ITEM 1. BUSINESS
General. Westfield Financial, Inc. ("Westfield Financial," "us," "our," or "we") is a Massachusetts-chartered stock holding company organized in November 2001 in connection with the reorganization of Westfield Mutual Holding Company, a federally-chartered mutual holding company which owns 56.3% of the outstanding common stock of Westfield Financial. Westfield Financial serves as the bank holding company for Westfield Bank, a federally-chartered stock savings bank. Unless the context otherwise requires, all references herein to Westfield Bank or Westfield Financial include Westfield Financial and Westfield Bank on a consolidated basis. In connection with our reorganizing, Westfield Financial sold 4,972,600 shares of its common stock to eligible depositors of Westfield Bank. Net proceeds of the stock offering were $47.7 million. The reorganization of Westfield Mutual Holding Company and the related stock offering by Westfield Financial were completed on December 27, 2001. The common stock of Westfield Financial commenced trading on The American Stock Exchange under the symbol "WFD" on December 28, 2001.
On July 23, 2004 Westfield Bank and Westfield Mutual Holding Company completed their conversions from Massachusetts-chartered companies regulated by the Massachusetts Division of Banks or the Federal Reserve Board to federally-chartered companies regulated by the Office of Thrift Supervision (the "OTS").
Westfield Securities Corp., a Massachusetts chartered security corporation, and Westfield Bank are the only operating subsidiaries of Westfield Financial. Westfield Securities Corp. was formed in December 2001 by Westfield Financial for the primary purpose of holding qualified investment securities.
Westfield Bank was formed in 1853 and reorganized into a mutual holding company structure without a stock offering in 1995. Historically, Westfield Bank has been a community-oriented provider of banking products and services to businesses and individuals, including traditional products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. In recent years, however, Westfield Bank has developed and implemented a lending strategy that focuses less on residential real estate lending and more on servicing commercial customers, including increased emphasis on commercial and industrial and consumer lending and deposit relationships, extending its branch network and broadening its product lines and services. Westfield Bank believes that this business strategy is best for its long term success and viability, and complements its existing commitment to high quality customer service.
Beginning on September 1, 2001, Westfield Bank began referring its residential real estate loan customers to a third party mortgage company. Under the program, substantially all of Westfield Bank's residential real estate loans are underwritten and originated by a third party mortgage company. In connection with this referral program, Westfield Bank receives fee income for each of the loans originated by the third party mortgage company. Westfield Bank may purchase residential real estate loans from the third party mortgage company depending on market conditions. To date, Westfield Bank has not purchased a significant amount of loans
from the third party mortgage company. Westfield Bank believes that this program diversifies its loan portfolio and reduces interest rate risk.
Westfield Bank operates through 10 banking offices in Agawam, East Longmeadow, Holyoke, Southwick, Springfield, West Springfield and Westfield, Massachusetts. It also has four free-standing ATM locations in Agawam, Feeding Hills and Springfield, Massachusetts. Westfield Bank's primary deposit gathering area is concentrated in the communities surrounding these locations and its primary lending area includes all of Hampden County in Western Massachusetts. In addition, Westfield Bank provides online banking services through its web site http://www.westfieldbank.com.
Westfield Bank's revenues are derived principally from interest on its loans and interest and dividends on its investment securities. Its primary sources of funds are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities, and funds provided by operations.
Market Area. Westfield Bank conducts its operations out of the Bank's main office in Westfield, Massachusetts. It also operates through nine other banking offices located in Westfield and in the communities of Agawam, East Longmeadow, Holyoke, Southwick, Springfield and West Springfield, Massachusetts. Its deposits are gathered from the general public in these towns and surrounding communities, and its lending activities are concentrated primarily in Hampden County, Massachusetts.
The City of Westfield is largely suburban and is located in the Pioneer Valley near the intersection of U.S. Interstates 90 (the Massachusetts Turnpike) and 91. Interstate 90 is the major east-west highway that crosses Massachusetts. Interstate 91 is the major north-south highway that runs directly through the heart of New England. Westfield is located approximately 90 miles west of Boston, Massachusetts, 70 miles southeast of Albany, New York and 30 miles north of Hartford, Connecticut. Westfield's 2004 population was approximately 41,000 and the estimated 2004 population for Hampden County was approximately 456,200.
