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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 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 0-23533
MYSTIC FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3401049
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
60 High Street, Medford, Massachusetts 02155
(Address of principal executive office-zip code)
(Registrant's telephone number including area code)
(781) 395-2800
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 $.01 per share
(Title of class)
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 twelve 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 registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K [X]
Indicate by check mark if the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of September 15, 2004, the aggregate market value of the voting and non-
voting common equity held by non-affiliates of the Registrant was
approximately $45,549,496.
As of September 15, 2004, 1,565,945 shares of Registrant's common stock
were outstanding.
Documents Incorporated by Reference:
Portions of the Registrant's Proxy Statement for its 2004 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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MYSTIC FINANCIAL, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
JUNE 30, 2004
TABLE OF CONTENTS
PART I
ITEM 1. Business 1
ITEM 2. Properties 27
ITEM 3. Legal Proceedings 27
ITEM 4. Submission of Matters to a Vote of Security Holders 27
PART II
ITEM 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities 28
ITEM 6. Selected Financial Data 29
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 30
ITEM 7A. Quantitative and Qualitative Disclosures About
Market Risk 41
ITEM 8. Financial Statements and Supplementary Data 42
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
ITEM 9A. Controls and Procedures 42
PART III
ITEM 10. Directors and Executive Officers of the Registrant 43
ITEM 11. Executive Compensation 43
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management 43
ITEM 13. Certain Relationships and Related Transactions 44
PART IV
ITEM 14. Principal Accounting Fees and Service 44
ITEM 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 44
SIGNATURES 48
PART I
Forward Looking Statements
Mystic Financial, Inc. ("Mystic" or the "Company") and Medford
Co-operative Bank (the "Bank") may from time to time make written or oral
"forward-looking statements." These forward-looking statements may be
contained in this annual filing with the Securities and Exchange Commission
(the "SEC"), the Annual Report to Shareholders, other filings with the SEC,
and in other communications by the Company and the Bank, which are made in
good faith pursuant to the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. The words "may," "could,"
"should," "would," "believe," "anticipate," "estimate," "expect," "intend,"
"plan" and similar expressions 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, that 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 discussed in this Form 10-K, as well as other factors identified in
the Company's filings with the SEC 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:
* the strength of the United States economy in general and the strength
of the local economies in which the Company and the Bank conduct
operations;
* the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the Federal Reserve
Board;
* inflation, interest rate, market and monetary fluctuations;
* the timely development of and acceptance of new products and services
and the perceived overall value of these products and services by
users, including the features, pricing and quality compared to
competitors' products and services;
* the willingness of users to substitute competitors' products and
services for the Company's and the Bank's products and services;
* the Company's and the Bank's success in gaining regulatory approval
of their products and services, when required;
* the impact of changes in financial services' laws and regulations
(including laws concerning taxes, banking, securities and insurance);
* the impact of technological changes;
* acquisitions;
* changes in consumer spending and saving habits; and
* the Company's and the Bank's success at managing the risks involved
in their business.
This list of important factors is not exclusive. The Company and the
Bank do 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.
ITEM 1. BUSINESS
General
On January 8, 1998, the Bank completed its conversion from mutual to
stock form and became a wholly-owned subsidiary of the Company. On such
date, the Company sold 2,711,125 shares of its common stock, par value
$0.01 per share (the "Common Stock"), to the public, at a per share price
of $10.00, not adjusted to reflect the Company's 5% stock dividend declared
on July 9, 2003. The
1
conversion of the Bank from mutual to stock form, the formation of the
Company as the holding company for the Bank and the issuance and sale of
the Common Stock are herein referred to collectively as the "Conversion."
The Conversion raised $25.7 million in net proceeds. Mystic used $3.2
million of retained net proceeds to fund a loan to its Employee Stock
Ownership Plan ("ESOP") to purchase 227,735 shares of the Common Stock in
open-market purchases following completion of the Conversion. In April
2002, the Company formed Mystic Financial Capital Trust I and in February
2003, the Company formed Mystic Financial Capital Trust II (the "Trusts").
The Company owns all of the voting stock of the Trusts. The Trusts have
issued $12.0 million in trust preferred securities. See Note 9 of the
Notes to Consolidated Financial Statements.
The Company's principal business activity consists of the ownership
of the Bank and the Trusts. The Company also invests in short-term
investment grade marketable securities and other liquid investments.
Mystic Financial Capital Trust I issued $5.0 million of floating-rate trust
preferred securities on April 10, 2002. The trust preferred securities are
scheduled to mature in 2032, and are callable at the option of the Company
on April 22, 2007 with the prior approval of the Federal Reserve Board. As
of June 30, 2004, the floating-rate was 5.07%. Distributions on these
securities are payable semi-annually in arrears on April 22nd and October
22nd. In February 2003, Mystic Financial Capital Trust II issued $7.0
million of floating-rate trust preferred securities that are scheduled to
mature in 2033, and are callable at the option of the Company on February
15, 2008, with the prior approval of the Federal Reserve Board. As of June
30, 2004 the floating-rate was 4.50%. Distributions on these securities
are payable quarterly in arrears on February 15th, May 15th, August 15th, and
November 15th. The proceeds were used to purchase subordinated debentures
from the Company. The Company has no significant liabilities (other than
the subordinated debentures and those of the Bank). The Company neither
owns nor leases any property, but instead uses the premises and equipment
of the Bank. At the present time, the Company does not employ any persons
other than certain officers of the Bank who do not receive any extra
compensation as officers of the Company. The Company utilizes the support
staff of the Bank from time to time, as needed. Additional employees may
be hired as deemed appropriate by the management of the Company.
The Bank is a Massachusetts chartered stock co-operative bank founded
in 1886 with three full-service offices in Medford, Massachusetts and an
additional four full-service offices in Lexington, Arlington, Bedford and
Malden, Massachusetts. The Bank's deposits are insured by the Bank
Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation
("FDIC") and the Share Insurance Fund of the Co-operative Central Bank. The
Bank has been a member of the Co-operative Central Bank since 1932 and a
member of the Federal Home Loan Bank of Boston ("FHLB") since 1988. The
Bank is subject to comprehensive examination, supervision and regulation by
the Commissioner of Banks of the Commonwealth of Massachusetts (the
"Commissioner") and the FDIC. These regulations are intended primarily for
the protection of depositors and borrowers. The Bank exceeded all of its
regulatory capital requirements at June 30, 2004.
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 eastern Middlesex County, Massachusetts, including mortgage
loans secured by one- to four-family residences, commercial loans secured
by general business assets and commercial real estate loans secured by
commercial property, and to invest in U.S. Government and Federal Agency
and other securities. To a lesser extent, the Bank engages in various
forms of consumer and home equity lending. The Bank's profitability
depends primarily on its net interest income, which is the difference
between the interest income it earns on its loans and investment portfolio
and its cost of funds, which consists mainly of interest paid on deposits
and on borrowings from the FHLB. Net interest income is affected by the
relative amounts of interest-earning assets and interest-bearing
liabilities and the interest rates earned or paid on these balances. When
interest-earning assets
2
approximate or exceed interest-bearing liabilities, any positive interest
rate spread will generate net interest income.
The Bank has one active subsidiary, Mystic Securities Corporation,
which was established for the sole purpose of acquiring and holding
securities. All securities held by Mystic Securities Corporation are
investments which are permissible for banks to hold under Massachusetts
law.
On July 7, 2004, Mystic entered into an agreement and plan of merger
with Brookline Bancorp, Inc., ("Brookline") pursuant to which Brookline
will acquire Mystic in an exchange of cash and stock. Brookline is
headquartered in Brookline, Massachusetts, and operates Brookline Bank.
Under the terms of the agreement, stockholders of Mystic will be entitled
to receive either cash or shares of Brookline common stock, subject to
election and allocation procedures which are intended to ensure that, in
aggregate, 40% of the shares of Mystic are converted into the right to
receive cash of $39.00 per share and that 60% are converted into the right
to receive a fixed exchange of 2.6786 shares of Brookline common stock for
each share of Mystic. It is anticipated that the merger will close in the
first quarter of 2005, provided that regulatory and Mystic shareholder
approvals are obtained. In connection with the merger of Mystic and
Brookline, Medford Co-operative Bank will merge into Brookline Bank.
Market Area
The Bank's main office and two of its branch offices are located in
Medford, Massachusetts. The Bank has full-service offices in Lexington,
Arlington, Bedford and Malden, Massachusetts. The Bank's Malden office
opened in September 2003. All locations are located in Middlesex County.
The city of Medford, containing approximately 60,000 residents, is
located approximately seven miles from downtown Boston in the northern
suburbs of Boston, bounded by the towns of Malden, Everett, Somerville,
Stoneham, Winchester and Arlington. The city of Medford is easily
accessible from downtown Boston via Interstate 93 and is accessible via
other state roads connecting the communities within the Route 128 corridor
surrounding Boston. As an established metropolitan suburb, Medford
consists mostly of developed single- and multi-family properties within a
network of well-maintained neighborhoods. The towns of Lexington and
Bedford are communities consisting mainly of single-family homes while the
towns of Arlington and Malden contain a greater mix of small businesses and
single- and multi-family housing. The Bank considers its primary market
area to be the communities of Medford, Malden, Everett, Stoneham,
Arlington, Winchester, Somerville, Melrose, Lexington, Bedford, Woburn and
Reading, Massachusetts.
