10QSB 1 wbor-q2.txt FORM 10-QSB FOR MARCH 31, 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 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: 000-27997 Westborough Financial Services, Inc. (Exact name of small business registrant as specified in its charter) Massachusetts 04-3504121 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 100 E. Main Street Westborough, Massachusetts 01581 (508) 366-4111 (Address of principal executive offices) (Registrant's telephone number, including area code) Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ------- ------- State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: Class Outstanding as of May 5, 2004 ----- ----------------------------- Common Stock, par value $0.01 1,588,674 Transitional Small Business Disclosure Format (check one): YES NO X ------- ------- Forward Looking Statements Westborough Financial Services, Inc. (the "Company") and The Westborough Bank (the "Bank") may from time to time make written or oral "forward-looking statements" which may be identified by the use of such words as "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions that are intended to identify forward-looking statements. Forward-looking statements include statements with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, which are subject to significant risks and uncertainties. The following factors, many of which are subject to change based on various other factors beyond the Company's control, and other factors identified in the Company's filings with the Securities and Exchange Commission and those presented elsewhere by management from time to time, could cause its financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which would cause actual results to differ materially from these estimates. These factors include, but are not limited to: * conditions which effect general and local economies; * changes in interest rates, deposit flows, demand for mortgages and other loans, real estate values and competition; * changes in accounting principles, policies, or guidelines; * changes in legislation or regulation; and * other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services. This list of important factors is not exclusive. The Company or the Bank does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank. WESTBOROUGH FINANCIAL SERVICES, INC. AND SUBSIDIARY INDEX PART I. FINANCIAL INFORMATION 1 Item 1. Financial Statements 1 Consolidated Balance Sheets 1 Consolidated Statements of Income 2 Consolidated Statements of Changes in Stockholders' Equity 3 Consolidated Statements of Cash Flows 4 Notes to Unaudited Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis. 7 Item 3. Controls and Procedures 20 PART II. OTHER INFORMATION 21 Item 1. Legal Proceedings 21 Item 2. Changes in Securities and Small Business Issuer Purchases of Equity Securities 21 Item 3. Defaults upon Senior Securities 21 Item 4. Submission of Matters to a Vote of Security Holders 22 Item 5. Other Information 22 Item 6. Exhibits and Reports on Form 8-K 22 SIGNATURES 23 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Westborough Financial Services, Inc. and Subsidiary Consolidated Balance Sheets (Dollars in thousands)
March 31, September 30, 2004 2003 --------- ------------- (unaudited) Assets Cash and due from banks $ 2,733 $ 4,190 Federal funds sold 3,931 6,024 Short-term investments 1,635 1,687 -------- -------- Total cash and cash equivalents 8,299 11,901 Securities available for sale 93,646 87,590 Federal Home Loan Bank stock, at cost 1,250 1,250 Loans, net of allowance for loan losses of $951 and $911, respectively 141,241 141,557 Banking premises and equipment, net 6,560 6,708 Accrued interest receivable 1,148 1,179 Deferred income taxes 182 93 Cash surrender value of life insurance 5,609 5,293 Due from broker 220 0 Other assets 621 551 -------- -------- Total assets $258,776 $256,122 ======== ======== Liabilities and Stockholders' Equity Deposits $211,969 $215,898 Federal Home Loan Bank advances 15,500 9,500 Mortgagors' escrow accounts 224 208 Accrued expenses and other liabilities 1,864 1,798 -------- -------- Total liabilities 229,557 227,404 -------- -------- Commitments and Contingencies Preferred stock, $.01 par value, 1,000,000 shares authorized, none outstanding 0 0 Common stock, $.01 par value, 5,000,000 shares authorized, 1,588,674 and 1,586,174 issued and outstanding, respectively 16 16 Additional paid-in capital 4,790 4,706 Retained earnings 23,815 23,325 Accumulated other comprehensive income 1,163 1,290 Unearned compensation-RRP (14,659 shares) (248) (288) Unearned compensation-ESOP (31,675 and 33,149 shares, respectively) (317) (331) -------- -------- Total stockholders' equity 29,219 28,718 -------- -------- Total liabilities and stockholders' equity $258,776 $256,122 ======== ========
See accompanying notes to unaudited consolidated financial statements 1 Westborough Financial Services, Inc. and Subsidiary Consolidated Statements of Income (Dollars in thousands, except per share data)
Three Months Ended Six Months Ended March 31, March 31, ------------------------- ------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- (unaudited) (unaudited) Interest and dividend income: Interest and fees on loans $ 1,881 $ 1,993 $ 3,897 $ 4,095 Interest and dividends on securities 857 1,036 1,801 2,101 Interest on federal funds sold 9 24 15 59 Interest on short term investments 2 6 6 31 ---------- ---------- ---------- ---------- Total interest and dividend income 2,749 3,059 5,719 6,286 ---------- ---------- ---------- ---------- Interest expense: Interest on deposits 572 850 1,198 1,835 Interest on borrowings 128 154 261 311 ---------- ---------- ---------- ---------- Total interest expense 700 1,004 1,459 2,146 ---------- ---------- ---------- ---------- Net interest income 2,049 2,055 4,260 4,140 Provision for loan losses 10 0 40 0 ---------- ---------- ---------- ---------- Net interest income, after provision for loan losses 2,039 2,055 4,220 4,140 ---------- ---------- ---------- ---------- Other income: Customer service fees 202 114 378 279 Gain (loss) on sales of securities available for sale, net 60 (7) 58 (3) Gain on sales of mortgages 84 5 87 5 Miscellaneous 43 43 98 85 ---------- ---------- ---------- ---------- Total other income 389 155 621 366 ---------- ---------- ---------- ---------- Operating expenses: Salaries and employee benefits 1,051 994 2,054 1,961 Occupancy and equipment 330 322 620 627 Data processing expenses 174 147 348 310 Marketing and advertising 46 33 74 86 Professional fees 87 84 139 149 Other general and administrative 309 333 659 680 ---------- ---------- ---------- ---------- Total operating expenses 1,997 1,913 3,894 3,813 ---------- ---------- ---------- ---------- Income before provision for income taxes 431 297 947 693 Provision for income taxes 132 118 299 236 ---------- ---------- ---------- ---------- Net income $ 299 $ 179 $ 648 $ 457 ========== ========== ========== ========== Number of weighted average shares outstanding-Basic 1,540,821 1,528,424 1,539,469 1,527,951 Earnings per share-Basic $0.19 $0.12 $0.42 $0.30 Number of weighted average shares outstanding-Dilutive 1,562,570 1,549,370 1,560,713 1,548,519 Earnings per share-Dilutive $0.19 $0.12 $0.42 $0.30
See accompanying notes to unaudited consolidated financial statements. 2 Westborough Financial Services, Inc. and Subsidiary Consolidated Statements of Changes in Stockholders' Equity (Dollars in thousands)
