person (an insider's related interest) are subject to the conditions and limitations imposed by Section 22(h) of the Federal Reserve Act and the FRB's Regulation O thereunder. Under these restrictions, the aggregate amount of the loans to any insider and the insider's related interests may not exceed the loans-to-one-borrower limit applicable to national banks, which is comparable to the loans-to-one-borrower limit applicable to the Bank's loans. See "Massachusetts Banking Regulation - Loans-to-One Borrower Limitations." All loans by a bank to all insiders and insiders' related interests in the aggregate may not exceed the bank's unimpaired capital and unimpaired retained earnings. With certain exceptions, loans to an executive officer, other than loans for the education of the officer's children and certain loans secured by the officer's residence, may not exceed the lesser of (1) $100,000 or (2) the greater of $25,000 or 2.5% of the bank's capital and unimpaired retained earnings. Regulation O also requires that any proposed loan to an insider or a related interest of that insider be approved in advance by a majority of the Board of Directors of the bank, with any interested director not participating in the voting, if such loan, when aggregated with any existing loans to that insider and the insider's related interests, would exceed either (1) $500,000 or (2) the greater of $25,000 or 5% of the bank's unimpaired capital and retained earnings. Generally, such loans must be made on substantially the same terms as, and follow credit underwriting procedures that are not less stringent than, those that are prevailing at the time for comparable transactions with other persons. An exception is made for extensions of credit made pursuant to a benefit or compensation plan of a bank that is widely available to employees of the bank and that does not give any preference to insiders of the bank over other employees of the bank. Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as the Bank, that are subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act. In addition, provisions of the BHCA prohibit extensions of credit to a bank's insiders and their related interests by any other institution that has a correspondent banking relationship with the bank, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features. Federal Home Loan Bank System The Bank is a member of the FHLB of Boston. The FHLB system consists of twelve regional Federal Home Loan Banks subject to supervision and regulation by the Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide a central credit facility primarily for member institutions. As part of a borrowing arrangement with the FHLB, the Bank is required to invest in 31 classes of common stock of the FHLB in an amount determined on the basis of the Bank's residential mortgage loans and borrowings from the FHLB. The stock is redeemable at par and earns dividends declared at the discretion of the FHLB. At September 30, 2006, the Bank's investment in the common stock of the FHLB was $3.4 million. The FHLB serves as a reserve or central bank for its member institutions within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHFB System. It offers advances to members in accordance with policies and procedures established by the FHLB and the Board of Directors of the FHLB. Pursuant to regulations promulgated by the FHFB, as required by the Gramm-Leech-Bliley Financial Services Modernization Act (the "GLB Act"), the FHLB of Boston adopted, and the FHFB had approved, a capital plan that changed the foregoing minimum stock ownership requirements for FHLB of Boston stock. Under the new capital plan, each member of the FHLB of Boston must maintain a minimum investment in FHLB of Boston capital stock in an amount equal to the sum of (i) 0.35% of member eligible collateral (subject to a minimum of $10,000 and a maximum of $25.0 million, per member), and (ii) 4.50% of the member's activity-based assets. As a member, the Bank is required to purchase and maintain stock in the FHLB. At September 30, 2006, the Bank was in compliance with this requirement. Holding Company Regulation Federal Regulation. The MHC and the Company are governed as bank holding companies under the BHCA. Bank holding companies are subject to examination, regulation and periodic reporting under the BHCA, as administered by the FRB. The FRB has adopted capital adequacy guidelines for bank holding companies on a consolidated basis substantially similar to those of the FDIC for the Bank. As of September 30, 2006, the Company's total capital and Tier 1 capital ratios for the MHC and the Company exceed these minimum capital requirements. Regulations of the FRB provide that a bank holding company must serve as a source of strength to any of its subsidiary banks and must not conduct its activities in an unsafe or unsound manner. Under the prompt corrective action provisions of FDICIA, a bank holding company parent of an undercapitalized subsidiary bank would be directed to guarantee, within limitations, the capital restoration plan that is required of such an undercapitalized bank. See "Federal Banking Regulation--Prompt Corrective Action" above. If the undercapitalized bank fails to file an acceptable capital restoration plan or fails to implement an accepted plan, the FRB may prohibit the bank holding company parent of the undercapitalized bank from paying any dividend or making any other form of capital distribution without the prior approval of the FRB. As bank holding companies, the MHC and the Company are required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior FRB approval is required for the MHC or the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of such bank or bank holding company. A bank holding company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, will be equal to 10% or more of the company's consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. Such notice and approval is not required for a bank holding company that would be treated as "well capitalized" under applicable regulations of the 32 FRB, that has received a composite "1" or "2" rating at its most recent bank holding company inspection by the FRB, and that is not the subject of any unresolved supervisory issues. The status of the Company and the MHC as registered bank holding companies under the BHCA does not exempt them from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws. In addition, a bank holding company that has elected to be regulated as a financial holding company under the GLB Act, such as the Company and the MHC, may generally engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity. In order to have qualified to be a financial holding company, each of the bank holding companies' depository institution subsidiaries must have been "well capitalized," "well managed," have at least a "satisfactory" CRA rating at its most recent examination and have filed a certification with the FRB that it elects to become a financial holding company. Under the FDICIA, depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This law would potentially be applicable to the Company if it ever acquired, as a separate subsidiary, a depository institution in addition to the Bank. Acquisition of the Company Under federal law, no person may acquire control of the Company or the Bank without first obtaining, as summarized below, approval of such acquisition of control by the FRB. Federal Restrictions. Under the federal Change in Bank Control Act, any person (including a company), or group acting in concert, seeking to acquire 10% or more of the outstanding shares of the Company's common stock will be required to submit prior notice to the FRB, unless the FRB has found that the acquisition of such shares will not result in a change in control of the Company. Under the BHCA, the FRB has 60 days within which to act on such notices, taking into consideration certain factors, including the financial and managerial resources of the acquirer, the convenience and needs of the communities served by the Company and the Bank, and the antitrust effects of the acquisition. Under the BHCA, any company would be required to obtain prior approval from the FRB before it may obtain "control," within the meaning of the BHCA, of the Company. The term "control" is defined generally under the BHCA to mean the ownership or power to vote 25% or more of any class of voting securities of an institution or the ability to control in any manner the election of a majority of the institution's directors. An existing bank holding company would require FRB approval prior to acquiring more than 5% of any class of voting stock of the Company. Dividend Waivers by the MHC Any dividend declared by the Company that is waived by the MHC will be subject to the following general restrictions: Massachusetts Restrictions. Under applicable Massachusetts regulations, a mutual holding company may not waive any dividends to be paid by any of its subsidiary institutions if any shares of the stock to which the waiver would apply is held by an insider (any officer, director or corporator of the mutual holding company or a subsidiary banking institution) or a stock benefit plan of the mutual holding company unless prior written notice of the waiver has been given to the Division and the Division does not object to the waiver. The Division may not object to a dividend waiver notice if (a) the waiver would not be detrimental to the safe and sound operation of the subsidiary banking institution, and (b) the board of trustees of the mutual holding company expressly determines, as evidenced by a 33 resolution of the board of trustees, that such waiver is consistent with the trustees' fiduciary duties to the mutual members of the mutual holding company. Federal Restrictions. In connection with its approval of the reorganization, the FRB imposed certain conditions on the waiver by the MHC of dividends paid on the common stock by the Company. Specifically, the FRB requires the MHC obtain prior approval of the FRB before the MHC may waive any dividends from the Company. In addition, the terms of the FRB approval of the Reorganization provides that any dividends waived by the MHC will not be available for payment to its public stockholders of the Company (i.e., stockholders except for the MHC) or may be excluded from the Company's capital for purposes of calculating dividends payable to the public stockholders. Moreover, the Company is required to maintain the cumulative amount of dividends waived by the MHC in a restricted capital account that would be added to the liquidation account established in the reorganization. This amount is not available for distribution to public stockholders. The restricted capital account and liquidation account amounts would not be reflected in the Company's financial statements, but would be considered as a notional or memorandum account of the Company. These accounts would be maintained in accordance with the laws, rules, regulations and policies of the Division and the plan of reorganization. In addition, if the MHC converted to stock form in the future (commonly referred to as a second-step conversion), any waived dividends would reduce the percentage of the converted company's shares of common stock issued to public stockholders in connection with any such transaction. To date, the MHC has not waived dividends declared by the Company. If the MHC decides that it is in its best interest to waive a particular dividend to be paid by the Company and the FRB approves such waiver, then the Company will pay such dividend only to its public stockholders. The amount of the dividend waived by the MHC would be treated in the manner described above. The MHC's decision as to whether or not to waive a particular dividend will depend on a number of factors, including the MHC's capital needs, the investment alternatives available to the MHC as compared to those available to the Company, and the possibility of regulatory approvals. The Company cannot guarantee: (1) the MHC will waive dividends paid by the Company; (2) that if the application is made to waive a dividend, that the FRB will approve such dividend waiver request; or (3) what conditions might be imposed by the Federal Reserve Board on any dividend waiver. USA Patriot Act. The Bank is subject to the Bank Secrecy Act, as amended by the USA Patriot Act, which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Title III of the USA Patriot Act takes measures intended to encourage information sharing among financial institutions, bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other requirements, the USA Patriot Act imposes the following obligations on financial institutions: o All financial institutions must establish risk-based anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program. o All financial institutions must implement a written customer identification program appropriate for its size, location and type of business. 34 o Financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) must establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering through these accounts. o Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and must take reasonable steps to ensure that correspondent accounts provided to foreign banks are not being used to indirectly provide banking services to foreign shell banks. o Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on BHCA and Bank Merger Act applications. The Sarbanes-Oxley Act The Company is subject to the Sarbanes-Oxley Act of 2002, which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate misconduct. The Sarbanes-Oxley Act's principal legislation and the derivative legislation and rulemaking promulgated by the SEC includes: o the creation of an independent accounting oversight board; o auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; o additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements; o the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; o an increase in the oversight of and enhancement of certain requirements relating to audit committees of public companies and how they interact with the company's independent auditors; o requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer; o requirement that companies disclose whether at least one member of their audit committee is a "financial expert" (as defined by the SEC) and if not, why not; o expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; o a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions; o disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; o mandatory disclosure by analysts of potential conflicts of interest; and 35 o a range of enhanced penalties for fraud and other violations. Federal Securities Laws The Company's common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is therefore subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. The Company is also required to file annual, quarterly and periodic reports with the SEC. 36 ITEM 2. DESCRIPTION OF PROPERTY The Company conducts its business at the main office of the Bank and its five retail banking offices, four of which are full service branch offices. As of September 30, 2006, these properties and leasehold improvements owned by the Company and the Bank had an aggregate net book value of $5.0 million. Original Date Leased or Leased or Date of Lease Location Owned Acquired Expiration -------- ----- -------- ---------- Main Office: 100 E. Main Street Owned 06/10/75 N/A Westborough, MA Branch Offices: 33 W. Main Street Owned 05/01/54 N/A Westborough, MA 53 W. Main Street Owned 07/01/81 N/A Northborough, MA 23 Maple Avenue Owned 5/12/03 N/A Shrewsbury, MA Other Offices: The Willows(1) Leased 08/01/87 Tenant at Will One Lyman Street Westborough, MA - -------------------- (1) This office provides limited retail banking services to the residents of the Willows. It is not open to the general public and maintains restricted operating hours. 37 ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended September 30, 2006. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS On September 30, 2006, there were 1,595,774 shares of common stock issued and outstanding and approximately 624 stockholders, not included persons and entities holding stock in nominee or street name through brokers and banks. The Company stock is not actively traded, although the stock is quoted on the OTC Electronic Bulletin Board under the symbol "WFSM.OB." The table below reflects the stock trading price and dividend payment frequency of the Company's stock for year ending September 30, 2006 and 2005. The quotations reflect inter-dealer prices, without mark-up, mark-down or commissions, and may not represent actual transactions. - -------------------------------------------------------------------------------- High Price Low Price Average Price Dividends per share - -------------------------------------------------------------------------------- First Quarter-2005 $32.00 $30.10 $30.98 $0.06 - -------------------------------------------------------------------------------- Second Quarter-2005 $32.00 $27.20 $29.44 $0.06 - -------------------------------------------------------------------------------- Third Quarter-2005 $27.20 $24.00 $24.79 $0.06 - -------------------------------------------------------------------------------- Fourth Quarter-2005 $29.19 $25.20 $27.77 $0.06 - -------------------------------------------------------------------------------- First Quarter-2006 $28.00 $25.09 $26.61 $0.06 - -------------------------------------------------------------------------------- Second Quarter-2006 $27.88 $25.38 $26.14 $0.06 - -------------------------------------------------------------------------------- Third Quarter-2006 $29.00 $25.44 $25.98 $0.06 - -------------------------------------------------------------------------------- Fourth Quarter-2006 $31.63 $26.49 $27.54 $0.06 - -------------------------------------------------------------------------------- The Company has not repurchased any of its common stock. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward Looking Statements Westborough Financial Services, Inc. (the "Company") and The Westborough Bank (the "Bank") may from time to time make written or oral "forward-looking statements" which may be identified by the use of such words as "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions. Forward-looking statements include statements with respect to the Company's or the Bank's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, which are subject to significant risks and uncertainties. The following factors, many of which are subject to change based on various other factors beyond the Company's and the Bank's control, and other factors identified in the Company's filings with the Securities and Exchange Commission and those presented elsewhere by management from time to time, could cause its financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which would cause actual results to differ materially from these estimates. These factors include, but are not limited to: * conditions which effect general and local economies; * changes in interest rates, deposit flows, demand for mortgages and other loans, real estate values and competition; * changes in accounting principles, policies, or guidelines; * changes in legislation or regulation; and * other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services. This list of important factors is not exclusive. The Company and the Bank do not undertake any obligation to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank. 38 General The Company is a Massachusetts chartered mid-tier holding company that completed its initial public offering in February 2000 in connection with the reorganization of The Westborough Bank (the "Bank") from a Massachusetts chartered mutual savings bank into the Massachusetts mutual holding company form of organization. Pursuant to the reorganization, the Bank converted to a Massachusetts chartered stock savings bank as a wholly-owned subsidiary of the Company, which is majority owned by Westborough Bancorp, MHC (the "MHC"), a Massachusetts chartered mutual holding company. The Company's common stock is traded on the Over-the-Counter Bulletin Board under the symbol "WFSM.OB." On November 13, 2006, the Company, the Bank and the MHC entered into an agreement and Plan of Merger with Assabet Valley Bancorp, Hudwest Financial Services, Inc., and Hudson Savings Bank. Under the terms of the agreement, the mutual holding company structure of the MHC will be eliminated and the Bank will merge with Hudson Savings Bank. The Company will merge with Hudwest Financial Services, Inc., with the Company as the surviving corporation and a wholly-owned subsidiary of Assabet Valley Bancorp. The Company will eventually be merged into Assabet Valley Bancorp. The stockholders of the Company, other than the MHC, will receive $35.00 in cash in exchange for each share of common stock they own. The transaction is subject to regulatory approval and the approval of the stockholders of the Company and the corporators of the MHC and Assabet Valley Bancorp. It is anticipated that the transaction will be completed in spring of 2007. Unless otherwise indicated, the information presented herein represents the consolidated activity of the Company and its subsidiary. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes that are included within this report. The business of the Bank consists of attracting deposits from the general public and using these funds to originate various types of loans primarily in the towns of Westborough, Northborough, Shrewsbury and Grafton, Massachusetts, including residential and commercial real estate mortgage loans and, to a lesser extent, consumer and commercial loans. The Company's profitability depends primarily on the Bank's net interest income, which is the difference between the interest income the Bank earns on its loans and securities portfolio and its cost of funds, which consists primarily of interest paid on deposits and borrowings from the Federal Home Loan Bank of Boston (the "FHLB"). Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on these balances. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The level of other (non-interest) income and operating expenses also affects the Company's profitability. Other income consists primarily of customer service fees, gains and losses on sales of securities and mortgages, income from the sale of non-deposit investment products and income from bank-owned life insurance. Operating expenses consist of salaries and benefits, occupancy-related expenses and other general operating expenses. The operations of the Company, and banking institutions in general, are significantly influenced by general economic conditions and related monetary and fiscal policies of financial institutions' regulatory agencies. Deposit flows and the cost of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for 39 financing real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting loan demand and the availability of funds. Business Strategy In past years, the Company's primary management strategy has been to offer savings and certificate of deposit accounts and residential mortgage loans in the market area of Westborough, Massachusetts and surrounding communities. In recent years, the Company has adopted a growth-oriented strategy that has focused on expanding its product lines and services, providing expanded electronic and traditional delivery systems for its customers and extending its branch network. The Company believes that this business strategy is best for its long-term success and viability, and complements its existing commitment to high quality customer service. In connection with the Company's overall growth strategy, it seeks to: o continue to focus on expanding its residential lending and retail banking franchise, and increasing the number of households served within its market area; o expand its commercial banking products and services for small- and medium-sized businesses, as a means to increase the yield on its loan portfolio and to attract lower cost transaction deposit accounts; o expand its branch network to increase its market share; o increase the use of alternative delivery channels, such as Internet-based and telephonic banking; and o offer a variety of non-deposit investment products and services as a means to compete for an increased share of its customers' financial service business and improve fee-based income. In order to create a platform for the accomplishment of the Company's goals, management has made significant investments in its physical infrastructure and human and technological resources. The Bank has completed renovating older sections of its Main Office and other branches to better serve its retail customers. The Bank continues to upgrade its on-line Internet bill payment and other on-line applications. Such investments have been necessary to ensure that adequate resources are in place to offer increased products and services. Management believes that the Company's long-term profitability is enhanced as it realizes the benefits of diversified product lines and market share growth. Asset/Liability Management; Market Risk Analysis A primary component of the Company's market risk is interest rate volatility. Interest rate risk is the exposure of the Company's net interest income to adverse movements in interest rates. Since net interest income (the difference between interest earned on loans and investments and interest paid on deposits and borrowings) is the Company's primary source of revenue, interest rate risk is the most significant non-credit related market risk to which the Company is exposed. Net interest income is affected by changes in interest rates as well as fluctuations in the level and duration of the Company's assets and liabilities. Fluctuations in interest rates and the relative difference between short-term and longer-term interest rates will ultimately impact the Company's level of interest income and interest expense. Fluctuations in interest rates will also affect the market value of all interest-earning assets and interest-costing liabilities, other than those that possess a short term to maturity. The primary objective of the Company's interest rate management strategy is to optimize its economic value and net income under likely market rate scenarios. To achieve this objective, the Company has developed policies and procedures to assist senior management in evaluating and 40 maintaining acceptable levels of interest rate risk, liquidity risk and capital. In particular, the Company seeks to coordinate asset and liability decisions to minimize the effects of interest rate movements. Due to the nature of the Company's operations, it is not subject to foreign currency exchange or commodity price risk. The Company's real estate loan portfolio, primarily concentrated in the towns of Westborough, Northborough, Shrewsbury and Grafton, Massachusetts, is, however, subject to risks associated with the local economy. Historically, the Company's lending activities have emphasized one- to four-family residential mortgage loans, and the Bank's primary source of funds has been deposits. More recently, the Company has increased its borrowing from the FHLB in order to fund loan growth. In recent years, the Company has attempted to employ certain strategies to manage the interest rate risk inherent in this asset/liability mix, including: (a) investing in securities with relatively short maturities or call dates; (b) maintaining and promoting, through various programs and pricing strategies, a concentration of less interest rate sensitive "core deposits;" (c) emphasizing the origination or purchase and retention of adjustable-rate one- to four-family loans; (d) emphasizing the origination of commercial loans with short-term maturities; and (e) borrowing funds from the FHLB, which may be used to originate or purchase loans with similar anticipated cash flow characteristics. The Company believes that the frequent re-pricing of its adjustable-rate mortgage loans and short-term securities, which reduces the exposure to interest rate fluctuations, will help stabilize the Company's net interest margin. The actual amount of time before mortgage loans and mortgage-backed securities are repaid can be significantly impacted by changes in mortgage prepayment rates and market interest rates. Mortgage prepayment rates vary due to a number of factors, including the regional economy in the area where the underlying mortgages were originated, seasonal factors, demographic variables and the assumability of the underlying mortgages. However, the major factors affecting prepayment rates are prevailing interest rates, related mortgage refinancing opportunities and competition. The Company monitors interest rate sensitivity so that it can make adjustments to its asset and liability mix on a timely basis. Gap Analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring a bank's interest rate sensitivity "gap." An asset or liability is deemed to be interest rate sensitive within a specific time period if it will mature or re-price within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or re-pricing within a specific time period and the amount of interest-bearing liabilities maturing or re-pricing within that same time period. At September 30, 2006, the Company's cumulative one-year gap position, which measures the difference between the amount of interest-earning assets maturing or re-pricing within one year, and interest-bearing liabilities maturing or re-pricing within one year, was a negative 12.87% of total assets. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. Accordingly, during a period of rising interest rates, an institution with a negative gap position generally is not in as favorable a position, compared to an institution with a positive gap, because the resulting yield on an its assets generally would increase at a slower rate than the increase in its cost of interest-bearing liabilities. Conversely, during a period of falling interest rates, an institution with a negative gap tends to experience a re-pricing of its assets at a slower rate than its interest-bearing liabilities which, consequently, would generally result in its net interest income growing at a faster rate than an institution with a positive gap position. The following table sets forth interest-earning assets and interest-bearing liabilities outstanding at September 30, 2006, which are anticipated by the Company, based upon certain assumptions, to re-price or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which re-price or mature during a particular period were determined in accordance with 41 the earlier term to re-pricing/call date or the contractual maturity of the asset or liability. The table sets forth an approximation of the projected re-pricing of assets and liabilities at September 30, 2006 on the basis of contractual maturities, anticipated prepayments and scheduled rate adjustments within a three-month period and subsequent projected time intervals. The loan amounts in the table reflect principal balances expected to be redeployed and/or re-priced as a result of contractual amortization and as a result of contractual rate adjustments on adjustable-rate loans. 42
GAP Table Amounts Maturing or Re-pricing as of September 30, 2006 ------------------------------------------------------------------------------------------ less than 3 to 6 6 months 1 to 3 to 5 to over 3 months months to 1 year 3 years 5 years 10 years 10 years Total ------------------------------------------------------------------------------------------ Interest-earning Assets (1) ($ in thousands) Short-term investments (2) $ 5,886 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 5,886 Investment securities (3) 16,459 3,742 6,969 13,091 1,529 0 0 41,790 Mortgage and asset backed securities 0 188 617 4,734 1,122 2,214 15,153 24,028 Loans (4) 18,614 6,153 4,576 23,285 33,301 68,623 55,972 210,524 ------- -------- -------- -------- -------- ------- ------- -------- Total interest-earning assets 40,959 10,083 12,162 41,110 35,952 70,837 71,125 282,228 ------- -------- -------- -------- -------- ------- ------- -------- Interest-bearing Liabilities: NOW accounts (5) 1,555 1,555 1,555 1,555 0 0 9,328 15,547 Regular and other savings accounts (5) 6,478 6,479 6,480 6,480 0 0 38,880 64,797 Money market deposit accounts (5) 3,221 3,221 3,221 3,221 0 0 19,323 32,207 Certificate of deposit accounts 17,534 19,017 23,247 14,380 2,586 0 0 76,764 Federal Home Loan Bank advances (6) 4,000 0 4,000 22,500 27,000 0 0 57,500 Mortgage escrow deposits 380 0 0 0 0 0 0 380 ------- -------- -------- -------- -------- ------- ------- -------- Total interest-bearing liabilities 33,168 30,271 38,503 48,136 29,586 0 67,531 247,195 ------- -------- -------- -------- -------- ------- ------- -------- Interest sensitivity gap $ 7,791 $(20,188) $(26,341) $ (7,026) $ 6,366 $70,837 $ 3,594 $ 35,033 ------- -------- -------- -------- -------- ------- ------- ======== Cumulative interest sensitivity gap $ 7,791 $(12,397) $(38,738) $(45,764) $(39,398) $31,439 $35,033 ======= ======== ======== ======== ======== ======= ======= Cumulative interest sensitivity gap as a percent of total assets 2.59% -4.12% -12.87% -15.21% -13.09% 10.45% 11.64% Cumulative interest sensitivity gap as a percent of total interest-earning assets 2.76% -4.39% -13.73% -16.22% -13.96% 11.14% 12.41% Cumulative interest sensitivity gap as a percent of total interest-bearing liabilities 3.15% -5.02% -15.67% -18.51% -15.94% 12.72% 14.17% - -------------------- Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or re-priced as a anticipated prepayments, scheduled rate adjustments, call dates and contractual maturities. Short-term Investments include federal funds, money market mutual funds and interest-earning amounts in the Federal Bank of Boston. Investment securities are at market value. Common stock and stock in the Federal Home Loan Bank of Boston is less than 3 month column. Loans are principal balances, net of deferred loan costs/fees/discounts/premiums on purchased loans and unadvanced 60% of NOW, regular and other savings and money market deposit accounts are included in the over ten year period and remaining allocated evenly within the four intervals up to and including one to three years. Federal Home Loan Bank advances are categorized by contractual maturity date.
43 Certain shortcomings are inherent in the method of analysis presented in the Gap Table. For example, although certain assets and liabilities may have similar maturities or periods to re-price, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of changes in interest rates, prepayment and early withdrawals, the level would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase. The following table sets forth certain information relating to the Company's financial condition and net interest income at and for the years ended September 30, 2006, 2005, and 2004, and reflects the average yield on assets and average cost of liabilities for the years indicated. Such yields and costs are derived by dividing interest and dividend income or interest expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include fees and costs, which are considered adjustments to yields. Loan interest and yield does not include any accrued interest from non-accrual loans. 44
For the Year Ended September 30, --------------------------------------------------------------------------------------------- 2006 2005 2004 ----------------------------- ----------------------------- ----------------------------- Average Yield Average Yield Average Yield Balance Interest or Cost Balance Interest or Cost Balance Interest or Cost --------------------------------------------------------------------------------------------- ($ in thousands) Assets: Interest-earning assets: Short-term investments (1) $ 3,644 $ 187 5.13% $ 4,512 $ 108 2.39% $ 5,037 $ 47 0.93% Investment securities (2) 67,108 2,690 4.01% 73,284 2,896 3.95% 91,511 3,588 3.92% Loans (3) 208,315 11,545 5.54% 180,125 9,560 5.31% 144,942 7,859 5.42% -------- ------- -------- ------- -------- ------- Total interest-earning assets 279,067 14,422 5.17% 257,921 12,564 4.87% 241,490 11,494 4.76% ------- ------- ------- Non-interest-earning assets 20,190 18,810 17,599 -------- -------- -------- Total assets $299,257 $276,731 $259,089 ======== ======== ======== Liabilities and Equity: Interest-bearing liabilities: NOW accounts $ 16,498 25 0.15% $ 19,189 25 0.13% $ 19,597 20 0.10% Savings accounts (4) 80,187 1,087 1.36% 109,829 1,469 1.34% 115,483 1,229 1.06% Money market deposit accounts 25,334 845 3.34% 5,042 52 1.03% 5,325 53 1.00% Certificate of deposit accounts 70,204 2,669 3.80% 55,329 1,434 2.59% 49,443 1,021 2.07% -------- ------- -------- ------- -------- ------- Total interest-bearing deposits 192,223 4,626 2.41% 189,389 2,980 1.57% 189,848 2,323 1.22% FHLB Advances 52,762 2,215 4.20% 32,125 1,192 3.71% 16,215 639 3.94% -------- ------- -------- ------- -------- ------- Total interest-bearing liabilities 244,985 6,841 2.79% 221,514 4,172 1.88% 206,063 2,962 1.44% -------- ------- -------- ------- -------- ------- Non-interest bearing deposits 22,145 23,369 22,229 Other non-interest-bearing liabilities 3,787 2,979 2,050 -------- -------- -------- Total non-interest-bearing liabilities 25,932 26,348 24,279 -------- -------- -------- Total liabilities 270,917 247,862 230,342 Total stockholders' equity 28,340 28,869 28,747 -------- -------- -------- Total liabilities and stockholders' equity $299,257 $276,731 $259,089 ======== ======== ======== Net interest income $ 7,581 $ 8,392 $ 8,532 ======= ======= ======= Net interest rate spread (5) 2.38% 2.99% 3.32% ====== ====== ====== Net interest margin (6) 2.72% 3.25% 3.53% ====== ====== ====== Ratio of interest-earning assets to interest-bearing liabilities 113.91% 116.44% 117.19% ====== ====== ====== Short-term investments include federal funds, money market mutual funds and interest earning amounts in the Federal Home Loan Bank of Boston. All investment securities are considered available for sale. Loans are net of deferred loan origination costs/fees, allowance for loan losses, discount/premium on purchased loans and unadvanced funds. Savings accounts include the balance in mortgagors' escrow accounts. Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-earning assets.
45 The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the years indicated. Information is provided in each category with respect to: o changes attributable to changes in volume (changes in volume multiplied by prior rate); o changes attributable to changes in rate (changes in rate multiplied by prior volume); and o the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Year Ended September 30, 2006 Year Ended September 30, 2005 Compared to Year Ended Compared to Year Ended September 30, 2005 September 30, 2004 Increase (Decrease) Increase (Decrease) -------------------------------------------------------------- Due to Due to -------------------------------------------------------------- Volume Rate Net Volume Rate Net -------------------------------------------------------------- ($ In thousands) Interest-earning assets: Short-term investments (1) $ (24) $ 103 $ 79 $ (5) $ 66 $ 61 Investment Securities (2) (247) 41 (206) (720) 28 (692) Loans (3) 1,547 438 1,985 1,871 (170) 1,701 ------ ------ ------ ------ ----- ------ Total interest-earning assets 1,276 582 1,858 1,146 (76) 1,070 ------ ------ ------ ------ ----- ------ Interest-bearing liabilities: NOW accounts (4) 3 (1) 0 5 5 Savings accounts (4) (402) 20 (382) (63) 303 240 Money market deposit accounts 510 283 793 (3) 2 (1) Certificate of deposit accounts 451 785 1,236 131 282 413 ------ ------ ------ ------ ----- ------ Total interest-bearing deposits 555 1,091 1,646 65 592 657 Borrowed funds 849 174 1,023 592 (39) 553 ------ ------ ------ ------ ----- ------ Total interest-bearing liabilities 1,404 1,265 2,669 657 553 1,210 ------ ------ ------ ------ ----- ------ Net change in net interest income $ (128) $ (683) $ (811) $ 489 $(629) $ (140) ====== ====== ====== ====== ===== ====== Short-term investments include federal funds, money market mutual funds and amounts in the Federal Home Loan Bank of Boston. All investment securities are considered available for sale. Loans are net of deferred loan origination costs (fees), allowance for loan discounts/premiums on purchased loans and unadvanced funds. Savings accounts include the balance in mortgagors' escrow accounts. Some numbers may not foot due to rounding.
46 Comparison of Financial Condition at September 30, 2006 and September 30, 2005 The Company's total assets increased by $9.5 million, or 3.3%, to $301.0 million at September 30, 2006 from $291.5 million at September 30, 2005. Loans increased by $9.2 million, or 4.6%, to $209.7 million at September 30, 2006 from $200.5 million at September 30, 2005. Within the loan portfolio, commercial loans increased by $7.4 million from September 30, 2005 to September 30, 2006. Residential real estate loans (primarily adjustable-rate) and home equity lines-of-credit increased by $1.8 million for the same period. Securities available for sale decreased by $1.5 million, or 2.3%, to $62.4 million at September 30, 2006 as compared to $63.9 million at September 30, 2005. The majority of the proceeds from the sale and maturity of securities available for sale were reinvested in the loan portfolio. Deposits increased by $1.0 million, or 0.5%, to $211.3 million at September 30, 2006, from $210.3 million at September 30, 2005, primarily in money market deposit accounts and certificates of deposit. Additionally, FHLB advances increased by $7.5 million, or 15.0%, to $57.5 million at September 30, 2006 from $50.0 million at September 30, 2005. The increase in FHLB advances was utilized to fund loan portfolio growth since deposit growth during the year was not sufficient to fund such loan growth. Total stockholders' equity declined by $220 thousand, to $28.4 million at September 30, 2006 primarily as a result of a combination of dividends paid to shareholders and the current year net loss, offset to a lesser extent by a decrease in accumulated other comprehensive loss resulting from changes in the market value of securities available for sale and stock activities. Accumulated other comprehensive after-tax loss at September 30, 2006 was $659 thousand, as compared to an after-tax loss of $714 thousand at September 30, 2005. The Company's securities consist primarily of interest-rate sensitive securities, whose market value changes inversely with changes in market interest rates. Deferred income tax benefits associated with this market value increase were $29 thousand. Comparison of Operating Results for the Years Ended September 30, 2006 and 2005 Net Income. The Company reported a loss per share (dilutive) for fiscal year ended September 30, 2006 of $0.03 on a net loss of $42 thousand, as compared to earnings per share of $0.57 per share (dilutive) on net income of $898 thousand for fiscal year ended September 30, 2005. For year ended September 30, 2006, net income declined by $940 thousand, primarily due to a decline in the Company's net interest margin, an increase in operating expenses, a decline in other income, and a decline in the credit for loan losses. The Company's return (loss) on average assets was (0.01%) for year ended September 30, 2006 as compared to 0.32% for year ended September 30, 2005. Interest and Dividend Income. Interest and dividend income increased by $1.9 million, or 14.8%, to $14.4 million for year ended September 30, 2006 from $12.6 million for year ended September 30, 2005. The increase in interest and dividend income was mainly the result of an increase in the volume of interest earning assets, as well as an increase in the interest rates earned on interest-earning assets. The average rate earned on interest-earning assets was 5.17% on average interest earning assets of $279.1 million for year ended September 30, 2006 as compared to 4.87% on average interest-earning assets of $257.9 million for the years ended September 30, 2005. The average balance of loans for year ended September 30, 2006 was $208.3 million, earning 5.54% for the year. This compares to an average balance of loans for year ended September 30, 2005 of $180.1 million, earning 5.31% for the year. During year ended September 30, 2006, the Company experienced net one-to-four family residential loan and home equity line growth of $1.8 million and net commercial real estate loan growth of $7.4 million. The increase in the earning rate on loans primarily reflects the general increase in market interest rates for mortgage loans granted during the recent year. The average balance of investment securities for year ended September 30, 2006 was $67.1 million, earning 4.01% for the year. This compares to an average balance of investment securities for year ended 47 September 30, 2005 of $73.3 million, earning 3.95% for the year. Finally, the average balance of short-term investments for year ended September 30, 2006 was $3.6 million, earning 5.13% for the year. This compares to an average balance of short-term investments for year ended September 30, 2005 of $4.5 million, earning 2.39% for the