UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1998
1-13691
Commission File Number
BAY STATE BANCORP, INC.
(Name of small business issuer as specified in its charter.)
Delaware 04-3398630
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1299 Beacon Street, Brookline, Massachusetts 02146
(Address of Principal Executive Offices)
Issuer's telephone number, including area code: (617) 739-9500
Securities registered pursuant to Section 12(b) of the Exchange Act:
Common Stock, par value The American Stock Exchange
$0.01 per share (Name of Exchange on which registered)
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: None
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The issuer's revenues for its most recent fiscal year were $19,562,000.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the issuer was $67,128,000. This figure is based on the
closing price on the American Stock Exchange for a share of the issuer's common
stock on June 8, 1998, which was $27.75 as reported in The Wall Street Journal
on June 9, 1998. For purposes of this calculation, the Registrant is assuming
that directors and executive officers are affiliates.
The Registrant had 2,535,232 shares of Common Stock outstanding as of June 8,
1998.
Transitional Small Business Disclosure Format. Yes [ ] No [ X ]
<PAGE>
INDEX
<TABLE>
<CAPTION>
PART I
Page No.
<S> <C> <C>
Item 1. Description of Business....................................................................... 1
Item 2. Description of Property....................................................................... 29
Item 3. Legal Proceedings............................................................................. 29
Item 4. Submission of Matters to a Vote of Security Holders........................................... 29
PART II
Item 5. Market for Common Equity and Related Stockholder Matters...................................... 30
Item 6. Management's Discussion and Analysis or Plan of Operation..................................... 30
Item 7. Financial Statements.......................................................................... 40
Item 8. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure........................................................... 65
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act............................................. 66
Item 10. Executive Compensation........................................................................ 69
Item 11. Security Ownership of Certain Beneficial Owners and Management................................ 76
Item 12. Certain Relationships and Related Transactions................................................ 77
Item 13. Exhibits and Reports on Form 8-K.............................................................. 78
SIGNATURES
</TABLE>
<PAGE>
Item 1. Description of Business.
General
Bay State Bancorp, Inc. (the "Company") was incorporated under Delaware law
on October 24, 1997. The Company was formed to acquire Bay State Federal Savings
Bank and subsidiaries, Brookline, Massachusetts (the "Bank") as part of the
Bank's conversion from a mutual to stock form of organization (the
"Conversion"). In connection with the Conversion, on March 27, 1998 the Company
issued an aggregate 2,535,232 shares of its common stock, par value $0.01 per
share (the "Common Stock"), at a purchase price of $20 per share, of which
2,347,437 shares were issued in a subscription offering and 187,795 shares were
issued to The Bay State Federal Savings Charitable Foundation (the
"Foundation"), a charitable foundation established by the Bank. The Company is a
savings and loan holding company and is subject to regulation by the Office of
Thrift Supervision ("OTS"), the Federal Deposit Insurance Corporation ("FDIC")
and the Securities and Exchange Commission ("SEC"). Currently, the Company does
not transact any material business other than through its subsidiary, the Bank.
At March 31, 1998, the Company had total assets of $295.3 million, total
deposits of $207.8 million and total stockholders' equity of $63.6 million.
The Bank was originally organized in 1920 as a state-chartered mutual
cooperative bank with the name Coolidge Corner Cooperative Bank. In 1936, the
Bank converted to a federally-chartered mutual savings and loan association and
changed its name to Brookline Federal Savings and Loan Association. In 1960, the
Bank changed its name to Bay State Federal Savings and Loan Association and, in
1983, changed its name again to Bay State Federal Savings Bank. In February
1997, the Bank merged with Union Federal Savings Bank ("Union Federal"), which
at the time of the merger had $38.2 million of total assets, $35.5 million of
deposits and $2.7 million of retained earnings and operated two branches located
in Boston and Westwood, Massachusetts. The Bank currently maintains five banking
offices located in the greater Boston metropolitan area.
The Bank's principal business has been and continues to be attracting
retail deposits from the general public in the areas surrounding its branch
offices and investing those deposits, together with funds generated from
operations and borrowings, primarily in adjustable-rate and shorter-term
fixed-rate one- to four-family residential mortgage loans. To a lesser extent,
the Bank invests in multi-family, commercial real estate, construction and
development, commercial and consumer loans. The Bank operates through its five
full service banking offices and one administrative office, all of which are
located in the greater Boston metropolitan area. The Bank originates loans for
investment and loans for sale in the secondary market, generally retaining the
servicing rights to all loans sold. The Bank's revenues are derived principally
from interest on its mortgage loans and, to a lesser extent, interest on its
investment and mortgage-backed and mortgage-related securities and loan
servicing income. The Bank's primary sources of funds are deposits, principal
and interest payments on loans and securities and Federal Home Loan Bank
("FHLB") advances.
Market Area and Competition
The Bank is headquartered in Brookline, Massachusetts and is a
community-oriented savings institution offering a variety of financial products
and services to meet the needs of the communities it serves. The Bank's primary
deposit gathering area is concentrated in the communities surrounding its five
full-service banking offices located in Brookline, Boston, Dedham, Norwood and
Westwood, Massachusetts. All of the Bank's branch offices are located within 15
miles of Brookline. The Bank's primary lending area is significantly broader
than its deposit gathering area and includes all of Massachusetts, with a
concentration in the greater Boston metropolitan area.
Brookline, Massachusetts is a fully-developed and densely populated town
located west of and adjacent to Boston. Brookline is surrounded by three major
U.S. Interstate Highways: Interstate 93, Interstate 90 and Interstate 95. The
major traffic roadways running through Brookline are heavily traveled and lined
with commercial and retail business operations and Brookline's 1990 census
population was approximately 54,000. The residents of Brookline
1
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are generally comprised of white- and blue-collar workers and college students.
The towns of Dedham, Norwood and Westwood are situated southwest of Boston.
These towns are primarily residential communities consisting of single-family
residences and are populated by middle- to high-income individuals employed in
the greater Boston metropolitan area.
New England has generally lagged behind the rest of the nation in coming
out of the recession of the late 1980s and early 1990s. During this time, the
market values of many one- to four-family residences declined throughout the
region. Loan demand diminished and competition for such loans increased.
However, over the past few years, the regional economy in the Bank's primary
market area, based on economic indicators such as unemployment rates,
residential and commercial real estate values and vacancy rates and household
income trends, has stabilized and begun to strengthen. Small business,
technology and service firms, higher education and tourism form the backbone of
the economy of the greater Boston metropolitan area.
The Bank faces significant competition both in generating loans and in
attracting deposits. The Bank's primary market area is highly competitive and
the Bank faces direct competition from a significant number of financial
institutions, many with a state-wide or regional presence and, in some cases, a
national presence. Many of these financial institutions are significantly larger
and have greater financial resources than the Bank. The Bank's competition for
loans comes principally from commercial banks, savings banks, credit unions,
mortgage brokers, mortgage banking companies and insurance companies. Its most
direct competition for deposits has historically come from other financial
institutions. In addition, the Bank faces significant competition for deposits
from non-bank institutions such as brokerage firms and insurance companies in
such instruments as short-term money market funds, corporate and government
securities funds, mutual funds and annuities. Competition may also increase as a
result of the lifting of restrictions on the interstate operations of financial
institutions. The Bank has also experienced significant competition from credit
unions which have a competitive advantage as they do not pay state or federal
income taxes. This competitive disadvantage has placed increased pressure on the
Bank with respect to its loan and deposit pricing.
Personnel
As of March 31, 1998 the Bank had 69 full-time employees and 14 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.
Lending Activities
Loan Portfolio Composition. The Bank's loan portfolio consists primarily of
first mortgage loans secured by one- to four-family residences. At March 31,
1998, gross loans totalled $230.4 million, of which $157.2 million were one- to
four-family, residential mortgage loans, or 68.2% of the Bank's total loans. At
such date, the remainder of the loan portfolio consisted of: $22.4 million of
multi-family residential loans, or 9.7% of total loans; $35.5 million of
commercial real estate loans, or 15.4% of total loans; $7.8 million of
construction and development loans, including unadvanced loan amounts, or 3.4%
of total loans; $4.0 million of equity lines of credit, or 1.7% of total loans;
and $3.4 million of other consumer loans, or 1.5% of total loans. At that same
date, 73.4% of the Bank's residential mortgage loans and construction and
development loans had adjustable interest rates.
The types of loans that the Bank may originate are subject to federal and
state laws and regulations. Interest rates charged by the Bank on loans are
affected by the demand for such loans and the supply of money available for
lending purposes and the rates offered by competitors. These factors are, in
turn, affected by, among other things, economic conditions, monetary policies of
the federal government, including the Federal Reserve Board ("FRB") and
legislative tax policies.
2
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The following table sets forth the composition of the Bank's loan portfolio
in dollar amounts and as a percentage of the portfolio at the dates indicated.
<TABLE>
<CAPTION>
At March 31,
-----------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential:
One- to four-family .. $157,240 68.23% $162,837 77.34% $149,941 78.74%
Multi-family ......... 22,411 9.73 14,624 6.95 13,294 6.98
Commercial real estate 35,468 15.39 25,260 12.00 19,129 10.05
Construction and
development(1) ....... 7,821 3.39 2,831 1.34 5,359 2.81
------- ------ ------- ------ ------- ------
Total mortgage loans 222,940 96.74 205,552 97.63 187,723 98.58
------- ------ ------- ------ ------- ------
Commercial ................ 43 .02 31 0.02 -- --
------- ------ ------- ------ ------- ------
Consumer loans:
Equity lines ........... 4,028 1.75 2,359 1.12 268 0.14
Other consumer loans ... 3,434 1.49 2,594 1.23 2,434 1.28
------- ------ ------- ------ ------- ------
Total consumer loans 7,462 3.24 4,953 2.35 2,702 1.42
------- ------ ------- ------ ------- ------
Total loans .............. 230,445 100.00% 210,536 100.00% 190,425 100.00%
====== ====== ======
Allowance for loan losses (2,513) (1,687) (1,774)
Undisbursed proceeds of
construction and
development loans in
process .............. (2,534) (1,349) (1,622)
Deferred loan origination
fees, net .............. (470) (437) (495)
------- ------- -------
Loans, net ......... 224,928 207,063 186,534
Mortgage loans held-for-
sale ................... 822 -- 47
------- ------- -------
Loans, net and mortgage
loans held-for-sale .... $225,750 $207,063 $186,581
======== ======== ========
<CAPTION>
At March 31,
----------------------------------------------------
1995 1994
---- ----
Percent Percent
Amount of Total Amount of Total
------ -------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Mortgage loans:
Residential:
One- to four-family .. $152,025 80.93% $148,613 80.21%
Multi-family ......... 12,505 6.65 10,519 5.68
Commercial real estate 17,820 9.49 21,120 11.40
Construction and
development(1) ....... 3,393 1.81 3,078 1.66
------- ------ -------- ------
Total mortgage loans 185,743 98.88 183,330 98.95
------- ------ -------- ------
Commercial ............... -- -- -- --
------- ------ -------- ------
Consumer loans:
Equity lines ........... -- -- -- --
Other consumer loans ... 2,110 1.12 1,951 1.05
------- ------ -------- ------
Total consumer loans 2,110 1.12 1,951 1.05
------- ------ -------- ------
Total loans .............. 187,853 100.00% 185,281 100.00%
====== ======
Allowance for loan losses (1,825) (2,480)
Undisbursed proceeds of
construction and
development loans in
process .............. (909) (903)
Deferred loan origination
fees, net .............. (588) (573)
-------- ---------
Loans, net ......... 184,531 181,325
Mortgage loans held-for-
sale ................... -- --
-------- --------
Loans, net and mortgage
loans held-for-sale ..... $184,531 $181,325
======== ========
</TABLE>
- ----------
(1) Includes committed but unadvanced loan amounts.
3
<PAGE>
Loan Maturity. The following table shows the remaining contractual maturity
of the Bank's loans at March 31, 1998. The table does not include the effect of
future principal prepayments.
<TABLE>
<CAPTION>
At March 31, 1998
--------------------------------------------------------------------
One- to Construction
Four- Multi- Commercial and
Family(1) Family Real Estate Development(2)
--------- ------ ----------- --------------
(In Thousands)
<S> <C> <C> <C> <C>
Amounts due:
One year or less.................................. $ 1,160 $ 791 $ 327 $6,352
-------- ------- ------- ------
After one year:
More than one year to three years................ 819 1,843 2,945 413
More than three years to five years.............. 1,545 473 772 12
More than five years to ten years................ 8,363 1,519 3,951 --
More than ten years to twenty years.............. 47,951 8,056 16,963 44
More than twenty years........................... 101,430 9,729 10,510 1,000
-------- ------- ------- ------
Total due after one year...................... 160,108 21,620 35,141 1,469
-------- ------- ------- ------
Total amount due.............................. $161,268 $22,411 $35,468 $7,821
======== ======= ======= ======
<CAPTION>
At March 31, 1998
---------------------------------------
Total
Commercial Consumer Loans
---------- -------- -----
(In Thousands)
<S> <C> <C> <C>
Amounts due:
One year or less.................................. $ -- $1,625 $ 10,255
---- ------ --------
After one year:
More than one year to three years................ 43 302 6,365
More than three years to five years.............. -- 353 3,155
More than five years to ten years................ -- 363 14,196
More than ten years to twenty years.............. -- 626 73,640
More than twenty years........................... -- 165 122,834
---- ------ --------
Total due after one year...................... 43 1,809 220,190
---- ------ --------
Total amount due.............................. $ 43 $3,434 230,445
==== ======
Less:
Allowance for loan losses............................................................ (2,513)
Undisbursed proceeds of construction and development loans in process................ (2,534)
Deferred loan origination fees, net.................................................. (470)
--------
Loans, net............................................................................. $224,928
========
</TABLE>
(1) Includes equity lines.
(2) Includes construction and development loans which will convert to one- to
four-family mortgage loans upon the completion of the construction.
The following table sets forth at March 31, 1998, the dollar amount of
loans, excluding mortgage loans held for sale, contractually due after March 31,
1999 and whether such loans have fixed interest rates or adjustable interest
rates.
Due After March 31, 1999
---------------------------------
Fixed Adjustable Total
----- ---------- -----
(In Thousands)
Mortgage loans:
One- to four-family ................ $ 35,533 $120,547 $156,080
Multi-family ....................... 3,406 18,214 21,620
Commercial real estate ............. 5,206 29,935 35,141
Construction and development ....... 413 1,056 1,469
-------- -------- --------
Total mortgage loans ............. 44,558 169,752 214,310
-------- -------- --------
Commercial loans ..................... -- 43 43
-------- -------- --------
Consumer loans:
Equity lines ....................... -- 4,028 4,028
Other consumer loans ............... 475 1,334 1,809
-------- -------- --------
Total consumer loans ............. 475 5,362 5,837
-------- -------- --------
Total loans .......................... $ 45,033 $175,157 $220,190
======== ======== ========
Origination, Sale and Servicing of Loans. The Bank's mortgage lending
activities are conducted primarily by its loan personnel operating at its five
branch offices and one administrative office and through a network of loan
correspondents, wholesale loan brokers and other financial institutions approved
by the Bank. All loans originated by the Bank, either through internal sources
or through loan correspondents are underwritten by the Bank pursuant to the
Bank's policies and procedures. The Bank originates both adjustable-rate and
fixed-rate loans. The Bank's
4
<PAGE>
ability to originate fixed- or adjustable-rate loans is dependent upon the
relative customer demand for such loans, which is affected by the current and
expected future level of interest rates.
Generally, all adjustable-rate mortgage loans originated by the Bank are
originated for investment. While the Bank has in the past, from time-to-time,
retained fixed-rate one- to four-family loans, it is currently the general
policy of the Bank to sell substantially all one- to four-family fixed-rate
mortgage loans with periods to repricing of greater than 15 years. The one- to
four-family mortgage loan products currently originated for sale by the Bank
include a variety of loans which conform to the underwriting standards specified
by the FHLMC ("conforming loans") and, to a lesser extent, loans which do not
conform to FHLMC standards due to loan amounts ("jumbo loans"). While the Bank
generally does not originate mortgage loans insured by the FHA and VA, the Bank
has, from time-to-time, purchased such loans for its own portfolio. All one- to
four-family mortgage loans sold by the Bank are sold pursuant to master
commitments negotiated with FHLMC and other investors to purchase loans meeting
such investors' defined criteria. Although the Bank has entered into such master
commitment contracts, such contracts generally do not require the purchasers to
buy or the Bank to deliver a specific amount of mortgage loans. All conforming
loans currently sold by the Bank are sold to FHLMC and all non-conforming loans
which are sold are generally sold to private investors. Sales of loans are made
without recourse to the Bank in the event of default by the borrower. The Bank
generally retains the servicing rights on the mortgage loans sold to FHLMC.
At March 31, 1998, the Bank was servicing in its portfolio $228.0 million
of loans, net, and $15.6 million of loans for others, primarily consisting of
conforming fixed-rate mortgage loans sold by the Bank. Loan servicing includes
collecting and remitting loan payments, accounting for principal and interest,
contacting delinquent mortgagors, supervising foreclosures and property
dispositions in the event of unremedied defaults, making certain insurance and
tax payments on behalf of the borrowers and generally administering the loans.
Substantially all of the loans currently being serviced for others are loans
which have been sold by the Bank. The gross servicing fee income from loans sold
is generally 24 to 48 basis points of the total balance of the loan serviced.
During the fiscal years ended March 31, 1998, 1997 and 1996, the Bank
originated $40.3 million, $38.1 million and $21.4 million of fixed-rate and
adjustable-rate one- to four-family loans, respectively, of which $38.0 million,
$37.5 million and $20.7 million, respectively, were retained by the Bank. The
Bank recognizes, at the time of sale, the cash gain or loss on the sale of the
loans based on the difference between the net cash proceeds received and the
carrying value of the loans sold. On April 1, 1996, the Bank implemented SFAS
No. 122 pursuant to which the value of servicing rights may be recognized as an
asset of the Bank. In the fiscal year ended March 31, 1998 the fair value of
servicing rights under SFAS No. 122 and SFAS No. 125 was not material and was
not recognized in the consolidated financial statements for that period. The
Bank has, in the past, from time-to-time, purchased loans, primarily one- to
four-family mortgage loans or participations in loans, primarily multi-family
and commercial real estate loans and, at March 31, 1998, had $15.8 million of
purchased loans and $10.8 million in loan participation interests. Loans
purchased from correspondent financial institutions are underwritten pursuant to
the Bank's policies and generally closed in the name of the correspondent
financial institution and then purchased by the Bank.
5
<PAGE>
The following table sets forth the Bank's loan originations, purchases,
sales and principal repayments for the periods indicated:
<TABLE>
<CAPTION>
For the Year Ended March 31,
----------------------------------
1998 1997 1996
--------- --------- ---------
(In Thousands)
<S> <C> <C> <C>
Beginning balance, loans, net(1) .............. $ 207,063 $ 186,581 $ 184,531
--------- --------- ---------
Loans originated:
Mortgage loans:
One- to four-family ..................... 41,107 38,062 21,411
Multi-family ............................ 5,768 1,129 2,025
Commercial real estate .................. 16,657 9,262 3,082
Construction and development ............ 5,940 3,750 6,147
--------- --------- ---------
Total mortgage loans .................. 69,472 52,203 32,665
--------- --------- ---------
Commercial ................................ -- 38 --
--------- --------- ---------
Consumer:
Equity lines ............................ 4,166 3,737 517
Other consumer loans .................... 3,277 1,312 1,689
--------- --------- ---------
Total consumer loans .................. 7,443 5,049 2,206
--------- --------- ---------
Total loans ......................... 76,915 57,290 34,871
--------- --------- ---------
Total ....................................... 283,978 243,871 219,402
Principal repayments and other, net ........... (56,059) (35,765) (32,049)
Loan charge-offs, net ......................... (30) (204) (52)
Sale of mortgage loans, principal balance ..... (2,269) (530) (673)
Transfer of mortgage loans to REO ............. (230) (309) --
--------- --------- ---------
Loans, net and mortgage loans held-for-sale 225,750 207,063 186,628
Mortgage loans held-for-sale .................. (822) -- (47)
--------- --------- ---------
Ending balance, loans, net ................ $ 224,928 $ 207,063 $ 186,581
========= ========= =========
</TABLE>
- ----------
(1) Includes mortgage loans held-for-sale.
One-to Four-Family Lending. The Bank currently offers both fixed-rate and
adjustable-rate mortgage ("ARM") loans with maturities of up to 30 years secured
by one- to four-family residences. Most of such loans are located in the Bank's
primary market area. One- to four-family mortgage loan originations are
generally obtained from the Bank's in-house loan representatives, from existing
or past customers, from mortgage brokers and through referrals from members of
the Bank's local communities. At March 31, 1998, the Bank's one- to four-family
mortgage loans totalled $157.2 million, or 68.2%, of total loans. Of the one- to
four-family mortgage loans outstanding at that date, 23.1% were fixed-rate
mortgage loans and 76.9% were ARM loans.
The Bank currently offers fixed-rate mortgage loans with terms from ten to
30 years. The Bank sells substantially all of the fixed-rate residential loans
with periods to repricing of greater than 15 years that it originates and
retains the servicing on all loans sold to FHLMC. The Bank generally retains for
its portfolio all adjustable-rate one- to four-family loans. From time-to-time,
the Bank will purchase one- to four-family mortgage loans. Such purchased loans
may be secured by real estate located outside the Bank's primary market area and
outside of Massachusetts. Such loans are generally purchased with servicing
retained by the seller.
The Bank currently offers a number of ARM loans with terms of up to 30
years and interest rates which adjust every one, three or five years from the
outset of the loan and which adjust annually after a three or five year initial
fixed period. The interest rates for the Bank's ARM loans are indexed to either
the one, three or five year Constant Maturity Treasury ("CMT") Index. The Bank
originates ARM loans with initially discounted rates, often
6
<PAGE>
known as "teaser rates." The Bank's ARM loans generally provide for periodic
(not more than 2%) and overall (not more than 6%) caps on the increase or
decrease in the interest rate at any adjustment date and over the life of the
loan.
The origination of adjustable-rate residential mortgage loans, as opposed
to fixed-rate residential mortgage loans, helps reduce the Bank's exposure to
increases in interest rates. However, adjustable-rate loans generally pose
credit risks not inherent in fixed-rate loans, primarily because as interest
rates rise, the underlying payments of the borrower rise, thereby increasing the
potential for default. Periodic and lifetime caps on interest rate increases
help to reduce the risks associated with adjustable-rate loans but also limit
the interest rate sensitivity of such loans.
All one- to four-family mortgage loans are underwritten according to the
Bank's policies and guidelines. Generally, the Bank originates one- to
four-family residential mortgage loans in amounts up to 80% of the lower of the
appraised value or the selling price of the property securing the loan and up to
95% of the appraised value or selling price if private mortgage insurance
("PMI") is obtained. Mortgage loans originated by the Bank generally include
due-on-sale clauses which provide the Bank with the contractual right to deem
the loan immediately due and payable in the event the borrower transfers
ownership of the property without the Bank's consent. Due-on-sale clauses are an
important means of adjusting the yields on the Bank's fixed-rate mortgage loan
portfolio and the Bank has generally exercised its rights under these clauses.
The Bank requires fire, casualty, title and, in certain cases, flood insurance
on all properties securing real estate loans made by the Bank.
In an effort to provide financing for first-time home buyers, the Bank
offers its own first-time home buyer loan program. This program offers one- to
four-family residential mortgage loans to qualified individuals. These loans are
offered with adjustable- and fixed-rates of interest and terms of up to 30
years. Pursuant to this program, borrowers receive reduced loan origination fees
and closing costs. Such loans must be secured by an owner-occupied residence.
These loans are originated using the same underwriting guidelines as are the
Bank's other one- to four-family mortgage loans. Such loans are originated in
amounts up to 95% of the lower of the property's appraised value or the sale
price. Private mortgage insurance is normally required for loans with
loan-to-value ("LTV") ratios of over 80%.
Multi-Family and Commercial Real Estate Lending. The Bank originates
multi-family and commercial real estate loans that are generally secured by 5 or
more unit apartment buildings and properties used for business purposes such as
office buildings, industrial facilities or retail facilities located in the
Bank's primary market area. The Bank's multi-family and commercial real estate
underwriting policies provide that such real estate loans may be made in amounts
up to 80% of the appraised value of the property, subject to the Bank's current
loans-to-one-borrower limit, which at March 31, 1998 was $6.3 million. The
Bank's multi-family and commercial real estate loans may be made with terms up
to 30 years and are offered with interest rates that adjust periodically and are
generally indexed to the prime rate as reported in The Wall Street Journal. In
reaching its decision on whether to make a multi-family or commercial real
estate loan, the Bank considers the net operating income of the property, the
borrower's expertise, credit history and profitability and the value of the
underlying property. The Bank has generally required that the properties
securing these real estate loans have debt service coverage ratios (the ratio of
earnings before debt service to debt service) of at least 1.25x. In addition,
environmental impact surveys are generally required for most multi-family and
commercial real estate loans. Generally, all multi-family and commercial real
estate loans made to corporations, partnerships and other business entities
require personal guarantees by the principals. On an exception basis, the Bank
may not require a personal guarantee on such loans depending on the
creditworthiness of the borrower and the amount of the downpayment and other
mitigating circumstances. The Bank's multi-family real estate loan portfolio at
March 31, 1998 was $22.4 million, or 9.7%, of total loans and the Bank's
commercial real estate loan portfolio at such date was $35.5 million, or 15.4%,
of total loans. The largest multi-family or commercial real estate loan in the
Bank's portfolio at March 31, 1998 was a $2,750,000 real estate loan secured by
a golf and country club located in Watertown, Massachusetts.
7
<PAGE>
The Bank also purchases participation interests in multi-family and
commercial real estate loans. Most of these loans are secured by real estate
located in the Bank's primary market area. When determining whether to
participate in such loans, the Bank will underwrite its participation interest
according to its own underwriting standards. At March 31, 1998, the Bank had
$4.8 million in multi-family and commercial real estate loan participation
interests, or 2.1% of total loans.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are often
dependent on successful operation or management of the properties, repayment of
such loans may be subject to adverse conditions in the real estate market or the
economy. The Bank seeks to minimize these risks through its underwriting
standards.
Construction and Development Lending. The Bank originates short-term
balloon fixed-rate construction loans for the development of residential and
commercial property. Construction and development loans are offered primarily to
experienced local developers operating in the Bank's market area. The Bank
currently does not originate loans secured by raw land. The majority of the
Bank's construction and development loans are originated to finance the
construction by developers of one- to four-family residential real estate and,
to a lesser extent, multi-family and commercial real estate properties located
in the Bank's primary market area. Construction loans are generally offered with
terms of up to 12 months and may be made in amounts up to 80% of the appraised
value of the property on multi-family and commercial real estate construction
and 85% on one- to four-family residential construction. Construction loan
proceeds are disbursed periodically in increments as construction progresses and
as inspections by the Bank's lending officers warrant. At March 31, 1998, the
Bank's largest construction and development loan was a performing loan with a
$1.0 million outstanding principal balance secured by a single-family residence
located in Wellesley, Massachusetts. At March 31, 1998, construction and
development loans totalled $7.8 million (including unadvanced loan amounts), or
3.4%, of the Bank's total loans. At March 31, 1998, $2.3 million, or 29.5%, of
construction and development loans had permanent financing commitments by the
Bank or third-parties or were secured by properties which were pre-sold pending
completion of the projects.
The Bank also originates construction and development loans to individual
borrowers for the construction of single-family owner-occupied residential
properties with permanent financing commitments by the Bank. The Bank's
underwriting standards and procedures for such loans are similar to those
applicable for one- to four-family residential mortgage lending. Proceeds for
such loans are disbursed as phases of the construction are completed. All such
loans are originated as one- to four-family interest-only adjustable-rate
mortgage loans. Upon completion of the construction, such loans convert to
principal and interest over the remaining term. At March 31, 1998, such loans
totalled $1.0 million, or 12.8%, of all of the $7.8 million of construction and
development loans.
Construction and development financing is generally considered to involve a
higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction or development compared to the estimated cost
(including interest) of construction and other assumptions, including the
estimated time to sell residential properties. If the estimate of value proves
to be inaccurate, the Bank may be confronted with a property, when completed,
having a value which is insufficient to assure full repayment.
Consumer and Other Lending. Total consumer loans at March 31, 1998 amounted
to $7.5 million, or 3.2%, of the Bank's total loans and consisted primarily of
equity lines of credit and, to a significantly lesser extent, secured and
unsecured personal loans and new and used automobile loans. Such loans are
generally originated in the Bank's primary market area and generally are secured
by real estate, deposit accounts, personal property and automobiles. These loans
are typically shorter term and generally have higher interest rates than one- to
four-family mortgage loans.
The Bank has recently begun to offer equity lines of credit. Substantially
all of these loans are secured by second mortgages on residential real estate
located in the Bank's primary market area. At March 31, 1998, these
8
<PAGE>
loans totalled $4.0 million, or 1.7%, of the Bank's total loans. Equity lines of
credit generally have fixed-rates of interest for the initial six months of the
loan and adjustable-rates of interest thereafter which adjust on a monthly
basis. The adjustable-rate of interest charged on such loans is indexed to the
prime rate as reported in The Wall Street Journal. Equity lines of credit
generally have an 18% lifetime cap on interest rates and may never adjust to be
less than the initial interest rate. Generally, the combined LTV ratio on equity
lines of credit is 80% where the Bank possesses the first mortgage lien interest
and 75% when another lender possesses the first mortgage lien interest. However,
exceptions may be made for previous customers of the Bank. The underwriting
standards employed by the Bank for equity lines of credit include a
determination of the applicant's credit history and an assessment of the
applicant's ability to meet existing obligations and payments on the proposed
loan and the value of the collateral securing the loan. The stability of the
applicant's monthly income may be determined by verification of gross monthly
income from primary employment and, additionally, from any verifiable secondary
income. Creditworthiness of the applicant is of primary consideration.
The Bank also originates other types of consumer loans consisting of
secured and unsecured personal loans and new and used automobile loans. Secured
personal loans may be secured by deposit accounts or other forms of collateral.
At March 31, 1998, personal loans (both secured and unsecured) totalled $2.9
million, or 1.3%, of the Bank's total loans.
Loans secured by rapidly depreciable assets such as automobiles or that are
unsecured entail greater risks than one- to four-family residential mortgage
loans. In such cases, repossessed collateral for a defaulted loan may not
provide an adequate source of repayment of the outstanding loan balance, since
there is a greater likelihood of damage, loss or depreciation of the underlying
collateral. Further, consumer loan collections on these loans are dependent on
the borrower's continuing financial stability and, therefore, are more likely to
be adversely affected by job loss, divorce, illness or personal bankruptcy.
Finally, the application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans in the event of a default. At March 31, 1998, the Bank
had six consumer loans 90 days or more delinquent, whose balances totalled
$28,000.
At March 31, 1998, the Bank had one outstanding commercial loan which was
unsecured and had an outstanding principal balance of $43,000.
Loan Approval Procedures and Authority. The Board of Directors of the Bank
establishes the lending policies of the Bank. Such policies provide that only
the Bank's President and Executive Vice President may approve loans. Any loans
approved by the President or Executive Vice President are submitted to the full
Board of Directors or the Bank's Executive Committee for ratification on a
monthly basis.
Delinquent Loans, Classified Assets and Real Estate Owned
Delinquencies and Classified Assets. Reports listing all delinquent
accounts are generated and reviewed by management on a monthly basis and the
Board of Directors performs a monthly review of all loans or lending
relationships delinquent 90 days or more and all REO. The procedures taken by
the Bank with respect to delinquencies vary depending on the nature of the loan,
period and cause of delinquency and whether the borrower is habitually
delinquent. When a borrower fails to make a required payment on a loan, the Bank
takes a number of steps to have the borrower cure the delinquency and restore
the loan to current status. The Bank generally sends the borrower a written
notice of non-payment after the loan is first past due. The Bank's guidelines
provide that telephone, written correspondence and/or face-to-face contact will
be attempted to ascertain the reasons for delinquency and the prospects of
repayment. When contact is made with the borrower at any time prior to
foreclosure, the Bank usually attempts to obtain full payment, work out a
repayment schedule with the borrower to avoid foreclosure or, in some instances,
accept a deed in lieu of foreclosure. In the event payment is not then received
or the loan not otherwise satisfied, additional letters and telephone calls
generally are made. If the loan is still not brought current or satisfied and it
becomes necessary for the Bank to take legal action, which typically occurs
after a loan is 90 days or more delinquent,
9
<PAGE>
the Bank will commence foreclosure proceedings against any real property that
secures the loan. If a foreclosure action is instituted and the loan is not
brought current, paid in full, or refinanced before the foreclosure sale, the
property securing the loan generally is sold at foreclosure and, if purchased by
the Bank, becomes real estate owned.
Federal regulations and the Bank's Asset Classification Policy require that
the Bank utilize an internal asset classification system as a means of reporting
problem and potential problem assets. The Bank has incorporated the OTS internal
asset classifications as a part of its credit monitoring system. The Bank
currently classifies problem and potential problem assets as "Substandard,"
"Doubtful" or "Loss" assets. An asset is considered "substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. "Substandard" assets include those
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified as
"Doubtful" have all of the weaknesses inherent in those classified "Substandard"
with the added characteristic that the weaknesses present make "collection or
liquidation in full," on the basis of currently existing facts, conditions and
values, "highly questionable and improbable." Assets classified as "Loss" are
those considered "uncollectible" and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not warranted.
Assets which do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are required to be designated "Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, it is required to establish a general
valuation allowance for loan losses in an amount deemed prudent by management.
General valuation allowances represent loss allowances which have been
established to recognize the inherent risk associated with lending activities,
but which, unlike specific allowances, have not been allocated to particular
problem assets. When an insured institution classifies one or more assets, or
portions thereof, as "Loss," it is required either to establish a specific
allowance for losses equal to 100% of the amount of the asset so classified or
to charge off such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies, has
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
Although management believes that, based on information currently available to
it at this time, its allowance for loan losses is adequate, actual losses are
dependent upon future events and, as such, further additions to the level of
allowances for loan losses may become necessary.
The Bank's Classification of Assets Committee reviews and classifies the
Bank's assets on a quarterly basis and the Board of Directors reviews the
results of the reports on a quarterly basis. The Bank classifies assets in
accordance with the management guidelines described above. At March 31, 1998,
the Bank had $2.1 million, or 0.7%, of total assets, designated as Substandard
consisting of nine one- to four-family mortgage loans, one consumer installment
loan and one land loan. At such date, no loans were designated as Doubtful (in
accordance with OTS regulations). Included in total classified assets at March
31, 1998, were $800,000 of assets classified as Substandard, which represent the
outstanding balance of second mortgage loans purchased by Union Federal and
secured by properties located outside the Bank's primary market area,
predominately in California and other southwestern states. During early 1997,
such second mortgage loans experienced increased delinquencies which caused the
Bank to adversely classify the entire pool of such loans and increase its
provision for loan losses. To the extent delinquencies continue to increase in
such portfolio of loans, the Bank may establish additional reserves against such
loans through provisions for loan losses or charge off portions of such loans
which would adversely affect the Company's net
10
<PAGE>
income. As of March 31, 1998, the Bank had a total of eight one- to four-family
loans, one multi-family, two commercial real estate and one consumer installment
loan, totaling $2.2 million, designated as Special Mention. At March 31, 1998,
the largest loan designated as Special Mention had a carrying balance of
$528,000 and was secured by commercial real estate. At March 31, 1998, all of
the Bank's classified and special mention assets totalled $3.3 million,
representing 1.4% of loans.
The following table sets forth the delinquencies in the Bank's loan
portfolio as of the dates indicated.