The economic base of the Bank's market area is diversified and
includes a number of financial service institutions, industrial and
manufacturing companies, hospitals and other health care facilities and
educational institutions. The major employers in the Medford area are Tufts
University, the city of Medford, and Lawrence Memorial Hospital, with
approximately 4,000, 1,400, and 900 employees, respectively. Management
believes that the housing vacancy rate in Medford is very low. The
majority of the Bank's lending and deposit activity has historically been
in Medford, although the commercial loan department has been largely
responsible for expanded business throughout eastern Middlesex County.
Middlesex County, located in eastern Massachusetts to the north and west of
the city of Boston, is part of the Boston metropolitan area. Based on U.S.
Census and HUD estimates for 2002, the median household income for
Middlesex County is $74,200.
Management believes that the Bank's lending success has been due, in
part, to the favorable income, population and housing demographics in
Medford and in the Bank's market area. At the same time, the growth of the
market area and delineated lending area and their proximity to Boston has
resulted
3
in a highly competitive environment among the many financial institutions
competing for deposits and loans.
Competition
The Bank experiences competition both in attracting and retaining
savings deposits and in the making of mortgage, commercial and other loans.
Direct competition for savings deposits primarily comes from larger
commercial banks and other savings institutions located in or near the
Bank's primary market area that often have significantly greater financial
and technological resources than the Bank. Additional significant
competition for savings deposits comes from credit unions, money market
funds and brokerage firms.
With regard to lending competition in the local market area, the Bank
experiences the most significant competition from the same institutions
providing deposit services, most of whom have placed an emphasis on real
estate lending as a line of business. In addition, the Bank competes with
local and regional mortgage companies, independent mortgage brokers and
credit unions in originating mortgage and non-mortgage loans. The primary
factors in competing for loans are interest rates, loan origination fees,
and the range of services offered.
While the Bank is subject to competition from other financial
institutions, which may have greater financial and marketing resources, the
Bank believes it benefits from its community bank orientation and from its
relatively high core deposit base. Management believes that the variety,
depth and stability of the communities in which the Bank is located support
the service and lending activities conducted by the Bank. The relative
economic stability of the Bank's lending area is reflected in the small
number of residential and commercial loan delinquencies experienced by the
Bank during the past several years.
Lending Activities
The Bank originates loans through its three offices located in
Medford and its offices in Lexington, Arlington, Bedford and Malden,
Massachusetts. The principal lending activities of the Bank are the
origination of conventional mortgage loans for the purpose of purchasing or
refinancing owner-occupied, one- to four-family residential properties in
its designated community reinvestment area, consisting of the Massachusetts
communities of Medford, Malden, Everett, Stoneham, Arlington, Winchester,
Somerville, Lexington, Bedford, Melrose, Woburn, and Reading and the
origination of commercial loans secured by commercial real estate and
commercial assets within eastern Middlesex County. To a lesser extent, the
Bank also originates consumer loans including home equity loans.
The Bank also lends to commercial businesses in the communities
that it serves. The Bank has senior lending officers with considerable
lending expertise and a support staff to the commercial lending department.
These loan officers are strategically located in our branch system to
support local community business.
4
Loan Portfolio. The following table presents selected data relating to the
composition of the Bank's loan portfolio by type of loan on the dates
indicated.
At June 30,
-------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Residential mortgage loans $167,701 53.8% $165,463 59.1% $153,915 63.1% $138,163 64.2% $127,862 67.6%
Commercial real estate loans 80,071 25.7 69,785 24.9 58,889 24.2 50,483 23.5 41,294 21.8
Commercial loans 21,580 6.9 20,250 7.2 16,215 6.7 13,514 6.3 10,881 5.8
Consumer loans 687 0.2 767 0.3 1,004 0.4 1,532 0.7 1,526 0.8
Home equity loans 18,171 5.8 9,385 3.4 4,965 2.0 3,880 1.8 3,470 1.8
Construction loans 26,069 8.4 16,557 5.9 11,015 4.5 9,282 4.3 5,686 3.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans 314,279 100.8 282,207 100.8 246,003 100.9 216,854 100.8 190,719 100.8
Deferred loan origination
(fees) costs 64 - 89 - (197) (0.1) (35) - 12 -
Allowance for loan losses (2,537) (0.8) (2,347) (0.8) (2,063) (0.8) (1,784) (0.8) (1,531) (0.8)
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Loans, net $311,806 100.0% $279,949 100.0% $243,743 100.0% $215,035 100.0% $189,200 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
5
One- to Four-Family Residential Real Estate Lending. The primary
emphasis of the Bank's lending activity is the origination of conventional
mortgage loans on one- to four-family residential dwellings located in the
Bank's primary market area. As of June 30, 2004, loans on one- to four-
family residential properties accounted for 53.6% of the Bank's net loan
portfolio.
During the year ended June 30, 2004, the Bank originated $38.1
million in adjustable-rate mortgage loans and $50.2 million in fixed-rate
mortgage loans. Of the fixed-rate loans originated, the Bank sold $24.3
million fixed-rate loans with terms of greater than 15 years and retained
$25.9 million fixed-rate loans, which had terms of 15 to 30 years.
Approximately 26.5% of all loan originations during fiscal 2004 were
refinances of loans already in the Bank's loan portfolio. At June 30, 2004,
the Bank's loan portfolio included $71.5 million in adjustable-rate one- to
four-family residential mortgage loans or 22.9% of the Bank's net loan
portfolio, and $96.2 million in fixed-rate one- to four-family residential
mortgage loans, or 30.9% of the Bank's net loan portfolio.
Commercial Real Estate Loans. At June 30, 2004, the Bank's
commercial real estate loan portfolio consisted of 167 loans, totaling
$80.1 million, or 25.7% of net loans. The Bank's largest aggregate loan
relationship is a commercial borrower with an outstanding balance of $6.3
million at June 30, 2004 secured by various properties in Massachusetts.
Commercial Loans. In the past several years, the Bank has emphasized
commercial business loans in order to address the needs of business
commercial borrowers. The Bank lends to companies that have $500,000 to
$15.0 million in sales. At June 30, 2004, the Bank's commercial loan
portfolio consisted of 192 loans, totaling $21.6 million, or 6.9% of net
loans.
Consumer Loans. The Bank's consumer loans consist of passbook and
automobile loans. At June 30, 2004, the consumer loan portfolio totaled
$687,000 or 0.2% of net loans.
Home Equity Loans. The Bank also originates home equity loans that
are secured by available equity based on the appraised value of owner-
occupied one- to four-family residential property. Home equity loans are
made for up to 90% of the appraised value of the property (less the amount
of the first mortgage). Home equity loans are offered at adjustable-rates
and fixed-rates. The adjustable interest rate is the prime rate as
reported in The Wall Street Journal. Fixed-rate home equity loans have
terms of ten years or less and adjustable-rate home equity loans have terms
of 15 years or less with up to a five year final payment if the loan is not
fully amortized at the end of the 15 year term. At June 30, 2004, the Bank
had $18.2 million in home equity loans with unused credit available to
existing borrowers of $27.8 million.
Construction Loans. The Bank engages in construction lending
primarily for the construction of single-family residences and a limited
number of construction loans for commercial properties. At present, all
construction loans are for the construction or renovation of single-family
housing developments. All construction loans are secured by first liens on
the property. Loan proceeds are disbursed as construction progresses and
inspections warrant. Loans involving construction financing present a
greater risk than loans for the purchase of existing homes, since
collateral values and construction costs can only be estimated at the time
the loan is approved. Because payment on loans secured by construction
properties is dependent upon the sale of completed homes or the successful
operation of the completed property, repayment of such loans may be
subject, to a greater extent, to adverse conditions in the real estate
market or the economy. At June 30, 2004, the Bank's construction loan
portfolio totaled $58.0 million, offset by $31.9 million in unadvanced
principal.
Loan Commitments. The Bank generally makes loan commitments to
borrowers not exceeding 60 days. At June 30, 2004, the Bank had $28.7
million in loan commitments outstanding, all for the
6
origination of one- to four-family residential real estate loans, home
equity loans, commercial loans and commercial real estate loans. In
addition, unadvanced funds on construction loans and lines of credit
totaled $71.4 million on June 30, 2004.
Loan Maturities. The following table sets forth certain information
at June 30, 2004 regarding the dollar amount of loans maturing in the
Bank's commercial real estate, commercial construction and commercial loan
portfolio based on their contractual terms to maturity.
Commercial Commercial
Real Estate Construction Commercial
Loans Loans Loans Total
----------- ------------ ---------- -----
(In thousands)
Loan balance by type scheduled
to mature after 1 year:
Fixed-rate $ 1,553 $ - $3,062 $ 4,615
Adjustable-rate 78,501 5,658 6,813 90,972
Originations and Sales of Loans. The Bank is a qualified
seller/servicer for "Fannie Mae." Beginning in 1987, the Bank began to sell
a portion of its fixed-rate loans with terms in excess of 15 years to
Fannie Mae. The Bank continues to service all loans sold to Fannie Mae.
At June 30, 2004, the Bank was servicing $45.4 million in loans for Fannie
Mae and $354,000 in loans for the FHLB as part of their Mortgage
Partnership Finance program. Depending upon market conditions, the Bank
retains a portion of its fixed-rate loans from time to time. In addition,
the Bank has also sold loans to other private investors. At June 30, 2004,
the Bank was servicing $237,000 of such loans.
Originations for the year ended June 30, 2004 decreased in all loan
categories except home equity loan originations that increased by $17.3
million. Loan sales decreased during the same period due to a higher
demand for an adjustable-rate product. Historically, the Bank has not
purchased loans. However, the Bank may in the future consider making
limited loan purchases, including purchases of commercial loans and
commercial real estate loans.