The economy of Westfield Bank's market area historically has been supported by a variety of industries. Its primary market area has benefited from the presence of large employers centered in insurance, health care, warehouse, manufacturing and education. Among the largest employers currently in its market area are Bay State Health Systems, Big Y Foods, Friendly Ice Cream Corporation, Hasbro, Mass Mutual Life Insurance Company, Mestek, Noble Hospital, the University of Massachusetts, Westfield State College, American International College, and the Sullivan Paper Company. In addition, other employment and economic activity is provided by a substantial number of small and medium size businesses in the area.
Westfield Bank's future growth opportunities will be influenced by the growth and stability of the statewide and regional economies, other demographic population trends and the competitive environment. Westfield Bank believes that it has developed lending products and marketing strategies to address the diverse credit-related needs of the residents in its market area.
As of December 2004, the unemployment rate of Westfield Bank's primary market area and Massachusetts was 5.9% and 5.6%, respectively, compared to 6.5% and 5.4%, respectively, in December 2003. From June 2003 to June 2004, the median household income in Westfield Bank's market area increased by 2.2% to $55,624, compared to $54,387 as of June 2003. Despite the increase, the median household income in Westfield Bank's market area is below state and national averages.
Competition. Westfield Bank faces intense competition both in making loans and attracting deposits. Its primary market area is highly competitive and it faces direct competition from approximately 24 financial institutions, many with a local, state-wide or regional presence and, in some cases, a national presence. Many of these financial institutions are significantly larger than and have greater financial resources than Westfield Bank. Westfield Bank's competition for loans comes principally from commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. Historically, Westfield Bank's most direct competition for deposits has come from savings, co-operative and commercial banks. Westfield Bank faces additional competition for deposits from short- term money market funds and other corporate and government securities funds and from brokerage firms and insurance companies. In Westfield Bank's market area, there were approximately eight of the foregoing institutions at December 31, 2004.
Lending Activities
Loan Portfolio Composition. Westfield Bank's loan portfolio primarily consists of residential real estate loans, home equity loans, commercial real estate loans, commercial and industrial loans and consumer loans.
At December 31, 2004, Westfield Bank had total loans of $373.4 million, of which 71.7% were adjustable-rate loans and 28.3% were fixed- rate loans. Commercial real estate loans and commercial and industrial loans totaled $144.3 million and $94.7 million respectively. The remainder of its loans at December 31, 2004 consisted of residential mortgage loans, home equity loans and consumer loans. Residential mortgage and home equity loans outstanding at December 31, 2004 totaled $122.8 million. Consumer loans outstanding at December 31, 2004 were $11.6 million.
Westfield Bank's loans are subject to federal law and regulations. The interest rates Westfield Bank charges on loans are affected principally by the demand for loans, the supply of money available for lending purposes and the interest rates offered by its competitors. These factors are, in turn, affected by general and local economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters. The following table presents the composition of Westfield Bank's loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated.
Loan Maturity and Repricing. The following table shows the repricing dates or contractual maturity dates as of December 31, 2004. The table does not reflect prepayments or scheduled principal amortization. Demand loans, loans having no stated maturity, and overdrafts are shown as due in within one year.
The following table presents, as of December 31, 2004, the dollar amount of all loans contractually due or scheduled to reprice after December 31, 2005 and whether such loans have fixed interest rates or adjustable interest rates.
The following table presents our loan originations, purchases, sales and principal payments for the years indicated:
Residential Mortgage Loans and Originations. Beginning in September, 2001, Westfield Bank began referring its residential real estate borrowers to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is closed on the books of the mortgage company. Westfield Bank receives a fee for each of these loans originated by the third party mortgage company. Under the program, substantially all of Westfield Bank's residential real estate loans are underwritten and originated by the third party mortgage company. In addition, depending on market conditions, Westfield Bank may purchase residential real estate loans from the third party mortgage company. To date, the Bank has not purchased a significant amount of loans from the third party mortgage company. Westfield Bank believes that this program diversifies its loan portfolio and reduces its interest rate risk.