year. The higher earnings rate on short-term investments reflects the interest rate increases by the Federal Open Market Committee (the "FOMC"). Interest Expense. Interest expense increased by $2.7 million, or 64.0%, to $6.8 million for year ended September 30, 2006 from $4.2 million for year ended September 30, 2005. Interest expense increased mainly due to an increase in the average rate paid on interest-bearing liabilities plus an increase in the average volume of interest-bearing liabilities. The average volume of interest-bearing liabilities, which includes interest-bearing deposits and FHLB advances, increased to $245.0 million with a cost of 2.79% for year ended September 30, 2006 as compared to $221.5 million with a cost of 1.88% for year ended September 30, 2005. The primary reason for the increase in costs was due to increased interest expense related to money market deposit accounts and certificates of deposit and reflects the Company's reaction to higher short-term interest rate decisions of the FOMC, coupled with an increase in expense related to FHLB advances. Net Interest Income. Net interest income decreased by $811 thousand for year ended September 30, 2006, or 9.7%, to $7.6 million from $8.4 million for year ended September 30, 2006. The Company's net interest rate spread, which represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities, decreased to 2.38% for year ended September 30, 2006 from 2.99% for year ended September 30, 2005. The decrease was attributed to the combination of an increase of $2.7 million in total interest expense offset, to a lesser extent, by an increase of $1.9 million in total interest and dividend income. Continued flattening of interest rates challenged the Company by limiting investment opportunities and returns. Compression of the net interest rate spread can be expected to result in lower net interest income, and possibly losses, until such time as the yield curve returns to a more normal, upward slope. Provision for Loan Losses. The Company had no provision for loan losses for year ended September 30, 2006 compared to a $173 thousand credit for loan losses for year ended September 30, 2005. The 2005 credit was the result of paydowns and the high credit quality of specific commercial loans for which a portion of the allowance for loan losses had been specifically allocated. The provision for loan losses is a result of management's periodic analysis of risks inherent in the loan portfolio from time to time, as well as the overall adequacy of the allowance for loan losses. It is the Company's policy to provide valuation allowances for estimated losses on loans based upon past loss experience, current trends in the level of delinquent and specific problem loans, loan concentrations to single borrowers, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions in our market area. Accordingly, the evaluation of the adequacy of the allowance for loan losses is not based directly on the level of non-performing loans. The allowance for loan losses, in management's opinion, is sufficient to cover losses in the Company's loan portfolio at this time. As the Company expands its commercial lending activities, management believes that growth in the provision for loan losses may be likely. Additionally, while the Company believes it continues to have excellent loan quality, with $416 thousand of non-accrual loans and non-performing assets at September 30, 2006, the Company recognizes that it is located in a market and geographic area that is considered in the high technology and financial services belt and, most likely, the Company's allowance for loan loss will reflect the relative health of these economic sectors. While management believes that its current level of allowance for loan losses is adequate, there can be no assurance that the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. Other Income. Other income declined by 18.2%, or $193 thousand, to $870 thousand for year ended September 30, 2006. Other income primarily consists of customer service fees, gains and losses 48 from the sale of securities and loans and income from bank-owned life insurance. Gains on the sale of securities and mortgages declined as compared to September 30, 2005, due to substantially lower volume of sales. Miscellaneous income decreased by $48 thousand, or 20.3%, to $188 thousand for year ended September 30, 2006 as compared to year ended September 30, 2005, resulting from a reduction in income from bank owned life insurance policies. Income from customer service fees increased by $71 thousand, or 11.8%, to $674 thousand for year ended September 30, 2006 primarily due to increases in non-deposit investment income and prepayment fees on commercial loans. Operating Expenses. For year ended September 30, 2006, operating expenses increased by $267 thousand, or 3.2%, to $8.6 million, from $8.3 million for year ended September 30, 2005. Salaries and employee benefits increased by $353 thousand, or 7.9%, to $4.8 million for year ended September 30, 2006, from $4.5 million for year ended September 30, 2005, primarily a result of increased benefit costs, general salary increases for employees and higher levels of sales incentive compensation. Professional fees increased by $92 thousand, or 21.8%, to $514 thousand for year ended September 30, 2006. Professional fees increased primarily due to legal and other expenses related to a civil action filed against the Bank and also due to expenses related to the examination of various strategic planning projects and initiatives. Primarily as a result of a higher volume of services provided, data processing expenses increased by $32 thousand, or 4.3%, to $773 thousand for year ended September 30, 2006. Marketing expenses declined by $55 thousand to $176 thousand for year ended September 30, 2006 primarily due to prior year's public relations related to a civil lawsuit filed against the Company in 2005. Other general and administrative expenses decreased by $146 thousand, or 11.0%, to $1.2 million for year ended September 30, 2006, from 1.3 million for year ended September 30, 2005 due to consultant expenses related to an employee opinion survey and crisis communication related to a civil lawsuit filed against the Company during 2005. Income Taxes. Income (loss) before provision (benefit) for income taxes decreased by $1.4 million, to ($165) thousand loss for year ended September 30, 2006 as compared to $1.3 million income for year ended September 30, 2005. Primarily as a result of this decrease, the provision (benefit) for income taxes decreased by $504 thousand, to ($123) thousand benefit for year ended September 30, 2006 as compared to $381 thousand provision for year ended September 30, 2005. The effective income tax rate was (74.5%) and 29.8% for years ended September 30, 2006 and 2005, respectively. The lower effective tax rate was attributable to relatively low level of income (loss) before income taxes for year ended September 30 2006, as compared to September 30, 2005, in addition to the Bank's utilization of a wholly-owned security investment subsidiary, and an increase in income from the cash surrender value of bank-owned life insurance as a percent of pre-tax income. 49 Liquidity and Capital Resources The term "liquidity" refers to the Company's ability to generate adequate amounts of cash to fund loan originations, deposit withdrawals and operating expenses. The Company's primary sources of funds are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by the Company's operations. From time to time, including during fiscal 2006, the Company has utilized borrowing from the FHLB as part of its management of interest rate risk and to fund loan growth in periods when deposit growth is not sufficient to meet such loan growth. At September 30, 2006, the Company had $57.5 million in outstanding borrowings from the FHLB with a weighted average interest rate of 4.39%, as compared to $50.0 million with a weighted average interest rate of 4.08% at September 30, 2005. The Company generally makes loan commitments to borrowers not exceeding 45 days. At September 30, 2006, the Company had $4.7 million in loan commitments outstanding. Unadvanced funds on home equity lines of credit and commercial lines of credit at September 30, 2006 represented $16.8 million and $1.9 million, respectively. Total deposits increased by $1.0 million during year ended September 30, 2006. During the year, a significant percentage of tiered-rate and regular savings account customers chose to move their funds either to higher rate certificates of deposit or money market deposit accounts, as a result of the current rate environment. During 2006, tiered-rate and regular savings accounts declined by $37.0 million, while certificates of deposit and money market accounts increased by $45.7 million. In order to fund increased loan volume, the Company increased low-cost borrowing from the FHLB. The level of deposit flow is affected by interest rates offered by the Company, products and rates offered by competitors and other factors. Certificate of deposit accounts scheduled to mature within one year were $60.0 million at September 30, 2006. Based on the Company's deposit retention experience and current pricing strategy, the Company anticipates that a significant portion of these certificates of deposit will remain with the Company. The Company is committed to maintaining a strong liquidity position; therefore, it monitors its liquidity position on a daily basis. The Company also periodically reviews liquidity information prepared by the Federal Deposit Insurance Corporation (the "FDIC"), Depositors Insurance Fund and other available reports that compare the Company's liquidity with Company's in its peer group. The Company anticipates that it will have sufficient funds to meet its current funding commitments. Further, the Company does not have any balloon or other payments due on any long-term obligations other than the commitments. The following table shows the Tier 1 leverage ratio, Tier 1 risk-based capital and Total risk-based capital ratios, for the Bank and consolidated Company, at September 30, 2006: 50
As of September 30, 2006 ----------------------------------------------------------------- Minimum to be Well Minimum for Capital Capitalized under Actual Adequacy Purposes Corrective Action ------------------ ------------------- ------------------ Amount Ratio Amount Ratio Amount Ratio ----------------------------------------------------------------- (Dollars in thousands) Total risk-based capital Company $29,014 17.92% $12,952 8.00% N/A N/A Bank $28,627 17.78% $12,878 8.00% $16,097 10.00% Tier 1 risk-based capital Company $28,228 17.44% $ 6,476 4.00% N/A N/A Bank $27,841 17.30% $ 6,439 4.00% $ 9,658 6.00% Tier 1 leverage capital Company $28,228 9.46% $11,937 4.00% N/A N/A Bank $27,841 9.38% $11,869 4.00% $14,836 5.00% For purposes of calculating Total risk-based capital and Tier capital, assets are based on total risk-weighted assets. In calculating Tier 1 leverage capital, assets are based on adjusted total average
At September 30, 2006, the Bank was considered "well capitalized" under FDIC guidelines. 51 Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The following table sets forth information relating to the Company's payments due under contractual obligations at September 30, 2006:
------------------------------------------------------ Payments due by period ------------------------------------------------------ Total < 1 yr 1-3 yrs 3-5 yrs > 5 yrs ------------------------------------------------------ Short-term debt (1) $ - $ - $ - $ - $ - Long-term debt (2) 57,500 8,000 22,500 27,000 - Capital lease obligations - - - - - Operating lease obligations (3) - - - - - Purchase obligations - - - - - Other long-term liabilities reflected on the company's balance sheet under GAAP - - - - - ------- ------ ------- ------- ------- $57,500 $8,000 $22,500 $27,000 $ - ======= ====== ======= ======= ======= Consists of FHLB advances with original maturities less than ninety days. Consists of FHLB advances with original maturities greater than one year which are scheduled to mature after September 30, 2006. Certain advances are callable in 2007. Pertains to noncancelable lease agreements in effect at September 30, 2006, pertaining to banking premises and equipment and future minimum rent commitments. The leases contain options to extend for periods from two to ten years.
Impact of Inflation and Changing Prices The consolidated financial statements and accompanying notes presented here have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike industrial companies, the Company's assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation. Critical Accounting Policies The Notes to our Audited Consolidated Financial Statements for year ended September 30, 2006 included in our Annual Report contain a summary of our significant accounting policies. We believe our policies with respect to the methodology for our determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. The Audit Committee and our Board of Directors periodically review this critical policy and their application. 52 ITEM 7. FINANCIAL STATEMENTS INDEX TO CONSOLIDATED FINANCIAL STATEMENTS WESTBOROUGH FINANCIAL SERVICES, INC. Report of Independent Registered Public Accounting Firm F-1 Consolidated Balance Sheets as of September 30, 2006 and 2005 F-2 Consolidated Statements of Operations for the Years Ended September 30, 2006 and 2005 F-3 - F-4 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended September 30, 2006 and 2005 F-5 Consolidated Statements of Cash Flows for the Years Ended September 30, 2006 and 2005 F-6 - F-7 Notes to Consolidated Financial Statements F-8 - F-47 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of Westborough Financial Services, Inc. We have audited the accompanying consolidated balance sheets of Westborough Financial Services, Inc. and subsidiary as of September 30, 2006 and 2005, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Westborough Financial Services, Inc. and subsidiary as of September 30, 2006 and 2005, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. /s/ Wolf & Company, P.C. Boston, Massachusetts November 14, 2006
WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS September 30, 2006 and 2005 (Dollars in thousands) ASSETS 2006 2005 -------- -------- Cash and due from banks $ 2,431 $ 3,590 Federal funds sold 3,444 1,785 Short-term investments 2,442 3,599 -------- -------- Total cash and cash equivalents 8,317 8,974 Securities available for sale, at fair value 62,442 63,940 Federal Home Loan Bank stock, at cost 3,376 2,966 Loans, net of allowance for loan losses of $780 in 2006 and $785 in 2005 209,744 200,477 Premises and equipment, net 6,560 6,094 Accrued interest receivable 1,368 1,181 Deferred income taxes 1,268 1,135 Bank-owned life insurance 6,555 6,118 Other assets 1,337 605 -------- -------- $300,967 $291,490 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $211,277 $210,281 Short-term borrowings - 4,000 Long-term borrowings 57,500 46,000 Mortgagors' escrow accounts 380 409 Accrued expenses and other liabilities 3,427 2,197 -------- -------- Total liabilities 272,584 262,887 -------- -------- Commitments and contingencies (Note 13) Stockholders' equity: Preferred stock - $.01 par value, 1,000,000 shares authorized, none outstanding - - Common stock - $.01 par value, 5,000,000 shares authorized, 1,595,774 and 1,594,774 shares issued and outstanding at September 30, 2006 and 2005, respectively 16 16 Additional paid-in capital 5,063 4,990 Retained earnings 24,289 24,714 Accumulated other comprehensive loss (659) (714) Unearned compensation - RRP (4,729 and 7,509 shares in 2006 and 2005, respectively) (83) (130) Unearned compensation - ESOP (24,308 and 27,255 shares in 2006 and 2005, respectively) (243) (273) -------- -------- Total stockholders' equity 28,383 28,603 -------- -------- $300,967 $291,490 ======== ======== See accompanying notes to consolidated financial statements.
F-2
WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share data) Years Ended September 30, ------------------------- 2006 2005 ------- ------- Interest and dividend income: Interest and fees on loans $11,545 $ 9,560 Interest and dividends on securities: Taxable interest 2,440 2,684 Non-taxable interest 33 55 Dividends 217 157 Interest on federal funds sold 76 75 Interest on short-term investments 111 33 ------- ------- Total interest and dividend income 14,422 12,564 ------- ------- Interest expense: Interest on deposits 4,626 2,980 Interest on Federal Home Loan Bank advances 2,215 1,192 ------- ------- Total interest expense 6,841 4,172 ------- ------- Net interest income 7,581 8,392 (Credit) provision for loan losses - (173) ------- ------- Net interest income, after (credit) provision for loan losses 7,581 8,565 ------- ------- Other income: Customer service fees 674 603 Gain on sales and calls of securities, net 3 59 Gain on sales of mortgages, net 5 165 Miscellaneous 188 236 ------- ------- Total other income 870 1,063 ------- ------- Operating expenses: Salaries and employee benefits 4,821 4,468 Occupancy and equipment expenses 1,154 1,163 Data processing expenses 773 741 Marketing and advertising 176 231 Professional fees 514 422 Other general and administrative expenses 1,178 1,324 ------- ------- Total operating expenses 8,616 8,349 ------- ------- (continued) See accompanying notes to consolidated financial statements. F-3 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Concluded) (Dollars in thousands, except share data) Years Ended September 30, ------------------------- 2006 2005 ------- ------- Income (loss) before provision (benefit) for income taxes (165) 1,279 Provision (benefit) for income taxes (123) 381 ------- ------- Net (loss) income $ (42) $ 898 ======= ======= Earnings (loss) per share: Basic $ (0.03) $ 0.58 Diluted $ (0.03) $ 0.57 See accompanying notes to consolidated financial statements.
F-4
WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) Years Ended September 30, 2006 and 2005 (Dollars in thousands, except share data) Accumulated Common Stock Additional Other Unearned Unearned Total ---------------- Paid-in Retained Comprehensive Compensation- Compensation- Stockholders' Shares Amount Capital Earnings Income (Loss) RRP ESOP Equity ------ ------ ---------- -------- ------------- ------------- ------------- ------------- Balance at September 30, 2004 1,589,574 $16 $4,843 $24,198 $ 159 $(209) $(302) $28,705 ------- Comprehensive income: Net income - - - 898 - - - 898 Change in net unrealized gain/ loss on securities available for sale, after reclassification adjustment and tax effects - - - - (873) - - (873) ------- Total comprehensive income 25 ------- Cash dividends declared ($0.24 per share) - - (382) - - - (382) ESOP shares released and committed to be released (2,947 shares) - - 54 - - - 29 83 Amortization of RRP stock (3,350 shares) 79 79 Issuance of common stock under stock option plan, including tax benefits of $30 5,200 - 93 - - - - 93 --------- --- ------ ------- ----- ----- ----- ------- Balance at September 30, 2005 1,594,774 16 4,990 24,714 (714) (130) (273) 28,603 ------- Comprehensive income: Net income (loss) - - - (42) - - - (42) Change in net unrealized gain/ loss on securities available for sale, after reclassification adjustment and tax effects - - - - 55 - - 55 ------- Total comprehensive income 13 ------- Cash dividends declared ($0.24 per share) - - - (383) - - - (383) ESOP shares released and committed to be released (2,947 shares) - - 49 - - - 30 79 Amortization of RRP stock (2,780 shares) 47 - 47 Tax benefit of RRP stock - - 8 - - - - 8 Issuance of common stock under stock option plan, including tax benefits of $5 1,000 - 16 - - - - 16 --------- --- ------ ------- ----- ----- ----- ------- Balance at September 30, 2006 1,595,774 $16 $5,063 $24,289 $(659) $ (83) $(243) $28,383 ========= === ====== ======= ===== ===== ===== ======= See accompanying notes to consolidated financial statements.
F-5
WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) Years Ended September 30, ------------------------- 2006 2005 -------- -------- Cash flows from operating activities: Net income (loss) $ (42) $ 898 Adjustments to reconcile net income to net cash provided by operating activities: (Credit) provision for loan losses - (173) Net amortization of securities 268 399 Amortization of net deferred loan costs and premiums on purchased loans and indirect lending 166 161 Depreciation expense 487 482 Gain on sales of mortgages, net (5) (165) Gain on sales and calls of securities, net (3) (59) Increase in accrued interest receivable (187) (131) Deferred income tax provision (benefit) (162) 68 ESOP shares released and committed to be released 79 83 Amortization of RRP stock 47 79 Increase in bank-owned life insurance (190) (140) Other, net 506 361 -------- -------- Net cash provided by operating activities 964 1,863 -------- -------- Cash flows from investing activities: Activity in available-for-sale securities: Sales and calls 833 4,318 Maturities 12,600 3,700 Purchases (17,702) (6,284) Principal payments 5,586 5,634 Purchase of Federal Home Loan Bank stock (410) (924) Loan originations, net (11,730) (43,226) Proceeds from loan sales 2,302 8,214 Purchase of premises and equipment, net (953) (139) Premiums paid on bank-owned life insurance (247) (232) -------- -------- Net cash used by investing activities (9,721) (28,939) -------- -------- (continued) See accompanying notes to consolidated financial statements. F-6 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded) (Dollars in thousands) Years Ended September 30, ------------------------- 2006 2005 -------- -------- Cash flows from financing activities: Net increase (decrease) in deposits 996 (1,429) Net (decrease) increase in short-term borrowings (4,000) 500 Proceeds from Federal Home Loan Bank advances 13,500 33,000 Repayment of Federal Home Loan Bank advances (2,000) (5,000) Net (decrease) increase in mortgagors' escrow accounts (29) 97 Issuance of common stock under stock option plan, net of tax benefits 16 93 Dividends paid (383) (382) -------- -------- Net cash provided by financing activities 8,100 26,879 -------- -------- Net change in cash and cash equivalents (657) (197) Cash and cash equivalents at beginning of year 8,974 9,171 -------- -------- Cash and cash equivalents at end of year $ 8,317 $ 8,974 ======== ======== Supplemental cash flow information: Interest paid on deposits $ 4,623 $ 2,978 Interest paid on Federal Home Loan Bank advances 2,157 1,110 Income taxes paid (refunded), net (2) 329 See accompanying notes to consolidated financial statements.