Accumulated Additional Other Unearned Unearned Common Paid-in Retained Comprehensive Compensation- Compensation- Stock Capital Earnings Income (Loss) RRP ESOP Total ------ ---------- -------- ------------- ------------- ------------- ----- Balance at September 30, 2002 $16 $4,583 $22,676 $1,439 $(365) $(360) $27,989 ------- Comprehensive income: Net income 0 0 457 0 0 0 457 Change in net unrealized gain on securities available for sale, net of reclassification adjustment and tax effects 0 0 0 (10) 0 0 (10) ------- Total comprehensive income 447 ------- Cash dividends declared and paid $(.10 per share) 0 0 (158) 0 0 0 (158) ESOP shares released and committed to be released (1,474 shares) 0 19 0 0 0 13 32 Amortization of RRP stock 0 0 0 0 38 0 38 --- ------ ------- ------ ----- ----- ------- Balance at March 31, 2003 $16 $4,602 $22,975 $1,429 $(327) $(347) $28,348 === ====== ======= ====== ===== ===== ======= Balance at September 30, 2003 $16 $4,706 $23,325 $1,290 $(288) $(331) $28,718 ------- Comprehensive income: Net income 0 0 648 0 0 0 648 Change in net unrealized gain on securities available for sale, net of reclassification adjustment and tax effects 0 0 0 (127) 0 0 (127) ------- Total comprehensive income 521 ------- Cash dividends declared and paid $(.10 per share) 0 0 (158) 0 0 0 (158) ESOP shares released and committed to be released (1,474 shares) 0 36 0 0 0 14 50 Amortization of RRP stock 0 0 0 0 40 0 40 Issuance of common stock under stock option plan, net of income tax benefits 0 48 0 0 0 0 48 --- ------ ------- ------ ----- ----- ------- Balance at March 31, 2004 (unaudited) $16 $4,790 $23,815 $1,163 $(248) $(317) $29,219 === ====== ======= ====== ===== ===== =======
See accompanying notes to unaudited consolidated financial statements. 3 Westborough Financial Services, Inc. and Subsidiary Consolidated Statements of Cash Flows (dollars in thousands)
Six Months Ended March 31, ---------------------- 2004 2003 ---- ---- (unaudited) Cash flows from operating activities: Net income $ 648 $ 457 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 40 0 Net amortization on securities 265 98 Amortization of net deferred loan costs and discounts (7) (26) Depreciation expense 278 318 (Gain) loss on sales and calls of securities available for sale, net (58) 3 Gain on sales of mortgages (87) (5) Decrease in accrued interest receivable 31 49 Deferred income tax benefit (105) (105) ESOP shares released and committed to be released 50 32 Amortization of RRP Stock 40 38 Increase in bank-owned life insurance (316) (353) Other, net (224) (320) -------- -------- Net cash provided by operating activities 555 186 -------- -------- Cash flows from investing activities: Activity in available for sale securities: Sales and calls 9,322 2,007 Maturities 3,000 1,495 Purchases (22,453) (21,101) Principal payments 3,757 5,869 Loan sales 4,884 0 Loan (originations) principal payments, net (4,514) 856 Purchase of banking premises and equipment (130) (1,217) -------- -------- Net cash used by investing activities (6,134) (12,091) -------- -------- Cash flows from financing activities: Net increase (decrease) in deposits (3,929) 10,623 Increase in FHLB advances 6,000 0 Net increase (decrease) in mortgagors' escrow accounts 16 (34) Issuance of common stock under stock option plan, net of tax benefits 48 0 Dividends paid (158) (158) -------- -------- Net cash provided by financing activities 1,977 10,431 -------- -------- Net change in cash and cash equivalents (3,602) (1,474) Cash and cash equivalents at beginning of period 11,901 19,253 -------- -------- Cash and cash equivalents at end of period $ 8,299 $ 17,779 ======== ========
See accompanying notes to unaudited consolidated financial statements. 4 Westborough Financial Services, Inc. and Subsidiary Notes to Unaudited Consolidated Financial Statements 1) Basis of Presentation and Consolidation. The unaudited consolidated interim financial statements of Westborough Financial Services, Inc. and Subsidiary (the "Company") presented herein should be read in conjunction with the consolidated financial statements for the year ended September 30, 2003, included in the Annual Report on Form 10-KSB of the Company, the holding company for The Westborough Bank (the "Bank"). The unaudited consolidated interim financial statements herein have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, the consolidated interim financial statements reflect all adjustments (consisting solely of normal recurring accruals) necessary for a fair presentation of such information. Interim results are not necessarily indicative of results to be expected for the entire year. A summary of significant accounting policies followed by the Company is set forth in the Notes to Consolidated Financial Statements of the Company's 2003 Annual Report to Stockholders. 2) Contingencies. At March 31, 2004, the Bank had residential and commercial loan commitments to borrowers of $5.7 million, commitments for home equity loans of $541 thousand, available home equity lines of credit of $11.8 million, unadvanced funds on commercial lines of credit, overdrafts and participation loans of $3.0 million, unadvanced funds on construction mortgages of $1.6 million and personal overdraft lines of credit of approximately $498 thousand. The Bank had a commitment at March 31, 2004 to purchase on April 20, 2004, a $5.0 million, 15-yr fixed-rate mortgage- backed security. Also, at March 31, 2004, the Bank was committed to borrow $3.0 million from the FHLBB to settle on April 1, 2004. 3) Earnings per Share. Basic earnings per share represent income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated in accordance with Statement of Financial Accounting Standards No. 128 and reflects additional common shares (common stock equivalents) that would have been outstanding if only dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. For the periods presented, the Company has no potential common shares outstanding that are considered anti-dilutive. If applicable, the Company would exclude from the diluted earnings per share calculation any potential common shares that would increase earnings per share. Potential common shares that may be issued by the Company relate solely to outstanding stock options and grants and are determined using the treasury stock method. On January 25, 2001, the Company's stockholders approved the Westborough Financial Services, Inc. 2001 Stock Option Plan (the "Stock Option Plan"). Under the Stock Option Plan, the Company may grant options to its directors, officers and employees for up to 55,348 shares of common stock. Both incentive stock options and non-qualified stock options may be granted under the Stock Option Plan. The exercise price of each option equals the market price of the Company's stock on the date of grant and an option's maximum term is ten years. Options generally vest over a five- year period. 5 The Company applies APB Opinion 25 and related Interpretations in accounting for the Stock Option Plan. Accordingly, no compensation cost has been recognized. Had compensation cost for the Company's Stock Option Plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123, the Company's net income and earnings per share would have been adjusted to the pro forma amounts indicated below:
Three Months Ended Six Months Ended March 31, March 31, ------------------ ---------------- 2004 2003 2004 2003 ---- ---- ---- ---- Net income As reported $ 299 $ 179 $ 648 $ 457 Pro forma $ 293 $ 173 $ 635 $ 444 Basic earnings per share As reported $0.19 $0.12 $0.42 $0.30 Pro forma $0.19 $0.11 $0.41 $0.29 Diluted earnings per share As reported $0.19 $0.12 $0.42 $0.30 Pro forma $0.19 $0.11 $0.41 $0.29