Even though substantially all residential mortgages are referred to a third party mortgage company, Westfield Bank still holds residential mortgages in its loan portfolio. The mortgages held in portfolio consist primarily of loans originated prior to the commencement of the third party residential mortgage program. As of December 31, 2004, loans on one-to- four family residential properties, including home equity lines, accounted for $122.8 million, or 32.89%, of Westfield Bank's total loan portfolio.
Westfield Bank offers adjustable-rate mortgage loans with either a one-year, three-year or five-year term to the initial repricing date. After that initial period, the interest rate for each adjustable-rate mortgage loan generally adjusts annually for the remainder of the term of the loan. Westfield Bank uses a different number of indices to reprice its adjustable-rate mortgage loans.
Westfield Bank's residential adjustable-rate mortgage loans generally are fully amortizing loans with contractual maturities of up to 30 years, payments due monthly. Its adjustable-rate mortgage loans generally provide for specified minimum and maximum interest rates, with a lifetime cap and floor, and a periodic adjustment on the interest rate over the rate in effect on the date of origination. As a consequence of using caps, the interest rates on these loans are not generally as rate sensitive as its cost of funds. The adjustable-rate mortgage loans that Westfield Bank originates generally are not convertible into fixed-rate loans.
Adjustable-rate mortgage loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower's payments rise, increasing the potential for default. To date, Westfield Bank has not experienced difficulty with payments for these loans. At December 31, 2004, its residential mortgage and home equity loan portfolio included $63.9 million in adjustable-rate loans or, 52.0% of its total loan portfolio, and $58.9 million in fixed-rate loans, or 48.0% of its total loan portfolio.
Westfield Bank's home equity lines of credit totaled $11.2 million and comprised 3.0% of its total loan portfolio at December 31, 2004. These loans may be originated in amounts of the existing first mortgage, or up to 100% of the value of the property securing the loan. The term to maturity on Westfield Bank's home equity and home improvement loans may be up to 15 years.
Commercial Real Estate Loans. Westfield Bank originates commercial real estate loans to finance the purchase of real property, which generally consists of apartment buildings, business properties, multi-family investment properties and construction loans to developers of commercial and residential properties. In underwriting commercial real estate loans, consideration is given to the property's historic cash flow, current and projected occupancy, location and physical condition. At December 31, 2004, Westfield Bank's commercial real estate loan portfolio consisted of 394 loans, totaling $144.3 million, or 38.6% of total loans. Since 2000, commercial real estate loans have grown by $51.5 million, or 55.5%, from $92.8 million at December 31, 2000 to $144.3 million at December 31, 2004.
Substantially all of the commercial real estate portfolio consists of loans which are collateralized by properties in Westfield Bank's normal lending area. Westfield Bank's commercial real estate loan portfolio is diverse, and does not have any significant loan concentration by type of property or borrower. Westfield Bank generally lends up to a maximum loan- to-value ratio of 80% on commercial properties and generally requires a minimum debt coverage ratio of 1.20 times. Its largest commercial real estate loan relationship had an outstanding balance of $6.3 million at December 31, 2004 which was secured by two commercial investment properties located in Massachusetts and one property in Connecticut. The loans of this borrower have performed to contractual terms.
Westfield Bank also offers construction loans to finance the construction of commercial properties located in its primary market area. Westfield Bank had $3.6 million in commercial construction loans and commitments at December 31, 2004.
Commercial real estate lending involves additional risks compared with one-to-four family residential lending. Payments on loans secured by commercial real estate properties often depend on the successful management of the properties, on the amount of rent from the properties, or on the level of expenses needed to maintain the properties. Repayment of such loans may therefore be adversely affected by conditions in the real estate market or the general economy. Also, commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. In order to mitigate this risk, Westfield Bank monitors its loan concentration on a quarterly basis and its loan policies generally limit the amount of loans to a single borrower or group of borrowers.
Because of increased risks associated with commercial real estate loans, Westfield Bank's commercial real estate loans generally have higher rates and shorter maturities than residential mortgage loans. Westfield Bank usually offers commercial real estate loans at adjustable rates tied to the prime rate or to yields on U.S. Treasury securities. The terms of such loans generally do not exceed 20 years.