F-7 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended September 30, 2006 and 2005 (Dollars in thousands, except per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of consolidation and presentation The consolidated financial statements include the accounts of Westborough Financial Services, Inc. (the "Company") and its wholly-owned subsidiary, The Westborough Bank (the "Bank"). The Bank's wholly-owned subsidiaries are The Hundredth Corporation, which was formed to own real estate, and the Eli Whitney Security Corporation, which is a Massachusetts security corporation. All significant intercompany balances and transactions have been eliminated in consolidation. Use of estimates In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The determination of the allowance for losses on loans is a material estimate that is particularly susceptible to significant change in the near term. Business and operating segments The Bank provides a variety of financial services to individuals and small businesses through its offices in Westborough, Northborough and Shrewsbury, Massachusetts. Its primary deposit products are checking, savings and term certificate accounts and its primary lending product is residential mortgage loans. Management evaluates the Company's performance and allocates resources based on a single segment concept. Accordingly, there are no separately identified operating segments. The Company does not derive revenues from, or have assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Company's total revenues. Reclassifications Certain amounts in the 2005 consolidated financial statements have been reclassified to conform to the 2006 presentation. F-8 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Cash equivalents Cash equivalents include amounts due from banks, federal funds sold on a daily basis and short-term investments which mature within ninety days. Securities available for sale Securities classified as "available for sale" are reflected on the consolidated balance sheet at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of securities that are deemed to be other than temporary are reflected in earnings as realized losses. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on disposition of securities are recorded on the trade date and computed by the specific identification method. Loans The Bank grants mortgage, commercial and consumer loans to its customers. A substantial portion of the loan portfolio consists of mortgage loans in Westborough and the surrounding communities. The ability of the Bank's debtors to honor their contracts is dependent upon the local economy and the local real estate market. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses and net deferred costs on originated loans. Interest income is accrued on the unpaid principal balance. Net loan origination costs are deferred and recognized as an adjustment of the related loan yield using the interest method. The accrual of interest on mortgage and commercial loans is discontinued when in the judgment of management the collection of principal or interest is doubtful. F-9 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Loans (concluded) All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are generally maintained on a non-accrual basis. Impairment is measured on a loan by loan basis by the fair value of the collateral. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer loans for impairment disclosures. Allowance for loan losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. 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, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, 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. The allowance consists of allocated, general and unallocated components. The allocated component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio. F-10 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Servicing Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on a valuation model that calculates the present value of estimated future net servicing income. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum. Premises and equipment Land is carried at cost. Buildings, leasehold improvements and equipment are stated at cost, less accumulated depreciation and amortization, computed on the straight-line method over the estimated useful lives of the assets. Retirement plan The compensation cost of an employee's pension benefit is recognized on the projected unit credit method over the employee's approximate service period. The aggregate cost method is utilized for funding purposes. F-11 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Stock compensation plans Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. The Company has elected to continue with the accounting methodology in Opinion No. 25. Stock options issued under the Company's stock option plan have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them. (Also see recent accounting pronouncement.) The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation. Years Ended September 30, ------------------------- 2006 2005 ------ ----- Net income (loss) As reported $ (42) $ 898 Pro forma $ (48) $ 872 Basic earnings (loss) per share As reported $(0.03) $0.58 Pro forma $(0.03) $0.56 Diluted earnings (loss) per share As reported $(0.03) $0.57 Pro forma $(0.03) $0.55 F-12 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Employee stock ownership plan ("ESOP") Compensation expense is recognized as ESOP shares are committed to be released. Allocated and committed to be released ESOP shares are considered outstanding for earnings per share calculations based on debt service payments. Other ESOP shares are excluded from earnings per share calculations. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders' equity. Advertising costs All advertising costs are expensed as incurred. Income taxes Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes. The Bank's base amount of its federal income tax reserve for loan losses that arose before 1987 is a permanent difference for which there is no recognition of a deferred tax liability. However, the allowance for loan losses maintained for financial reporting purposes is treated as a temporary difference with allowable recognition of a related deferred tax asset, if it is deemed realizable. Earnings per common share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. For the year ended September 30, 2006, 30,290 outstanding stock option shares were anti-dilutive as the Company had recorded a net loss for the year. For the year ended September 30, 2005, there were no anti-dilutive potential common shares. Anti-dilutive potential common shares are excluded from dilutive earnings per share calculations. F-13 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Earnings per common share (concluded) Earnings per common share for the year ended September 30, 2006 and 2005 has been computed based on the following:
2006 2005 --------- --------- Average number of common shares outstanding 1,562,323 1,553,046 Effect of dilutive options - 18,158 --------- --------- Average number of common shares outstanding used to calculate diluted earnings per common share 1,562,323 1,571,204 ========= =========
Comprehensive income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale are reported in accumulated comprehensive income (loss) in the consolidated balance sheet, such items, along with net income, are components of comprehensive income. The components of the change in accumulated other comprehensive income (loss) and related tax effects are as follows: Years Ended September 30, ------------------------- 2006 2005 ---- ------- Change in net unrealized holding gains (losses) on securities available for sale $87 $(1,252) Reclassification adjustment for gains realized in income (3) (59) ---- ------- 84 (1,311) Tax effect (29) 438 ---- ------- Net-of-tax amount $55 $ (873) ==== ======= F-14 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Recent accounting pronouncements Share-based payments On December 16, 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123R, "Share-Based Payment," which is an Amendment of FASB Statement Nos. 123 and 95. SFAS No. 123R changes, among other things, the manner in which share-based compensation, such as stock options, will be accounted for by public companies. SFAS 123R will be effective for public companies that file as small business issuers as of the beginning of the annual reporting period that begins after December 15, 2005. For public companies, the cost of employee services received in exchange for equity instruments including options and similar awards generally will be measured at fair value at the grant date. The grant date fair value will be estimated using option-pricing models adjusted for the unique characteristics of those options and instruments, unless observable market prices for the same or similar options are available. The cost will be recognized over the requisite service period, often the vesting period. The change in accounting will replace existing requirements under SFAS No. 123, "Accounting for Stock-Based Compensation," and will eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees," which does not require companies to expense options if the exercise price is equal to the trading price at the date of grant. This Statement is not expected to have a material impact on the Company's consolidated financial statements. Servicing of financial assets In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets," which amends FASB Statement No. 140. This Statement requires that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this Statement permits an entity to choose either of the following subsequent measurement methods: (1) amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss, or (2) report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur. This Statement also requires additional disclosures for all separately recognized servicing rights, and is effective for new transactions occurring and for subsequent measurement at the beginning of an entity's first fiscal year that begins after September 15, 2006. This Statement is not expected to have a material impact on the Company's consolidated financial statements. F-15 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Recent accounting pronouncements (continued) Income taxes In July 2006, the FASB issued Financial Accounting Standards Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes." FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises' financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. This Interpretation is not expected to have a material impact on the Company's consolidated financial statements. Endorsement Split-Dollar Life Insurance Arrangements The Company has entered into agreements with its Trustees and certain executives whereby the Company will pay a death benefit at the lesser of (1) an amount based on salary at the date of death, or (2) the amount the Company receives as beneficiary of certain life insurance policies on the individual minus the policies' cash surrender values. The Company is the sole owner of the life insurance policies and may cancel the insurance in its sole discretion, which would result in termination of any future death benefit, or terminate the agreement to provide death benefits at any time. No liability has been recognized on the consolidated balance sheet for such death benefits. In September 2006, the Emerging Issues Task Force reached a consensus on Issue No. 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements." As a result, effective for fiscal years beginning after December 15, 2007, the Company will be required to recognize a liability for future death benefits, and may choose to retroactively apply the accounting change to all periods presented, or to cumulatively adjust the financial statements as of the beginning of the year of adoption. Management is in the process of evaluating the impact of Issue No. 06-4 on the Company's consolidated financial statements. F-16 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded) Recent accounting pronouncements (concluded) Fair Value Measurement In September 2006, FASB issued Financial Standards No. 157, "Fair Value Measurement," which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands the disclosures about fair value measurement. This Statement was developed to provide guidance for consistency and comparability in fair value measurements and disclosures and applies under other accounting pronouncements that require or permit fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently evaluating the impact this statement may have on the Company's consolidated financial statements. Defined Benefit Pension and Other Postretirement Plans In September 2006, the Financial Accounting Standards Board issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans". This Statement will require employers, such as the Company, to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. Specifically, the new standard requires an employer to (a) recognize on its balance sheet an asset for a plan's over-funded status or a liability for a plan's under-funded status, (b) measure a plan's assets and its obligations that determine its funded status as of the end of the employer's fiscal year, and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective for the Company at the end of its fiscal year ending September 30, 2007. The requirement to measure plan assets and benefit obligations as of the date of the employer's fiscal year-end balance sheet is effective for the Company's fiscal year ending September 30, 2009. Management is in the process of evaluating the impact of this Statement on the Company's consolidated financial statements. 2. RESTRICTIONS ON CASH AND DUE FROM BANKS The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At September 30, 2006 and 2005, these reserve balances amounted to $825 and $1,015, respectively. F-17 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 3. SECURITIES AVAILABLE FOR SALE The amortized cost and estimated fair value of securities available for sale, at September 30, 2006 and 2005, with gross unrealized gains and losses, is as follows:
September 30, 2006 --------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ----- Government-sponsored enterprise obligations $31,323 $ 5 $ (290) $31,038 Banking and finance obligations 6,119 21 (25) 6,115 Mortgage-backed securities 24,741 40 (753) 24,028 Other bonds and obligations 1,261 9 (9) 1,261 ------- ---- ------- ------- Total debt securities 63,444 75 (1,077) 62,442 Marketable equity securities 1 - (1) - ------- ---- ------- ------- $63,445 $ 75 $(1,078) $62,442 ======= ==== ======= ======= September 30, 2005 --------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ----- Government-sponsored enterprise obligations $27,917 $ 3 $ (446) $27,474 Banking and finance obligations 7,801 26 (101) 7,726 Mortgage-backed securities 25,597 71 (649) 25,019 Other bonds and obligations 3,711 27 (17) 3,721 ------- ---- ------- ------- Total debt securities 65,026 127 (1,213) 63,940 Marketable equity securities 1 - (1) - ------- ---- ------- ------- $65,027 $127 $(1,214) $63,940 ======= ==== ======= =======
F-18 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SECURITIES AVAILABLE FOR SALE (continued) Proceeds from sales and calls of securities amounted to $833 and $4,318 for the years ended September 30, 2006 and 2005, respectively. Gross realized gains amounted to $3 and $99, respectively. Gross realized losses amounted to $40 for the year ended September 30, 2005. There were no gross realized losses for the year ended September 30, 2006. The amortized cost and estimated fair value of debt securities by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
September 30, 2006 September 30, 2005 --------------------- ---------------------- Amortized Fair Amortized Fair Cost Value Cost Value --------- ------- --------- ------- Within 1 year $17,205 $17,074 $13,427 $13,375 Over 1 year through 5 years 21,498 21,340 26,002 25,546 ------- ------- ------- ------- 38,703 38,414 39,429 38,921 Mortgage and asset-backed securities 24,741 24,028 25,597 25,019 ------- ------- ------- ------- $63,444 $62,442 $65,026 $63,940 ======= ======= ======= =======
At September 30, 2006 and 2005, a government-sponsored enterprise obligation with a carrying value of $1,000 and $1,003, respectively, and fair value of $982 and $1,005, respectively, was pledged to secure treasury, tax and loan deposits. F-19 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) SECURITIES AVAILABLE FOR SALE (concluded) Information pertaining to securities with gross unrealized losses at September 30, 2006 and 2005, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
Less Than Twelve Months Over Twelve Months ----------------------- ---------------------- Gross Gross Unrealized Fair Unrealized Fair Losses Value Losses Value ---------- ------- ---------- ------- September 30, 2006: Government-sponsored enterprise obligations $ 5 $ 2,995 $ 285 $25,042 Banking and finance obligations - - 25 4,334 Mortgage-backed securities 1 115 752 18,372 Other bonds and obligations - - 9 751 ---- ------- ------ ------- Total debt securities 6 3,110 1,071 48,499 Marketable equity securities - - 1 - ---- ------- ------ ------- Total temporarily impaired securities $ 6 $ 3,110 $1,072 $48,499 ==== ======= ====== ======= September 30, 2005: Government-sponsored enterprise obligations $109 $ 8,310 $ 337 $16,653 Banking and finance obligations - - 101 5,200 Mortgage-backed securities 47 3,823 602 18,595 Other bonds and obligations - 500 17 762 ---- ------- ------ ------- Total debt securities 156 12,633 1,057 41,210 Marketable equity securities - - 1 - ---- ------- ------ ------- Total temporarily impaired securities $156 $12,633 $1,058 $41,210 ==== ======= ====== =======
At September 30, 2006, 76 debt securities have unrealized losses with aggregate depreciation of 2.05% from the Company's amortized cost basis. These unrealized losses relate principally to the interest rate environment. In analyzing an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts' reports. As management has the ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary. F-20 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 4. LOANS A summary of the balances of loans follows:
September 30, --------------------- 2006 2005 -------- -------- Mortgage loans: Fixed rate $ 54,169 $ 57,953 Variable rate 100,282 100,365 Commercial 32,853 26,979 Home equity lines-of-credit 19,530 15,452 -------- -------- Total mortgage loans 206,834 200,749 -------- -------- Other loans: Personal loans 265 198 Deposit secured loans 212 312 Home improvement loans 40 6 Commercial lines-of-credit 1,749 870 Commercial installment 3,842 2,534 -------- -------- Total other loans 6,108 3,920 -------- -------- Total loans 212,942 204,669 Due to borrowers on incomplete loans (3,360) (4,287) Net deferred loan costs 721 620 Net premiums on purchased loans and indirect lending 221 260 Allowance for loan losses (780) (785) -------- -------- Loans, net $209,744 $200,477 ======== ========
An analysis of the allowance for loan losses follows:
Years Ended September 30, ------------------------- 2006 2005 -------- -------- Balance at beginning of year $ 785 $ 950 (Credit) provision for loan losses - (173) Charge-offs (5) - Recoveries - 8 -------- -------- Balance at end of year $ 780 $ 785 ======== ========
F-21 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) LOANS (concluded) The following is a summary of information pertaining to impaired and non-accrual loans: September 30, ------------- 2006 2005 ---- ---- Impaired loans without a valuation allowance $ 10 $175 Impaired loans with a valuation allowance 411 - ---- ---- Total impaired loans $421 $175 ==== ==== Valuation allowance related to impaired loans $147 $ - ==== ==== Total non-accrual loans $416 $175 ==== ==== At September 30, 2006 and 2005, there were no loans past-due ninety days or more and still accruing. Years Ended September 30, ------------------------- 2006 2005 ---- ---- Average investment in impaired loans $453 $191 ==== ==== Interest income recognized on a cash basis on impaired loans $ 54 $ 32 ==== ==== No additional funds are committed to be advanced in connection with impaired loans. 5. SERVICING The Bank has sold mortgage loans, without recourse, in the secondary mortgage market and has retained the servicing responsibility and receives fees for the services provided. Total loans serviced for others at September 30, 2006 and 2005 amounted to $11,537 and $14,673, respectively. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. At September 30, 2006 and 2005, $99 and $113, respectively, of capitalized servicing rights are included in other assets. During the years ended September 30, 2006 and 2005, $26 and $114, respectively, of servicing rights were capitalized and $40 and $30, respectively, of servicing rights were amortized. The carrying value of servicing rights approximates fair value. F-22 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 6. PREMISES AND EQUIPMENT A summary of the cost and accumulated depreciation of premises and equipment and their estimated useful lives follows: September 30, ------------------- Estimated 2006 2005 Useful Lives ------- ------- ------------ Premises: Land $ 1,200 $ 1,200 Buildings 5,720 5,159 5 - 40 years Equipment 4,503 4,196 3-7 years ------- ------- 11,423 10,555 Less accumulated depreciation (4,863) (4,461) ------- ------- $ 6,560 $ 6,094 ======= ======= Depreciation expense for the years ended September 30, 2006 and 2005 amounted to $487 and $482, respectively. 7. DEPOSITS A summary of deposit balances, by type, is as follows: September 30, --------------------- 2006 2005 -------- -------- Non-interest bearing accounts $ 21,962 $ 22,245 NOW accounts 15,547 17,800 Regular and other savings accounts 64,797 101,826 Money market deposit accounts 32,207 5,161 -------- -------- Total non-certificate accounts 134,513 147,032 -------- -------- Term certificates of $100,000 and over 24,110 18,598 Term certificates less than $100,000 52,654 44,651 -------- -------- Total certificate accounts 76,764 63,249 -------- -------- Total deposits $211,277 $210,281 ======== ======== F-23 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) DEPOSITS (concluded) A summary of certificates, by maturity, is as follows: September 30, 2006 September 30, 2005 -------------------- ------------------ Weighted Weighted Average Average Amount Rate Amount Rate ------ -------- ------ -------- Within 1 year $59,798 4.28% $44,371 2.97% Over 1 year through 3 years 14,380 4.21 17,831 3.46 Over 3 years 2,586 5.18 1,047 4.05 ------- ------- $76,764 4.30% $63,249 3.13% ======= ======= 8. SHORT-TERM BORROWINGS There were no short-term borrowings at September 30, 2006. At September 30, 2005, short-term borrowings consist of advances from the Federal Home Loan Bank of Boston ("FHLB") with original maturities of less than ninety days at a weighted average interest rate of 4.21%. The Bank also has a $2,999 available line of credit with the FHLB at an interest rate that adjusts daily. Borrowings under the line are limited to 2% of the Bank's total assets. All borrowings from the FHLB are secured by a blanket lien on qualified collateral, defined principally as 75% of the carrying value of first mortgage loans on owner-occupied residential property. As of September 30, 2006 and 2005, there were no advances outstanding on the line of credit. F-24 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 9. LONG-TERM BORROWINGS Long-term borrowings consist of Federal Home Loan Bank advances as follows: Weighted Average Rate Maturing During September 30, September 30, the Year Ending ------------------- --------------------- September 30, 2006 2005 2006 2005 --------------- ------- ------- ---- ---- 2006 $ - $ 2,500 -% 2.91% 2007 8,000 8,000 3.06 3.06 2008 7,000 7,000 3.91 3.91 2009* 15,500 7,000 4.56 3.81 2010 18,500 15,000 4.63 4.56 2011 8,500 6,500 4.81 4.62 ------- ------- $57,500 $46,000 4.33% 4.02% ======= ======= * Includes a $3,000,000 advance callable on October 2, 2006. 10. INCOME TAXES Allocation of federal and state income taxes between current and deferred portions is as follows:
Years Ended September 30, ------------------------- 2006 2005 ---- ---- Current income tax provision: Federal $ 16 $291 State 23 22 ----- ---- 39 313 ----- ---- Deferred income tax provision (benefit): Federal (121) 51 State (41) 17 ----- ---- (162) 68 ----- ---- Total provision (benefit) for income taxes $(123) $381 ===== ====
F-25 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) INCOME TAXES (continued) The following is a reconciliation of the effective income tax rates and amounts in the consolidated statements of operations with the statutory federal income tax rates and amounts as follows:
Years Ended September 30, --------------------------------------- 2006 2005 ------------------ ---------------- Amount Rate Amount Rate ------ ---- ------ ---- Statutory rate $ (56) (34.0)% $435 34.0% Increase (decrease) resulting from: State taxes, net of federal tax benefit (12) (7.3) 26 2.0 Dividends received deduction (4) (2.4) (7) (0.5) Officers' life insurance (55) (33.3) (57) (4.4) Municipal income (11) (6.7) (19) (1.5) Other 15 9.2 3 0.2 ----- ----- ---- ---- Effective tax rates $(123) (74.5)% $381 29.8% ===== ===== ==== ====
The components of the net deferred tax asset are as follows: September 30, ----------------- 2006 2005 ------ ------ Deferred tax asset: Federal $1,361 $1,239 State 357 307 ------ ------ 1,718 1,546 ------ ------ Deferred tax liability: Federal (363) (334) State (87) (77) ------ ------ (450) (411) ------ ------ Net deferred tax asset $1,268 $1,135 ====== ====== F-26 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) INCOME TAXES (concluded) The tax effects of each item that give rise to deferred taxes are as follows:
September 30, ------------------ 2006 2005 ------ ------ Employee benefit plans $ 879 $ 697 Allowance for loan losses 392 397 Net unrealized gain/loss on securities available for sale 344 373 Depreciation and amortization (42) (54) Net deferred loan costs (295) (253) Other, net (10) (25) ------ ------ Net deferred tax asset $1,268 $1,135 ====== ======
A summary of the change in the net deferred tax asset is as follows:
Years Ended September 30, ------------------------- 2006 2005 ------ ------ Balance at beginning of year $1,135 $ 765 Deferred tax (provision) benefit 162 (68) Deferred tax effect on net unrealized (gain)/loss on securities available for sale (29) 438 ------ ------ Balance at end of year $1,268 $1,135 ====== ======
The federal income tax reserve for loan losses at the Bank's base year amounted to $2,423. If any portion of the reserve is used for purposes other than to absorb loan losses, approximately 150% of the amount actually used (limited to the amount of the reserve) would be subject to taxation in the fiscal year in which used. As the Bank intends to use the reserve to only absorb loan losses, a deferred income tax liability of $994 has not been provided. F-27 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 11. STOCKHOLDERS' EQUITY Minimum regulatory capital requirements 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 consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and 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. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2006 and 2005, that the Company and the Bank meet all capital adequacy requirements to which they are subject. The most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank's category. F-28 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) STOCKHOLDERS' EQUITY (continued) Minimum regulatory capital requirements (concluded) The Company's and the Bank's actual and minimum required capital amounts and ratios as of September 30, 2006 and 2005 are as follows:
Minimum To Be Well Minimum Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------ ----------------- ----------------- Amount Ratio Amount Ratio Amount Ratio ------- ------ ------- ----- ------- ----- September 30, 2006: Total capital (to risk weighted assets) Consolidated $29,014 17.92% $12,952 8.00% N/A N/A Bank 28,627 17.78 12,878 8.00 $16,097 10.00% Tier 1 capital (to risk weighted assets) Consolidated 28,228 17.44 6,476 4.00 N/A N/A Bank 27,841 17.30 6,439 4.00 9,658 6.00 Tier 1 capital (to average assets) Consolidated 28,228 9.46 11,937 4.00 N/A N/A Bank 27,841 9.38 11,869 4.00 14,836 5.00 September 30, 2005: Total capital (to risk weighted assets) Consolidated $29,988 19.51% $12,295 8.00% N/A N/A Bank 29,518 19.22 12,286 8.00 $15,357 10.00% Tier 1 capital (to risk weighted assets) Consolidated 29,203 19.00 6,147 4.00 N/A N/A Bank 28,733 18.71 6,143 4.00 9,214 6.00 Tier 1 capital (to average assets) Consolidated 29,203 10.18 11,480 4.00 N/A N/A Bank 28,733 10.09 11,387 4.00 14,234 5.00
F-29 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) STOCKHOLDERS' EQUITY (concluded) Restrictions on dividends, loans and advances Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank, and loans or advances are limited to 10% of the Bank's capital stock and surplus, as defined, (which for this purpose represents total capital as calculated under the risk-based capital guidelines) on a secured basis. At September 30, 2006 and 2005, the Bank's retained earnings available for the payment of dividends was $15,749 and $17,232, respectively. Accordingly, $12,878 and $12,286 of the Company's equity in the net assets of the Bank was restricted at September 30, 2006 and 2005, respectively. Funds available for loans or advances by the Bank to the Company amounted to $1,575 and $1,723 at September 30, 2006 and 2005, respectively. The Company and the Bank may not declare or pay dividends on, and the Company may not purchase any of its shares of, its common stock if the effect thereof would cause stockholders' equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration, payment or repurchase would otherwise violate regulatory requirements. F-30 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 12. EMPLOYEE BENEFIT PLANS Pension plan The Bank provides pension benefits for eligible employees through a defined benefit pension plan which is administered through the Savings Bank Employees Retirement Association ("SBERA"). Substantially all employees participate in the retirement plan on a non-contributing basis, and are fully vested after three years of service. Information pertaining to the activity in the plan is as follows:
Plan Years Ended October 31, ---------------------------- 2006 2005 ------- ------ (Projected) Change in plan assets: Fair value of plan assets at beginning of year $2,653 $2,693 Actual gain on plan assets 342 202 Employer contribution 218 187 Benefits paid (311) (429) ------ ------ Fair value of plan assets at end of year 2,902 2,653 ------ ------ Change in benefit obligation: Benefit obligation at beginning of year 3,000 3,253 Service cost 217 201 Interest cost 173 187 Actuarial gain (51) (212) Benefits paid (311) (429) ------ ------ Benefit obligation at end of year 3,028 3,000 ------ ------ Funded status (126) (347) Unrecognized net actuarial gain (350) (181) Transition liability 14 18 ------ ------ Accrued pension cost $ (462) $ (510) ====== ====== Accumulated benefit obligation $2,156 $2,070 ====== ======
At October 31, 2006 and 2005, the assumptions used to determine the benefit obligation are as follows: 2006 2005 ---- ---- Discount rate 5.75% 5.75% Rate of compensation increase 4.50% 4.50% F-31 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Pension plan (continued) The components of net periodic pension cost are as follows: Plan Years Ended October 31, ---------------------------- 2006 2005 ---- ---- (Projected) Service cost $ 217 $ 201 Interest cost 173 187 Expected return on plan assets (214) (215) Transition obligation 4 2 Recognized net actuarial loss (gain) (11) 1 ----- ----- $ 169 $ 176 ===== ===== Total pension expense for the years ended September 30, 2006 and 2005 amounted to $185 and $184, respectively. For the plan years ended October 31, 2006 and 2005, actuarial assumptions used in accounting were as follows: 2006 2005 ---- ---- (Projected) Discount rate on benefit obligations 5.75% 5.75% Expected long-term rate of return on plan assets 8.00 8.00 Annual salary increases 4.50 4.50 In general, the Bank has selected their assumption with respect to the long term rate of return based on prevailing yields on high quality fixed income investments increased by a premium for equity return expectations. F-32 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Pension plan (concluded) The Bank's pension plan weighted average asset allocation at September 30, 2006 and 2005, are as follows: Percentage of Plan Assets at September 30, ---------------- Asset Category 2006 2005 -------------- ---- ---- Fixed income 36.5% 34.2% Equity securities 63.5 65.8 ----- ----- 100.0% 100.0% ===== ===== SBERA offers a common and collective trust as the underlying investment structure for pension plans. The target allocation mix for the common and collective trust portfolio calls for an equity-based investment range from 55% to 75% of total portfolio assets. The Trustees of SBERA, through the Investment Committee, select investment managers for the common and collective trust portfolio. A professional investment advisory firm is retained by the Investment Committee to provide allocation analysis, performance measurement and to assist with manager searches. The overall investment objective is to diversify equity investments across a spectrum of investment types (e.g., small cap, large cap, international, etc) and styles (e.g., growth, value, etc.). The Bank expects to contribute $246 to its pension plan in fiscal 2007. Estimated future benefit payments, which reflects expected future service, as appropriate, are as follows: Years Ending October 31, Amount ------------ ------ 2007 $ 153 2008 23 2009 86 2010 86 2011 1,119 2012-2016 1,168 F-33 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Incentive compensation plan Management and employees of the Bank participate in an annual incentive compensation plan which is based on a percentage of the Bank's annual net profits (as defined) and other factors and objectives set forth and administered by the Bank's Executive Committee. Incentive compensation expense for the years ended September 30, 2006 and 2005 amounted to $38 and $50, respectively. 401(k) Plan The Bank has a 401(k) Plan whereby each employee reaching the age of 21 and having completed at least three months of service, beginning with date of employment, automatically becomes a participant in the Plan. Employees may contribute up to 75% of their compensation subject to certain limits based on federal tax laws. The Bank matches 50% of the first 6% of an employee's compensation contributed to the Plan. All participants are fully vested. For the years ended September 30, 2006 and 2005, expense attributable to the Plan amounted to $59 and $53, respectively. Supplemental retirement plans The Bank provides supplemental retirement benefits to certain executive officers and Directors. In connection with the supplemental retirement plans, the Bank has purchased life insurance contracts as a funding source. At September 30, 2006 and 2005, the Bank has accrued $973 and $854, respectively, relating to these plans. For the years ended September 30, 2006 and 2005, expenses attributable to the plans amounted to $271 and $114, respectively. Prior to fiscal 2005, the supplemental retirement liability for certain executive officers was based on the present value of the future payments and was accrued over the executive's employment. During 2005, a plan of deferred compensation ("Plan") was adopted which covers the executive officers. The previous agreements were terminated and new agreements were entered into under the Plan. The Plan is accounted for under SFAS No. 87 "Employers Accounting for Pensions". F-34 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Supplemental retirement benefits (continued) The funded status of the Plan is as follows: Plan Years Ended September 30, -------------------- 2006 2005 ------- ------- Fair value of plan assets $ - $ - Benefit obligation 1,310 1,359 ------- ------- Funded status $(1,310) $(1,359) ======= ======= Accumulated benefit obligation $ 1,206 $ 1,065 ======= ======= Accrued supplemental pension cost $ 619 $ 350 Additional minimum liability 587 715 ------- ------- Accrued supplemental pension liability $ 1,206 $ 1,065 ======= ======= Intangible asset $ 587 $ 715 ======= ======= The following assumptions were used to determine the benefit obligation and the net periodic pension cost at or for the years ended September 30, 2006 and 2005: 2006 2005 ---- ---- Discount rate 5.50% 6.50% Rate of compensation increase 5.00% 5.00% The Company expects to contribute $537 to the Plan in fiscal 2007. F-35 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Supplemental retirement benefits (concluded) Estimated future benefit payments, which reflect expected future services, as appropriate, are as follows: Year Ending September 30, Amount ------------- -------------- (In thousands) 2007 $ 537 2011 1,013 Expenses related to the Plan amounted to $269,000 and $222,000, respectively, for the years ended September 30, 2006 and 2005. The Company purchased bank-owned life insurance ("BOLI") on the lives of certain officers and has entered into agreements with certain executives to provide their beneficiaries certain benefits upon death from the proceeds of the BOLI. The BOLI is carried at cash surrender value on the balance sheet, which is less than the face value of the policy less benefits to be paid to beneficiaries. Deferred compensation plan The Company has adopted an Officers' Deferred Compensation Plan whereby qualified officers may elect to defer all or a portion of their salary. The Company pays monthly interest on amounts deferred at an interest rate that is determined annually. Employees' stock ownership plan The Company established an ESOP for the benefit of each eligible employee that has reached the age of 21 and has completed at least 1,000 hours of service in the previous twelve-month period. In addition, the Company provided a loan to the ESOP which was used to purchase 8%, or 44,200 shares, of the shares sold to the public in the Company's stock offering. The loan bears interest equal to 8% and provides for annual payments of principal and interest for 15 years. F-36 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Employees' stock ownership plan (concluded) At September 30, 2006, the remaining principal balance is payable as follows: Years Ending September 30, Amount ------------- -------- 2007 $ 25,593 2008 27,640 2009 29,852 2010 32,240 2011 34,819 Thereafter 169,450 -------- $319,594 ======== The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased by the ESOP which are held in a suspense account for allocation among the members as the loans are paid. Total compensation expense applicable to the ESOP amounted to $79 and $83 for the years ended September 30, 2006 and 2005, respectively. Shares held by the ESOP include the following: September 30, ----------------- 2006 2005 ------ ------ Allocated 17,682 14,735 Committed to be released 2,210 2,210 Unallocated 24,308 27,255 ------ ------ 44,200 44,200 ====== ====== Cash dividends received on allocated shares are allocated to members and cash dividends received on shares held in suspense are applied to repay the outstanding debt of the ESOP. The fair market value of unallocated shares at September 30, 2006 and 2005 was $662 and $763, respectively. F-37 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (continued) Stock option plan A summary of the status of the Company's stock option plan for the years ended September 30, 2006 and 2005 is presented below:
2006 2005 -------------------- -------------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price ------ -------- ------ -------- Fixed Options: Outstanding at beginning of year 28,500 $11.27 33,900 $11.38 Granted 2,790 25.50 - Forfeited - (200) 10.31 Exercised (1,000) 10.31 (5,200) 12.05 ------ ------ Outstanding at end of year 30,290 $12.61 28,500 $11.27 ====== ====== Options exercisable at year-end 26,100 $10.66 19,880 $10.31 Weighted-average fair value of options granted during the year $ 9.45 -
The fair value of each option grant when applicable is estimated on the date of grant using the Black-Scholes option-pricing model. The assumptions used for grants during the year ended September 30, 2006 were a dividend yield of .94%, expected life of 10 years, expected volatility of 20.94% and a risk-free interest rate of 4.92%. F-38 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) EMPLOYEE BENEFIT PLANS (concluded) Stock option plan (concluded) Information pertaining to stock options outstanding at September 30, 2006 is as follows:
Options Outstanding Options Exercisable ---------------------------------------- -------------------------- Weighted Average Weighted Weighted Remaining Average Average Number Contractual Exercise Number Exercise Exercise Price Outstanding Life Price Exercisable Price -------------------------- ----------- ----------- -------- ----------- -------- $10.31 25,400 4.0 years $10.31 25,400 $10.31 23.25 2,100 5.0 23.25 700 23.25 25.50 2,790 9.6 25.50 - ------ ------ Outstanding at end of year 30,290 4.6 years 26,100 ====== ======
Recognition and retention plan On January 25, 2001, the Company's stockholders approved the Company's adoption of the Westborough Financial Services, Inc. 2001 Recognition and Retention Plan (the "RRP"), which allows the Company to grant restricted stock awards ("Awards") to certain officers, employees and outside directors. The RRP is authorized to acquire no more than 22,139 shares of Common stock in the open market. Shares generally vest at a rate of 20% per year with the first vesting period ending April 30, 2002. There were no Awards granted during the years ended September 30, 2006 and 2005. The aggregate purchase price of all shares acquired by the RRP has been reflected as a reduction of stockholders' equity and amortized to compensation expense as the Company's employees and directors become vested in their stock awards. Compensation expense relating to the RRP amounted to $47 and $79 for the years ended September 30, 2006 and 2005, respectively. Compensation expense is based on the fair value of common stock on the purchase date. F-39 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 13. COMMITMENTS AND CONTINGENCIES In the normal course of business, there are outstanding commitments and contingencies which are not reflected in the accompanying consolidated balance sheets. Loan commitments The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, which involve elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheets. The contract amount of these instruments reflects the extent of involvement the Bank has in these particular classes of financial instruments. The Bank's exposure to credit loss is represented by the contractual amount of the instruments. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments. At September 30, 2006 and 2005, financial instruments whose contract amounts represent credit risk consist of: 2006 2005 ------- ------- Commitments to grant loans $ 4,666 $12,094 Unadvanced funds on home equity and personal lines-of-credit 16,846 14,810 Unadvanced funds on commercial loans and lines-of-credit 1,875 1,978 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Unadvanced funds on lines-of-credit have fixed expiration dates and may expire without being drawn upon. Therefore, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. Except for commercial lines-of-credit, these financial instruments are secured by mortgage liens on real estate. F-40 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) COMMITMENTS AND CONTINGENCIES (concluded) Employment and change in control agreements The Company and the Bank have entered into employment agreements with its President and Chief Financial Officer which generally provide for a base salary and the continuation of certain benefits currently received. The employment agreements require payments for the remaining base salary due to the employee for the remaining term of the agreement and the contributions that would have been made on the employee's behalf to any employee benefit plans of the Company and the Bank for certain reasons other than cause, including a "change in control" as defined in the agreement. However, such employment may be terminated for cause, as defined, without incurring any continuing obligations. Contingencies Various legal claims may arise from time to time and, in the opinion of management, these claims will have no material effect on the Company's consolidated financial statements. 14. RELATED PARTY TRANSACTIONS In the ordinary course of business, the Bank has granted loans to its Directors. At September 30, 2006 and 2005, the amount of such loans, which exceeded $60 in the aggregate to each related party, was approximately $2,405 and $1,776, respectively. Such loans are made in the ordinary course of business at the Bank's normal credit terms, including interest rate and collateral requirements, and do not represent more than a normal risk of collection. During the years ended September 30, 2006 and 2005, total principal additions were $1,312 and $129, respectively, and total principal payments were $683 and $85, respectively. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. F-41 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) FAIR VALUE OF FINANCIAL INSTRUMENTS (continued) The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amounts of cash and due from banks, federal funds sold and short-term investments approximate fair value. Securities available for sale: Fair values for securities available for sale are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Federal Home Loan Bank Stock: The carrying amount approximates fair value based on the redemption provisions of the Federal Home Loan Bank. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other types of loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. Deposits: The fair values for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificate accounts are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Short-term borrowings and long-term borrowings: The fair value is based upon the Company's current incremental borrowing rate for a similar advance. Accrued interest: The carrying amounts of accrued interest approximate fair value. Off-balance sheet instruments: Fair values for off-balance sheet lending com-mitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The estimated fair value of off-balance sheet financial instruments at September 30, 2006 and 2005, was immaterial. F-42 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded) The carrying amounts and related estimated fair values of the Company's financial instruments are as follows:
September 30, ----------------------------------------------- 2006 2005 --------------------- --------------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- -------- -------- Financial assets: Cash and cash equivalents $ 8,317 $ 8,317 $ 8,974 $ 8,974 Securities available for sale 62,442 62,442 63,940 63,940 Federal Home Loan Bank stock 3,376 3,376 2,966 2,966 Loans, net 209,744 205,691 200,477 200,780 Accrued interest receivable 1,368 1,368 1,181 1,181 Financial liabilities: Deposits 211,277 210,898 210,281 209,984 Short-term borrowings - - 4,000 4,000 Long-term borrowings 57,500 56,758 46,000 45,542
F-43 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 16. CONDENSED FINANCIAL STATEMENTS OF WESTBOROUGH FINANCIAL SERVICES, INC. September 30, ------------------- BALANCE SHEETS 2006 2005 -------------- ------- ------- Assets ------ Cash and due from bank $ 537 $ 667 Short-term investments 425 359 ------- ------- Total cash and cash equivalents 962 1,026 Investment in subsidiary 27,075 27,230 Loan receivable - ESOP 320 343 Other assets 26 4 ------- ------- Total assets $28,383 $28,603 ======= ======= Liabilities and Stockholders' Equity ------------------------------------ Stockholders' equity $28,383 $28,603 ------- ------- Total liabilities and stockholders' equity $28,383 $28,603 ======= ======= Years Ended September 30, ----------------- STATEMENTS OF OPERATIONS 2006 2005 ------------------------ ------ ------ Income: Interest on short-term investments $ 16 $ 9 Interest on loan - ESOP 26 28 ----- ----- Total income 42 37 Operating expenses 318 161 ----- ----- Loss before income taxes and equity in undistributed net income of subsidiary (276) (124) Income tax benefit (94) (42) ----- ----- Loss before undistributed net income of subsidiary (182) (82) Equity in undistributed net income of subsidiary 140 980 ----- ----- Net (loss) income $ (42) $ 898 ===== ===== F-44 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) CONDENSED FINANCIAL STATEMENTS OF WESTBOROUGH FINANCIAL SERVICES, INC. (concluded) Years Ended September 30, ---------------- STATEMENTS OF CASH FLOWS 2006 2005 ------------------------ ------ ------ Cash flows from operating activities: Net (loss) income $ (42) $ 898 Adjustments to reconcile net income to net cash used by operating activities: (Increase) decrease in other assets (22) 58 Equity in undistributed earnings of subsidiary (140) (980) ------ ------ Net cash used by operating activities (204) (24) ------ ------ Cash flows from investing activities: Principal paydowns received on ESOP loan 23 22 ------ ------ Net cash provided by investing activities 23 22 ------ ------ Cash flows from financing activities: Intercompany cash transfer 500 - Dividends paid (383) (382) ------ ------ Net cash provided (used) by financing activities 117 (382) ------ ------ Net change in cash and cash equivalents (64) (384) Cash and cash equivalents at beginning of year 1,026 1,410 ------ ------ Cash and cash equivalents at end of year $ 962 $1,026 ====== ====== F-45
WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Dollars in thousands, except per share data) 17. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED) Years Ended September 30, ------------------------------------------------------------------------------------------- 2006 2005 ------------------------------------------- ------------------------------------------- Fourth Third Second First Fourth Third Second First Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter ------- ------- ------- ------- ------- ------- ------- ------- Interest and dividend income $ 3,738 $ 3,611 $ 3,584 $ 3,489 $ 3,324 $ 3,173 $ 3,080 $ 2,987 Interest expense 1,884 1,761 1,676 1,520 1,262 1,113 983 814 ------- ------- ------- ------- ------- ------- ------- ------- Net interest income 1,854 1,850 1,908 1,969 2,062 2,060 2,097 2,173 (Credit) provision for loan losses - - - - - - (48) (125) ------- ------- ------- ------- ------- ------- ------- ------- Net interest income, after (credit) provision for loan losses 1,854 1,850 1,908 1,969 2,062 2,060 2,145 2,298 Gain on securities, net 3 - - - 10 - 47 2 All other income 180 200 231 256 191 338 254 221 Operating expenses 2,109 1,962 2,436 2,109 2,143 2,136 2,045 2,025 ------- ------- ------- ------- ------- ------- ------- ------- Income (loss) before income taxes (72) 88 (297) 116 120 262 401 496 Provision (benefit) for income taxes (50) - (99) 26 19 91 114 157 ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss) $ (22) $ 88 $ (198) $ 90 $ 101 $ 171 $ 287 $ 339 ======= ======= ======= ======= ======= ======= ======= ======= Earnings (loss) per common share: Basic $ (0.01) $ 0.06 $ (0.13) $ 0.06 $ 0.06 $ 0.11 $ 0.18 $ 0.22 ======= ======= ======= ======= ======= ======= ======= ======= Diluted $ (0.01) $ 0.06 $ (0.13) $ 0.06 $ 0.06 $ 0.11 $ 0.18 $ 0.22 ======= ======= ======= ======= ======= ======= ======= =======
Differences from the consolidated statements of operations due to rounding. F-46 WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded) (Dollars in thousands, except per share data) 18. SUBSEQUENT EVENT On November 13, 2006, the Company, the Bank and Westborough Bancorp, MHC entered into an Agreement and Plan of Merger with Assabet Valley Bancorp and Hudson Savings Bank. Under the terms of the agreement, the mutual holding company structure of Westborough Bancorp, MHC will be eliminated and the Bank will merge with Hudson Savings Bank. The stockholders of the Company, other than Westborough Bancorp, MHC, will receive $35.00 in cash in exchange for each share of common stock. The transaction is expected to be completed in the spring of 2007 and is subject to shareholder approval and various regulatory approvals. F-47 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has been no Current Report on Form 8-K filed within 24 months prior to the date of the most recent consolidated financial statements reporting a change of accountants and/or reporting disagreements on any matter of accounting principle or financial statement disclosure. ITEM 8A. CONTROLS AND PROCEDURES Management, including the Company's President and Chief Executive Officer and Senior Vice President, Treasurer and Clerk, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Company's President and Chief Executive Officer and Senior Vice President, Treasurer and Clerk concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding disclosure. 53 There have been no changes in the Company's internal control over financial reporting identified in connection with the evaluation that occurred during the Company's last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Company's internal control over financial reporting. ITEM 8B. OTHER INFORMATION None. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Board of Directors Westborough Financial's Board of Directors currently consists of 14 members. Westborough Financial's Articles of Organization provides that the Board of Directors shall be divided into three classes. The Board of Directors oversees our business and monitors the performance of our management. In accordance with our corporate governance procedures, the Board of Directors does not involve itself in the day-to-day operations of Westborough Financial. Westborough Financial's executive officers and management oversee our day-to-day operations. Our directors fulfill their duties and responsibilities by attending regular meetings of the Board of Directors, which are held on a monthly basis. Our directors also discuss business and other matters with the Chairman, other key executives and our principal external advisers (legal counsel, auditors, financial advisors and other consultants).