6 Item 2. Management's Discussion and Analysis. General The following discussion compares the financial condition of the Company and its wholly owned subsidiary, the Bank, at March 31, 2004 and September 30, 2003, and the results of operations for three and six-months ended March 31, 2004, compared to the same periods in 2003. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes that are included within this report. The Company's principal business is its investment in the Bank, which is a community-oriented financial institution providing a variety of financial services to the communities which it serves. The business of the Bank consists of attracting deposits from the general public and using these funds to originate various types of loans primarily in the towns of Westborough, Northborough and Shrewsbury, Massachusetts, including residential and commercial real estate mortgage loans and, to a lesser extent, consumer and commercial loans. The Bank's results of operations depend primarily on net interest income. Net interest income is the difference between the interest income the Bank earns on its interest-earning assets and the interest it pays on its interest-bearing liabilities. Interest-earning assets primarily consist of mortgage loans and investment securities. Interest-bearing liabilities consist primarily of certificates of deposit, savings accounts and borrowings. The Bank's results of operations are also affected by its provision for loan losses, income from security and mortgage transactions, income from the sale of non-deposit investment products, other income and operating expenses. Operating expenses consist primarily of salaries and employee benefits, occupancy, data processing, marketing, professional fees and other general and administrative expenses. Other income consists mainly of customer service fees and charges, income from bank-owned life insurance and fees from the sale of non-insured investment products. The Bank's results of operations may also be affected significantly by general and local economic and competitive conditions, particularly those with respect to changes in market interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact the Bank. Additionally, the Bank's lending activity is concentrated in loans secured by real estate located in Westborough, Northborough and Shrewsbury, Massachusetts. Accordingly, the Bank's results of operations are affected by regional market and economic conditions. 7 Comparison of Financial Condition at March 31, 2004 and September 30, 2003 The Company's total assets increased by $2.7 million, or 1.0%, to $258.8 million at March 31, 2004 from $256.1 million at September 30, 2003. While deposits declined by $3.9 million, or 1.8%, to $212.0 million from $215.9 million, advances from the Federal Home Loan Bank of Boston (the "FHLBB") increased by $6.0 million, or 63.2%, to $15.5 million at March 31, 2004. Management believes the recent decline in deposits is generally related to customer desires to invest in equity securities and to reduce personal debt. Management continually compares offering rates on retail certificates of deposits and other deposit rates with rates of advances from the FHLBB. During this period, management deemed it prudent to borrow money, rather than offer above-market rates on deposit products. Accordingly, the increase in advances was used primarily to fund the maturities of relatively higher-rate certificates of deposits and also to fund the purchases of securities available for sale. Securities available for sale increased by $6.1 million, or 6.9%, to $93.6 million, at March 31, 2004 as compared to $87.6 million at September 30, 2003. Much of the increase in securities available for sale was in the categories of federal agency mortgage-backed securities and bonds. During March 2004, the Company borrowed $5 million from the FHLBB to fund one-half of a $10 million purchase of 15-year, fixed-rate federal agency mortgage-backed securities with an average borrowing term selected to somewhat match the estimated life and other characteristics of the underlying securities. Also, at March 31, 2004, the Company had committed to borrow an additional $3 million from the FHLBB to partially fund the remaining $5 million of the aforementioned 15-year security. Loans declined by 0.2%, or $316 thousand, to $141.2 million. Within the category of loans, while commercial loans increased by $3.3 million from September 30, 2003 to March 31, 2004, residential real estate and home equity lines-of-credit declined by $3.4 million for the same period and primarily reflect the sale of $4.9 million fixed-rate mortgage loans, offset, to a lesser extent, by originations of new residential mortgage and home equity lines-of-credit. Regarding asset quality, non-performing loans declined to $561 thousand, or 0.40% of loans at March 31, 2004 as compared to $634 thousand, or 0.45% of total loans at September 30, 2003. Total stockholders' equity increased by $501 thousand, to $29.2 million at March 31, 2004 from $28.7 million at September 30, 2003 primarily as a result of current period net income, net of common stock dividends paid, changes in accumulated comprehensive income relating to the change in after-tax value in securities available for sale, the issuance of common stock relating to the Company's stock option plan, and due to recognition of earned compensation on the Company's employee stock ownership and recognition and retention plans. Comparison of Operating Results for Three-Months Ended March 31, 2004 and 2003 Net Income: The Company reported earnings per share (dilutive) for three-months ended March 31, 2004 of $0.19 on net income of $299 thousand, as compared to $0.12 per share (dilutive) on net income of $179 thousand for three-months ended March 31, 2003. The Company's annualized return on average assets was 0.48% for three-months ended March 31, 2004 as compared to 0.29% for three-months ended March 31, 2003. The increase in net income for three-months ended March 31, 2004 was primarily due to an increase in customer service fees, plus net gains on the sale of securities available for sale and mortgages, offset, to a lesser extent, by an increase in operating expenses. Income from customer service fees increased by $88 thousand, or 77.2%, to $202 thousand for three-months ended March 31, 2004 as compared to $114 thousand for three- months ended March 31, 2003, primarily from an increase in fee income from the sale of non-deposit investment products, such as mutual funds and annuities. Additionally, for three-months ended March 31, 2004, the Company sold securities available for sale, 8 primarily common stocks, and realized net pre-tax gains of $60 thousand, as compared to net pre-tax losses of $7 thousand for three-months ended March 31, 2003. Also, during three-months ended March 31, 2004, the Company sold 30 year fixed-rate mortgage loans, with servicing retained by the Bank, and recognized a pre-tax gain on the sale of $84 thousand, as compared to a pre-tax gain of $5 thousand, on a substantially reduced volume of loans sold, for three-months ended March 31, 2003. For three-months ended March 31, 2004, operating expenses increased by $84 thousand, or 4.4%, to $2.0 million, from $1.9 million for three-months ended March 31, 2003. The primary reasons for the increase were due to general increases in staff salaries and also due to a decline in mortgage lending volume. As it relates to mortgage lending volume, the Bank is allowed to defer certain operating costs, primarily salaries, related to originating loans. As a result of the decline in originated loans during the current period, such cost deferrals also declined accordingly. With regard to the Bank's net interest income, it declined by $6 thousand, or 0.3% for three-months ended March 31, 2004, as compared to three-months ended March 31, 2003. The Company's net interest margin, expressed as a percentage of average interest-earning assets, declined by .05%, to 3.49%, from 3.54%, for three- months ended March 31, 2003. The following schedule of the Bank's net interest rate spread and net interest margin for the periods indicated is based upon average balances and will aid in the subsequent discussion of interest and dividend income, interest expense and net interest income: 9
