10-K405 1 d02-36664.txt MEDFORD BANCORP, INC. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 0-23435 Medford Bancorp, Inc. (Exact name of registrant as specified in its charter) Massachusetts 04-3384928 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 29 High Street Medford, Massachusetts 02155 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (781) 395-7700 ---------------------------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.50 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. |X| The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the closing price on March 4, 2002, on the Nasdaq National Market was $172,207,456. Although directors and executive officers of the registrant were assumed to be "affiliates" of the registrant for the purposes of this calculation, this classification is not to be interpreted as an admission of such status. As of March 4, 2002, there were 7,755,300 shares of the registrant's common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Medford Bancorp, Inc. Definitive Notice of Annual Meeting and Proxy Statement for the Annual Meeting of Stockholders to be held on April 29, 2002 are incorporated by reference into Part III of this Form 10-K. PART I The discussions set forth below and elsewhere herein contain certain statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. The Company may also make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to stockholders, in press releases and other written materials, and in oral statements made by our officers, directors and employees. You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," "intend," estimate," "assume," "will," "should," and other expressions which predict or indicate future events or trends and which do not relate to historical matters. The Company's actual results could differ materially from those projected in the forward-looking statements as a result of, among other factors, the risk factors described herein, changes in volume of loan originations, fluctuations in prevailing interest rates, increases in costs to borrowers of loans held, increases in costs of funds, and changes in assumptions used in making such forward-looking statements. Readers should carefully review the factors described under "Risk Factors and Factors Affecting Forward Looking Statements" and should not place undue reliance on our forward looking statements. The Company assumes no obligations to update any forward-looking statements. ITEM 1. BUSINESS General Medford Bancorp, Inc. (the "Company") was organized in 1997 as a Massachusetts corporation to be the holding company for Medford Savings Bank (the "Bank"). Established as a Massachusetts savings bank in 1869, the Bank converted from mutual to stock form on March 18, 1986 and issued 3,680,000 shares of common stock. The Bank is principally engaged in the business of attracting deposits from the general public, originating residential and commercial real estate mortgages, consumer and commercial loans, and investing in securities on a continuous basis. For a detailed description of the Company's business and financial information, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this report. The Bank is headquartered in Medford, Massachusetts, which is located approximately seven miles north of downtown Boston. The Bank principally offers its products and services through a network of nineteen banking offices located in Medford, Malden, Arlington, Belmont, Burlington, North Reading, Somerville, Tewksbury, Waltham, and Wilmington. The Bank's primary market area includes these communities as well as other cities and towns in Middlesex County and the surrounding area north of Boston. The Bank presently has one wholly-owned subsidiary, Medford Securities Corporation ("MSC"), which became operational on March 1, 1995. MSC engages exclusively in the buying, selling, dealing in, and holding of securities. Supervision and Regulation Medford Bancorp, Inc. In addition to the generally applicable state and federal laws governing businesses and employers, we are further regulated by federal and state laws and regulations applicable to financial institutions and their parent companies. Virtually all aspects of our operations are subject to specific requirements or restrictions and general regulatory oversight. State and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers or classes of consumers, rather than the specific protection of stockholders of a bank or its parent company. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. General. The Company is a Massachusetts corporation and a bank holding company (a "BHC") subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "FRB") pursuant to the Bank Holding Company Act of 1956, as amended (the "BHCA"), and files with the Federal Reserve Board an annual report and such additional reports as the Federal Reserve Board may require. The Company is also subject to the jurisdiction of the Commissioner of Banks of the Commonwealth of Massachusetts (the "Commissioner"). As a bank holding company, the Company's activities are limited to the business of banking and activities closely related or incidental to banking. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of BHCs, and to order termination of ownership and control of a non-banking subsidiary by a BHC. 1 BHCA - Activities and Other Limitations. The BHCA prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any BHC without prior approval of the FRB. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") generally authorizes BHCs to acquire banks located in any state, possibly subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers and to a lesser extent, interstate branching. Unless a BHC becomes a "financial holding company" ("FHC") under the Gramm-Leach-Bliley Act ("GLBA") (as discussed below), the BHCA also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or BHC and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. The GLBA established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework to permit BHCs that qualify and elect to be treated as FHCs to engage in a range of financial activities broader than would be permissible for traditional BHCs, such as the Company, that have not elected to be treated as FHCs. "Financial activities" is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Capital Requirements. The FRB has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a BHC and in analyzing applications to it under the BHCA. These capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the "Total Risk-Based Capital Ratio"), with at least one-half of that amount consisting of Tier I or core capital and the remaining amount consisting of Tier II or supplementary capital. In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier I capital (defined by reference to the risk-based capital guidelines) to total average assets (the 'Leverage Ratio') of 3.0%. Total average assets for this purpose does not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier I capital. The Company currently is in compliance with both the Risk Based Capital Ratio and the Leverage Ratio requirements. At December 31, 2001, the Company had a Tier I Risk Based Capital Ratio equal to 12.9% and a Total Risk Based Capital Ratio equal to 13.8% and a Leverage Ratio equal to 7.4%. U.S. bank regulatory authorities and international bank supervisory organizations, principally the Basel Committee on Banking Supervision, currently are considering changes to the risk-based capital adequacy framework which ultimately could affect the appropriate capital guidelines applicable to U.S. banking institutions. Limitations on Acquisitions of Common Stock. The Federal Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a BHC unless the FRB has been given at least 60 days to review the proposal. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting stock of a BHC, such as the Company, with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") would, under the circumstances set forth in the presumption, constitute the acquisition of control. In addition, any company, as that term is broadly defined in the statute, would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a BHC) or more, or such lesser percentage of our outstanding common stock as the FRB deems to constitute control over the Company. Massachusetts Law. The Company is deemed a bank holding company for purposes of Massachusetts law due to the manner in which it acquired the Bank. Accordingly, it is registered with the Commissioner and is obligated to make reports to the Commissioner. Further, as a Massachusetts bank holding company, the Company may not acquire all or substantially all of the stock or assets of a banking institution or merge or consolidate with another bank holding company without the prior consent of the Massachusetts Board of Bank Incorporation (the "BBI"). As a general matter, however, the Commissioner does not rule upon or regulate the activities in which bank holding companies or their nonbank subsidiaries engage. 2 Medford Savings Bank As a Massachusetts-chartered savings bank, the Bank is subject to comprehensive regulation and examination by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is also subject to certain requirements established by the FRB and is a member of the Federal Home Loan Bank of Boston (the "FHLBB"). The federal and state laws and regulations which are applicable to banks regulate among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. FDIC Insurance Premiums. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund-member institutions. The FDIC has established a risk-based assessment system under which institutions are classified, and generally pay premiums according to their perceived risk to the federal deposit insurance funds. The Federal Deposit Insurance Act ("FDIA") does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. A resumption of assessments of deposit insurance premiums charged to well capitalized institutions, such as the Bank, could have an effect on our net earnings. Federal Deposit Insurance Corporation. The FDIC insures the Bank's deposit accounts to the $100,000 maximum per separately insured account. As a state-chartered, FDIC-insured nonmember savings bank, the Bank is subject to regulation, examination, and supervision by the FDIC, and to reporting requirements of the FDIC. The FDIC has adopted requirements setting minimum standards for capital adequacy. These requirements are substantially similar to those adopted by the FRB regarding BHCs, as described above. Transactions with Affiliates. The FDIA restricts the range of permissible transactions between a bank and an affiliated company. The Bank is subject to certain restrictions on loans to the Company, on investment in the stock or securities thereof, on the taking of such stock or securities as collateral for loans to any borrower, and on the issuance of a guarantee or letter of credit on the Company's behalf. The Bank also is subject to certain restrictions on most types of transactions with the Company, requiring that the terms of such transactions be substantially equivalent to terms to similar transactions with non-affiliates. The GLBA requires the FRB to promulgate rules addressing credit exposure relating to derivatives transactions between banks and their affiliates. The FRB has adopted interim rules addressing such transactions, and it has solicited comments on the types of restrictions that should apply to derivatives transactions between banks and their affiliates. Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA generally limits the activities as principal and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 to ease the ability of state banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notice to engage in such activities. Further, the GLBA permits national banks and state banks, to the extent permitted under state law, to engage in certain new activities which are permissible for subsidiaries of an FHC. Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires the FDIC to evaluate the Bank's performance in helping to meet the credit needs of the community. Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate the Bank's performance in helping to meet community credit needs. As a part of the CRA program, the Bank is subject to periodic examinations by the Commissioner, and maintains comprehensive records of its CRA activities for this purpose. Management believes the Bank is currently in compliance with all CRA requirements. Federal Home Loan Bank System. The Federal Home Loan Bank System functions as a reserve credit source for its member financial institutions and is governed by the Federal Housing Finance Board ("FHFB"). The Bank is a voluntary member of the FHLBB. Members of the FHLBB are required to own capital stock that is directly proportionate to the member's home mortgage loans and borrowings from the FHLBB outstanding from time to time. FHLBB advances must be secured by specific types of collateral and may be obtained principally for the purpose of providing funds for residential housing finance. Federal Reserve Board Regulations. Regulation D promulgated by the Federal Reserve Board requires all depository institutions, including the Bank, to maintain reserves against its transaction accounts (generally, demand deposits, NOW accounts and certain other types of accounts that permit payments or transfer to third parties) or non-personal time deposits (generally, money market deposit accounts or other savings deposits held by corporations or other depositors that are not natural persons, and certain other types of time deposits), subject to certain exemptions. Because required reserves must be maintained in the form of either vault cash, a non-interest bearing account at a Federal Reserve Bank or a pass-through account as defined by the Federal Reserve Board, the effect of this reserve requirement is to reduce the amount of the institution's interest-bearing assets. 3 Customer Information Security. The FRB, the FDIC and other bank regulatory agencies have adopted final guidelines (the "Guidelines") for safeguarding confidential customer information. The Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors, to create a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information; and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires us to explain to consumers our policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, we are prohibited from disclosing such information except as provided in our policies and procedures. USA Patriot Act. The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the United States financial system, has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act mandates or will require financial institutions to implement additional policies and procedures with respect to the following matters, among others: money laundering; suspicious activities and currency transaction reporting; and currency crimes. Massachusetts Commissioner of Banks and Board of Bank Incorporation. The Bank is also subject to regulation, examination and supervision by the Commissioner and to the reporting requirements promulgated by the Commissioner. Massachusetts statutes and regulations govern, among other things, investment powers, lending powers, deposit activities, maintenance of surplus and reserve accounts, the distribution of earnings, the payment of dividends, issuance of capital stock, branching, acquisitions and mergers and consolidation. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Commissioner may be subject to sanctions for noncompliance. The Commissioner may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the Bank's business in a manner which is unsafe, unsound or contrary to the depositor's interest, or been negligent in the performance of their duties. In response to a Massachusetts law enacted in 1996, the Commissioner finalized rules in 1997 and 2000 that give Massachusetts banks, and their subsidiaries, many powers equivalent to those of national banks. The Commissioner also has adopted procedures expediting branching by strongly capitalized banks. Depositors Insurance Fund. Massachusetts-chartered savings banks are required to be members of the Depositors Insurance Fund ("DIF"), a corporation created by the Commonwealth of Massachusetts for the purpose of insuring savings bank deposits not covered by federal deposit insurance. To the extent the Bank's deposit accounts are not insured by federal insurance, such deposits are insured by the DIF. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Under the Interstate Act , different types of interstate transactions and activities are permitted. Interstate transactions and activities provided for under the law include: (i) bank holding company acquisitions of separately held banks in a state other than a bank holding company's home state; (ii) mergers between banks with different home states, including consolidations of affiliated banks; (iii) establishment of interstate branches either de novo or by branch acquisition; and (iv) affiliate banks acting as agents for one another for certain banking functions without being considered a "branch". In general, subject to certain limitations, nationwide interstate acquisitions are now permissible, irrespective of state law limitations other than limitations related to deposit concentrations and bank age requirements. Interstate mergers also are permissible. Affiliated banks may act as agents for one another. Each of the transactions and activities must be approved by the appropriate federal bank regulator, with separate and specific criteria established for each category. In 1996, Massachusetts enacted interstate banking laws in response to the Interstate Act. The laws permit, subject to certain deposit and other limitations, interstate acquisitions, mergers and branching on a reciprocal basis. Federal Securities Laws. Pursuant to the Securities Exchange Act of 1934 (the "Exchange Act"), the Company files annual, quarterly, and periodic reports with the Securities and Exchange Commission (the "SEC"). The Company is also subject to the insider trading requirements of Sections 16(a) and 16(b) of the Exchange Act, as administered by the SEC. 4 Other Securities Laws Issues. The GLBA also amended the federal securities laws to eliminate the blanket exceptions that banks traditionally have had from the definition of broker dealer and investment adviser. With respect to broker dealer registration, the SEC has extended the date by which banks must comply with new broker-dealer registration requirements until May 12, 2002. Banks not falling within the specific exemptions provided by the new law may have to register with the SEC as a broker-dealer and become subject to SEC jurisdiction. With respect to investment adviser registration, the GLBA requires a bank that acts as investment adviser to a registered investment company to register as an investment adviser or to conduct such advisory activities through a separately identifiable department or division of the bank so registered. The Bank will not be required to register as a broker dealer or investment adviser as a result of these changes. Other Activities The Bank owns stock in The Savings Bank Life Insurance Company of Massachusetts ("SBLI"). The Bank sells life insurance and tax-deferred annuities and sold over $1.4 million in SBLI annuities in 2001, making it the top seller of this product in Massachusetts. The Bank provides safe deposit services at nine of its branches. The Bank periodically originates 30-year, fixed-rate, residential 1-4 family loans in correspondent relationships with third parties such as General Motors Acceptance Corporation (GMAC), Plymouth Mortgage Company and Federal Home Loan Mortgage Corporation (FHLMC), whereby the Bank originates loans in exchange for an origination fee. The Bank does not retain the servicing rights for these loans. Competition The Company faces substantial competition for loan origination and for the attraction and retention of deposits. Competition for loan origination arises primarily from commercial banks, other thrift institutions, credit unions and mortgage companies. The Company competes for loans on the basis of product variety and flexibility, competitive interest rates and fees, service quality and convenience. Competition for the attraction and retention of deposits arises primarily from commercial banks, other thrift institutions, and credit unions having a presence within and around the market area served by the Bank's main office and its community branch and ATM network. There are approximately 200 of these financial institutions in the Bank's market area. In addition, the Company competes with regional and national firms which offer stocks, bonds, mutual funds and other investment alternatives to the general public. The Company competes on its ability to satisfy such requirements of savers and investors as product alternatives, competitive rates, liquidity, service quality, convenience, and safety against loss of principal and earnings. Moreover, under the GLBA, as of March 11, 2000, securities firms, insurance companies and other financial services providers that elect to become financial holding companies may acquire banks and other financial institutions. The GLBA may significantly change the competitive environment in which the Company and its subsidiaries conduct business. See "Supervision and Regulation --BHCA-Activities and Other Limitations" above. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. Management believes that the Company's emphasis on personal service and convenience, coupled with active involvement within the communities it serves, contributes to its ability to compete successfully. Risk Factors and Factors Affecting Forward Looking Statements In addition to the other information contained or incorporated by reference in this Annual report on Form 10-K, you should consider the following factors relating to the business of the Company. Interest Rate Volatility May Reduce The Bank's Profitability The Bank's profitability depends to a large extent upon its net interest income, which is the difference between its interest income on interest-earning assets, such as loans and investments, and its interest expense on interest bearing liabilities, such as deposits and borrowed funds. Significant changes in market interest rates may adversely affect both the Bank's profitability and its financial condition. Since market interest rates may change by differing magnitudes and at different times, significant changes in interest rates over an extended period of time could reduce overall net interest income. (See Item 7A, Quantitative and Qualitative Disclosures about Market Risk, for additional discussion on interest rate risk.) 5 Defaults in the Repayment of Loans by Customers May Negatively Impact the Bank's Business The Bank makes various assumptions and judgments about the collectibility of its loan portfolio and provides an allowance for potential losses based on a number of factors. If the Bank's assumptions are wrong, its allowance for loan losses may not be sufficient to cover its losses, which would have an adverse effect on its operating results, and may also cause the Bank to increase the allowance in the future. Further, the Bank's net income would decrease if it had to add additional amounts to its allowance for loan losses. Geographic Credit Concentration The Bank is exposed to real estate and economic market conditions in the greater Boston metropolitan area and eastern Massachusetts because virtually all of its loan portfolio is concentrated among borrowers in this market. Further, because a substantial portion of its loan portfolio is secured by real estate in this area, the value of the Bank's collateral is also subject to regional real estate market conditions. A downturn in the economy in the Bank's primary lending area may likely adversely affect the Bank's operations by impacting the ability of the Bank's borrowers to repay their loans and affecting the value of the collateral securing these loans. Strong Competition within the Bank's Market Area Competition in the banking and financial services industry is strong. In its market area, the Bank competes for loans and deposits with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally as well as nationally. Many of these competitors have substantially greater resources and lending limits than the Bank; as a result, these competitors may have a marketplace advantage because they are able to maintain numerous banking locations, mount extensive promotional campaigns and may offer services that the Bank does not or cannot provide. The Bank's long-term success depends on the ability of the Bank to compete successfully with other financial institutions in their service areas. (See information under the caption "Competition" for additional discussion.) In addition, as the Company strives to compete with other financial institutions, it may expand into new areas, and there is no assurance that it will be successful in these efforts. Employees As of December 31, 2001, the Bank employed 223 full-time staff, including 50 officers, and 114 part-time staff. None of the Bank's employees is represented by a labor union. The Company has no officers or employees separate from the Bank. ITEM 2. PROPERTIES All of the Bank's branches located in Medford (except for the West Medford branch), the branches located in Arlington (except for Arlington Center), the Malden Center, Maplewood and Oak Grove branches located in Malden, and the Tewksbury branch, located in Tewksbury, are owned by the Bank. All other branches are leased from unrelated third parties. The Company also owns an office building currently housing the Company's lending and certain administrative offices. Additional space in this operations center is leased to third parties. Subject to the foregoing, the Company believes that its properties are adequate for its present needs. ITEM 3. LEGAL PROCEEDINGS There are no material legal proceedings to which the Company is a party or to which any of its property is subject, although the Company is a party to ordinary routine litigation incidental to its business. In the opinion of management, final disposition of these proceedings will not have a material adverse effect on the financial condition or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 6 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's common stock is traded on the Nasdaq National Market System under the symbol "MDBK." The following table sets forth cash dividends declared on common stock and the high and low closing prices for the quarters indicated. All prices set forth below are based on information provided by the National Association of Securities Dealers, Inc. Common Stock Sale Prices ------------------------ Dividends Declared High Low Per Share ------ ------ ------------------ 2001 1st quarter $19.00 $15.13 $0.13 2nd quarter 20.45 17.30 0.13 3rd quarter 23.22 19.30 0.13 4th quarter 22.05 19.13 0.15 2000 1st quarter $16.50 $12.13 $0.12 2nd quarter 15.63 13.75 0.12 3rd quarter 16.13 13.88 0.12 4th quarter 15.63 13.38 0.16 At March 4, 2002, according to the Company's transfer agent, the Company had approximately 1,007 record holders of its common stock. The number of holders of record does not reflect the number of persons or entities who or which held their stock in nominee or "street" name through various brokerage firms or other entities. The declaration of future dividends to the Company's stockholders is subject to future operating results, financial conditions, tax and legal considerations and other factors, such as the Bank's ability to declare and pay dividends to the Company. As the principal asset of the Company, the Bank currently provides the only source of payment of dividends by the Company. The Federal Deposit Insurance Corporation Improvement Act of 1991 limits the ability of undercapitalized insured banks to pay dividends. Moreover, under Massachusetts law, a stock-form savings bank may pay dividends no more frequently than quarterly only out of its net profits and only to the extent such dividends do not impair the Bank's capital stock, as defined; and the Commissioner's approval may be required under certain circumstances. Under Federal Reserve Board and FDIC regulations, the Company and the Bank would be prohibited from declaring dividends if, among other things, they were not in compliance with applicable regulatory capital requirements. Funds held by the Company are available for various corporate uses, including the payment of future dividends. 7 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
At December 31, ------------------------------------------------------------------ (Dollars in thousands, except per share data) 2001 2000 1999 1998 1997 ---------- ---------- ---------- ---------- ---------- BALANCE SHEET DATA Total assets $1,412,771 $1,309,690 $1,224,912 $1,151,188 $1,135,572 Securities (includes FHLB stock) 657,205 582,964 534,713 511,534 512,304 Loans, net 675,183 668,747 626,751 580,665 570,844 Deposits 1,095,947 975,857 911,328 871,702 821,706 Borrowed funds 200,281 223,843 215,724 170,116 205,779 Stockholders' equity 111,565 104,965 90,870 102,267 101,510 Book value per share 14.43 12.89 10.84 11.74 11.18 Stockholders' equity to total assets 7.90% 8.01% 7.42% 8.88% 8.94% Number of offices 19 18 17 17 16 -----------------------------------------------------------------------------------------------------------
Years Ended December 31, ---------------------------------------------------- (Dollars in thousands, except per share data) 2001 2000 1999 1998 1997 ------- ------- ------- ------- ------- STATEMENT OF INCOME DATA Interest and dividend income $88,889 $86,050 $77,849 $76,802 $75,332 Interest expense 51,073 49,914 43,109 42,613 41,349 ------- ------- ------- ------- ------- Net interest income 37,816 36,136 34,740 34,189 33,983 Provision for loan losses 150 175 -- 75 125 ------- ------- ------- ------- ------- Net interest income, after provision for loan losses 37,666 35,961 34,740 34,114 33,858 ------- ------- ------- ------- ------- Other income: Gain (loss) on sales of securities, net 2,121 (1,031) 1,522 1,670 835 All other income 3,417 7,781 2,680 3,088 3,007 ------- ------- ------- ------- ------- Total other income 5,538 6,750 4,202 4,758 3,842 ------- ------- ------- ------- ------- Operating expenses 21,683 19,991 19,301 19,074 19,054 ------- ------- ------- ------- ------- Income before income taxes 21,521 22,720 19,641 19,798 18,646 Provision for income taxes 7,743 8,951 6,990 7,546 7,256 ------- ------- ------- ------- ------- Net income $13,778 $13,769 $12,651 $12,252 $11,390 ======= ======= ======= ======= ======= Basic earnings per share $ 1.76 $ 1.69 $ 1.51 $ 1.38 $ 1.25 ======= ======= ======= ======= ======= Diluted earnings per share $ 1.72 $ 1.64 $ 1.44 $ 1.31 $ 1.19 ======= ======= ======= ======= ======= Cash dividends declared per share $ 0.54 $ 0.52 $ 0.51 $ 0.50 $ 0.45 ======= ======= ======= ======= ======= SELECTED RATIOS Return on average assets 1.02% 1.09% 1.07% 1.09% 1.05% Return on average equity 12.81 15.06 13.52 11.99 11.81 Average equity to average assets 7.92 7.23 7.88 9.07 8.91 Weighted average rate spread 2.44 2.49 2.63 2.72 2.84 Net yield on average earning assets 2.88 2.93 3.03 3.16 3.26 Dividend payout ratio - basic earnings per share 30.68 30.77 33.77 36.23 36.00 -----------------------------------------------------------------------------------------------------------
8 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussions set forth below, elsewhere herein, in our press releases and in oral statements we make by or with the approval of our authorized executives contain certain statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. The Company may make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to stockholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," "intend," "estimate," "assume," "will," "should," and other expressions which predict or indicate future events or trends and which do not relate to historical matters. You should exercise caution in interpreting and relying on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Company. These risks, uncertainties and other factors may cause the actual results of the Company to be materially different from the anticipated future results expressed or implied by the forward-looking statements. Some of the factors that might cause these differences include the following: changes in general, national or regional economic conditions, including changes that adversely affect borrowers ability to service and repay our loans; changes in loan default and charge-off rates; reductions in deposit levels necessitating increased borrowing to fund loans and investments; changes in interest rates; changes in laws and regulations; changes in the size and nature of the Company's competition; and changes in the assumptions used in making such forward-looking statements. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences, including, among others, the factors listed under "Risk Factors and Factors Affecting Forward Looking Statements," beginning on page 5, which readers should carefully review. These forward-looking statements reflect our good faith beliefs based on information, plans and estimates at the date of this report, and we expressly disclaim any duty to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. GENERAL The Company's net income is primarily attributable to its level of net interest income, which represents the difference between interest and dividend income earned on earning assets and interest paid on deposits and other borrowed money. The main components of the Company's earning assets are loans, securities and short-term investments. Interest-bearing deposits include NOW, savings, money market and term certificates of deposit. The net interest income performance of the Company is significantly affected by general economic conditions, by the Company's corporate strategies, its asset/liability management, tactical programs and by the policies of regulatory authorities. Sources of non-interest income such as loan servicing fees, gains on sales of securities and other fees derived from various banking services contribute positively to the Company's results. The principal operating expenses of the Bank are salaries and employee benefits, occupancy and equipment expenses, data processing expenses, amortization of intangibles, advertising and marketing and other general and administrative expenses. Despite a challenging economic environment in 2001, for the ninth consecutive year the Company continued to improve its earnings per share performance. Earnings per share for 2001 were $1.76 ($1.72 on a diluted basis), compared with $1.69 ($1.64 on a diluted basis) for 2000, an increase of $0.08 on a diluted basis or 4.9%. Due to the gain recorded from the curtailment and settlement of its defined benefit plan in year 2000, the Company's year-to-year earnings remained essentially level with $13,778,000 in 2001 as compared to $13,769,000 in 2000. At December 31, 2001, total assets were $1.4 billion, an increase of $103.1 million or 7.9% from the prior year. Growth in the funding side of the balance sheet was led by strong growth in total deposits of 12.3%, with core deposits growing by 15.7%. Stockholders' equity increased 6.3% to $111.6 million at December 31, 2001, representing a book value of $14.43 per share, compared to $12.89 per share at December 31, 2000. Stockholders' equity to total assets was 7.90% at December 31, 2001, exceeding all regulatory requirements. The growth in deposits and stockholders' equity allowed the Company to modestly reduce its total borrowings by $23.6 million to a level of $200.3 million at December 31, 2001. The sources of funds were principally utilized by the Company to grow its interest-bearing deposits and investment portfolio in 2001, which increased by $97.2 million, or 16.5%. As the Company exercised restraint in growing its loan portfolio during a weakening economy, gross loans increased by a more modest level of $6.6 million or 1.0%. 9 FINANCIAL CONDITION Investment Portfolio The investment policy of the Company is structured to provide an adequate level of liquidity in order to meet anticipated deposit outflows, normal working capital needs and expansion of the loan portfolio within guidelines approved by the Board of Directors, while earning market returns. Accordingly, the majority of securities are in shorter-term Government, agency, or high-quality (rated "A" or better) corporate securities. Debt securities purchased generally have maturities or call dates within three years or less. Although the emphasis on short-term and medium-term investments reduces the overall yield, this strategy is in accordance with the Company's desire to minimize interest rate risk. Securities, including FHLB stock, were higher than 2000 year-end levels, at $657.2 million at December 31, 2001 versus $583.0 million at December 31, 2000. During 2001, as rates declined and the economy weakened, the Company modified the mix of the investment portfolio to generate higher levels of interest income and to reduce credit risk. The strategy included the replacement of corporate bonds as they matured or were sold with U.S. Government, federal agency, and mortgage-backed securities. At December 31, 2000, U.S. Government, federal agency and mortgage-backed securities equaled 44.1% of total securities while corporate bonds equaled 53.6%. At December 31, 2001, U.S. Government, federal agency and mortgage-backed securities increased to 58.6% of total securities while corporate bond exposure was reduced to 39.4% from 53.6%. Investments in corporate bonds consist primarily of "A" or better rated or bonds with maturities of three years or less. Purchases of mortgage-backed securities throughout 2000 and 2001 consist primarily of fixed-rate, low-coupon, government-backed securities that have limited extension or contraction risk. Purchases of mortgage-backed securities give consideration to the underlying collateral, the impact of rising or falling rates on the average life of these securities and other factors associated with the Bank's investment policies and strategies. Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and reflected at amortized cost. All other marketable securities are classified as "available for sale" and reflected on the balance sheet at fair value, with unrealized gains and losses excluded from earnings and reported, net of tax, in other comprehensive income (loss) in stockholders' equity. As of December 31, 2001, the pre-tax net unrealized gain on investments classified as "available for sale" was $9.1 million as compared to the net unrealized gain of $651,000 as of December 31, 2000. The Bank also holds limited amounts of equity securities subject to the investment limitations imposed by FDICIA and the Commissioner. The following table sets forth certain information concerning the securities portfolio at carrying value: At December 31, ------------------------------ 2001 2000 1999 -------- -------- -------- (In thousands) Debt securities: U.S. Government and federal agency $ 78,452 $ 7,806 $ 62,127 Mortgage-backed securities 306,995 249,452 214,456 Corporate bonds 258,958 312,315 246,767 Marketable equity securities 880 1,971 1,680 -------- -------- -------- Total marketable securities 645,285 571,544 525,030 Federal Home Loan Bank stock 11,920 11,420 9,683 -------- -------- -------- Total securities $657,205 $582,964 $534,713 ======== ======== ======== 10 The following table sets forth the maturity distribution of debt securities (excluding mortgage-backed securities) at carrying value, with related weighted average yields:
At December 31, 2001 -------------------------------------------------------------------- Weighted Weighted Weighted Within Average Over 1 Year Average Over Average 1 Year Yield to 5 Years Yield 5 Years Yield --------- --------- ---------- --------- --------- --------- (Dollars in thousands) U.S. Government and federal agency $ -- --% $ 64,842 4.18% $13,550 5.27% Corporate bonds 76,891 6.30 174,640 6.31 -- -- ------- -------- ------- $76,891 6.30% $239,482 5.73% $13,550 5.27% ======= ======== =======