Position(s) Held ---------------- with Westborough Directors Age(1) Term Expires Financial Director Since(2) - -------------------------- ------ ------------ ----------------------------- ----------------- James N. Ball 44 2009 Director 2003 Nelson P. Ball 75 2007 Director 1980 Edward S. Bilzerian 73 2008 Director 1992 Nancy M. Carlson 60 2007 Director 2003 David E. Carlstrom 72 2009 Director 1976 John L. Casagrande 60 2009 Senior Vice President, Chief 1994 Financial Officer, Treasurer, Clerk and Director Benjamin H. Colonero, Jr. 58 2007 Director 2003 Robert A. Klugman 55 2009 Director 1994 Jeffrey B. Leland 41 2007 Director 2005 Joseph F. MacDonough 60 2007 President, Chief Executive 1982 Officer and Director Paul F. McGrath 60 2008 Director 1991 Charlotte C. Spinney 70 2008 Director 1990 Phyllis A. Stone 63 2008 Director 1999 James E. Tashjian 65 2008 Director 1973 54 - ------------------ (1) As of September 30, 2006. (2) Includes service as a trustee of Westborough Bank prior to the formation of Westborough Financial in 2000.
The principal occupation and business experience of each director are set forth below. Unless otherwise indicated, each of the following persons has held his or her present position for the last five years. James N. Ball is the sole owner and president of Secure Futures, Inc. He has been in that position since 1984. Mr. Ball is a financial independence specialist and a member of the National Association of Securities Dealers as a registered representative. Mr. Ball assists individuals, families and small business owners to create and maintain multi-generational wealth. Mr. Ball is also the son of Nelson P. Ball, also a member of the Board of Directors. Nelson P. Ball is the owner of Ball Financial Services, Co., located in Westborough, Massachusetts. He has served as a financial services consultant for over 40 years. Mr. Ball is the father of James N. Ball, also a member of the Board of Directors. Edward S. Bilzerian is retired from Bilzerian Consulting Group, Inc., a privately held company located in Worcester, Massachusetts, specializing in small business turnarounds, where he served as president. Prior to that, he was Vice President of Marketing and Finance at Bay State Abrasive's Division of Dresser Industries. He has been self-employed for over 18 years. Mr. Bilzerian was a member of the Worcester Airport Commission and was Chairman of the Worcester Health and Hospital Authority. Nancy M. Carlson is the owner and president of The Suburban Group, Inc., a company that provides full staffing services, employee retention and development, pay rolling services and vendor management services, located in Westborough, Massachusetts since 1968. She purchased the company in 1994 and has grown in size and services to include consulting services, Human Resources and Management training, automated data management and conversions. Nancy has served on the Board of Directors of the Corridor Nine Chamber of Commerce since 1995, served on the Chamber's executive committee since 1997 and as president from 2001-2003. David E. Carlstrom is formerly the President of Carlstrom Pressed Metal Co., Inc., a contract manufacturer of metal stampings located in Westborough for the past 55 years, and now serves as a consultant to the family owned company. Mr. Carlstrom also served in the United States Air Force and retired as a Lieutenant Colonel. He served as the President of the Westborough Rotary Club and is the former Vice Chairman of the CMEA, The Employers Association. John L. Casagrande has served as the senior vice president and chief financial officer of Westborough Bank since 1993 and of Westborough Financial Services since its inception in 2000. He joined Westborough Bank after having been employed as a senior bank officer and certified public accountant for over 15 years at various times by several financial institutions (including mutual and stock institutions) and the accounting firm of Peat Marwick. Mr. Casagrande has been serving as clerk of Westborough Financial Services since 2001. Mr. Casagrande had served as a director of the Massachusetts Bank Insurance Association, a division of the Massachusetts Bankers Association. Benjamin H. Colonero, Jr. has served as chief financial officer and executive director in the healthcare industry for over 20 years. Mr. Colonero is currently the executive director of the 55 Westborough campus of the Salmons Family of Services, which serves the health and social needs of over 430 seniors. Robert A. Klugman, M.D., F.A.C.P. has practiced general medicine in Westborough, Massachusetts for over 25 years. Dr. Klugman is currently the Chief Quality Officer of Medicine at the University of Massachusetts Medical School as well as Medical Director of Managed Care for UMASS/Memorial. Jeffrey B. Leland has practiced estate administration, elder law and real estate law and other general practices of law at Leland Law Associates, P.C. for 14 years. At the same time, he has also served as an insurance broker selling property and casualty insurance through Leland Insurance Agency, Inc. Both Leland Law Associates, P.C. and Leland Insurance Agency, Inc. are located in Northborough, Massachusetts. Mr. Leland is an officer and director of both of the corporations. Joseph F. MacDonough has served as President and Chief Executive Officer of Westborough Bank since 1994 and of Westborough Financial Services since its inception in 2000. He joined Westborough Bank in 1981 and served as Vice President and Treasurer until his appointment as President. Mr. MacDonough serves on the Board of Directors of the Massachusetts Bankers Association. Paul F. McGrath is a certified public accountant and has served as President of Mottle McGrath Braney & Flynn, P.C. for over fifteen years. Mottle McGrath is a certified public accounting firm, located in Worcester, Massachusetts, that provides accounting, tax and business advisory services throughout central New England. Charlotte C. Spinney is a retired social studies teacher. Ms. Spinney taught at Westborough High School for 41 years and, during that time, she created the curriculum for the community service component of the school's Sociology course. Phyllis A. Stone served as Vice President and Treasurer of Comey Oil Co., Inc., located in Westborough, Massachusetts, for 13 years prior to her retirement in 2001. Ms. Stone served in various other capacities within Comey Oil for over 30 years. Ms. Stone is currently President of Schenker Properties, Inc., a real estate holding company based in Westborough, Massachusetts. She is past Treasurer of the Regatta Point Community Sailing Inc. of Worcester, Massachusetts. James E. Tashjian, the Chairman of the Westborough Board of Directors, is an attorney engaged in the general practice of law and is associated with the firm of Tashjian, Simsarian & Wickstrom, LLP located in Worcester, Massachusetts. He has engaged in the general practice of law for over 40 years. Executive Officers Who Are Not Directors Biographical information and the business experience of each non-director executive officer of Westborough Financial and Westborough Bank are set forth below. Michael D. Allard, age 44, is Senior Vice President of Marketing and Retail Sales of Westborough Bank, a position he has held since 2001. Prior to joining Westborough Bank in 2001, he served as Senior Vice President of Sales, Marketing and Branch Administration at Ipswich Bank, a position he held from 2000 to 2001. Prior to that, from 1996 to 2000, he served as Vice President and Regional Sales and Marketing Coordinator of US Trust Bank. Mr. Allard has over 17 years retail banking experience. 56 Vickie A. Bouvier, age 49, currently serves as Senior Vice President and Senior Operations Officer of Westborough Bank. She has worked for Westborough Bank in various capacities since 1976. In 2001, she was named Senior Vice President and Senior Operations Officer. Prior to that, she served as Vice President and Senior Operations Officer. Margaret I. Duquette, age 54, has worked for Westborough Bank as its Vice President - Director of Human Resources since 1997. Prior to 1997, she held the position of Director of Human Resources at Bay State Savings Bank in Worcester, Massachusetts where she worked for 19 years. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires Westborough Financial's directors and executive officers, and persons who own more than 10% of Westborough Financial's common stock, to report to the Securities and Exchange Commission their initial ownership of Westborough Financial's common stock, on Form 3, and any subsequent changes in that ownership, on Form 4. Reports on Form 3 must be filed within 10 days of becoming a beneficial owner, director or officer. Reports on Form 4 must be filed before the end of the second business day following the day on which the transaction effecting a change in ownership occurred. Westborough Financial is required to disclose in this annual report any late filings or failures to file. To Westborough Financial's knowledge, based solely on its review of the copies of such reports furnished to Westborough Financial and written representations that no other reports were required during the fiscal year ended September 30, 2006, all Section 16(a) filing requirements applicable to Westborough Financial's executive officers and directors during fiscal year 2006 were met, with the exception of the following: a Form 4 filing for Vickie A. Bouvier reflecting shares of common stock disposed of on December 8, 2005 was filed late on January 9, 2006 and Form 4s for James N. Ball, Nancy M. Carlson and Benjamin H. Colonero, Jr. reflecting stock option awards granted on April 24, 2006 were filed late on May 3, 2006. Code of Ethics Westborough Financial's Board of Directors has adopted a Code of Ethics and Conflicts of Interest Policy that applies to each of our directors, officers and employees. The Code of Ethics sets forth our policies and expectations on a number of topics, including: o acceptance of gifts; o financial responsibility regarding both personal and business affairs, including loans or other transactions with Westborough Bank; o personal conduct, including ethical behavior and outside employment and other activities; o affiliated transactions, including separate identities and usurpation of corporate opportunities; o preservation and accuracy of Westborough Financial's and Westborough Bank's records; o compliance with laws, including insider trading compliance; 57 o preservation of confidential information relating to our business and that of our clients; o conflicts of interest; o the safeguarding and proper use of our assets and institutional property; o code administration and enforcement; o reporting, investigating and resolving of all code violations; and o code-related training, certification of compliance and maintenance of code-related records. The Audit Committee will review the Code of Ethics on a regular basis, and propose or adopt additions or amendments to the Code of Ethics as appropriate. The Code of Ethics is posted on our website, www.westboroughbank.com. A copy of the Code of Ethics may also be obtained free of charge by sending a written request to: John L. Casagrande, Clerk Westborough Financial Services, Inc. 100 East Main Street Westborough, Massachusetts 01581 Code of Ethics for Senior Financial Officers Westborough Financial's Board of Directors has adopted a Code of Ethics for Senior Financial Officers that applies to each of our senior financial officers, including our principal executive officer, principal financial officer and principal accounting officer. The Code of Ethics for Senior Financial Officers sets forth our policies and expectations on a number of topics, including: o personal conduct, including ethical behavior and personal integrity; o conflicts of interest; o compliance with laws, rules and regulations; o preservation of confidential information; o proper use of corporate assets and opportunities; and o compliance and compliance monitoring. The Audit Committee will review the Code of Ethics for Senior Financial Officers on a regular basis, and propose or adopt additions or amendments to the Code of Ethics for Senior Financial Officers as appropriate. The Code of Ethics for Senior Financial Officers is posted on our website, www.westboroughbank.com. A copy of the Code of Ethics for Senior Financial Officers may also be obtained free of charge by sending a written request to: 58 John L. Casagrande, Clerk Westborough Financial Services, Inc. 100 East Main Street Westborough, Massachusetts 01581 Audit Committee Westborough Financial's Board of Directors has established an Audit Committee. The Audit Committee reviews the annual audit prepared by the independent accountants and recommends the appointment of accountants. The Board of Directors of Westborough Financial has adopted a written charter for the Audit Committee, which was attached to the Westborough Financial proxy statement for the 2005 Annual Meeting. Directors Bilzerian, Colonero, and McGrath currently serve as members of the committee. Mr. McGrath is the Chairman of the Committee. Mr. McGrath has been determined by the Board of Directors to meet the definition of an "audit committee financial expert" as such term is defined in Section 407(d)(5) of Regulation S-B as promulgated by the Securities and Exchange Commission. In addition, all members of the Audit Committee are independent directors as defined under The Nasdaq Stock Market listing standards. ITEM 10. EXECUTIVE COMPENSATION The following table sets forth compensation paid during the fiscal year ended September 30, 2006 to the Chief Executive Officer of Westborough Financial and Westborough Bank and to the other most highly compensated executive officers of Westborough Financial and Westborough Bank whose salary and bonus for 2006 was in excess of $100,000.
Summary Compensation Table Long Term Compensation ------------------------------------------------ Annual Compensation Awards Payouts ------------------------------------- --------------------- ----------------------- Other Restricted Annual Stock LTIP All Other Name and Principal Bonus Compensation Awards Options Payouts Compensation Positions Year Salary($) ($) ($)(1) ($) (#) ($) ($)(2) - ------------------------- ---- --------- ------- ------------ ---------- ------- ------- ------------ Joseph F. MacDonough... 2006 $200,000 $ 0 $22,893 President and Chief 2005 $220,509 $ 6,130 - - - - $20,731 Executive Officer 2004 $216,827 - - - - - $23,682 John L. Casagrande..... 2006 $120,800 $ 2,400 $12,593 Senior Vice President, 2005 $119,877 $13,393 - - - - $10,788 Chief Financial Officer 2004 $120,600 - - - - - $14,404 Treasurer and Clerk - ------------------ (1) Westborough Bank provides Mr. MacDonough with certain non-cash benefits and perquisites, such as the use of an automobile, club membership dues and certain other personal benefits, the aggregate value of which did not exceed the lesser of $50,000 or 10% of the total annual salary and annual bonus reported for him in the Summary Compensation Table. (2) Includes the dollar value of the benefit of the following components: (1) premiums paid by Westborough Bank under their split dollar life and group term life insurance arrangements during 2006: Mr. MacDonough, $9,951 and Mr. Casagrande, $4,435; (2) contributions on behalf of Westborough Bank's 401(k) plan during 2006: Mr. MacDonough, $4,923 and Mr. Casagrande, $3,362; (3) allocations of common stock under the ESOP during 2006: Mr. MacDonough, $6,894 and Mr. Casagrande, $4,796; and (4) accruals under the benefit restoration plan for Mr. MacDonough during 2006 were $1,525.