Three Months Ended March 31, ------------------ Increase 2004 2003 (decrease) ---- ---- ---------- Interest-earning assets: Short-term investments (1) 0.82% 0.98% -0.16% Investment securities (2) 3.82% 4.64% -0.82% Loans (3) 5.39% 6.11% -0.72% Total interest-earning assets 4.68% 5.27% -0.59% Interest-bearing liabilities: NOW accounts 0.11% 0.16% -0.05% Savings accounts (4) 1.03% 1.43% -0.40% Money market deposit accounts 0.98% 1.26% -0.28% Certificate of deposit accounts 2.05% 2.93% -0.88% Total interest-bearing deposits 1.21% 1.80% -0.59% Borrowed funds 5.16% 6.48% -1.32% Total interest-bearing liabilities 1.40% 2.02% -0.62% Net interest rate spread (5) 3.28% 3.25% 0.03% Net interest margin (6) 3.49% 3.54% -0.05% Short-term investments include federal funds sold. All investment securities are considered available for sale. Loans are net of deferred loan origination costs (fees), allowance for loan losses, discount/premium on purchased loans and unadvanced funds. Savings accounts include the balance in mortgagors' escrow accounts. Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-earning assets.
10 Interest and Dividend Income: The Bank's interest and dividend income declined by $310 thousand, or 10.1%, to $2.7 million for three- months ended March 31, 2004 as compared to $3.1 million for three-months ended March 31, 2003. The decline was primarily due to the combination of lower rates earned on average interest-earning assets offset, to a lesser extent, by an increase in the average volume of interest-earning assets. The Bank's average interest rate earned on all interest-earning assets declined by 0.59%, to 4.68% for three-months ended March 31, 2004 from 5.27% for three-months ended March 31, 2003. However, the average volume of interest-earning assets for three-months ended March 31, 2004 increased to $234.8 as compared to an average volume of $232.2 million for three- months ended March 31, 2003. The increase in the average volume of interest-earning assets was primarily the result of increases in the average volume of interest-bearing deposits, interest-bearing borrowings and non-interest bearing deposits. This increase in volume was invested in assets with comparatively lower interest-earning rates. The average balance of investment securities for three-months ended March 31, 2004 increased to $89.9 million, earning 3.82% as compared to an average balance of $89.3 million, earning 4.64% for three-months ending March 31, 2003. The average balance of short-term investments for three-months ended March 31, 2004 declined to $5.3 million earning 0.82% as compared to an average balance of $12.3 million earning 0.98% for three-months ending March 31, 2003. In this environment of low interest rates, management has chosen to reduce the balance of short-term investments, and to re-invest such balances in longer-term investment securities that offer higher rates of interest and, when necessary, to borrow overnight funds from the FHLBB for cash management purposes. The average balance of loans for three-months ended March 31, 2004, increased to $139.6 million earning 5.39%, as compared to an average balance of $130.6 million earning 6.11% for three- months ending March 31, 2003. While the average volume of real estate and commercial loans increased, the Bank continued to experience a decline in its rate of interest earned on loans primarily in response to the general decline in market-based interest rates offered on new loans granted during the period, a decline in the rates of interest charged on adjustable-rate loans which were subject to contractual adjustment, loan sales and unscheduled customer refinancing and renegotiations of existing loan interest rates. Interest Expense: Total interest expense declined by $304 thousand, or 30.3%, to $700 thousand for three-months ended March 31, 2004, from $1.0 million for three-months ended March 31, 2003. The decline in interest expense was mainly due to management of the Bank constantly monitoring and actively reducing rates offered on various deposit accounts to coincide with the general decline in competitive loan, investment and deposit interest rates during the most recent three-month period. The average volume of all interest-bearing liabilities (which includes interest-bearing deposits and borrowings) increased to $199.7 million, with a cost of 1.40%, for three-months ended March 31, 2004 as compared to $198.7 million, with a cost of 2.02%, for three-months ending March 31, 2003. The average volume of interest-bearing deposits increased to $189.8 million, with a cost of 1.21%, for three-months ended March 31, 2004 as compared to $189.2 million, with a cost of 1.80%, for three-months ended March 31, 2003. The average balance of borrowings increased to $9.9 million, with an average cost of 5.16%, for three-months ended March 31, 2004, as compared to an average balance of $9.5 million, with an average cost of 6.48%, for three-months ended March 31, 2003. Net Interest Income: The Bank's net interest income declined by $6 thousand, or 0.3%, for three-months ended March 31, 2004, to $2.0 million compared to three-months ended March 31, 2003. As noted above, the decline was primarily attributed to the combination of a decrease in interest and dividend income of $310 thousand and a decline in interest expense of $304 thousand. The Bank's reduction in rates paid on interest-bearing liabilities was exceeded by the effect of lower yields earned on interest- earning assets, which resulted in a declined net interest rate margin. The Bank's net interest rate margin, which represents net interest income as a percentage of average interest-earning 11 assets declined to 3.49% for three-months ended March 31, 2004 as compared to 3.54% for three-months ended March 31, 2003. Provision for Loan Losses: The Bank had a $10 thousand provision for loan losses for three-months ended March 31, 2004 compared to $0 for three- months ended March 31, 2003. Total loans at March 31, 2004 were $141.2 million, $141.6 million at September 30, 3003 and $132.1 million at March 31, 2003. The provision for loan losses is a result of management's periodic analysis of risks inherent in its loan portfolio as well as the adequacy of the allowance for loan losses. It is the Bank's policy to provide valuation allowances for estimated losses on loans based upon past loss experience, current trends in the level of delinquent and specific problem loans, loan concentrations to single borrowers, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions in our market area. Accordingly, the evaluation of the adequacy of the allowance for loan losses is not based directly on the level of non-performing loans. As the Bank expands its commercial lending activities, management believes that growth in the provision for loan losses may be likely. Additionally, while management believes it continues to have excellent loan quality, with $561 thousand of non-accrual loans and non-performing assets and an allowance for loan losses of $951 thousand at March 31, 2004, the Bank recognizes that it is located in a market and geographic area that is considered in the high technology and financial services belt and, most likely, the