Commercial and Industrial Loans. Westfield Bank offers commercial and industrial loan products and services which are designed to give business owners borrowing opportunities for modernization, inventory, equipment, construction, consolidation, real estate, working capital, vehicle purchases and the financing of existing corporate debt. Westfield Bank offers business installment loans, vehicle and equipment financing, lines of credit, equipment leasing and other commercial loans. At December 31, 2004, Westfield Bank's commercial and industrial loan portfolio consisted of 765 loans, totaling $94.7 million or 25.4% of its total loans. Since 2000, commercial and industrial loans have grown $57.2 million, or 153.0%, from $37.5 at December 31, 2000 to $94.7 million at December 31, 2004. Westfield Bank's commercial loan team includes six commercial loan officers, one business development manager, and four credit analysts. Westfield Bank may hire additional commercial loan officers on an as needed basis.
As part of Westfield Bank's strategy of increasing its emphasis on commercial lending, Westfield Bank seeks to attract its business customers' entire banking relationship. Most commercial borrowers also maintain a commercial deposit at Westfield Bank. Westfield Bank provides complementary commercial products and services, including an equipment leasing program with a third party vendor, a variety of commercial deposit accounts, cash management services, internet banking, sweep accounts, a broad ATM network and night deposit services. Commercial loan officers are based in its main and branch offices, and Westfield Bank views its potential branch expansion as a means of facilitating these commercial relationships. Westfield Bank intends to continue to expand the volume of its commercial business products and services within its current underwriting standards.
Westfield Bank's commercial loan portfolio does not have any significant loan concentration by type of property or borrower. The largest concentration of loans was for testing laboratories, which comprise approximately 3.4 % of the total loan portfolio as of December 31, 2004. At December 31, 2004, Westfield Bank's largest commercial and industrial loan relationship was $11.6 million to a company engaged in the wholesale distribution of beer and wine products in western Massachusetts. The loans of this borrower have performed to contractual terms.
Commercial and industrial loans generally have terms of five years or less, however on an occasional basis, may have terms of up to ten years. Although Westfield Bank does originate fixed-rate commercial loans, substantially all of its commercial loans have variable interest rates tied to the prime rate. Whenever possible, Westfield Bank also collateralizes these commercial and industrial loans with a lien on commercial real estate. Alternatively, Westfield Bank may collateralize these loans with a lien on business assets and equipment. In some cases, both types of liens are required. Westfield Bank also generally requires the personal guarantee of the business owner. Interest rates on commercial loans generally have higher yields than residential or commercial real estate loans.
Commercial and industrial loans are generally considered to involve a higher degree of risk than residential or commercial real estate loans because the collateral may be in the form of intangible assets and/or inventory subject to market obsolescence. Commercial and industrial loans may also involve relatively large loan balances to single borrowers or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation and income stream of the borrower. These risks can be significantly affected by economic
conditions. In addition, business lending generally requires substantially greater oversight efforts by Westfield Bank's staff compared to residential or commercial real estate lending. In order to mitigate this risk, Westfield Bank monitors its loan concentration and its loan policies generally limit the amount of loans to a single borrower or group of borrowers. Westfield Bank also utilizes the services of an outside consultant to conduct on-site credit quality reviews of the commercial and industrial loan portfolio.
Consumer Loans. Consumer loans are generally originated at higher interest rates than residential and commercial mortgage loans, but they also generally tend to have a higher credit risk than residential mortgage loans because they are usually unsecured or secured by rapidly depreciable assets. Management, however, believes that offering consumer loan products helps to expand and create stronger ties to Westfield Bank's existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.
Westfield Bank offers a variety of consumer loans to retail customers in the communities it serves. Examples of its consumer loans include:
* automobile loans;
* secured passbook loans;
* credit lines tied to deposit accounts to provide overdraft protection; and
* unsecured personal loans.
At December 31, 2004, the consumer loan portfolio totaled $11.6 million or 3.1% of total loans. Westfield Bank's consumer lending will allow it to diversify its loan portfolio while continuing to meet the needs of the individuals and businesses that it serves.