<TABLE>
<CAPTION>
At March 31, 1998 At March 31, 1997
--------------------------------------------- ----------------------------------------------
30-89 Days 90 Days or More 30-89 Days 90 Days or More
-------------------- -------------------- -------------------- ----------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
-------- ---------- ---------- --------- --------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One- to four-family ............... 8 $ 616 8 $1,258 14 $1,622 12 $1,499
Multi-family ...................... 1 699 1 254 -- -- -- --
Commercial real estate ............ -- -- 2 739 1 530 -- --
------ ------ ------ ------ ------ ------ ------ ------
Total mortgage loans ............ 9 1,315 11 2,251 15 2,152 12 1,499
------ ------ ------ ------ ------ ------ ------ ------
Consumer loans:
Equity lines ...................... 1 45 -- -- -- -- 1 40
Other consumer loans .............. 5 37 6 28 3 13 2 7
------ ------ ------ ------ ------ ------ ------ ------
Total consumer loans ............ 6 82 6 28 3 13 3 47
------ ------ ------ ------ ------ ------ ------ ------
Total loans ......................... 15 $1,397 17 $2,279 18 $2,165 15 $1,546
====== ====== ====== ====== ====== ====== ====== ======
Delinquent loans to loans, net ...... 0.62% 1.01% 1.04% 0.75%
====== ====== ====== ======
<CAPTION>
At March 31, 1996
--------------------------------------
30-89 Days 90 Days or More
---------- ---------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
-------- --------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Mortgage loans:
One- to four-family .............. 16 $1,521 15 $1,128
Multi-family ..................... -- -- -- --
Commercial real estate ........... 1 198 -- --
------ ------ ------ ------
Total mortgage loans
17 1,719 15 1,128
------ ------ ------ ------
Consumer loans:
Other consumer loans ............. 1 35 3 22
------ ------ ------ ------
Total consumer loans ........... 1 35 3 22
------ ------ ------ ------
Total loans ........................ 18 $1,754 18 $1,150
====== ====== ====== ======
Delinquent loans to loans, net ..... 0.94% 0.62%
====== ======
</TABLE>
Non-Performing Assets and Impaired Loans. The following table sets forth
information regarding non-accrual loans and REO. At March 31, 1998, the Bank had
no REO in its portfolio. It is the policy of the Bank to cease accruing interest
on loans 90 days or more past due and to charge off all accrued interest. For
the fiscal years ended March 31, 1998, 1997 and 1996, the amount of interest
income that was recorded on non-accrual loans was $130,000, $78,000 and $23,000,
respectively. For the fiscal years ended March 31, 1998, 1997 and 1996, the
amount of additional interest income that would have been recognized on
non-accrual loans if such loans had continued to perform in accordance with
their contractual terms was $144,000, $79,000 and $56,000, respectively. On
April 1, 1995, the Bank adopted SFAS No. 114 "Accounting by Creditors for
Impairment of a Loan" ("SFAS No. 114"), as
11
<PAGE>
amended by SFAS No. 118. There were no loans that met the definition of an
impaired loan per SFAS No. 114 at or during the fiscal years ended March 31,
1998, 1997 and 1996.
<TABLE>
<CAPTION>
At March 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Mortgage loans:
One- to four-family ................................. $1,258 $1,499 $1,128 $ 996 $2,056
Multi-family ........................................ 254 -- -- -- --
Commercial real estate .............................. 739 -- -- -- 360
Construction and development ........................ -- -- -- 158 632
------ ------ ------ ------ ------
Total mortgage loans .............................. 2,251 1,499 1,128 1,154 3,048
------ ------ ------ ------ ------
Consumer loans:
Equity lines ........................................ -- 40 -- -- --
Other consumer loans ................................ 28 7 22 18 7
------ ------ ------ ------ ------
Total consumer loans .............................. 28 47 22 18 7
------ ------ ------ ------ ------
Total nonaccrual loans ............................ 2,279 1,546 1,150 1,172 3,055
Real estate owned, net .................................. -- 73 65 70 512
------ ------ ------ ------ ------
Total non-performing assets(2) .................... $2,279 $1,619 $1,215 $1,242 $3,567
====== ====== ====== ====== ======
Allowance for loan losses as a percent .................. 1.10% 0.81% 0.94% 0.98% 1.35%
of loans(1)
Allowance for loans losses as a percent
of non-performing loans(2) ............................. 110.27 109.12 154.26 155.72 81.18
Non-performing loans as a percent of
loans(1)(2) ........................................... 1.00 0.74 0.61 0.63 1.66
Non-performing assets as a percent of
total assets(3) ....................................... 0.77 0.69 0.55 0.61 1.76
</TABLE>
- ----------
(1) Loans are presented before allowance for loan losses.
(2) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified by the Bank as presenting
uncertainty with respect to the collectibility of interest or principal.
(3) Non-performing assets consist of non-performing loans and REO.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to cover
estimated losses on loans which are deemed probable and estimable based on
information currently known to management. The allowance is based upon a number
of factors, including economic conditions, actual loss experience and industry
trends. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to make additional provisions for estimated
loan losses based upon judgments different from those of management. The economy
in the Bank's primary market area suffered significantly in the late 1980s and
early 1990s. These adverse economic conditions negatively affected the Bank's
loan loss and delinquency activities and led to a deterioration of the
collateral values of the Bank's loans during those years. In more recent years,
the economy and real estate market in and around the greater Boston metropolitan
area has stabilized and begun to improve which has had a positive impact on the
Bank's loan loss and delinquency activities and the value of properties securing
the Bank's loans. As of March 31, 1998, the Bank's allowance for loan losses was
1.10% of total loans as compared to 0.81% as of March 31, 1997. The Bank had
non-accrual loans of $2.3 million and $1.5 million at March 31, 1998 and March
31, 1997, respectively. The Bank will continue to monitor and modify its
allowances for loan losses as conditions dictate. While management believes the
Bank's allowance for loan losses is sufficient to cover losses inherent in its
loan portfolio at this time, no assurances can be given that the Bank's level of
allowance for loan losses will be sufficient to cover loan losses incurred by
the Bank or that future adjustments to
12
<PAGE>
the allowance for loan losses will not be necessary if economic and other
conditions differ substantially from the economic and other conditions used by
management to determine the current level of the allowance for loan losses.
The following table sets forth activity in the Bank's allowance for loan
losses for the periods as indicated.
<TABLE>
<CAPTION>
For the Year Ended March 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period ......................................... $1,687 $1,774 $1,825 $2,480 $1,792
------ ------ ------ ------ ------
Provision for loan losses .............................................. 856 117 1 6 862
------ ------ ------ ------ ------
Charge-offs:
Mortgage loans:
One- to four-family ................................................ 49 225 94 241 219
Commercial real estate ............................................. -- -- -- 296 242
Construction and development ....................................... -- -- -- 145 --
Consumer loans ....................................................... -- -- 55 9 --
------ ------ ------ ------ ------
Total charge-offs ................................................ 49 225 149 691 461
------ ------ ------ ------ ------
Recoveries ............................................................. 19 21 97 30 287
------ ------ ------ ------ ------
Balance at end of period ............................................... $2,513 $1,687 $1,774 $1,825 $2,480
====== ====== ====== ====== ======
Ratio of net charge-offs during the period to average loans
outstanding during the period ........................................ 0.01% 0.10% 0.03% 0.36% 0.10%
====== ====== ====== ====== ======
Allowance for loan losses as a percent of loans(1) ..................... 1.10% 0.81% 0.94% 0.98% 1.35%
====== ====== ====== ====== ======
Allowance for loans losses as a percent of
non-performing loans(2) ............................................... 110.27% 109.12% 154.26% 155.72% 81.18%
====== ====== ====== ====== =====
</TABLE>
- ----------
(1) Loans are presented before deducting the allowance for loan losses.
(2) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified by the Bank as presenting
uncertainty with respect to the collectibility of interest or principal.
13
<PAGE>
The following table sets forth the Bank's percentage of allowance for loan
losses to total allowance for loan losses and the percent of loans to total
loans in each of the categories listed at the dates indicated.
<TABLE>
<CAPTION>
At March 31,
--------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- ------------------------------
Percent Percent Percent
of Loans of Loans of Loans
Percent of in Each Percent of in Each Percent of in Each
Allowance Category Allowance Category Allowance Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------ --------- ----- ------ --------- ----- ------ --------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential ................... $1,131 45.01% 81.35% $ 793 47.00% 85.63% $ 781 44.03% 88.53%
Commercial real estate ........ 955 38.00 15.39 523 31.00 12.00 514 28.97 10.05
------ ------ ------ ------ ------ ------ ------ ------ ------
Total ..................... 2,086 83.01 96.74 1,316 78.00 97.63 1,295 73.00 98.58
Commercial loans ................... -- -- 0.02 -- -- 0.02 -- -- --
Consumer loans ..................... 50 1.99 3.24 34 2.02 2.35 18 1.01 1.42
Unallocated ........................ 377 15.00 -- 337 19.98 -- 461 25.99 --
------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for loan losses .... $2,513 100.00% 100.00% $1,687 100.00% 100.00% $1,774 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
At March 31,
---------------------------------------------------------------------------------------
1995 1994
---------------------------------------- --------------------------------------------
Percent Percent
of Loans of Loans
Percent of in Each Percent of in Each
Allowance Category Allowance Category
to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans
------------ ------------- ---------- ------------ ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential ......................... $1,022 56.00% 89.39% $ 992 40.00% 87.55%
Commercial real estate .............. 420 23.01 9.49 1,017 41.01 11.40
------ ------ ------ ------ ------ ------
Total ........................... 1,442 79.01 98.88 2,009 81.01 98.95
Commercial loans ......................... -- -- -- -- -- --
Consumer loans ........................... 18 0.99 1.12 25 1.01 1.05
Unallocated .............................. 365 20.00 -- 446 17.98 --
------ ------ ------ ------ ------ ------
Total allowance for loan losses .......... $1,825 100.00% 100.00% $2,480 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
Real Estate Owned. At March 31, 1998 and March 31, 1997, the Bank had $0
and $73,000 of REO, respectively. When the Bank acquires property through
foreclosure or deed in lieu of foreclosure, it is initially recorded at the
lower of the recorded investment in the corresponding loan or the fair value of
the related assets at the date of foreclosure, less costs to sell. Thereafter,
if there is a further deterioration in value, the Bank provides for a specific
valuation allowance and charges operations for the diminution in value. It is
the policy of the Bank to have obtained an appraisal on all real estate subject
to foreclosure proceedings prior to the time of foreclosure. It is the Bank's
policy to require appraisals on a periodic basis on foreclosed properties and
conduct inspections on foreclosed properties.
14
<PAGE>
Securities Investment Activities
Federally-chartered savings institutions have the authority to invest in
various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certificates of deposit of insured banks
and savings institutions, bankers' acceptances, repurchase agreements and
federal funds. Subject to various restrictions, federally-chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally-chartered savings institution is otherwise
authorized to make directly. Additionally, the Bank must maintain minimum levels
of investments that qualify as liquid assets under OTS regulations.
Historically, the Bank has maintained liquid assets above the minimum OTS
requirements and at a level considered to be adequate to meet its normal daily
activities.
The investment policy of the Bank, as approved by the Board of Directors,
requires management to maintain adequate liquidity and a high quality investment
portfolio. The Bank primarily utilizes investments in securities for liquidity
management and as a method of deploying excess funds not utilized for investment
in loans. Generally, the Bank's investment policy is more restrictive than the
OTS regulations allow and, accordingly, the Bank has invested primarily in U.S.
Government and agency securities, which qualify as liquid assets under the OTS
regulations, federal funds and U.S. Government sponsored agency issued
mortgage-backed securities. The Bank is required by SFAS No. 115 to categorize
its securities as held-to-maturity, available-for-sale or held for trading. As
of March 31, 1998, the Bank's securities portfolio consisted of investment
securities, marketable equity securities and mortgage-backed and
mortgage-related securities. The held-to-maturity portfolio totalled $4.3
million, or 1.5% of total assets, and the available-for-sale securities
portfolio totalled $6.5 million, or 2.2% of total assets.
As of March 31, 1998, $7.4 million, or 2.5% of total assets, of the Bank's
securities portfolio consisted of investment securities, primarily debt
securities issued by the U. S. Government or government sponsored agencies (such
as the FHLB) and marketable equity securities, primarily consisting of mutual
fund securities and common stock issued by government-sponsored agencies. The
Bank generally invests in U.S. Treasury and agency obligations with maturities
of 24 to 60 months. The weighted average maturities of the Bank's investment
securities portfolio, excluding any equity securities, was 33 months as of March
31, 1998.
At March 31, 1998, the Bank had $2.3 million of mortgage-backed and
mortgage-related securities, or 0.8% of total assets, substantially all of which
were backed by fixed-rate mortgages and which consisted of mortgage-backed
securities and collateralized mortgage obligations ("CMOs") insured or issued by
Ginnie Mae ("GNMA"), Freddie Mac ("FHLMC"), Fannie Mae ("FNMA") or private
issuers, such as Countrywide Mortgage Corp., GE Capital Mortgage Services, Inc.
and Independent Mortgage Corp. The Bank generally invests in mortgage-backed or
mortgage-related securities with estimated maturities of 18 to 36 months. At
March 31, 1998, the weighted average estimated maturity of its mortgage-backed
and mortgage-related securities portfolio was 23 months. Investments in
mortgage-backed and mortgage-related securities involve a risk that actual
prepayments will be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby changing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities or in the event such securities are redeemed by
the issuer. In addition, the market value of such securities may be adversely
affected by changes in interest rates. While investments in privately issued
mortgage-backed securities generally bear yields higher than mortgage-backed
securities insured by government sponsored agencies, they involve a greater
degree of risk than those issued by government sponsored agencies as such
securities are not insured or guaranteed by such government sponsored agencies.
CMOs are a type of debt security issued by a special purpose entity that
aggregates pools of mortgages and mortgage-backed securities and creates
different classes of CMO securities with varying maturities and amortization
schedules as well as a residual interest, with each class, or "tranche,"
possessing different risk characteristics. A particular tranche of CMOs may,
therefore, carry prepayment risk that differs from that of both the underlying
collateral and other tranches. CMO tranches purchased by the Bank attempt to
moderate reinvestment risk associated with mortgage-backed securities resulting
from unexpected prepayment activities. All of the Bank's investment in
mortgage-backed and mortgage-related securities at March 31, 1998 were
categorized as held-to-maturity.
15
<PAGE>
The following table sets forth certain information regarding the amortized
cost and fair value of the Bank's securities at the dates indicated.
<TABLE>
<CAPTION>
At March 31,
------------------------------------------------------------------------------
1998 1997 1996
--------------------- ---------------------- -----------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Held-to-maturity:
Investment securities ........................ $ 2,001 $ 1,999 $10,303 $10,129 $12,304 $12,152
Mortgage-backed and mortgage-
related securities ........................ 2,271 2,275 3,250 3,177 3,877 3,866
------- ------- ------- ------- ------- -------
Total held-to-maturity ..................... 4,272 4,274 13,553 13,306 16,181 16,018
Available-for-sale(1) .......................... 5,391 6,523 2,250 2,903 2,639 3,286
------- ------- ------- ------- ------- -------
Total securities ........................... $ 9,663 $10,797 $15,803 $16,209 $18,820 $19,304
======= ======= ======= ======= ======= =======
</TABLE>
- ----------
(1) Consists of marketable equity securities.
The following table sets forth certain information regarding the amortized
cost and fair values of the Bank's mortgage-backed and mortgage-related
securities, all of which were classified as held-to-maturity at the dates
indicated.
<TABLE>
<CAPTION>
At March 31,
-----------------------------------------------------------------------------------------
1998 1997 1996
---------------------------- --------------------------- ----------------------------
Percent Percent Percent
Amortized of Fair Amortized of Fair Amortized of Fair
Cost Total(1) Value Cost Total(1) Value Cost Total(1) Value
---- -------- ----- ---- -------- ----- ---- -------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed and
mortgage-related
securities:
Fixed rate:
GNMA .............................. $ 383 16.86% $ 383 $ 529 16.28% $ 529 $ 717 18.49% $ 732
FHLMC ............................. 183 8.06 185 239 7.35 239 303 7.82 315
CMOs .............................. 1,705 75.08 1,707 2,419 74.43 2,345 2,793 72.04 2,756
------ ------ ------ ------ ------ ------ ------ ------ ------
Total fixed rate ................ 2,271 100.00 2,275 3,187 98.06 3,113 3,813 98.35 3,803
Adjustable rate:
FNMA .............................. -- -- -- 63 1.94 64 64 1.65 63
------ ------ ------ ------ ------ ------ ------ ------ ------
Total mortgage-backed
and mortgage-related
securities .......................... $2,271 100.00% $2,275 $3,250 100.00% $3,177 $3,877 100.00% $3,866
====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
- ----------
(1) Based on amortized cost.
16
<PAGE>
The following table sets forth the Bank's mortgage-backed and
mortgage-related securities activities for the periods indicated.
For the Year Ended March 31,
----------------------------
1998 1997 1996
---- ---- ----
(In Thousands)
Beginning balance ........... $ 3,250 $ 3,877 $ 1,703
Principal repayments ...... (973) (631) (355)
Purchases ................. -- -- 2,522
Accretion of discount and
amortization of (premium). (6) 4 7
------- ------- -------
Ending balance .............. $ 2,271 $ 3,250 $ 3,877
======= ======= =======
The table below sets forth certain information regarding the carrying
amount, weighted average yields and contractual maturities of the Bank's debt
securities, all of which were classified as held-to-maturity as of March 31,
1998.
<TABLE>
<CAPTION>
At March 31, 1998
--------------------------------------------------------------------------------------------
More than More than
One Year Five Years More than Ten
One Year or Less to Five Years to Ten Years Years Total
---------------- ---------------- ---------------- ----------------- -----------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Debt securities:
Investment securities(1) ........... $2,001 5.12% $ -- --% $ -- --% $ -- --% $2,001 5.12%
Mortgage-backed and
mortgage-related securities:
Fixed-rate:
GNMA ........................... -- -- -- -- 383 8.00 -- -- 383 8.00
FHLMC .......................... -- -- 48 9.50 67 8.00 68 8.50 183 8.57
CMOs ........................... -- -- -- -- -- -- 1,705 6.93 1,705 6.93
------ ------ ------ ------ ------
Total debt securities ................ $2,001 5.12% $ 48 9.50% $ 450 8.00% $1,773 6.99% $4,272 6.25%
====== ==== ====== ==== ====== ==== ====== ==== ====== ====
</TABLE>
- ----------
(1) Consists of U.S. Treasury and government agency obligations.
Sources of Funds
General. Deposits, loan repayments and prepayments, proceeds from sales of
loans, cash flows generated from operations and FHLB advances are the primary
sources of the Bank's funds for use in lending, investing and for other general
purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of
interest rates and terms. The Bank's deposits consist of business checking,
money market, savings, NOW and certificate accounts. For the year ended March
31, 1998, the average balance of core deposits represented 46.5% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Bank's deposits are obtained predominantly from the areas
surrounding its branch offices. The Bank has historically relied primarily on
providing a higher level of customer service and long-standing relationships
with customers to attract and retain these deposits; however, market interest
rates and rates offered by competing financial institutions significantly affect
the Bank's ability to attract and retain deposits. The Bank uses traditional
means of advertising its deposit products, including print media, and generally
does not solicit deposits from
17
<PAGE>
outside its market area. While the Bank does not actively solicit certificate
accounts in excess of $100,000 or use brokers to obtain deposits, the Bank may
solicit, from time-to-time, such deposits depending upon market conditions. The
Bank offers negotiated rates on some of its certificate accounts. At March 31,
1998, $109.7 million, or 52.8%, of total deposits were certificate accounts with
a weighted average remaining maturity of 10 months. The Bank has experienced an
increase in certificate accounts since 1996, from an average balance of $92.9
million, or 53.6%, of average deposits, for 1996 to $107.8 million, or 53.4%, of
average deposits, for the year ended March 31, 1998. Such increase in
certificate accounts is due to offering new competitively priced certificate
account products which, in part, resulted in an increase in the average cost of
certificates of deposit from 5.62% for fiscal 1997 to 5.65% for the year ended
March 31, 1998. For the year ended March 31, 1998, certificate accounts in
excess of $100,000 increased $1.7 million, or 12.9%, from $13.2 million to $14.9
million. Further increases in certificate accounts, which tend to be more
sensitive to movements in market interest rates than core deposits, may result
in the Bank's deposit base being less stable than if it had a larger amount of
core deposits which, in turn, may result in further increases in the Bank's cost
of deposits and may adversely affect net interest income in future periods.
The following table presents the deposit activity of the Bank for the
periods indicated:
For the Year Ended
March 31,
-------------------------------
1998 1997 1996
------- ------- -------
(In Thousands)
Net deposits ............................... $ 1,727 $ 854 $ 1,660
Interest credited on deposit accounts ...... 8,994 8,272 7,936
------- ------- -------
Total increase in deposit accounts ......... $10,721 $ 9,126 $ 9,596
======= ======= =======
At March 31, 1998, the Bank had $14.9 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
Weighted
Average
Maturity Period Amount Rate
- --------------- ------ --------
(Dollars in Thousands)
3 months or less ............................. $ 6,675 5.59%
Over 3 through 6 months ...................... 3,779 5.65
Over 6 through 12 months ..................... 2,276 5.75
Over 12 months ............................... 2,146 6.39
-------
Total .................................. $14,876 5.75%
======= ====
18
<PAGE>
The following table sets forth the distribution of the Bank's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented. Averages for the periods presented
utilize month-end balances.
<TABLE>
<CAPTION>
For the Year Ended March 31,
----------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------ ------------------------------ ------------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
------- -------- -------- ------- -------- -------- ------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand deposits ................... $ 257 0.13% --% $ 132 0.07% --% $ 165 0.10% --%
Money market accounts ............. 43,019 21.32 3.91 34,839 18.37 4.12 29,972 17.30 4.28
Regular savings accounts .......... 29,167 14.46 2.83 30,863 16.27 2.14 31,560 18.20 2.14
NOW accounts ...................... 21,494 10.65 1.81 20,835 10.99 1.85 18,727 10.81 2.05
-------- ------ -------- ------ -------- ------
Total ......................... 93,937 46.56 3.08 86,669 45.70 2.86 80,424 46.41 2.91
-------- ------ -------- ------ -------- ------
Certificate accounts(1)(2):
Less than 6 months .............. 4,981 2.47 5.32 24,744 13.05 5.13 24,448 14.11 5.39
Over 6 through 12 months ........ 69,005 34.20 5.54 48,117 25.37 5.54 40,997 23.66 5.88
Over 12 through
36 months ..................... 21,715 10.76 5.75 25,360 13.36 5.95 23,615 13.63 5.73
Over 36 months .................. 12,119 6.01 6.52 4,774 2.52 6.85 3,792 2.19 7.05
-------- ------ -------- ------ -------- ------
Total certificate
accounts .................... 107,820 53.44 5.65 102,995 54.30 5.62 92,852 53.59 6.02
-------- ------ -------- ------ -------- ------
Total average deposits ........ $201,757 100.00% 4.46% $189,664 100.00% 4.36% $173,276 100.00% 4.58%
======== ====== ======== ====== ======== ======
</TABLE>
- ----------
(1) Based on remaining maturity of certificates.
(2) Includes retirement accounts such as IRA and Keogh accounts.
The following table presents by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at March 31, 1998.
<TABLE>
<CAPTION>
Period to Maturity from March 31, 1998
---------------------------------------------------------------
Less One Two Three Four More
than to to to to than At March 31,
One Two Three Four Five Five ------------------------------
Year Years Years Years Years Years 1998 1997 1996
-------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts:
0 to 4.00% .................. $ 326 $ -- $ -- $ -- $ -- $ -- $ 326 $ 197 $ 790
4.01% to 5.00% .............. 350 13 -- -- -- -- 363 1,912 12,400
5.01% to 6.00% .............. 84,776 8,142 1,662 265 251 -- 95,096 93,782 64,157
6.01% to 7.00% .............. 3,372 3,763 634 1,466 1,477 25 10,737 6,520 20,883
7.01% to 8.00% .............. 418 1,080 1,512 -- 117 -- 3,127 3,611 3,893
8.01% to 9.00% .............. 1 -- -- -- -- -- 1 1 1
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total ................... $ 89,243 $ 12,998 $ 3,808 $ 1,731 $ 1,845 $ 25 $109,650 $106,023 $102,124
======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
Borrowings. As part of its operating strategy, the Bank utilizes advances
from the FHLB as an alternative to retail deposits to fund its operations. The
Bank has recently increased its emphasis on the utilization of FHLB borrowings
to fund its asset growth, primarily its origination of adjustable-rate one- to
four-family loans. By utilizing FHLB advances, which possess varying stated
maturities, the Bank can meet its liquidity needs without otherwise being
dependent upon retail deposits and revising its deposit rates to attract retail
deposits, which have no stated
19
<PAGE>
maturities (except for certificates of deposit), which are interest rate
sensitive and which are subject to withdrawal from the Bank at any time. These
FHLB advances are collateralized primarily by certain of the Bank's mortgage
loans and mortgage-backed securities and secondarily by the Bank's investment in
capital stock of the FHLB. FHLB advances are made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time-to-time in accordance
with the policies of the FHLB. At March 31, 1998, the Bank had $20.0 million in
outstanding advances from the FHLB and $2.2 million in other borrowings as
compared to $14.5 million and $1.1 million at March 31, 1997, respectively.
The following table sets forth certain information regarding the Bank's
borrowed funds at or for the periods ended on the dates indicated:
<TABLE>
<CAPTION>
At or For the Year Ended
March 31,
-----------------------------------------------
1998 1997 1996
------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C>
FHLB advances:
Average balance outstanding .................................. $21,102 $16,813 $ 7,786
Maximum amount outstanding at any month-end
during the period ......................................... 25,000 25,500 11,650
Balance outstanding at end of period ......................... 20,000 14,500 11,650
Weighted average interest rate during the period ............. 5.72% 5.63% 6.25%
Weighted average interest rate at end of period .............. 5.13% 5.46% 5.36%
Other borrowed funds(1):
Average balance outstanding .................................. $ 2,053 $ 926 $ 743
Maximum amount outstanding at any month-end
during the period ......................................... 3,144 2,214 1,313
Balance outstanding at end of period ......................... 2,176 1,065 1,048
</TABLE>
- ----------
(1) Represents noninterest-bearing credit balance on the FHLB-Boston account.
20
<PAGE>
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act, as amended
(the "HOLA"). In addition, the activities of savings institutions, such as the
Bank, are governed by the HOLA and the Federal Deposit Insurance Act ("FDI
Act").
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer.
The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its
deposit accounts are insured up to applicable limits by the Savings Association
Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the
OTS and the FDIC concerning its activities and financial condition in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers with, or acquisitions of, other savings institutions. The OTS
and/or the FDIC conduct periodic examinations to test the Bank's safety and
soundness and compliance with various regulatory requirements. This regulation
and supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulatory
requirements and policies, whether by the OTS, the FDIC or the Congress, could
have a material adverse impact on the Company, the Bank and their operations.
Certain of the regulatory requirements applicable to the Bank and to the Company
are referred to below or elsewhere herein. The description of statutory
provisions and regulations applicable to savings institutions and their holding
companies set forth in this Form 10-K does not purport to be a complete
description of such statutes and regulations and their effects on the Bank and
the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As a unitary savings and loan holding company,
the Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that the Bank continues to
be a qualified thrift lender ("QTL"). See "Federal Savings Institution
Regulation - QTL Test." Upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the QTL test and is
deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"),
subject to the prior approval of the OTS, and certain activities authorized by
OTS regulation, and no multiple savings and loan holding company may acquire
more than 5% the voting stock of a company engaged in impermissible activities.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
21
<PAGE>
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMELS financial
institution rating system), and, together with the risk-based capital standard
itself, a 4% Tier I risk-based capital standard. Core capital is defined as
common stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships. The OTS regulations
also require that, in meeting the tangible, leverage (core) and risk-based
capital standards, institutions must generally deduct investments in and loans
to subsidiaries engaged in activities as principal that are not permissible for
a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, as assigned by the OTS capital regulation based on the
risks OTS believes are inherent in the type of asset. The components of Tier I
(core) capital are equivalent to those discussed earlier. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
The OTS regulatory capital requirements also incorporate an interest rate
risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts) that would result from
a hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2% must deduct an
amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
institution's assets. The Director of the OTS may waive or defer a savings
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At March 31, 1998, the Bank
met each of its capital requirements.
22
<PAGE>
The following table presents the Bank's capital position at March 31, 1998.
<TABLE>
<CAPTION>
Capital
--------------------------
Actual Required
Capital Capital Excess Actual Required
------- -------- ------- ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Tangible ............................... $39,034 $ 4,399 $34,635 13.31% 1.50%
Core (Leverage) ........................ $39,034 $11,732 $27,302 13.31% 4.00%
Risk-based ............................. $40,991 $12,494 $28,497 26.25% 8.00%
</TABLE>
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations, the OTS is required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution generally is considered "adequately
capitalized" if its ratio of total capital to risk-weighted assets is at least
8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%,
and its ratio of core capital to total assets is at least 4% (3% if the
institution receives the highest CAMELS rating). A savings institution that has
a ratio of total capital to risk weighted assets of less than 8%, a ratio of
Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
"critically undercapitalized." Subject to a narrow exception, the banking
regulator is required to appoint a receiver or conservator for an institution
that is "critically undercapitalized." The regulation also provides that a
capital restoration plan must be filed with the OTS within 45 days of the date a
savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently insured
by the SAIF. On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed
a special one-time assessment on SAIF member institutions, including the Bank,
to recapitalize the SAIF. The SAIF was undercapitalized due primarily to a
statutory requirement that SAIF members make payments on bonds issued in the
late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor
to the SAIF. As required by the Funds Act, the FDIC imposed a special assessment
of 65.7 basis points on SAIF assessable deposits held as of March 31, 1995,
payable November 27, 1996 (the "SAIF Special Assessment"). The SAIF Special
Assessment was recognized by the Bank as an expense in the quarter ended
September 30, 1996 and was generally tax deductible. The SAIF Special Assessment
recorded by the Bank amounted to $1.1 million on a pre-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and Bank Insurance Fund ("BIF") members. The BIF is the fund
which primarily insures commercial bank deposits. Beginning on January 1, 1997,
BIF deposits were assessed for a FICO payment of approximately 1.3 basis points,
while SAIF deposits paid approximately 6.4 basis points. Full pro rata sharing
of the FICO payments between BIF and SAIF members will occur on the earlier of
January 1, 2000 or the date the BIF and SAIF are merged. The Funds Act
23
<PAGE>
specifies that the BIF and SAIF will be merged on January 1, 1999, provided no
savings associations remain as of that time.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to
that of BIF members. The FDIC reviews the assessment rate semi-annually and
currently has maintained the 0 to 27 basis point range. SAIF members will also
continue to make the FICO payments described above. Management cannot predict
the level of FDIC insurance assessments on an on-going basis, whether the
savings association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
The Bank's assessment rate for fiscal year 1998 ranged from 6.25 to 6.28
basis points and the premium paid for this period was $125,000. A significant
increase in SAIF insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Bank.
Under the FDI 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
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. The Funds Act provides that the BIF and
SAIF will merge on January 1, 1999 if there are no more savings associations as
of that date. Various proposals to eliminate the federal thrift charter, create
a uniform financial institutions charter and abolish the OTS have been
introduced in Congress. Some bills would require federal savings institutions to
convert to a national bank or some type of state charter by a specified date
under some bills, or they would automatically become national banks. Under some
proposals, converted federal thrifts would generally be required to conform
their activities to those permitted for the charter selected and divestiture of
nonconforming assets would be required over a two year period, subject to two
possible one year extensions. State chartered thrifts would become subject to
the same federal regulation as applies to state commercial banks. A more recent
bill passed by the House Banking Committee would allow savings institutions to
continue to exercise activities being conducted when they convert to a bank
regardless of whether a national bank could engage in the activity. Holding
companies for savings institutions would become subject to the same regulation
as holding companies that control commercial banks, with some limited
grandfathering, including savings and loan holding company activities. The
grandfathering would be lost under certain circumstances such as a change in
control of the company. The Bank is unable to predict whether such legislation
would be enacted or the extent to which the legislation would restrict or
disrupt its operations.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the limits on loans to one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if such loan is secured by readily-marketable collateral, which is
defined to include certain financial instruments and bullion. At March 31, 1998,
the Bank's limit on loans to one borrower was $6.3 million. At March 31, 1998,
the Bank's largest aggregate outstanding balance of loans to one borrower was
$3.6 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings and loan association is either must qualify as a
"domestic building and loan association" as defined in the Internal Revenue Code
or maintain at least 65% of its "portfolio assets" (total assets less: (i)
specified liquid assets up to 20% of total assets; (ii) intangibles, including
goodwill; and (iii) the value of property used to conduct business) in certain
"qualified thrift investments" (primarily residential mortgages and related
investments, including certain mortgage-backed securities) in at least 9 months
out of each 12 month period.
24
<PAGE>
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
March 31, 1998, the Bank maintained 82.8% of its portfolio assets in qualified
thrift investments and, therefore, met the QTL test. Recent legislation has
expanded the extent to which education loans, credit card loans and small
business loans may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in
need of more than normal supervision, could, after prior notice but without
obtaining approval of the OTS, make capital distributions during a calendar year
equal to the greater of (i) 100% of its net earnings to date during the calendar
year plus the amount that would reduce by one-half its "surplus capital ratio"
(the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year or (ii) 75% of its net income for the previous
four quarters. Any additional capital distributions would require prior
regulatory approval. In the event the Bank's capital fell below its regulatory
requirements or the OTS notified it that it was in need of more than normal
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice. In January 1998, the OTS proposed amendments to its capital
distribution regulation that would generally authorize the payment of capital
distributions without OTS approval provided that the payment does not cause the
institution to be undercapitalized within the meaning of the prompt corrective
action regulation. However, institutions in a holding company structure would
still have a prior notice requirement. At March 31, 1998, the Bank was a Tier 1
Bank.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage of its net withdrawable deposit accounts plus short-term borrowings.
This liquidity requirement was 5% for fiscal 1997, but is subject to change from
time to time by the OTS to any amount within the range of 4% to 10% depending
upon economic conditions and the savings flows of member institutions. In 1997,
OTS regulations also required each savings institution to maintain an average
daily balance of short-term liquid assets of at least 1% of the total of its net
withdrawable deposit accounts and borrowings payable in one year or less.
Monetary penalties may be imposed for failure to meet the liquidity
requirements. The OTS has recently lowered the liquidity requirement from 5% to
4% and eliminated the 1% short term liquid asset requirement. The Bank's
liquidity ratio for March 31, 1998 was 24.7%, which exceeded the applicable
requirements. The Bank has never been subject to monetary penalties for failure
to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the
OTS to fund the agency's operations. The general assessments, paid on a
semi-annual basis, are computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
thrift financial report. The assessments paid by the Bank for the fiscal year
ended March 31, 1998 totalled $67,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and 23B
of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of
covered transactions with any individual affiliate to 10% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to
25
<PAGE>
20% of the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in Section 23A and the purchase of low quality assets from affiliates
is generally prohibited. Section 23B generally provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and
10% shareholders ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS that enforcement action to be taken with respect to a
particular savings institution. If action is not taken by the Director, the FDIC
has authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; asset quality; earnings; and
compensation, fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
Guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard, as required by the FDI
Act. The final rule establishes deadlines for the submission and review of such
safety and soundness compliance plans when such plans are required.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally required for most of 1997 that reserves be maintained
against aggregate transaction accounts as follows: for accounts aggregating
$49.3 million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement was 3%; and for accounts aggregating greater than $49.3
million, the reserve requirement was $1.48 million plus 10% (subject to
adjustment by the Federal Reserve Board between 8% and 14%) against that portion
of total transaction accounts in excess of $49.3 million. The first $4.4 million
of otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) were exempted from the reserve requirements. The Bank maintained
compliance with the foregoing requirements. For 1998, the Federal Reserve Board
has decreased
26
<PAGE>
from $49.3 to $47.8 million the amount of transaction accounts subject to the 3%
reserve requirement and to increase the amount of exempt reservable balances
from $4.4 million to $4.7 million. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the OTS.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their income on a consolidated
basis and 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 reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary 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 or Massachusetts
Department of Revenue in the past five years. For its 1998 taxable year, the
Bank is subject to a maximum federal income tax rate of 34.0%.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (i.e.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. Thrift institutions that would be treated as
small banks are allowed to utilize the Experience Method applicable to such
institutions, while thrift institutions that are treated as large banks (those
generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing reserves
for bad debts will treat such change as a change in method of accounting,
initiated by the taxpayer, and having been made with the consent of the IRS. Any
Section 481(a) adjustment required to be taken into income with respect to such
change generally will be taken into income ratably over a six-taxable year
period, beginning with the first taxable year beginning after 1995, subject to
the residential loan requirement.