Bank's allowance for loan loss will reflect the relative health of these economic sectors. While management believes it's current level of allowance for loan losses is adequate, there can be no assurance that the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. Other Income: Other income consists primarily of fee income for customer services, gains and losses from the sale of mortgages and the sale of securities available for sale, and income from bank-owned life insurance ("BOLI"). Total other income increased by $234 thousand, or 151.0%, to $389 thousand for three-months ended March 31, 2004, from $155 thousand for the comparative three-months ended March 31, 2003. Income from customer service fees increased by $88 thousand, or 77.2%, to $202 thousand for three-months ended March 31, 2004 as compared to $114 thousand for three- months ended March 31, 2003, primarily from an increase in fee income from the sale of non-deposit investment products, such as mutual funds and annuities. Additionally, for three-months ended March 31, 2004, the Company sold securities available for sale, primarily common stocks, and realized net pre-tax gains of $60 thousand, as compared to net pre-tax losses of $7 thousand for three-months ended March 31, 2003. Also, during three-months ended March 31, 2004, the Company sold fixed-rate mortgage loans, with servicing retained by the Bank, and recognized a pre-tax gain on the sale of $84 thousand, as compared to a pre-tax gain of $5 thousand, on a substantially reduced volume of loans sold, for three-months ended March 31, 2003. With regard to the Company's common stock holdings, the Company's internal investment policy requires management to either write-down to market value, or sell, any common stock issue that has sustained a decline in market value of 50% or more, for a continuous period of nine-months or more. Although management believes that it has established and maintained an adequate accounting policy as it relates to investment impairment, such judgments involve a higher degree of complexity and require management to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. This critical policy and its application are periodically reviewed with the Audit Committee and the Company's Board of Directors. For three-months ended March 31, 2004 and March 31, 2003, no investment in common stock met the criteria noted above. 12 Operating Expenses: For three-months ended March 31, 2004, operating expenses increased by $84 thousand, or 4.4%, to $2.0 million, from $1.9 million for three-months ended March 31, 2003. Salary and employee benefit expenses increased $57 thousand, or 5.7%, to $1.1 million for three-months ended March 31, 2004, as compared to $994 thousand for three-months ended March 31, 2003. Some salary and benefit expenses increased as a result of general salary adjustments, however, certain salary and benefit expenses declined. The Bank reduced its use of temporary outside help and reduced some sales incentive compensation payments. The Bank also experienced a reduction in employee retirement expenses relating to its defined-benefit pension plan. The Bank is allowed to defer certain operating costs, primarily salaries, related to originating loans. As a result of a general decline in lending volume, the reduction in salary costs associated with the closing of new residential, commercial and construction loans declined to $19 thousand for three-months ended March 31, 2004 as compared to $86 thousand for three-months ended March 31, 2003. These deferred costs are considered yield adjustments, and are subsequently charged to interest income over the life of each loan. Data processing expenses increased $27 thousand, or 18.4%, to $174 thousand for three-months ended March 31, 2004, as compared to $147 thousand for three-months ended March 31, 2003 primarily due to a higher level of services provided by the data processing vendor. Marketing and advertising expense increased by $13 thousand, to $46 thousand, for three-months ended March 31, 2004 as compared to $33 thousand, for three-months ended March 31, 2003, primarily as a result of an increase in expenses relating to print and cable TV advertising. Professional fees increased by $3 thousand, to $87 thousand, for three- months ended March 31, 2004 as compared to $84 thousand for three-months ended March 31, 2003 primarily as a result of an increase in financial printing costs. Occupancy and equipment expenses increased by $8 thousand, to $330 thousand for three-months ended March 31, 2004 as compared to $322 thousand for three-months ended March 31, 2003 primarily as a result of an increase in real estate tax rates. As it relates to occupancy and equipment expenses, during this fiscal year, management expects to begin a program of replacing certain older generation personal computers and software. Additionally, in April 2004, the Bank closed its branch office located in the Shaw's Supermarket in the town of Shrewsbury. The Company expects that the increase in occupancy and equipment expenses resulting from the replacement of older generation personal computers and software will be offset by the decline in occupancy expenses resulting from the closing of the supermarket branch. Income Taxes. Primarily as a result of increased pre-tax income, the provision for income taxes increased by $14 thousand, to $132 thousand, for three-months ended March 31, 2004 as compared to $118 thousand for three- months ended March 31, 2003, resulting in an effective tax rate of 30.6% and 39.7%, respectively. The Bank also utilizes a wholly-owned security investment subsidiary to substantially reduce state income taxes, receives the benefit of a dividends received deduction on common stock held and receives favorable tax treatment from the increase in the cash surrender value of BOLI. Comparison of Operating Results for Six-Months Ended March 31, 2004 and 2003 Net Income: The Company reported earnings per share (dilutive) for six-months ended March 31, 2004 of $0.42 on net income of $648 thousand, as compared to $0.30 per share (dilutive) on net income of $457 thousand for six-months ended March 31, 2003. For six-months ended March 31, 2004, net income increased by $191 thousand, or 41.8%, to $648 thousand, as compared to $457 thousand, for six-months ended March 31, 2003. The Company's return on average assets was 0.51% for six-months ended March 31, 2004 as compared to 0.37% for six-months ended March 31, 2003. The increase in net income for six-months ended March 31, 2004 was due primarily to an increase in net interest income, customer service fees, net gains on the sales of mortgages and securities available for sale, offset, to a lesser extent, by an increase in operating expenses and provisions for 13 income taxes and loan losses. Net interest income increased by $120 thousand, or 2.9%, to $4.3 million, for six-months ended March 31, 2004, as compared to $4.1 million for six-months ended March 31, 2003. While the average rate earned on interest-earning assets declined by 0.65%, to 4.82% for six-months ended March 31, 2004 from 5.47% for six-months ended March 31, 2003, the average cost of interest-bearing liabilities declined by 0.74%, to 1.44% for six-months ended March 31, 2004 from 2.18% for six- months ended March 31, 2003. The decline in rates of interest paid on interest-bearing liabilities was primarily the result of maturing certificates of deposits reinvested at lower rates and also due to an increase in the amount of low-cost borrowing from the FHLBB. Income from customer service fees increased by $99 thousand, or 35.5%, to $378 thousand for six-months ended March 31, 2004 as