Non-Performing Assets, Asset Classification and Allowances for
Losses. Management and the Security Committee of the Bank perform a
monthly review of all delinquent loans and loans are placed on a non-
accrual status when loans are over 90 days past due or, in the opinion of
management, the collection of principal and interest are doubtful. All
delinquent loans are ratified by the Bank's Board of Directors on a monthly
basis. One of the primary tools used to manage and control problem loans
is the Bank's "Watch-List," a listing of loans or commitments that are
considered to have characteristics that could result in loss to the Bank if
not properly supervised. The list is managed by the Senior Lending
Officer, Chief Executive Officer and other officers as needed from the
commercial, residential and consumer loan areas, who meet periodically to
discuss the status of the loans on the Watch-List and to add or delete
loans from the list. The Board of Directors can request that a loan
relationship be placed on Watch-List status.
Real estate acquired by the Bank as a result of foreclosure is
classified as real estate owned until such time as it is sold. When such
property is acquired, it is recorded at the lower of the unpaid principal
balance or its fair value. Any required write-down of the loan to its fair
value is charged to the allowance for loan losses.
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The following table sets forth the Bank's problem assets and loans at
the dates indicated.
At June 30,
----------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Loans 30-89 days past due
(not included in non-performing loans) $1,335 $1,297 $1,191 $1,854 $ 540
Loans 90 days or more past due
(not included in non-performing loans) - - - 276 148
------ ------ ------ ------ ------
Total delinquent loans $1,335 $1,297 $1,191 $2,130 $ 688
====== ====== ====== ====== ======
Delinquent loans as a percentage of net loans 0.43% 0.46% 0.49% 0.99% 0.36%
====== ====== ====== ====== ======
Non-performing loans (over 90 days past due) $1,822 $ 223 $ 108 $ 15 $ 2
------ ------ ------ ------ ------
Total non-performing loans $1,822 $ 223 $ 108 $ 15 $ 2
====== ====== ====== ====== ======
Non-performing loans as a percent of total
loans 0.58% 0.08% 0.04% 0.01% 0.00%
At June 30, 2004, management was not aware of any loans not currently
classified as non-accrual, 90 days past due or restructured that may be so
classified in the near future because of concerns over the borrower's
ability to comply with repayment terms.
Federal regulations require each banking institution to classify its
asset quality on a regular basis. In addition, in connection with
examinations of such banking institutions, federal and state examiners have
authority to identify problem assets and, if appropriate, classify them.
An asset is classified as substandard if it is determined to be
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. As a general rule, the Bank
will classify a loan as substandard if the Bank can no longer rely on the
borrower's income as the primary source for repayment of the indebtedness
and must look to secondary sources such as guarantors or collateral. An
asset is classified as doubtful if full collection is highly questionable
or improbable. An asset is classified as loss if it is considered
uncollectible, even if a partial recovery could be expected in the future.
The regulations also provide for a special mention designation, described
as assets which do not currently expose a banking institution to a
sufficient degree of risk to warrant classification but do possess credit
deficiencies or potential weaknesses deserving management's close
attention. Assets classified as substandard or doubtful require a banking
institution to establish general allowances for loan losses. If an asset
or portion thereof is classified as a loss, a banking institution must
either establish specific allowances for loan losses in the amount of the
portion of the asset classified as a loss, or charge off such amount.
Examiners may disagree with a banking institution's classifications and
amounts reserved. If a banking institution does not agree with an
examiner's classification of an asset, it may appeal this determination to
the Regional Director of the FDIC. At June 30, 2004, the Bank had loans in
the amount of $133,000 classified as doubtful or loss, and loans in the
amount of $3.2 million classified as substandard.
In originating loans, the Bank recognizes that credit losses will
occur and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term
of the loan, general economic conditions and, in the case of a secured
loan, the quality of the security for the loan. It is management's policy
to maintain an adequate general allowance for loan losses based on, among
other things, evaluation of economic conditions and regular reviews of
delinquencies and loan portfolio quality. Further, after properties are
acquired following loan defaults, additional losses may occur with respect
to such properties while the Bank is holding them for sale. The Bank
increases its allowances for loan losses and losses on real estate owned by
charging provisions for losses against
8
the Bank's income. Specific reserves are also recognized against specific
assets when management believes it is warranted.
While the Bank believes it has established its existing allowances
for loan losses in accordance with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing the
Bank's loan portfolio, will not request the Bank to increase its allowance
for loan losses, thereby negatively affecting the Bank's financial
condition and earnings. Alternately, there can be no assurance that
increases in the Bank's allowance for loan losses will occur.
The following table analyzes activity in the Bank's allowance for
loan losses for the years indicated.
Years Ended June 30,
--------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands)
Average loans, net $291,535 $257,519 $226,711 $205,837 $173,319
======== ======== ======== ======== ========
Year-end net loans $311,806 $279,949 $243,743 $215,035 $189,200
======== ======== ======== ======== ========
Allowance for loan losses at
beginning of year $ 2,347 $ 2,063 $ 1,784 $ 1,531 $ 1,348
Provision charged to operations 584 300 305 275 200
Recoveries:
Real estate mortgage:
Residential - - - - -
Commercial - - - - -
Commercial loans - 3 - 2 -
Consumer and home equity 15 21 4 3 6
Construction - - - - -
-------- -------- -------- -------- --------
Total recoveries 15 24 4 5 6
-------- -------- -------- -------- --------
Charge-offs:
Real estate mortgage:
Residential - - - - -
Commercial - - - - -
Commercial loans (400) - (12) - -
Consumer and home equity (9) (40) (18) (27) (23)
Construction - - - - -
-------- -------- -------- -------- --------
Total charge-offs (409) (40) (30) (27) (23)
-------- -------- -------- -------- --------
Net charge-offs (394) (16) (26) (22) (17)
-------- -------- -------- -------- --------
Allowance for loan losses at end of year $ 2,537 $ 2,347 $ 2,063 $ 1,784 $ 1,531
======== ======== ======== ======== ========
Ratios:
Allowance for loan losses to year-end net loans 0.81% 0.84% 0.85% 0.83% 0.81%
Net charge-offs to average loans, net 0.14% 0.01% 0.01% 0.01% 0.01%
Net charge-offs to allowance for loan losses 15.53% 0.68% 1.26% 1.23% 1.11%
9
Allowance for Loan Losses
The allowance for loan losses is an estimate of the amount necessary
to absorb probable losses in the loan portfolio. The allowance consists of
specific, general and unallocated components. Commercial real estate and
commercial business loans are evaluated individually for allowance
purposes. Other categories of loans are generally evaluated as a group.
The specific component relates to loans that are classified as doubtful,
substandard or special mention. Loans classified as doubtful are
considered impaired in accordance with SFAS No. 114, and an allowance is
determined using the fair value of existing collateral. Loss factors for
loans are based on the Company's historical loss experience with similar
loans of similar quality as determined by the Company's internal rating
system. Loss factors are then adjusted for additional points that consider
qualitative factors such as current economic trends (both local and
national), concentrations, growth and performance trends and the results of
risk management assessments. Accordingly, increases or decreases in the
amount of each loan category as well as the ratings of the loans within
each category are considered in calculating the overall allowance. The
allowance is an estimate, and ultimate losses may vary from current
estimates. As adjustments become necessary, they are reported in earnings
of the periods in which they become known.
For the each of the years in the preceding table, the provision was
principally impacted by growth in the portfolio, as credit quality remained
strong. In fiscal year 2004, the increased provision was necessary due to
a specific reserve allocated to one impaired loan.
10
The following table sets forth a breakdown of the allowance for loan losses
by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. These
allocations are not necessarily indicative of future losses and do not
restrict the use of the allowance to absorb losses in any other loan
category.
At June 30,
--------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------------- -------------------- -------------------- -------------------- --------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each Loans in Each Loans in Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
------ ------------- ------ ------------- ------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
Real estate-mortgage:
Residential and
home equity $ 489 59.1% $ 628 58.6% $ 588 62.6% $ 578 63.7% $ 563 67.0%
Commercial 1,083 25.5 947 24.7 827 23.9 767 23.3 687 21.7
Commercial loans 463 6.9 466 7.2 373 6.6 240 6.2 172 5.7
Consumer 12 0.2 11 3.6 30 2.4 34 2.5 19 2.6
Construction 490 8.3 295 5.9 245 4.5 165 4.3 90 3.0
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total allowance for
loan losses $2,537 100.0% $2,347 100.0% $2,063 100.0% $1,784 100.0% $1,531 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
11
Investment Activities
General. The investment policy of the Bank, which is approved by the
Bank's Board of Directors, is based upon its asset and liability management
goals and is designed primarily to provide and maintain adequate liquidity,
maintain a balance of high quality, diversified investments, minimize risks
to the Bank and compliment the Bank's lending activities. The investment
policy is implemented by the Chief Financial Officer. Under applicable
federal and state regulations, the Bank is required to maintain an amount
of liquid assets appropriate for its level of net savings withdrawals and
current borrowings. It has generally been the Bank's policy to maintain a
liquidity portfolio in excess of regulatory requirements. The Bank uses
several measures to assess the adequacy of its liquidity. At June 30,
2004, the Bank's liquidity was adequate to meet its foreseeable needs.