Under the residential loan requirement provision, the recapture required by
the 1996 Act will be suspended for each of two successive taxable years,
beginning with the Bank's current taxable year, in which the Bank originates a
minimum of certain residential loans based upon the average of the principal
amounts of such loans made by the Bank during its six taxable years preceding
its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank is
permitted to make additions to its tax bad debt reserves. In addition, the Bank
is required to recapture (i.e., take into income) over a six year period the
excess of the balance of its tax bad debt reserves as of December 31, 1995 other
than its supplemental reserve for losses on loans, if any over the balance of
such reserves as of December 31, 1987 (or a lesser amount since the Bank's loan
portfolio decreased since December 31, 1987). As a result of such recapture, the
Bank will incur an additional tax liability of approximately $89,000 which is
generally expected to be taken into income beginning in 1998 over a six year
period.
27
<PAGE>
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if the Bank makes a non-dividend distribution
to the Company, approximately one and one-half times the amount of such
distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Banks does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7 basis point
fee on every $100 of thrift deposits held on March 31, 1995. For financial
statement purposes, this assessment was reported as an expense for the quarter
ended September 30, 1996. The Funds Act includes a provision which states that
the amount of any special assessment paid to capitalize SAIF under this
legislation is deductible under Section 162 of the Code in the year of payment.
State and Local Taxation
Commonwealth of Massachusetts Taxation. On July 27, 1995, the Governor of
Massachusetts approved legislation to reduce the tax rate applicable to
financial institutions, including savings banks, from 12.54% on their net income
to 10.50% on their net income apportioned to Massachusetts. The reduced rate is
to be phased-in over a five year period whereby the rate was 11.71% for 1996 and
11.32% for 1997, and will be 10.91% for 1998, 10.50% for 1999 and 10.50% for
2000. Net income for years beginning before January 1, 1999 includes gross
income as defined under the provisions of the Code, plus interest from bonds,
notes and evidences of indebtedness of any state, including Massachusetts, less
the deductions, excluding the deductions for dividends received, state taxes,
and net operating losses, as defined under the provisions of the Code. For
taxable years beginning on or after January 1, 1999, the definition of state
taxable income is modified to allow a deduction for 95% of dividends received
from stock where the Company owns 15% or more of the voting stock of the
institution paying the dividend and to allow deductions from certain expenses
allocated to federally tax exempt obligations. Subsidiary corporations of the
Company conducting business in Massachusetts must file separate Massachusetts
state tax returns and are taxed as financial institutions, with certain
modifications and grandfathering for taxable years before 1996. The net worth or
tangible property of such grandfathered subsidiaries is taxed at a rate of
0.26%. Such grandfathered subsidiaries may file consolidated tax returns on the
net earnings portion of the corporate tax.
Corporations which qualify as "securities corporations," as defined by the
Massachusetts tax code, are taxed at a special rate of 0.33% of their gross
income if they qualify as a "bank-holding company" under the Massachusetts tax
code. The Company is expected to qualify for this reduced tax rate provided that
it is exclusively engaged in activities of a "securities corporation." The
Company believes that it will qualify as a securities corporation because a
separate subsidiary was formed to make the loan to the Bank's Employee Stock
Ownership Plan and related trust and all of the Company's other activities
qualify as activities permissible for a securities corporation. If the Company
fails to so qualify, however, it will be taxed as a financial institution at a
rate of 10.50% beginning in fiscal 1999 rather than at the phased-in rates.
28
<PAGE>
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
Item 2. Description of Property.
The Bank currently conducts its business through its executive,
administrative and full service offices. The Company believes that the Bank's
current facilities are adequate to meet the present needs of the Bank and the
Company.
<TABLE>
<CAPTION>
Net Book Value of
Property or
Original Leasehold
Leased or Year Leased Date of Lease Improvements at
Location Owned or Acquired Expiration March 31, 1998
- -------- ----- ----------- ---------- --------------
(In Thousands)
<S> <C> <C> <C> <C>
Executive/Branch Office:
1299 Beacon Street
Brookline, MA 02146................... Owned 1950 -- $951
Administrative Office:
1309 Beacon Street February
Brookline, MA 02146................... Leased 1987 2002(1) 143
Branch Offices:
184 Massachusetts Avenue December
Boston, MA 02115...................... Leased 1973 1998(2) 17
Dedham Mall February
Dedham, MA 02026...................... Leased 1982 2000 8
61 Lenox Street
Norwood, MA 02062..................... Owned 1975 -- 317
705 High Street
Westwood, MA 02090.................... Owned 1977 -- 289
------
Total............................................................... $1,725
======
</TABLE>
- ----------
(1) The Bank has an option to renew this lease for one additional five-year
period.
(2) The Bank has an option to renew this lease for one additional two-year
period.
Item 3. Legal Proceedings.
The Bank is not 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 financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
29
<PAGE>
PART II
Item 5. Market for the Company's Common Equity and Related Stockholder Matters.
The Company began trading its Common Stock on the American Stock Exchange
on March 30, 1998 under the symbol "BYS." The reported high and low sales prices
for the quarter ended March 31, 1998 are $30.00 and $29.00, respectively. Bay
State Bancorp, Inc. had approximately 1,500 shareholders of record as of March
31, 1998.
The Board of Directors of the Company has the authority to declare
dividends on the Common Stock, subject to statutory and regulatory requirements.
In the future, the Board of Directors intends to consider a policy of paying
cash or stock dividends on the Common Stock. However, no decision has been made
with respect to the payment of dividends. Declarations of dividends by the Board
of Directors, if any, will depend upon a number of factors, including the amount
of net proceeds retained by the Company in the Conversion, investment
opportunities available to the Company or the Bank, capital requirements,
regulatory limitations, the Company's and the Bank's financial condition and
results of operations, tax considerations and general economic conditions. No
assurances can be given, however, that any dividends will be paid or, if
commenced, will continue to be paid.
The Company is subject to the requirements of Delaware law, which generally
limit dividends to an amount equal to the excess of the net assets of the
Company (the amount by which total assets exceed total liabilities) over its
statutory capital (generally defined as the aggregate par value of the
outstanding shares of the Company's capital stock having a par value plus the
amount of the consideration paid for shares of the Company's capital stock
without par value) or, if there is no such excess, to its net profits for the
current and/or immediately preceding fiscal year.
Additionally, in connection with the Conversion, the Company committed to
the OTS that during the one-year period following the consummation of the
Conversion, the Company would not declare an extraordinary dividend to
stockholders which would be treated by recipient stockholders as a tax-free
return of capital for federal income tax purposes without prior approval of the
OTS.
Item 6. Management's Discussion and Analysis or Plan of Operation.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The Company does not transact any material business other than through its
wholly-owned subsidiary, the Bank. The Bank's results of operations are
dependent primarily on net interest income, which is the difference between the
income earned on its loan and investment portfolios and its cost of funds,
consisting of the interest paid on deposits and borrowings. Results of
operations are also affected by the Bank's provision for loan losses, loan sale
activities and loan servicing. The Bank's noninterest expense principally
consists of compensation and employee benefits, office occupancy and equipment
expense, federal deposit insurance premiums, data processing, advertising and
business promotion and other expenses. Results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in interest rates, government policies and actions of
regulatory authorities. Future changes in applicable law, regulations or
government policies may materially impact the Bank.
The predceding and following discussion may contain certain forward-looking
statements which are based on managaement's current expectations regarding
economic, legislative, and regulatory issues that may impact the Company's
earnings in future periods. Factors that could cause future results to vary
materially from current management expectations include, but are not limited to:
general economic conditions, changes in interest rates, deposit flows, real
estate values, and competition; changes in accounting principles, policies, or
guidelines; changes in legislation or regulation; and other economic,
competitive, governmental, regulatory and technological factors affecting the
Company's operations, pricing, products and services. In particular, these
issues may impact management's estimates used in evaluating market risk and
interest rate risk in its GAP and NPV tables, loan loss provisions,
classification of assets, Year 2000 issues, accounting estimates and other
estimates used throughout this discussion. Further description of the risks and
uncertainties to the business are included in detail in the "Description of
Business" section (Item 1) of the Company's 10-KSB.
Management Strategy
Management's primary goal has been to maintain the Bank's profitability,
asset quality and its capital position by: (i) investing primarily in one- to
four-family loans secured by properties located in its primary market area; (ii)
investing in multi-family, commercial real estate and construction and
development loans secured by properties located in the Bank's primary market
area, to the extent that such loans meet the Bank's general underwriting
criteria including, but not limited to, satisfaction of certain LTV and debt
service coverage ratios and satisfaction that the borrower is experienced in
these types of real estate projects; (iii) investing funds not utilized for loan
investments in short-term U.S. Treasury and mortgage-backed and mortgage-related
securities; and (iv) managing interest rate
30
<PAGE>
risk by emphasizing the origination of adjustable-rate loans and short-term
fixed-rate loans and investing in short-term securities and generally selling
longer-term fixed-rate loans that the Bank originates. The Bank intends to
continue this operating strategy in an effort to enhance its long-term
profitability while maintaining a reasonable level of interest rate risk and
enhance such strategy by expanding the products and services it offers, as
necessary, in order to improve its market share in its primary market area. In
this regard, the Bank has begun to offer business checking accounts, 24-hour
banking by telephone and, in the future, may expand its consumer retail products
to include debit card services and in-home banking.
Management of Interest Rate Risk and Market Risk Analysis
The principal objective of the Bank's interest rate risk management
function is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the appropriate level of risk given the Bank's business
strategy, operating environment, capital and liquidity requirements and
performance objectives and manage the risk consistent with the Board of
Directors' approved guidelines. Through such management, the Bank seeks to
reduce the vulnerability of its operations to changes in interest rates. The
Bank monitors its interest rate risk as such risk relates to its operating
strategies. The Bank's Board of Directors has established an Asset/Liability
Committee, responsible for reviewing its asset/liability policies and interest
rate risk position, which meets on a quarterly basis and reports trends and
interest rate risk position to the Board of Directors on a quarterly basis. The
extent of the movement of interest rates is an uncertainty that could have a
negative impact on the earnings of the Bank.
In recent years, the Bank has primarily utilized the following strategies
to manage interest rate risk: (i) emphasizing the origination and purchase of
adjustable-rate loans; (ii) investing primarily in short-term U.S. Government
securities or mortgage-backed and mortgage-related securities with shorter
estimated maturities; (iii) utilizing FHLB advances to better structure the
maturities of its interest rate sensitive liabilities; and (iv) to a
substantially lesser extent, selling in the secondary market longer-term
fixed-rate mortgage loans originated while generally retaining the servicing
rights on such loans.
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a bank's interest rate sensitivity "gap." An asset
and liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At March 31, 1998, the Bank's cumulative one year interest
rate gap (which is the difference between the amount of interest-earning assets
maturing or repricing within one year and interest-bearing liabilities maturing
or repricing within one year) as a percentage of total assets, was a positive
6.3%. A gap is considered positive when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities. A gap is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. Accordingly, during a
period of rising interest rates, an institution with a negative gap position
would be in a worse position to invest in higher yielding assets as compared to
an institution with a positive gap position which, consequently, may result in
the cost of its interest-bearing liabilities increasing at a rate faster than
its yield on interest-earning assets than if it had a positive gap. During a
period of falling interest rates, an institution with a negative gap position
would tend to have its interest-bearing liabilities repricing downward at a
faster rate than its interest-earning assets as compared to an institution with
a positive gap which, consequently, may tend to positively affect the growth of
its net interest income.
31
<PAGE>
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at March 31, 1998, which are
anticipated by the Bank, based upon certain assumptions, to reprice or mature in
each of the future time periods shown (the "Gap Table"). Except as stated below,
the amount of assets and liabilities shown which reprice or mature during a
particular period were determined in accordance with the earlier of term to
repricing or the contractual maturity of the asset or liability. The table sets
forth an approximation of the projected repricing of assets and liabilities at
March 31, 1998, on the basis of contractual maturities, and scheduled rate
adjustments within a one year period and subsequent selected time intervals. The
loan amounts in the table reflect principal balances expected to be redeployed
and/or repriced as a result of contractual amortization of adjustable-rate loans
and fixed-rate loans, and as a result of contractual rate adjustments on
adjustable-rate loans. Money Market accounts, Regular Savings accounts and NOW
accounts are assumed to have annual decay rates of 80%, 15% and 5%,
respectively. Deposit decay rates can have a significant impact on the Bank's
estimated gap. While the Bank believes such assumptions to be reasonable, there
can be no assurance that assumed decay rates will approximate future withdrawal
activity.
<TABLE>
<CAPTION>
More More More More
than than than than
1 Year 2 Years 3 Years 4 Years More
1 Year to to to to than Total Fair
or Less 2 Years 3 Years 4 Years 5 Years 5 Years Amount Value(1)
-------- ------- ------- ------- ------- ------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
FHLB overnight account ....... $ 46,000 $ -- $ -- $ -- $ -- $ -- $ 46,000 $ 46,000
Securities ................... 7,392 -- -- -- -- -- 7,392 8,522
Mortgage-backed
securities ................. -- -- -- -- -- 2,271 2,271 2,275
Stock in FHLB-Boston ......... 1,873 -- -- -- -- -- 1,873 1,873
Loans (2) .................... 111,774 25,753 25,425 7,177 9,971 45,063 225,163 224,466
Loans held-for-sale .......... 822 -- -- -- -- -- 822 822
-------- -------- -------- -------- -------- -------- -------- --------
Total interest-
earning assets .......... $167,861 $ 25,753 $ 25,425 $ 7,177 $ 9,971 $ 47,334 $283,521 $283,958
======== ======== ======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Money market accounts ........ $ 33,952 $ 8,488 $ -- $ -- $ -- $ -- $ 42,440 $ 42,440
Regular savings accounts ..... 4,832 4,832 4,832 4,832 4,832 8,056 32,216 32,216
NOW accounts ................. 1,149 1,149 1,149 1,149 1,149 17,244 22,989 22,989
Certificate accounts ......... 89,243 12,998 3,808 1,731 1,845 25 109,650 110,046
FHLB advances ................ 20,000 -- -- -- -- -- 20,000 19,849
-------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities ............. $149,176 $ 27,467 $ 9,789 $ 7,712 $ 7,826 $ 25,325 $227,295 $227,540
======== ======== ======== ======== ======== ======== ======== ========
Interest-earning assets less ....
interest-bearing liabilities . $ 18,685 $ (1,714) $ 15,636 $ (535) $ 2,145 $ 22,009 $ 56,226
======== ======== ======== ======== ======== ======== ========
Cumulative interest-rate
sensitivity gap ............... $ 18,685 $ 16,971 $ 32,607 $ 32,072 $ 34,217 $ 56,226
======== ======== ======== ======== ======== ========
Cumulative interest-rate gap as
a percentage of total assets .. 6.33% 5.75% 11.04% 10.86% 11.59% 19.04%
Cumulative interest-rate gap as
a percentage of total interest-
earning assets ................ 6.59% 5.99% 11.50% 11.31% 12.07% 19.83%
Cumulative interest-earning
assets as a percentage of
cumulative interest-bearing
liabilities .................. 112.53% 109.61% 117.49% 116.52% 116.94% 124.74%
</TABLE>
- ----------
(1) Fair value of securities, including mortgage-backed securities, is based on
quoted market prices, where available. If quoted market prices are not
available, fair value is based on quoted market prices of comparable
instruments. Fair value of loans is, depending on the type of loan, based
on carrying values or estimates based on discounted cash flow analyses.
Fair value of deposit liabilities are either based on carrying amounts or
estimates based on a discounted cash flow calculation. Fair values for FHLB
advances are estimated using a discounted cash flow analysis that applies
interest rates concurrently being offered on advances to a schedule of
aggregated expected monthly maturities on FHLB advances.
(2) Excludes nonaccrual loans.
32
<PAGE>
Certain shortcomings are inherent in the method of analysis presented in
the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react to different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate loans, have
features which restrict changes in interest rates both on a short-term basis and
over the life of the asset. Further, in the event of change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Finally, the ability of many borrowers
to service their adjustable-rate loans may decrease in the event of an interest
rate increase.
Net Portfolio Value. As part of its interest rate risk analysis, the Bank
uses an interest rate sensitivity model which generates estimates of the change
in the Bank's net portfolio value ("NPV") over a range of interest rate
scenarios and which is prepared by the OTS on a quarterly basis. NPV is the
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. The NPV ratio, under any interest rate scenario, is defined as
the NPV in that scenario divided by the market value of assets in the same
scenario. The OTS produces such analysis using its own model, based upon data
submitted on the Bank's quarterly Thrift Financial Reports, including estimated
loan prepayment rates, reinvestment rates and deposit decay rates. The following
table sets forth the Bank's NPV as of March 31, 1998 (the latest NPV analysis
prepared by the OTS), as calculated by the OTS.
<TABLE>
<CAPTION>
NPV as % of Portfolio
Change in Net Portfolio Value Value of Assets
Interest Rates in -------------------------------------------------- -----------------------------
Basis Points NPV
(Rate Shock) Amount $ Change % Change Ratio Change(1)
- -------------------- -------- -------- -------- ----- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
400................. $38,326 $(6,256) (14)% 13.22% (167)
300................. 40,766 (3,816) (9) 13.91 (98)
200................. 42,745 (1,837) (4) 14.45 (45)
100................. 44,096 (487) (1) 14.79 (10)
Static.............. 44,582 -- -- 14.89 --
(100)............... 44,750 168 -- 14.90 1
(200)............... 44,883 301 1 14.89 --
(300)............... 45,491 909 2 15.02 13
(400)............... 46,820 2,238 5 15.35 45
</TABLE>
(1) Expressed in basis points.
As is the case with the Gap Table, certain shortcomings are inherent in the
methodology used in the above interest rate risk measurements. Modeling changes
in NPV require the making of certain assumptions which may or may not reflect
the manner in which actual yields and costs respond to changes in market
interest rates. In this regard, the NPV model presented assumes that the
composition of the Bank's interest sensitive assets and liabilities existing at
the beginning of a period remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Accordingly, although the NPV measurements and
net interest income models provide an indication of the Bank's interest rate
risk exposure at a particular point in time, such measurements are not intended
to and do not provide a precise forecast of the effect of changes in market
interest rates on the Bank's net interest income and will differ from actual
results.
Analysis of Net Interest Income
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them.
33
<PAGE>
Average Balance Sheets. The following table sets forth certain information
relating to the Bank for the years ended March 31, 1998, 1997, and 1996. The
average yields and costs are derived by dividing income or expense by the
average balance of interest-earning assets or interest-bearing liabilities,
respectively, for the periods shown except where noted otherwise and reflect
annualized yields and costs. Average balances are derived from average month-end
balances. Management does not believe that the use of average monthly balances
instead of average daily balances has caused any material differences in the
information presented. The yields and costs include fees which are considered
adjustments to yields. Loan interest and yield data does not include any accrued
interest from non-accruing loans.
<TABLE>
<CAPTION>
For the Years Ended March 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- ------------------------------- ---------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Federal funds sold/FHLB
overnight account ......... $ 5,150 $ 368 7.15%(6) $ 5,985 $ 321 5.36% $ 6,759 $ 423 6.26%
Investment securities(1) .... 13,642 819 6.00 15,041 951 6.32 11,391 565 4.96
Mortgage-backed and
mortgage-related securities 2,787 190 6.82 3,380 246 7.28 1,917 146 7.62
Loans, net and mortgage
loans held-for-sale(2) ..... 215,542 17,872 8.29 195,471 15,958 8.16 173,285 15,414 8.90
-------- ------- -------- ------- -------- -------
Total interest-
earning assets ........ 237,121 19,249 8.12 219,877 17,476 7.95 193,352 16,548 8.56
------- ------- -------
Noninterest-earning assets .... 8,096 6,931 6,205
-------- -------- --------
Total assets ............ $245,217 $226,808 $199,557
======== ======== ========
Liabilities and Equity:
Interest-bearing liabilities:
NOW accounts ................ $ 21,494 $ 389 1.81% $ 20,835 $ 386 1.85% $ 18,727 $ 384 2.05%
Regular savings accounts .... 29,167 824 2.83 30,863 660 2.14 31,560 676 2.14
Money market accounts ....... 43,019 1,684 3.91 34,839 1,436 4.12 29,972 1,284 4.28
Certificate accounts ........ 107,820 6,097 5.65 102,995 5,790 5.62 92,852 5,592 6.02
-------- ------- -------- ------- -------- -------
Total interest-
bearing deposits ........ 201,500 8,994 4.46 189,532 8,272 4.36 173,111 7,936 4.58
FHLB advances ............... 21,102 1,206 5.72 16,813 946 5.63 7,786 487 6.25
-------- ------- -------- ------- -------- -------
Total interest-
bearing liabilities ..... 222,602 10,200 4.58 206,345 9,218 4.47 180,897 8,423 4.66
------- ------- -------
Demand deposits(3) ............ 257 132 165
Other liabilities ............. 2,088 1,511 1,931
-------- -------- --------
Total liabilities ......... 224,947 207,988 182,993
Equity ........................ 20,270 18,820 16,564
-------- -------- --------
Total liabilities
and equity ............. $245,217 $226,808 $199,557
======== ======== ========
Net interest income/
Net interest rate spread(4) .. $ 9,049 3.54% $ 8,258 3.48% $ 8,125 3.90%
======= ===== ======= ===== ======= ====
Net interest margin(5) ........ 3.82% 3.76% 4.20%
==== ===== ====
Ratio of interest-earning
assets to interest-bearing
liabilities .................. 106.52% 106.56% 106.89%
====== ====== ======
</TABLE>
(1) Includes investment securities available-for-sale and held-to-maturity and
stock in FHLB-Boston.
(2) Amount is net of deferred loan origination costs, undisbursed proceeds of
construction loans in process, allowance for loan losses and includes
non-accruing loans. The Bank records interest income on non-accruing loans
on a cash basis.
(3) Demand deposits primarily represent noninterest-bearing custodial accounts.
(4) Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(5) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
(6) The rate for Federal funds sold/FHLB overnight account for the year ended
March 31, 1998 is inflated due to the use of subscription rights proceeds
for 16 days in March 1998. The average daily balance for that period of
time was approximately $100 million.
34
<PAGE>
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Bank's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to: (i) changes attributable to changes in volume (changes
in volume multiplied by prior rate); (ii) changes attributable to changes in
rate (changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated on a proportional basis between changes in rate and volume.
<TABLE>
<CAPTION>
Year Ended Year Ended
March 31, 1998 March 31, 1997
Compared to Compared to
Year Ended Year Ended
March 31, 1997 March 31, 1996
--------------------------------- ----------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
-------------------- --------------------
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold/FHLB overnight account .......... $ (34) $ 81 $ 47 $ (45) $ (57) $ (102)
Investment securities .............................. (86) (46) (132) 208 178 386
Mortgage-backed securities ......................... (41) (15) (56) 106 (6) 100
Loans, net, and mortgage
loans held-for-sale ............................... 1,661 253 1,914 1,520 (976) 544
------- ------- ------- ------- ------- -------
Total interest-earning assets .................. 1,500 273 1,773 1,789 (861) 928
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
NOW accounts ....................................... 11 (8) 3 14 (12) 2
Regular savings accounts ........................... (34) 198 164 (16) -- (16)
Money market accounts .............................. 316 (68) 248 198 (46) 152
Certificate accounts ............................... 273 34 307 504 (306) 198
------- ------- ------- ------- ------- -------
Total deposits ................................. 566 156 722 700 (364) 336
FHLB advances ...................................... 245 15 260 503 (44) 459
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities ............. 811 171 982 1,203 (408) 795
------- ------- ------- ------- ------- -------
Net change in net interest income .................... $ 689 $ 102 $ 791 $ 586 $ (453) $ 133
======= ======= ======= ======= ======= =======
</TABLE>
Comparison of Financial Condition at March 31, 1998 and March 31, 1997
Total assets at March 31, 1998 were $295.3 million, compared to $233.1
million at March 31, 1997, an increase of $62.2 million, or 26.7%. Asset growth
was primarily due to increases in the Bank's loan and investment portfolios,
funded primarily by the inflow of capital from the Conversion, and, to a lesser
extent, growth in deposits and FHLB borrowings. Loans receivable, net of
allowance for loan losses, increased $17.8 million, or 8.6%, to $224.9 million
at March 31, 1998 compared to $207.1 million at March 31, 1997. The increase in
loans was due to a $7.8 million, or 53.4%, increase in multi-family loans, a
$10.2 million, or 40.4%, increase in commercial real estate loans, a $3.8
million, or 253%, increase in construction and development loans and an
$840,000, or 30.8%, increase in consumer loans. This increase was funded
primarily from the $10.7 million increase in deposits and $5.5 million increase
in FHLB borrowings. Non-performing assets increased $660,000, or 43.7%, to $2.3
million at March 31, 1998, compared to $1.6 million at March 31, 1997. This
increase was the result of the internal classification of four pools of one- to
four-family residential loans. The allowance for loan losses increased $826,000,
or 47.1%, to $2.5 million at March 31, 1998, compared to $1.7 million at March
31, 1997. At March 31, 1998 the allowance represents 110.3% of non-performing
assets and 1.1% of total loans. There was no other real estate owned at March
31, 1998 compared to $73,000 at March 31, 1997. Deposits increased $10.7
million, or 5.4%, to $207.8 million at March 31, 1998, from $197.1 million at
March 31, 1997. The deposit growth occurred in certificate accounts which
increased $3.7 million, or 3.5%, and savings and NOW accounts which increased
$6.1 million, or 6.7%. Borrowed funds, which consist of FHLB borrowings,
increased $5.5 million, or 37.9%, to $20.0 million at March 31, 1998, from $14.5
million at March 31, 1997. The increased level of borrowings were in the 10 year
maturity, with callable features after one year at the option of the lender.
Investments and federal funds sold at March 31, 1998 increased $40.3 million, or
244%, to $56.8 million, compared to $16.5 million at March 31, 1997. This
35
<PAGE>
increase was primarily due to an increase in the FHLB overnight account funded
primarily by the receipt of the net proceeds from the Conversion. Investment
securities decreased $5.7 million, or 34.6%, to $10.8 million at March 31, 1998,
compared to $16.5 million at March 31, 1997. This decrease was the result of
principal repayments on mortgage-backed securities and the call of debentures.
Short-term investments were $46.0 million at March 31, 1998 and consisted solely
of federal funds sold/FHLB overnight accounts of which there were none at March
31, 1997. At March 31, 1998, total equity increased $44.1 million, or 226% to
$63.6 million, or 21.5% of total assets, from $19.5 million, or 8.4% of total
assets, at March 31, 1997. The increase in equity was the net result of the net
proceeds generated in the Conversion and the net loss for the twelve months
ended March 31, 1998. The Company's book value per share at March 31, 1998 was
$27.02.
Comparison of Operating Results for the Year Ended March 31, 1998 and 1997
General. For the fiscal year ended March 31, 1998, results were a net loss
of $1.8 million compared to net income of $1.1 million for the fiscal year ended
March 31, 1997. Since the Company converted to a stock form of ownership on
March 27, 1998, earnings per share data is not meaningful. The net loss for the
fiscal year ended March 31, 1998 resulted primarily from the recognition of
certain items related to the Conversion. As part of the Conversion, the Company
donated 187,795 shares of the Company's stock to The Bay State Federal Savings
Charitable Foundation (the "Foundation"). The total contribution expense
associated with the establishment of the Foundation was $3.8 million, or $2.5
million net of income taxes. Additionally, due to the timing of the consummation
of the Conversion and the establishment of the Bank's Employee Stock Ownership
Plan and related trust (the "ESOP"), which was funded with 8% of the common
stock issued in the Conversion, or 202,818 shares, the Company incurred
additional compensation expense of $600,000, or $433,000 net of income taxes,
relating to the ESOP allocation for the fiscal year ended March 31, 1998. In
addition, certain non-recurring expenses and adjustments associated with the
Conversion totalled $688,000, or $405,000 net of income taxes. Excluding the
effect of these items, the Company would have recognized net income for the
fiscal year ended March 31, 1998 of approximately $1.6 million.
Interest Income. Interest income for the fiscal year ended March 31, 1998
increased $1.8 million, or 10.3%, to $19.3 million, compared to $17.5 million
for the fiscal year ended March 31, 1997. The increase in interest income was
primarily due to an increase in the average balance of interest-earning assets
and an increase in the yield on interest-earning assets. The average balance of
interest-earning assets increased from $219.9 million for fiscal year 1997 to
$237.1 million for fiscal 1998, an increase of $17.2 million, or 7.8%. The
increase in the average balance of interest-earning assets was primarily a
result of an increase in the average balance of loans, net, of $20.0 million, or
10.2%, and an decrease in short-term investments and investment securities of
$2.8 million, or 11.6%. The yield on average interest-earning assets increased
17 basis points to 8.12%.
Interest Expense. Interest expense increased $1.0 million, or 10.9%, to
$10.2 million at March 31, 1998, compared to $9.2 million for the fiscal year
ended March 31, 1997. The increase in interest expense was primarily due to a
$16.2 million, or 7.9%, increase in the average balance of interest-bearing
liabilities which increased from $206.4 million for the fiscal year ended March
31, 1997 to $222.6 million for the fiscal year ended March 31, 1998 and an
increase in the cost of interest-bearing liabilities which increased from 4.47%
for the fiscal year ended March 31, 1997 to 4.58% for the fiscal year ended
March 31, 1998. The increase in the average balance of interest-bearing
liabilities was primarily a result of an increase in the average balance of
deposits of $12.0 million, or 6.3%, and an increase of borrowed funds of $4.3
million, or 25.5%. The cost of average interest-bearing liabilities increased 11
basis points to 4.58%.
Net Interest Income. Net interest income before the provision for loan
losses increased $791,000, or 9.5%, for the fiscal year. These increases were
primarily the result of the increased level of the loan and investment
portfolios and the increase in net interest margin. The net interest margin was
3.82% for the fiscal year ended March 31, 1998, compared to 3.76% for the fiscal
year ended March 31, 1997.
36
<PAGE>
Provision for Loan Losses. The provision for loan losses increased $739,000
to $856,000 for the fiscal year ended March 31, 1998, compared to $117,000 for
the fiscal year ended March 31, 1997. The increase in the provision for loan
losses resulted from management's review and evaluation of the risks inherent in
its loan portfolio. This increase was made after an assessment of the Bank's
loan portfolio and, in particular, specific loan pools that were internally
classified by the Bank. At March 31, 1998, the allowance for loan losses
totalled $2.5 million, representing 110.3% of non-performing assets and 1.10% of
total loans, compared to $1.7 million representing 104.2% of non-performing
assets and 0.81% of total loans at March 31, 1997. Management believes that the
provision for loan losses and the allowance for loan losses are currently
reasonable and adequate to cover any losses reasonably expected in the existing
loan portfolio. While management estimates loan losses using the best available
information, no assurances can be given that future additions to the allowance
will not be necessary based on changes in economic and real estate market
conditions, further information obtained regarding problem loans, identification
of additional problem loans and other factors, both within and outside of
management's control. Additionally, with the recent Conversion and the
expectations of the Bank to grow its existing loan portfolio, future additions
to the allowance may be necessary to maintain adequate coverage ratios.
Noninterest Income. Total noninterest income decreased $94,000, or 23.1% to
$313,000 for the fiscal year ended March 31, 1998 compared to $407,000 for the
fiscal year ended March 31, 1997. This reduction was primarily the result of the
recognition of gains on sale of investments of $123,000 in the fiscal year ended
March 31, 1997 of which there were none in 1998. In addition, for the year ended
March 31, 1998, only minor increases in service charges on deposit accounts and
other income were recognized by the Bank.
Noninterest Expense. Total noninterest expense increased $3.6 million, or
48.6%, to $11.0 million for the fiscal year ended March 31, 1998, compared to
the $7.4 million for the fiscal year ended March 31, 1997. Total salaries and
benefits increased $741,000, or 19.5%, a net result of the $601,000 in
compensation expense associated with the ESOP allocation and the increased level
of salaries in fiscal 1998 and a $697,000 expense in fiscal 1997 associated with
the establishment of a benefit equalization plan. Occupancy and equipment
expense totalled $944,000 for the fiscal year ended March 31, 1998, compared to
$849,000 for the same period last year, primarily due to the increased level of
depreciation expense on building and leasehold improvements. Deposit insurance
premiums decreased $1.3 million in fiscal 1998, mainly from the recognition in
fiscal 1997 of a $1.1 million expense related to the SAIF Special Assessment.
Other operating expenses, which include contribution of shares of Common Stock
to the Foundation, increased to $5.0 million for the fiscal year ended March 31,
1998 from $1.0 million for the fiscal year ended March 31, 1997. Such increase
is primarily attributable to the contribution expense of $3.8 million in forming
the Foundation and $688,000 in expenses associated with the Conversion during
fiscal year 1998 and the expenses associated with the merger of Union Federal
Savings Bank during the fiscal year ended March 31, 1997.
Income Taxes. A tax benefit of $751,000 was recognized for the fiscal year
ended March 31, 1998, an effective rate of 30.0%. The effective rate is lower
than the expected rate due to the non-deductibility of certain items relating to
the Conversion. Income tax expense for the year ended March 31, 1997 was $10,000
on income before taxes of $1.1 million, an effective rate of 0.88%. This
reduction from a normalized tax expense was the result of an adjustment of
deferred taxes pertaining to the provision for loan losses resulting from a
change in federal tax law of $339,000 and the elimination of the valuation
allowance for deferred taxes of $209,000.
Liquidity and Capital Resources
The Bank's primary sources of funds are deposits, principal and interest
payments on loans, mortgage-backed and investment securities and FHLB advances.
While maturities and scheduled amortization of loans are predictable sources of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition. The Bank has continued to
maintain the required levels of liquid assets as defined by OTS regulations.
This requirement of the OTS, which may be varied at the direction of the OTS
depending upon economic conditions and deposit flows, is based upon a percentage
of deposits and short-term borrowings. The Bank's currently required liquidity
ratio is 4%. At March 31, 1998 and March 31, 1997, the Bank's liquidity ratios
were 24.7% and
37
<PAGE>
6.9%, respectively. Management's strategy is to maintain liquidity as close as
possible to the minimum regulatory requirement and to invest any excess
liquidity in higher yielding interest-earning assets. The Bank manages its
liquidity position and demands for funding primarily by investing excess funds
in short-term investments and utilizing FHLB advances in periods when the Bank's
demands for liquidity exceed funding from deposit inflows.
The Bank's most liquid assets are cash and cash equivalents and securities.
The levels of these assets are dependent on the Bank's operating, financing,
lending and investing activities during any given period. At March 31, 1998,
cash and cash equivalents and securities totalled $62.2 million, or 21.06% of
total assets.
The Bank has other sources of liquidity if a need for additional funds
arises, including FHLB advances. At March 31, 1998, the Bank had $20.0 million
in advances outstanding from the FHLB and, at March 31, 1998, had an additional
overall borrowing capacity from the FHLB of $146.8 million. Depending on market
conditions, the pricing of deposit products and FHLB advances, the Bank may
continue to rely on FHLB borrowings to fund asset growth.