compared to $279 thousand for six- months ended March 31, 2003, primarily due to the recognition of a non- refundable $71 thousand prepayment fee from the payment in full of a $2.6 million commercial loan. Also for six-months ended March 31, 2004, the Company sold fixed-rate mortgage loans, with servicing retained by the Bank, and recognized a pre-tax gain on the sale of $87 thousand, as compared to a pre-tax gain of $5 thousand, on a substantially reduced volume of loans sold, for six-months ended March 31, 2003. Additionally, for six-months ended March 31, 2004, the Company sold securities available for sale, primarily common stocks, and realized net pre-tax gains of $58 thousand, as compared to net pre-tax losses of $3 thousand for six-months ended March 31, 2003. For six-months ended March 31, 2004, operating expenses increased by $81 thousand, or 2.1%, to $3.9 million, from $3.8 million for six-months ended March 31, 2003. The primary reasons for the increase were due to general increases in staff salaries and also due to a decline in deferred costs related to the decrease in new mortgage loans. As a result of a higher level of services provided, data processing expenses increased by $38 thousand, or 12.3%, to $348 thousand for six- months ended March 31, 2004 as compared to $310 thousand. Other general and administrative expenses declined by $21 thousand, to $659 thousand, for six-months ended March 31, 2004, mainly due to a decline in printing and other variable expenses relating to the decline in mortgage loan volume. The following schedule of the Bank's net interest rate spread and net interest margin for the periods indicated is based upon average balances and will aid in the subsequent discussion of interest and dividend income, interest expense and net interest income: 14
Six Months Ended March 31, ---------------- Increase 2004 2003 (decrease) ---- ---- ---------- Interest-earning assets: Short-term investments (1) 0.82% 1.25% -0.43% Investment securities (2) 3.99% 4.91% -0.92% Loans (3) 5.50% 6.31% -0.81% Total interest-earning assets 4.82% 5.47% -0.65% Interest-bearing liabilities: NOW accounts 0.10% 0.20% -0.10% Savings accounts (4) 1.06% 1.59% -0.53% Money market deposit accounts 1.00% 1.44% -0.44% Certificate of deposit accounts 2.12% 3.07% -0.95% Total interest-bearing deposits 1.24% 1.95% -0.71% Borrowed funds 5.02% 6.55% -1.53% Total interest-bearing liabilities 1.44% 2.18% -0.74% Net interest rate spread (5) 3.38% 3.29% 0.09% Net interest margin (6) 3.59% 3.60% -0.01% Short-term investments include federal funds sold. All investment securities are considered available for sale. Loans are net of deferred loan origination costs (fees), allowance for loan losses, discount/premium on purchased loans and unadvanced funds. Savings accounts include the balance in mortgagors' escrow accounts. Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-earning assets.
15 Interest and Dividend Income: The Bank's interest and dividend income declined by $567 thousand, or 9.0%, to $5.7 million for six-months ended March 31, 2004 as compared to $6.3 million for six-months ended March 31, 2003. The decline was due to the combination of lower rates earned on average interest-earning assets offset, to a lesser extent, by an increase in the average volume of interest-earning assets. The Bank's average interest rate earned on all interest-earning assets declined by 0.65%, to 4.82% for six-months ended March 31, 2004 from 5.47% for six-months ended March 31, 2003. However, the average volume of interest-earning assets for six-months ended March 31, 2004 increased to $237.3 as compared to an average volume of $230.0 million for six-months ended March 31, 2003. This $7.3 million increase in average volume of interest-earning assets was primarily the result of positive cash flows from interest-bearing deposits and FHLBB advances. This new earning asset volume was invested in assets with comparatively lower interest-earning rates than the portfolio as a whole. The average balance of investment securities for six-months ended March 31, 2004 increased to $90.3 million, earning 3.99% as compared to an average balance of $85.7 million, earning 4.91% for six-months ending March 31, 2003. The average balance of short-term investments for six-months ended March 31, 2004 declined to $5.1 million earning 0.82% as compared to an average balance of $14.4 million earning 1.25% for six-months ending March 31, 2003. In this environment of low interest rates, management has chosen to reduce the balance of short-term investments, and to re-invest such balances in longer-term investment securities that offer higher rates of interest and, when necessary, to borrow overnight funds from the FHLBB for cash management purposes. The average balance of loans for six-months ended March 31, 2004, increased to $141.8 million earning 5.50%, as compared to an average balance of $129.9 million earning 6.31% for six- months ending March 31, 2003. The average volume of real estate and commercial loans increased, however, the Bank continued to experience a decline in its rate of interest earned on loans primarily in response to the general decline in market-based interest rates offered on new loans granted during the period, a decline in the rates of interest charged on adjustable-rate loans which were subject to contractual adjustment, loan sales and unscheduled customer refinancing and renegotiations of existing loan interest rates. Interest Expense: Total interest expense declined by $687 thousand, or 32.0%, to $1.5 million for six-months ended March 31, 2004, from $2.1 million for six-months ended March 31, 2003. The decline in interest expense was mainly due to management of the Bank constantly monitoring and actively reducing rates offered on various deposit accounts to coincide with the general decline in competitive loan, investment and deposit interest rates and to a decline in the cost of borrowing from the FHLBB. The average volume of all interest-bearing liabilities (which includes interest-bearing deposits and borrowings) increased to $202.9 million, with a cost of 1.44%, for six-months ended March 31, 2004 as compared to $197.3 million, with a cost of 2.18%, for six-months ending March 31, 2003. Within this category of interest-bearing liabilities, the average volume of interest-bearing deposits increased to $192.5 million, with a cost of 1.24%, for six-months ended March 31, 2004 as compared to $187.8 million, with a cost of 1.95%, for six-months ended March 31, 2003. As noted in the above discussion of interest and dividend income, when necessary, management borrows funds from the FHLBB. As a result, the average balance of borrowings increased to $10.4 million, with an average cost of 5.02%, for six-months ended March 31, 2004, as compared to an average balance of $9.5 million, with an average cost of 6.55%, for six-months ended March 31, 2003. Net Interest Income: The Bank's net interest income increased by $120 thousand, or 2.9%, for six-months ended March 31, 2004, to $4.3 million, from $4.1 million for six-months end March 31, 2003. As noted above, the increase was primarily attributed to the combination of a decrease in interest and dividend income of $567 thousand and a decline in interest expense of $687 thousand. The Bank's reduction in rates paid on interest-bearing deposit accounts exceeded the effect of lower 16 yields on interest-earning assets, which resulted in an expanded net interest rate spread. The Bank's net interest rate spread, which represents the difference between the weighted average yield on interest- earning assets and the weighted average cost of interest-bearing