Liquidity levels may be increased or decreased depending upon the yields on
investment alternatives, management's judgment as to the attractiveness of
the yields then available in relation to other opportunities, management's
expectations of the level of yield that will be available in the future and
management's projections as to the short-term demand for funds to be used
in the Bank's loan origination and other activities.
The Bank invests in U.S. Government and federal agency securities,
mortgage-backed securities, equity securities, corporate debt securities
and overnight federal funds. The balance of securities maintained by the
Bank in excess of regulatory requirements reflects management's historical
objective of maintaining liquidity at a level that assures the availability
of adequate funds, taking into account anticipated cash flows and available
sources of credit, for meeting withdrawal requests and loan commitments and
making other investments.
The Bank purchases securities through a primary dealer of U.S.
Government obligations or such other mortgage-backed securities, securities
dealers authorized by the Board of Directors and requires that the
securities be delivered to a safekeeping agent before the funds are
transferred to the broker or dealer. The Bank purchases securities pursuant
to its investment policy.
Available-for-sale securities are reported at fair value with unrealized
gains or losses reported as a separate component of other comprehensive
income/loss. The following table sets forth the Bank's securities at the
dates indicated.
At June 30,
---------------------------------------------------------------------
2004 2003 2002
------------------- ------------------- -------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ----- --------- ----- --------- -----
(Dollars in thousands)
Securities available for sale:
Marketable equity securities $ 3,022 $ 3,376 $ 3,009 $ 3,033 $ 2,698 $ 2,586
U.S. Government and federal
agency obligations 2,444 2,394 41,468 42,002 25,198 25,517
Corporate 8,549 8,566 7,565 7,655 8,668 8,685
Mortgage-backed securities 67,622 65,839 58,414 59,016 28,759 29,112
Other 8,775 8,549 6,171 6,165 - -
------- ------- -------- -------- ------- -------
Total $90,412 $88,724 $116,627 $117,871 $65,323 $65,900
======= ======= ======== ======== ======= =======
Securities held to maturity:
U.S. Government and federal
agency obligations $11,287 $11,032 $ - $ - $ - $ -
------- ------- -------- -------- ------- -------
Total $11,287 $11,032 $ - $ - $ - $ -
======= ======= ======== ======== ======= =======
12
The following table sets forth the final maturity dates, carrying values
and average yields for the Bank's debt securities at June 30, 2004.
At June 30, 2004
--------------------------------------------------------------------------------------------------
One Year One to Over Five through Over
or Less Five Years Ten Years Ten Years Totals
------------------ ------------------ ------------------ ------------------ ------------------
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
--------- ------- --------- ------- --------- ------- --------- ------- --------- -------
(Dollars in thousands)
Securities available for sale:
U.S. Government and federal
agency obligations $ - -% $ 2,444 2.72% $ - -% $ - -% $ 2,444 2.72%
Other bonds and obligations 4,019 6.39 11,056 3.24 - - 2,249 2.37 17,324 3.86
Mortgage-backed securities - - 14,321 3.82 21,683 3.76 31,618 4.13 67,622 4.25
------ ------- ------- ------- -------
Total $4,019 6.39% $27,821 3.49% $21,683 3.76% $33,867 4.01% $87,390 4.13%
====== ======= ======= ======= =======
Securities held to maturity:
U.S. Government and federal
agency obligations $ - -% $ 2,500 3.61% $ - -% $ 8,787 4.13% $11,287 4.06%
------ ------- ------- ------- -------
Total $ - -% $ 2,500 3.61% $ - -% $ 8,787 4.13% $11,287 4.06%
====== ======= ======= ======= =======
13
Deposit Activity and Other Sources Of Funds
General. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank
derives funds from principal repayments and interest payments on loans and
investments as well as other sources arising from operations in the
production of net earnings. Loan repayments and interest payments are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources, or on a longer
term basis for general business purposes.
Deposits. Deposits are attracted principally from within the Bank's
primary market area through the offering of a broad selection of deposit
instruments, including checking accounts, passbook savings, NOW accounts,
demand deposits, money market accounts and certificates of deposit. Deposit
account terms vary, with the principal differences being the minimum
balance required, the time periods the funds must remain on deposit and the
interest rate.
The Bank's policies are designed primarily to attract deposits from
local residents and businesses rather than to solicit deposits from areas
outside its primary market. The Bank does not accept deposits from brokers
due to the volatility and rate sensitivity of such deposits. Interest rates
paid, maturity terms, service fees and withdrawal penalties are established
by the Bank on a periodic basis. Determination of rates and terms are
predicated upon funds acquisition and liquidity requirements, rates paid by
competitors, growth goals and federal regulations.
The following table sets forth the various types of deposit accounts
at the Bank and the balances in these accounts at the dates indicated.
At June 30,
------------------------------------------------------------------------
2004 2003 2002
-------------------- -------------------- --------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Savings deposit $ 83,001 23.6% $ 69,015 20.1% $ 52,762 19.7%
NOW accounts 26,292 7.5 26,342 7.7 26,971 10.1
IOLTA accounts 12,505 3.6 28,659 8.4 22,397 8.4
Money market deposits 54,968 15.6 51,719 15.1 21,466 8.0
Demand deposits 36,066 10.3 25,871 7.5 19,856 7.4
Certificate of deposits 138,575 39.4 141,958 41.2 123,986 46.4
-------- ----- -------- ----- -------- -----
Total deposits $351,407 100.0% $343,564 100.0% $267,438 100.0%
======== ===== ======== ===== ======== =====
For more information on the Bank's deposit accounts, see Note 7 of
Notes to Consolidated Financial Statements.
14
The following table indicates the amount of the Bank's certificates
of deposit of $100,000 or more by time remaining until maturity at June 30,
2004.
Weighted
Average
Maturity Period Certificates of Deposit Rate
--------------- ----------------------- --------
(Dollars in thousands)
0-3 months $ 9,146 1.85%
3-6 months 6,218 1.90
6-12 months 7,030 1.92
1-2 years 17,825 3.30
2-3 years 10,105 3.27
> 3 years 4,719 3.98
-------
Total $55,043 2.78%
=======
Borrowings. Deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from
the FHLB to supplement its supply of lendable funds and to meet liquidity
requirements. Due to recent lending activity and demand for liquidity, the
Bank has utilized this borrowing power, and has received advances from the
FHLB. Advances from the FHLB are secured by a portion of the Bank's
mortgage loan portfolio. The Bank had FHLB advances of $47.9 million
outstanding at June 30, 2004.
The FHLB functions as a central reserve bank providing credit for
savings institutions and certain other financial institutions. As a member,
the Bank is required to own capital stock in the FHLB and is authorized to
apply for advances on the security of its home mortgages provided certain
standards related to creditworthiness have been met.
Personnel
As of June 30, 2004, the Bank had 82 full-time employees and 21 part-
time employees. The employees are not represented by a collective
bargaining unit and the Bank considers its relationship with its employees
to be good.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The following is intended only as a discussion of material
tax matters and does not purport to be a comprehensive description of the
tax rules applicable to the Bank or the Company. The Bank has not been
audited by the IRS during the last five years. For federal income tax
purposes, the Company and the Bank file consolidated income tax returns and
report their income on a fiscal year basis using the accrual method of
accounting and are subject to federal income taxation in the same manner as
other corporations with some exceptions, including particularly the Bank's
tax reserve for bad debts.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to shareholders, such distributions will be considered to
result in distributions from the Bank's "base year reserve," i.e., its
reserve as of April 30, 1988, to the extent thereof and then from its
supplemental reserve for losses on loans, and an amount based on the amount
distributed will be included in the Bank's taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation.
15
However, dividends paid out of the Bank's current or accumulated earnings
and profits, as calculated for federal income tax purposes, will not
constitute non-dividend distributions and, therefore, will not be included
in the Bank's income.
The amount of additional taxable income created from a non-dividend
distribution is equal to the lesser of the Bank's base year reserve and
supplemental reserve for losses on loans; or an amount that, when reduced
by the tax attributable to the income, is equal to the amount of the
distribution. Thus, in certain situations, approximately one and one-half
times the non-dividend distribution would be includable in gross income for
federal income tax purposes, assuming a 34% federal corporate income tax
rate.
Corporate Alternative Minimum Tax. The Internal Revenue Code of
1986, as amended, imposes a tax ("AMT") on alternative minimum taxable
income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net
operating loss carryovers. AMTI is also adjusted by determining the tax
treatment of certain items in a manner that negates the deferral of income
resulting from the regular tax treatment of those items. The Bank does not
expect to be subject to the AMT.
Elimination of Dividends; Dividends Received Deduction. The Company
may exclude from its income 100% of dividends received from the Bank as a
member of the same affiliated group of corporations. A 70% dividends
received deduction generally applies with respect to dividends received
from domestic corporations that are not members of such affiliated group,
except that an 80% dividends received deduction applies if the Company and
the Bank own more than 20% of the stock of a corporation paying a dividend.
State and Local Taxation
Massachusetts. The Bank is subject to an annual Massachusetts excise
(income) tax equal to 10.50% of its pre-tax income, adjusted for certain
items. Taxable income includes gross income as defined under the Code,
plus interest from bonds, notes and evidences of indebtedness of any state,
including Massachusetts, less deductions, but not the credits, allowable
under the provisions of the Code. In addition, carryforwards and
carrybacks of net operating losses are not allowed.
The Bank's active subsidiary, Mystic Securities Corporation, was
established solely for the purpose of acquiring and holding securities
which are permissible for banks to hold under Massachusetts law. Mystic
Securities Corporation is classified with the Massachusetts Department of
Revenue as a "security corporation" under Massachusetts law, qualifying it
to take advantage of the low 1.32% income tax rate on gross income
applicable to companies that are so classified.