Indirect automobile loans currently represent the largest portion of its consumer loan portfolio, totaling $5.9 million, or 1.6% of its total loan portfolio and 50.9% of its consumer loan portfolio, at December 31, 2004. Management curtailed its indirect lending beginning in fiscal year 2000 and in fourth quarter of 2003 the Bank ceased writing new loans under this program.
When the indirect lending program was in operation, Westfield Bank maintained contractual relationships with approximately 40 new and used car dealers located throughout western Massachusetts and northern Connecticut. Westfield Bank had maintained a contractual arrangement and outsourced a portion of the origination function and all of the servicing function to a nationally recognized service provider. As of the fourth quarter of 2003, the Bank no longer originates indirect loans and in the first quarter of 2004, transferred servicing of the indirect loans from the service provider to Westfield Bank. The collection and liquidation functions had been, and continue to be, handled in-house by Westfield Bank personnel.
Loans collateralized by rapidly depreciable assets such as automobiles or that are unsecured entail greater risks than 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. The remaining deficiency often does not warrant further substantial
collection efforts against the borrower beyond obtaining a deficiency judgment. Further, 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. Repossessed collateral relating to consumer loans at December 31, 2004 approximated $18,000. 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 if a borrower defaults.
Loan Approval Procedures and Authority. As established by the Executive Committee of the Board of Directors, Westfield Bank's lending policies provide that its mortgage underwriting department may review and approve mortgage loans up to $500,000. Westfield Bank's underwriting department also may review and approve home equity loans up to $100,000. Any loan applications, including mortgage loans, that exceed $500,000 or $100,000 for home equity loans require approval of the Executive Committee. For loans requiring board approval, management is responsible for presenting to the board information about the creditworthiness of a borrower and the estimated value of the subject property. Generally, the estimated value of the property must be supported by an independent appraisal report prepared in accordance with Westfield Bank's appraisal policy.
The following generally describes Westfield Bank's current lending procedures. Upon receipt of a completed loan application from a prospective borrower, Westfield Bank must order a credit report and verify other information. If necessary, Westfield Bank obtains additional financial or credit related information. Westfield Bank requires an appraisal for all mortgage loans. Appraisals for mortgage loans are performed by licensed or certified third-party appraisal firms and are reviewed by Westfield Bank's lending department. Appraisals for second mortgages or home equity loans are not required. Rather, a designated employee of Westfield Bank conducts an inspection of the property. Westfield Bank requires title insurance on all mortgage loans and certain other loans. Westfield Bank requires borrowers to obtain hazard insurance. Westfield Bank also requires borrowers to obtain flood insurance, if applicable, prior to closing. In addition, Westfield Bank makes available to borrowers the option to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which it makes disbursements for items such as real estate taxes, flood insurance, and private mortgage insurance premiums. Beginning on September 1, 2001, Westfield Bank began referring its residential real estate loans to a third-party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is closed on the books of the mortgage company.
Asset Quality. One of Westfield Bank's key operating objectives has been and continues to be the achievement of a high level of asset quality. Westfield Bank maintains a large proportion of loans secured by residential and commercial properties, sets sound credit standards for new loan originations and follows careful loan administration procedures. Westfield Bank also utilizes the services of an outside consultant to conduct on-site credit quality reviews of Westfield Bank's commercial and industrial loan portfolio on an annual basis. These practices and relatively favorable economic and real estate market conditions have resulted in historically low delinquency ratios and, in recent years, a low level of nonaccrual loans.
Delinquent Loans and Foreclosed Assets. Westfield Bank's policies require that management continuously monitor the status of the loan portfolio and report to the Board of Directors on a monthly basis. These reports include information on delinquent loans and foreclosed real estate, as well as Westfield Bank's actions and plans to cure the delinquent status of the loans and to dispose of the foreclosed property.