Loan Portfolio The Company offers a variety of lending products, including fixed-rate and adjustable-rate residential mortgages, equity lines of credit, fixed-rate and adjustable-rate commercial mortgages, construction loans, consumer loans and commercial business loans. As a portfolio lender, the Company generally retains all newly originated loans. From time to time, the Company originates and retains 30-year, fixed-rate residential loans. More frequently, however, the 30-year, fixed-rate residential loan product is generally offered whereby the Bank originates these loans for correspondent banks and collects origination fees therefrom. As mortgage interest rates declined in 2001 to their lowest level in years, the Company has, from time to time, also elected to originate 15-year fixed-rate residential loan products for correspondent banks. Real estate and commercial loan originations are initiated by the Bank's officers and lending personnel from a number of sources, including referrals from realtors, builders, attorneys, and customers. Direct mail to existing and potential customers is used to solicit other loan services. Advertising media is also used to promote loans. The Bank employs on-the-road originators and pays them commissions for loan originations. Applications for residential and consumer loans are accepted at all of the Bank's locations and are referred to the main office for processing. The Company has lending policies in place which are intended to control credit risk inherent in the origination and retention of loans in portfolio. Among other considerations, these policies delineate the Bank's geographic market region, and establish credit procedures and acceptable loan-to-value ratios for all loans. Additional specific policies are in effect for commercial and commercial real estate loans. Gross loans increased to $682.3 million at December 31, 2001 compared to $675.7 million at December 31, 2000. The modest increase in loans was primarily the result of growth in commercial real estate and equity lines of credit which increased $6.0 million and $3.6 million, respectively. The growth in such categories was partially offset by the contraction in the other loan segments. Residential real estate loans declined as external refinances and the origination of 15 and 30 year fixed rate loans for correspondents offset record volume generation in 2001. The Company expects continued intense competition for loans within its geographic region. Within this framework, management continues its marketing efforts for loans. 11 The following table shows the composition of the loan portfolio by type of loan:
At December 31, --------------------------------------------------------- 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- (In thousands) Commercial loans $ 17,954 $ 17,219 $ 18,124 $ 17,358 $ 14,941 Loans secured by real estate: Residential 487,331 487,964 465,618 421,685 389,863 Construction loans, net of unadvanced funds 17,228 19,913 13,504 13,073 11,278 Commercial 130,207 124,201 112,050 109,561 124,094 Second mortgages 444 699 774 1,111 1,539 Equity lines of credit 25,199 21,609 19,394 20,606 22,146 Consumer loans 2,652 2,925 2,912 3,145(1) 12,931 -------- -------- -------- -------- -------- 681,015 674,530 632,376 586,539 576,792 Net deferred loan origination costs 1,248 1,167 1,154 1,002 785 Allowance for loan losses (7,080) (6,950) (6,779) (6,876) (6,733) -------- -------- -------- -------- -------- Loans, net $675,183 $668,747 $626,751 $580,665 $570,844 ======== ======== ======== ======== ========
(1) The Bank sold $11.0 million of education loans in 1998 thereby exiting this business due to profitability concerns. The following table presents the maturity distribution of commercial and construction loans at December 31, 2001: Maturities ------------------------------------------------ 1 Year Over 1 Year Over or Less to 5 Years 5 Years Total --------- ----------- --------- -------- (In thousands) Commercial loans $13,760 $3,263 $ 931 $17,954 Construction loans 7,217 1,144 8,867 17,228 Generally, construction loans provide for payments of interest only during the construction period, and then payments of principal and interest throughout the remaining life of the loans. In all cases, these construction loans have adjustable interest rates. Commercial loans with maturities of over one year are subject to interest rate adjustment or maturity according to the following schedule: Scheduled Maturity or Rate Adjustment --------------------------------------- Over 1 Year Over to 5 Years 5 Years Total ------------ ---------- ---------- (In thousands) Predetermined rates $2,389 $ -- $2,389 Adjustable rates 874 931 1,805 ------ ---- ------ $3,263 $931 $4,194 ====== ==== ====== 12 Non-performing Assets It is the Bank's policy to discontinue the accrual of interest on loans 90 days or more past due. Interest accrual ceases, and all previously accrued but unpaid interest is reversed, when a loan is placed on non-accrual status. At the option of management, a loan may be placed on non-accrual status prior to being 90 days past due if the collection of future interest and principal is, in the opinion of management, doubtful. Non-accrual loans are generally classified as impaired loans. The Bank recognizes impaired loans based on Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan." Under this Statement, a loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All of the Bank's loans, which have been identified as impaired, have been measured by the fair value of existing collateral. Impaired loans are generally placed on non-accrual status whereby interest income is recognized only when received. The Bank does not apply SFAS No. 114 to individual consumer loans which are collectively evaluated for impairment. The following table sets forth information with respect to impaired and non-accrual loans and foreclosed real estate, at the dates indicated. There were no loans 90 days or more past due and still accruing at the dates indicated.
At December 31, -------------------------------------------------- 2001 2000 1999 1998 1997 ------- ------- ------- ------- ------- (In thousands) Impaired loans accounted for on a non-accrual basis $975 $1,047 $2,482 $1,766 $1,726 Other loans accounted for on a non-accrual basis 1 -- 18 47 -- Foreclosed real estate -- -- 119 48 ---- ------ ------ ------ ------ $976 $1,047 $2,500 $1,932 $1,774 ==== ====== ====== ====== ======
For non-accrual loans at December 31, 2001, gross interest income of $289,000 would have been recorded during the year had the loans remained current in accordance with original terms. The amount of interest income on such loans that was included in net income for the period was $260,000. Allowance for Loan Losses The allowance for loan losses is established through a provision for loan losses charged through the statement of income. Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based on management's evaluation of the amount required to absorb estimated losses inherent in the loan portfolio after weighing various factors. Ultimate losses may vary significantly from current estimates. Quarterly reviews of the loan portfolio are performed to identify loans for which specific allowance allocations are considered prudent. The Bank also engages an independent third party to review and ascertain the underlying quality of targeted portfolio segments, three times a year, to support a comprehensive analysis of the overall portfolio. These review processes identify weaknesses as well as improvements in lending relationships since the last review. Management utilizes the results in its evaluation of the adequacy of its allowance for loan losses. Specific allocations include the results of measuring impaired loans under SFAS No. 114. General risk allocations are determined by formula whereby the loan portfolio is stratified by loan type and by risk rating category. Loss factors are then applied to each category based on various considerations including historical loss experience, delinquency trends, and current economic conditions. Any remaining unallocated portion is reviewed for adequacy in relation to the overall loan portfolio and in recognition of estimates inherent in the calculation methodology. 13 An analysis of the allowance for loan losses is presented in the following table:
Years Ended December 31, ------------------------------------------------------ 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- (In thousands) Allowance for loan losses, beginning of year $6,950 $6,779 $6,876 $6,733 $7,231 ------ ------ ------ ------ ------ Loans charged-off --- Residential real estate (13) (20) (2) (24) (38) --- Commercial real estate -- (5) (16) -- (720) --- Consumer (65) (28) (25) (33) (42) --- Commercial -- (6) (121) (108) (31) Recoveries --- Residential real estate 38 36 11 20 26 --- Commercial real estate 14 7 24 204 147 --- Consumer 5 10 19 9 25 --- Commercial 1 2 13 -- 10 ------ ------ ------ ------ ------ Net recoveries (charge-offs) (20) (4) (97) 68 (623) ------ ------ ------ ------ ------ Provision for loan losses, charged to operations 150 175 -- 75 125 ------ ------ ------ ------ ------ Allowance for loan losses, end of year $7,080 $6,950 $6,779 $6,876 $6,733 ====== ====== ====== ====== ====== Ratio of net charge-offs (recoveries) to average loans 0.00% 0.00% 0.02% (0.01)% 0.11% ====== ====== ====== ====== ======
An analysis of the allocation of the allowance for loan losses is presented in the following table:
At December 31, -------------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ---------------- ---------------- ---------------- ---------------- ---------------- Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- (Dollars in thousands) Residential real estate $2,133 75.32% $2,002 75.66% $1,858 76.86% $1,683 75.64% $1,067 71.73% Commercial real estate 4,222 19.12 4,179 18.41 4,121 17.69 4,433 18.65 5,220 21.49 Construction 360 2.53 398 2.95 270 2.13 261 2.22 169 1.95 Consumer 38 0.39 44 0.43 41 0.46 42 0.54 48 2.24 Commercial 327 2.64 327 2.55 489 2.86 457 2.95 229 2.59 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total $7,080 100.00% $6,950 100.00% $6,779 100.00% $6,876 100.00% $6,733 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
While management considers the allowance for loan losses to be adequate at December 31, 2001, there is no assurance that additional charge-offs and provisions will not be necessary in 2002. The unallocated allowance component has been allocated principally to commercial real estate for purposes of the above presentation. The provision for loan losses during 2002 will depend primarily on market conditions and the Bank's actual experience. Loan Concentrations Other than the focus of the Bank's lending activities to its market area, the Bank does not have a concentration of loans exceeding 10% of total loans at the end of 2001. 14 Deposits Deposits historically have been the Bank's primary source of funds. The Bank offers a wide variety of deposit products to attract both short-term and long-term deposits from individuals, partnerships and corporations, non-profits and municipalities. Deposit products include regular savings accounts, NOW accounts, money market deposit accounts, individual retirement accounts, term certificates, and retail and commercial demand deposit accounts. The Bank also solicits corporate and municipal deposits. To maintain stable deposit rates and manage interest rate risk, the Bank's strategy has been to attract deposits through selective promotions. To increase core deposits, the Bank continues to promote its "ComboPlus" account, which combines a statement savings account and checking account into one convenient account offered at a competitive rate which exceeds the regular statement and passbook savings account rates. This account type has contributed significantly to the increase in savings and demand deposits. Total deposits increased $120.1 million, or 12.3%, to $1.1 billion at December 31, 2001 from $975.9 million at December 31, 2000. With the equities market in a second year of decline and a lower interest rate environment, the Bank's Combo savings account provided a safe haven and a competitive rate. Combo savings increased $113.5 million or 87.9% from $129.1 million at December 31, 2000 to a level of $242.5 million at December 31, 2001. As retail customers continue to seek alternative banking relationships in a consolidating market, demand deposits increased $11.5 million or 18.2%, when compared to the prior year. The growth in money market deposits and decline in term certificates of $100,000 or more can be explained primarily by the shift in the mix of municipal accounts even as municipal deposit balances remained relatively unchanged year-over-year. The decrease in other term certificates is a reflection of customers shifting to the Combo savings account seeking liquidity and higher rates in a declining rate environment. At December 31, 2001, term certificates of deposit having balances of $100,000 or more, by maturity, are as follows: At December 31, 2001 ---------------------------------------------------------------------- 3 Months Over 3 Months Over 6 Months Over or Less to 6 Months to 12 Months 12 Months Total ---------- ------------- -------------- ----------- --------- (In thousands) $29,332 $8,868 $17,182 $29,076 $84,458 Borrowed Funds The Bank is a voluntary member of the FHLBB. As such, the Bank may borrow up to the amount of its qualified collateral, as defined by the FHLBB. The Bank has selectively borrowed long-term funds from the FHLBB to fund large commercial real estate loans in addition to purchases of mortgage-backed securities. Short-term borrowings are generally used to meet the Bank's daily liquidity needs. The Bank may also enter into repurchase or reverse repurchase agreements with a number of authorized brokers as an alternative source of funds. Securities sold under agreements to repurchase are borrowings that mature within one year and are secured by U.S. government obligations. Total borrowed funds decreased to $200.3 million at December 31, 2001 from $223.8 million at December 31, 2000. 15 The following table presents information pertaining to the Bank's short-term borrowings: At December 31, ------------------------------ 2001 2000 1999 -------- -------- -------- (Dollars in thousands) FHLBB advances $10,000 $20,000 $45,000 Federal Reserve Bank of Boston advances 206 443 844 Securities sold under agreements to repurchase -- -- 21,227 ------- ------- ------- Total short-term borrowings $10,206 $20,443 $67,071 ======= ======= ======= Weighted average rate at year end 5.04% 6.53% 5.35% Average balance of short-term borrowings during the year $17,845 $37,441 $48,265 Weighted average rate paid on short-term borrowings during the year 5.48% 6.17% 5.07% Maximum amount outstanding at any month-end during the year $30,389 $66,480 $75,991 Stockholders' Equity Stockholders' equity to total assets was 7.90% at December 31, 2001, compared to 8.01% at December 31, 2000. Stockholders' equity at December 31, 2001 and 2000 exceeded all regulatory requirements. Book value at December 31, 2001 was $14.43 per share, compared with $12.89 per share at December 31, 2000. (See "Liquidity and Capital Resources.") 16 RESULTS OF OPERATIONS General In 2001, the Company reported consolidated net income of $13.8 million or $1.76 per share (basic), as compared to net income of $13.8 million or $1.69 per share in 2000, and net income of $12.7 million or $1.51 per share in 1999. Diluted earnings per share were $1.72, $1.64, and $1.44 for 2001, 2000 and 1999, respectively. Consolidated net income in 2001 increased .1% over 2000 and consolidated net income in 2000 increased 8.8% over 1999. Diluted earnings per share in 2001 increased 4.9% over 2000, and diluted earnings per share in 2000 increased 13.9% over 1999. The Company's return on average assets was 1.02% for 2001, as compared to 1.09% in 2000 and 1.07% in 1999. The return on average equity decreased to 12.81% in 2001 from 15.06% in 2000 and 13.52% in 1999. Net Interest Income The Company's most integral challenge is managing net interest income through various interest rate environments. In 2000, rates increased in the first half and the yield curve inverted during the second half. In 2001, as the economy slowed, the Federal Reserve Bank lowered the overnight federal funds target rate an unprecedented total of eleven times for a 475 basis point decline from 6.50% to 1.75% at December 31, 2001. During such periods of volatile changes in rates, management continues to focus on managing its net interest margin by the constant monitoring of its mix of earning assets and paying liabilities and the interest yields and costs thereon. As detailed in the following "Rate/Volume Analysis (RVA)" and "Distribution of Assets and Liabilities (DAL)" schedules, the Bank has improved its net interest income principally through its ability to constantly grow its average earning asset volumes, even as the net yield on average earning assets has declined. The Company reported net interest income of $37.8 million in 2001, an increase of $1.7 million or 4.6% from 2000. Net interest income in 2001, as compared to 2000, increased $2.4 million due to changes in volume, while changes in rate created a negative affect of $675,000. In 2000, net interest income was $36.1 million, an increase of $1.4 million or 4.0% from the 1999 level. The improvement in net interest income in 2000, as compared to 1999, can be similarly explained by the favorable changes in volume partially offset by the changes in rate of $2.4 million and $1.0 million, respectively. Interest and Dividend Income Interest and dividend income totaled $88.9 million for 2001, an increase of $2.8 million or 3.3% from 2000. Interest and dividend income totaled $86.1 million for 2000, an increase of $8.2 million or 10.5% from 1999. The $2.8 million increase in interest and dividend income in 2001 can be accounted for by growth in the average volume of earning assets. Average earning assets increased from $1.23 billion for 2000 to $1.31 billion in 2001 and the change in volume provided $4.4 million of interest income as detailed in the RVA schedule. With the exception of mortgage-backed securities, which essentially remained level, the DAL schedule shows that the average balance of each category of earning assets increased year over year. The contribution from changes in volume were partially offset by the changes in rate of $1.6 million as yields declined on total average earning assets from 6.98% in 2000 to 6.78% in 2001. Increases in interest and dividend income of $8.2 million in 2000, as compared to 1999, is accounted for by growth in the average volume of earning assets and an increase in yield on average earning assets. The DAL schedule shows average earning asset volumes and rates increased from 1999 to 2000 from $1.15 billion and 6.78% to $1.23 billion and 6.98%, respectively. As detailed in the RVA schedule, the change in volume and rate provided increases of $6.1 million and $2.1 million, respectively. Interest Expense Interest expense totaled $51.1 million for 2001, an increase of $1.2 million or 2.3% from 2000. Interest expense totaled $49.9 million for 2000, an increase of $6.8 million or 15.8% from 1999. The $1.2 million increase in interest expense when comparing 2001 to 2000 can be explained by the growth in total interest-bearing liabilities. Total average interest-bearing liabilities increased from $1.11 billion in 2000 to $1.18 billion in 2001 or $67.4 million. The growth in volume accounts for interest expense increasing $2.1 million while lower average rates paid decreased interest expense by $906,000. Although the volumes of the various categories of interest-bearing liabilities have changed, it is the Bank's Combo savings that primarily accounts for the increase. The lower rates paid on interest-bearing liabilities reflects the Federal Reserve Bank's interest rate policies during 2001. 17 Interest expense was $49.9 million in 2000 compared to $43.1 million in 1999. The increase in interest expense in 2000 is primarily attributable to increases in both volume and rates on interest-bearing liabilities. In 2000, average interest-bearing deposits increased $40.7 million and rates increased from 3.85% to 4.09%. The average balance of borrowings increased $30.9 million and the rates paid increased from 5.53% to 6.14%. Rate/Volume Analysis The following table presents, for the periods indicated, changes in interest and dividend income and changes in interest expense attributable to changes in interest rates and volumes of interest-bearing assets and liabilities. Changes attributable to both rate and volume have been allocated proportionally to the two categories.