At March 31, 1998, the Bank had commitments to fund loans and unused
outstanding lines of credit and undisbursed proceeds of construction mortgages
totaling $4.9 million. The Bank anticipates that it will have sufficient funds
available to meet its current loan origination commitments. Certificate
accounts, including IRA and Keogh accounts, which are scheduled to mature in
less than one year from March 31, 1998, totalled $89.2 million.
At March 31, 1998, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $39.0 million, or 13.3%, of total
adjusted assets, which is above the required level of $4.4 million, or 1.5%;
core capital of $39.0 million, or 13.3%, of total adjusted assets, which is
above the required level of $11.7 million, or 4.0%; and risk-based capital of
$41.0 million, or 26.3%, of risk-weighted assets, which is above the required
level of $12.5 million, or 8.0%.
Year 2000 Compliance
As the year 2000 approaches, an important business issue has emerged
regarding how existing application software programs and operating systems can
accommodate this date value. Many existing application software products,
including the Bank's, were designed to accommodate a two-digit year. For
example, "97" is stored on the system and represents 1997. The Bank primarily
utilizes a third-party vendor for processing the primary banking applications.
In addition, the Bank also uses third-party vendor application software for all
ancillary computer applications. The third-party vendor for the Bank's banking
applications is in the process of modifying and upgrading its computer
applications to ensure Year 2000 compliance. To assist in this effort, the Bank
has been advised by such vendor that the vendor has hired the services of a
consultant to review the plan and assist such vendor in achieving Year 2000
compliance by December 31, 1998. In addition, the Bank instituted a Year 2000
compliance program whereby the Bank reviewed the Year 2000 compliance issues
that may be faced by its other third-party vendors. The Bank examined the need
for modifications or replacement of all non-Year 2000 compliant pieces of
software. The Bank does not currently expect that the cost of its Year 2000
compliance program will be material to its financial condition and believes that
it will satisfy such compliance program by the end of 1998 without material
disruption of its operations. In the event that the Bank's significant suppliers
do not successfully and timely achieve Year 2000 compliance, the Bank's business
or operations could be adversely affected. However, management believes that the
Bank's own internal system, networks and resources would allow the Bank to
effectively operate and service its customers in the event its significant
vendors do not achieve satisfactory Year 2000 compliance. In addition, if
significant vendors failed to meet Year 2000 operating requirements, the Bank
intends to engage alternative vendors and suppliers. While the Bank cannot
estimate the costs and expenses associated with hiring new vendors and
suppliers, management believes that such costs would not have a material impact
on the Bank's earnings or results of operations.
38
<PAGE>
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented elsewhere
herein have been prepared in accordance with generally accepted accounting
principles ("GAAP"), which require the measurement of financial position and
operating results generally in terms of historical dollar amounts without
considering the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of the
Bank's operations. Unlike industrial companies, nearly all of the assets and
liabilities of the Bank are monetary in nature. As a result, interest rates have
a greater impact on the Bank's performance than do the effects of general levels
of inflation. Interest rates do not necessarily move in the same direction or to
the same extent as the prices of goods and services.
Impact of New Accounting Standards
Accounting for Long Lived Assets. In March 1995, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for Impairment of Long-Lived Assets and for Long
Lived Assets to be Disposed of" ("SFAS No. 121"). This Statement establishes
accounting standards for the impairment of long-lived assets, certain
identifiable intangibles and goodwill related to those assets to be held and
used and for long-lived assets and certain identifiable intangibles to be
disposed of. The Statement requires that long-lived assets and certain
identifiable intangibles to be held and used by an institution be reviewed for
impairment whenever events change and circumstances indicate the carrying amount
of the asset may not be recoverable. This Statement became effective for the
Bank on April 1, 1996. Adoption of this Statement did not have a material impact
on the earnings or financial position of the Bank.
Accounting for Stock-Based Compensation. In November 1995, the FASB issued
SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS No. 123"). This
statement establishes financial accounting standards for stock-based employee
compensation plans. SFAS No. 123 permits the Bank to choose either a new fair
value based method or the current Accounting Principles Board ("APB") Opinion 25
intrinsic value based method of accounting for its stock-based compensation
arrangements. SFAS No. 123 requires pro forma disclosures of net earnings and
earnings per share computed as if the fair value based method had been applied
in financial statements of companies that continue to follow current practice in
accounting for such arrangements under APB Opinion 25. SFAS No. 123 applies to
all stock-based employee compensation plans in which an employer grants shares
of its stock or other equity instruments to employees except for employee stock
ownership plans. SFAS No. 123 also applies to plans in which the employer incurs
liabilities to employees in amounts based on the price of the employer's stock,
(e.g., stock option plans, stock purchase plans, restricted stock plans and
stock appreciation rights). The statement also specifies the accounting for
transactions in which a company issues stock options or other equity instruments
for services provided by nonemployees or to acquire goods or services from
outside suppliers or vendors. The recognition provisions of SFAS No. 123 for
companies choosing to adopt the new fair value based method of accounting for
stock-based compensation arrangements will apply to all transactions entered
into in fiscal years that begin after December 15, 1995. Any effect that this
statement will have on the Bank will be applicable upon the granting of any
stock under stock-based employee compensation plans. The Bank intends to follow
the APB Opinion 25 method upon adoption, but will provide pro forma disclosure
as if the fair value method had been applied.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. In June 1996 the FASB issued Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 125"). This
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. It distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. Under the financial-components approach,
after a transfer of financial assets, an entity recognizes all financial and
servicing assets it controls and liabilities it has incurred and derecognizes
financial assets it no longer controls and liabilities that have been
extinguished. The financial-components approach focuses on the assets and
liabilities that exist after the transfer. Many of these assets and liabilities
are components of financial assets that existed prior to the transfer. If a
transfer does not meet the criteria for a sale, the
39
<PAGE>
transfer is accounted for as a secured borrowing with a pledge of collateral.
The Statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, applied
prospectively. Earlier or retroactive application of this Statement is not
permitted. The adoption of the non-deferred provisions of this Statement as of
January 1, 1997 did not have a material impact on the Bank's consolidated
financial statements.
Reporting Comprehensive Income. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income," ("SFAS No. 130"). This statement establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general-purpose
financial statements. This statement requires that all items that are required
to be recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. This statement does not require a
specific format for that financial statement but requires that an enterprise
display an amount representing total comprehensive income for the period in that
financial statement. SFAS No. 130 requires that an enterprise (a) classify items
of other comprehensive income by their nature in a financial statement and (b)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of a
statement of financial position. It does not address issues of recognition or
measurement for comprehensive income and its components. SFAS No. 130 is
effective for fiscal years beginning after December 31, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes is
required. The Bank does not expect that upon adoption, this statement will have
a material effect on its consolidated financial statements.
Disclosures about Segments of an Enterprise and Related Information. In
June 1997 the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," ("SFAS No. 131"). This Statement
establishes standards for the way public business enterprises report information
about operating segments in financial statements. SFAS No. 131 is effective for
financial statements for periods beginning after December 15, 1997. The Bank
does not expect that under this statement it will be required to report
additional information because its present organization consists of only one
operating segment as defined by the Statement.
Other New Accounting Standards. SFAS No. 128, "Earnings per Share" ("SFAS
No. 128") is effective for periods ending after December 15, 1997. SFAS No. 129,
"Disclosure of Information about Capital Structure" ("SFAS No. 129") is
effective for periods ending after December 15, 1997. The Company and Bank
expect that the adoption of these standards will not have a material impact on
the Company's and Bank's consolidated financial statements.
Item 7. Financial Statements.
40
<PAGE>
[LETTERHEAD OF SHATSWELL, MACLEOD & COMPANY, P.C.]
The Board of Directors and Stockholders
Bay State Bancorp, Inc.
Brookline, Massachusetts
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheets of Bay State
Bancorp, Inc. and Subsidiaries as of March 31, 1998 and 1997 and the related
consolidated income statements, changes in stockholders' equity and cash flows
for each of the years in the three-year period ended March 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the restated consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Bay State Bancorp, Inc. and Subsidiaries as of March 31, 1998 and 1997 and the
consolidated results of their operations and their cash flows for each of the
years in the three-year period ended March 31, 1998, in conformity with
generally accepted accounting principles.
/s/ SHATSWELL, MacLEOD & COMPANY, P.C.
----------------------------------
SHATSWELL, MacLEOD & COMPANY, P.C.
April 27, 1998
41
<PAGE>
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 AND 1997
(In Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
ASSETS 1998 1997
-------- ---------
<S> <C> <C>
Cash and due from banks $ 3,513 $ 3,617
Federal Home Loan Bank overnight account 46,000 --
--------- ---------
Cash and cash equivalents 49,513 3,617
Investments in available-for-sale securities (at fair value) 6,523 2,903
Investments in held-to-maturity securities (fair values of $4,274 as of
March 31, 1998 and $13,306 as of March 31, 1997) 4,272 13,553
Stock in Federal Home Loan Bank of Boston, at cost 1,873 1,672
Loans, net of the allowance for loan losses of $2,513 as of March 31, 1998
and $1,687 as of March 31, 1997 224,928 207,063
Loans held-for-sale 822 --
Premises and equipment, net of depreciation and amortization 2,581 1,898
Other real estate owned -- 73
Accrued interest receivable 1,260 1,233
Deferred tax asset, net 2,065 554
Other assets 1,454 508
--------- ---------
Total assets $ 295,291 $ 233,074
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Demand deposits $ 485 $ 117
Savings and NOW deposits 97,645 90,919
Certificate accounts 109,650 106,023
--------- ---------
Total deposits 207,780 197,059
Advances from Federal Home Loan Bank of Boston 20,000 14,500
Other borrowed funds 2,176 1,065
Other liabilities 1,761 976
--------- ---------
Total liabilities 231,717 213,600
--------- ---------
Stockholders' equity:
Common stock, $.01 par value; 11,000,000 shares authorized in
1998, 2,535,232 shares issued and outstanding in 1998 25 --
Paid-in capital 49,194 --
Retained earnings 17,340 19,091
Unearned ESOP shares (3,651) --
Net unrealized holding gain on available-for-sale securities,
net of taxes 666 383
--------- ---------
Total stockholders' equity 63,574 19,474
--------- ---------
Total liabilities and stockholders' equity $ 295,291 $ 233,074
========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
42
<PAGE>
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
(In Thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Interest and dividend income:
Interest and fees on loans $ 17,872 $ 15,958 $ 15,414
Interest and dividends on securities:
Taxable 1,009 1,197 711
Other interest 368 321 423
-------- -------- --------
Total interest and dividend income 19,249 17,476 16,548
-------- -------- --------
Interest expense:
Interest on deposits 8,994 8,272 7,936
Interest on FHLB advances 1,206 946 487
-------- -------- --------
Total interest expense 10,200 9,218 8,423
-------- -------- --------
Net interest and dividend income 9,049 8,258 8,125
Provision for loan losses 856 117 1
-------- -------- --------
Net interest and dividend income after provision for loan losses 8,193 8,141 8,124
-------- -------- --------
Other income:
Service charges on deposit accounts 174 163 182
Securities gains -- 123 --
Gain on sale of mortgage loans 15 6 2
Other income 124 115 182
-------- -------- --------
Total other income 313 407 366
-------- -------- --------
Other expense:
Salaries and employee benefits 4,545 3,804 3,268
Occupancy expense 644 611 605
Equipment expense 300 238 213
Federal deposit insurance premiums 125 1,432 319
Advertising 174 144 164
Data processing 225 164 202
Contribution of shares of the common stock of Bay State Bancorp, Inc.
to The Bay State Federal Savings Charitable Foundation at the
conversion issued price 3,756 -- --
Other expense 1,239 1,016 766
-------- -------- --------
Total other expense 11,008 7,409 5,537
-------- -------- --------
Income (loss) before income taxes (benefit) (2,502) 1,139 2,953
Income taxes (benefit) (751) 10 1,269
-------- -------- --------
Net income (loss) $ (1,751) $ 1,129 $ 1,684
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
43
<PAGE>
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
(In Thousands)
<TABLE>
<CAPTION>
Net
Unrealized
Holding
Gain On
Unearned Available-
Common Paid-in Retained ESOP For-Sale
Stock Capital Earnings Shares Securities Total
----- ------- -------- ------ ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1995 $-- $ -- $ 16,278 $ -- $ 199 $ 16,477
Net income -- -- 1,684 -- -- 1,684
Net change in unrealized
holding gain on available-
for-sale securities -- -- -- -- 178 178
-------- -------- -------- -------- -------- --------
Balance, March 31, 1996 -- -- 17,962 -- 377 18,339
Net income -- -- 1,129 -- -- 1,129
Net change in unrealized
holding gain on available-
for-sale securities -- -- -- -- 6 6
-------- -------- -------- -------- -------- --------
Balance, March 31, 1997 -- -- 19,091 -- 383 19,474
Net loss -- -- (1,751) -- -- (1,751)
Net change in unrealized
holding gain on available-
for-sale securities -- -- -- -- 283 283
Stock issued pursuant to
initial common stock
offering 23 45,245 -- -- -- 45,268
Issuance of 187,795 shares
of common stock to The
Bay State Federal Savings
Charitable Foundation 2 3,754 -- -- -- 3,756
Common stock acquired by
ESOP -- -- -- (4,056) -- (4,056)
Reduction in unearned ESOP
shares charged to expense -- -- -- 405 -- 405
Appreciation in fair value of
unearned ESOP shares
charged to expense -- 195 -- -- -- 195
-------- -------- -------- -------- -------- --------
$ 25 $ 49,194 $ 17,340 $ (3,651) $ 666 $ 63,574
======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
44
<PAGE>
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
(In Thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (1,751) $ 1,129 $ 1,684
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Contribution of shares to The Bay State Federal Savings
Charitable Foundation 3,756 -- --
Appreciation in fair value of ESOP shares 195 -- --
Reduction in unearned ESOP shares 405 -- --
Gain on sales of premises and equipment -- (5) --
Disposals of premises and equipment -- 17 --
Provision for loan losses 856 117 1
Net (increase) decrease in mortgage loans
held-for-sale (822) 47 (47)
Gain on sale of mortgage loans (15) (6) (2)
Depreciation and amortization 235 199 201
Increase (decrease) in deferred loan origination fees 33 (58) (93)
Securities gains from sales of available-for-sale securities, net -- (123) --
Amortization of securities, net of accretion 9 3 --
Deferred tax (benefit) expense (1,707) (626) 119
Decrease in income taxes payable (118) (214) (65)
Write-downs of other real estate owned -- -- 5
Gain on sale of other real estate owned (19) (33) --
Increase (decrease) in other liabilities 329 3 (87)
Increase (decrease) in accrued expenses 439 549 (3)
Increase (decrease) in accrued interest payable 6 (2) 2
Decrease in other assets 63 83 32
Increase in cash surrender value -- (27) (28)
(Increase) decrease in prepaid expenses (176) 130 6
Increase in accrued interest receivable (27) (55) (176)
-------- -------- --------
Net cash provided by operating activities 1,691 1,128 1,549
-------- -------- --------
Cash flows from investing activities:
Proceeds from sales of other real estate owned 322 49 --
Proceeds from maturities of held-to-maturity
securities 9,272 2,625 2,353
Purchases of held-to-maturity securities -- -- (12,822)
Proceeds from sales of available-for-sale securities -- 139 --
Proceeds from maturities of available-for-sale securities -- 1,500 --
Purchases of available-for-sale securities (3,141) (1,127) (1,083)
Purchase of Federal Home Loan Bank stock (201) -- (8)
Distribution to Rabbi Trust (704) -- --
Net increase in loans (18,988) (20,627) (2,006)
Recoveries of loans previously charged off 19 21 97
Proceeds from sales of premises and equipment -- 14 --
Capital expenditures (918) (604) (152)
-------- -------- --------
Net cash used in investing activities (14,339) (18,010) (13,621)
-------- -------- --------
</TABLE>
45
<PAGE>
BAY STATE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
(Continued)
(In Thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of common stock 46,949 -- --
Costs related to issuance of common stock (1,681) -- --
Payments to acquire common stock for ESOP (4,056) -- --
Net increase (decrease) in demand deposits, NOW
and savings accounts 7,094 5,227 (5,316)
Net increase in certificate accounts 3,627 3,899 14,912
Repayment of advances from the Federal Home
Loan Bank (74,000) (71,300) (38,650)
Advances from the Federal Home Loan Bank 79,500 74,150 42,300
Net increase in other borrowed funds 1,111 17 385
-------- -------- --------
Net cash provided by financing activities 58,544 11,993 13,631
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 45,896 (4,889) 1,559
Cash and cash equivalents at beginning of period 3,617 8,506 6,947
-------- -------- --------
Cash and cash equivalents at end of period $ 49,513 $ 3,617 $ 8,506
======== ======== ========
Supplemental disclosures:
Interest paid $ 10,194 $ 9,220 $ 8,421
Income taxes paid 1,074 916 1,215
Loans transferred to other real estate owned 230 309 --
Loans originated from sales of other real estate owned -- 285 --
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
46
<PAGE>
BAYSTATE FEDERAL SAVINGS BANK AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 and 1996
(Dollars in Thousands)
NOTE 1 - NATURE OF OPERATIONS
Bay State Bancorp, Inc. (Company) is a Delaware corporation that was organized
to become the holding company of Bay State Federal Savings Bank (Bank). The
Company's primary purpose is to act as the holding company for the Bank.
In connection with the organization of the Company, on March 27, 1998, the Bank
became a wholly owned subsidiary of the Company and the Bank converted from a
federally-chartered mutual savings bank to a federally-chartered capital stock
savings bank as described in Note 16.
The Bank was incorporated in 1920 and is headquartered in Brookline,
Massachusetts. The Bank operates its business from five banking offices located
in Massachusetts. The reporting entity is Bay State Bancorp, Inc. and its wholly
owned subsidiaries Bay State Funding Corporation and Bay State Federal Savings
Bank and the Bank's wholly owned subsidiary, BSF Service Corporation. In the
year ended March 31, 1997 Union Federal Savings Bank ("Union Federal"), a mutual
entity was merged with and into Bay State Federal Savings Bank. The merger was
accounted for as a pooling-of-interests. The merger met all of the conditions
specified by APB 16 to be accounted for by the pooling-of-interests method. The
two banks were independent of each other and combined in their entirety to
continue what was once previously separate operations, with Bay State Federal
Savings Bank being the surviving entity. The depositors of Union Federal became
depositors of Bay State Federal Savings Bank. There were no transactions after
the merger that were inconsistent with the combining of the interests of the
depositors. See Note 15.
The Company provides a full range of banking services to individual and business
customers in eastern Massachusetts. The Company is subject to competition from
other financial institutions doing business in eastern Massachusetts.
NOTE 2 - ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform to generally
accepted accounting principles and predominant practices within the banking
industry. The financial statements of the Company were prepared using the
accrual basis of accounting. The significant accounting policies of the Company
are summarized below to assist the reader in better understanding the financial
statements and other data contained herein.
PERVASIVENESS OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from the
estimates.
BASIS OF PRESENTATION:
The accompanying consolidated financial statements include the accounts of
Bay State Bancorp, Inc. and its wholly owned subsidiaries Bay State Funding
Corporation and Bay State Federal Savings Bank and the Bank's wholly owned
subsidiary, BSF Service Corporation. BSF Service Corporation, which has
been inactive since 1994, is a subsidiary which was formed for the purpose
of real estate development activities. Bay State Funding Corporation was
established to lend funds to the Company sponsored employee stock ownership
plan and related trust for the purchase of stock in the initial public
offering. All significant intercompany balances and transactions have been
eliminated in consolidation.
47
<PAGE>
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, cash items, due from banks and the Federal Home Loan Bank
overnight account.
SECURITIES:
Investments in debt securities are adjusted for amortization of premiums
and accretion of discounts calculated using the interest method. Gains or
losses on sales of investment securities are computed on a specific
identification basis.
The Company classifies debt and equity securities into one of two
categories: available-for-sale or held-to-maturity. In general, securities
may be classified as held-to-maturity only if the Company has the positive
intent and ability to hold them to maturity. All other securities must be
classified as available-for-sale.
-- Available-for-sale securities are carried at fair value on the balance
sheet. Unrealized holding gains and losses are not included in
earnings, but are reported as a net amount (less expected tax) in a
separate component of capital until realized.
-- Held-to-maturity securities are measured at amortized cost in the
balance sheet. Unrealized holding gains and losses are not included in
earnings or in a separate component of capital. They are merely
disclosed in the notes to the consolidated financial statements.
LOANS:
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their
outstanding principal balances reduced by amounts due to borrowers on
unadvanced loans, any charge-offs, the allowance for loan losses and any
deferred fees or costs on originated loans, or unamortized premiums or
discounts on purchased loans.
Interest on loans is recognized on a simple interest basis.
Loan origination and commitment fees and certain direct origination costs
are deferred, and the net amount amortized as an adjustment of the related
loan's yield. The Company is amortizing these amounts over the contractual
life of the related loans using the interest method.
Cash receipts of interest income on impaired loans is credited to principal
to the extent necessary to eliminate doubt as to the collectibility of the
net carrying amount of the loan. Some or all of the cash receipts of
interest income on impaired loans is recognized as interest income if the
remaining net carrying amount of the loan is deemed to be fully
collectible. When recognition of interest income on an impaired loan on a
cash basis is appropriate, the amount of income that is recognized is
limited to that which would have been accrued on the net carrying amount of
the loan at the contractual interest rate. Any cash interest payments
received in excess of the limit and not applied to reduce the net carrying
amount of the loan are recorded as recoveries of charge-offs until the
charge-offs are fully recovered.
ALLOWANCE FOR LOAN LOSSES:
An allowance is available for losses which may be incurred in the future on
loans in the current portfolio. The allowance is increased by provisions
charged to current operations and is decreased by loan losses, net of
recoveries. The allowance for loan losses is established through a
provision for loan losses based on management's evaluation of the risks
inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to
cover estimated losses on loans which are deemed probable and estimable
based on information currently known to management. The allowance is based
upon a number of factors, including current economic conditions, actual
loss experience and industry trends. The balance in the allowance for loan
losses is considered adequate by management to absorb any reasonably
foreseeable loan losses.
48
<PAGE>
As of April 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as
amended by SFAS No. 118. According to SFAS No. 114, a loan is impaired
when, based on current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the
contractual terms of the loan agreement. The Statement requires that
impaired loans be measured on a loan by loan basis by either the present
value of expected future cash flows discounted at the loan's effective
interest rate, the loan's observable market price, or the fair value of the
collateral if the loan is collateral dependent.
The Statement is applicable to all loans, except large groups of smaller
balance homogeneous loans that are collectively evaluated for impairment,
loans that are measured at fair value or at the lower of cost or fair
value, leases, and convertible or nonconvertible debentures and bonds and
other debt securities. The Company considers its residential real estate
loans and consumer loans that are not individually significant to be large
groups of smaller balance homogeneous loans.
Factors considered by management in determining impairment include payment
status, net worth and collateral value. An insignificant payment delay or
an insignificant shortfall in payment does not in itself result in the
review of a loan for impairment. The Company applies SFAS No. 114 on a
loan-by-loan basis. The Company does not apply SFAS No. 114 to aggregations
of loans that have risk characteristics in common with other impaired
loans. Interest on a loan is not generally accrued when the loan becomes
ninety or more days overdue. The Company may place a loan on nonaccrual
status but not classify it as impaired, if (i) it is probable that the
Company will collect all amounts due in accordance with the contractual
terms of the loan or (ii) the loan is an individually insignificant
residential mortgage loan or consumer loan. Impaired loans are charged-off
when management believes that the collectibility of the loan's principal is
remote. Substantially all of the Company's loans that have been identified
as impaired have been measured by the fair value of existing collateral.
The financial statement impact of adopting the provisions of this Statement
was not material.
LOANS HELD-FOR-SALE:
Loans held-for-sale are carried at the lower of cost or estimated market
value in the aggregate. Net unrealized losses are recognized through a
valuation allowance by charges to income.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost, less accumulated depreciation
and amortization. Cost and related allowances for depreciation and
amortization of premises and equipment retired or otherwise disposed of are
removed from the respective accounts with any gain or loss included in
income or expense. Depreciation and amortization are calculated principally
on the straight-line method over the estimated useful lives of the assets.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:
Other real estate owned includes properties acquired through foreclosure
and properties classified as in-substance foreclosures in accordance with
Financial Accounting Standards Board Statement No. 15, "Accounting by
Debtors and Creditors for Troubled Debt Restructuring." These properties
are carried at the lower of cost or estimated fair value less estimated
costs to sell. Any writedown from cost to estimated fair value required at
the time of foreclosure or classification as in-substance foreclosure is
charged to the allowance for loan losses. Expenses incurred in connection
with maintaining these assets, subsequent writedowns and gains or losses
recognized upon sale are included in other expense.
In accordance with Statement of Financial Accounting Standards No. 114
"Accounting by Creditors for Impairment of a Loan," the Company classifies
loans as in-substance repossessed or foreclosed if the Company receives
physical possession of the debtor's assets regardless of whether formal
foreclosure proceedings take place.
49
<PAGE>
INCOME TAXES:
The Company recognizes income taxes under the asset and liability method.
Under this method, deferred tax assets and liabilities are established for
the temporary differences between the accounting basis and the tax basis of
the Company's assets and liabilities at enacted tax rates expected to be in
effect when the amounts related to such temporary differences are realized
or settled.
PENSION:
Pension costs are funded as accrued.
FAIR VALUES OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires that the Company disclose
estimated fair value for its financial instruments. Fair value methods and
assumptions used by the Company in estimating its fair value disclosures
are as follows:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and the Federal Home Loan Bank overnight account approximate
those assets' fair values.
Securities (including mortgage-backed securities): Fair values for
securities are based on quoted market prices, where available. If quoted
market prices are not available, fair values are based on quoted market
prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently and with
no significant change in credit risk, fair values are based on carrying
values. The fair values for other loans are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. The carrying amount
of accrued interest approximates its fair value.
Deposit liabilities: The fair values disclosed for demand deposits (e.g.,
interest and non-interest checking, passbook savings and money market
accounts) are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts). Fair values for fixed-rate
certificate accounts are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on certificates to a
schedule of aggregated expected monthly maturities on certificate accounts.
Federal Home Loan Bank Advances: Fair values for FHLB advances are
estimated using a discounted cash flow technique that applies interest
rates currently being offered on advances to a schedule of aggregated
expected monthly maturities on FHLB advances.
Other borrowed funds: Fair values of other borrowed funds are estimated
using discounted cash flow analyses based on the Company's current
incremental borrowing rates for similar types of borrowing arrangements.
Off-balance sheet instruments: The fair value of commitments to originate
loans is estimated using the fees currently charged to enter similar
agreements, taking into account the remaining terms of the agreements and
the present creditworthiness of the counterparties. For fixed-rate loan
commitments and the unadvanced portion of loans, fair value also considers
the difference between current levels of interest rates and the committed
rates. The fair value of letters of credit is based on fees currently
charged for similar agreements or on the estimated cost to terminate them
or otherwise settle the obligation with the counterparties at the reporting
date.
50
<PAGE>
NOTE 3 - SECURITIES
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The amortized cost basis of securities
and their approximate fair values are as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
Cost Holding Holding Fair
Basis Gains Losses Value
----- ----- ------ -----
(In Thousands)
<S> <C> <C> <C> <C>
Available-for-sale securities:
March 31, 1998:
Marketable equity securities $5,391 $1,135 $ 3 $6,523
====== ====== ====== ======
March 31, 1997:
Marketable equity securities $2,250 $ 654 $ 1 $2,903
====== ====== ====== ======
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
Cost Holding Holding Fair
Basis Gains Losses Value
----- ----- ------ -----
(In Thousands)
<S> <C> <C> <C> <C>
Held-to-maturity securities:
March 31, 1998:
U.S. Government securities $ 2,001 $ -- $ 2 $ 1,999
Mortgage-backed securities 2,271 5 1 2,275
------- ------- ------- -------
$ 4,272 $ 5 $ 3 $ 4,274
======= ======= ======= =======
March 31, 1997:
U.S. Government securities $10,303 $ -- $ 174 $10,129
Mortgage-backed securities 3,250 -- 73 3,177
------- ------- ------- -------
$13,553 $ -- $ 247 $13,306
======= ======= ======= =======
</TABLE>
The scheduled maturities of debt securities classified as held-to-maturity were
as follows as of March 31, 1998:
Amortized
Cost Fair
Basis Value
----- -----
(In Thousands)
Debt securities other than mortgage-backed securities:
Due within one year $2,001 $1,999
Mortgage-backed securities 2,271 2,275
------ ------
$4,272 $4,274
====== ======
There were no securities pledged as of March 31, 1998 and 1997.
During the years ended March 31, 1998, 1997 and 1996 proceeds from sales of
available-for-sale securities amounted to $0, $139 and $0, respectively. During
the years ended March 31, 1998, 1997 and 1996 gross realized gains on those
sales amounted to $0, $123 and $0, respectively.
51
<PAGE>
There were no issuers of securities whose amortized cost basis and fair value
exceeded 10% of stockholders' equity as of March 31, 1998.
NOTE 4 - LOANS
Loans consisted of the following as of March 31:
1998 1997
---------- ----------
(In Thousands)
Mortgage loans:
Residential - secured by 1-4 family $ 157,240 $ 162,837
Equity lines 4,028 2,359
Residential - secured by multi-family 22,411 14,624
Construction and development 5,287 1,482
Commercial 35,511 25,291
--------- ---------
Total mortgage loans 224,477 206,593
--------- ---------
Other loans:
Loans secured by deposit accounts 564 407
Other consumer loans 2,870 2,187
--------- ---------
Total other loans 3,434 2,594
--------- ---------
Total principal balance 227,911 209,187
--------- ---------
Allowance for loan losses (2,513) (1,687)
Deferred loan origination fees (470) (437)
--------- ---------
(2,983) (2,124)
--------- ---------
Loans, net $ 224,928 $ 207,063
========= =========
Certain directors and executive officers of the Company and companies in which
they have significant ownership interest were customers of the Company during
the year ended March 31, 1998. Total loans to such persons and their companies
amounted to $4,379 as of March 31, 1998. During the year ended March 31, 1998
principal payments and advances totaled $297 and $0, respectively.
Changes in the allowance for loan losses were as follows for the years ended
March 31:
1998 1997 1996
------ ------ -------
(In Thousands)
Balance at beginning of period $ 1,687 $ 1,774 $ 1,825
Loans charged off (49) (225) (149)
Provision for loan losses 856 117 1
Recoveries of loans previously charged off 19 21 97
------- ------- -------
Balance at end of period $ 2,513 $ 1,687 $ 1,774
======= ======= =======
There were no loans that meet the definition of an impaired loan in Statement of
Financial Accounting Standards No. 114 as of March 31, 1998 and 1997, during the
years ended March 31, 1998, 1997 and 1996.
52
<PAGE>
Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage
Servicing Rights," SFAS No. 122, became effective for the Bank on April 1, 1996.
As of April 1, 1997, SFAS No. 122 was superceded by Statement of Financial
Accounting Standards No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" (SFAS No. 125). In the
fiscal years ending March 31, 1998 and 1997 the Company sold mortgage loans
totaling $2,359 and $749, respectively and retained the servicing rights. The
fair value of those rights under SFAS No. 122 and SFAS No. 125 is not material
and has not been recognized in the financial statements for the years ended
March 31, 1998 and 1997.
NOTE 5 - PREMISES AND EQUIPMENT, NET OF DEPRECIATION AND AMORTIZATION
The following is a summary of premises and equipment as of March 31:
Estimated
Useful
1998 1997 Life
------- ------- ----------
(In Thousands)
Land $ 355 $ 355
Building and improvements 2,144 1,614 25-50 years
Furniture, fixtures and equipment 1,869 1,528 5-10 years
Leasehold improvements 263 208 5-10 years
Construction in progress 68 76
------- -------
4,699 3,781
Accumulated depreciation and amortization (2,118) (1,883)
------- -------
$ 2,581 $1,898
======= =======
NOTE 6 - DEPOSITS
The aggregate amount of certificate accounts, each with a minimum denomination
of $100 was approximately $14,876 and $13,188 as of March 31, 1998 and 1997,
respectively. Deposits greater than $100 are not federally insured.
For certificate accounts as of March 31, 1998, the aggregate amount of
maturities for each of the following five years ended March 31, and thereafter
are:
(In Thousands)
1999 $ 89,243
2000 12,998
2001 3,808
2002 1,731
2003 1,845
Thereafter 25
--------
$109,650
========
NOTE 7 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
The Bank is a member of the FHLB of Boston and as such is required to invest in
$100 par value stock in the amount of 1% of its outstanding home loans or 5% of
its outstanding advances from the FHLB or 1% of 30% of total assets, whichever
is highest. When such stock is redeemed, the Bank receives from the FHLB an
amount equal to the par value of the stock.
53
<PAGE>
FHLB of Boston advances by year of maturity were as follows as of March 31,
1998:
Average
Stated
Amount Rate
------ ----
(In Thousands)
1999 $ 5,000 5.59%
2008 15,000 4.97%
--------
$ 20,000
========
The advances with maturity dates in 2008 all have call dates in the year ended
March 31, 1999 and are callable quarterly thereafter.
In accordance with the FHLB of Boston's collateral requirements, a portion of
first mortgage loans on residential property and all deposits and stock in the
FHLB of Boston are available as collateral to secure such advances.
NOTE 8 - OTHER BORROWED FUNDS
Other borrowed funds consist of overdrawn accounts with the Federal Home Loan
Bank of Boston.
NOTE 9 - INCOME TAXES (BENEFIT)
The components of the income tax expense (benefit) are as follows for the years
ended March 31:
1998 1997 1996
------ ------ ------
(In Thousands)
Current:
Federal $ 672 $ 461 $ 830
State 284 175 320
------- ------- -------
956 636 1,150
------- ------- -------
Deferred:
Federal (1,572) (317) 84
State (135) (100) 35
------- ------- -------
(1,707) (417) 119
------- ------- -------
Change in valuation allowance -- (209) --
------- ------- -------
Total income tax expense (benefit) $ (751) $ 10 $ 1,269
======= ======= =======
The reasons for the differences between the statutory federal income tax rates
and the effective tax rates are summarized as follows for the years ended March
31:
1998 1997 1996
---- ---- ----
Federal income tax at statutory rate (34.0)% 34.0% 34.0%
Increase (decrease) in tax resulting from:
Cash surrender value of life insurance .3 (.8) (.4)
Other (.2) (19.2) 1.4
Change in valuation allowance -- (18.3) --
State income tax, net of federal income tax benefit 3.9 4.3 8.0
----- ----- -----
(30.0)% 0% 43.0%
===== ===== =====
54
<PAGE>
The Company had gross deferred tax assets and gross deferred tax liabilities as
follows as of March 31:
1998 1997
------- ------
(In Thousands)
Deferred tax assets:
Allowance for loan losses $ 961 $ 618
Deferred loan fees 29 36
Contribution carryover 1,203 --
ESOP expense 56 --
Accrued retirement expense 67 --
Writedowns-other assets -- 26
Accrued deferred compensation 265 236
Other 98 24
------- -------
Gross deferred tax assets 2,679 940
------- -------
Deferred tax liabilities:
Depreciation (148) (116)
Net unrealized holding gain on securities (466) (270)
------- -------
Gross deferred tax liabilities (614) (386)
------- -------
Net deferred tax assets $ 2,065 $ 554
======= =======
Based on the Company's historical and current pretax earnings, management
believes it is more likely than not that the Company will realize the net
deferred tax asset existing as of March 31, 1998 and 1997. Management believes
that existing net deductible temporary differences which give rise to the net
deferred tax asset will reverse during periods in which the Company generates
net taxable income. In addition, gross deductible temporary differences are
expected to reverse in periods during which offsetting gross taxable temporary
differences are expected to reverse. Factors beyond management's control, such
as the general state of the economy and real estate values, can affect future
levels of taxable income and no assurance can be given that sufficient taxable
income will be generated to fully absorb gross deductible temporary differences.
As of March 31, 1998 and 1997, recoverable income taxes exceed the amount of the
net deferred tax asset.