Delaware. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and has paid an annual franchise tax
to the State of Delaware.
For additional information regarding taxation, see Note 10 of the
Notes to Consolidated Financial Statements.
16
REGULATION
General
As a co-operative bank chartered by the Commonwealth of
Massachusetts, the Bank is subject to extensive regulation under state law
with respect to many aspects of its banking activities; this state
regulation is administered by the Commissioner of the Massachusetts
Division of Banks (the "Commissioner"). In addition, as a bank whose
deposits are insured by the FDIC under the Bank Insurance Fund, the Bank is
subject to deposit insurance assessments by the FDIC, and the FDIC has
examination and supervisory authority over the Bank, with a broad range of
enforcement powers. Finally, the Bank is required to maintain reserves
against deposits according to a schedule established by the Federal Reserve
System. These laws and regulations have been established primarily for the
protection of depositors and the deposit insurance funds, not bank
stockholders.
The following references to the laws and regulations under which the
Bank and the Company are regulated are brief summaries thereof, do not
purport to be complete, and are qualified in their entirety by reference to
such laws and regulations.
Massachusetts Banking Laws and Supervision
Massachusetts co-operative banks such as the Bank are regulated and
supervised by the Commissioner. The Commissioner is required to regularly
examine each state-chartered bank. The approval of the Commissioner is
required to establish or close branches, to merge with another bank, to
form a bank holding company, to issue stock or to undertake many other
activities. Any Massachusetts bank that does not operate in accordance
with the regulations, policies and directives of the Commissioner is
subject to sanctions. The Commissioner may under certain circumstances
suspend or remove directors or officers of a bank who have violated the
law, conducted a bank's business in a manner which is unsafe, unsound or
contrary to the depositors' interests, or been negligent in the performance
of their duties.
All Massachusetts-chartered co-operative banks are required to be
members of the Co-operative Central Bank and are subject to its
assessments. The Co-operative Central Bank maintains the Share Insurance
Fund, a private deposit insurer, which insures all deposits in member banks
in excess of FDIC deposit insurance limits. In addition, the Co-operative
Central Bank acts as a source of liquidity to its members in supplying them
with low-cost funds, and purchasing certain qualifying obligations from
them.
Lending Activities. A Massachusetts chartered co-operative bank may
make a wide variety of mortgage loans. Fixed-rate loans, adjustable-rate
loans, participation loans, graduated payment loans, construction loans,
condominium and co-operative loans, second mortgage loans and other types
of loans may be made in accordance with applicable regulations. Mortgage
loans may be made on real estate in Massachusetts or in another New England
state if the bank making the loan has an office there or under certain
other circumstances. In addition, certain mortgage loans may be made on
improved real estate located anywhere in the United States. Commercial
loans may be made to corporations and other commercial enterprises with or
without security. With certain exceptions, such loans may be made without
geographic limitation. Consumer and personal loans may be made with or
without security and without geographic limitation. Loans to individual
borrowers generally will be limited to 20% of the total of the Bank's
capital accounts and stockholders' equity.
Investments Authorized. Massachusetts-chartered co-operative banks
have broad investment powers under Massachusetts law, including so-called
"leeway" authority for investments that are not otherwise specifically
authorized. The investment powers authorized under Massachusetts law are
17
restricted by federal law to permit, in general, only investments of the
kinds that would be permitted for national banks. The Bank has authority to
invest in all of the classes of loans and investments that are permitted by
its existing loan and investment policies.
Payment of Dividends. Under Massachusetts banking laws, a stock co-
operative bank may declare and pay a dividend on its capital stock out of
the bank's net profits. Net profits means the remainder of all earnings
from current operations plus actual recoveries on loans and investments and
other assets after deducting from the total, all current operating
expenses, actual losses, accrued dividends on preferred stock, if any, and
all federal and state taxes. A dividend, however, may not be declared,
credited or paid by a stock co-operative bank so long as there is
impairment of capital stock.
Prior approval of the Commissioner is required if the Bank intends to
declare dividends on its common stock for any period other than for which
dividends are declared upon the preferred stock; or the total of all
dividends declared by the Bank in any calendar year shall exceed the total
of its net profits for that year combined with its retained net profit of
the preceding two years, less any required transfer to surplus or a fund
for the retirement of any preferred stock.
In addition, federal law also may limit the amount of dividends that
may be paid by the Bank.
Branches. With the approval of the Commissioner, bank branches may
be established in any city or town in Massachusetts; in addition, co-
operative banks may operate automated teller machines ("ATMs") at any of
their offices or, with the Commissioner's approval, anywhere in
Massachusetts. Sharing of ATMs or "networking" is also permitted with the
Commissioner's approval. Massachusetts chartered co-operative banks may
also operate ATMs outside of Massachusetts if permitted to do so by the law
of the jurisdiction in which the ATM is located.
Interstate Acquisitions. An out-of-state bank may (subject to
various regulatory approvals and to reciprocity in its home state)
establish and maintain bank branches in Massachusetts by (i) merging with a
Massachusetts bank that has been in existence for at least three years,
(ii) acquiring a branch or branches of a Massachusetts bank without
acquiring the entire bank, or (iii) opening such branches de novo.
Massachusetts banks' ability to exercise similar interstate banking powers
in other states depends upon the laws of the other states. For example,
according to the law of the bordering state of New Hampshire, out-of-state
banks may acquire New Hampshire banks by merger, but may not establish de
novo branches in New Hampshire.
Other Powers. Massachusetts-chartered co-operative banks may also
lease machinery and equipment, act as trustee or custodian for tax
qualified retirement plans, establish trust departments and act as
professional trustee or fiduciary, provide payroll services for their
customers, issue or participate with others in the issuance of mortgage-
backed securities and establish mortgage banking companies and discount
securities brokerage operations. Some of these activities require the
prior approval of the Commissioner.
Federal Banking Regulations
Capital Requirements. Under FDIC regulations, state-chartered banks
that are not members of the Federal Reserve System ("state non-member
banks"), such as the Bank, are required to comply with minimum leverage
capital requirements. The FDIC Regulations define two tiers, or classes,
of capital - Tier I Capital and Tier 2 Capital. For an institution with a
rating of 1, the highest examination rating of the FDIC for banks, under
the Uniform Financial Institutions Ranking System, the minimum capital
leverage requirement is a ratio of Tier 1 capital to total assets of 3%.
For all other institutions, the
18
minimum leverage capital ratio is 4% unless a higher leverage capital ratio
is warranted by the particular circumstances or risk profile of the bank.
The FDIC regulations also require that co-operative banks meet a
risk-based capital standard. The risk-based capital standard requires the
maintenance of a ratio of total capital, which is defined as the sum of
Tier 1 capital and Tier 2 capital, to risk-weighted assets of at least 8%
and a ratio of Tier 1 capital to risk-weighted assets of at least 4%. In
determining the amount of risk-weighted assets, all assets, plus certain
off balance sheet items, are multiplied by a risk-weight of 0% to 100%,
based on the risks the FDIC believes are inherent in the type of asset or
item.
The federal banking agencies, including the FDIC, have also adopted
regulations to require an assessment of an institution's exposure to
declines in the economic value of a bank's capital due to changes in
interest rates when assessing the bank's capital adequacy. Under such a
risk assessment, examiners will evaluate a bank's capital for interest rate
risk on a case-by-case basis, with consideration of both quantitative and
qualitative factors.
Institutions with significant interest rate risk may be required to
hold additional capital. The agencies also issued a joint policy statement
providing guidance on interest rate risk management, including a discussion
of the critical factors affecting the agencies' evaluation of interest rate
risk in connection with capital adequacy.
The following table shows the Company's and the Bank's leverage
ratio, its Tier 1 risk-based capital ratio, and its total risk-based
capital ratio, at June 30, 2004. Prompt corrective action provisions are
not applicable to financial holding companies.
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Total Capital to Risk Weighted Assets
Consolidated $42,499 16.3% $20,842 8.0% N/A N/A
Bank 39,302 15.1 20,779 8.0 $25,973 10.0%
Tier 1 Capital to Risk Weighted Assets
Consolidated 36,964 14.2 10,421 4.0 N/A N/A
Bank 36,596 14.1 10,389 4.0 15,584 6.0
Tier 1 Capital to Average Assets
Consolidated 36,964 8.6 17,192 4.0 N/A N/A
Bank 36,596 8.6 17,095 4.0 21,368 5.0
As the preceding table shows, the Company and the Bank exceeded the
minimum capital adequacy requirements at June 30, 2004.
Enforcement. The FDIC has extensive enforcement authority over
insured co-operative banks, including the Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties,
to issue cease and desist orders and to remove directors and officers. In
general, these enforcement actions may be initiated in response to
violations of laws and regulations and to unsafe or unsound practices.
19
The FDIC has authority under federal law to appoint a conservator or
receiver for an insured bank under certain circumstances. The FDIC is
required, with certain exceptions, to appoint a receiver or conservator for
an insured state bank if that bank was "critically undercapitalized." For
this purpose, "critically undercapitalized" means having a ratio of
tangible equity to total assets equal to or less than 2%. See "-Prompt
Corrective Action." The FDIC may also appoint a conservator or receiver
for a state bank on the basis of the institution's financial condition or
upon the occurrence of certain events, including: (i) insolvency (whereby
the assets of the bank are less than its liabilities to depositors and
others); (ii) substantial dissipation of assets or earnings through
violations of law or unsafe or unsound practices; (iii) existence of an
unsafe or unsound condition to transact business; (iv) likelihood that the
bank will be unable to meet the demands of its depositors or to pay its
obligations in the normal course of business; and (v) insufficient capital,
or the incurring or likely incurring of losses that will deplete
substantially all of the institution's capital with no reasonable prospect
of replenishment of capital without federal assistance.