2001 Compared to 2000 2000 Compared to 1999 Increase (Decrease) Increase (Decrease) -------------------------- -------------------------- Volume Rate Total Volume Rate Total ------ ---- ----- ------ ---- ----- (In thousands) INTEREST AND DIVIDEND INCOME Short-term investments $ 911 $ (261) $ 650 $ -- $ 85 $ 85 Mortgage-backed securities 1 2,708 2,709 (52) 289 237 Other securities 2,005 (2,502) (497) 1,916 958 2,874 Loans 1,503 (1,526) (23) 4,218 787 5,005 ------- ------- ------- ------ ------ ------ Total interest and dividend income 4,420 (1,581) 2,839 6,082 2,119 8,201 ------- ------- ------- ------ ------ ------ INTEREST EXPENSE NOW deposits 11 (22) (11) (7) 8 1 Savings deposits and MMDA 2,116 (495) 1,621 525 482 1,007 Term certificates 17 (191) (174) 1,302 1,462 2,764 Short-term borrowings (1,097) (233) (1,330) (609) 472 (137) Long-term debt 1,018 35 1,053 2,520 650 3,170 ------- ------- ------- ------ ------ ------ Total interest expense 2,065 (906) 1,159 3,731 3,074 6,805 ------- ------- ------- ------ ------ ------ Net interest income $ 2,355 $ (675) $ 1,680 $2,351 $ (955) $1,396 ======= ======= ======= ====== ====== ======
18 Distribution of Assets and Liabilities; Interest Rates and Interest Differential The following presents an analysis of average yields earned and rates paid for the years indicated. Average balances are computed using daily averages except for average stockholders' equity for which month-end balances are used.
Years Ended December 31, 2001 December 31, 2000 December 31, 1999 -------------------------------------------------------------------- ------------------------------- ----------------------------- Interest Average Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate Balance Paid Rate ---------- -------- ------- ---------- -------- ------- ---------- -------- ------- (Dollars in thousands) ASSETS Earning assets: Short-term investments $ 31,302 $ 1,066 3.41% $ 6,719 $ 416 6.19% $ 6,696 $ 331 4.94% Mortgage-backed securities 234,064 17,185 7.34 234,064 14,476 6.18 234,928 14,239 6.06 Other securities 368,205 20,614 5.60 334,647 21,111 6.31 303,784 18,237 6.00 Loans (a) 678,102 50,024 7.38 658,041 50,047 7.61 602,429 45,042 7.48 ------------------------------------------------------------------------------------------------------------------------------------ Total earning assets 1,311,673 88,889 6.78 1,233,471 86,050 6.98 1,147,837 77,849 6.78 Other assets 45,487 -- -- 30,485 -- -- 39,696 -- -- ------------------------------------------------------------------------------------------------------------------------------------ Total assets $1,357,160 -- -- $1,263,956 -- -- $1,187,533 -- -- ==================================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: NOW deposits $ 61,548 $ 333 0.54% $ 59,674 $ 344 0.58% $ 60,931 $ 343 0.56% Savings deposits and MMDA 460,147 14,168 3.08 391,883 12,547 3.20 375,169 11,540 3.08 Term certificates 441,075 23,458 5.32 440,761 23,632 5.36 415,643 20,868 5.02 Short-term borrowings 17,845 979 5.48 37,441 2,309 6.17 48,265 2,446 5.07 Long-term debt 197,312 12,135 6.15 180,747 11,082 6.13 139,034 7,912 5.69 ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 1,177,927 51,073 4.34 1,110,506 49,914 4.49 1,039,042 43,109 4.15 Demand deposits 65,947 -- -- 55,244 -- -- 47,409 -- -- Other liabilities 5,750 -- -- 6,768 -- -- 7,479 -- -- Stockholders' equity 107,536 -- -- 91,438 -- -- 93,603 -- -- ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $1,357,160 -- -- $1,263,956 -- -- $1,187,533 -- -- ==================================================================================================================================== Net interest income $37,816 $36,136 $34,740 Weighted average rate spread (b) 2.44% 2.49% 2.63% Net yield on average earning assets (c) 2.88% 2.93% 3.03% ====================================================================================================================================
(a) Includes non-accrual loans. (b) Weighted average yield on earning assets less weighted average rate paid on interest-bearing liabilities. (c) Net interest income divided by average earning assets. 19 Provision for Loan Losses The provision for loan losses represents a charge against current earnings and an addition to the allowance for loan losses. The provision is determined by management on the basis of many factors, including the quality of specific loans, risk characteristics of the loan portfolio, the level of non-performing loans, current economic conditions, trends in delinquency and charge-offs, and collateral values of the underlying security. Ultimate losses may vary from current estimates. The Bank recorded a provision for loan losses of $150,000 and $175,000 for the years ended 2001 and 2000, respectively, while no provision was recorded for 1999. The provision for loan losses is primarily based upon growth, changes in mix and risk levels of non-performing loans in the loan portfolio. Credit quality of the Bank's loan portfolio remains strong as gross loans charged-off were $78,000 in 2001, $59,000 in 2000 and $164,000 in 1999 or less than 0.03% of average loans in each of the three years. Growth in total loans over the past three years of $94.5 million has come primarily from residential real estate, commercial and construction real estate and equity lines of credit of $65.6 million, $24.8 million and $4.6 million, respectively. Applying general risk allocations to the growth in each of these loan categories has modestly increased the level of allowance for loan losses over the period. While management considers the allowance for loan losses to be adequate at December 31, 2001, there is no assurance that additional charge-offs and provisions will not be necessary in 2002. The provision for loan losses during 2002 will depend primarily on market conditions and the Bank's actual experience. Other Income Total other income amounted to $5.5 million in 2001, down $1.2 million or 18.0% from $6.8 million in 2000. When comparing 2001 with 2000, changes in net gain (loss) on sales of securities of $3.2 million and improvement in both customer service fees and miscellaneous income of $435,000 increased other income by $3.6 million. However, the increase in these other income categories did not offset the $4.8 million gain from the termination of the defined benefit plan recorded in 2000. The $2.5 million increase in other income when comparing year 2000 with 1999 can primarily be accounted for by the recognition of a $4.8 million gain from the termination of the defined benefit plan in 2000 partially offset by the $2.6 million decrease in net gain (loss) on sales of securities. The Company recorded a net loss on sales of securities of $1.0 million in 2000 as compared to a net gain on sales of securities of $1.5 million in 1999. The net loss on sales of securities in 2000 is reflective of a portfolio restructuring, whereby securities totaling $40.2 million and yielding 5.02% were sold and the proceeds were reinvested in securities yielding approximately 7.0%. Operating Expenses Operating expenses totaled $21.7 million for 2001, increasing $1.7 million or 8.5% year over year. Approximately 66% of the overall increase is related to the increase in salaries and employee benefits which increased $1.1 million or 10.0%. Much of the increase in this expense category is related to staffing costs associated with de-novo branching, salary increases, and rising insurance costs of employee benefits. The Bank's de-novo branching strategy has also increased its costs relative to occupancy and equipment expenses by $349,000 and data processing by $237,000 from 2000 to 2001. Operating expenses were $20.0 million for 2000, up $690,000 or 3.6% over 1999 operating expenses of $19.3 million. This increase in operating expenses was driven by staff related costs to support Company growth, which were partially offset by a net overall decline of $336,000 in defined benefit pension and 401(k) plan expense. This decline is a result of the Bank's termination of its defined benefit pension plan effective February 29, 2000. Provision for Income Taxes The Bank's effective tax rate for the year ended December 31, 2001 was 36.0% as compared with 39.4% and 35.6% for 2000 and 1999, respectively. The effective tax rates exceeded the statutory federal tax rate of 35.0% (for taxable income exceeding $10.0 million) due to state taxes, and in 2000, due principally to a tax of $639,000 related to the pension plan settlement. 20 IMPACT OF INFLATION The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and results of operations in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Bank is reflected in increased operating costs. Unlike most industrial companies, virtually all assets of a financial institution are monetary in nature. As a result, interest rates have a more significant effect on a financial institution's performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. LIQUIDITY AND CAPITAL RESOURCES The Bank's principal sources of funds are customer deposits, amortization and payoff of existing loan principal, and sales or maturities of various securities. The Bank is a voluntary member of the FHLBB and, as such, may take advantage of the FHLBB's borrowing programs to enhance liquidity and leverage its favorable capital position. The Bank also may draw on lines of credit at the FHLBB and a large commercial bank or enter into repurchase or reverse repurchase agreements with authorized brokers. These various sources of liquidity are used to fund withdrawals, new loans, and investments. Management seeks to promote deposit growth while controlling the Bank's cost of funds. Sales-oriented programs to attract new depositors and the cross-selling of various products to its existing customer base are currently in place. Management reviews, on an ongoing basis, possible new products, with particular attention to products and services which will aid in retaining the Bank's base of lower-costing deposits. Maturities and sales of securities provide significant liquidity to the Bank. The Bank's policy of purchasing shorter-term debt securities reduces market risk in the bond portfolio while providing significant cash flow. In 2001, cash flow from maturities of securities was $73.8 million and proceeds from sales of securities totaled $103.7 million, compared to maturities of securities of $70.0 million and proceeds from sales of securities of $55.2 million in 2000. Principal payments on mortgage-backed securities in 2001 and 2000 totaled $71.4 million and $32.4 million, respectively. Purchases of securities during 2001 and 2000 totaled $312.7 million and $190.9 million, respectively. These purchases consisted primarily of short-term debt instruments. During periods of high interest rates or active mortgage origination, maturities in the bond portfolio have provided significant liquidity to the Bank, generally at a lower cost than borrowings. Amortization and pay-offs of the loan portfolio contribute significant liquidity to the Bank. Traditionally, amortization and pay-offs are reinvested into loans. Excess liquidity is invested in short-term debt instruments. The Bank has also used borrowed funds as a source of liquidity. At December 31, 2001, the Bank's outstanding borrowings from the FHLBB were $200.1 million. The Bank also utilizes repurchase agreements to fund loan purchases or to leverage the balance sheet. At December 31, 2001, there were no securities sold under agreements to repurchase. Residential and commercial mortgage loan originations for 2001, 2000 and 1999 totaled $117.6 million, $139.2 million and $147.9 million, respectively. Commitments to originate commercial and residential real estate mortgages at December 31, 2001 were $21.5 million, excluding unadvanced construction funds totaling $9.6 million. Unadvanced funds on equity and commercial lines of credit aggregated $38.9 million at December 31, 2001. Management believes that adequate liquidity is available to fund loan commitments utilizing deposits, loan amortization, maturities of securities, or borrowings. The Bank's capital position (total stockholders' equity) was $111.6 million, or 7.90% of total assets at December 31, 2001, compared with $105.0 million, or 8.01% of total assets at December 31, 2000. In 2001, the Company completed 5% and 100,000 share stock repurchase plans. A total of 500,048 shares of common stock were repurchased. In addition, the Company recently announced another stock repurchase plan of up to 300,000 outstanding shares. 21 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Through the Bank's Asset-Liability Management Committee ("ALCO"), which is comprised of certain senior and middle management personnel, the Bank closely monitors the level and general mix of interest rate-sensitive assets and liabilities. The primary objective of the Bank's ALCO program is to manage the assets and liabilities of the Bank to enhance profitability and capital at prudent levels of liquidity, interest rate, credit and market risk. Market risk is the risk of loss from adverse changes in market prices and interest rates. The Bank's market risk arises primarily from interest rate risk inherent in lending, investing in marketable securities, deposit taking, and borrowing activities. To that end, management actively monitors and manages its interest rate risk exposure. In addition, the Bank is exposed to equity price risk associated with investing in marketable equity securities, which is not material. The Bank's primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Bank's net interest income and capital, while adjusting the Bank's asset-liability mix to achieve the maximum yield to cost spread from the mix. However, a sudden and substantial increase or decrease in interest rates may adversely impact the Bank's earnings to the extent that interest sensitive assets and liabilities do not change at the same speed, to the same extent, or on the same basis. It is ALCO's general policy to closely match the maturity or rate sensitivity of its assets and liabilities. Strategies implemented to improve the match between interest-rate sensitive assets and liabilities include, but are not limited to: daily monitoring of the Bank's changing cash requirements, with particular concentration on investment in shorter-term securities; a general policy of originating adjustable-rate and fifteen-year, fixed-rate mortgage loans for the Bank's own portfolio, monitoring the cost and composition of deposits; and generally using matched borrowings to fund specified purchases of loan packages and large loan originations. Occasionally, management may choose to deviate somewhat from specific matching of maturities of assets and liabilities to take advantage of an opportunity to enhance yields. The Bank seeks to manage its liability portfolio in order to effectively plan and manage growth and maturities of deposits. Plans designed to achieve growth of different deposit types are reviewed regularly. Programs which are designed to build multiple relationships with customers and to enhance the Bank's ability to retain deposits at controlled rates of interest have been implemented. Management has also adopted a policy of reviewing interest rates on an ongoing basis on all deposit accounts in order to monitor deposit growth and interest costs. In addition to attracting deposits, the Bank has selectively borrowed funds using advances from the FHLBB and reverse repurchase agreements. 22 The following table presents, as of December 31, 2001, interest-rate sensitive assets and liabilities categorized by expected maturity and weighted average rate. Expected maturities are contractual maturities adjusted for amortization and prepayments of principal. For adjustable-rate instruments, contractual maturity is deemed to be the earliest possible interest rate adjustment date.