In prior years, the Bank was allowed a special tax-basis bad debt deduction
under certain provisions of the Internal Revenue Code. As a result, retained
earnings of the Bank as of March 31, 1998 and 1997 includes approximately $5,812
and $5,818, respectively for which federal and state income taxes have not been
provided. If the Bank no longer qualifies as a bank as defined in certain
provisions of the Internal Revenue Code, this amount will be subject to
recapture in taxable income ratably over six (6) years, subject to a combined
federal and state tax rate of approximately 41%.
NOTE 10 - REGULATORY MATTERS
The Company and its subsidiary Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance-sheet
items as calculated under regulatory accounting practices. Their capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), of Tier 1 capital (as
defined) to adjusted total assets (as defined) and Tangible capital (as defined)
to Tangible assets (as defined). Management believes, as of March 31, 1998, that
the Company and the Bank meets all capital adequacy requirements to which they
are subject.
55
<PAGE>
As of March 31, 1998, the most recent notification from the Office of Thrift
Supervision categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 and
Tangible capital ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollar amounts in Thousands)
<S> <C> <C> <C> <C> <C> <C>
As of March 31, 1998:
Total Capital (to Risk Weighted Assets):
Consolidated $64,865 41.53% $12,494 >/=8.0% N/A N/A
Bank 40,991 26.25 12,494 >/=8.0 $15,617 >/=10.0%
Core Capital (to Adjusted Tangible Assets):
Consolidated 62,908 21.45 11,732 >/=4.0 N/A N/A
Bank 39,034 13.31 11,732 >/=4.0 14,665 >/=5.0
Tangible Capital (to Tangible Assets):
Consolidated 62,908 21.45 N/A N/A N/A N/A
Bank 39,034 13.31 4,399 >/=1.5 N/A N/A
Tier 1 Capital (to Risk Weighted Assets):
Consolidated 62,908 40.28 6,246 >/=4.0 N/A N/A
Bank 39,034 24.99 6,246 >/=4.0 9,370 >/=6.0
As of March 31, 1997:
Total Capital (to Risk Weighted Assets) $20,708 16.02% $10,341 >/=8.0% $12,927 >/=10.0%
Core Capital (to Adjusted Tangible Assets) 19,091 8.20 9,307 >/=4.0 11,634 >/=5.0
Tangible Capital (to Tangible Assets) 19,091 8.20 3,490 >/=1.5 N/A N/A
Tier 1 Capital (to Risk Weighted Assets) 19,091 14.76 5,173 >/=4.0 7,760 >/=6.0
</TABLE>
NOTE 11 - EMPLOYEE BENEFIT PLANS
All eligible officers and employees are included in noncontributory defined
benefit pension plan provided by the Company as a participating employer in the
Financial Institutions Retirement Fund (Fund), a multi-employer plan as defined
by Statement of Financial Accounting Standards No. 87. Employees are eligible to
participate in the Retirement Plan after the completion of 12 consecutive months
of employment with the Company and the attainment of age 21. Hourly paid
employees are excluded from participation in the Retirement Plan. Contributions
are based on individual employers' experience. According to the Fund's
administrators, as of June 30, 1997, the date of the latest actuarial valuation,
the market value of the Fund's net assets exceeded the actuarial present value
of vested and nonvested benefits in the aggregate, using an assumed rate of
return of 7.5%.
Defined benefit pension expense for the years ended March 31, 1998, 1997 and
1996 was $170, $177 and $167, respectively.
The Company sponsors a defined contribution plan, Financial Institutions Thrift
Plan (Thrift Plan), covering substantially all of its employees. Employees are
eligible to participate in the Thrift Plan upon the completion of 12 months of
continuous employment with the Company (during which period they complete at
least 1,000 hours of service) and the attainment of age 21. Employees paid on a
hourly basis are not eligible for participation. Thrift Plan contributions made
by the Company for the years ended March 31, 1998, 1997 and 1996 were $45, $34
and $29, respectively.
In the fiscal year ended March 31, 1997 the Company established a deferred
compensation benefit equalization plan for officers and employees designated by
management. The liability for such plan as of March 31, 1998 and 1997 was $766
and $697, respectively, and is included in other liabilities on the balance
sheets.
56
<PAGE>
In the year ended March 31, 1998 the Company distributed $704 to a Rabbi Trust
in connection with the deferred compensation benefit equalization plan. This
asset has been included in the Company's balance sheet as of March 31, 1998
under other assets because it is available to the general creditors of the
Company in the event of the Company's insolvency.
NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases space in three buildings under noncancelable operating leases
which expire in December 1998, February 2000 and February 2002. Rental expense
on these leases was $387, $358 and $354 for the years ended March 31, 1998, 1997
and 1996, respectively. The leases require minimum annual rental payments as
follows:
Year ended March 31, (In Thousands)
- --------------------
1999 $ 376
2000 340
2001 305
2002 280
-------
Total minimum lease payments $ 1,301
=======
NOTE 13 - FINANCIAL INSTRUMENTS
The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to originate loans, standby letters of
credit and unadvanced funds on loans. The instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
balance sheets. The contract amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby letters
of credit is represented by the contractual amounts of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments to originate loans are agreements to lend to a customer provided
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the borrower. Collateral held varies, but may
include secured interests in mortgages, accounts receivable, inventory,
property, plant and equipment and income-producing properties.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.
57
<PAGE>
The estimated fair values of the Company's financial instruments, all of which
are held or issued for purposes other than trading, are as follows as of March
31:
<TABLE>
<CAPTION>
1998 1997
------------------------------ ----------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(In Thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 49,513 $ 49,513 $ 3,617 $ 3,617
Available-for-sale securities 6,523 6,523 2,903 2,903
Held-to-maturity securities 4,272 4,274 13,553 13,306
Stock in Federal Home Loan Bank
of Boston 1,873 1,873 1,672 1,672
Loans, net 224,928 224,466 207,063 206,124
Loans held-for-sale 822 822 -- --
Accrued interest receivable 1,260 1,260 1,233 1,233
Financial liabilities:
Deposits 207,780 208,176 197,059 197,464
Federal Home Loan Bank advances 20,000 19,849 14,500 14,493
Other borrowed funds 2,176 2,176 1,065 1,065
</TABLE>
The carrying amounts of financial instruments shown in the above tables are
included in the consolidated balance sheets under the indicated captions.
Accounting policies related to financial instruments are described in Note 2.
Notional amounts of financial instrument liabilities with off-balance sheet
credit risk are as follows as of March 31:
1998 1997
-------- --------
Notional Notional
Amount Amount
------ ------
(In Thousands)
Commitments to originate loans $14,353 $10,795
Letters of credit -- 25
Unadvanced funds on loans:
Residential loans 503 1,279
Multi-family loans 186 --
Home equity loans 2,753 1,199
Commercial loans 1,707 578
Construction loans 2,534 1,349
------- -------
$22,036 $15,225
======= =======
There is no material difference between the notional amount and the estimated
fair value of loan commitments and unadvanced portions of loans.
The Company has no derivative financial instruments subject to the provisions of
SFAS No. 119, "Disclosure About Derivative Financial Instruments and Fair Value
of Financial Instruments."
NOTE 14 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Company's business activity is with customers located within the
state. There are no concentrations of credit to borrowers that have similar
economic characteristics. The majority of the Company's loan portfolio is
comprised of loans collateralized by real estate located in the state of
Massachusetts.
58
<PAGE>
NOTE 15 - MERGER WITH UNION FEDERAL SAVINGS BANK
On February 21, 1997 Union Federal Savings Bank (Union), a mutual entity, was
merged with and into Bay State Federal Savings Bank (Bay State). The merger was
accounted for as a pooling of interests, and accordingly, the accompanying
consolidated financial statements include the accounts and operations of Union
for all periods prior to the merger.
Separate results of the combining entities are as follows:
Bay State Union Combined
--------- ----- --------
(In Thousands)
April 1, 1996 to February 20, 1997
Net interest and dividend income $6,372 $1,257 $7,629
Net income 1,177 56 1,233
Year ended March 31, 1996
Net interest and dividend income 6,683 1,442 8,125
Net income 1,513 171 1,684
Union's fiscal years ended on December 31. The restated financial statements
reflect a change in fiscal years for Union to March 31, to conform to Bay
State's presentation.
NOTE 16 - CONVERSION TO FEDERALLY CHARTERED CAPITAL STOCK SAVINGS BANK
On September 9, 1997, the Board of Directors of the Bank approved a Plan of
Conversion for Bay State Federal Savings Bank ("Plan"). Under the Plan the Bank
converted from a federally-chartered mutual savings bank to a
federally-chartered capital stock savings bank. As of March 31, 1998 all of the
stock of the Bank is held by the Company.
The Company issued 2,535,232 shares of its common stock through a public
offering which provided net proceeds of $49,024 after costs of $1,681.
Pursuant to the Plan, the Company established a Charitable Foundation
("Foundation") in connection with the Conversion. Under the Plan, the Bank and
the Company donated an amount of the Company's common stock equal to 8% of the
common stock sold in the Conversion. The Foundation is dedicated to charitable
purposes within the communities in which the Bank operates and to complement the
Bank's existing community activities.
The Foundation has submited a request to the Internal Revenue Service to be
recognized as a tax-exempt organization and will likely be classified as a
private foundation. A contribution of common stock to the Foundation by the
Company is tax deductible, subject to a limitation based on 10 percent of the
Company's annual taxable income. The Company, however, will be able to carry
forward any unused portion of the deduction for five years following the
contribution. Upon funding the Foundation, the Company recognized an expense in
the full amount of the contribution, offset in part by the corresponding tax
deduction.
At the time of the Conversion, the Bank established a liquidation account in an
amount equal to its equity as reflected in the latest balance sheet used in the
final conversion prospectus. The liquidation account will be maintained for the
benefit of eligible account holders and supplemental eligible account holders
who continue to maintain their accounts at the Bank after the conversion. The
liquidation account will be reduced annually to the extent that eligible account
holders and supplemental eligible account holders have reduced their qualifying
deposits as of each anniversary date. Subsequent increases will not restore an
eligible account holder's or supplemental eligible account holder's interest in
the liquidation account. In the event of a complete liquidation of the Bank,
each eligible account holder and supplemental eligible account holder will be
entitled to receive a distribution from the liquidation account in an amount
proportionate to the current adjusted qualifying balances for accounts then
held.
The balance of the liquidation account was $12,871 as of March 31, 1998.
After the conversion, the Bank may not declare or pay dividends on its stock if
such declaration and payment would violate statutory or regulatory requirements.
59
<PAGE>
NOTE 17 - STOCK-BASED COMPENSATION
As of March 31, 1998 the Company plans to adopt two stock-based compensation
plans.
Stock Program. The Company intends to adopt the Stock Program which would
provide for the granting of Common Stock to directors, officers and employees of
the Company and its affiliates and seek stockholder approval of such plans at a
meeting of stockholders following the Conversion which, under current OTS
regulations, may be held no earlier than six months after completion of the
Conversion. Assuming the receipt of stockholder approval, the Company expects to
acquire Common Stock on behalf of the Stock Program in an amount equal to 4% of
the Common Stock issued in the Conversion, including shares issued to the
Foundation, or 101,409 shares. These shares will be acquired either through open
market purchases by a trust established for the Stock Program or contributed by
the Company from authorized but unissued Common Stock.
Although no specific award determinations have been made, the Company
anticipates that it will provide awards to the directors, officers and employees
to the extent permitted by applicable regulations. Current OTS regulations
provide that, with respect to any such benefit plan which is implemented within
one year after consummation of the Conversion, no individual may receive more
than 25% of the shares of any such plan and non-employee directors may not
receive more than 5% individually, or 30% in the aggregate, of the shares
awarded under any such plan. Common Stock awarded under the Stock Program will
be awarded at no cost to the recipients. Under the terms of the Stock Program,
an independent trustee will vote unallocated shares in the same proportion as it
receives instructions from recipients with respect to allocated shares which
have not been earned and distributed. The trustee will not vote allocated shares
which have not been distributed if it does not receive instructions from the
recipient. The specific terms of the Stock Program intended to be adopted and
the amounts of awards thereunder have not yet been determined by the Board of
Directors and any such determination will consider various factors, including
but not limited to, the financial condition of the Company, current and past
performance of plan participants and tax and securities law and regulation
requirements. The stock-based benefits provided under the Stock Program and
Stock Option Plan discussed below, may be provided under separate stock program
plans and stock option plans for officers, employees and directors or such
benefits may be provided for under a single master stock-based benefit plan
adopted by the Company which would incorporate the benefits and features in the
separate plans (the "Master Stock-Based Benefit Plan"). The award of Common
Stock under the Stock Program will be an additional compensation expense to the
Company and, accordingly, may result in an increase in the overall compensation
expense in future periods.
Stock Option Plan. The Company also intends to adopt the Stock Option Plan which
would provide to officers, employees and directors of the Company and its
affiliates options to purchase Common Stock. The Company intends to seek
stockholder approval of such plan at a meeting of stockholders following the
Conversation, which under current OTS regulations may be held no earlier than
six months after completion of the Conversion. Although no specific
determinations have been made, assuming the receipt of stockholder approval, the
Company expects that employees, officers and directors will be granted options
to purchase an amount of authorized but unissued Company Stock or treasury
stock, if any, equal to 10% of the Common Stock issued in the Conversion,
including shares issued to the Foundation, or 253,232 shares. Under the Stock
Option Plan, the exercise price of options will be at least equal to the fair
market value of underlying Common Stock on the date of grant. Such options will
permit such officers, employees and directors to benefit from any increase in
the market value of the shares in excess of the exercise price at the time of
exercise. Officers, employees and directors receiving such options will not be
required to pay for the shares until the date of exercise. The specific terms of
the Stock Option Plan intended to be adopted and amounts and awards thereunder
have not yet been determined by the Board of Directors and any such
determination will consider various factors, including but not limited to, the
financial condition of the Company, current and past performance of award
recipients and tax and securities law and regulation requirements. The Stock
Options discussed above may be provided under the Stock Option Plan, may be
provided under separate plans for officers, employees and directors or under the
Master Stock-Based Benefit Plan which would incorporate the features and
benefits of the separate plans. Although no specific award determinations have
been made, the Company anticipates that it will provide awards to the directors,
officers and employees to the extent permitted by applicable regulations.
Current OTS regulations provide that, with respect to any such benefit plan
which is implemented within one year after consummation of the Conversion, no
individual may receive more than 25% of the shares of any such plan and
non-employee directors may not receive more than 5% individually, or 30% in the
aggregate, of the shares awarded under any such plan.
60
<PAGE>
The award and exercise of stock options will result in additional compensation
expense to the Company and, accordingly, may result in an increase in the
overall compensation expense in future periods.
NOTE 18 - EMPLOYEE STOCK OWNERSHIP PLAN
On March 27, 1998 (the Conversion date) the Company adopted the Bay State
Federal Savings Bank Employee Stock Ownership Plan (ESOP) that became effective
as of April 1, 1997. On March 27, 1998 the ESOP purchased 202,818 shares of the
common stock of the Company. To fund the purchases, the ESOP borrowed $4,056
from Bay State Funding Corporation, a subsidiary of the Company. The borrowing
is at an interest rate of 8.5% and is to be repaid in ten equal installments of
$615 commencing on March 31, 1998 through March 31, 2007. The collateral for the
borrowing is the common stock of the Company purchased by the ESOP.
Contributions by the Company to the ESOP are discretionary, however, the Company
intends to make annual contributions to the ESOP in an aggregate amount at least
equal to the principal and interest requirements on the debt. The shares of
stock of the Company are held in a suspense account until released for
allocation among participants. The shares will be released annually from the
suspense account and the released shares will be allocated among the
participants on the basis of the participant's compensation for the year of
allocation. Participants will vest in their ESOP account at a rate of 20%
annually. As any shares are released from collateral, the Company reports
compensation expense equal to the current market price of the shares and the
shares will be outstanding for earnings-per-share purposes. The shares not
released are reported as unearned ESOP shares in the stockholders' equity
section of the balance sheet. ESOP expense of the year ended March 31, 1998 was
$600. The ESOP shares as of March 31, 1998 were as follows:
Allocated shares 0
Shares released for allocation 20,282
Unreleased shares 182,536
-------
Total ESOP shares 202,818
=======
Fair value of unreleased shares $5,453
=======
NOTE 19 - CONTRIBUTION TO CHARITABLE FOUNDATION
On March 27, 1998, the Company contributed 187,795 shares of its common stock to
The Bay State Federal Savings Charitable Foundation (Foundation). The
contribution has been reflected as an expense of the Company at the conversion
issue price of $20.00 per share. The Foundation directors are also officers of,
or members of the Board of the Company or the Bank.
NOTE 20 - EMPLOYMENT AGREEMENTS AND SEVERANCE PLAN
Upon regulatory approval, the Bank and the Company intend to enter into
employment agreements with its President and Executive Vice President. The
employment agreements would provide for the continued payment of specified
compensation and benefits for specified periods. The agreements would also
provide for termination by the Company for cause (as defined in the agreements)
at any time. The employment agreements would provide for the payment, under
certain circumstances, of amounts upon termination following a "change in
control" as defined in the agreements. The agreements would also provide for
certain payments in the event of the officers' termination for other than cause
and in the case of voluntary termination.
Upon regulatory approval, the Bank and the Company intend to enter into
change-in-control agreements with certain officers, none of who are covered by
an employment agreement. The agreements would provide that in the event
voluntary or involuntary termination follows a change in control of the Bank or
the company, the officer would be entitled to a severance payment equal to two
times the officers annual compensation.
The Bank's Board of Directors intends to, upon regulatory approval, establish a
severance plan which will provide eligible employees with severance pay benefits
in the event of a change in control of the Bank or the Company. Management
personnel with employment or change in control agreements are not eligible to
participate in the severance plan. The benefit is equal to one-twelfth of annual
compensation for each year of service up to a maximum of 199% of annual
compensation.
61
<PAGE>
NOTE 21 - EARNINGS PER SHARE
Earnings per share data have not been presented because such data would not be
meaningful given the short period during which common stock was outstanding.
NOTE 22 - RECLASSIFICATION
Certain amounts in the prior years have been reclassified to be consistent with
the current year's statement presentation.
62
<PAGE>
NOTE 23 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following financial statements are for Bay State Bancorp, Inc. (Parent
Company Only) and should be read in conjunction with the consolidated financial
statements of Bay State Bancorp, Inc. and Subsidiaries.
BAY STATE BANCORP, INC.
(Parent Company Only)
Balance Sheet
(Dollars in Thousands)
March 31,
ASSETS 1998
-----------
Cash $ 13
Federal funds sold 18,575
--------
Cash and cash equivalents 18,588
Investment in subsidiary, Bay State Federal Savings Bank 39,700
Investment in subsidiary, Bay State Funding Corp. 4,056
Deferred tax asset 1,203
Other assets 93
--------
Total assets $ 63,640
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 66
Stockholders' equity 63,574
--------
Total liabilities and stockholders' equity $ 63,640
========
Income Statement
For the period from March 28, 1998 to March 31, 1998
Interest income $ 15
--------
Expenses:
Contribution of shares to The Bay State Federal Savings
Charitable Foundation at the conversion issued price 3,756
Other expense 70
--------
Total expenses 3,826
--------
Loss before income tax benefit and equity in undistributed net
income of subsidiary (3,811)
Income tax benefit (1,295)
--------
Loss before equity in undistributed net income of subsidiary (2,516)
Equity in undistributed net income of subsidiary, Bay State Federal
Savings Bank 36
--------
Net loss $ (2,480)
========
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<PAGE>
BAY STATE BANCORP, INC.
(Parent Company Only)
Statement of Cash Flows
For the period from March 28, 1998 to March 31, 1998
(Dollars in Thousands)
Cash flows from operating activities:
Net loss $ (2,480)
Adjustments to reconcile net income to net cash
provided by operating activities:
Contribution of shares to The Bay State Federal
Savings Charitable Foundation 3,756
Appreciation in fair value of ESOP shares 195
Increase in taxes receivable (93)
Deferred tax benefit (1,203)
Increase in accrued expenses 66
Undistributed net income of subsidiary (36)
--------
Net cash provided by operating activities 205
--------
Cash flows from investing activities:
Investment in subsidiary, Bay State Federal Savings Bank (22,829)
Investment in subsidiary, Bay State Funding Corp. (4,056)
--------
Net cash used in investing activities (26,885)
--------
Cash flows from financing activities:
Proceeds from issuance of common stock 46,949
Costs relating to issuance of common stock (1,681)
--------
Net cash provided by financing activities 45,268
--------
Net increase in cash and cash equivalents 18,588
Cash and cash equivalents at beginning of period --
--------
Cash and cash equivalents at end of period $ 18,588
========
64
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures.
None.
65
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act.
MANAGEMENT OF THE COMPANY
Directors of the Company
The Board of Directors' of the Company currently consists of nine members
each of whom is also a director of the Bank. The Board of Directors is divided
into three classes, each of which contains one-third of the Board. The directors
shall be elected by the stockholders of the Company for staggered three year
terms, or until their successors are elected and qualified. One class of
directors, consisting of Messrs. Robert B. Cleary, Jerome R. Dangel and Kent T.
Spellman, has a term of office expiring at the first annual meeting of
stockholders, a second class, consisting of Messrs. Leo F. Grace, H. Chester
Webster and Richard F. Hughes, has a term of office expiring at the second
annual meeting of stockholders and a third class, consisting of Messrs. John F.
Murphy, Richard F. McBride and Denise M. Renaghan, has a term of office expiring
at the third annual meeting of stockholders. Their names and biographical
information are set forth under "Management of the Bank--Directors."
Executive Officers of the Company
The following individuals are the executive officers of the Company and
hold the offices set forth below opposite their names.
<TABLE>
<CAPTION>
Name Age(1) Position(s) Held With Company
- ---------------------------- ------ -------------------------------------------------------------
<S> <C> <C>
John F. Murphy.............. 58 President, Chief Executive Officer, Treasurer and Chairman of
the Board
Denise M. Renaghan.......... 41 Executive Vice President and Chief Operating Officer
Michael O. Gilles(2)........ 38 Senior Vice President and Chief Financial Officer
Jill W. MacDougall(3)....... 33 Corporate Secretary
</TABLE>
- ---------------
(1) As of March 31, 1998.
(2) Michael O. Gilles was named Senior Vice President and Chief Financial
Officer of the Company and Bank, effective April 23, 1998.
(3) Jill W. MacDougall was appointed Secretary of the Company and the Bank,
effective April 23, 1998.
The executive officers of the Company are elected annually and hold office
until their respective successors have been elected and qualified or until
death, resignation or removal at the discretion of the Board of Directors.
Except for directors' meeting fees, since the formation of the Company,
none of the executive officers, directors or other personnel has received
remuneration from the Company. Information concerning the principal occupations,
employment and other information concerning the directors and officers of the
Company during the past five years is set forth under "Management of the
Bank--Biographical Information."
66
<PAGE>
MANAGEMENT OF THE BANK
Directors of the Bank
The following table sets forth certain information regarding the Board of
Directors of the Bank.
<TABLE>
<CAPTION>
Director Term
Name Age(1) Position(s) Held With the Bank Since Expires
- ---- ------ --------------------------------------------- ------- -------
<S> <C> <C> <C> <C>
John F. Murphy.............. 58 President, Chief Executive Officer, Treasurer 1975 2001
and Chairman of the Board of Directors
Robert B. Cleary............ 61 Director 1987 2000
Jerome R. Dangel............ 54 Director 1996 2000
Leo F. Grace................ 66 Director 1997(2) 2000
Richard F. Hughes........... 66 Director 1997(2) 2001
Richard F. McBride.......... 69 Director 1994 2001
Kent T. Spellman............ 49 Director 1988 1999
H. Chester Webster.......... 87 Director 1959 1999
Denise M. Renaghan.......... 41 Director, Executive Vice President and Chief 1997(3) 2001
Operating Officer
</TABLE>
- ----------
(1) As of March 31, 1998.
(2) Former director of Union Federal Savings Bank who was named to the Bank's
Board of Directors effective the date of the merger of the Bank and Union
Federal.
(3) Ms. Renaghan was elected as a director in December 1997. In May 1998, Ms.
Renaghan was elected to the Board of Directors of the Company, filling the
vacancy created by the death of C. Brendan Noonan who passed away on
February 1, 1998. Until the time of his death, Mr. Noonan was a director of
both the Bank and the Company.
Executive Officer of the Bank who is not a Director
The following table sets forth certain information regarding the executive
officer of the Bank who is not a director.
<TABLE>
<CAPTION>
Name Age(1) Position(s) Held With the Bank
- ----------------- ------ -------------------------------------------------
<S> <C> <C>
Michael O. Gilles 38 Senior Vice President and Chief Financial Officer
</TABLE>
- --------------------
(1) As of March 31, 1998.
The executive officer of the Bank will retain his office until his
re-election at the annual meeting of the Board of Directors of the Bank, held
immediately after the first annual meeting of stockholders, and until his
successor is elected and qualified or until he is removed or replaced. Officers
are subject to re-election by the Board of Directors annually.
Biographical Information
Directors
John F. Murphy joined the Bank in 1961 and served in various positions
until 1976, when he was named President and Chief Executive Officer of the Bank.
In 1994, he was also named treasurer of the Bank. In 1996, Mr. Murphy was
elected Chairman of the Board of Directors. He has been a member of the Board of
Directors since 1975. Mr. Murphy is a director of Connecticut On-Line Computer
Center Trust and is a member of the Legislative,
67
<PAGE>
Secondary Market and Federal Home Loan Bank System Committees and the Government
Affairs Council of the America's Community Bankers. He is a past president of
the New England League of Savings Institutions and a former director of the
Federal Home Loan Bank of Boston. Mr. Murphy received a Bachelor of Science from
Northeastern University.
Robert B. Cleary has been principal of the Robert Cleary Insurance Group, a
provider of life, property and casualty insurance and financial planning,
located in Boston, for approximately forty years. He has been a member of the
Board of Directors since 1987.
Jerome R. Dangel is President of Investment Properties LTD, a real estate
investment firm located in Newton, Massachusetts. He has been a member of the
Board of Directors since October 1996.
Leo F. Grace was President, Chief Executive Officer and Chairman of the
Board of Directors of Union Federal Savings Bank of Boston from 1968 until the
merger of Union Federal with the Bank in February 1997. He joined Union Federal
Savings Bank in 1956 and was a director of Union Federal from 1957 until the
merger, when he joined the Board of Directors of the Bank. He currently serves
as a consultant to the Bank.
Richard F. Hughes is the founder and President of Hughes & Associates,
Inc., an organizational and management consulting firm located in Quincy,
Massachusetts. Mr. Hughes was a director of Union Federal from 1993 until the
merger with the Bank, when he became a director of the Bank.
Richard F. McBride is the owner of R.F. McBride Insurance Agency and H. R.
McBride Realtor, both of which are located in Watertown, Massachusetts. Mr.
McBride has been a director of the Bank since 1994.
Kent T. Spellman is founder and President of Telluride Clothing
Corporation., Inc., a branded clothing wholesaler, located in Needham,
Massachusetts. He is also a general partner of several partnerships holding
commercial real estate. Mr. Spellman has been a director of the Bank since 1988.
H. Chester Webster was President of the Bank from 1959 until his retirement
in 1976. He has served on the Bank's Board of Directors since 1959 and served as
Chairman of the Board from 1988 to 1996.
Denise M. Renaghan joined the Bank in 1974 and has served in various
positions since that time. In 1994, she was promoted to Senior Vice President
and Chief Operating Officer and, in January 1997, she was named Executive Vice
President and Chief Operating Officer. Ms. Renaghan became a member of the Board
of Directors of the Bank in December 1997. Ms. Renaghan is a member of the
Education Committee of America's Community Bankers, the Board of Directors of
the Brookline Chamber of Commerce, the Loan Committee of the Connecticut On-Line
Computer Center, and the Massachusetts Mortgage Bankers Association. She is a
past president and currently a member of the Financial Managers Society and is a
past president of the Brookline Consortium for Community Housing.
Executive Officer Who is Not a Director
Michael O. Gilles is Senior Vice President and Chief Financial Officer of
the Bank and the Company. From January of 1997 to February of 1998, Mr. Gilles
was Senior Vice President, Treasurer and Chief Financial Officer of
Cambridgeport Bank, a mutual savings bank located in Cambridge, Massachusetts.
Prior to that, Mr. Gilles was the Executive Vice President, Treasurer and Chief
Financial Officer of Walden Bancorp, Inc., a publicly traded multi-bank holding
company located in Acton, Massachusetts. Mr. Gilles is a certified management
accountant, a member of the American Management Association, and is currently an
officer of the Boston Chapter of the Financial Managers Society.
68
<PAGE>
Item 10. Executive Compensation.
Compensation of Directors of the Bank and Company
All directors of the Bank are currently paid an annual retainer of $4,000
and receive a fee of $500 for each regularly scheduled monthly and special Board
meeting attended. Members of the Executive Committee of the Bank additionally
receive an annual retainer of $4,000 and a fee of $500 for each meeting
attended. For fiscal 1998, there were 2 special meetings of the Board of
Directors and 12 meetings of the Executive Committee. All directors of the
Company will be paid an annual retainer fee of $4,000.
Summary Compensation Table
The following table sets forth the cash compensation paid by the Bank as
well as other compensation paid or accrued for services rendered in all
capacities during the fiscal years ended March 31, 1998, 1997 and 1996, to the
Chief Executive Officer and the highest paid executive officer of the Bank who
received salary and bonus in excess of $100,000 ("Named Executive Officers").
<TABLE>
<CAPTION>
Long-Term Compensation
------------------------------------
Annual Compensation(1) Awards Payouts
---------------------------------- ------------------------- -------
Other Restricted Securities
Annual Stock Underlying LTIP All Other
Name and Fiscal Salary Bonus Compensation Awards Options/SARs Payouts Compensation
Principal Positions Year ($) ($) ($)(2) ($)(3) (#)(4) ($) (5) ($)(6)
- --------------------------- ------ -------- ------- ----------- ---------- ----------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John F. Murphy
President, Chief 1998 $241,223 $60,000 -- -- -- -- $147,450
Executive Officer 1997 228,813 82,145 -- -- -- -- 29,093
and Treasurer .............. 1996 213,701 30,025 -- -- -- -- 28,829
Denise M. Renaghan
Executive Vice 1998 $136,000 $39,846 -- -- -- -- $7,473
President and Chief 1997 116,640 58,325 -- -- -- -- 7,206
Operating Officer........... 1996 108,000 16,200 -- -- -- -- 3,060
</TABLE>
- ----------
(1) Under Annual Compensation, the column titled "Salary" includes directors'
fees for Mr. Murphy and Ms. Renaghan.
(2) For fiscal years 1998, 1997 and 1996, there were no (a) perquisites over
the lesser of $50,000 or 10% of the individual's total salary and bonus for
the year; (b) payments of above-market preferential earnings on deferred
compensation; (c) payments of earnings with respect to long-term incentive
plans prior to settlement or maturation; (d) tax payment reimbursements; or
(e) preferential discounts on stock. For fiscal years 1998, 1997 and 1996,
the Bank had no restricted stock or stock related plans in existence.
(3) Does not include awards pursuant to the Stock Program, which may be granted
in conjunction with a meeting of stockholders of the Company to be held no
sooner than six months after the Conversion, subject to OTS and stockholder
approval, as such awards were not earned, vested or granted in fiscal years
1998, 1997 and 1996. For a discussion of the terms of the Stock Program,
see "--Benefits--Stock Program." For fiscal years 1998, 1997 and 1996, the
Bank had no restricted stock plans in existence.
(4) No stock options or SARs were earned or granted in fiscal years 1998, 1997
and 1996. For a discussion of the Stock Option Plan which is intended to be
adopted by the Company, see "--Benefits--Stock Option Plan."
(5) For fiscal years 1998, 1997 and 1996, there were no payouts or awards under
any long-term incentive plan.
(6) Other Compensation includes matching contributions under the Bank's 401(a)
Plan of $6,450 for Mr. Murphy, and $3,573 for Ms. Renaghan, and life
insurance premiums of $141,000 for Mr. Murphy and $3,900 for Ms. Renaghan
for fiscal year 1998. Such life insurance policies provide that Mr. Murphy
and Ms. Renaghan may receive a benefit, if any, equal to the difference
between the cash surrender value of the policy and the premiums paid by the
Bank.
Employment Agreements
Upon regulatory approval, the Bank and the Company intend to enter into
employment agreements (collectively, the "Employment Agreements") with Mr.
Murphy and Ms. Renaghan (individually, the "Executive"). Review of compensation
arrangements by the OTS does not indicate, and should not be construed to
indicate, that the
69
<PAGE>
OTS has passed upon the merits of such arrangements. The Employment Agreements
are intended to ensure that the Bank and the Company will be able to maintain a
stable and competent management base. The continued success of the Bank and the
Company depends to a significant degree on the skills and competence of Mr.
Murphy and Ms. Renaghan.
The Employment Agreements provide for a three-year term for each Executive
and are renewable on an annual basis, unless written notice of non-renewal is
given by the Board of Directors after conducting a performance evaluation of the
Executive. The terms of the Company Employment Agreements shall be extended on a
daily basis unless written notice of non-renewal is given by the Board of the
Company. The Bank and the Company Employment Agreements provide that the
Executive's base salary will be reviewed annually. The base salaries, which will
be effective for such Employment Agreements for Mr. Murphy and Ms. Renaghan will
be $250,000 and $150,000, respectively. In addition to the base salary, the
Employment Agreements provide for, among other things, participation in stock
benefits plans and other fringe benefits applicable to similarly situated
executive personnel. The Employment Agreements provide for termination by the
Bank or the Company for cause (as defined in the agreements) at any time. In the
event the Bank or the Company chooses to terminate the Executive's employment
for reasons other than for cause, or in the event of the Executive's resignation
from the Bank and the Company upon (i) the failure to re-elect the Executive to
his/her current offices; (ii) a material change in the Executive's functions,
duties or responsibilities; (iii) a relocation of the Executive's principal
place of employment by more than 25 miles; (iv) liquidation or dissolution of
the Bank or the Company; or (v) a breach of the Employment Agreements by the
Bank or the Company; the Executive or, in the event of death, the Executive's
beneficiary would be entitled to receive an amount equal to the remaining base
salary payments due to the Executive and the contributions that would have been
made on the Executive's behalf to any employee benefit plans of the Bank or the
Company during the remaining term of the Employment Agreements. The Bank and the
Company would also continue and pay for the Executive's life, health and
disability coverage for the remaining term of the Employment Agreement. Upon any
termination of the Executive, the Executive is subject to a covenant not to
compete with the Company or the Bank for one year.
Under the agreements, if voluntary or involuntary termination follows a
change in control of the Bank or the Company, the Executive or, in the event of
the Executive's death, the Executive's beneficiary would be entitled to a
severance payment equal to the greater of: (i) the payments due for the
remaining terms of the agreement; or (ii) three times the average of the five
preceding taxable years' annual compensation. The Bank and the Company would
also continue the Executive's life, health, and disability coverage for
thirty-six months following the change in control. Notwithstanding that both
Employment Agreements provide for a severance payment in the event of a change
in control, the Executive would only be entitled to receive a severance payment
under one agreement. In the event of a change in control of the Bank or Company,
the total amount of payments due under the Agreements, based solely on the base
salaries to be paid Mr. Murphy and Ms. Renaghan effective upon the consummation
of the Conversion and excluding any benefits under any employee benefit plan
which may be payable, would be approximately $1.2 million.
Payments to the Executive under the Bank employment agreement will be
guaranteed by the Company in the event that payments or benefits are not paid by
the Bank. Payment under the Company Employment Agreements would be made by the
Company. All reasonable costs and legal fees paid or incurred by the Executive
pursuant to any dispute or question of interpretation relating to the Employment
Agreements shall be paid by the Bank or Company, respectively, if the Executive
is successful on the merits pursuant to a legal judgment, arbitration or
settlement. The Employment Agreements also provide that the Bank and Company
shall indemnify the Executive to the fullest extent allowable under federal and
Delaware law, respectively. The terms of the agreements as described herein may
be revised as a result of OTS review.