Deposit Insurance. The FDIC has adopted a risk-based deposit
insurance assessment system. The FDIC assigns an institution to one of
three capital categories based on the institution's financial information,
as of the reporting period ending seven months before the assessment
period, consisting of (1) well capitalized, (2) adequately capitalized or
(3) undercapitalized, and one of three supervisory subcategories within
each capital group. The supervisory subgroup to which an institution is
assigned is based on a supervisory evaluation provided to the FDIC by the
institution's primary federal regulator and information that the FDIC
determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment
rate depends on the capital category and supervisory category to which it
is assigned. Assessment rates for BIF deposits currently range from 0
basis points to 27 basis points. The Bank's assessment rate is currently 0
basis points. The FDIC is authorized to raise the assessment rates in
certain circumstances, including to maintain or achieve the designated
reserve ratio of 1.25%, which requirement the BIF currently meets. The
FDIC has exercised its authority to raise rates in the past and may raise
insurance premiums in the future. If such action is taken by the FDIC, it
could have an adverse effect on the earnings of the Bank. In addition,
legislation requires BIF-insured institutions like the Bank to assist in
the payment of FICO bonds.
Under the Federal Deposit Insurance Act (the "FDICIA Act"), insurance
of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable
law, regulation, rule, order or condition imposed by the FDIC or the
Division. The management of the Bank does not know of any practice,
condition or violation that might lead to termination of deposit insurance.
Transactions with Affiliates and Insiders of the Bank. Transactions
between an insured bank, such as the Bank, and any of its affiliates is
governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate
of a bank is any company or entity that controls, is controlled by or is
under common control with the bank. Currently, a subsidiary of a bank that
is not also a depository institution is not treated as an affiliate of the
bank for purposes of Sections 23A and 23B, but the FRB has proposed
comprehensive regulations implementing Sections 23A and 23B, which would
establish certain exceptions to this policy. Generally, Sections 23A and
23B (i) limit the extent to which the bank or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal to 10%
of such institution's capital stock and surplus, and limit all such
transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all such transactions be on terms
that are consistent with safe and sound banking practices. The term
"covered transaction" includes the making of loans, purchase of assets,
issuance of guarantees and similar other types of transactions. In
addition, any covered transaction and certain other transactions, including
the sale of assets or purchase of services, between a bank and any of its
affiliates must be on terms that are substantially the same, or at least as
favorable, to the bank as those that would be provided to a non-affiliate.
Further, most loans by a bank to
20
its affiliate must be supported by collateral in amounts ranging from 100
to 130 percent of the loan amounts.
Effective April 1, 2003, the Federal Reserve Board, or FRB, rescinded
its interpretations of Sections 23A and 23B of the FRA and is replacing
these interpretations with Regulation W. In addition, Regulation W makes
various changes to existing law regarding Sections 23A and 23B, including
expanding the definition of what constitutes an affiliate subject to
Sections 23A and 23B and exempting certain subsidiaries of state-chartered
banks from the restrictions of Sections 23A and 23B.
Under Regulation W, all transactions entered into on or before
December 12, 2002, which either became subject to Sections 23A and 23B
solely because of Regulation W, and all transactions covered by Sections
23A and 23B, the treatment of which will change solely because of
Regulation W, will become subject to Regulation W on July 1, 2003. All
other covered affiliate transactions become subject to Regulation W on
April 1, 2003. The Federal Reserve Board expects each depository
institution that is subject to Sections 23A and 23B to implement policies
and procedures to ensure compliance with Regulation W. We do not expect
that the changes made by Regulation W will have a material adverse effect
on our business.
A bank's loans to its executive officers, directors, any owner of 10%
or more of its stock and any of certain entities affiliated to any such
person (each an "insider") are subject to the conditions and limitations
imposed by Section 22(h) of the Federal Reserve Act and the Federal Reserve
Board's Regulation O thereunder. Under Section 22(h), loans to an insider
may not exceed, together with all other outstanding loans to such person
and affiliated interests, the loans-to-one-borrower limit applicable to
national banks (generally 15% of the institution's unimpaired capital and
surplus), and all loans to all such persons in the aggregate may not exceed
the institution's unimpaired capital and unimpaired surplus. Regulation O
also prohibits the making of loans in an amount greater than either (a)
$500,000 or (b) the greater of $25,000 or 5% of the bank's unimpaired
capital and surplus, unless certain requirements are met.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension
of personal loans to directors and executive officers of issuers (as
defined in Sarbanes-Oxley). The prohibition, however, does not apply to
mortgages advanced by an insured depository institution, such as the Bank,
that are subject to the insider lending restrictions of Section 22(h) of
the FRA.
State chartered non-member banks are further subject to the
requirements and restrictions of 12 U.S.C. Section 1972 on certain tying
arrangements and extensions of credit by correspondent banks. Specifically,
this statute (i) prohibits a depository institution from extending credit
to or offering any other service, or fixing or varying the consideration
for such extension of credit or service, on the condition that the customer
obtain some additional service from the institution or certain of its
affiliates or not obtain services of a competitor of the institution,
subject to certain exceptions, and (ii) also prohibits extensions of credit
to executive officers, directors, and greater than 10% stockholders of a
depository institution by any other institution which has a correspondent
banking relationship with the institution, unless such extension of credit
is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than
the normal risk of repayment or present other unfavorable features.
Real Estate Lending Policies. FDIC regulations require that state-
chartered non-member banks adopt and maintain written policies that
establish appropriate limits and standards for extensions of credit that
are secured by liens or interest in real estate or are made for the purpose
of financing permanent improvements to real estate. These policies must
establish loan portfolio diversification standards, prudent underwriting
standards, including loan-to-value limits that are clear and measurable,
loan administration
21
procedures and documentation, approval and reporting requirements. The real
estate lending policies must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies that have been adopted by the
federal bank regulators.
Safety and Soundness Standards. Pursuant to the requirements of
FDICIA, as amended by the Riegle Community Development and Regulatory
Improvement Act of 1994, each federal banking agency, including the FDIC,
has adopted guidelines establishing general standards relating to internal
controls, information and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, asset quality,
earnings, and compensation, fees and benefits. In general, the guidelines
require, among other things, appropriate systems and practices to identify
and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound
practice and describe compensation as excessive when the amounts paid are
unreasonable or disproportionate to the services performed by an executive
officer, employee, director, or principal shareholder. In addition, the
FDIC adopted regulations to require a bank that is given notice by the FDIC
that it is not satisfying any of such safety and soundness standards to
submit a compliance plan to the FDIC. If, after being so notified, a bank
fails to submit an acceptable compliance plan or fails in any material
respect to implement an accepted compliance plan, the FDIC may issue an
order directing corrective and other actions of the types to which a
significantly undercapitalized institution is subject under the "prompt
corrective action" provisions of FDICIA. If a bank fails to comply with
such an order, the FDIC may seek to enforce such an order in judicial
proceedings and to impose civil monetary penalties.
Prompt Corrective Action. FDICIA also established a system of prompt
corrective action to resolve the problems of undercapitalized institutions.
The FDIC, as well as the other federal banking regulators, adopted
regulations governing the supervisory actions that may be taken against
undercapitalized institutions. The regulations establish five categories,
consisting of "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." At June 30, 2004, the Bank was categorized as "well
capitalized".
The severity of the action authorized or required to be taken under
the prompt corrective action regulations increases as a bank's capital
deteriorates within the three undercapitalized categories. All banks are
prohibited from paying dividends or other capital distributions or paying
management fees to any controlling person if, following such distribution,
the bank would be undercapitalized.
Community Reinvestment. Under the Community Reinvestment Act
("CRA"), as implemented by FDIC regulations, a bank has a continuing and
affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate
income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that
it believes are best suited to its particular community. The CRA requires
the FDIC, in connection with its examination of a bank, to assess the
bank's record of meeting the credit needs of its community. The FDIC is
also required to assess the depository institution's record of meeting the
credit needs of its community. The CRA also requires all institutions to
make public disclosure of their CRA ratings. The Bank received a "High
Satisfactory" CRA rating in its most recent examination from the
Commonwealth of Massachusetts.
Holding Company Regulation
Federal Regulation. The Company is subject to examination,
regulation and periodic reporting under the Bank Holding Company Act (the
"BHCA"), as administered by the Federal Reserve Board (the "FRB"). The FRB
has adopted capital adequacy guidelines for bank holding companies on a
consolidated
22
basis substantially similar to those of the FDIC for the Bank. As of June
30, 2004, the Company's total capital and Tier 1 capital ratios exceeded
these minimum capital requirements.
The Company will be required to obtain the prior approval of the FRB
to acquire all, or substantially all, of the assets of any bank or bank
holding company. Prior FRB approval will be required for the Company to
acquire direct or indirect ownership or control of any voting securities of
any bank or bank holding company if, after giving effect to such
acquisition, it would, directly or indirectly, own or control more than 5%
of any class of voting shares of such bank or bank holding company.