59 Employment Agreements. Westborough Financial has entered into separate employment agreements with Messrs. MacDonough and Casagrande to secure their services as President and Chief Executive Officer, and as Senior Vice President, Chief Financial Officer, Treasurer, and Clerk, respectively. The employment agreements provide for an initial term of three years in the case of Mr. MacDonough, and two years in the case of Mr. Casagrande. Commencing on the first anniversary of the effective date of each agreement, and continuing on each anniversary date thereafter, the employment agreements may be extended, after review by the Compensation Committee of the Board of the executive's performance, for an additional one-year period, so that the remaining term will be three years in the case of Mr. MacDonough, and two years in the case of Mr. Casagrande. The employment agreements provide for each executive's base salary to be reviewed annually by the Board. Each executive's base salary may be adjusted based on his job performance and the overall performance of Westborough Financial and Westborough Bank. In addition to base salary, each employment agreement provides for participation in stock, retirement and welfare benefit plans, and eligibility for fringe benefits applicable to executive personnel. Mr. MacDonough's agreement provides for the reimbursement of his ordinary and necessary business expenses, which specifically include travel and entertainment expenses, expenses related to the use of an automobile, and fees for membership in clubs and organizations that he and Westborough Financial agree are for business purposes. Mr. Casagrande's agreement provides for the reimbursement of his ordinary and necessary business expenses, which specifically include certain travel and entertainment expenses. Westborough Financial may terminate each executive's employment at any time with or without cause, and each executive may resign at any time provided he provides 30 days' prior written notice and fully cooperates in the transition of his duties. In the event an executive's employment is terminated without cause during the term of the employment agreement, the executive will be entitled to severance benefits. These severance benefits include a lump sum payment equal to the present value of the base salary and bonus payments that would have been made to the executive for the remaining term of his employment agreement, assuming the executive would have been awarded a bonus for each year remaining in the agreement term equal to the highest annual bonus paid to him in the preceding three-year period and paid his base salary during the remaining agreement term at the annual rate in effect as of the termination. In addition, the executive would be entitled to continue his participation in the group life, health, dental, accidental death and long-term disability plans sponsored by Westborough Bank for the remaining term of his employment agreement. The same severance benefits would be payable if the executive resigns during the term of the employment agreement following: (1) failure of the Board to reappoint the executive to the position provided for in his employment agreement; (2) failure of Westborough Financial to vest in the executive the duties set forth in the agreement; and (3) Westborough Financial's material breach of the agreement. The employment agreements also provide certain uninsured benefits in the event the executive's employment terminates because of death or disability. Under his employment agreement, Mr. MacDonough agrees that for the three-year period following his termination of employment, he will not take a position with any competitor that would require him to work within a 50 mile radius of the headquarters of Westborough Financial or Westborough Bank. Mr. Casagrande agrees under his employment agreement that for a period of two years following his termination of employment he will not take a position with any competitor that would require him to work within a 30 mile radius of the headquarters of Westborough Financial or Westborough Bank. Change in Control Provisions. The employment agreements described above provide that, in the event Mr. MacDonough or Mr. Casagrande resigns for any reason or is terminated without cause following a change in control of Westborough Financial or Westborough Bank, he will be entitled to 60 certain severance benefits. These severance benefits include a lump sum payment equal to the present value of the base salary and bonus payments that would have been made to the executive for the remaining term of his employment agreement, assuming the executive would have been awarded a bonus for each year remaining in the agreement term equal to the highest annual bonus paid to him in the preceding three-year period and paid his base salary during the remaining agreement term at the annual rate in effect as of the termination. However, in no event will the amount of this lump sum payment be less than 2.99 multiplied by the executive's average annual compensation for the preceding five years. In addition, the executive will be entitled to continue his participation in the group life, health, dental, accidental death and long-term disability plans sponsored by Westborough Bank for the remaining term of his employment agreement. A second-step conversion will not trigger additional benefits or accelerate benefits under the employment agreements or under any other arrangement. If Westborough Financial or Westborough Bank experiences a change in ownership, a change in effective ownership or control or a change in the ownership of a substantial portion of their assets as contemplated by section 280G of the Internal Revenue Code of 1988, as amended (the "Code"), a portion of any severance payments under the employment agreements might constitute an "excess parachute payment" under current federal tax laws. Any excess parachute payment would be subject to a 20% federal excise tax payable by the executive. Neither Westborough Bank nor Westborough Financial could claim a federal income tax deduction for an excess parachute payment. The employment agreements require Westborough Financial to indemnify each executive against the financial effects of the excise tax. Directors' Compensation Meeting Fees. Currently, each non-employee director of Westborough Bank receives the following fees: o $275 per Board of Directors meeting attended; and o $275 per committee meeting attended, with the Chairman of each committee receiving a fee of $350. In addition, Directors Carlson, Carlstrom, Klugman, McGrath and Tashjian receive an annual retainer of $7,500 as members of the Executive Committee. Directors Bilzerian and Colonero receive an annual retainer of $5,000 as members of the Audit Committee. The remaining directors, Directors Ball (J.), Ball (N.), Leland, Spinney and Stone receive an annual retainer of $3,500. Total directors' meeting and committee fees for fiscal year 2006 were $193,825. We do not compensate our employee-directors for service as directors. Directors are also entitled to the protection of certain indemnification provisions in our Articles of Organization. Deferred Income Agreements. Westborough Bank has entered into deferred income agreements with Messrs. Carlstrom and Tashjian. Under these agreements, Messrs. Carlstrom and Tashjian (or his beneficiary in the event of his death) are entitled to payments for ten years following the attainment of age 65 equal to $14,567 and $21,500, respectively, per year payable in monthly installments. These agreements also provide for payments upon the death of the director as if the director had attained age 65. Pursuant to his agreement, Mr. Carlstrom was paid an aggregate of $14,567 and Mr. Tashjian was paid an aggregate of $7,167 in the last fiscal year. Supplemental Compensation Agreements. Westborough Bank has entered into supplemental compensation agreements with Directors Ball (N.), Bilzerian, Carlstrom, Klugman McGrath, Spinney, 61 Stone and Tashjian which provide for benefits when they each retire from service after age 75. Westborough Bank will also enter into similar supplemental compensation agreements with Directors Ball (J.), Carlson and Colonero, effective in April 2006. Under these agreements, each director retiring after age 75 (or his or her beneficiary in the event of death) is entitled to an annual benefit equal to eighty percent (80%) of the average annual fees paid as calculated from the average of the highest three (3) years paid to the director by Westborough Bank payable in monthly installments for a period of ten (10) years. These agreements also provide for payments upon the death or disability of the director as if the director had retired after age 75 or upon the change of control of Westborough Bank (as defined in the agreements). Benefit Plans Pension Plans. Westborough Bank maintains a tax-qualified pension plan that covers substantially all employees who have attained age 21 and have at least one year of service. The following table shows the estimated aggregate benefits payable under the pension plan upon retirement at age 65 with various years of service and average compensation combinations. Years of Service Average -------------------------------------------------------------- Compensation 10 15 20 25 30 35 - ------------ ------- ------- ------- ------- ------- ------- $ 20,000 $ 2,500 $ 3,750 $ 5,000 $ 6,250 $ 6,250 $ 6,250 $ 40,000 $ 5,000 $ 7,500 $10,000 $12,500 $12,500 $12,500 $ 50,000 $ 6,250 $ 9,375 $12,500 $15,625 $15,625 $15,625 $ 75,000 $10,800 $16,200 $21,600 $27,000 $27,000 $27,000 $100,000 $15,425 $23,137 $30,850 $38,562 $38,562 $38,562 $120,000 $19,125 $28,687 $38,250 $47,812 $47,812 $47,812 $125,000 $20,050 $30,075 $40,100 $50,125 $50,125 $50,125 $140,000 $22,825 $34,237 $45,650 $57,062 $57,062 $57,062 $150,000 $24,675 $37,012 $49,350 $61,687 $61,687 $61,687 $160,000 $26,525 $39,787 $53,050 $66,312 $66,312 $66,312 $175,000 $29,300 $43,950 $58,600 $73,250 $73,250 $73,250 $200,000 $33,925 $50,887 $67,850 $84,812 $84,812 $84,812 $300,000 $37,625 $56,437 $75,250 $94,062 $94,062 $94,062 $400,000 $37,625 $56,437 $75,250 $94,062 $94,062 $94,062 The benefits shown in the preceding table are annual benefits payable in the form of a single life annuity and are not subject to any deduction for Social Security benefits or other offset amounts. At September 30, 2006, Mr. MacDonough's and Mr. Casagrande's average compensation and estimated years of service were $205,000 and 28.75 years of service and $145,509 and 12.75 years of service, respectively. Supplemental Executive Retirement Agreements. Mr. MacDonough, Mr. Casagrande and one other executive officer are entitled to supplemental retirement benefits under a Supplemental Executive Retirement Agreement each has entered into with Westborough Bank. Under each agreement, each executive is entitled to an annual retirement benefit equal to 37%, 35% and 20%, respectively, of the executive's final average compensation for life with fifteen years certain (payable either in the annuity form or a lump sum as elected by each executive). Under the agreements, each executive's final average compensation is the average annual compensation for the final three calendar years of the executive's service to Westborough Bank. These agreements provide for full payments at age 65 with a discount applied for retirement prior to age 65. These agreements also provide for payments upon the death or disability of the executive that are equal in amount to the payments that would have been payable to the 62 executive upon retirement at age 65. The agreements also provide benefits to be paid in a lump sum upon the change of control of Westborough Bank and Westborough Financial as if the executive had attained age 65 with a five percent imputed increase in compensation each year until age 65 would have been attained. Employee Stock Ownership Plan. This plan is a tax-qualified plan that covers substantially all employees of Westborough Bank and Westborough Financial who have at least one year of service and have attained age 21. The ESOP purchased 44,200 shares of common stock issued by Westborough Financial in its mutual holding company reorganization with borrowed funds. This loan is for a term of 15 years and calls for level annual payments of principal and interest. The plan has pledged the shares as collateral for the loan and holds them in a suspense account. The plan will release a portion of the pledged shares annually, allocating the shares released each year among the accounts of participants in proportion to their salary for the year. For example, if a participant's base salary for a year represents 1% of the total base salaries of all participants for the year, the plan would allocate to that participant 1% of the shares released for the year. Participants direct the voting of shares allocated to their accounts. Shares in the suspense account will usually be voted in a way that mirrors the votes which participants cast for shares in their individual accounts. This plan may purchase additional shares in the future, and may do so using borrowed funds, cash dividends, periodic employer contributions or other cash flow. Upon the consummation of the merger, all participants in this plan will become fully vested in their accounts, the outstanding loan balance on the plan loan will be repaid and any surplus assets will then be allocated to the accounts of plan participants. Benefit Restoration Plan. Westborough Financial has also adopted a benefit restoration plan for Mr. MacDonough. This plan is designed to provide Mr. MacDonough with the benefits that would otherwise be earned by him as a participant in the 401(k) Plan and the ESOP if such benefits were not limited by certain provisions of the Code. The benefit restoration plan provides for a benefit equal in value to the allocations under the ESOP and the 401(k) Plan that would have been made on Mr. MacDonough's behalf but for these IRS limits, including employer matching contributions that would have been made under the 401(k) Plan if Mr. MacDonough had elected to make pre-tax contributions to the 401(k) Plan up to the maximum percentage of salary permitted under the terms of the plan and the annual IRS limit on pre-tax contributions did not apply. Under the benefit restoration plan, a bookkeeping account has been established for Mr. MacDonough that will be credited with a number of "stock units" equal to the number of shares that could not be allocated on his behalf under the ESOP each year because of the IRS limits. The value of this supplemental ESOP bookkeeping account at any time is equal to the number of stock units credited to the account multiplied by the current fair market value per share. A bookkeeping account also has been established for Mr. MacDonough which will be credited each year with an amount equal to the employer matching contributions that could not be allocated to his account under the 401(k) Plan because of the IRS limits. Each year, this supplemental employer matching contribution bookkeeping account will be credited with hypothetical investment earnings as if the amount credited to the account were invested in certain investment funds selected by the Compensation Committee. Unless a different time or form of distribution is elected by Mr. MacDonough within the 30-day period following the effective date of the plan, the value of his supplemental employee stock ownership 63 plan and employer matching contribution bookkeeping accounts will be paid to him in one lump sum cash payment as soon as possible following the end of the calendar year in which his employment terminates. The benefit restoration plan is an unfunded plan, and benefits payable thereunder will be paid from the general assets of Westborough Financial. Officers' Deferred Compensation Plan. Westborough Financial also maintains the Officers' Deferred Compensation Plan of Westborough Financial Services, Inc., a non-qualified plan, in order to offer eligible executives the opportunity to defer the receipt of a portion of their income in a manner that defers the taxation of such income. 2001 Stock Option Plan. The Westborough Financial Services, Inc. 2001 Stock Option Plan (the "Stock Option Plan") was adopted by our Board of Directors and approved by our shareholders at an annual meeting held on January 25, 2001. Article IX of the Stock Option Plan, which allows for acceleration of vesting upon retirement of the option holder or a change in control of Westborough Financial, terms that are defined in the plan, was approved by our shareholders at our 2002 Annual Meeting. No additional options were granted to the named executive officers during the 2006 fiscal year. The purpose of the Stock Option Plan is to encourage the retention of key employees and directors by facilitating their purchase of a stock interest in Westborough Financial. The Stock Option Plan is not subject to ERISA and is not a tax-qualified plan. Westborough Financial has reserved an aggregate of 55,348 shares of common stock for issuance upon the exercise of stock options granted under the plan. Awards typically vest and become distributable at the rate of 20% per year, over a five year period, subject to automatic full vesting on the date of the Award holder's death, disability, retirement or upon a change in control of Westborough Financial. Westborough Financial may amend or terminate the Stock Option Plan, in whole or in part, at any time, subject to the requirements of all applicable laws. 64 The following table provides the value for "in-the-money" options, which represent the positive spread between the exercise price of any such existing stock options and the closing price per share of the common stock on September 29, 2006, the last trading day of the 2006 fiscal year for Westborough Financial, which was $27.25 per share.
2006 Fiscal Year-End Option/SAR Values - --------------------------------------------------------------------------------------------------------------- Number of Securities Value of Unexercised Underlying Unexercised In-the-Money Shares Value Options/SARs at Fiscal Options/SARs at Fiscal Acquired Realized Year-End Year-End on Exercise on Exercise (#) ($) Name (#) ($) Exercisable/Unexercisable Exercisable/Unexercisable(1) - -------------------- ----------- ----------- ------------------------- ---------------------------- Joseph F. MacDonough - - 9,600/0 $162,605/0 John L. Casagrande - - 2,700/0 $45,733/0 - ------------------ (1) The closing price per share of common stock on September 29, 2006, the last trading day of the 2006 fiscal year, was $27.25, and all options have an exercise price of $10.312 per share, which equals a spread of $16.938 per share.
2001 Recognition and Retention Plan. The Westborough Financial Services, Inc. 2001 Recognition and Retention Plan (the "RRP") was adopted by our Board of Directors and approved by our shareholders at an annual meeting held on January 25, 2001. Article X of the RRP, which allows for acceleration of vesting upon retirement or change in control of Westborough Financial, terms which are defined in the plan, was approved by our shareholders at our 2002 Annual Meeting. Similar to the Stock Option Plan, the RRP functions as a long-term incentive compensation program for eligible officers, employees and directors of Westborough Financial and Westborough Bank. The RRP is not subject to ERISA and is not a tax-qualified plan. Westborough Financial pays all costs and expenses of administering the RRP. The maximum number of restricted stock awards ("Awards") that may be granted under the RRP is 22,139 shares of common stock. Shares of common stock subject to an Award are held in a trust until the Award vests at which time the shares of common stock attributable to the portion of the Award that have vested are distributed to the Award holder. An Award recipient is entitled to exercise voting rights and receive cash dividends with respect to the shares of common stock subject to his Award, whether or not the underlying shares have vested. Awards typically vest and become distributable at the rate of 20% per year, over a five year period, subject to automatic full vesting on the date of the Award holder's death, disability, retirement or upon a change in control of Westborough Financial. Westborough Financial may amend or terminate the RRP, in whole or in part, at any time, subject to the requirements of all applicable laws. 65 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Principal Shareholders of Westborough Financial The following table contains common stock ownership information for persons known to Westborough Financial to "beneficially own" 5% or more of Westborough Financial's common stock as of December 26, 2006. In general, beneficial ownership includes those shares that a person has the power to vote, sell or otherwise dispose. Beneficial ownership also includes the number of shares that an individual has the right to acquire within 60 days (such as stock options) after December 26, 2006. Two or more persons may be considered the beneficial owner of the same shares. We obtained the information provided in the following table from filings with the Securities and Exchange Commission and with Westborough Financial. In this annual report, "voting power" is the power to vote or direct the voting of shares, and "investment power" includes the power to dispose or direct the disposition of shares. Name and Address of Amount and Nature of Title of Class Beneficial Owner Beneficial Ownership(1) Percent - --------------- ------------------- ----------------------- ------- Common Stock Westborough Bancorp, MHC 1,027,893 63.89% $0.01 par value 100 East Main Street Westborough, Massachusetts 01581 - ------------------ (1) As reported by Westborough Bancorp, MHC in a Schedule 13D dated February 15, 2000, which reported sole voting and dispositive power with respect to 1,027,893 shares. Security Ownership of Management. The following table shows the number of shares of Westborough Financial's common stock beneficially owned by each director, the named executive officers identified in the Summary Compensation Table included elsewhere in this annual report, and all directors and executive officers of Westborough Financial as a group, as of December 26, 2006. The percent of common stock outstanding was based on a total of 1,608,774 shares of Westborough Financial's common stock outstanding on that date, plus shares of common stock that such person or group has the right to acquire within 60 days after that date by the exercise of stock options. Except as otherwise indicated, each person and each group shown in the table has sole voting and investment power with respect to the shares of common stock listed next to their name.