70
<PAGE>
Change in Control Agreements
Upon regulatory approval, the Company and the Bank intend to enter into
Change in Control Agreements (the "CIC Agreements") with certain officers of the
Company and the Bank, none of whom will be covered by an Employment Agreement.
The CIC Agreements provide for either a two-year or three-year term and are
renewable on an annual basis. The CIC Agreements will provide that in the event
voluntary or involuntary termination follows a change in control of the Bank or
the Company, the officer would be entitled to receive a severance payment equal
to two times (or three times, as the case may be) the officer's compensation for
the twelve months preceding termination. The Bank would also continue and pay
for the officer's life, health and disability coverage for 24 or 36 months (as
the case may be) following termination. Payments to the officer under the CIC
Agreements will be guaranteed by the Company in the event that payments or
benefits are not paid by the Bank. In the event of a change in control of the
Bank or Company, the total payments that would be due under the CIC Agreement,
based solely on the current annual compensation paid to the officers covered by
the CIC Agreement and excluding any benefits under any employee benefit plan
which may be payable, would be approximately $1.3 million.
Employee Severance Compensation Plan
The Bank's Board of Directors intends to, upon regulatory approval,
establish the Bay State Federal Savings Bank Employee Severance Compensation
Plan ("Severance Plan") which will provide eligible employees with severance pay
benefits in the event of a change in control of the Bank or the Company.
Management personnel with employment or CIC agreements are not eligible to
participate in the Severance Plan. Generally, employees are eligible to
participate in the Severance Plan if they have completed at least one year of
service with the Bank. The Severance Plan vests in each participant a
contractual right to the benefits such participant is entitled to thereunder.
Under the Severance Plan, in the event of a change in control of the Bank or the
Company, eligible employees who are terminated from or terminate their
employment within one year after the change in control (for reasons specified
under the Severance Plan), will be entitled to receive a severance payment. A
participant, whose employment has terminated, will be entitled to a cash
severance payment equal to one-twelfth of annual compensation for each year of
service up to a maximum of 199% of annual compensation. Such payments may tend
to discourage takeover attempts by increasing costs to be incurred by the Bank
in the event of a takeover. In the event the provisions of the Severance Plan
were triggered, the total amount of payments that would be due thereunder, based
solely upon current salary levels, would be approximately $1.1 million.
Consulting Agreement
Pursuant to the Bank's merger with Union Federal in February 1997, the Bank
entered into a consulting agreement (the "Consulting Agreement") with Mr. Grace,
who at the time of the merger was Union Federal's President and Chief Executive
Officer. The agreement, which is for a three-year term, commenced on February
21, 1997 and provides that Mr. Grace be paid an annual amount of $127,000 for
consulting services to the Bank. The Consulting Agreement also provides for his
termination for cause (as defined in the consulting agreement) or without cause
upon a vote of the Board of Directors. During the term of the Consulting
Agreement and for a period of 12 months after the termination of the agreement,
Mr. Grace is subject to a covenant not to compete, either directly or
indirectly, with the Bank.
Insurance Plans
All full-time employees of the Bank, upon completion of the applicable
introductory period, may elect coverage for comprehensive hospitalization,
including major medical, and are covered with long-term disability insurance.
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<PAGE>
Benefits
Thrift Plan/Savings Plan. The Bank maintains the Financial Institutions
Thrift Plan (the "Thrift Plan"), a tax-qualified retirement plan, to encourage
eligible employees to save and invest on a regular, long term basis. The Thrift
Plan permits eligible employees to make monthly contributions of 1% - 15% of
their base monthly salary on an after-tax basis to the Thrift Plan. The Bank
makes monthly employer contributions to each participant's account in the Thrift
Plan equal to 50% of the participant's contribution up to 6% of the
participant's annual base salary. Participants are 100% vested in the amounts
credited to their Thrift Plan accounts. Participants in the Thrift Plan do not
recognize taxable income on Bank contributions or investment income credited to
their accounts under the Thrift Plan until such amounts are distributed to them.
During fiscal 1998, the Bank contributed $45,000 to the Thrift Plan.
Employees are eligible to participate in the Thrift Plan upon the
completion of 12 months of continuous employment with the Bank (during which
period they complete at least 1,000 hours of service) and the attainment of age
21. Employees paid on an hourly basis are not eligible for participation.
Currently, participants in the Thrift Plan may direct the investment of their
accounts in several types of investment funds including, but not limited to, an
Employer Stock Fund which invests in Company Common Stock. Participants
investing in the Employer Stock Fund may directly vote shares of Common Stock
held in their Thrift Plan accounts.
Retirement Plan. The Bank maintains the Financial Institutions Retirement
Fund (the "Retirement Plan") to provide retirement benefits for eligible
employees. Employees are eligible to participate in the Retirement Plan after
the completion of 12 consecutive months of employment with the Bank and the
attainment of age 21. Hourly paid employees are excluded from participation in
the Retirement Plan. Benefits payable to a participant under the Retirement Plan
are based on the participant's years of service and salary. The formula for
normal retirement benefits payable annually under the Retirement Plan is 2%
multiplied by years of benefit service multiplied by the average of the
participant's highest three years of salary paid by the Bank. A participant may
elect early retirement as early as age 45. However, such participant's normal
retirement benefits will be reduced by an early retirement factor based on age
at early retirement.
Participants generally have no vested interest in Retirement Plan benefits
prior to the completion of five years of service with the Bank. Following the
completion of five years of vesting service, or in the event of a participant's
attainment of age 65, death or termination of employment due to disability, a
participant will become 100% vested in the accrued benefit under the Retirement
Plan. The table below reflects the pension benefit payable and any payment due
under the Supplemental Retirement Plan, discussed below, to a participant
assuming various levels of earnings and years of service. The amounts of
benefits paid under the Retirement Plan are not reduced for any social security
benefit payable to participants. As of January 1, 1998, Mr. Murphy and Ms.
Renaghan had credited years of service of 32 years and 24 years, respectively.
Management Supplemental Executive Retirement Plan. The Bank intends to
implement a non-tax qualified Management Supplemental Executive Retirement Plan
("SERP") to provide certain officers and highly compensated employees with
additional retirement benefits. The SERP benefit is intended to make up benefits
lost under the ESOP allocation procedures to participants who retire prior to
the complete repayment of the ESOP loan. At the retirement of a participant, the
benefits under the SERP are determined by first: (i) projecting the number of
shares that would have been allocated to the participant under the ESOP if they
had been employed throughout the period of the ESOP loan (measured from the
participant's first date of ESOP participation); and (ii) reducing the number
determined by (i) above by the number of shares actually allocated to the
Participant's account under the ESOP; and second, by multiplying the number of
shares that represent the difference between such figures by the average fair
market value of the Common Stock over the preceding five years. Benefits under
the SERP vest in 20% annual increments over a five year period commencing as of
the date of a Participant's participation in the SERP. The vested portion of the
SERP Participant's benefits are payable upon the retirement of the Participant
upon or after the attainment of age 65 or in accordance with the requirements of
early retirement under the Retirement Plan. A separate trust may be
72
<PAGE>
established to hold assets of the Bank for the purpose of paying benefits under
the SERP or the Bank may hold assets for SERP payments through a common trust
established for the Retirement Benefit Equalization Plan discussed below.
Benefit Equalization Plan. The Bank has implemented a retirement benefit
equalization plan to provide selected employees with retirement benefits which
would have been payable under the Retirement Plan and Thrift Plan (the "Benefit
Equalization Plan" or "BEP"), but for the limits imposed by the Code on the
amount of compensation that may be considered when determining benefits that are
payable under tax-qualified plans ("Compensation Code Limit"). In connection
with the Conversion, the Bank amended the Benefit Equalization Plan to provide
participants with benefits which would be payable under the ESOP but for such
limits imposed by the Code discussed above.
A participant's annual benefit under the BEP equals the excess of the
annual benefit that would otherwise be payable to or on account of the
participant, but for the limitations imposed by the Code over the annual benefit
that is payable to or on account of the participant after giving effect to any
reduction of such benefit by the limitations imposed by the Code. The Bank has
established a grantor trust (also known as a "rabbi trust") to hold assets of
the Bank for the purpose of paying benefits under the BEP, provided that, in the
event of the insolvency of the Bank, the assets of the trust are subject to the
claims of the Bank's creditors. The assets of this trust may be used to acquire
shares of Common Stock to be used to satisfy the obligations of the Bank for the
payment of benefits under the BEP.
Employee Stock Ownership Plan and Trust. The Bank established the ESOP and
related trust for all eligible employees effective March 1998. Employees
employed with the Bank as of the effective date of the Conversion and employees
of the Company and the Bank employed after such date, who have been credited
with at least 1,000 hours of service during a 12-month period and who have
attained age 21 are eligible to become participants. The ESOP purchased 8% of
the Company Common Stock issued in the Conversion, including the issuance of
shares to the Foundation. In order to fund the ESOP's purchase of Company Common
Stock, the ESOP borrowed funds from a third-party lender, Bay State Funding
Corp., a wholly-owned subsidiary of the Company, equal to 100% of the aggregate
purchase price of the Company Common Stock. The ESOP trustee will repay the loan
principally from the Company's or the Bank's contributions to the ESOP over a
10-year period. Bay State Funding Corp. holds the Company Common Stock purchased
by the ESOP as collateral for the loan. Participants become 100% vested in their
ESOP benefits after five years of service, as well as upon death, permanent
disability, early retirement or a change in control.
Stock-Based Incentive Plan. Following the Conversion, the Board of
Directors of the Company intends to adopt the Stock-Based Incentive Plan which
will provide for the granting of stock options to purchase Common Stock ("Stock
Options"), Common Stock ("Stock Awards"), Limited Option Rights and Limited
Stock Rights to eligible officers, directors and employees of the Company and
the Bank. The Company may provide such stock based benefits under the
Stock-Based Incentive Plan or may establish one or more separate plans which
would provide for the benefits described herein. In the event the Stock-Based
Incentive Plan (or any separate plan(s)) is adopted within one year after
conversion, OTS regulations require such plan to be approved by a majority of
the Company's stockholders at a meeting of stockholders to be held no earlier
than six (6) months after the completion of the Conversion. Under the
Stock-Based Incentive Plan the Company intends to grant Stock Options in an
amount equal to 10% of the shares of Common Stock issued in the Conversion,
including shares issued to the Foundation (or 253,523 shares) and intends to
grant Stock Awards in an amount equal to 4% of the shares of Common Stock issued
in the Conversion, including shares issued to the Foundation (or 101,409
shares). Any Common Stock awarded under the Stock-Based Incentive Plan will be
awarded at no cost to the recipients. The plan may be funded through the
purchase of Common Stock by a trust established in connection with the
Stock-Based Incentive Plan (or any separate plan(s)) or from authorized but
unissued shares. The Board intends to appoint an independent fiduciary to serve
as trustee of a trust to be established in connection with the Stock-Based
Incentive Plan.
The grants of Stock Options and Stock Awards under the Stock-Based
Incentive Plan will be designed to attract and retain qualified personnel in key
positions, provide officers and key employees with a proprietary interest in the
Company as an incentive to contribute to the success of the Company and reward
key employees for outstanding
73
<PAGE>
performance. It is expected that the Committee administering the plan will
determine the terms and conditions of the awards. The Committee may condition
the granting or vesting of Stock Options and Stock Awards on the achievement of
individual or Company-wide performance goals, including the achievement by the
Company or the Bank of specified levels of net income, asset growth, return on
equity or other specific financial goals. In addition the Committee will
determine the type of options awarded (Incentive Stock Options or Non-Statutory
Stock Options), the exercise price of the options and the vesting schedule of
all Awards under the plan (subject to OTS Regulations). OTS Regulations provide
that no individual officer of employee of the Bank may receive more than 25% of
the Stock Options and 25% of the Stock Awards available under the Stock-Based
Incentive Plan and non-employee directors may not receive more than 5%
individually or 30% in the aggregate of the Stock Options and Stock Awards
available under the plan.
The Stock-Based Incentive Plan will provide for the grant of: (i) options
to purchase the Company's Common Stock intended to qualify as incentive stock
options under Section 422 of the Code ("Incentive Stock Options"); (ii) options
that do not so qualify ("Non-Statutory Stock Options"); and (iii) Limited Option
Rights (discussed below) which participants may exercise only in the event of a
change in control of the Bank or the Company. Only officers or employees of the
Bank and Company may receive Incentive Stock Options. Unless sooner terminated,
the plan will be in effect for a period of ten years from the earlier of
adoption by the Board of Directors or approval by the Company's stockholders.
The Company intends to grant options with Limited Rights at an exercise price
equal to the fair market value of the underlying Common Stock on the date of
grant. Subject to any applicable OTS regulations, upon exercise of "Limited
Option Rights" in the event of a change in control, the employee will be
entitled to receive a lump sum cash payment equal to the difference between the
exercise price of all unexercised options, whether then exercisable or not, and
the fair market value of the shares of common stock subject to the option on the
date of exercise of the right in lieu of purchasing the stock underlying the
option. It is anticipated that all options granted contemporaneously with
stockholder approval of the Stock-Based Incentive Plan will be intended to be
Incentive Stock Options to the extent permitted under Section 422 of the Code.
An individual will not be deemed to have received taxable income upon grant
or exercise of any Incentive Stock Option, provided that the employee does not
dispose of shares received through the exercise of such option for at least one
year after the date the employee receives the stock in connection with the
option exercise and two years after the date of grant of the option
("disqualifying disposition"). The Company may not take a compensation expense
deduction with respect to the grant or exercise of Incentive Stock Options,
unless the employee disposes such shares before the expiration of the period
described above (a "disqualifying disposition"). In the case of a Non-Statutory
Stock Option and in the case of a disqualifying disposition of an Incentive
Stock Option, an employee will be deemed to receive ordinary income upon
exercise of the stock option in an amount equal to the amount by which the
exercise price is exceeded by the fair market value of the Common Stock
purchased by exercising the option on the date of exercise. The amount of
taxable income realized by an optionee upon the exercise of a Non-Statutory
Stock Option or due to a disqualifying disposition of an Incentive Stock Option
is a deductible expense for tax purposes for the Company. Upon the exercise of a
Limited Right, the option holder realizes taxable income equal to the amount
paid to him or her upon exercise of the right and the Company receives a
deduction equal to that same amount.
The Stock-Based Incentive Plan will provide for the granting of Stock
Awards and Limited Stock Rights. Limited Stock Rights will be exercisable by a
recipient upon a change in control of the Company or Bank as described in the
plan. Subject to OTS Regulations, upon exercise of a Limited Stock Right, the
recipient will be entitled to receive a lump sum cash payment equal to the
difference of the fair market value of all unvested Stock Awards in exchange for
any rights to such unvested Stock Awards.
The vesting periods for awards under the Stock-Based Incentive Plan will be
determined by the Committee administering the Plan. If the Stock-Based Incentive
Plan (or any separate plans for employees and directors) is adopted within one
year after conversion, awards would become vested and exercisable subject to
applicable OTS regulations, which such regulations require that any awards begin
vesting no earlier than one year from the date of shareholder approval of the
plan and, thereafter, vest at a rate of no more than 20% per year and may not be
74
<PAGE>
accelerated except in the case of death or disability. In the event of death,
Stock Awards will become 100% vested. In the event of disability, Stock Awards
would be 100% vested upon termination of employment of an officer or employee,
or upon termination of service as a director. In the event of retirement, if the
participant continues to perform services as a Director or consultant on behalf
of the Bank, the Company or an affiliate or, in the case of a retiring Director,
as a consulting director, unvested Stock Awards would continue to vest in
accordance with their original vesting schedule until the recipient ceases to
perform such services at which time any unvested Stock Awards would lapse. In
the case of death or disability, Stock Options may be exercised for a period of
12 months. However, any Incentive Stock Options exercised more than three months
following the date the employee ceases to perform services as an employee would
be treated as a Non-Statutory Stock Option. In the event of retirement, if the
optionee continues to perform services as a director or consultant on behalf of
the Bank, the Company or an affiliate, unvested options would continue to vest
in accordance with their original vesting schedule until the optionee ceases to
serve as a consultant or director. In the event of death, disability or normal
retirement, the Company, if requested by the optionee, or the optionee's
beneficiary, could elect, in exchange for vested options, to pay the optionee,
or the optionee's beneficiary in the event of death, the amount by which the
fair market value of the Common Stock exceeds the exercise price of the options
on the date of the employee's termination of employment.
Applicable OTS regulations currently do not permit accelerated vesting in
the event of a change in control of Stock Awards or Stock Options granted under
the Stock-Based Incentive Plan described above. Subject to any applicable
regulatory requirements, the Stock-Based Incentive Plan may be amended
subsequent to the expiration of the one-year period following Conversion to
provide for accelerated vesting in the event of a change in control of Stock
Awards and Stock Options granted under the Stock-Based Incentive Plan. A change
in control is expected to be defined in the plan document and would generally
occur when a person or group of persons acting in concert acquires beneficial
ownership of 20% or more of a class of equity securities of the Company or the
Bank or in the event of a tender or exchange offer, merger or other form of
business combination, sale of all or substantially all of the assets of the
Company or the Bank or contested election of directors which results in the
replacement of a majority of the Board of Directors by persons not nominated by
the directors in office prior to the contested election.
When a participant becomes vested with respect to a Stock Award, the
participant will realize ordinary income equal to the fair market value of the
Common Stock at the time of vesting (unless the participant made an election
pursuant to Section 83(b) of the Code). The amount of income recognized by the
participant will be a deductible expense for tax purposes for the Bank. When
restricted Stock Awards become vested and are actually distributed to
participants, the participants would receive amounts equal to any accrued
dividends with respect thereto. Prior to vesting, recipients of Stock Awards
could direct the voting of the shares awarded to them. Shares not subject to
Stock Awards and shares allocated subject to the achievement of performance
goals will be voted by the trustee of the Stock-Based Incentive Plan in
proportion to the directions provided with respect to shares subject to Stock
Awards. Vested shares are distributed to recipients as soon as practicable
following the day on which they are vested.
Subject to any applicable regulatory requirements, the Stock-Based
Incentive Plan (or any separate plans for employees and directors) may be
amended subsequent to the expiration of the one-year period to provide for
accelerated vesting of previously granted Stock Options or Stock Awards in the
event of a change in control of the Company or the Bank. A change in control
would generally be considered to occur when a person or group of persons acting
in concert acquires beneficial ownership of 20% or more of any class of equity
security of the Company or the Bank or in the event of a tender or exchange
offer, merger or other form of business combination, sale of all or
substantially all of the assets of the Company or the Bank or contested election
of directors which resulted in the replacement of a majority of the Board of
Directors by persons not nominated by the directors in office prior to the
contested election.
75
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management.
Security Ownership of Beneficial Owners. The following table sets forth
information as to those persons believed by management to be beneficial owners
of more than 5% of the Company's outstanding shares of Common Stock as of May
31, 1998 or as disclosed in certain reports received to date regarding such
ownership filed by such persons with the Company and with the SEC, in accordance
with Sections 13(d) and 13(g) of the Securities Exchange Act of 1934, as amended
("Exchange Act"). Other than those persons listed below, the Company is not
aware of any person, as such term is defined in the Exchange Act, that owns more
than 5% of the Company's Common Stock as of March 31, 1998.
<TABLE>
<CAPTION>
Name and Address of
Title of Class Beneficial Owner Number of Shares Percent of Class
- -------------- ---------------------------------------- ---------------- ----------------
<S> <C> <C> <C>
Common Stock Bay State Federal Savings Bank Employee 202,818(1) 8.0%
Stock Ownership Plan
1299 Beacon Street
Brookline, Massachusetts 02146
Common Stock The Bay State Federal Savings Charitable 187,795(2) 7.4%
Foundation
1299 Beacon Street
Brookline, Massachusetts 02146
</TABLE>
(1) Shares of Common Stock were acquired by the ESOP in the Bank's conversion.
The ESOP Committee administers the ESOP. BankBoston, N.A. has been
appointed as the corporate trustee for the ESOP ("ESOP Trustee"). The ESOP
Trustee, subject to its fiduciary duty, must vote all allocated shares held
in the ESOP in accordance with the instructions of the participants. As of
March 31, 1998, 20,282 shares have been allocated to ESOP participants'
accounts. Under the ESOP, unallocated shares held in a suspense account
will be voted by the ESOP Trustee in a manner calculated to most accurately
reflect the instructions received from participants regarding the allocated
stock so long as such vote is in accordance with the provisions of ERISA.
(2) The Foundation was established and funded by the Company in connection with
the Bank's Conversion with an amount of the Company's Common Stock equal to
8.0% of the total amount of Common Stock sold in the Conversion. The
Foundation is a Delaware non-stock corporation and is dedicated to the
promotion of charitable purposes within the communities in which the Bank
operates. The Foundation is governed by a board of directors with four
members, all of whom are directors or officers of the Company or the Bank.
Pursuant to the terms of the contribution of Common Stock, as mandated by
the OTS, all shares of Common Stock held by the Foundation must be voted in
the same ratio as all other shares of the Company's Common Stock on all
proposals considered by shareholders of the Company.
76
<PAGE>
Security Ownership of Management. The following table sets forth the number
of shares of Common Stock beneficially owned by the Bank's executive officers
and directors as of May 31, 1998. The table also sets forth the beneficial
ownership of Common Stock as to all directors and executive officers as a group.
<TABLE>
<CAPTION>
Number Percent
of of
Title of Class Name Shares Class
- -------------- --------- ------ -----
<S> <C> <C> <C>
Common Stock John F. Murphy.................................... 12,529 0.49%
Common Stock Robert B. Cleary.................................. 1,000 0.04
Common Stock Jerome R. Dangel.................................. 20,413 0.81
Common Stock Leo F. Grace...................................... 11,250 0.44
Common Stock Richard F. Hughes................................. 2,850 0.11
Common Stock Richard F. McBride................................ 20,263 0.80
Common Stock Kent T. Spellman.................................. 36,780 1.45
Common Stock H. Chester Webster................................ 600 0.02
Common Stock Denise M. Renaghan................................ 5,991 0.24
Common Stock Michael O. Gilles ................................ 4,524 0.18
-------- ----
Common Stock All Directors and Executive Officers
as a Group (10 persons)......................... 116,200 4.58%
======== ====
</TABLE>
Item 12. Certain Relationships and Related Transactions.
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires that all loans or extensions of credit to executive officers and
directors must be made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions with
the general public and must not involve more than the normal risk of repayment
or present other unfavorable features. In addition, loans made to a director or
executive officer in excess of the greater of $25,000 or 5% of the Bank's
capital and surplus (up to a maximum of $500,000) must be approved in advance by
a majority of the disinterested members of the Board of Directors.
Prior to FIRREA, the Bank made loans to its executive officers and
Directors which were secured by their primary residences. The rates of interest
charged by the Bank on such loans were the Bank's cost of funds. Pursuant to
FIRREA, in 1989, the Bank discontinued its practice of making such preferential
loans to its officers and Directors. However, all such pre-FIRREA preferential
loans were "grandfathered" under FIRREA. Since the enactment of FIRREA, the Bank
has not made any loans to its executive officers or Directors. The Bank intends
to implement a policy whereby it will begin to again offer loans to executive
officers and Directors. Such loans, as well as loans made to Bank employees,
will be made on the same terms and conditions offered to the general public. If
the Bank implements a policy of extending credit to executive officers and
Directors, such policy will provide that all such loans will be made in the
ordinary course of business, on substantially the same terms, including
collateral, as those prevailing at the time for comparable transactions with
other persons and may not involve more than the normal risk of collectibility or
present other unfavorable features. As of March 31, 1998, the Bank had $4.4
million of loans to executive officers or Directors. With the exception of loans
to Messrs. Cleary and Murphy, which are secured by mortgage liens on their
primary residences and, at March 31, 1998, had balances of $515,000 and
$387,000, respectively, all other of the Bank's loans to executive officers and
Directors had balances of less than $60,000 as of March 31, 1998 or were made by
the Bank in the ordinary course of business with no favorable terms and do not
involve more than the normal risk of collectibility or present unfavorable
features. Although such loans to Messrs. Cleary and Murphy were made prior to
the enactment of FIRREA and do not involve more than the normal risk of
77
<PAGE>
collectibility or present unfavorable features, such loans were made with
interest rates which were below the interest rates otherwise available to the
Bank's customers at the time such loans were made.
The Company intends that all transactions in the future between the Company
and its executive officers, directors, holders of 10% or more of the shares of
any class of its common stock and affiliates thereof, will contain terms no less
favorable to the Company than could have been obtained by it in arm's length
negotiations with unaffiliated persons and will be approved by a majority of
independent outside directors of the Company not having any interest in the
transaction.
Item 13. Exhibits and Reports on Form 8-K.
(a) The following exhibits are filed as a part of this report:
2.1 Amended Plan of Conversion (including the Federal Stock Charter
and Bylaws of Bay State Federal Savings Bank)*
3.1 Certificate of Incorporation of Bay State Bancorp, Inc.*
3.2 Bylaws of Bay State Bancorp, Inc.*
4.0 Draft Stock Certificate of Bay State Bancorp, Inc.*
10.1 Bay State Federal Savings Bank Employee Stock Ownership Plan
10.2 Draft ESOP Loan Commitment Letter and ESOP Loan Documents*
10.3 Forms of Employment Agreement between Bay State Federal Savings
Bank and certain executive officers*
10.4 Forms of Employment Agreement between Bay State Bancorp, Inc.
and certain executive officers*
10.5 Form of Change in Control Agreement between Bay State Federal
Savings Bank and certain executive officers*
10.6 Form of Bay State Federal Savings Bank Management Supplemental
Executive Retirement Plan*
10.7 Form of Bay State Federal Savings Bank Retirement Benefit
Equalization Plan*
10.8 Bay State Federal Savings Bank Employee Severance Compensation
Plan*
11.0 Computation of earnings per share**
21.0 Subsidiary information is incorporated herein by reference
"Item 1. Business -- General"
27.0 Financial Data Schedule
---------------
* Incorporated herein by reference into this document
from the Exhibits to Form S-1, Registration Statement,
and any amendments thereto, Registration No. 333-40115
** Not applicable as the Company did not have a full
quarter of earnings in fiscal 1998.
(b) Reports on Form 8-K.
None.
78
<PAGE>
SIGNATURES
In accordance with Section 13 of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
BAY STATE BANCORP, INC.
By: /s/ John F. Murphy
-----------------------------------------
John F. Murphy
President and Chief Executive Officer
Treasurer and Chairman of the Board
DATED: June 29, 1998
In accordance with the Exchange Act, this report has been signed by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ John F. Murphy President, Chief Executive Officer, Treasurer June 29, 1998
- ----------------------------- and Chairman of the Board
John F. Murphy (Principal Executive Officer)
/s/ Michael O. Gilles Chief Financial Officer June 29, 1998
- ----------------------------- (Principal Accounting and Financial Officer)
Michael O. Gilles
/s/ Robert B. Cleary Director June 29, 1998
- -----------------------------
Robert B. Cleary
/s/ Jerome R. Dangel Director June 29, 1998
- -----------------------------
Jerome R. Dangel
/s/ Leo F. Grace Director June 29, 1998
- -----------------------------
Leo F. Grace
/s/ Richard F. Hughes Director June 29, 1998
- -----------------------------
Richard F. Hughes
/s/ Richard F. McBride Director June 29, 1998
- -----------------------------
Richard F. McBride
/s/ Kent T. Spellman Director June 29, 1998
- -----------------------------
Kent T. Spellman
/s/ H. Chester Webster Director June 29, 1998
- -----------------------------
H. Chester Webster
/s/ Denise M. Renaghan Director June 29, 1998
- -----------------------------
Denise M. Renaghan
</TABLE>
Bay State Federal Savings Bank
Employee Stock Ownership Plan
Effective April 1, 1997
<PAGE>
Bay State Federal Savings Bank
Employee Stock Ownership Plan
Certification
I, John F. Murphy, President, Chief Executive Officer and Treasurer of Bay
State Federal Savings Bank, a federally-chartered stock savings bank, hereby
certify that the attached Bay State Federal Savings Bank Employee Stock
Ownership Plan, effective April 1, 1997, was adopted at a duly held meeting of
the Board of Directors of the Bank.
ATTEST: Bay State Federal Savings Bank
/s/ Barbara L. Olafsson By: /s/ John F. Murphy
- ----------------------------- --------------------------------------
Barbara L. Olafsson John F. Murphy
Secretary President, Chief Executive Officer and
Treasurer
<PAGE>
Bay State Federal Savings Bank
Employee Stock Ownership Plan
Table of Contents
Section 1 - Introduction.......................................................1
Section 2 - Definitions........................................................2
Section 3 - Eligibility and Participation......................................9
Section 4 - Contributions.....................................................11
Section 5 - Allocation and Valuation..........................................14
Section 6 - Vesting and Forfeitures...........................................21
Section 7 - Distributions.....................................................24
Section 8 - Voting of Company Stock and Tender Offers.........................29
Section 9 - The Committee and Plan Administration.............................30
Section 10 - Rules Governing Benefit Claims ..................................34
Section 11 - The Trust........................................................36
Section 12 - Adoption, Amendment and Termination..............................38
Section 13 - General Provisions...............................................40
Section 14 - Top-Heavy Provisions.............................................42
<PAGE>
Bay State Federal Savings Bank
Employee Stock Ownership Plan
Section 1
Introduction
Section 1.01 Nature of the Plan.
Effective as of April 1, 1997, (the "Effective Date"), Bay State Federal Savings
Bank, a federally-chartered savings bank (the "Bank"), hereby establishes the
Bay State Federal Savings Bank Employee Stock Ownership Plan (the "Plan") to
enable Eligible Employees (as defined in Section 2.01(p) of the Plan) to acquire
stock ownership interests in Bay State Bancorp, Inc., the holding company of the
Bank (the "Company"). The Bank intends this Plan to be a tax-qualified stock
bonus plan under Section 401(a) of the Internal Revenue Code of 1986, as amended
(the "Code") and an employee stock ownership plan within the meaning of Section
407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended
("ERISA") and Sections 409 and 4975(e)(7) of the Code. The Plan is designed to
invest primarily in the common stock of the Company, which stock constitutes
"qualifying employer securities" within the meaning of Section 407(d)(5) of
ERISA and Sections 409(l) and 4975(e)(8) of the Code. Accordingly, the Plan and
Trust Agreement (as defined in Section 2.01(oo) of the Plan) shall be
interpreted and applied in a manner consistent with the Bank's intent for it to
be a tax-qualified plan designed to invest primarily in qualifying employer
securities.
Section 1.02 Employers and Affiliates.
The Bank and each of its Affiliates (as defined in Section 2.01(c) of the Plan)
which, with the consent of the Bank, adopt the Plan pursuant to the provisions
of Section 12.01 of the Plan are collectively referred to as the "Employers" and
individually as an "Employer." The Plan shall be treated as a single plan with
respect to all participating Employers.
<PAGE>
Section 2
Definitions
Section 2.01 Definitions.
In this Plan, whenever the context so indicates, the singular or the plural
number and the masculine or feminine gender shall be deemed to include the
other, the terms "he," "his," and "him," shall refer to a Participant or
Beneficiary, as the case may be, and, except as otherwise provided, or unless
the context otherwise requires, the capitalized terms shall have the following
meanings:
(a) "Account" or "Accounts" mean a Participant's or Beneficiary's Company Stock
Account and/or his Other Investments Account, as the context so requires.
(b) "Acquisition Loan" means a loan (or other extension of credit, including an
installment obligation to a "party in interest" (as defined in Section 3(14) of
ERISA)) incurred by the Trustee in connection with the purchase of Company
Stock.
(c) "Affiliate" means any corporation, trade or business, which, at the time of
reference, is together with the Bank, a member of a controlled group of
corporations, a group of trades or businesses (whether or not incorporated)
under common control, or an affiliated service group, as described in Sections
414(b), 414(c), and 414(m) of the Code, respectively, or any other organization
treated as a single employer with the Bank under Section 414(o) of the Code;
provided, however, that, where the context so requires, the term "Affiliate"
shall be construed to give full effect to the provisions of Sections 409(l)(4)
and 415(h) of the Code.
(d) "Bank" means Bay State Federal Savings Bank, and any entity which succeeds
to the business of Bay State Federal Savings Bank and which adopts this Plan in
accordance with the provisions of Section 12.02 of the Plan or by written
agreement assuming the obligations under the Plan.
(e) "Beneficiary" means the person(s) entitled to receive benefits under the
Plan following a Participant's death, pursuant to Section 7.03 of the Plan.
(f) "Code" means the Internal Revenue Code of 1986, as amended.
(g) "Committee" means the individual(s) responsible for the administration of
the Plan in accordance with Section 9 of the Plan.
(h) "Company" means Bay State Bancorp, Inc. and any entity which succeeds to the
business of Bay State Bancorp, Inc.
2
<PAGE>
(i) "Company Stock" means shares of the voting common stock or preferred stock,
meeting the requirements of Section 409 of the Code and Section 407(d)(5) of
ERISA, issued by the Bank or its Affiliates.
(j) "Company Stock Account" means the account established and maintained in the
name of each Participant or Beneficiary to reflect his share of the Trust Fund
invested in Company Stock.
(k) "Compensation" means, for salaried employees,
(i) an Employee's base salary, determined as of the last day of the Plan
Year (including elective contributions excluded from the Employee's gross
income under Section 125 of the Code for such Plan Year), plus
(ii) bonuses and overtime paid to the Employee during the Plan Year.
For hourly employees, Compensation means the total cash compensation paid to the
employee during the Plan Year (including elective contributions excluded from
the Employee's gross income under Section 125 of the Code for the Plan Year),
excluding bonuses and overtime; provided however, that for the first Plan Year
such Compensation shall be determined with respect to the period beginning April
1, 1997, through March 31,1998.
A Participant's Compensation shall not exceed $150,000 (as periodically adjusted
pursuant to Section 401(a)(17) of the Code (the "Compensation Limit")). If a
Participant's Compensation is determined on a basis of a period of less than
twelve (12) calendar months, then the Compensation Limit for such Participant
shall be the Compensation Limit in effect for the Plan Year in which the period
begins multiplied by a ratio obtained by dividing the number of full months in
the period by twelve (12).
(l) "Conversion Date" means the date the Company first issues common stock
pursuant to its initial public offering.
(m) "Disability" means that a Participant has suffered a disability which is
expected to last in excess of 12 consecutive months and such Participant is
either:
(i) eligible for, or is receiving, disability insurance benefits under the
Federal Social Security Act, or
(ii) approved for disability under the provisions of any other benefit
program or policy maintained by the Employer, which policy or program is
applied on a uniform and nondiscriminatory basis to all Employees of the
Employer.
(n) "Effective Date" means April 1, 1997.
3
<PAGE>
(o) "Eligibility Computation Period" means a twelve (12) consecutive month
period. An Employee's first Eligibility Computation Period shall begin on date
he first performs an Hour of Service for the Employer ("employment commencement
date"). Subsequent Eligibility Computation Periods shall be the Plan Year,
commencing with the first Plan Year that includes the first anniversary date of
the Employee's employment commencement date. To determine an Eligibility
Computation Period after a One Year Break in Service, the Plan shall use the
twelve (12) consecutive month period beginning on the date the Employee again
performs an Hour of Service for the Employer.
(p) "Eligible Employee" means any Employee who is not precluded from
participating in the Plan by reason of the provisions of Section 3.02 of the
Plan.
(q) "Employee" means any person who is actually performing services for the Bank
or an Affiliate in a common-law, employer-employee relationship as determined
under Sections 31.3121(d)-1, 31.3306(i)-1, or 31.3401(c)-1 of the Treasury
Regulations and any "leased employee" (within the meaning of Section 414(n) of
the Code).
(r) "Employer" or "Employers" means the Bank and its Affiliates, which adopt the
Plan in accordance with the provisions of Section 12.01 of the Plan, and any
entity which succeeds to the business of the Bank or its Affiliates and which
adopts the Plan in accordance with the provisions of Section 12.02 of the Plan
or by written agreement assumes the obligations under the Plan.