liabilities, increased by 0.09%, to 3.38% for six-months ended March 31, 2004 as compared to 3.29% for six-months ending March 31, 2003. Provision for Loan Losses: The Bank had a $40 thousand provision for loan losses for six-months ended March 31, 2004 compared to $0 for six- months ended March 31, 2003. Total loans at March 31, 2004 were $141.2 million, $141.6 million at September 30, 3003 and $132.1 million at March 31, 2003. The provision for loan losses is a result of management's periodic analysis of risks inherent in its loan portfolio as well as the adequacy of the allowance for loan losses. It is the Bank's policy to provide valuation allowances for estimated losses on loans based upon past loss experience, current trends in the level of delinquent and specific problem loans, loan concentrations to single borrowers, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions in our market area. Accordingly, the evaluation of the adequacy of the allowance for loan losses is not based directly on the level of non-performing loans. As the Bank expands its commercial lending activities, management believes that growth in the provision for loan losses may be likely. Additionally, while management believes it continues to have excellent loan quality, with $561 thousand of non-accrual loans and non-performing assets and an allowance for loan losses of $951 thousand at March 31, 2004, the Bank recognizes that it is located in a market and geographic area that is considered in the high technology and financial services belt and, most likely, the Bank's allowance for loan loss will reflect the relative health of these economic sectors. While management believes it's current level of allowance for loan losses is adequate, there can be no assurance that the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. Other Income: Other income consists primarily of fee income for customer services, gains and losses from the sale of mortgages and the sale of securities available for sale, and income from bank-owned life insurance ("BOLI"). Total other income increased by $255 thousand, or 69.7%, to $621 thousand for six-months ended March 31, 2004, from $366 thousand for the comparative six-months ended March 31, 2003. Income from customer service fees increased by $99 thousand, or 35.5%, to $378 thousand for six-months ended March 31, 2004 as compared to $279 thousand for six-months ended March 31, 2003, due primarily from the recognition of a non-refundable $71 thousand prepayment fee from the payment in full of a $2.6 million commercial loan. Also for six-months ended March 31, 2004, the Company sold fixed-rate mortgage loans, with servicing retained by the Bank, and recognized a pre-tax gain on the sale of $87 thousand, as compared to a pre-tax gain of $5 thousand, on a substantially reduced volume of loans sold, for six-months ended March 31, 2003. Additionally, for six-months ended March 31, 2004, the Company sold securities available for sale, primarily common stocks, and realized net pre-tax gains of $58 thousand, as compared to net pre-tax losses of $3 thousand for six-months ended March 31, 2003. With regard to the Company's common stock holdings, the Company's internal investment policy requires management to either write-down to market value, or sell, any common stock issue that has sustained a decline in market value of 50% or more, for a continuous period of nine-months or more. Although management believes that it has established and maintained an adequate accounting policy as it relates to investment impairment, such judgments involve a higher degree of complexity and require management to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. This critical policy and its application are periodically reviewed with the 17 Audit Committee and the Company's Board of Directors. For six-months ended March 31, 2004 and March 31, 2003, no investment in common stock met the criteria noted above. Operating Expenses: For six-months ended March 31, 2004, operating expenses increased by $81 thousand, or 2.1%, to $3.9 million, from $3.8 million for six-months ended March 31, 2003. While salary and benefit expenses and data processing expenses increased, expenses relating to marketing and advertising, professional fees, occupancy and equipment and other general and administrative expenses declined for six-months ended March 31, 2004 as compared to six-months ended March 31, 2003. Salary and employee benefit expenses increased $93 thousand, or 4.7%, to $2.1 million for six-months ended March 31, 2004, as compared to $2.0 million for six- months ended March 31, 2003. Salary and benefit expenses increased as a result of general salary adjustments, a decrease in lending volume that resulted in a reduction of salary cost deferrals, and increased compensation expense relating to the Company's Employee Stock Ownership Plan. Some areas did, however, decrease. Decreases in salary and benefit expenses occurred due to a decline in retirement expenses relating to the defined-benefit pension plan, and declines in the use of temporary help and the payment of overtime. Data processing expenses increased 12.3%, or $38 thousand, to $348 thousand for six-months ended March 31, 2004 as compared to $310 thousand for six-months ended March 31, 2003 primarily as a result of an increase in the level of services provided. Marketing and advertising expenses declined by 14.0%, or $12 thousand, to $74 thousand for six-months ended March 31, 2004 primarily due to a delay in the timing and nature of marketing and advertising placement. Professional fees declined by 6.7%, to $139 thousand for six-months ended March 31, 2004 as compared to $149 thousand for six-months ended March 31, 2003 due to a decline in legal and accounting expenses. Other general and administrative expenses declined by 3.1%, to $659 thousand for six-months ended March 31, 2004 as compared to $680 thousand for six-months ended March 31, 2003 primarily due to a decline in state examination expenses and a decline in variable costs relating to a decline in mortgage lending. To a lesser extent, other general and administrative costs relating to reviews of commercial loan quality and loan compliance increased by $24 thousand for six-months ended March 31, 2004 as compared to six-months ended March 31, 2003. Occupancy and equipment expenses declined by $7 thousand, to $620 thousand for six-months ended March 31, 2004 as compared to $627 thousand for six-months ended March 31, 2003 primarily as a result of a decline in the level of depreciation expenses relating to software and computer equipment which was fully depreciated in the prior year. Also, occupancy expenses relating to real estate taxes increased as towns in which the Bank operates increased their rates of property taxation. During this fiscal year, management expects to begin a program of replacing certain older generations of personal computers and software. Additionally, in April 2004, the Bank closed its branch office located in the Shaw's Supermarket in the town of Shrewsbury. The Company expects that the increase in occupancy and equipment expenses resulting from the replacement of older generation personal computers and software will be offset by the decline in occupancy expenses resulting from the closing of the supermarket branch. Income Taxes. Primarily as a result of an increase of income before the provision for income taxes, the provision for income taxes increased by $63 thousand, to $299 thousand, for six-months ended March 31, 2004 as compared to $236 thousand for six-months ended March 31, 2003, resulting in an effective tax rate of 31.6% and 34.1%, respectively. The