The Company will be required to give the FRB prior written notice of
any purchase or redemption of its outstanding equity securities if the
gross consideration for the purchase or redemption, when combined with the
net consideration paid for all such purchases or redemptions during the
preceding 12 months, will be equal to 10% or more of the Company's
consolidated net worth. The FRB may disapprove such a purchase or
redemption if it determines that the proposal would constitute an unsafe
and unsound practice, or would violate any law, regulation, FRB order or
directive, or any condition imposed by, or written agreement with, the FRB.
Such notice and approval is not required for a bank holding company that
would be treated as "well capitalized" under applicable regulations of the
FRB, that has received a composite "1" or "2" rating at its most recent
bank holding company inspection by the FRB, and that is not the subject of
any unresolved supervisory issues.
The status of the Company as a registered bank holding company under
the BHCA does not exempt it from certain federal and state laws and
regulations applicable to corporations generally, including, without
limitation, certain provisions of the federal securities laws.
In addition, a bank holding company which does not qualify as a
financial holding company under the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 (the "GLBA") is generally prohibited from
engaging in, or acquiring direct or indirect control of any company engaged
in non-banking activities. One of the principal exceptions to this
prohibition is for activities found by the Federal Reserve Board to be so
closely related to banking or managing or controlling banks as to be
permissible. Some of the principal activities that the Federal Reserve
Board has determined by regulation to be so closely related to banking as
to be permissible are:
* making or servicing loans;
* performing certain data processing services;
* providing discount brokerage services;
* acting as fiduciary, investment or financial advisor;
* leasing personal or real property;
* making investments in corporations or projects designed
primarily to promote community welfare; and
* acquiring a savings and loan association.
Bank holding companies that do qualify as a financial holding company
may engage in activities that are financial in nature or incident to
activities that are financial in nature. Bank holding companies may
qualify to become a financial holding company if:
* each of its depository institution subsidiaries is "well
capitalized";
* each of its depository institution subsidiaries is "well
managed";
* each of its depository institution subsidiaries has at least a
"satisfactory" Community Reinvestment Act rating at its most
recent examination; and
* the bank holding company has filed a certification with the
Federal Reserve Board that it elects to become a financial
holding company.
23
As of June 30, 2004, the Company had registered as a financial
holding company.
Under the Federal Deposit Insurance Act, depository institutions are
liable to the FDIC for losses suffered or anticipated by the FDIC in
connection with the default of a commonly controlled depository institution
or any assistance provided by the FDIC to such an institution in danger of
default. This law would potentially be applicable to the Company if it
ever acquired as a separate subsidiary a depository institution in addition
to the Bank.
The Company is subject to capital adequacy guidelines for bank
holding companies (on a consolidated basis) that are substantially similar
to those of the FDIC for the Bank. The Company's stockholders' equity
exceeds these requirements. The FRB in May 2004 proposed to continue to
permit trust preferred securities to qualify as an element of bank holding
companies Tier 1 capital but on a more limited basis. The proposal in
general would continue to limit the aggregate amount of trust preferred
securities and certain other restricted core capital elements to 25% of
Tier 1 capital, net of goodwill. Previously, however, goodwill was not
deducted when calculating the 25% limit. The amount of trust preferred
securities and other restricted core capital elements in excess of the
limit could be included in Tier 2 capital, subject to certain limits. The
new limits would become fully effective on March 31, 2007. Before then,
bank holding companies with outstanding trust preferred securities and
other restricted core capital elements that do not conform to the new
limits would be asked to consult with their Federal Reserve Banks on plans
to ensure that the companies are not placing undue reliance on these
instruments and, where appropriate, to reduce such reliance.
The Company's wholly-owned subsidiaries, Mystic Financial Capital
Trust I ("Trust I") and Mystic Financial Trust II ("Trust II"), have
participated in pooled offerings of trust preferred securities. In
connection with the offerings, Trust I and Trust II, respectively, issued
$5.0 million in April 2002 and $7.0 million in February 2003 of trust
preferred securities and reinvested the proceeds in 30-year, subordinated
debenture issued by the Company. Approximately $9.2 million of the
proceeds of the offerings qualified as an element of the Company's Tier 1
capital under both the current and proposed FRB capital adequacy
guidelines, representing the maximum allowed under the 25.0% limitation as
of June 30, 2004. The Company currently does not have any goodwill.
Federal Home Loan Bank System
The Bank is a member of the FHLB of Boston, which is one of the
regional FHLBs composing the FHLB System. Each FHLB provides a central
credit facility primarily for its member institutions. The Bank, as a
member of the FHLB of Boston, must maintain a minimum investment in FHLB of
Boston capital stock in an amount equal to the sum of (i) .35% of member
eligible collateral (subject to a minimum of $10,000 and a maximum of
$25,000,000, per member), and (ii) 4.50% of the member's activity-based
assets. The Bank was in compliance with this requirement with an
investment in FHLB of Boston stock at June 30, 2004 of $3.2 million. Any
advances from a FHLB must be secured by specified types of collateral, and
all long-term advances may be obtained only for the purpose of providing
funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of
insolvent thrifts and to contribute funds for affordable housing programs.
These requirements could reduce the amount of earnings that the FHLBs can
pay as dividends to their members and could also result in the FHLBs
imposing a higher rate of interest on advances to their members. If
dividends were reduced, or interest on future FHLB advances increased, the
Bank's net interest income would be affected.
Under the Gramm-Leach Bliley Financial Services Modernization Act,
membership in the FHLB is now voluntary for all state chartered banks, such
as the Bank. The Gramm-Leach Bliley Act also
24
replaces the existing redeemable stock structure of the FHLB System with a
capital structure that requires each FHLB to meet a leverage limit and a
risk-based permanent capital requirement. Two classes of stock are
authorized: Class A (redeemable on 6-months notice) and Class B (redeemable
on 5-years notice).
Federal Reserve System
Under Federal Reserve Board regulations, the Bank is required to
maintain noninterest-earning reserves against its transaction accounts.
The Federal Reserve Board regulations generally require that reserves of 3%
must be maintained against aggregate transaction accounts of $38.8 million
or less, subject to adjustment by the Federal Reserve Board. Total
transaction accounts in excess of $38.8 million are required to have a
reserve of 10% held against them, which are also subject to adjustment by
the Federal Reserve Board. The first $6.6 million of otherwise reservable
balances, subject to adjustments by the Federal Reserve Board, are exempted
from the reserve requirements. The Bank is in compliance with these
requirements. Because required reserves must be maintained in the form of
either vault cash, a noninterest-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 Bank's interest-earning
assets.
Other Federal Regulation
The USA PATRIOT Act
In response to the events of September 11th, 2001, President George W.
Bush signed into law the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001,
or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the
federal government new powers to address terrorist threats through enhanced
domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. By
way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act
takes measures intended to encourage information sharing among bank
regulatory agencies and law enforcement bodies. Further, certain
provisions of Title III impose affirmative obligations on a broad range of
financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes
the following requirements with respect to financial institutions:
* Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls, (ii)
specific designation of an anti-money laundering compliance
officer, (iii) ongoing employee training programs, and (iv) an
independent audit function to test the anti-money laundering
program.
* Pursuant to Section 326, on May 9, 2003, the Secretary of the
Department of Treasury, in conjunction with other bank
regulators issued Joint Final Rules that provide for minimum
standards with respect to customer identification and
verification. These rules became effective on October 1, 2003.
* Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United
States persons or their representatives (including foreign
individuals visiting the United
25
States) to establish appropriate, specific, and, where
necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering.
* Effective December 25, 2001, financial institutions are
prohibited from establishing, maintaining, administering or
managing correspondent accounts for foreign shell banks
(foreign banks that do not have a physical presence in any
country), and will be subject to certain record keeping
obligations with respect to correspondent accounts of foreign
banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on
Federal Reserve Act and Bank Merger Act applications.
The Sarbanes-Oxley Act
On July 30, 2002, President George W. Bush signed into law the
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act implements a broad
range of corporate governance and accounting measures for public companies
designed to promote honesty and transparency in corporate America and
better protect investors from the type of corporate wrongdoing. The
Sarbanes-Oxley Act's principal legislation includes:
* the creation of an independent accounting oversight board;
* auditor independence provisions which restrict non-audit
services that accountants may provide to their audit clients;
* additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and
chief financial officer certify financial statements;
* the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by
directors and senior officers in the twelve month period
following initial publication of any financial statements that
later require restatement;
* an increase the oversight of, and enhancement of certain
requirements relating to audit committees of public companies
and how they interact with the company's independent auditors;
* requirement that audit committee members must be independent
and are absolutely barred from accepting consulting, advisory
or other compensatory fees from the issuer;
* requirement that companies disclose whether at least one member
of the committee is an "audit committee financial expert" (as
such term is defined by the Securities and Exchange Commission)
and if not, why not;
* expanded disclosure requirements for corporate insiders,
including accelerated reporting of stock transactions by
insiders and a prohibition on insider trading during pension
blackout periods;
* a prohibition on personal loans to directors and officers,
except certain loans made by insured financial institutions;
* disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
* mandatory disclosure by analysts of potential conflicts of
interest; and
* a range of enhanced penalties for fraud and other violations.
Although we anticipate that we will incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, management does not expect that such compliance will have a
material impact on our results of operations or financial condition.
26
Federal Securities Law
Our common stock is registered with the Securities and Exchange
Commission under Section 12(g) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). We are subject to information, proxy
solicitation, insider trading restrictions, and other requirements under
the Exchange Act.