(s) "Entry Date" means the first day of each January, April, July, and October
coinciding with or next following the date the Employee satisfies the
eligibility requirements under Section 3 of the Plan.
(t) "ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
(u) "Exchange Act" means the Securities Exchange Act of 1934, as amended.
(v) "Financed Shares" means shares of Company Stock acquired by the Trustee with
the proceeds of an Acquisition Loan, which shall constitute "qualifying employer
securities" under Section 409(l) of the Code and any shares of Company Stock
received upon conversion or exchange of such shares.
(w) "Highly Compensated Employee" means an Employee who, for a particular Plan
Year, satisfies one of the following conditions:
(i) was a "5-percent owner" (as defined in Section 414(q)(2) of the Code)
during the year or the preceding year, or
(ii) for the preceding year,
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(A) had "compensation" (as defined in Section 414(q)(4) of the Code)
from the Bank and its Affiliates exceeding $80,000 (as periodically
adjusted pursuant to Section 414(q)(1) of the Code), and
(B) if the Employer elects, was in the "top-paid group" (as defined in
Section 414(q)(3) of the Code) of Employees for such preceding year.
(x) "Hours of Service" means:
(i) Each hour for which an Employee is paid, or entitled to payment, for
performing duties for the Employer during the applicable computation
period.
(ii) Each hour for which an Employee is paid, or entitled to payment, for a
period during which no duties are performed (irrespective of whether the
employment relationship has terminated) due to vacation, holiday, illness,
incapacity (including disability), layoff, jury duty, military duty or
leave of absence. Notwithstanding the preceding sentence, no credit shall
be given to the Employee for:
(A) more than 501 hours under this clause (ii) because of any single
continuous period in which the Employee performs no duties (whether or
not such period occurs in a single computation period);
(B) an hour for which the Employee is directly or indirectly paid, or
entitled to payment, because of a period in which no duties are
performed if such payment is made or due under a plan maintained
solely for the purpose of complying with applicable worker's or
workmen's compensation, or unemployment, or disability insurance laws;
or
(C) an hour or a payment which solely reimburses the Employee for
medical or medically-related expenses incurred by the Employee.
(iii) Each hour for which back pay, irrespective of mitigation of damages,
is either awarded or agreed to by the Employer; provided, however, that
hours credited under either clause (i) or (ii) above shall not also be
credited under this clause (iii). Crediting of hours for back pay awarded
or agreed to with respect to periods described in clause (ii) above will be
subject to the limitations set forth in that clause.
The crediting of Hours of Service shall be determined by the Committee in
accordance with the rules set forth in Section 2530.200b-3 of the regulations
prescribed by the Department of Labor, which rules shall be consistently applied
with respect to all Employees within the same job classification. Hours of
Service will be credited for employment with an Affiliate.
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For purposes of determining whether an Employee has incurred a One Year Break in
Service and for vesting and participation purposes, if an Employee begins a
maternity/paternity leave of absence described in Section 411(a)(6)(E)(i) of the
Code, his Hours of Service shall include the Hours of Service that would have
been credited to him if he had not been so absent (or eight (8) Hours of Service
for each day of such absence if the actual Hours of Service cannot be
determined). An Employee shall be credited for such Hours of Service (up to a
maximum of 501 Hours of Service) in the Plan Year in which his absence begins
(if such crediting will prevent him from incurring a One Year Break in Service
in such Plan Year) or, in all other cases, in the following Plan Year. An
absence from employment for maternity or paternity reasons means an absence:
(i) by reason of pregnancy of the Employee,
(ii) by reason of a birth of a child of the Employee,
(iii) by reason of the placement of a child with the Employee in connection
with the adoption of such child by such Employee, or
(iv) for purposes of caring for such child for a period beginning
immediately following such birth or placement.
(y) "Loan Suspense Account" means that portion Trust Fund consisting of Company
Stock acquired with an Acquisition Loan which has not yet been allocated to the
Participants' Accounts.
(z) "Matching Contribution" means any contribution made to the Plan pursuant to
the provisions of Section 4.01(c) of the Plan.
(aa) "Normal Retirement Age" means the date the Employee attains age sixty-five
(65).
(bb) "Normal Retirement Date" means the first day of the month coincident with
or next following the Participant's attainment of Normal Retirement Age.
(cc) "One Year Break in Service" means a twelve (12) consecutive month period
during which the Participant does not complete more than 500 Hours of Service.
(dd) "Other Investments Account" means the account established and maintained in
the name of each Participant or Beneficiary to reflect his share of the Trust
Fund, other than Company Stock.
(ee) "Participant" means any Employee who has become a participant in accordance
with Section 3.01 of the Plan or any other person with an Account balance under
the Plan.
(ff) "Plan" means this Bay State Federal Savings Bank Employee Stock Ownership
Plan, as amended from time to time.
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(gg) "Plan Year" means the 12 month period ending March 31; provided, however
the first Plan Year shall be a short Plan Year commencing on the Effective Date
and ending on March 31, 1998.
(hh) "Postponed Retirement Date" means the first day of the month coincident
with or next following a Participant's date of actual retirement which occurs
after his Normal Retirement Date.
(ii) "Recognized Absence" means a period for which:
(i) an Employer grants an Employee a leave of absence for a limited period
of time, but only if an Employer grants such leaves of absence on a
nondiscriminatory basis to all Eligible Employees; or
(ii) an Employee is temporarily laid off by an Employer because of a change
in the business conditions of the Employer; or
(iii) an Employee is on active military duty, but only to the extent that
his employment rights are protected by the Military Selective Service Act
of 1967 (38 U.S.C. sec. 2021).
(jj) "Retirement Date" means a Participant's Normal Retirement Date or Postponed
Retirement Date, whichever is applicable.
(kk) "Savings Plan" means the Bay State Federal Savings Bank Employees' Savings
& Profit Sharing Plan and Trust, as amended from time to time.
(ll) "Service" means employment with the Bank or an Affiliate.
(mm) "Treasury Regulations" means the regulations promulgated by the Department
of Treasury under the Code.
(nn) "Trust" means the Bay State Federal Savings Bank Employee Stock Ownership
Plan Trust created in connection with the establishment of the Plan.
(oo) "Trust Agreement" means the trust agreement establishing the Trust.
(pp) "Trust Fund" means the assets held in the Trust for the benefit of
Participants and their Beneficiaries.
(qq) "Trustee" means the trustee or trustees from time to time in office under
the Trust Agreement.
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(rr) "Valuation Date" means the last day of the Plan Year and each other date as
of which the Committee shall determine the investment experience of the Trust
Fund and adjust the Participants' Accounts accordingly.
(ss) "Valuation Period" means the period following a Valuation Date and ending
with the next Valuation Date.
(tt) "Year of Service" means any Plan Year in which an Employee completes at
least 1,000 Hours of Service.
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Section 3
Eligibility and Participation
Section 3.01 Initial Participation.
(a) Employees Employed as of the Effective Date. Any Employee who is employed by
an Employer at any time from the Effective Date to the Conversion Date shall
enter the Plan and become a Participant immediately as of the later of the
Effective Date or the date he first performs an Hour of Service for the
Employer.
(b) Employees Employed After the Conversion Date. An Eligible Employee who
becomes employed by an Employer subsequent to the Conversion Date shall enter
the Plan and become a Participant as of the Entry Date coincident with or next
following the date he satisfies the following requirements:
(i) He has completed one Year of Service during an Eligibility Computation
Period; and
(ii) He has attained 21 years of age.
Section 3.02 Certain Employees Ineligible.
Except as provided for in Section 3.01(a) of the Plan, the following Employees
are ineligible to participate in the Plan:
(a) Employees covered by a collective bargaining agreement between the Employer
and the Employee's collective bargaining representative if:
(i) retirement benefits have been the subject of good faith bargaining
between the Employer and the representative, and
(ii) the collective bargaining agreement does not expressly provide that
Employees of such unit be covered under the Plan;
(b) Employees paid solely on an hourly basis.
(c) Employees who are nonresident aliens and who receive no earned income from
an Employer which constitutes income from sources within the United States; and
(d) Employees of an Affiliate that has not adopted the Plan pursuant to Sections
12.01 or 12.02 of the Plan.
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Section 3.03 Transfer to Eligible Employment.
If an Employee ineligible to participate in the Plan by reason of Section 3.02
of the Plan transfers to employment as an Eligible Employee, he shall enter the
Plan as of the later of:
(a) the first Entry Date after the date of transfer, or
(b) the first Entry Date on which he could have become a Participant pursuant to
Section 3.01 of the Plan if his prior employment with the Bank or Affiliate had
been as an Eligible Employee.
Section 3.04 Participation After Reemployment and Recognized Absences.
A former Employee who is reemployed by an Employer and has previously satisfied
the eligibility requirements of Section 3.01 of the Plan shall become a
Participant as of his date of reemployment.
Section 3.05 Participation Not Guarantee of Employment.
Participation in the Plan does not constitute a guarantee or contract of
employment and will not give any Employee the right to be retained in the employ
of the Bank or any of its Affiliates nor any right or claim to any benefit under
the terms of the Plan unless such right or claim has specifically accrued under
the Plan.
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Section 4
Contributions
Section 4.01 Employer Contributions.
(a) Discretionary Contributions. Each Plan Year, each Employer, in its
discretion, may make a contribution to the Trust. Each Employer making a
contribution for any Plan Year under this Section 4.01(a) will contribute to the
Trustee cash equal to, or Company Stock or other property having an aggregate
fair market value equal to, such amount as the Board of Directors of the
Employer shall determine by resolution. Notwithstanding the Employer's
discretion with respect to the medium of contribution, an Employer shall not
make a contribution in any medium which would make such contribution a
prohibited transaction (for which no exemption is provided) under Section 406 of
ERISA or Section 4975 of the Code.
(b) Employer Contributions for Acquisition Loans. Each Plan Year, the Employers
shall, subject to the provisions of the Bank's "Plan of Conversion" (as filed
with the appropriate governmental agencies in connection with the Bank's
conversion from a mutual to stock form of organization) and any related
regulatory prohibitions, contribute an amount of cash sufficient to enable to
the Trustee to discharge any indebtedness incurred with respect to an
Acquisition Loan pursuant to the terms of the Acquisition Loan. The Employers'
obligation to make contributions under this Section 4.01(b) shall be reduced to
the extent of any investment earnings attributable to such contributions and any
cash dividends paid with respect to Company Stock held by the Trustee in the
Loan Suspense Account. The Employers' obligation to make contributions under
this Section 4.01(b) shall further be reduced to the extent of any cash
contribution made pursuant to the provisions of paragraph (c) of this Section
4.01. If there is more than one Acquisition Loan, the Employers shall designate
the one to which any contribution pursuant to this Section 4.01(b), and, if
applicable paragraph (c) of this Section 4.01, is to be applied.
(c) Employer Matching Contributions under the Savings Plan. For each Plan Year,
each Employer, in its discretion, may make a contribution to the Trust equal to
a percentage of the Employee's voluntary contributions made for the Plan Year
under the Savings Plan. Each Employer making a contribution for any Plan Year
under this Section 4.01(c) shall contribute to the Trustee cash equal to, or
Company Stock or other property having an aggregate fair market value equal to,
such amount as the Board of Directors of the Employer shall determine by
resolution or as shall be set forth in the Savings Plan, as applicable.
Notwithstanding the Employer's discretion with respect to the medium of
contribution, an Employer shall not make a contribution in any medium which
would make such contribution a prohibited transaction (for which no exemption is
provided) under Section 406 of ERISA or Section 4975 of the Code.
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<PAGE>
Section 4.02 Limitations on Contributions.
In no event shall an Employer's contribution(s) made under Section 4.01 of the
Plan for any Plan Year exceed the lesser of:
(a) The maximum amount deductible under Section 404 of the Code by that Employer
as an expense for Federal income tax purposes; and
(b) The maximum amount which can be credited for that Plan Year in accordance
with the allocation limitation provisions of Section 5.05 of the Plan.
Section 4.03 Acquisition Loans.
The Trustee may incur Acquisition Loans from time to time to finance the
acquisition of Company Stock for the Trust or to repay a prior Acquisition Loan.
An Acquisition Loan shall be for a specific term, shall bear a reasonable rate
of interest, and shall not be payable on demand except in the event of default,
and shall be primarily for the benefit of Participants and Beneficiaries of the
Plan. An Acquisition Loan may be secured by a collateral pledge of the Financed
Shares so acquired and any other Plan assets which are permissible security
within the provisions of Section 54.4975-7(b) of the Treasury Regulations. No
other assets of the Plan or Trust may be pledged as collateral for an
Acquisition Loan, and no lender shall have recourse against any other Trust
assets. Any pledge of Financed Shares must provide for the release of shares so
pledged on a basis equal to the principal and interest (or if the requirements
of Section 54.4975-7(b)(8)(ii) of the Treasury Regulations are met and the
Employer so elects, principal payments only), paid by the Trustee on the
Acquisition Loan. The released Financed Shares shall be allocated by
Participants' Accounts in accordance with the provisions of Sections 5.04 or
5.09 of the Plan, whichever is applicable. Payment of principal and interest on
any Acquisition Loan shall be made by the Trustee only from the Employer
contributions paid in cash to enable the Trustee to repay such loan in
accordance with Sections 4.01(b) or 4.01(c) of the Plan, from earnings
attributable to such contributions, and any cash dividends received by the
Trustee on Financed Shares acquired with the proceeds of the Acquisition Loan
(including contributions, earnings and dividends received during or prior to the
year of repayment less such payments in prior years), whether or not allocated.
Financed Shares shall initially be credited to the Loan Suspense Account and
shall be transferred for allocation to the Company Stock Account of Participants
only as payments of principal and interest (or, if the requirements of Section
54.4975-7(b)(8)(ii) of the Treasury Regulations are met and the Employer so
elects, principal payments only), on the Acquisition Loan are made by the
Trustee. The number of Financed Shares to be released from the Loan Suspense
Account for allocation to Participants' Company Stock Account for each Plan Year
shall be based on the ratio that the payments of principal and interest (or, if
the requirements of Section 54.4975-7(b)(8)(ii) of the Treasury Regulations are
met and the Employer so elects, principal payments only), on the Acquisition
Loan for that Plan Year bears to the sum of the payments of principal and
interest on the Acquisition Loan for that Plan Year plus the total remaining
payment of principal and interest projected (or, if the
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<PAGE>
requirements of Section 54.4975-7(b)(8)(ii) of the Treasury Regulations are met
and the Employer so elects, principal payments only), on the Acquisition Loan
over the duration of the Acquisition Loan repayment period, subject to the
provisions of Section 5.05 of the Plan.
Section 4.04. Conditions as to Contributions.
In addition to the provisions of Section 12.03 of the Plan for the return of an
Employer's contributions in connection with a failure of the Plan to qualify
initially under the Code, any amount contributed by an Employer due to a good
faith mistake of fact, or based upon a good faith but erroneous determination of
its deductibility under Section 404 of the Code, shall be returned to the
Employer within one year after the date on which the Employer originally made
such contribution, or within one year after its nondeductibility has been
finally determined. However, the amount to be returned shall be reduced to take
account for any adverse investment experience within the Trust in order that the
balance credited to each Participant's Accounts is not less that it would have
been if the contribution had never been made by the Employer.
Section 4.05 Employee Contributions.
Employee contributions are neither required nor permitted under the Plan.
Section 4.06 Rollover Contributions.
Rollover contributions of assets from other tax-qualified retirement plans are
not permitted under the Plan.
Section 4.07 Trustee-to-Trustee Transfers.
Trustee-to-trustee transfer of assets from other tax-qualified retirement plans
are not permitted under the Plan.
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Section 5
Plan Accounting
Section 5.01 Accounting for Allocations.
The Committee shall establish the Accounts (and sub-accounts, if deemed
necessary) for each Participant, and the accounting procedures for the purpose
of making the allocations to the Participants' Accounts provided for in this
Section 5. The Committee shall maintain adequate records of the cost basis of
shares of Company Stock allocated to each Participant's Company Stock Account.
The Committee also shall keep separate records of Financed Shares attributable
to each Acquisition Loan and of contributions made by the Employers (and any
earnings thereon) made for the purpose of enabling the Trustee to repay any
Acquisition Loan. From time to time, the Committee may modify its accounting
procedures for the purpose of achieving equitable and nondiscriminatory
allocations among the Accounts of Participants, in accordance with the
provisions of this Section 5 and the applicable requirements of the Code and
ERISA. In accordance with Section 9 of the Plan, the Committee may delegate the
responsibility for maintaining Accounts and records.
Section 5.02 Maintenance of Participants' Company Stock Accounts.
As of each Valuation Date, the Committee shall adjust the Company Stock Account
of each Participant to reflect activity during the Valuation Period as follows:
(a) First, charge to each Participant's Company Stock Account all distributions
and payments made to him that have not been previously charged;
(b) Next, credit to each Participant's Company Stock Account the shares of
Company Stock, if any, that have been purchased with amounts from his Other
Investments Account, and adjust such Other Investments Account in accordance
with the provisions of Section 5.03 of the Plan; and
(c) Finally, credit to each Participant's Company Stock Account the shares of
Company Stock representing contributions made by the Employers in the form of
Company Stock and the number of Financed Shares released from the Loan Suspense
Account under Section 4.03 of the Plan that are to be allocated and credited as
of that date in accordance with the provisions of Section 5.04 of the Plan.
Section 5.03 Maintenance of Participants' Other Investments Accounts.
As of each Valuation Date, the Committee shall adjust the Other Investments
Account of each Participant to reflect activity during the Valuation Period as
follows:
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(a) First, charge to each Participant's Other Investments Account all
distributions and payments made to him that have not previously been charged;
(b) Next, if Company Stock is purchased with assets from a Participant's Other
Investments Account, the Participant's Other Investments Account shall be
charged accordingly;
(c) Next, subject to the dividend provisions of Section 5.09 of the Plan, credit
to the Other Investments Account of each Participant any cash dividends paid to
the Trustee on shares of Company Stock held in that Participant's Company Stock
Account (as of the record date for such cash dividends) and dividends paid on
shares of Company Stock held in the Loan Suspense Account that have not been
used to repay any Acquisition Loan. Cash dividends that have not been used to
repay an Acquisition Loan and have been credited to a Participant's Other
Investments Account shall be applied by the Trustee to purchase shares of
Company Stock, which shares shall then be credited to the Company Stock Account
of such Participant. The Participant's Other Investments Account shall then be
charged by the amount of cash used to purchase such Company Stock or used to
repay any Acquisition Loan. In addition, any earnings on:
(i) Other Investments Accounts will be allocated to Participants' Other
Investments Account, pro rata, based on such Other Investment Accounts
balances as of the first day of the Valuation Period, and
(ii) the Loan Suspense Account, other than dividends used to repay the
Acquisition Loan, will be allocated to Participants' Other Investments
Accounts, pro rata, based on their Other Investment Account Balances as of
the first day of the Valuation Period.
(d) Next, allocate and credit the Employer contributions made pursuant to
Section 4.01(b) of the Plan for the purpose of repaying any Acquisition Loan in
accordance with Section 5.04 of the Plan. Such amount shall then be used to
repay any Acquisition Loan and such Participant's Other Investments Account
shall be charged accordingly; and
(e) Finally, allocate and credit the Employer contributions (other than amounts
contributed to repay an Acquisition Loan) that are made in cash (or property
other than Company Stock) for the Plan Year to the Other Investments Account of
each Participant in accordance with Section 5.04 of the Plan.
Section 5.04 Allocation and Crediting of Employer Contributions.
(a) Except as otherwise provided for in Section 5.09 of the Plan, as of the
Valuation Date for each Plan Year.
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(i) Company Stock released from the Loan Suspense Account for that year and
shares of Company Stock contributed directly to the Plan shall be allocated
and credited to each Active Participant's (as defined in paragraph (c) of
this Section 5.04) Account as follows:
(A) first the number of shares of Company Stock with a fair market
value (valued as of the time the Matching Contributions are accrued
under the Savings Plan) equal to the Matching Contributions made under
Section 4.01(c) of the Plan on behalf of an Active Participant shall
be credited to the Active Participant's Company Stock Account (and a
matching contribution sub-account); and then
(B) the number of shares of Company Stock that bears the same ratio as
the Active Participant's Compensation bears to the aggregate
Compensation of all Active Participants for the Plan Year shall be
credited to such Active Participant's Company Stock Account, and then
(ii) The cash contributions not used to repay an Acquisition Loan and any
other property (other than shares of Company Stock) contributed for that
year and forfeitures (as determined pursuant to Section 6 of the Plan)
shall be allocated and credited to each Active Participant's Account based
on the ratio determined by comparing each Active Participant's Compensation
to the aggregate Compensation of all Active Participants for the Plan Year.
(b) For purposes of this Section 5.04, the term "Active Participant" means:
(i) with respect to contributions made pursuant to Section 4.01(c) of the
Plan, those Participants who would have otherwise have been entitled to an
allocation of matching contributions under the terms of the Savings Plan
for such period; and
(ii) with respect to contributions made pursuant to Sections 4.01(a) and
4.01(b) of the Plan, those Employees who:
(A) were employed by that Employer, including Employees on a
Recognized Absence, on the last day of the Plan Year and, for Plan
Years beginning on or after April 1, 1998, completed 1,000 Hours of
Service during the Plan Year, or
(B) who terminated employment during the Plan Year by reason of death,
Disability, or attainment of their Retirement Date.
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Section 5.05 Limitations on Allocations.
(a) In General. Subject to the provisions of this Section 5.05, Section 415 of
the Code shall be incorporated by reference into the terms of the Plan. No
allocation shall be made under Section 5.04 of the Plan that would result in a
violation of Section 415 of the Code.
(b) Code Section 415 Compensation. For purposes of this Section 5.05,
Compensation shall be adjusted to reflect the general rule of Section 1.415-2(d)
of the Treasury Regulations.
(c) Limitation Year. The "limitation year" (within the meaning of Section 415 of
the Code) shall be the calendar year.
(d) Multiple Defined Contribution Plans. In any case where a Participant also
participates in another defined contribution plan of the Bank or its Affiliates,
the appropriate committee of such other plan shall first reduce the after-tax
contributions under any such plan, shall then reduce any elective deferrals
under any such plan subject to Section 401(k) of the Code, shall then reduce all
other contributions under any other such plan and, if necessary, shall then
reduce contributions under this Plan, subject to the provisions of paragraph (f)
of this Section 5.05.
(e) Combined Plan Limitations. To the extent necessary to comply with the
requirements of Section 415(e) of the Code, the plan administration or
appropriate committee shall first reduce the annual benefit payable under any
defined benefit plan in which the Participant participates and, if necessary,
the Committee shall thereafter reduce the contributions under the defined
contribution plans in which such Participant participates in accordance with
paragraph (d) of this Section 5.05.
(f) Excess Allocations. If, after applying the allocation provisions under
Section 5.04 of the Plan, allocations under Section 5.04 of the Plan would
otherwise result in a Participant's account being in violation of Section 415 of
the Code, the Committee shall reduce the Employer contributions for the next
limitation year (and succeeding limitation years, as necessary) for that
Participant if that Participant is covered by the Plan as of the end of the
limitation year. However, if that Participant is not covered by the Plan as of
the end of the limitation year, then the excess amounts shall be held
unallocated in a suspense account for the limitation year and allocated and
reallocated in the next limitation year to all the remaining Participants in the
Plan; furthermore, the excess amounts shall be used to reduce Employer
contributions for the next limitation year (and succeeding limitation years, as
necessary) for all the remaining Participants in the Plan.
Section 5.06 Other Limitations.
Aside from the limitations set forth in Sections 5.05 of the Plan, in no event
shall more than one-third of the Employer contributions to the Plan (including
Matching Contributions) be allocated to the Accounts of Highly Compensated
Employees. In order to ensure such allocations are not made, the Committee
shall, beginning with the Participants whose Compensation exceeds the limit then
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<PAGE>
in effect under Section 401(a)(17) of the Code, reduce the amount of
Compensation of such Highly Compensated Employees on a pro-rata basis per
individual that would otherwise be taken into account for purposes of allocating
benefits under Section 5.04 of the Plan. If, in order to satisfy this Section
5.06, any such Participant's Compensation must be reduced to an amount that is
lower than the Compensation amount of the next highest paid (based on such
Participant's Compensation) Highly Compensated Employee (the "breakpoint
amount"), then, for purposes of allocating benefits under Section 5.04 of the
Plan, the Compensation of all concerned Participants shall be reduced to an
amount not to exceed such breakpoint amount.
Section 5.07 Limitations as to Certain Section 1042 Transactions.
To the extent that a shareholder of Company Stock sell qualifying Company Stock
to the Plan and elects (with the consent of the Bank) nonrecognition of gain
under Section 1042 of the Code, no portion of the Company Stock purchased in
such nonrecognition transaction (or dividends or other income attributable
thereto) may accrue or be allocated during the nonallocation period (the ten
(10) year period beginning on the later of the date of the sale of the qualified
Company Stock or the date of the Plan allocation attributable to the final
payment of an Acquisition Loan incurred in connection with such sale) for the
benefit of:
(a) The selling shareholder;
(b) the spouse, brothers or sisters (whether by the whole or half blood),
ancestors or lineal descendants of the selling shareholder or descendant
referred to in (a) above; or
(c) any other person who owns, after application of Section 318(a) of the Code,
more than twenty-five percent (25%) of:
(i) any class of outstanding stock of the Bank or any Affiliate, or
(ii) the total value of any class of outstanding stock of the Bank or any
Affiliate.
For purposes of this Section 5.07, Section 318(a) of the Code shall be applied
without regard to the employee trust exception of Section 318(a)(2)(B)(i) of the
Code.
Section 5.08 Nondiscrimination Test for Matching Contributions.
(a) Notwithstanding anything herein to the contrary, the Plan shall meet the
nondiscrimination test of Section 401(m) of the Code for each Plan Year. In
order to meet the nondiscrimination test, any or all of the following steps may
be taken:
(i) At any time during the Plan Year, the Committee may limit the amount
of Matching Contributions that may be made on behalf of Highly
Compensated Employees;
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(ii) The Committee may distribute to Highly Compensated Employees the
excess aggregate contributions made for the Plan Year, to the extent
necessary to meet the requirements of Section 401(m) of Code, on the
basis of the amount of contributions on behalf of, or by, each
Highly Compensated Employee;
(iii) The Committee may recommend to the Board of Directors of the Bank
that the Employer make an additional Matching Contribution to the
Plan for the benefit of Participants who are not Highly Compensated
Employees to the extent necessary to meet the requirements of
Section 401(m) of the Code; and
(iv) The Committee may take any other steps that the Committee deems
appropriate.
(b) The nondiscrimination requirements of Section 401(m) of the Code require
that, in each Plan Year, the "Contribution Percentage" (defined below) of the
eligible Highly Compensated Employees for such Plan Year does not exceed the
greater of:
(i) The Contribution Percentage of all other eligible Employees for the
preceding Plan Year multiplied by 1.25; or
(ii) The lesser of the Contribution Percentage of all other eligible
Employees for the preceding Plan Year multiplied by 2, or the
Contribution Percentage of all other eligible Employees for the
preceding Plan Year plus 2 percentage points. (Use of this
alternative limitation shall be subject to the provisions of Section
1.401(m)-2 of the Treasury Regulations regarding the multiple use of
the alternative deferral tests set for forth in Section 401(k) and
401(m) of the Code.)
The Committee may elect to calculate the Contribution Percentages using the Plan
Year rather than the preceding Plan Year; provided, however, that if the
Committee so elects, the election may only be changed as provided by the
Secretary of the Treasury.
(c) The "Contribution Percentage" for a group of Employees is the average of the
ratios, calculated separately for each Employee in the group, of the amount of
Matching Contributions that are credited under the Plan on behalf of each
Employee for the Plan Year, to the Employee's Compensation for the Plan Year.
Section 5.09 Dividends.
(a) Stock Dividends. Dividends on Company Stock which are received by the
Trustee in the form of additional Company Stock shall be retained in the portion
of the Trust Fund consisting of Company Stock, and shall be allocated among the
Participant's Accounts and the Loan Suspense Account in accordance with their
holdings of the Company Stock on which the dividends have been paid.
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(b) Cash Dividends on Allocated Shares. Dividends on Company Stock credited to
Participants' Accounts which are received by the Trustee in the form of cash
shall, at the direction of the Bank, either:
(i) be credited to Participants' Accounts in accordance with Section 5.03
of the Plan and invested as part of the Trust Fund;
(ii) be distributed immediately to the Participants;
(iii) be distributed to the Participants within ninety (90) days of the
close of the Plan Year in which paid; or
(iv) be used to repay principal and interest on the Acquisition Loan used
to acquire Company Stock on which the dividends were paid.
(c) Cash Dividends on Unallocated Shares. Dividends on Company Stock held in the
Loan Suspense Account which are received by the Trustee in the form of cash
shall be applied as soon as practicable to payments of principal and interest
under the Acquisition Loan incurred with the purchase of the Company Stock.
(d) Financed Shares. Financed Shares released from the Loan Suspense Account by
reason of dividends paid with respect to such Company Stock shall be allocated
under Sections 5.03 and 5.04 of the Plan as follows:
(i) First, Financed Shares with a fair market value at least equal to the
dividends paid with respect the Company Stock allocated to Participants'
Accounts shall be allocated among and credited to the Accounts of such
Participants, pro rata, according to the number of shares of Company Stock
held in such accounts on the date such dividend is declared by the Company;
(ii) Then, any remaining Financed Shares released from the Loan Suspense
Account by reason of dividends paid with respect to Company Stock held in
the Loan Suspense Account shall be allocated among and credited to the
Accounts of all Participants, pro rata, according to each Participant's
Compensation.
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Section 6
Vesting and Forfeitures
Section 6.01 Deferred Vesting in Accounts.
(a) A Participant shall become vested in his Accounts in accordance with the
following schedule:
Years of Service Vested Percentage
---------------- -----------------
Less than 1 year 0%
1 to 2 years 20%
2 to 3 years 40%
3 to 4 years 60%
4 to 5 years 80%
5 years or more 100%
(b) For purposes of determining a Participant's Years of Service under this
Section 6.01, employment with the Bank or an Affiliate shall be deemed
employment with the Employer. With respect to Employees who enter the Plan
pursuant to Section 3.01(a) of the Plan, for purposes of determining a
Participant's vested percentage, all Years of Service shall be included. With
respect to Employees who enter the Plan pursuant to Section 3.01(b) of the Plan,
for purposes of determining a Participant's vested percentage, all Years of
Service shall be included, subject to the provisions of Section 6.05 of the
Plan.
Section 6.02 Immediate Vesting in Certain Situations.
(a) Notwithstanding Section 6.01(a) of the Plan, a Participant shall become
fully vested in his Accounts upon the earlier of:
(i) termination of the Plan or upon the permanent and complete
discontinuance of contributions by his Employer to the Plan; provided,
however, that in the event of a partial termination, the interest of each
Participant shall fully vest only with respect to that part of the Plan
which is terminated;
(ii) The Participant's Normal Retirement Age;
(iii) A "Change in Control" (as defined below); or
(iv) Termination of employment by reason of death or Disability.
For purposes of this Section 6.02, a "Change in Control" of the Bank or the
Company means an event of a nature that: (i) would be required to be reported in
response to Item 1 of the current report
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on Form 8-K, as in effect on the date hereof, pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"); or (ii)
results in a Change in Control of the Bank or the Company within the meaning of
the Home Owners' Loan Act of 1933, as amended, the Federal Deposit Insurance Act
and the Rules and Regulations promulgated by the Office of Thrift Supervision
("OTS") (or its predecessor agency), as in effect on the date hereof (provided,
that in applying the definition of change in control as set forth under the
rules and regulations of the OTS, the Board shall substitute its judgment for
that of the OTS); or (iii) without limitation such a Change in Control shall be
deemed to have occurred at such time as (A) any "person" (as the term is used in
Sections 13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of voting securities of the Bank or the Company representing 25% or
more of the Bank's or the Company's outstanding voting securities or right to
acquire such securities except for any voting securities of the Bank purchased
by the Company and any voting securities purchased by any employee benefit plan
of the Bank or the Company, or (B) individuals who constitute the Board on the
date hereof (the "Incumbent Board") cease for any reason to constitute at least
a majority thereof, provided that any person becoming a director subsequent to
the date hereof whose election was approved by a vote of at least three-quarters
of the directors comprising the Incumbent Board, or whose nomination for
election by the Company's stockholders was approved by the same Nominating
Committee serving under an Incumbent Board, shall be, for purposes of this
clause (B), considered as though he were a member of the Incumbent Board, or (C)
a plan of reorganization, merger, consolidation, sale of all or substantially
all the assets of the Bank or the Company or similar transaction occurs in which
the Bank or Company is not the resulting entity.
Section 6.03 Treatment of Forfeitures.
(a) If a Participant who is not fully vested in his Accounts terminates
employment, that portion of his Accounts in which he is not vested shall be
forfeited upon the earlier of:
(i) The date the Participant receives a distribution of his entire vested
benefits under the Plan, or
(ii) The date at which the Participant incurs five (5) consecutive One Year
Breaks in Service.
(b) If a Participant who has terminated employment and has received a
distribution of his entire vested benefits under the Plan is subsequently
reemployed by an Employer prior to incurring five (5) consecutive One Year
Breaks in Service, he shall have the portion of his Accounts which was
previously forfeited restored to his Accounts, provided he repays to the Trustee
within five (5) years of his subsequent employment date an amount equal to the
distribution. The amount restored to the Participant's Account shall be credited
to his Account as of the last day of the Plan Year in which the Participant
repays the distributed amount to the Trustee and the restored amount shall come
from other Employees' forfeitures and, if such forfeitures are insufficient,
from a special contribution by his Employer for that year. If a Participant's
employment terminates prior to his Account having
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become vested, such Participant shall be deemed to have received a distribution
of his entire vested interest as of the Valuation Date next following his
termination of employment.
(c) If a Participant who has terminated employment but has not received a
distribution of his entire vested benefits under the Plan is subsequently
reemployed by an Employer subsequent to incurring five (5) consecutive One Year
Breaks in Service, any undistributed balance of his Accounts from his prior
participation which was not forfeited shall be maintained as a fully vested
subaccount with his Account.
(d) If a portion of a Participant's Account is forfeited, assets other than
Company Stock must be forfeited before any Company Stock may be forfeited.
(e) Forfeitures shall be reallocated among the other Participants in the Plan.
Section 6.04 Accounting for Forfeitures.
A forfeiture shall be charged to the Participant's Account as of the first day
of the first Valuation Period in which the forfeiture becomes certain pursuant
to Section 6.03 of the Plan. Except as otherwise provided in Section 6.03 of the
Plan, a forfeiture shall be added to the contributions of the terminated
Participant's Employer which are to be credited to other Participants pursuant
to Section 4 as of the last day of the Plan Year in which the forfeiture becomes
certain.
Section 6.05 Vesting Upon Reemployment.
(a) If an Employee is not vested in his Accounts, incurs a One Year Break in
Service and again performs an Hour of Service, such Employee shall receive
credit for his Years of Service prior to his One Year Break in Service only if
the number of consecutive One Year Breaks in Service is less than the greater
of: (i) five (5) years of (ii) the aggregate number of his Years of Service
credited before his One Year Break in Service.
(b) If a Participant is partially vested in his Accounts, incurs a One Year
Break in Service and again performs an Hour of Service, such Participant shall
receive credit for his Years of Service prior to his One Year Break in Service;
provided, however, that after five (5) consecutive One Year Breaks in Service, a
former Participant's vested interest in his Accounts attributable to Years of
Service prior to his One Year Break in Service shall not be increased as a
result of his Years of Service following his reemployment date.
(c) If a Participant is fully vested in his Accounts, incurs a One Year Break in
Service and again performs an Hour of Service, such Participant shall receive
credit for all his Years of Service prior to his One Year Breaks in Service.