(Dollars in thousands) 0-1 yr. 1-2 yrs. 2-3 yrs. 3-4 yrs. 4-5 yrs. 5+ yrs. Total ---------- ---------- ---------- ---------- ---------- --------- ----------- Rate-sensitive assets: Short-term investments $ 28,280 $ -- $ -- $ -- $ -- $ -- $ 28,280 1.54% Mortgage-backed investments 152,311 65,642 35,456 9,694 4,068 38,290 305,461 5.91% 6.04% 6.04% 6.04% 6.04% 6.04% Other investment securities 76,891 118,059 44,695 64,030 12,698 13,500 329,873 6.29% 6.06% 5.68% 5.38% 5.62% 5.30% Adjustable-rate mortgages 167,198 76,599 70,994 40,173 66,902 22,224 444,090 6.88% 7.28% 7.02% 7.55% 6.84% 6.81% Fixed-rate mortgages 27,513 22,355 21,617 19,618 21,835 103,632 216,570 7.35% 7.11% 7.09% 7.03% 7.04% 7.03% All other loans 17,889 1,335 1,135 197 70 -- 20,626 6.20% 10.05% 9.11% 10.48% 8.41% ------------------------------------------------------------------------------------------------------------------------------ Total rate-sensitive assets 470,082 283,990 173,897 133,712 105,573 177,646 1,344,900 ------------------------------------------------------------------------------------------------------------------------------ Rate-sensitive liabilities: NOW accounts 1,031 31,828 31,827 -- -- -- 64,686 0.66% 0.49% 0.49% Savings accounts 111,445 111,445 111,445 111,446 -- -- 445,781 2.70% 2.70% 2.70% 2.70% Money market accounts 21,562 21,562 21,562 21,564 -- -- 86,250 2.18% 2.18% 2.18% 2.18% Term certificates 258,940 127,351 27,101 5,369 5,816 51 424,628 4.33% 4.71% 4.67% 6.09% 4.72% 5.67% Borrowings 80,206 87,500 16,600 10,975 5,000 -- 200,281 6.26% 5.37% 4.25% 4.11% 4.69% ------------------------------------------------------------------------------------------------------------------------------ Total rate-sensitive liabilities 473,184 379,686 208,535 149,354 10,816 51 1,221,626 ------------------------------------------------------------------------------------------------------------------------------
The prepayment experience reflected is based on the Bank's historical experience. Based on the Bank's experience, partial or full payment prior to contractual maturity can be expected and is reflected. Loans and mortgage-backed securities reflect regular amortization of principal and pre-payment estimates. When adjustable-rate loans reprice at the rate adjustment date, they are generally indexed to the one-, three-, or five-year Treasury rate with an average spread of 275 basis points, with average period caps of 2.0% and lifetime caps of 6.0%. The table does not include loans which have been placed on non-accrual status. Assets and liabilities that immediately reprice are placed in the 0-1 year column. These financial instruments do not have a contractual maturity date. Although NOW, savings and money market deposit accounts are subject to immediate repricing or withdrawal, based on the Bank's history, management considers these liabilities to have longer lives and less interest rate sensitivity than term certificates. 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Independent Auditors' Report..................................................25 Consolidated Balance Sheets at December 31, 2001 and 2000.....................26 Consolidated Statements of Income for the Years Ended December 31, 2001, 2000 and 1999..........................27 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2001, 2000 and 1999..........................28 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999.......................29-30 Notes to Consolidated Financial Statements.................................31-55 24 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Medford Bancorp, Inc.: We have audited the consolidated balance sheets of Medford Bancorp, Inc. and subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. 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 Medford Bancorp, Inc. and subsidiary as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Boston, Massachusetts January 16, 2002 25 MEDFORD BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, ------------------------ 2001 2000 --------- ---------- (In thousands) ASSETS Cash and due from banks $ 18,210 $ 16,905 Interest-bearing deposits 28,280 5,353 ---------- ---------- Cash and cash equivalents 46,490 22,258 Securities available for sale 588,263 528,690 Securities held to maturity 57,022 42,854 Federal Home Loan Bank of Boston stock, at cost 11,920 11,420 Loans 682,263 675,697 Less allowance for loan losses (7,080) (6,950) ---------- ---------- Loans, net 675,183 668,747 ---------- ---------- Banking premises and equipment, net 11,578 10,884 Accrued interest receivable 9,596 10,211 Intangible assets 1,532 2,588 Other assets 11,187 12,038 ---------- ---------- Total assets $1,412,771 $1,309,690 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $1,095,947 $ 975,857 Short-term borrowings 10,206 20,443 Long-term debt 190,075 203,400 Accrued taxes and expenses 2,338 2,278 Other liabilities 2,640 2,747 ---------- ---------- Total liabilities 1,301,206 1,204,725 ---------- ---------- Commitments and contingencies (Notes 4 and 9) Stockholders' equity: Serial preferred stock, $.50 par value, 5,000,000 shares authorized; none issued -- -- Common stock, 15,000,000 shares authorized; $.50 par value, 9,122,596 shares issued 4,561 4,561 Additional paid-in capital 21,985 22,705 Retained earnings 104,275 94,697 Treasury stock, at cost (1,388,948 and 980,048 shares, respectively) (24,883) (17,422) Shares held in rabbi trust, at cost 1,167 1,071 Deferred compensation obligation (1,167) (1,071) Accumulated other comprehensive income 5,627 424 ---------- ---------- Total stockholders' equity 111,565 104,965 ---------- ---------- Total liabilities and stockholders' equity $1,412,771 $1,309,690 ========== ========== See accompanying notes to consolidated financial statements. 26 MEDFORD BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, ----------------------------- 2001 2000 1999 ------- ------- ------ (In thousands, except per share data) Interest and dividend income: Interest and fees on loans $50,024 $ 50,047 $45,042 Interest on debt securities 37,018 34,686 31,827 Dividends on equity securities 781 901 649 Interest on interest-bearing deposits 1,066 416 331 ------- -------- ------- Total interest and dividend income 88,889 86,050 77,849 ------- -------- ------- Interest expense: Interest on deposits 37,959 36,523 32,751 Interest on short-term borrowings 979 2,309 2,446 Interest on long-term debt 12,135 11,082 7,912 ------- -------- ------- Total interest expense 51,073 49,914 43,109 ------- -------- ------- Net interest income 37,816 36,136 34,740 Provision for loan losses 150 175 -- ------- -------- ------- Net interest income, after provision for loan losses 37,666 35,961 34,740 ------- -------- ------- Other income: Customer service fees 2,285 1,968 1,851 Gain (loss) on sales of securities, net 2,121 (1,031) 1,522 Pension plan curtailment and settlement gains -- 4,799 -- Miscellaneous 1,132 1,014 829 ------- -------- ------- Total other income 5,538 6,750 4,202 ------- -------- ------- Operating expenses: Salaries and employee benefits 12,181 11,069 10,673 Occupancy and equipment 2,960 2,611 2,488 Data processing 1,790 1,553 1,512 Professional fees 421 497 657 Amortization of intangibles 1,056 1,091 1,128 Advertising and marketing 610 690 654 Other general and administrative 2,665 2,480 2,189 ------- -------- ------- Total operating expenses 21,683 19,991 19,301 ------- -------- ------- Income before income taxes 21,521 22,720 19,641 Provision for income taxes 7,743 8,951 6,990 ------- -------- ------- Net income $13,778 $ 13,769 $12,651 ======= ======== ======= Weighted average shares outstanding: Basic 7,814 8,139 8,393 ======= ======== ======= Diluted 8,014 8,395 8,775 ======= ======== ======= Earnings per share: Basic $ 1.76 $ 1.69 $ 1.51 ======= ======== ======= Diluted $ 1.72 $ 1.64 $ 1.44 ======= ======== =======
See accompanying notes to consolidated financial statements. 27 MEDFORD BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2001, 2000 and 1999
Accumulated Common Stock Additional Treasury Stock Other --------------- Paid-In Retained ------------------ Comprehensive Shares Dollars Capital Earnings Shares Dollars Income (Loss) Total ------ ------- -------- --------- ------ -------- ------------- -------- (In thousands) Balance at December 31, 1998 9,123 $4,561 $26,389 $ 76,770 (413) $ (8,511) $ 3,058 $102,267 -------- Comprehensive income: Net income -- -- -- 12,651 -- -- -- 12,651 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- (12,463) (12,463) -------- Total comprehensive income 188 -------- Cash dividends declared ($.51 per share) -- -- -- (4,268) -- -- -- (4,268) Repurchase of treasury stock -- -- -- -- (425) (7,689) -- (7,689) Issuance of common stock under option plan -- -- (1,550) -- 99 1,922 -- 372 ------ ------ -------- --------- ------ -------- -------- -------- Balance at December 31, 1999 9,123 4,561 24,839 85,153 (739) (14,278) (9,405) 90,870 -------- Comprehensive income: Net income -- -- -- 13,769 -- -- -- 13,769 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- 9,829 9,829 -------- Total comprehensive income 23,598 -------- Cash dividends declared ($.52 per share) -- -- -- (4,225) -- -- -- (4,225) Repurchase of treasury stock -- -- -- -- (423) (6,428) -- (6,428) Issuance of common stock under option plan -- -- (2,790) -- 182 3,284 -- 494 Income tax benefits on options exercised -- -- 656 -- -- -- -- 656 ------ ------ -------- --------- ------ -------- -------- -------- Balance at December 31, 2000 9,123 4,561 22,705 94,697 (980) (17,422) 424 104,965 -------- Comprehensive income: Net income -- -- -- 13,778 -- -- -- 13,778 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects -- -- -- -- -- -- 5,203 5,203 -------- Total comprehensive income 18,981 -------- Cash dividends declared ($.54 per share) -- -- -- (4,200) -- -- -- (4,200) Repurchase of treasury stock -- -- -- -- (500) (9,078) -- (9,078) Issuance of common stock under option plan -- -- (967) -- 91 1,617 -- 650 Income tax benefits on options exercised -- -- 247 -- -- -- -- 247 ------ ------ -------- --------- ------ -------- -------- -------- Balance at December 31, 2001 9,123 $4,561 $21,985 $104,275 (1,389) $(24,883) $ 5,627 $111,565 ====== ====== ======== ========= ====== ======== ======== ========
See accompanying notes to consolidated financial statements. 28 MEDFORD BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, --------------------------------- 2001 2000 1999 --------- --------- --------- (In thousands) Cash flows from operating activities: Net income $ 13,778 $ 13,769 $ 12,651 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 150 175 -- Depreciation and amortization, net 2,812 2,594 3,183 (Gain) loss on sales of securities, net (2,121) 1,031 (1,522) Deferred tax provision (benefit) (241) 448 (100) Decrease (increase) in accrued interest receivable and other assets (1,758) (1,598) 549 Increase (decrease) in accrued taxes and expenses and other liabilities 585 (1,104) 367 --------- --------- --------- Net cash provided by operating activities 13,205 15,315 15,128 --------- --------- --------- Cash flows from investing activities: Activity in securities available for sale: Maturities 73,773 64,974 45,250 Sales 103,707 55,196 105,440 Purchases (280,087) (144,649) (259,337) Principal amortization of mortgage-backed securities 53,330 32,369 47,360 Activity in securities held to maturity: Maturities -- 4,997 21,000 Purchases (32,115) (44,552) -- Principal amortization of mortgage-backed securities 18,102 -- -- Purchases of Federal Home Loan Bank of Boston stock (500) (1,737) (2,361) Loans originated and purchased, net of amortization and payoffs (6,961) (42,358) (46,460) Proceeds from sales of loans -- -- 77 Proceeds from sales of real estate -- -- 431 Additions to banking premises and equipment, net (1,978) (491) (1,036) --------- --------- --------- Net cash used by investing activities (72,729) (76,251) (89,636) --------- --------- ---------
See accompanying notes to consolidated financial statements. 29 MEDFORD BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
Years Ended December 31, -------------------------------- 2001 2000 1999 --------- --------- -------- (In thousands) Cash flows from financing activities: Net increase in deposits 120,090 64,529 39,626 Net decrease in short-term borrowings with maturities of three months or less (237) (21,628) (16,392) Proceeds from short-term borrowings with maturities in excess of three months 15,000 67,166 55,000 Repayment of short-term borrowings with maturities in excess of three months (25,000) (92,166) (10,000) Proceeds from long-term debt 109,675 123,000 67,000 Repayment of long-term debt (123,000) (68,253) (50,000) Issuance of common stock 650 494 372 Payments to acquire treasury stock (9,078) (6,428) (7,689) Cash dividends paid (4,344) (4,430) (4,501) --------- --------- -------- Net cash provided by financing activities 83,756 62,284 73,416 --------- --------- -------- Net change in cash and cash equivalents 24,232 1,348 (1,092) Cash and cash equivalents at beginning of year 22,258 20,910 22,002 --------- --------- -------- Cash and cash equivalents at end of year $ 46,490 $ 22,258 $ 20,910 ========= ========= ======== Supplementary information: Interest paid on deposit accounts $ 38,053 $ 36,486 $ 32,413 Interest paid on borrowed funds 13,339 13,207 10,115 Income taxes paid, net of refunds 7,666 8,054 7,285
See accompanying notes to consolidated financial statements. 30 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2001, 2000 and 1999 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Consolidation The consolidated financial statements include the accounts of Medford Bancorp, Inc. (the "Company") and its wholly-owned subsidiary, Medford Savings Bank (the "Bank"). The Bank's wholly-owned subsidiary, Medford Securities Corporation, engages in the buying, selling, dealing in, or holding of securities. All significant intercompany balances and transactions have been eliminated in consolidation. Use of Estimates In preparing 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. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for losses on loans. Business and Operating Segments The Company is principally engaged in the business of attracting deposits from the general public, originating residential and commercial real estate mortgages and consumer and commercial loans, and investing in securities. The Company is headquartered in Medford, Massachusetts. It has a network of nineteen banking offices located in Medford, Malden, Arlington, Belmont, Burlington, North Reading, Somerville, Tewksbury, Waltham, and Wilmington. The Company's primary market area includes these communities as well as other cities and towns in Middlesex County and the surrounding area north of Boston. Management evaluates the Company's performance and allocates resources based on a single segment concept. Accordingly, there are no separately identified operating segments for which discrete financial information is available. 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. Cash and Cash Equivalents Cash and cash equivalents include cash, amounts due from banks and interest-bearing deposits that mature overnight or on demand. Securities Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and reflected at amortized cost. All other marketable securities are classified as "available for sale" and reflected on the consolidated balance sheet at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income/loss, net of related tax effects, in stockholders' equity. Purchase premiums and discounts on debt securities are amortized to earnings by the interest method over the terms of the securities. Declines in the value of securities that are deemed to be other than temporary are reflected in earnings when identified. Gains and losses on disposition of securities are recorded on the trade date and computed by the specific identification method. 31 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Loans The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans in the eastern New England area. The ability of the Company's debtors to honor their obligations is dependent upon the real estate, construction, and general economic sectors of that region. Loans, as reported, have been increased by net deferred loan origination costs and reduced by the allowance for loan losses. Interest on loans is recognized on the interest method and is not accrued on loans which are ninety days or more past due. Loans may be placed on non-accrual status prior to becoming ninety days past due if the collection of principal and interest is, in the opinion of management, doubtful. Loans which are identified as impaired are generally placed on non-accrual status. Interest income previously accrued on such loans is reversed against current period earnings. Interest income on all non-accrual loans is recognized only to the extent of interest payments received. Net deferred loan origination costs are amortized as an adjustment of the related loan yield by the interest method over the contractual lives of the loans. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. An impaired loan is required to be measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. All of the Company's loans, which have been identified as impaired, have been measured by the fair value of existing collateral. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosure. 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 collectibility of the loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, known inherent risks in the nature and volume of the loan portfolio, levels of non-performing loans, adverse situations that may affect the borrower's ability to repay, trends in delinquencies and charge-offs, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Ultimate losses may vary from current estimates and future additions to the allowance may be necessary. The allowance consists of specific, general and unallocated components. Specific allocations include the results of measuring impaired loans under Statement of Financial Accounting Standards No. 114. General risk allocations are determined by formula whereby the loan portfolio is stratified by loan type and by risk rating category. Loss factors are then applied to each category based on various considerations including historical loss experience, delinquency trends and current economic conditions. Any remaining unallocated portion is reviewed for adequacy in relation to the overall loan portfolio and in recognition of estimates inherent in the calculation methodology. 32 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Banking Premises and Equipment Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets. Intangible Assets Intangible assets pertaining to core deposits acquired are amortized over 15 years on an accelerated basis, based on the expected run-off of the related deposits. Other intangible assets are amortized by the straight-line method over periods ranging from 10 to 15 years. 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 Company's base amount of its federal income tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of a related deferred tax asset, if deemed realizable. Pension Plan The compensation cost of an employee's defined pension benefit is recognized on the net periodic pension cost method over the employee's approximate service period. The aggregate cost method is utilized for funding purposes. The defined benefit plan was terminated effective March 31, 2000. Stock Compensation Plans The Company measures compensation cost for its stock compensation plans using the intrinsic value based method of accounting, 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. Stock options issued under the Company's stock option plans have no intrinsic value at the grant date and no compensation cost is recognized for them. The Company is required to make pro forma disclosures of net income and earnings per share as if compensation cost had been measured at the grant date based on the fair value of the award and recognized over the service period, which is usually the vesting period. (See Note 12.) Advertising Costs Advertising costs are charged to expense as incurred. Earnings Per Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive stock options had been exercised. Additional common shares are determined using the treasury stock method. For the years ended December 31, 2001, 2000 and 1999, options applicable to 12,000 shares, 149,000 shares and 62,000 shares, respectively, were anti-dilutive and excluded from the diluted earnings per share computations. 33 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded) 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 as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income/loss. The components of other comprehensive income (loss) and related tax effects are as follows:
Years Ended December 31, ------------------------------ 2001 2000 1999 -------- -------- -------- (In thousands) Change in unrealized holding gains (losses) on securities available for sale $ 10,547 $ 14,992 $(18,877) Reclassification adjustment for (gains) losses realized in income (2,121) 1,031 (1,522) -------- -------- -------- Change in net unrealized gains (losses) 8,426 16,023 (20,399) Tax effects (3,223) (6,194) 7,936 -------- -------- -------- Net-of-tax amount $ 5,203 $ 9,829 $(12,463) ======== ======== ========
Recent Accounting Pronouncement In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for business combinations initiated after June 30, 2001. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. In addition, this Statement requires that acquired identifiable intangible assets, as defined, be amortized over their useful lives. Unidentified intangible assets pertaining to acquisitions of banking or thrift institutions, where the fair value of liabilities assumed exceeds the fair value of assets acquired, will continue to be amortized, as such transactions are outside the scope of SFAS. No.142. This Statement is effective for the Company on January 1, 2002. Management does not anticipate that the adoption of these Statements will have a material impact on the consolidated financial statements. Accounting Change In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which, as amended by SFAS No. 137, is effective for fiscal years beginning after June 15, 2000. This Statement establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other contracts, and requires that an entity recognize all derivatives as assets or liabilities in the balance sheet and measure them at fair value. If certain conditions are met, an entity may elect to designate a derivative as a hedging instrument. The Statement generally provides for matching the timing of the recognition of the gain or loss on derivatives designated as hedging instruments with the recognition of the changes in the fair value of the item being hedged. Depending on the type of hedge, such recognition will be in either net income or other comprehensive income. For a derivative not designated as a hedging instrument, changes in fair value will be recognized in net income in the period of change. The Company adopted this Statement on January 1, 2001, with no impact on the consolidated financial statements. 34 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SECURITIES The amortized cost and fair value of securities, with gross unrealized gains and losses at December 31, 2001 and 2000, follows:
Gross Gross Amortized Unrealized Unrealized Fair December 31, 2001 Cost Gains Losses Value ------------------------------------------------ --------- ---------- ---------- -------- (In thousands) Securities Available for Sale Debt securities: Corporate bonds $251,531 $ 7,760 $ (333) $258,958 Mortgage-backed securities 253,323 2,397 (863) 254,857 U.S. Government and federal agency 73,458 334 (224) 73,568 -------- ------- ------- -------- Total debt securities 578,312 10,491 (1,420) 587,383 Marketable equity securities 874 98 (92) 880 -------- ------- ------- -------- Total securities available for sale $579,186 $10,589 $(1,512) $588,263 ======== ======= ======= ======== Securities Held to Maturity Federal agency obligations $ 4,884 $ 335 $ -- $ 5,219 Mortgage-backed securities 52,138 1,217 (93) 53,262 -------- ------- ------- -------- Total securities held to maturity $ 57,022 $ 1,552 $ (93) $ 58,481 ======== ======= ======= ========
Gross Gross Amortized Unrealized Unrealized Fair December 31, 2000 Cost Gains Losses Value ------------------------------------------------ --------- ---------- ---------- -------- (In thousands) Securities Available for Sale Debt securities: Corporate bonds $310,165 $2,628 $ (478) $312,315 Mortgage-backed securities 212,589 668 (1,850) 211,407 Federal agency obligations 3,000 -- (3) 2,997 -------- ------ ------- -------- Total debt securities 525,754 3,296 (2,331) 526,719 Marketable equity securities 2,285 81 (395) 1,971 -------- ------ ------- -------- Total securities available for sale $528,039 $3,377 $(2,726) $528,690 ======== ====== ======= ======== Securities Held to Maturity Federal agency obligations $ 4,809 $ 210 $ -- $ 5,019 Mortgage-backed securities 38,045 871 -- 38,916 -------- ------ ------- -------- Total securities held to maturity $ 42,854 $1,081 $ -- $ 43,935 ======== ====== ======= ========
35 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SECURITIES (concluded) The amortized cost and fair value of debt securities by contractual maturity at December 31, 2001 is as follows: Available for Sale Held to Maturity --------------------- ------------------- Amortized Fair Amortized Fair Cost Value Cost Value --------- -------- --------- ------- (In thousands) Within 1 year $ 76,891 $ 78,275 $ -- $ -- After 1 year through 5 years 234,598 240,704 4,884 5,219 After 5 years 13,500 13,547 -- -- -------- -------- ------- ------- 324,989 332,526 4,884 5,219 Mortgage-backed securities 253,323 254,857 52,138 53,262 -------- -------- ------- ------- $578,312 $587,383 $57,022 $58,481 ======== ======== ======= ======= At December 31, 2001, mortgage-backed securities with an amortized cost of $6,815,000 and a fair value of $6,894,000 have been pledged as collateral for a line of credit and mortgage-backed securities with an amortized cost of $18,812,000 and a fair value of $18,693,000 have been pledged as collateral for a loan and credit agreement. At December 31, 2000, mortgage-backed securities with an amortized cost of $8,063,000 and a fair value of $8,002,000 have been pledged as collateral for a line of credit and mortgage-backed securities with an amortized cost of $22,179,000 and a fair value of $21,851,000 have been pledged as collateral for a loan and credit agreement. For the years ended December 31, 2001, 2000 and 1999, proceeds from the sales of securities available for sale amounted to $103,707,000, $55,196,000 and $105,440,000, respectively. Gross realized gains amounted to $2,292,000, $3,000 and $1,529,000, respectively. Gross realized losses amounted to $171,000, $1,031,000 and $7,000, respectively. For the year ended December 31, 2000, proceeds from the sales of securities held to maturity that were sold within three months of maturity amounted to $4,997,000. Gross realized losses on these sales amounted to $3,000. These sales have been included in the Statement of Cash Flows as maturities. Mortgage-backed securities consist of collateralized mortgage obligations and participation certificates guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association. 36 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. LOANS A summary of the balances of loans follows: December 31, -------------------------- 2001 2000 --------- --------- (In thousands) Mortgage loans on real estate: Residential $ 487,331 $ 487,964 Commercial 130,207 124,201 Construction 17,228 19,913 Second mortgages 444 699 Equity lines of credit 25,199 21,609 --------- --------- 660,409 654,386 --------- --------- Other loans: Commercial 17,954 17,219 Personal and other 2,652 2,925 --------- --------- 20,606 20,144 --------- --------- Net deferred loan origination costs 1,248 1,167 --------- --------- Total loans 682,263 675,697 Less allowance for loan losses (7,080) (6,950) --------- --------- Loans, net $ 675,183 $ 668,747 ========= ========= An analysis of the allowance for loan losses follows: Years Ended December 31, ----------------------------------- 2001 2000 1999 ------- ------- ------- (In thousands) Balance at beginning of year $ 6,950 $ 6,779 $ 6,876 Provision for loan losses 150 175 -- Recoveries 58 55 67 Loans charged-off (78) (59) (164) ------- ------- ------- Balance at end of year $ 7,080 $ 6,950 $ 6,779 ======= ======= ======= Impaired loans at December 31, 2001 and 2000 amounted to $976,000 and $1,047,000, respectively, none of which required a corresponding valuation allowance. No additional funds are committed to be advanced in connection with impaired loans. For the years ended December 31, 2001, 2000 and 1999, the average recorded investment in impaired loans amounted to $1,385,000, $1,593,000 and $2,888,000, respectively. Impaired loans are generally placed on non-accrual status. The Bank recognized interest income on impaired loans, on a cash basis, of $0 in 2001, $6,000 in 2000 and $52,000 in 1999 during the periods that they were impaired. 37 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. BANKING PREMISES AND EQUIPMENT A summary of the cost and accumulated depreciation of banking premises and equipment follows: December 31, -------------------------- 2001 2000 -------- -------- (In thousands) Banking Premises: Land $ 2,068 $ 2,068 Buildings 10,875 10,321 Equipment 6,182 6,609 -------- -------- 19,125 18,998 Less accumulated depreciation (7,547) (8,114) -------- -------- $ 11,578 $ 10,884 ======== ======== Depreciation expense for the years ended December 31, 2001, 2000 and 1999 amounted to $1,284,000, $1,173,000 and $1,174,000, respectively. Pursuant to the terms of noncancelable lease agreements in effect at December 31, 2001, pertaining to banking premises and equipment, future minimum rent commitments under various operating leases are as follows: Years Ending December 31, Amount -------------- ------ (In thousands) 2002 $ 425 2003 374 2004 348 2005 145 2006 75 Thereafter 60 ------ $1,427 ====== The leases contain options to extend for periods from one to ten years. The cost of such rentals is not included above. Total rent expense for the years ended December 31, 2001, 2000 and 1999 amounted to $450,000, $378,000 and $332,000, respectively. 38 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. DEPOSITS A summary of deposit balances, by type, is as follows: December 31, ------------------------- 2001 2000 ---------- ---------- (In thousands) Demand $ 74,602 $ 63,122 NOW 64,686 65,106 Regular savings 445,781 323,298 Money market deposits 86,250 65,357 ---------- ---------- Total non-certificate accounts 671,319 516,883 ---------- ---------- Term certificates ($100,000 or more) 84,458 101,406 Other term certificates 340,170 357,568 ---------- ---------- Total term certificates 424,628 458,974 ---------- ---------- Total deposits $1,095,947 $ 975,857 ========== ========== A summary of term certificate accounts, by maturity, is as follows: December 31, 2001 December 31, 2000 -------------------- -------------------- Weighted Weighted Average Average Amount Rate Amount Rate --------- --------- --------- --------- (Dollars in thousands) Within 1 year $258,940 4.33% $375,579 5.70% Over 1 year to 3 years 154,452 4.70 72,123 6.03 Over 3 years to 5 years 11,185 5.38 11,165 5.45 Over 5 years 51 5.67 107 5.30 -------- -------- $424,628 4.50% $458,974 5.75% ======== ======== 6. SHORT-TERM BORROWINGS Short-term borrowings consist of the following:
December 31, 2001 December 31, 2000 ------------------- ------------------- Weighted Weighted Average Average Amount Rate Amount Rate ------- --------- -------- --------- (Dollars in thousands) Federal Reserve Bank of Boston advances $ 206 1.50% $ 443 6.29% Federal Home Loan Bank of Boston advances 10,000 5.11 20,000 6.54 ------- ------- $10,206 5.04% $20,443 6.53% ======= =======