ITEM 2. PROPERTIES
The following table sets forth certain information at June 30, 2004
regarding the Bank's Medford office facilities, which are owned by the
Bank, the Lexington, Arlington, Bedford and Malden offices, which are
leased, and certain other information relating to its property at that
date.
Year Square
Acquired Footage
-------- -------
Main Office 60 High Street 1931 7,000
Medford, MA 02155
West Medford Office 430 High Street 1970 2,500
Medford, MA 02155
Salem Street Office 201 Salem Street 1995 3,500
Medford, MA 02155
Lexington Office 1793 Massachusetts Avenue 1998 3,000
Lexington, MA 02420
Arlington Office 856 Massachusetts Avenue 2000 3,000
Arlington, MA 02476
Bedford Office 168 Great Road 2002 2,500
Bedford, MA 01730
Malden Office 280 Medford Street 2003 3,000
Malden, MA 02148
The Bank also owns an office building adjacent to its main office,
located at 66 High Street, Medford, MA 02155. The Bank uses a portion of
the second and third floors of this building to house some of its
administrative and clerical services and leases the remaining space to
third-party tenants.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Banks is involved in any pending legal
proceedings other than routine legal proceedings occurring in the ordinary
course of business. Such routine legal proceedings in the aggregate are
believed by management to be immaterial to the Company's consolidated
financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to security holders, through the solicitation
of proxies or otherwise, during the quarter ended June 30, 2004.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is traded on the Nasdaq National Market
under the symbol "MYST." The table below shows the high and low sales
price during the periods indicated. The Company's common stock began
trading on January 8, 1998, the date of the conversion and initial public
offering. At June 30, 2004, the last trading date in the Company's fiscal
year, the Company's common stock closed at $32.15. On September 15, 2004,
there were 1,565,945 shares of the Company's common stock outstanding,
which were held of record by approximately 850 stockholders, not including
persons or entities that hold the stock in nominee or "street" name through
various brokerage firms.
The Board of Directors considers paying dividends, dependent on the
results of operations and financial condition of the Company, tax
considerations, industry standards, economic conditions, regulatory
restrictions and other factors. There are significant regulatory
limitations on the Company's ability to pay dividends depending on the
dividends it receives from its subsidiary, Medford Co-operative Bank, which
are subject to regulations and the Bank's continued compliance with all
regulatory capital requirements and the overall health of the institution.
Share amounts for the fiscal year ended June 30, 2003 have been
restated to reflect the Company's 5% stock dividend declared on July 9,
2003.
Quarter Ended High Low Dividends
- ------------- ---- --- ---------
Fiscal year ended June 30, 2004:
Fourth Quarter ended June 30, 2004 $32.750 $28.100 $0.115
Third Quarter ended March 31, 2004 33.470 29.500 0.100
Second Quarter ended December 31, 2003 30.230 24.000 0.100
First Quarter ended September 30, 2003 25.220 20.476 0.100
Fiscal year ended June 30, 2003:
Fourth Quarter ended June 30, 2003 $21.981 $16.867 $0.086
Third Quarter ended March 31, 2003 17.638 16.705 0.086
Second Quarter ended December 31, 2002 17.619 15.429 0.086
First Quarter ended September 30, 2002 17.286 15.457 0.086
28
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data concerning the
Company at the dates and for the years indicated. The following information
is only a summary and should be read in conjunction with the consolidated
financial statements and notes beginning on page F-1. All share amounts
have been restated to reflect the Company's 5% stock dividend declared on
July 9, 2003.
At or For the Years Ended June 30,
-----------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Balance sheet data:
Total assets $ 441,192 $ 429,689 $ 356,733 $ 300,402 $ 263,888
Loans, net 311,806 279,949 243,743 215,035 189,200
Securities:
Available for sale 88,724 117,871 65,900 28,820 32,452
Held to maturity 11,287 - - - -
Deposits 351,407 343,564 267,438 224,750 194,135
Borrowings 47,861 41,200 58,135 44,618 38,750
Subordinated debt 12,373 12,373 5,155 - -
Total stockholders' equity 26,740 26,244 23,923 29,015 29,189
Asset quality data:
Non-performing loans 1,822 223 108 15 2
Allowance for loan losses 2,537 2,347 2,063 1,784 1,531
Number of employees:
Full-time 82 75 66 55 62
Part-time 21 20 25 25 28
Statement of income data:
Interest and dividend income $ 21,377 $ 21,388 $ 19,868 $ 19,422 $ 16,177
Interest expense 8,238 10,342 10,171 9,967 7,446
--------- --------- --------- --------- ---------
Net interest income 13,139 11,046 9,697 9,455 8,731
Provision for loan losses 584 300 305 275 200
--------- --------- --------- --------- ---------
Net interest income after
provision for loan losses 12,555 10,746 9,392 9,180 8,531
Non-interest income 1,718 2,165 1,137 1,196 945
Non-interest expense 11,432 10,081 7,871 8,470 6,715
--------- --------- --------- --------- ---------
Income before income taxes 2,841 2,830 2,658 1,906 2,761
Provision for income taxes 966 1,114 1,031 721 1,072
--------- --------- --------- --------- ---------
Net income $ 1,875 $ 1,716 $ 1,627 $ 1,185 $ 1,689
========= ========= ========= ========= =========
Per share data:
Weighted average shares
outstanding - basic 1,448,850 1,399,407 1,535,424 1,818,468 2,024,201
Basic earnings per share $ 1.29 $ 1.23 $ 1.06 $ 0.65 $ 0.79
Weighted average shares
outstanding - diluted 1,538,673 1,460,347 1,579,461 1,856,297 2,125,411
Diluted earnings per share $ 1.22 $ 1.18 $ 1.03 $ 0.64 $ 0.79
Cash dividends paid per share $ 0.42 $ 0.34 $ 0.31 $ 0.27 $ 0.25
Dividend pay-out ratio (basic) 0.32% 0.28% 0.29% 0.42% 0.30%
Book value per share $ 18.14 $ 18.46 $ 16.72 $ 15.61 $ 15.65
29
At or For the Years Ended June 30,
-----------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Selected operating ratios:
Interest rate spread (1) 2.96% 2.70% 2.88% 3.11% 3.43%
Net interest margin (2) 3.18 2.96 3.29 3.70 4.04
Return on average assets 0.44 0.44 0.53 0.44 0.74
Return on average equity 7.13 6.86 6.27 4.04 5.37
Non-interest expense as a
percent of average total assets 2.66 2.58 2.54 3.15 2.95
Efficiency ratio (3) 76.95 76.31 72.65 79.52 69.40
Asset quality ratios:
Non-performing loans as a
percent of total loans 0.58 0.08 0.04 0.01 0.00
Non-performing loans as a
percent of total assets 0.41 0.05 0.04 0.01 0.00
Net charge-offs to average loans 0.14 0.01 0.01 0.01 0.01
Regulatory Capital ratios:
Regulatory Tier 1 leverage
capital ratio 7.97 8.16 8.69 10.12 11.35
Total risk-based capital 15.65 13.74 13.92 16.39 19.22
___________________
Interest rate spread represents the difference between weighted
average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
Net interest margin represents net interest income divided by average
interest-earning assets.
Operating expenses divided by the sum of net interest income and
other income.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Medford Co-operative Bank (the "Bank") completed its conversion from
a mutual to a stock institution and was simultaneously acquired by Mystic
Financial, Inc. ("Mystic" or the "Company") on January 8, 1998. The
following discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes thereto included within
this report.
The business of the Bank consists of attracting deposits from the
general public and using these funds to originate various types of loans
primarily in eastern Middlesex County, Massachusetts, including mortgage
loans secured by one-to four-family residences, commercial loans secured by
general business assets, commercial real estate loans secured by commercial
property, and to invest in U.S. Government and federal agency and other
securities. To a lesser extent, the Bank engages in various forms of
consumer and home equity lending.
The Company's profitability depends primarily on its net interest
income, which is the difference between the interest income it earns on its
loans and investment portfolio and its cost of funds, which consists mainly
of interest paid on deposits and on borrowings from the FHLB. Net interest
income is affected by the relative amounts of interest-earning assets and
interest-bearing liabilities and the interest rates earned or paid on these
balances. When interest-earning assets approximate or exceed interest-
bearing liabilities, any positive interest rate spread will generate net
interest income.
30
The Company's profitability is also affected by the level of non-
interest income and non-interest expense. Non-interest income consists
primarily of service fees, loan servicing and other loan fees and gains on
sales of securities. Non-interest expense consists of salaries and
benefits, occupancy related expenses and other general operating expenses.
The operations of the Bank, and banking institutions in general, are
significantly influenced by general economic conditions and related
monetary and fiscal policies of financial institution's regulatory
agencies. Deposit flows and the cost of funds are influenced by interest
rates on competing investments and general market rates of interest.
Lending activities are affected by the demand for financing real estate and
other types of loans, which in turn are affected by the interest rates at
which such financing may be offered and other factors affecting loan demand
and the availability of funds.
Business Strategy
The Bank's business strategy is to operate as a well-capitalized,
profitable community bank dedicated to financing home ownership, small
business and consumer needs in its market area and providing quality
service to its customers. The Bank has implemented this strategy by: (i)
monitoring the needs of customers and providing quality service; (ii)
emphasizing consumer-oriented banking by originating residential mortgage
loans and consumer loans, and by offering various deposit accounts and
other financial services and products; (iii) recently increasing its
emphasis on commercial banking and lending by originating loans for small
businesses and providing greater services in its commercial and commercial
real estat