Position with Percent of Westborough Financial and Amount and Nature of Common Stock Name Westborough Bank Beneficial Ownership(1) Outstanding - --------------------------- ------------------------- ----------------------- ------------ James N. Ball Director 1,150(2) * Nelson P. Ball Director 1,450(3) * Edward S. Bilzerian Director 4,450(4) * Nancy M. Carlson Director 650 * David E. Carlstrom Director 3,950(5) * John L. Casagrande Senior Vice President, Chief 5,279(6) * Financial Officer, Treasurer, Clerk and Director 66 Benjamin H. Colonero, Jr. Director 490 * Robert A. Klugman Director 3,450(7) * Jeffrey B. Leland Director 600 * Joseph F. MacDonough President, Chief Executive 22,238(8) 1.4% Officer and Director Paul F. McGrath Director 5,850(9) * Charlotte C. Spinney Director 2,950(10) * Phyllis A. Stone Director 2,500(11) * James E. Tashjian Director 4,450(12) * All directors and executive officers as a group ([17] persons)(13) 96,644 6.01% - ------------------ * Less than one percent of the total outstanding shares of common stock. (1) Includes stock options that may be acquired by executive officers and directors of Westborough Financial under the Westborough Financial Services Inc. 2001 Stock Option Plan within 60 days after December 26, 2006. These amounts also include unvested restricted stock awards under the Westborough Financial Services, Inc. 2001 Recognition and Retention Plan. Under the plan, each of Mr. James Ball, Ms. Carlson and Mr. Colonero holds unvested restricted stock awards of 450 shares of common stock. Each holder of an unvested restricted stock award has sole voting power but no investment power, except in limited circumstances, over the common stock covered by the award. (2) Includes 700 shares held jointly with Mr. Ball's spouse. (3) Includes options to purchase 1,000 shares that are currently vested. Excludes 3,500 shares held by his spouse for which Mr. Ball disclaims beneficial ownership. (4) Includes options to purchase 1,000 shares that are currently vested. (5) Includes options to purchase 600 shares that are currently vested. (6) Includes 705 shares held in Westborough Bank's 401(k) plan. (7) Includes options to purchase 1,000 shares that are currently vested. (8) Includes: 1,741 shares held in Mr. MacDonough's individual retirement account; 314 shares held in his spouse's individual retirement account; 1,679 shares held in Westborough Bank's 401(k) plan and 3,500 shares held jointly with his spouse. (9) Includes 5,000 shares held in Mr. McGrath's individual retirement account and options to purchase 400 shares that are currently vested. (10) Includes: 1,500 shares held in Ms. Spinney's individual retirement account; 90 shares held as custodian for a minor child under the Uniform Transfer to Minors Act; and options to purchase 900 shares that are currently vested. (11) Includes: 75 shares held by Ms. Stone as custodian under the Uniform Transfers to Minors Act; and 900 shares held jointly with her spouse. (12) Includes 3,000 shares held jointly with his spouse and options to purchase 1,000 shares that are currently vested. (13) The Westborough Financial Services, Inc. Employee Stock Ownership Plan ("ESOP") is administered by the ESOP committee of Westborough Financial (the "ESOP Committee"). The ESOP's assets are held in a trust (the "ESOP Trust"), for which First Bankers Trust serves as trustee (the "ESOP Trustee"). The ESOP Trust purchased these shares with funds borrowed from Westborough Financial, and initially placed these shares in a suspense account for future allocation to be allocated to employees participating in the ESOP over a period of years as its acquisition debt is retired. The ESOP Trustee is the beneficial owner of the shares held in the ESOP Trust. The terms of the ESOP Trust Agreement provide that, subject to the ESOP Trustee's fiduciary responsibilities under the Employee Retirement Income Security Act of 1974, as 67 amended, the ESOP Trustee will vote, tender or exchange shares of common stock held in the ESOP Trust in accordance with instructions received from the participants. As of December 26, 2006, 17,682 shares held by the ESOP Trust have been released and are allocated to participant accounts. The ESOP Trustee will vote allocated shares as to which no instructions are received and any shares that have not been allocated to participants' accounts in the same proportion as allocated shares with respect to which the ESOP trustee receives instructions are voted. In the event of a tender or exchange offer, the ESOP Trustee will tender or exchange any shares in the suspense account or that otherwise have not been allocated to participants' accounts in the same proportion as allocated shares with respect to which the ESOP Trustee receives instructions are tendered or exchanged, but otherwise has no disposition power. This amount also includes shares held in trust pursuant to the ESOP that have been allocated to individual accounts as follows: 1,074 shares to Mr. Casagrande and 1,604 shares to Mr. MacDonough. The amount of shares for all directors and executive officers as a group also includes 26,518 shares held by the ESOP Trust that have not been allocated to eligible employees as of December 26, 2007, over which the ESOP Committee (consisting of Ms. Carlson and Messrs. Carlstrom and Klugman) may be deemed to have sole investment power, except in limited circumstances, thereby causing each committee member to be a beneficial owner of such shares. Each of the members of the ESOP Committee disclaims beneficial ownership of such shares and accordingly, such shares are not attributed to the members of the ESOP Committee individually.
68 Equity Compensation Plans The following table sets forth the aggregate information of the Company's equity compensation plans in effect as of September 30, 2006.
--------------------------------------------------------------------------------- Number of securities Number of securities remaining available for to be issued Weighted-average future issuance under upon exercise of exercise price of equity compensation plans outstanding options, outstanding options, (excluding securities reflected Plan category warrants and rights warrants and rights in column (a)) see note(1) - ------------- --------------------------------------------------------------------------------- (a) (b) (c) Equity compensation plans approved by security holders 30,290 $10.66 13,237 Equity compensation plans not approved by security holders None None None ------ ------ ------ Total 30,290 $10.66 13,237 ====== ====== ====== - ------------------ (1) This amount represents 10,458 and 2,779 shares remaining to be issued from the 2001 Stock Option Plan and the 2001 Recognition and Retention Plan, respectively.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Transactions with Certain Related Persons In the normal course of business, Westborough Bank makes loans to its Directors, Officers and employees. These loans bear interest and have the same underwriting terms that apply to any non-affiliated borrower. The outstanding principal balance of such loans to Directors and Officers totaled $3.3 million or 11.6% of Westborough Financial's total equity at September 30, 2006. Westborough Financial retains the law firm of Tashjian, Simsarian & Wickstrom. Mr. James E. Tashjian, a director of Westborough Financial and Westborough Bank, and a trustee of Westborough MHC, has been a partner of Tashjian, Simsarian & Wickstrom since 1995. The legal fees received by the law firm for professional services rendered to Westborough Bank during the year ended September 30, 2006 did not exceed 5% of the firm's gross revenues. Westborough Financial retains Suburban Staffing, Inc., to provide temporary staffing as needed. Nancy M. Carlson, a director of Westborough Financial and Westborough Bank, is the owner and president of Suburban Staffing, Inc., a full-service staffing firm located in Westborough, Massachusetts since 1968, which Ms. Carlson purchased in 1994. The fees received by Suburban Staffing, Inc. for staffing services rendered to Westborough Bank during the year ended September 30, 2006 did not exceed 5% of the firm's gross revenues. 69 Independent Directors Although Westborough Financial's common stock is not traded on The Nasdaq Stock Market, we use the definition of independence of the The Nasdaq Stock Market's rules to determine the independence of our directors. For a director to be "independent" under The Nasdaq Stock Market's rules, the director must not be an officer or employee of Westborough Financial or any of its subsidiaries, and must not have a relationship that, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The Nasdaq Stock Market's rules also expressly provide that the following persons cannot be considered independent: o a director who is, or during the past three years was, employed by Westborough Financial or by any subsidiary of Westborough Financial; o a director who accepts or who has a family member who accepts any payments from Westborough Financial or any subsidiary of Westborough Financial in excess of $60,000 during the current fiscal year or any of the past three fiscal years, other than (1) payments for board service, (2) payments arising solely from investments in Westborough Financial's securities, (3) compensation paid to a family member who is a non-executive employee of Westborough Financial, (4) benefits under a tax-qualified retirement plan, or non-discretionary compensation or (5) loans to directors and executive officers permitted under Section 13(k) of the Securities Exchange Act of 1934; o a director who is a family member of an individual who is, or during the past three years was, employed by Westborough Financial or by any subsidiary of Westborough Financial as an executive officer; o a director who is, or has a family member who is, a partner in, or a controlling shareholder or an executive officer of, any organization to which Westborough Financial made, or from which Westborough Financial received, payments for property or services (other than those arising solely from investments in Westborough Financial's securities or payments under non-discretionary charitable contribution matching schemes) that exceed 5% of the recipient's consolidated gross revenues for that year, or $200,000, whichever is more, in the current fiscal year or any of the past three fiscal years; o a director of Westborough Financial who is employed, or has a family member who is employed, as an executive officer of another entity where any of the officers of Westborough Financial serve on the compensation committee of such other entity, or if such relationship existed during the past three years; or o a director who is, or has a family member who is, a current partner of Westborough Financial's outside auditor, or was a partner or employee of Westborough Financial's outside auditor, and worked on Westborough Financial's audit during the past three years. The Board of Directors has determined that all of its current non-management members, a majority of the board, are "independent" directors under The Nasdaq Stock Market's rules. Consistent with The Nasdaq Stock Market's rules, independent directors meet in regularly scheduled executive sessions without non-independent directors. The independent directors have 70 selected James E. Tashjian to serve as the presiding director at the executive sessions for the 2007 fiscal year. The presiding director will take a lead role in the Board's self-evaluation process. The Nasdaq Stock Market's rules, as well as recently adopted Securities and Exchange Commission rules, impose additional independence requirements for all members of the Audit Committee. Specifically, in addition to the "independence" requirements discussed above, "independent" audit committee members must: (1) not accept, directly or indirectly, any consulting, advisory, or other compensatory fess from Westborough Financial or any subsidiary of Westborough Financial other than in the member's capacity as a member of the Board of Directors and any board committee; (2) not be an affiliated person of Westborough Financial or any subsidiary of Westborough Financial; and (3) not have participated in the preparation of the financial statements of Westborough Financial or any current subsidiary of Westborough Financial at any time during the past three years. In addition, The Nasdaq Stock Market's rules require that all audit committee members be able to read and understand fundamental financial statements, including Westborough Financial's balance sheet, income statement, and cash flow statement. Westborough Financial's Board of Directors believes that the current members of the Audit Committee meet these additional standards. Furthermore, the Securities and Exchange Commission requires that Westborough Financial disclose whether the Audit Committee has, and will continue to have, at least one member who is "financial expert." The Board of Directors has determined that Paul F. McGrath meets the Securities and Exchange Commission definition of an audit committee financial expert. ITEM 13. EXHIBITS The following exhibits are either filed as part of this report or are incorporated herein by reference: 2.1 Plan of Reorganization from Mutual Savings Bank to Mutual Holding Company and Stock Issuance Plan of Westborough Savings Bank* 3.1 Articles of Organization of Westborough Financial Services, Inc.* 3.2 Bylaws of Westborough Financial Services, Inc.* 3.3 Articles of Organization of The Westborough Bank* 3.4 Bylaws of The Westborough Bank* 3.5 Charter of Westborough Bancorp, MHC* 3.6 Bylaws of Westborough Bancorp, MHC* 3.7 Amendment to Article IV of the Articles of Organization of Westborough Financial Services, Inc. filed on December 26, 2000 as Exhibit A to the Proxy Statement (File No. 000-27997) is incorporated herein by reference. 4.1 Articles of Organization of Westborough Financial Services, Inc. (See Exhibit 3.1) 4.2 Bylaws of Westborough Financial Services, Inc. (See Exhibit 3.2) 71 4.3 Form of Stock Certificate of Westborough Financial Services, Inc.* 10.1(a) Form of Employee Stock Ownership Plan of Westborough Financial Services, Inc.* 10.1(a)1 Amendment No. 2 to Employee Stock Ownership Plan of Westborough Financial Services, Inc. *** 10.1(a)2 Amendment No. 3 to Employee Stock Ownership Plan of Westborough Financial Services, Inc. **** 10.2 Form of Executive Employment Agreement, by and between Joseph F. MacDonough and Westborough Financial Services, Inc.* 10.3 Form of Executive Employment Agreement, by and between John L. Casagrande and Westborough Financial Services, Inc.* 10.4 Westborough Financial Services, Inc. 2001 Stock Option Plan filed on December 26, 2000 as Exhibit C to the Proxy Statement (File No. 000-27997) is incorporated herein by reference. 10.5 Westborough Financial Services, Inc. 2001 Recognition and Retention Plan filed on December 26, 2000 as Exhibit D to the Proxy Statement (File No. 000-27997) is incorporated herein by reference. 10.6 Form of Officers' Deferred Compensation Plan of Westborough Financial Services, Inc.** 10.7 Form of Supplemental Executive Retirement agreement.# 10.8 Benefit Restoration Plan of Westborough Financial Services, Inc.## 10.9 Form of Amendment to Supplemental Executive Retirement Agreement.### 14.1 Code of Ethics of Senior Financial Officers filed as Exhibit 14.1 to the Company's Annual Report on Form 10-KSB for the fiscal year ended September 30, 2003 is incorporated herein by reference. 21.1 Subsidiaries of the Registrant.* 23.1 Independent Registered Public Accounting Firm's Consent 31.1 Certificates of the CEO and CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certificates of the CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 72 * Incorporated herein by reference to the Registration Statement on Form SB-2 (Registration No. 333-80075), as filed with the Securities and Exchange Commission on June 4, 1999, as amended. ** Incorporated by reference to the Company's Form 10-KSB for the year ended September 30, 2001, as filed with the Securities and Exchange Commission on December 28, 2001. *** Incorporated by reference to the Company's Form 10-KSB for the year ended September 30, 2003, as filed with the Securities and Exchange Commission on December 29, 2003. **** Incorporated by reference to the Company's Form 8-K filed with the Securities and Exchange Commission on September 2, 2005. # Incorporated by reference to the Company's Form 8-K filed with the Securities and Exchange Commission on December 29, 2005. ## Incorporated by reference to the Company's Form 8-K filed with the Securities and Exchange Commission on January 26, 2006. ### Incorporated by reference to the Company's Form 8-K filed with the Securities and Exchange Commission on December 22, 2006. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Principal Accountant Fees and Services During the fiscal years ended September 30, 2006 and 2005, Westborough Financial retained Wolf & Company, P.C. to provide audit and other services and incurred fees as follows: 2006 2005 ---- ---- Audit fees(1) $ 99,600 $ 94,650 Tax fees(2) 21,800 20,800 All other fees -- -- Total $121,400 $115,450 - ------------------ (1) Audit fees consisted of work performed in connection with the audit of the consolidated financial statements as well as work generally only the independent auditors can reasonably be expected to provide, such as quarterly reviews and review of the annual form 10-KSB filings. (2) Tax fees consisted of fees related to the preparation of Westborough Financial's income tax returns and reviews of income tax provisions. Audit Committee Pre-Approval Policy The Audit Committee, or a designated member of the Audit Committee, shall pre-approve all auditing services and permitted non-audit services (including the fees and terms) to be performed for the Company by its independent auditor, subject to the de minimis exceptions for non-audit services that are approved by the Audit Committee prior to completion of the audit, provided that: (1) the aggregate amount of all such services provided constitutes no more than five percent of the total amount of revenues paid by the Company to its auditor during the fiscal year in which the services are provided; (2) such services were not recognized by the Company at the time of the engagement to be non-audit services; and (3) such services are promptly brought to the attention of the Audit Committee and approved prior to the completion of the audit by the Audit Committee or by one or more members of the Audit Committee who are members of the Board of Directors to whom authority to grant such approvals has been delegated by the Audit Committee. Of the services set forth in the table above, all were pre-approved by the Audit Committee. 73 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. WESTBOROUGH FINANCIAL SERVICES, INC. By: /s/ Joseph F. MacDonough ------------------------------------ President and Chief Executive Officer (Duly Authorized Representative) In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Name Title Date - ---- ----- ---- /s/ James E. Tashjian Chairman of the Board of January 26, 2007 - ------------------------------- Directors James E. Tashjian /s/ Joseph F. MacDonough President, Chief Executive January 26, 2007 - ------------------------------- Officer and Director Joseph F. MacDonough (Principal Executive and Operating Officer) /s/ James N. Ball Director January 26, 2007 - ------------------------------- James N. Ball /s/ Nelson P. Ball Director January 26, 2007 - ------------------------------- Nelson P. Ball /s/ Edward S. Bilzerian Director January 26, 2007 - ------------------------------- Edward S. Bilzerian /s/ Nancy M. Carlson Director January 26, 2007 - ------------------------------- Nancy M. Carlson /s/ David E. Carlstrom Director January 26, 2007 - ------------------------------- David E. Carlstrom /s/ John L. Casagrande Senior Vice President, January 26, 2007 - ------------------------------- Treasurer, Clerk and John L. Casagrande Director (Principal Financial and Accounting Officer) /s/ Benjamin H. Colonero, Jr. Director January 26, 2007 - ------------------------------- Benjamin H. Colonero, Jr. /s/ Jeffrey B. Leland Director January 26, 2007 - ------------------------------- Jeffrey B. Leland 74 /s/ Paul F. McGrath Director January 26, 2007 - ------------------------------- Paul F. McGrath /s/ Charlotte C. Spinney Director January 26, 2007 - ------------------------------- Charlotte C. Spinney /s/ Phyllis A. Stone Director January 26, 2007 - ------------------------------- Phyllis A. Stone 75 EX-23 2 ex23.txt EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S CONSENT We consent to the incorporation by reference in the Registration Statement No. 333-67888 (dated August 17, 2001 on Form S-8) of Westborough Financial Services, Inc., of our report dated November 14, 2006, appearing in this Annual Report on Form 10-KSB/A of Westborough Financial Services, Inc. for the year ended September 30, 2006. /s/ Wolf & Company, P.C. Boston, Massachusetts January 29, 2007 EX-31 3 ex31.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATIONS FURNISHED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Joseph F. MacDonough, certify that: 1. I have reviewed this annual report on Form 10-KSB/A of Westborough Financial Services, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report; 4. The company's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-5(e)) for the company and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the company's internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting; and 5. The company's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company's auditors and the audit committee of the company's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal control over financial reporting. Date: January 26, 2007 /s/ Joseph F. MacDonough ------------------------ Joseph F. MacDonough President and Chief Executive Officer I, John L. Casagrande, certify that: 1. I have reviewed this annual report on Form 10-KSB/A of Westborough Financial Services, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report; 4. The company's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-5(e)) for the company and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the company's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the company's internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting; and 5. The company's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company's auditors and the audit committee of the company's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal control over financial reporting. Date: January 26, 2007 /s/ John L. Casagrande ---------------------- John L. Casagrande Senior Vice President, Treasurer and Clerk EX-32 4 ex32.txt EXHIBIT 32.1 EXHIBIT 32.1 STATEMENT FURNISHED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350 The undersigned, Joseph F. MacDonough, is the President and Chief Executive Officer of Westborough Financial Services, Inc. (the "Company"). This statement is being furnished in connection with the filing by the Company of the Company's Annual Report on Form 10-KSB/A for the fiscal year ended September 30, 2006 (the "Report"). By execution of this statement, I certify that: A) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and B) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered by the Report. This statement is authorized to be attached as an exhibit to the Report so that this statement will accompany the Report at such time as the Report is filed with the Securities and Exchange Commission, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Date: January 26, 2007 /s/ Joseph F. MacDonough ------------------------ Joseph F. MacDonough Exhibit 32.1 STATEMENT FURNISHED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350 The undersigned, John L. Casagrande, is the Senior Vice President, Treasurer and Clerk of Westborough Financial Services, Inc. (the "Company"). This statement is being furnished in connection with the filing by the Company of the Company's Annual Report on Form 10-KSB/A for the fiscal year ended September 30, 2006 (the "Report"). By execution of this statement, I certify that: A) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and B) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered by the Report. This statement is authorized to be attached as an exhibit to the Report so that this statement will accompany the Report at such time as the Report is filed with the Securities and Exchange Commission, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Date: January 26, 2007 /s/ John L. Casagrande ---------------------- John L. Casagrande -----END PRIVACY-ENHANCED MESSAGE-----