39 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. SHORT-TERM BORROWINGS (concluded) The Federal Home Loan Bank of Boston ("FHLBB") advances mature within four months. The Company also has an available line of credit with the FHLBB 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 FHLBB 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. The Company has a $3,000,000 line of credit (treasury, tax and loan) with the Federal Reserve Bank of Boston ("FRB") at December 31, 2001 and 2000, of which $206,000 and $443,000, respectively, was advanced. The interest rate adjusts weekly and certain mortgage-backed securities have been pledged as collateral for the line of credit at December 31, 2001 and 2000, respectively. At December 31, 2001 and 2000, the Company also has a loan and credit agreement with the FRB at an interest rate which adjusts daily. Borrowings under the agreement are limited to 95% of the fair value of pledged collateral. Certain mortgage-backed securities have been pledged as collateral for the loan and credit agreement. (See Note 2.) 7. LONG-TERM DEBT Long-term debt consists of FHLBB advances secured by a blanket lien on qualified collateral (see Note 6), as follows: December 31, 2001 December 31, 2000 -------------------- ------------------- Weighted Weighted Average Average Maturity Amount Rate Amount Rate --------------- -------- -------- -------- -------- (Dollars in thousands) 2001 $ -- --% $113,000 6.09% 2002 70,000 6.50 60,000 6.78 2003 87,500 5.37 30,000 6.28 2004 16,600 4.25 -- -- 2005 10,975 4.11 400 5.61 2006 5,000 4.69 -- -- -------- -------- $190,075 5.60% $203,400 6.32% ======== ======== At December 31, 2001 and 2000, a $400,000 advance maturing in 2005 is callable on a quarterly basis by the FHLBB. 40 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. INCOME TAXES Allocation of the provision for federal and state income taxes between current and deferred portions is as follows: Years Ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- (In thousands) Current tax provision: Federal $ 7,513 $ 7,928 $ 6,702 State 471 575 388 ------- ------- ------- 7,984 8,503 7,090 ------- ------- ------- Deferred tax provision (benefit): Federal (180) 335 (99) State (61) 113 (1) ------- ------- ------- (241) 448 (100) ------- ------- ------- $ 7,743 $ 8,951 $ 6,990 ======= ======= ======= The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows: Years Ended December 31, --------------------------- 2001 2000 1999 ---- ---- ---- Statutory rate 35.0% 35.0% 35.0% Increase (decrease) resulting from: State taxes, net of federal tax benefit 1.2 2.0 1.3 Tax on pension plan settlement -- 2.8 -- Other, net (.2) (.4) (.7) ---- ---- ---- Effective tax rates 36.0% 39.4% 35.6% ==== ==== ==== 41 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. INCOME TAXES (continued) The components of the net deferred tax asset, included in other assets, are as follows: December 31, -------------------- 2001 2000 ------- ------- (In thousands) Deferred tax assets: Federal $ 3,986 $ 3,914 State 1,336 1,312 ------- ------- 5,322 5,226 ------- ------- Deferred tax liabilities: Federal (3,864) (1,266) State (827) (347) ------- ------- (4,691) (1,613) ------- ------- Net deferred tax asset $ 631 $ 3,613 ======= ======= The tax effects of each type of income and expense item that give rise to deferred taxes are as follows: December 31, --------------------- 2001 2000 ------- ------- (In thousands) Cash basis of accounting $ 362 $ 401 Investments: Net unrealized (gain) loss on securities available for sale (3,450) (227) Other (288) (288) Depreciation (961) (961) Allowance for loan losses 2,961 2,814 Employee benefit plans 709 669 Other 1,298 1,205 ------- ------- Net deferred tax asset $ 631 $ 3,613 ======= ======= 42 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. INCOME TAXES (concluded) A summary of the change in the net deferred tax asset is as follows:
Years Ended December 31, -------------------------------- 2001 2000 1999 -------- -------- -------- (In thousands) Balance at beginning of year $ 3,613 $ 10,255 $ 2,219 Deferred tax effect of the change in net unrealized gains and losses on securities available for sale (3,223) (6,194) 7,936 Deferred tax (provision) benefit for the year 241 (448) 100 -------- -------- -------- Balance at end of year $ 631 $ 3,613 $ 10,255 ======== ======== ========
The federal income tax reserve for loan losses at the Company's base year is $8,265,000. If any portion of the reserve is used for purposes other than to absorb the losses for which it was established, approximately 150% of the amount actually used (limited to the amount of the reserve) would be subject to taxation in the year in which used. As the Company intends to use the reserve only to absorb loan losses, a deferred income tax liability of $3,389,000 has not been provided. 9. OTHER COMMITMENTS AND CONTINGENCIES In the normal course of business, there are outstanding commitments and contingencies which are not reflected in the consolidated financial statements. Employment and Special Termination Agreements The Company has entered into an employment agreement with the President and Chief Executive Officer that provides for a specified minimum annual compensation and the continuation of benefits currently received. However, such employment may be terminated for cause, as defined, without incurring any continuing obligations. The Company and/or the Bank have also entered into special termination agreements with the President and Chief Executive Officer and certain senior executives. The agreements generally provide for certain lump-sum severance payments within a three-year period following a "change in control," as defined in the agreements. Loan Commitments The Company 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. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the consolidated balance sheet. The Company's exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. 43 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. OTHER COMMITMENTS AND CONTINGENCIES (concluded) Loan Commitments (concluded) The following financial instruments were outstanding whose contract amounts represent credit risk: December 31, -------------------- 2001 2000 -------- ------- (In thousands) Commitments to grant loans $22,442 $ 4,856 Unadvanced funds on equity lines of credit 26,161 23,322 Unadvanced funds on commercial lines of credit 12,693 9,765 Unadvanced funds on construction loans 9,611 16,271 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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. Funds disbursed under these financial instruments are generally collateralized by real estate, except for the commercial lines of credit which are generally secured by the business assets of the borrower. Legal Contingencies Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will not have a material effect on the Company's consolidated financial statements. 10. 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 Bank's 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. Holding companies are not subject to prompt corrective action provisions. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (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 December 31, 2001 and 2000, that the Company and the Bank met all capital adequacy requirements to which they are subject. 44 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. STOCKHOLDERS' EQUITY (continued) Minimum Regulatory Capital Requirements (concluded) As of December 31, 2001, 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, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. As a well capitalized entity, the Bank is entitled to engage in specified activities on a more expedited basis than entities that are not well capitalized. There are no conditions or events that management believes have changed the Bank's category. The Company's and the Bank's actual capital amounts and ratios as of December 31, 2001 and 2000, are also presented in the table.
Minimum To Be Minimum Categorized Capital as Well Actual Requirement Capitalized ----------------- --------------- --------------- Amount Ratio Amount Ratio Amount Ratio -------- ----- ------- ----- ------- ----- (Dollars in thousands) December 31, 2001: Total Capital to Risk-Weighted Assets: Consolidated $111,486 13.8% $64,626 8.0% $ -- --% Bank 109,940 13.6 64,626 8.0 80,782 10.0 Tier 1 Capital to Risk-Weighted Assets: Consolidated 104,406 12.9 32,313 4.0 -- -- Bank 102,860 12.7 32,313 4.0 48,469 6.0 Tier 1 Capital to Average Assets: Consolidated 104,406 7.4 42,179 3.0 -- -- Bank 102,860 7.3 42,179 3.0 70,298 5.0 December 31, 2000: Total Capital to Risk-Weighted Assets: Consolidated $108,719 13.0% $67,125 8.0% $ -- --% Bank 104,230 12.4 67,125 8.0 83,906 10.0 Tier 1 Capital to Risk-Weighted Assets: Consolidated 101,769 12.1 33,562 4.0 -- -- Bank 97,280 11.6 33,562 4.0 50,343 6.0 Tier 1 Capital to Average Assets: Consolidated 101,769 7.9 38,930 3.0 -- -- Bank 97,280 7.5 38,930 3.0 64,883 5.0
45 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. 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. Under Massachusetts law, stock savings banks such as the Bank, like national banks, may pay dividends no more often than quarterly, and only out of net profits and to the extent that such payments will not impair the Bank's capital stock, as defined. Moreover, prior Commissioner approval is required if the total dividends for a calendar year would exceed net profits for that year combined with retained net profits for the previous two years. These restrictions on the ability of the Bank to pay dividends to the Company may restrict the ability of the Company to pay dividends to its stockholders. Loans or advances are limited to 10% of the Bank's capital stock and surplus, as defined, (which for this purpose represents Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for loan losses excluded from Tier 2 capital) on a secured basis. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements. At December 31, 2001, $64,626,000 of the Company's equity in the Bank was restricted and funds available for loans or advances amounted to $10,994,000. Shareholder Rights Plan The Company has a Shareholder Rights Plan under which one preferred stock purchase right was distributed for each outstanding share of common stock. Such rights only become exercisable, or transferable apart from the common stock, ten business days after a person or group acquires beneficial ownership of, or commences a tender or exchange offer for, 15% or more of the Company's common stock, or the declaration by the Board of Directors that any person is an Adverse Person. Each right may then be exercised to acquire one one-hundredth of a share of Series A Junior Participating Cumulative Preferred Stock at an exercise price specified in the Company's Amended and Restated Shareholder Rights Agreement (the "Rights Agreement") subject to adjustment. If the Company is acquired in a merger or other business combination transaction, or 50% of the Company's assets or earning power is sold, the rights entitle holders to acquire common stock of the Acquiring Person (as defined in the Rights Agreement) having a value twice the exercise price of the rights. The rights may be redeemed in whole by the Company at $.01 per right at any time until the earliest of (i) the declaration of a person as an Adverse Person (as defined in the Rights Agreement), (ii) the tenth day following public announcement that a 15% position has been acquired, or (iii) the expiration date of the Rights Agreement. The rights will expire on September 22, 2003. Director Deferred Compensation Plan The Company has deferred compensation arrangements with certain members of the Board of Directors, whereby directors' fees earned are paid to a "Rabbi Trust" and used to purchase shares of the Company's common stock in the open market. The plan does not permit diversification of assets held, and the plan's obligation to each director must be settled by the delivery of the fixed number of shares of the Company's common stock purchased on the director's behalf. The cost of the Company's common stock held by the rabbi trust, and the related deferred compensation obligation offset, are reflected in stockholders' equity. 46 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. EMPLOYEE BENEFIT PLANS Pension Plan The Bank has in the past provided basic and supplemental pension benefits for eligible employees through the Savings Banks Employees Retirement Association Pension Plan. Each employee reaching the age of 21 and having completed at least 1,000 hours of service in one twelve-month period beginning with such employee's date of employment, or any anniversary thereof, automatically became a participant in the pension plan. Participants were fully vested after three years of such service. Effective March 31, 2000, the Bank terminated its defined benefit pension plan and transferred plan assets to its vested employees who had the option to rollover into the Bank's 401(k) plan, or an IRA, or receive a cash payout in amounts that would effectively settle the plan's accumulated benefit obligation. As a result, the Company recognized settlement and curtailment gains totaling $4,799,000 in 2000. Information pertaining to activity in the plan is as follows: Years Ended October 31, ----------------------- 2000 1999 ------- ------- (In thousands) Change in benefit obligation: Benefit obligation at beginning of year $ 5,106 $ 5,472 Service cost -- 642 Interest cost 406 369 Amendment (409) -- Actuarial gain -- (1,010) Benefits paid (5,103) (367) ------- ------- Benefit obligation at end of year -- 5,106 ------- ------- Change in plan assets: Fair value of plan assets at beginning of year 6,879 5,464 Actual return on plan assets 1,420 1,076 Employer contribution -- 706 Benefits paid (5,103) (367) Distribution to employer (3,196) -- ------- ------- Fair value of plan assets at end of year -- 6,879 ------- ------- Funded status -- 1,773 Unrecognized net actuarial gain -- (3,242) Transition asset -- (227) ------- ------- Accrued pension cost $ -- $(1,696) ======= ======= Net periodic pension (income) expense for the plan years ended October 31, 2000 and 1999 consisted of the following: 2000 1999 ------ ------ (In thousands) Service cost $ -- $ 642 Interest cost 406 369 Expected return on plan assets (498) (437) Net amortization and deferral -- (20) Net gain -- (75) ------ ------ Net periodic pension (income) expense $ (92) $ 479 ====== ====== 47 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. EMPLOYEE BENEFIT PLANS (concluded) Pension Plan (concluded) Total pension (income) expense for the years ended December 31, 2000 and 1999 amounted to $(131,000) and $418,000, respectively. For the plan years ended October 31, 2000 and 1999, actuarial assumptions include an assumed discount rate on benefit obligations of 7.00% and 6.75%, respectively, and an expected long-term rate of return on plan assets of 6.00% and 8.00%, respectively. An annual salary increase of 4.50% was used for the year ended October 31, 1999. 401(k) Plan The Bank maintains a 401(k) plan that provides for voluntary contributions by participating employees ranging from 1 percent to 15 percent of their compensation, subject to certain limits based on federal tax laws. Employees are eligible to participate in the plan upon hire and receive matching contributions after three months of service. Prior to January 1, 2000, the Bank made matching contributions equal to twenty-five percent (25%) of the first six percent (6%) of annual compensation contributed to the plan. Effective January 1, 2000, the Bank makes matching contributions equal to seventy-five percent (75%) of the first six percent (6%) of annual compensation contributed to the plan. For the years ended December 31, 2001, 2000 and 1999, expense attributable to the Plan amounted to $335,000, $289,000 and $76,000, respectively. Incentive Plan Short-term incentives can be earned through a discretionary bonus plan, administered by the Compensation and Options Committee of the Board of Directors. Senior executive officers as well as other officers are eligible to receive a bonus payable prior to the end of the first quarter of the following year if the Company or the Bank meets or exceeds certain base standards and individual performance warrants consideration. Incentive compensation expense amounted to $337,000, $266,000 and $136,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Executive Supplemental Benefit Agreement The Company has entered into supplemental executive retirement agreements with its President that are designed to provide benefits lost under defined benefit plans and to increase overall retirement benefits. The present value of future benefits is being accrued over the term of employment. Supplemental compensation expense for the years ended December 31, 2001, 2000 and 1999 amounted to $32,000, $192,000 and $240,000, respectively. 12. STOCK OPTION PLANS The Company has stock option plans for the benefit of directors, officers and full-time employees. The Medford Savings Bank 1986 and 1993 Stock Option Plans covered 1,472,000 and 400,000 shares of common stock, respectively, (the options under which have all been granted). Both "Incentive Stock Options" and "Non-qualified Stock Options" may be granted under the plans, with a maximum option term of ten years. Under the terms of the plans, stock options may be granted as determined appropriate by the Compensation and Options Committee of the Board of Directors, and will have an exercise price equal to, or in excess of, the fair market value of a share of common stock of the Company on the date the option is granted. The plans also permit the inclusion of stock appreciation rights ("SARs") in any option granted which would permit the optionee to surrender an option (or portion thereof) for cancellation and to receive cash or common stock equal to the excess, if any, of the then fair market value of the common stock subject to such option or portion thereof over the option exercise price. No SARs have been granted to date. 48 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. STOCK OPTION PLANS (continued) The Company measures compensation cost for its stock option plans using the intrinsic value based method of accounting. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: Years Ended December 31, ----------------------------- 2001 2000 1999 ------- -------- -------- (In thousands, except per share data) Net income: As reported $13,778 $13,769 $12,651 Pro forma 13,601 13,404 12,459 Basic earnings per share: As reported $ 1.76 $ 1.69 $ 1.51 Pro forma 1.74 1.65 1.48 Diluted earnings per share: As reported $ 1.72 $ 1.64 $ 1.44 Pro forma 1.70 1.60 1.42 In determining the pro forma amounts, the fair value of each option grant was estimated as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: Years Ended December 31, ----------------------------- 2001 2000 1999 -------- -------- -------- Dividend yield 2.7% 3.5% 3.1% Expected life 10 years 10 years 10 years Expected volatility 58% 54% 50% Risk-free interest rate 4.9% 5.2% 6.4% 49 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. STOCK OPTION PLANS (concluded) Stock option activity under the plans is as follows:
Years Ended December 31, ------------------------------------------------------------------------- 2001 2000 1999 --------------------- ---------------------- ----------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Amount Price Amount Price Amount Price --------- -------- --------- -------- --------- --------- Shares under option: Outstanding at beginning of year 527,236 $11.06 674,632 $ 8.50 725,852 $ 7.37 Granted 18,700 19.78 42,000 14.78 54,000 16.36 Cancelled (3,200) 15.64 (7,000) 4.55 (6,000) 20.25 Exercised (91,148) 7.13 (182,396) 2.71 (99,220) 3.75 -------- --------- -------- Outstanding at end of year 451,588 12.18 527,236 11.06 674,632 8.50 ======== ========= ======== Exercisable at end of year 433,388 $11.87 475,586 $10.60 589,732 $ 7.27 ======== ========= ======== Weighted average fair value of options granted during the year $ 10.19 $ 6.68 $ 8.07 ======== ========= ========
Information pertaining to options outstanding at December 31, 2001 is as follows:
Options Outstanding Options Exercisable ---------------------------------------------- ---------------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price --------------- --------------- ------------- ----------- ------------- ----------- $ 3.06 - $ 5.44 81,000 1.1 years $ 5.25 81,000 $ 5.25 $ 6.13 - $ 7.22 20,000 1.8 6.87 20,000 6.87 $ 8.63 - $ 9.72 127,388 2.6 9.53 127,388 9.53 $10.38 - $10.88 18,000 4.1 10.54 18,000 10.54 $12.44 - $14.94 52,000 8.1 14.24 52,000 14.24 $16.00 - $17.70 84,500 7.7 16.60 79,000 16.57 $19.35 - $21.63 68,700 6.8 20.26 56,000 20.15 ------- ------- Outstanding at end of year 451,588 4.6 years $12.18 433,388 $11.87 ======= =======
13. EMPLOYEES' STOCK OWNERSHIP PLAN The Company has an Employees' Stock Ownership Plan ("ESOP") for the benefit of each employee that has reached the age of 21 and has completed at least 500 hours of service with the Company in the previous twelve-month period. The Company may contribute to the ESOP cash or shares of common stock as voted by the Board of Directors, not to exceed the maximum amount deductible for federal income tax purposes. At December 31, 2001, the ESOP held 344,508 shares, all of which have been allocated to participants and included in outstanding shares for earnings per share calculations. Dividends on all shares held by the ESOP are allocated to participants on a pro rata basis. There were no contributions to the ESOP for the years ended December 31, 2001, 2000 or 1999. 50 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" requires disclosures of estimated fair values of all financial instruments where it is practicable to estimate such values. 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 derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. 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 short-term instruments approximate fair values. Securities: Fair values for securities are based on quoted market prices. FHLBB stock: The carrying value of FHLBB stock approximates fair value based on stock redemption provisions. 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 loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial 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 disclosed for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date which is the carrying amount. Fair values for fixed-rate certificates of deposit 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. Borrowings: The carrying amounts of short-term borrowings maturing within ninety days approximate their fair values. Fair values of other borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. Accrued interest: The carrying amounts of accrued interest approximate fair value. Off-balance sheet instruments: Fair values for off-balance-sheet lending commitments 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, and are not material. 51 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded) The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows:
December 31, ------------------------------------------------------ 2001 2000 -------------------------- ---------------------- Carrying Fair Carrying Fair Amount Value Amount Value ----------- ------------ ------------ -------- (In thousands) Financial assets: Cash and cash equivalents $ 46,490 $ 46,490 $ 22,258 $ 22,258 Securities available for sale 588,263 588,263 528,690 528,690 Securities held to maturity 57,022 58,481 42,854 43,935 FHLBB stock 11,920 11,920 11,420 11,420 Loans, net 675,183 677,737 668,747 669,808 Accrued interest receivable 9,596 9,596 10,211 10,211 Financial liabilities: Deposits 1,095,947 1,100,545 975,857 976,783 Short-term borrowings 10,206 10,206 20,443 20,443 Long-term debt 190,075 196,205 203,400 204,465 Accrued interest payable 1,578 1,578 1,897 1,897
15. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY Financial information pertaining only to Medford Bancorp, Inc. is as follows: BALANCE SHEETS December 31, ------------------- 2001 2000 -------- -------- (In thousands) Assets Short-term investments with Medford Savings Bank $ 1,472 $ 4,812 Investment in common stock of Medford Savings Bank 110,019 100,476 Other assets 1,247 992 -------- -------- Total assets $112,738 $106,280 ======== ======== Liabilities and Stockholders' Equity Dividends payable on common stock $ 1,173 $ 1,315 Stockholders' equity 111,565 104,965 -------- -------- Total liabilities and stockholders' equity $112,738 $106,280 ======== ======== 52 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (concluded) STATEMENTS OF INCOME
Years Ended December 31, ---------------------------- 2001 2000 1999 ------- -------- ------- (In thousands) Interest on short-term investments with Medford Savings Bank $ 53 $ 96 $ 40 Dividends from Medford Savings Bank 9,450 11,200 11,200 ------- ------- ------- 9,503 11,296 11,240 Operating expenses 71 86 199 ------- ------- ------- Income before income taxes and equity in undistributed net income of Medford Savings Bank 9,432 11,210 11,041 Applicable income tax provision (benefit) (6) 4 (55) ------- ------- ------- 9,438 11,206 11,096 Equity in undistributed net income of Medford Savings Bank 4,340 2,563 1,555 ------- ------- ------- Net income $13,778 $13,769 $12,651 ======= ======= =======
STATEMENTS OF CASH FLOWS
Years Ended December 31, -------------------------------- 2001 2000 1999 -------- -------- -------- (In thousands) Cash flows from operating activities: Net income $ 13,778 $ 13,769 $ 12,651 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of Medford Savings Bank (4,340) (2,563) (1,555) Decrease (increase) in due from Medford Savings Bank -- 3,500 (1,725) Other, net (6) 2 (306) -------- -------- -------- Net cash provided by operating activities 9,432 14,708 9,065 -------- -------- -------- Cash flows from financing activities: Issuance of common stock 650 494 372 Payments to acquire treasury stock (9,078) (6,428) (7,689) Cash dividends paid (4,344) (4,430) (4,501) -------- -------- -------- Net cash used by financing activities (12,772) (10,364) (11,818) -------- -------- -------- Net change in cash and cash equivalents (3,340) 4,344 (2,753) Cash and cash equivalents at beginning of year 4,812 468 3,221 -------- -------- -------- Cash and cash equivalents at end of year $ 1,472 $ 4,812 $ 468 ======== ======== ========
53 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 16. QUARTERLY DATA (UNAUDITED) A summary of consolidated operating results on a quarterly basis is as follows:
Year Ended December 31, 2001 -------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter -------- -------- -------- -------- (In thousands, except per share data) Interest and dividend income $ 21,902 $ 22,267 $ 22,331 $ 22,389 Interest expense (11,917) (12,876) (13,101) (13,179) -------- -------- -------- -------- Net interest income 9,985 9,391 9,230 9,210 Provision for loan losses (50) (100) -- -- -------- -------- -------- -------- Net interest income, after provision for loan losses 9,935 9,291 9,230 9,210 Gain on sales of securities, net 124 1,626 155 216 Other income 957 776 818 866 Operating expenses (5,709) (5,458) (5,307) (5,209) -------- -------- -------- -------- Income before income taxes 5,307 6,235 4,896 5,083 Provision for income taxes (1,922) (2,254) (1,743) (1,824) -------- -------- -------- -------- Net income $ 3,385 $ 3,981 $ 3,153 $ 3,259 ======== ======== ======== ======== Earnings per share: Basic $ 0.44 $ 0.51 $ 0.41 $ 0.41 ======== ======== ======== ======== Diluted $ 0.43 $ 0.50 $ 0.40 $ 0.40 ======== ======== ======== ========
54 MEDFORD BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded) 16. QUARTERLY DATA (UNAUDITED) (concluded)
Year Ended December 31, 2000 -------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter -------- -------- -------- -------- (In thousands, except per share data) Interest and dividend income $ 22,461 $ 21,894 $ 21,179 $ 20,516 Interest expense (13,397) (12,884) (12,087) (11,546) -------- -------- -------- -------- Net interest income 9,064 9,010 9,092 8,970 Provision for loan losses (100) -- -- (75) -------- -------- -------- -------- Net interest income, after provision for loan losses 8,964 9,010 9,092 8,895 Pension plan curtailment gain -- -- -- 1,195 Pension plan settlement gain 3,604 -- -- -- Loss on sales of securities, net (867) (90) -- (74) Other income 741 731 745 765 Operating expenses (5,136) (4,997) (4,958) (4,900) -------- -------- -------- -------- Income before income taxes 7,306 4,654 4,879 5,881 Provision for income taxes (3,390) (1,638) (1,749) (2,174) -------- -------- -------- -------- Net income $ 3,916 $ 3,016 $ 3,130 $ 3,707 ======== ======== ======== ======== Earnings per share: Basic $ 0.48 $ 0.37 $ 0.39 $ 0.45 ======== ======== ======== ======== Diluted $ 0.47 $ 0.36 $ 0.37 $ 0.43 ======== ======== ======== ========
55 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The response to this item is incorporated by reference from the discussion under the captions "Directors," and "Executive Officers of the Company and the Bank" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on April 29, 2002 (the "Proxy Statement"), to be filed with the SEC pursuant to Regulation 14A of the Exchange Act Rules. ITEM 11. EXECUTIVE COMPENSATION The response to this item is incorporated by reference from the discussion under the captions "Executive Compensation" and "The Board of Directors, its Committees and Compensation" in the Company's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this item is incorporated by reference from the discussion under the caption "Ownership by Management and Other Stockholders" in the Company's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The response to this item is incorporated by reference from the discussion under the caption "Relationships and Transactions with the Company" in the Company's Proxy Statement. 56 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Contents: (1) Financial Statements: All financial statements are included in Item 8 of Part II to this Report. (2) Financial Statement Schedules: All financial statement schedules have been omitted because they are not required, not applicable or are included in the consolidated financial statements or related notes. (3) Exhibits: EXHIBIT INDEX Exhibit Description ------- ----------- 2.1 Plan of Reorganization and Acquisition dated as of July 29, 1997 between the Company and the Bank (filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on November 26, 1997, and incorporated herein by reference) 3.1 Amended Articles of Organization of the Company (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on May 15, 1998, and incorporated herein by reference) 3.2 Amended and Restated By-laws of the Company (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 4.1 Specimen certificate for shares of Common Stock of the Company (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K filed with the SEC on November 26, 1997, and incorporated herein by reference) 4.2 Articles IV, VI(A), VI(C), VI(I)-(J) of the Amended Articles of Organization of the Company (see Exhibit 3.1) 4.3 Articles II and V of the Amended and Restated By-laws of the Company (see Exhibit 3.2) 4.4 Amended and Restated Shareholder Rights Agreement, dated November 26, 1997, between Medford Bancorp, Inc. and State Street Bank and Trust Company, as Rights Agent (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on November 26, 1997, and incorporated herein by reference) 10.1 Amended and Restated Employment Agreement with Arthur H. Meehan (filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.2 Amended and Restated Special Termination Agreement with Arthur H. Meehan (filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.3 Amended and Restated Special Termination Agreement with Phillip W. Wong (filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.4 Amended and Restated Special Termination Agreement with George A. Bargamian (filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.5 Amended and Restated Special Termination Agreement with Eric B. Loth (filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.6 Amended and Restated Special Termination Agreement with William F. Rivers (filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 57 10.7 Supplemental Executive Retirement Plan and Corresponding Adoption Agreement with Arthur H. Meehan (filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.8 Executive Supplemental Benefit Agreement with Arthur H. Meehan (filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K filed with the SEC on March 23, 1998, and incorporated herein by reference) 10.9 Deferred Investment Plan for Outside Directors (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-8 filed with the SEC on December 24, 1997, and incorporated herein by reference) 10.10 First Amendment to Deferred Investment Plan for Outside Directors (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 filed with the SEC on December 24, 1997, and incorporated herein by reference) 10.11 Medford Savings Bank 1986 Stock Option Plan (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-8 filed with the SEC on November 26, 1997, and incorporated herein by reference) 10.12 Medford Bancorp, Inc. Stock Option Plan (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 filed with the SEC on November 26, 1997, and incorporated herein by reference) 10.13 Discretionary Bonus Plan (not set forth in a formal document -- a description of the plan is contained in both the Proxy Statement to be filed with the SEC, and incorporated herein by reference, under the caption "Compensation Committee Report on Executive Compensation" and in the "Notes to Consolidated Financial Statements" under the caption "Employee Benefit Plans -- Incentive Plan" in Item 8 to this Report) 10.14 Special Termination Agreement with William L. Marshall (filed as Exhibit 10.14 to the Company's Form 10Q filed with the SEC on August 14, 2001, and incorporated herein by reference) 21 Subsidiaries of the Company -- The Company has one direct subsidiary: Medford Savings Bank, a Massachusetts-chartered savings bank in stock form. Medford Savings Bank has one subsidiary: Medford Securities Corporation, a Massachusetts corporation. *23 Consent of Wolf & Company, P.C. as independent certified public accountants * Filed herewith (b) Reports on Form 8-K: None. 58 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MEDFORD BANCORP, INC. By: /s/ Arthur H. Meehan --------------------------- Arthur H. Meehan Chairman, President, Chief Executive Officer and Director Date: March 5, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Arthur H. Meehan Chairman, President, March 5, 2002 ------------------------------ Chief Executive Officer Arthur H. Meehan and Director /s/ Phillip W. Wong Executive Vice President, March 5, 2002 ------------------------------ Chief Financial Officer Phillip W. Wong and Treasurer /s/ Edward D. Brickley Director March 5, 2002 ------------------------------ Edward D. Brickley /s/ David L. Burke Director March 5, 2002 ------------------------------ David L. Burke /s/ Deborah A. Burke-Santoro Director March 5, 2002 ------------------------------ Deborah A. Burke-Santoro Director ,2002 ------------------------------ Paul J. Crowley Director ,2002 ------------------------------ Mary L. Doherty /s/ Edward J. Gaffey Clerk and Director March 5, 2002 ------------------------------ Edward J. Gaffey /s/ Andrew D. Guthrie, Jr. Director March 5, 2002 ------------------------------ Andrew D. Guthrie, Jr. /s/ Robert A. Havern, III Director March 5, 2002 ------------------------------ Robert A. Havern, III /s/ Francis D. Pizzella Director March 5, 2002 ------------------------------ Francis D. Pizzella /s/ John J. Sheehan Director March 5, 2002 ------------------------------ John J. Sheehan 59