Bank also utilizes a wholly-owned security investment subsidiary to substantially reduce state income taxes, receives the benefit of a dividends received deduction on common stock held and receives favorable tax treatment from the increase in the cash surrender value of BOLI. Liquidity and Capital Resources The term "liquidity" refers to the Bank's ability to generate adequate amounts of cash to fund 18 loan originations, deposit withdrawals and operating expenses. The Bank's primary sources of funds are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by the Bank's operations. The Bank also borrows money from time to time from the FHLBB as part of its management of interest rate risk. Loan repayments and maturing securities are a relatively predictable source of funds. However, deposit flows, calls of securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. The Bank's primary investing activities are the origination of one-to four-family real estate and other loans and the purchase of securities. During six-months ended March 31, 2004, the Bank originated loans of $26.6 million, experienced principal repayments on loans of $22.0 million and sold $4.9 million of 30-yr fixed-rate loans. The Bank purchased securities of $22.5 million and sales and calls on securities provided $9.3 million and principal payments on mortgage-backed securities provided an additional $3.8 million. There were $3.0 million of securities that matured during six-months ended March 31, 2004. During six-months ended March 31, 2004, the Bank experienced a net decrease in deposits of $3.9 million as depositors chose to move their money out of relatively low interest-earning deposit accounts to pay down debt or place funds into the stock market and other alternative investments. These investing activities were financed primarily by an increase in FHLBB borrowing of $6.0 million and by a net decrease in cash and cash equivalents of $3.6 million during six-months ended March 31, 2004. As noted above, deposits declined by $3.9 million during six-months ended March 31, 2004. Most of this deposit decline occurred in certificates of deposits. The level of interest rates, products offered by competitors and other general market factors, such as the relative attractiveness of equity investments and mutual fund investments, affect deposit flows. Certificate of deposit accounts scheduled to mature within one year were $38.2 million at March 31, 2004. Based on the Bank's deposit historical retention experience and current pricing strategy and enhanced product offerings, the Bank anticipates that a significant portion of these certificates of deposit will remain with the Bank. Recently, the Bank introduced a new certificate of deposit that will permit the certificate holder a one-time option to have the interest rate "stepped-up" to the then current rate offered by the Bank on a similar certificate for the remaining term of the original certificate of deposit. Management has recently begun promoting this new certificate of deposit and believes it will significantly improve retention and attract new depositors as well. The Bank is committed to maintaining a strong liquidity position; therefore, it monitors its liquidity position on a daily basis. The Bank also periodically reviews liquidity information prepared by the Depositors Insurance Fund, the Federal Deposit Insurance Corporation and other available reports, which compare the Bank's liquidity with banks in its peer group. The Bank anticipates that it will have sufficient funds to meet its current funding commitments. At March 31, 2004, the Bank had $15.5 million in outstanding borrowings and, based upon estimated eligible collateral that could be pledged with the FHLBB, the Bank had additional borrowing capacity of $63.7 million at March 31, 2004. At March 31, 2004, the Company's capital to assets ratio was 11.29% and it exceeded applicable regulatory capital requirements. Further, it does not have any balloon or other payments due on any long-term obligations or any off-balance sheet items other than the commitments and unused lines of credit. 19 Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Item 3. Controls and Procedures. Management, including the Company's President and Chief Executive Officer and Senior Vice President, Treasurer and Clerk, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Company's President and Chief Executive Officer and Senior Vice President, Treasurer and Clerk concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required. There have been no changes in the Company's internal control over financial reporting identified in connection with the evaluation that occurred during the Company's last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Company's internal control over financial reporting. 20 PART II. OTHER INFORMATION ---------------- Item 1. Legal Proceedings. None. Item 2. Changes in Securities and Small Business Issuer Purchases of Equity Securities. The following table provides information with respect to purchases made by or on behalf of the Company or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Company's common stock during the three months ended March 31, 2004.
(d) Maximum Number (or (c) Total Approximate Number of Dollar Shares (or Value) of Units) Shares (or Purchased as Units) that (a) Total Part of may yet be Number of (b) Average Publicly Purchased Shares (or Price Paid Announced under the Units) per Share Plans or Plans or Period Purchased (or Unit) Programs Programs ------ --------- ----------- ------------ ----------- January 1, 2004 through January 31, 2004 0 0 0 79,069(1) February 1, 2004 through February 29, 2004 0 0 0 79,069 March 1, 2004 through March 31, 2004 0 0 0 79,069 Total 0 0 0 79,069 In September 2000, the Massachusetts Division of Banks approved a share repurchase program which authorized the repurchase of up to 79,069 shares. The program will continue until the repurchase of the 79,069 shares is complete.
21 Item 3. Defaults upon Senior Securities. None Item 4. Submission of Matters to a Vote of Security Holders. Westborough Financial Services, Inc. (the "Company") held its annual meeting of shareholders on January 29, 2004 (the "Meeting"). All of the proposals submitted to the shareholders at the Meeting were approved. The proposals submitted to shareholders and the tabulation of votes for each proposal is as follows: 1. Election of six directors of the Company. The number of votes cast with respect to this matter was as follows: Nominee For Withheld Broker Non-Votes James N. Ball 1,421,897 3,656 0 Nelson F. Ball 1,423,847 1,706 0 Nancy M. Carlson 1,421,802 3,751 0 Benjamin H. Colonero, Jr. 1,424,102 1,451 0 Roger B. Leland 1,423,002 2,551 0 Joseph F. MacDonough 1,424,352 1,201 0 2. Ratification of the appointment of Wolf & Company, P.C. as the Company's independent public accountants for the fiscal year ending September 30, 2004. For Against Abstain Broker Non-Votes 1,425,328 150 75 0 Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibit 31.1: Rule 13a-14(a)/15d-14(a) Certifications Exhibit 32.1: Section 1350 Certifications (b) Reports on 8-K. On April 27, 2004, the registrant filed with the SEC a form 8-K Report dated April 27, 2004 furnishing its press release announcing earnings for the second quarter of the 2004 fiscal year, under Item 12. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Westborough Financial Services, Inc. Date: May 17, 2004 By: /s/ Joseph F. MacDonough ------------------------------ President and Chief Executive Officer Date: May 17, 2004 By: /s/ John L. Casagrande ------------------------------ Senior Vice-President, Treasurer and Clerk 23