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Section 7
Distributions
Section 7.01 Distribution of Benefit Upon a Termination of Employment.
(a) A Participant whose employment terminates for any reason shall receive the
entire vested portion of his Accounts in a single payment on a date selected by
the Committee; provided, however, that such date shall be on or before the 60th
day after the end of the Plan Year in which the Participant's employment
terminated. The benefits from that portion of the Participant's Other
Investments Account shall be calculated on the basis of the most recent
Valuation Date before the date of payment. Subject to the provisions of Section
7.05 of the Plan, if the Committee so provides, a Participant may elect that his
benefits be distributed to him in the form of either Company Stock, cash, or
some combination thereof.
(b) Notwithstanding paragraph (a) of this Section 7.01, if the balance credited
to a Participant's Accounts exceeds, or has ever exceeded at the time such
benefit was distributable, $5,000, his benefits shall not be paid before the
latest of his 65th birthday or the tenth anniversary of the year in which he
commenced participation in the Plan, unless he elects an early payment date in a
written election filed with the Committee. Such an election is not valid unless
it is made after the Participant has received the required notice under Section
1.411(a)-11(c) of the Treasury Regulations that provides a general description
of the material features of a lump sum distribution and the Participant's right
to defer receipt of his benefits under the Plan. The notice shall be provided no
less than 30 days and no more than 90 days before the first day on which all
events have occurred which entitle the Participant to such benefit. Written
consent of the Participant to the distribution generally may not be made within
30 days of the date the Participant receives the notice and shall not be made
more than 90 days from the date the Participant receives the notice. However, a
distribution may be made less than 30 days after the notice provided under
Section 1.411(a)-11(c) of the Treasury Regulations is given, if:
(i) the Committee clearly informs the Participant that he has a right to
period of at least 30 days after receiving the notice to consider the
decision of whether or not to elect a distribution (and if applicable, a
particular distribution option), and
(ii) the Participant, after receiving the notice, affirmatively elects a
distribution.
A Participant may modify such an election at any time, provided any new benefit
payment date is at least 30 days after a modified election is delivered to the
Committee.
Section 7.02 Minimum Distribution Requirements.
With respect to all Participants, other than those who are "5% owners" (as
defined in Section 416 of the Code), benefits shall be paid no later than the
April 1st of the later of:
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(i) the calendar year following the calendar year in which the Participant
attains age 70-1/2, or
(ii) the calendar year in which the Participant retires.
With respect to all Participants who are 5% owners within the meaning of Section
416 of the Code, such Participants benefits shall be paid no later than the
April 1st of the calendar year following the calendar year in which the
Participant attains age 70-1/2.
Section 7.03 Benefits on a Participant's Death.
(a) If a Participant dies before his benefits are paid pursuant to Section 7.01
of the Plan, the balance credited to his Accounts shall be paid to his
Beneficiary in a single distribution on or before the 60th day after the end of
the Plan Year in which the Participant died. If the Participant has not named a
Beneficiary or if his named Beneficiary should not survive him, then the balance
in his Account shall be paid to his estate. The benefits from that portion of
the Participant's Other Investments Account shall be calculated on the basis of
the most recent Valuation Date before the date of payment.
(b) If a married Participant dies before his benefit payments begin, then,
unless he has specifically elected otherwise, the Committee shall cause the
balance in his Accounts to be paid to his spouse, as Beneficiary. A married
Participant may name an individual other than his spouse as his Beneficiary,
provided that such election is accompanied by the spouse's written consent,
which must:
(i) acknowledge the effect of the election;
(ii) explicitly provide either that the designated Beneficiary may not
subsequently be changed by the Participant without the spouse's further
consent or that it may be changed without such consent; and
(iii) must be witnessed by the Committee, its representative, or a notary
public.
This requirement shall not apply if the Participant establishes to the
Committee's satisfaction that the spouse may not be located.
(c) The Committee shall from time to time take whatever steps it deems
appropriate to keep informed of each Participant's marital status. Each Employer
shall provide the Committee with the most reliable information in the Employer's
possession regarding its Participants' marital status, and the Committee may, in
its discretion, require a notarized affidavit from any Participant as to his
marital status. The Committee, the Plan, the Trustee, and the Employers shall be
fully protected and discharged from any liability to the extent of any benefit
payments made as a result of the Committee's good faith and reasonable reliance
upon information obtained from a Participant as to the Participant's marital
status.
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Section 7.04 Delay in Benefit Determination.
If the Committee is unable to determine the benefits payable to a Participant or
Beneficiary on or before the latest date prescribed for payment pursuant to this
Section 7, the benefits shall in any event be paid within 60 days after they can
first be determined, with whatever makeup payments may be appropriate in view of
the delay.
Section 7.05 Options to Receive and Sell Stock.
(a) Unless ownership of virtually all Company Stock is restricted to active
Employees and qualified retirement plans for the benefit of Employees pursuant
to the certificates of incorporation or by-laws of the Employers issuing Company
Stock, a terminated Participant or the Beneficiary of a deceased Participant may
instruct the Committee to distribute the Participant's entire vested interest in
his Accounts in the form of Company Stock. In that event, the Committee shall
apply the Participant's vested interest in his Other Investments Account to
purchase sufficient Company Stock to make the required distribution.
b) Any Participant who receives Company Stock pursuant to this Section, and any
person who has received Company Stock from the Plan or from such a Participant
by reason of the Participant's death or incompetency, by reason of divorce or
separation from the Participant, or by reason of a rollover distribution
described in Section 402(c) of the Code, shall have the right to require the
Employer which issued the Company Stock to purchase the Company Stock for its
current fair market value (hereinafter referred to as the "put right"). The put
right shall be exercisable by written notice to the Committee during the first
60 days after the Company Stock is distributed by the Plan, and, if not
exercised in that period, during the first 60 days in the following Plan Year
after the Committee has communicated to the Participant its determination as to
the Company Stock's current fair market value. If the put right is exercised,
the Trustee may, if so directed by the Committee in its sole discretion, assume
the Employer's rights and obligations with respect to purchasing the Stock.
However, the put right shall not apply to the extent that the Company Stock, at
the time the put right would otherwise be exercisable, may be sold on an
established market in accordance with federal and state securities laws and
regulations.
(c) With respect to a put right, the Employer or the Trustee, as the case may
be, may elect to pay for the Company Stock in equal periodic installments, not
less frequently than annually, over a period not longer than five (5) years from
the 30th day after the put right is exercised pursuant to paragraph (b) of this
Section 7.05, with adequate security and interest at a reasonable rate on the
unpaid balance, all such terms to be set forth in a promissory note delivered to
the seller with normal terms as to acceleration upon any uncured default.
(d) Nothing contained in this Section 7.05 shall be deemed to obligate any
Employer to register any Company Stock under any federal or state securities law
or to create or maintain a public market to facilitate the transfer or
disposition of any Company Stock. The put right described in this Section
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7.05 may only be exercised by a person described in the paragraph (b) of this
Section 7.05, and may not be transferred with any Company Stock to any other
person. As to all Company Stock purchased by the Plan in exchange for any
Acquisition Loan, the put right be nonterminable. The put right for Company
Stock acquired through a Acquisition Loan shall continue with respect to such
Company Stock after the Acquisition Loan is repaid or the Plan ceases to be an
employee stock ownership plan. Except as provided above, in accordance with the
provisions of Sections 54.4975-7(b)(4) of the Treasury Regulations, no Company
Stock acquired with the proceeds of an Acquisition Loan may be subject to any
put, call or other option or buy-sell or similar arrangement while held by, and
when distributed from, the Plan, whether the Plan is then an employee stock
ownership plan.
Section 7.06 Restrictions on Disposition of Stock.
Except in the case of Company Stock which is traded on an established market, a
Participant who receives Company Stock pursuant to this Section 7, and any
person who has received Company Stock from the Plan or from such a Participant
by reason of the Participant's death or incompetency, by reason of divorce or
separation from the Participant, or by reason of a rollover distribution
described in Section 402(c) of the Code, shall, prior to any sale or other
transfer of the Company Stock to any other person, first offer the Company Stock
to the issuing Employer and to the Plan at its current fair market value. This
restriction shall apply to any transfer, whether voluntary, involuntary, or by
operation of law, and whether for consideration or gratuitous. Either the
Employer or the Trustee may accept the offer within 14 days after it is
delivered. Any Company Stock distributed by the Plan shall bear a conspicuous
legend describing the right of first refusal under this Section 7.06, as
applicable, as well as any other restrictions upon the transfer of the Company
Stock imposed by federal and state securities laws and regulations.
Section 7.07 Direct Transfer of Eligible Plan Distributions.
(a) A Participant or Beneficiary may direct that an "eligible rollover
distribution" (as defined below) included in a payment made pursuant to this
Section 7 be paid directly to an "eligible retirement plan" (as defined below).
(b) To effect such a direct transfer, the Participant or Beneficiary must notify
the Committee that a direct transfer is desired and provide to the Committee the
eligible retirement plan to which the payment is to be made. Such notice shall
be made in such form and at such time as the Committee may prescribe. Upon
receipt of such notice, the Committee shall direct the Trustee to make a
trustee-to-trustee transfer of the eligible rollover distribution to the
eligible retirement plan so specified.
(c) For purposes of this Section 7.07, an "eligible rollover distribution" shall
have the meaning set forth in Section 402(c)(4) of the Code and any Treasury
Regulations promulgated thereunder. To the extent such meaning is not
inconsistent with the above references, an eligible rollover distribution shall
mean any distribution of all or any portion of the Participant's Account, except
that
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such term shall not include any distribution which is one of a series of
substantially equal periodic payments (not less frequently than annually) made
(i) for the life (or life expectancy) of the Participant or the joint lives (or
joint life expectancies) of the Participant and a designated Beneficiary, or
(ii) for a period of ten years or more. Further, the term "eligible rollover
distribution" shall not include any distribution required to be made under
Section 401(a)(9) of the Code.
(d) For purposes of this Section 7.07, an "eligible retirement plan" shall have
the meaning set forth in Section 402(c)(8) of the Code and any Treasury
Regulations promulgated thereunder. To the extent such meaning is not
inconsistent with the above references, an eligible retirement plan shall mean:
(i) an individual retirement account described in Section 408(a) of the Code;
(ii) an individual retirement annuity described in Section 408(b) of the Code
(other than an endowment contract), (iii) a qualified trust described in Section
401(a) of the Code and exempt under Section 501(a) of the Code, and (iv) an
annuity plan described in Section 403(a) of the Code.
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Section 8
Voting of Company Stock and Tender Offers
Section 8.01 Voting of Company Stock.
(a) In General. The Trustee shall generally vote all shares of Company Stock
held in the Trust in accordance with the provisions of this Section 8.01.
(b) Allocated Shares. Shares of Company Stock which have been allocated to
Participants' Accounts shall be voted by the Trustee in accordance with the
Participants' written instructions.
(c) Uninstructed and Unallocated Shares. Shares of Company Stock which have been
allocated to Participants' Accounts but for which no written instructions have
been received by the Trustee regarding voting shall be voted by the Trustee in a
manner calculated to most accurately reflect the instructions the Trustee has
received from Participants regarding voting shares of allocated Company Stock.
Shares of unallocated Company Stock shall also be voted by the Trustee in a
manner calculated to most accurately reflect the instructions the Trustee has
received from Participants regarding voting shares of allocated Company Stock.
Notwithstanding the preceding two sentences, all shares of Company Stock which
have been allocated to Participants' Accounts and for which the Trustee has not
timely received written instructions regarding voting and all unallocated shares
of Company Stock must be voted by the Trustee in a manner determined by the
Trustee to be solely in the best interests of the Participants and
Beneficiaries.
(d) Voting Prior to Allocation. In the event no shares of Company Stock have
been allocated to Participants' Accounts at the time Company Stock is to be
voted, each Participant shall be deemed to have one share of Company Stock
allocated to his Accounts for the sole purpose of providing the Trustee with
voting instructions.
(e) Procedure and Confidentiality. Whenever such voting rights are to be
exercised, the Employers, the Committee, and the Trustee shall see that all
Participants and Beneficiaries are provided with the same notices and other
materials as are provided to other holders of the Company Stock, and are
provided with adequate opportunity to deliver their instructions to the Trustee
regarding the voting of Company Stock allocated to their Accounts or deemed
allocated to their Accounts for purposes of voting. The instructions of the
Participants with respect to the voting of shares of Company Stock shall be
confidential.
Section 8.02 Tender Offers.
In the event of a tender offer, Company Stock shall be tendered by the Trustee
in the same manner set forth in Section 8.01 of the Plan regarding the voting of
Company Stock.
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Section 9
The Committee and Plan Administration
Section 9.01 Identity of the Committee.
The Committee shall consist of three or more individuals selected by the Bank.
Any individual, including a director, trustee, shareholder, officer, or Employee
of an Employer, shall be eligible to serve as a member of the Committee. The
Bank shall have the power to remove any individual serving on the Committee at
any time without cause upon ten (10) days written notice to such individual and
any individual may resign from the Committee at any time without reason upon ten
(10) days written notice to the Bank. The Bank shall notify the Trustee of any
change in membership of the Committee.
Section 9.02 Authority of Committee.
(a) The Committee shall be the "plan administrator" within the meaning of ERISA
and shall have exclusive responsibility and authority to control and manage the
operation and administration of the Plan, including the interpretation and
application of its provisions, except to the extent such responsibility and
authority are otherwise specifically:
(i) allocated to the Bank, the Employers, or the Trustee under the Plan and
Trust Agreement;
(ii) delegated in writing to other persons by the Bank, the Employers, the
Committee, or the Trustee; or
(iii) allocated to other parties by operation of law.
(b) The Committee shall have exclusive responsibility regarding decisions
concerning the payment of benefits under the Plan.
(c) The Committee shall have full investment responsibility with respect to the
Investment Fund except to the extent, if any, specifically provided in the Trust
Agreement.
(d) In the discharge of its duties, the Committee may employ accountants,
actuaries, legal counsel, and other agents (who also may be employed by an
Employer or the Trustee in the same or some other capacity) and may pay such
individuals reasonable compensation and expenses for their services rendered
with respect to the operation or administration of the Plan to the extent such
payments are not otherwise prohibited by law.
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Section 9.03 Duties of Committee.
(a) The Committee shall keep whatever records may be necessary in connection
with the maintenance of the Plan and shall furnish to the Employers whatever
reports may be required from time to time by the Employers. The Committee shall
furnish to the Trustee whatever information may be necessary to properly
administer the Trust. The Committee shall see to the filing with the appropriate
government agencies of all reports and returns required with respect to the Plan
under ERISA and the Code and other applicable laws.
(b) The Committee shall have exclusive responsibility and authority with respect
to the Plan's holdings of Company Stock and shall direct the Trustee in all
respects regarding the purchase, retention, sale, exchange, and pledge of
Company Stock and the creation and satisfaction of any Acquisition Loan to the
extent such responsibilities are not set forth in the Trust Agreement.
(c) The Committee shall at all times act consistently with the Bank's long-term
intention that the Plan, as an employee stock ownership plan, be invested
primarily in Company Stock. Subject to the direction of the Committee with
respect to any Acquisition Loan pursuant to the provisions of Section 4.03 of
the Plan, and subject to the provisions of Sections 7.05 and 11.04 of the Plan
as to Participants' rights under certain circumstances to have their Accounts
invested in Company Stock or in assets other than Company Stock, the Committee
shall determine, in its sole discretion, the extent to which assets of the Trust
shall be used to repay any Acquisition Loan, to purchase Company Stock, or to
invest in other assets selected by the Committee or an investment manager. No
provision of the Plan relating to the allocation or vesting of any interests in
the Company Stock or investments other than Company Stock shall restrict the
Committee from changing any holdings of the Trust Fund, whether the changes
involve an increase or a decrease in the Company Stock or other assets credited
to Participants' Accounts. In determining the proper extent of the Trust Fund's
investment in Company Stock, the Committee shall be authorized to employ
investment counsel, legal counsel, appraisers, and other agents and to pay their
reasonable compensation and expenses to the extent such payments are not
prohibited by law.
(d) If the valuation of any Company Stock is not established by reported trading
on a generally recognized public market, then the Committee shall have the
exclusive authority and responsibility to determine value of the Company Stock
for all purposes under the Plan. Such value shall be determined as of each
Valuation Date and on any other date as of which the Trustee purchases or sells
Company Stock in a manner consistent with Section 4975 of the Code and the
Treasury Regulations thereunder. The Committee shall use generally accepted
methods of valuing stock of similar corporations for purposes of arm's length
business and investment transactions, and in this connection the Committee shall
obtain, and shall be protected in relying upon, the valuation of Company Stock
as determined by an independent appraiser experienced in preparing valuations of
similar businesses.
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Section 9.04 Compliance with ERISA and the Code.
The Committee shall perform all acts necessary to ensure the Plan's compliance
with ERISA and the Code. Each individual member of the Committee shall discharge
his duties in good faith and in accordance with the applicable requirements of
ERISA and the Code.
Section 9.05 Action by Committee.
All actions of the Committee shall be governed by the affirmative vote of a
number of the members of the Committee which is a majority of the total number
of the members of the Committee. The members of the Committee may meet
informally and may take any action without meeting as a group.
Section 9.06 Execution of Documents.
Any instrument executed by the Committee may be signed by any member of the
Committee.
Section 9.07 Adoption of Rules.
The Committee shall adopt such rules and regulations of uniform applicability as
it deems necessary or appropriate for the proper operation, administration and
interpretation of the Plan.
Section 9.08 Responsibilities to Participants.
The Committee shall determine which Employees qualify to participate in the
Plan. The Committee shall furnish to each Eligible Employee whatever summary
plan descriptions, summary annual reports, and other notices and information may
be required under ERISA. The Committee also shall determine when a Participant
or his Beneficiary qualifies for the payment of benefits under the Plan. The
Committee shall furnish to each such Participant or Beneficiary whatever
information is required under ERISA or the Code (or is otherwise appropriate) to
enable the Participant or Beneficiary to make whatever elections may be
available pursuant to Section 7, and the Committee shall provide for the payment
of benefits in the proper form and amount from the Trust. The Committee may
decide in its sole discretion to permit modifications of elections and to defer
or accelerate benefits to the extent consistent with the terms of the Plan,
applicable law, and the best interests of the individuals concerned.
Section 9.09 Alternative Payees in Event of Incapacity.
If the Committee finds at any time that an individual qualifying for benefits
under this Plan is a minor or is incompetent, the Committee may direct the
benefits to be paid, in the case of a minor, to his parents, his legal guardian,
a custodian for him under the Uniform Transfers to Minors Act,
32
<PAGE>
or the person having actual custody of him, or, in the case of an incompetent,
to his spouse, his legal guardian, or the person having actual custody of him.
The Committee and the Trustee shall not be obligated to inquire as to the actual
use of the funds by the person receiving them under this Section 9.09, and any
such payment shall completely discharge the obligations of the Plan, the
Trustee, the Committee, and the Employers to the extent of the payment.
Section 9.10 Indemnification by Employers.
Except as separately agreed in writing, the Committee, and any member or
employee of the Committee, shall be indemnified and held harmless by the
Employers, jointly and severally, to the fullest extent permitted by law against
any and all costs, damages, expenses, and liabilities reasonably incurred by or
imposed upon the Committee or such individual in connection with any claim made
against the Committee or such individual or in which the Committee or such
individual may be involved by reason of being, or having been, the Committee, or
a member or employee of the Committee, to the extent such amounts are not paid
by insurance.
Section 9.11 Abstention by Interested Member.
Any member of the Committee who also is a Participant in the Plan shall take no
part in any determination specifically relating to his own participation or
benefits under the Plan, unless his abstention would render the Committee
incapable of acting on the matter.
33
<PAGE>
Section 10
Rules Governing Benefit Claims
Section 10.01 Claim for Benefits.
Any Participant or Beneficiary who qualifies for the payment of benefits shall
file a claim for his benefits with the Committee on a form provided by the
Committee. The claim, including any election of an alternative benefit form,
shall be filed at least 30 days before the date on which the benefits are to
begin. If a Participant or Beneficiary fails to file a claim by the 30th day
before the date on which benefits become payable, he shall be presumed to have
filed a claim for payment for the Participant's benefits in the standard form
prescribed by Section 7 of the Plan.
Section 10.02 Notification by Committee.
Within 90 days after receiving a claim for benefits (or within 180 days, if
special circumstances require an extension of time and written notice of the
extension is given to the Participant or Beneficiary within 90 days after
receiving the claim for benefits), the Committee shall notify the Participant or
Beneficiary whether the claim has been approved or denied. If the Committee
denies a claim in any respect, the Committee shall set forth in a written notice
to the Participant or Beneficiary:
(a) each specific reason for the denial;
(b) specific references to the pertinent Plan provisions on which the denial is
based;
(c) a description of any additional material or information which could be
submitted by the Participant or Beneficiary to support his claim, with an
explanation of the relevance of such information; and
(d) an explanation of the claims review procedures set forth in Section 10.03 of
the Plan.
Section 10.03 Claims Review Procedure.
Within 60 days after a Participant or Beneficiary receives notice from the
Committee that his claim for benefits has been denied in any respect, he may
file with the Committee a written notice of appeal setting forth his reasons for
disputing the Committee's determination. In connection with his appeal the
Participant or Beneficiary or his representative may inspect or purchase copies
of pertinent documents and records to the extent not inconsistent with other
Participants' and Beneficiaries' rights of privacy. Within 60 days after
receiving a notice of appeal from a prior determination (or within 120 days, if
special circumstances require an extension of time and written notice of the
extension is given to the Participant or Beneficiary and his representative
within 60 days after receiving the notice of appeal), the Committee shall
furnish to the Participant or
34
<PAGE>
Beneficiary and his representative, if any, a written statement of the
Committee's final decision with respect to his claim, including the reasons for
such decision and the particular Plan provisions upon which it is based.
35
<PAGE>
Section 11
The Trust
Section 11.01 Creation of Trust Fund.
All amounts received under the Plan from an Employer and investments shall be
held in a Trust Fund pursuant to the terms of this Plan and the Trust Agreement.
The benefits described in this Plan shall be payable only from the assets of the
Trust Fund. Neither the Bank, any other Employer, its board of directors or
trustees, its stockholders, its officers, its employees, the Committee, nor the
Trustee shall be liable for payment of any benefit under this Plan except from
the Trust Fund.
Section 11.02 Company Stock and Other Investments.
Trust Fund held by the Trustee shall be divided into Company Stock and
investments other than Company Stock. The Trustee shall have no investment
responsibility for the portion of the Trust Fund consisting of Company Stock,
but shall accept any Employer contributions made in the form of Company Stock,
and shall acquire, sell, exchange, distribute, and otherwise deal with and
dispose of Company Stock in accordance with the instructions of the Committee.
Section 11.03 Acquisition of Company Stock.
From time to time the Committee may, in its sole discretion, direct the Trustee
to acquire Company Stock from the issuing Employer or from shareholders,
including shareholders who are or have been Employees, Participants, or
fiduciaries with respect to the Plan. The Trustee shall pay for such Company
Stock no more than its fair market value, which shall be determined conclusively
by the Committee pursuant to Section 9.03(d) of the Plan. The Committee may
direct the Trustee to finance the acquisition of Company Stock through an
Acquisition Loan subject to the provisions of Section 4.03 of the Plan.
Section 11.04 Participants' Option to Diversify.
The Committee shall provide for a procedure under which each Participant may,
during the first five years of a certain six-year period, elect to have up to 25
percent of the value of his Accounts committed to alternative investment options
within an "Investment Fund." For the sixth year in this period, the Participant
may elect to have up to 50 percent of the value of his Accounts committed to
other investments. The six-year period shall begin with the Plan Year following
the first Plan Year in which the Participant has both reached aged 55 and
completed 10 years of participation in the Plan; a Participant's election to
diversify his Accounts must be made within the 90-day period immediately
following the last day of each of the six Plan Years. The Committee shall see
that the Investment Fund includes a sufficient number of investment options to
comply with Section 401(a)(28)(B) of the Code. The Committee may, in its
discretion, permit a transfer of a portion of the Participant's Accounts to the
Savings Plan in order to satisfy this Section 11.04, provided such
36
<PAGE>
investments comply with Section 401(a)(28)(B) and such transfer is not otherwise
prohibited under the Code or ERISA. The Trustee shall comply with any investment
directions received from Participants in accordance with the procedures adopted
from time to time by the Committee under this Section 11.04.
37
<PAGE>
Section 12
Adoption, Amendment and Termination
Section 12.01 Adoption of Plan by Other Employers.
With the consent of the Bank, any entity may become a participating Employer
under the Plan by:
(a) taking such action as shall be necessary to adopt the Plan;
(b) becoming a party to the Trust Agreement establishing the Trust Fund; and
(c) executing and delivering such instruments and taking such other action as
may be necessary or desirable to put the Plan into effect with respect to the
entity's Employees.
Section 12.02 Adoption of Plan by Successor.
In the event that any Employer shall be reorganized by way of merger,
consolidation, transfer of assets or otherwise, so that an entity other than an
Employer shall succeed to all or substantially all of the Employer's business,
the successor entity may be substituted for the Employer under the Plan by
adopting the Plan and becoming a party to the Trust Agreement. Contributions by
the Employer shall be automatically suspended from the effective date of any
such reorganization until the date upon which the substitution of the successor
entity for the Employer under the Plan becomes effective. If, within 90 days
following the effective date of any such reorganization, the successor entity
shall not have elected to become a party to the Plan, or if the Employer shall
adopt a plan of complete liquidation other than in connection with a
reorganization, the Plan shall be automatically terminated with respect to
Employees of the Employer as of the close of business on the 90th day following
the effective date of the reorganization, or as of the close of business on the
date of adoption of a plan of complete liquidation, as the case may be.
Section 12.03 Plan Adoption Subject to Qualification.
Notwithstanding any other provision of the Plan, the adoption of the Plan and
the execution of the Trust Agreement are conditioned upon their being determined
initially by the Internal Revenue Service to meet the qualification requirements
of Section 401(a) of the Code, so that the Employers may deduct currently for
federal income tax purposes their contributions to the Trust and so that the
Participants may exclude the contributions from their gross income and recognize
income only when they receive benefits. In the event that this Plan is held by
the Internal Revenue Service not to qualify initially under Section 401(a) of
the Code, the Plan may be amended retroactively to the earliest date permitted
by the Code and the applicable Treasury Regulations in order to secure
qualification under Section 401(a) of the Code. If this Plan is held by the
Internal Revenue Service not to qualify initially under Section 401(a) of the
Code either as originally adopted or as amended, each Employer's contributions
to the Trust under this Plan (including any earnings thereon) shall be
38
<PAGE>
returned to it and this Plan shall be terminated. In the event that this Plan is
amended after its initial qualification and the Plan as amended is held by the
Internal Revenue Service not to qualify under Section 401(a) of the Code, the
amendment may be modified retroactively to the earliest date permitted by the
Code and the applicable Treasury Regulations in order to secure approval of the
amendment under Section 401(a) of the Code.
Section 12.04 Right to Amend or Terminate.
The Bank intends to continue this Plan as a permanent program. However, each
participating Employer separately reserves the right to suspend, supersede, or
terminate the Plan at any time and for any reason, as it applies to that
Employer's Employees, and the Bank reserves the right to amend, suspend,
supersede, merge, consolidate, or terminate the Plan at any time and for any
reason, as it applies to the Employees of all Employers. No amendment,
suspension, supersession, merger, consolidation, or termination of the Plan
shall reduce any Participant's or Beneficiary's proportionate interest in the
Trust Fund, or shall divert any portion of the Trust Fund to purposes other than
the exclusive benefit of the Participants and their Beneficiaries prior to the
satisfaction of all liabilities under the Plan. Except as is required for
purposes of compliance with the Code or ERISA, the provisions of Section 4.04
relating to the crediting of contributions, forfeitures and shares of Company
Stock released from the Loan Suspense Account, nor any other provision of the
Plan relating to the allocation of benefits to Participants, may be amended more
frequently than once every six months. Moreover, there shall not be any transfer
of assets to a successor plan or merger or consolidation with another plan
unless, in the event of the termination of the successor plan or the surviving
plan immediately following such transfer, merger, or consolidation, each
participant or beneficiary would be entitled to a benefit equal to or greater
than the benefit he would have been entitled to if the plan in which he was
previously a participant or beneficiary had terminated immediately prior to such
transfer, merger, or consolidation. Following a termination of this Plan by the
Bank, the Trustee shall continue to administer the Trust and pay benefits in
accordance with the Plan and the Committee's instructions.
39
<PAGE>
Section 13
General Provisions
Section 13.01 Nonassignability of Benefits.
The interests of Participants and other persons entitled to benefits under the
Plan shall not be subject to the claims of their creditors and may not be
voluntarily or involuntarily assigned, alienated, pledged, encumbered, sold, or
transferred. The prohibitions set forth in this Section 13.01 shall also apply
any judgement, decree, or order (including approval of a property or settlement
agreement) which relates to the provision of child support, alimony, or property
rights to a present or former spouse, child, or other dependent of a Participant
pursuant to a domestic relations order, unless such judgement, decree or order
is determined to be a "qualified domestic relations order" as defined in Section
414(p) of the Code.
Section 13.02 Limit of Employer Liability.
The liability of the Employers with respect to Participants and other persons
entitled to benefits under the Plan shall be limited to making contributions to
the Trust from time to time, in accordance with Section 4 of the Plan.
Section 13.03 Plan Expenses.
All expenses incurred by the Committee or the Trustee in connection with
administering the Plan and Trust shall be paid by the Trustee from the Trust
Fund to the extent the expenses have not been paid or assumed by the Employers
or by the Trustee.
Section 13.04 Nondiversion of Assets.
Except as provided in Sections 5.05 and 12.03 of the Plan, under no
circumstances shall any portion of the Trust Fund be diverted to or used for any
purpose other than the exclusive benefit of the Participants and their
Beneficiaries prior to the satisfaction of all liabilities under the Plan.
Section 13.05 Separability of Provisions.
If any provision of the Plan is held to be invalid or unenforceable, the other
provisions of the Plan shall not be affected but shall be applied as if the
invalid or unenforceable provision had not been included in the Plan.
Section 13.06 Service of Process.
The agent for the service of process upon the Plan shall be the president of the
Bank and the Trustee, or such other person as may be designated from time to
time by the Bank.
40
<PAGE>
Section 13.07 Governing Law.
The Plan is established under, and its validity, construction and effect shall
be governed by the laws of the Commonwealth of Massachusetts to the extent those
laws are not preempted by federal law, including the provisions of ERISA.
Section 13.08 Special Rules for Persons Subject to Section 16(b) Requirements.
Notwithstanding anything herein to the contrary, any former Participant who is
subject to the provisions of Section 16(b) of the Securities Exchange Act of
1934, who becomes eligible to again participate in the Plan, may not become a
Participant prior to the date that is six months from the date such former
Participant terminated participation in the Plan. In addition, any person
subject to the provisions of Section 16(b) of the 1934 Act receiving a
distribution of Company Stock from the Plan must hold such Company Stock for a
period of six months commencing with the date of distribution. However, this
restriction will not apply to Company Stock distributions made in connection
with death, retirement, disability or termination of employment, or made
pursuant to the terms of a qualified domestic relations order.
41
<PAGE>
Section 14
Top-Heavy Provisions
Section 14.01 Top-Heavy Provisions.
If, as of the last day of the first Plan Year, or thereafter, if as of the day
next preceding the beginning of any Plan Year (the "Determination Date"), the
Plan is a "top-heavy plan" (determined in accordance with the provisions of
Section 416(g) of the Code); that is, the aggregate present value of the accrued
benefits and account balances of all "Key Employees" (within the meaning of
Section 416(i) of the Code and for this purpose using the definition of
Compensation, as modified under Section 5.5(b) of the Plan) and their
Beneficiaries, the provision specified in this Section 14 will automatically
become effective as of the first day of the Plan Year. For purposes of the above
sentence, the aggregate present value of the accrued benefits and account
balances of a Participant who has not performed any services for the Bank or any
of its Affiliates during the five-year period ending on the Determination Date
shall not be taken into account. This calculation shall be made in accordance
with Section 416(g) of the Code, taking into consideration plans which are
considered part of the Aggregation Group. The term "Aggregation Group" shall
include each plan of the Bank or any of its Affiliates that includes a Key
Employee and each plan of the Bank or any of its Affiliates that allows the Plan
to meet the requirements of Section 401(a)(4) of the Code or Section 410 of the
Code and may include any other plan of the Bank or any of its Affiliates, if the
Aggregation Group would continue to meet the requirements of Sections 401(a)(4)
and 410 of the Code.
Section 14.02 Plan Modifications Upon Becoming Top-Heavy.
(a) Minimum Accruals. Section 5.04 of the Plan will be modified to provide that
the aggregate amount of Employer contributions allocated in each Plan Year to
the Accounts of each Participant who is a Non-Key Employee (within the meaning
of Section 416(i)(1) of the Code), and who is employed by an Employer as of the
last day of the Plan Year, may not be less than the lesser of:
(i) three percent of his Compensation for the Plan Year; and
(ii) a percentage of his Compensation equal to the largest percentage
obtained by dividing the sum of the amount credited to the Accounts of any
key Employee by that key Employee's Compensation; and
(b) Section 415(e) of the Code. Section 5.05 of the Plan will be modified to
provide that the dollar limitations in the denominators of the "defined benefit
plan fraction" and "defined contribution plan fraction" (as such terms are
defined in Section 415(e) of the Code) will be multiplied by 1.0 instead of
1.25. However, the above sentence shall not apply if "four percent" is
substituted for "three percent" in paragraph (a) of this Section 14.02.
42
<PAGE>
The preceding provisions will remain in effect for the period in which the Plan
is top-heavy. If, for any particular year thereafter, the Plan is no longer
top-heavy, the provisions contained in this Section 14 shall cease to apply,
except that any previously vested portion of any Account balance shall remain
nonforfeitable.
Section 14.03 Super Top-Heavy Provisions.
If, as of a Determination Date, the aggregate present value of the accrued
benefits and Account balances of all "Key Employees" (within the meaning of
Section 416(i) of the Code) and their Beneficiaries exceed 90% of the aggregate
present value of the accrued benefits and Account balances of all Participants
and Beneficiaries, paragraph (a) of Section 14.02 will automatically become
effective as of the first day of such Plan Year, except that Section 14.02(b) of
the Plan will be modified to provide that the dollar limitations in the
denominators of the defined benefit plan fraction and defined contribution plan
fraction in Section 5.05 of the Plan shall be multiplied by 1.0 instead of 1.25,
whether or not the minimum benefit is increased under Section 14.02(a) of the
Plan.
43
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF BAYSTATE BANCORP, INC. AT AND FOR THE YEAR ENDED MARCH
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 5,213
<INT-BEARING-DEPOSITS> 207,295
<FED-FUNDS-SOLD> 46,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 6,523
<INVESTMENTS-CARRYING> 6,145
<INVESTMENTS-MARKET> 6,147
<LOANS> 224,928
<ALLOWANCE> 2,513
<TOTAL-ASSETS> 295,291
<DEPOSITS> 207,780
<SHORT-TERM> 22,176
<LIABILITIES-OTHER> 1,761
<LONG-TERM> 0
0
0
<COMMON> 25
<OTHER-SE> 63,574
<TOTAL-LIABILITIES-AND-EQUITY> 295,291
<INTEREST-LOAN> 17,872
<INTEREST-INVEST> 1,009
<INTEREST-OTHER> 368
<INTEREST-TOTAL> 19,249
<INTEREST-DEPOSIT> 8,994
<INTEREST-EXPENSE> 1,206
<INTEREST-INCOME-NET> 9,049
<LOAN-LOSSES> 856
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 11,008
<INCOME-PRETAX> (2,502)
<INCOME-PRE-EXTRAORDINARY> (2,502)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,751)
<EPS-PRIMARY> 0
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<YIELD-ACTUAL> 8.12
<LOANS-NON> 2,279
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
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<ALLOWANCE-OPEN> 1,687
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</TABLE>