The following table presents information regarding nonperforming mortgage, consumer and other loans, and foreclosed real estate as of the dates indicated. All loans where the interest payment is 90 days or more in arrears as of the closing date of each month are placed on non-accrual status. At December 31, 2004, 2003, and 2002, Westfield Bank had $2.2 million, $1.8 million, and $2.4 million, respectively, of non-accrual loans. If all non-accrual loans had been performing in accordance with their terms, Westfield Bank would have earned additional interest income of $176,000, $134,000 and $146,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
Allowance for Loan Losses. The following table presents the activity in Westfield Bank's allowance for loan losses and other ratios at or for the dates indicated.
Westfield Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio based on ongoing quarterly assessments of the estimated losses. Westfield Bank's methodology for assessing the appropriateness of the allowance consists of a review of the components, which include a specific valuation allowance for identified problem loans and a formula allowance for current performing loans. Fluctuations in the balances of impaired loans affect the specific valuation allowance while fluctuations in volume and concentrations of loans affects the formula reserve and the allocation of the allowance of the loan losses among loan types.
The specific valuation allowance incorporates the results of measuring impairment for specifically identified non-homogenous problem loans in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting By Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." In accordance with SFAS No. 114 and No. 118 the specific allowance reduces the carrying amount of the impaired loans to their estimated fair value. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan's contractual terms. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Westfield Bank expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on 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. Measurement of impairment does not apply to large groups of smaller balance homogenous loans that are collectively evaluated for impairment such as the Westfield Bank portfolios of home equity loans, real estate mortgages, installment and other loans.
The formula allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. As part of this analysis, each quarter Westfield Bank prepares an allowance for loan losses worksheet which categorizes the loan portfolio by risk characteristics such as loan type and loan grade. The formula allowance is inherently subjective as it requires material estimates that may be susceptible to significant change. There are a number of factors that are considered when evaluating the appropriate level of the allowance. These factors include current economic and business conditions that affect key lending areas of the company, new loan products, collateral values, loan volumes and concentrations, credit quality trends such as nonperformance loans, delinquency and loan losses, and specific industry connections within the portfolio segments that may impact the collectibility of the loan portfolio. Loss factors are described as follows:
* Classified loan loss factors are derived from loss percentages utilized by banking regulators for similarly graded loans. Loss factors of 3% to 5%, 10% to 15% and 50% to 75% are applied to the outstanding balance of loans internally classified special mention, substandard and doubtful, respectively.
* Pass graded loan loss factors are based on actual losses for the previous twelve quarters adjusted for qualitative factors, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations and specific industry conditions within portfolio segments that exist at the balance sheet date. The loss factors are applied to outstanding loans by loan type.
In addition, management employs an independent third party to perform an annual review of all of Westfield Bank's commercial and industrial loans and owner occupied commercial real estate loans with balances or commitments equal or greater than $600,000. The third party also reviews all commercial investment real estate loans in excess of $1 million, watch list loans with aggregate balances greater than $100,000, and all 30 day or longer past due commercial loans with balances in excess of $50,000.
Westfield Bank's methodologies include several factors that are intended to reduce the difference between estimated and actual losses. The loss factors that are used to establish the allowance for pass graded loans are designated to be self-correcting by taking into account changes in loan classification, loan concentrations and loan volumes and by permitting adjustments based on management's judgments of qualitative factors as of the evaluation date. Similarly, by basing the pass graded loan loss factors on loss experience over the prior three years, the methodology is designed to take Westfield Bank's recent loss experience into account.
Westfield Bank's allowance methodology has been applied on a consistent basis. Based on this methodology, Westfield Bank believes that it has established and maintained the allowance for loan losses at adequate levels. Future adjustments to the allowance for loan losses, however, may be necessary if economic, real estate and other conditions differ substantially from the current operating environment resulting in estimated and actual losses differing substantially. Adjustments to the allowance for loan losses are charged to income through the provision for loan losses.
A summary of the components of the allowance for loan losses is as follows:
In addition, the OTS, as an integral part of its examination process, periodically reviews Westfield Bank's loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The OTS may require Westfield Bank to adjust the allowance for loan losses or the valuation allowance for foreclosed real estate based on their judgments of information available to them at the time of their examination, thereby adversely affecting Westfield Bank's results of operations.
For the year ended December 31, 2004, Westfield Bank provided $750,000 to the allowance for loan losses based on its evaluation of the items discussed above. Westfield Bank believes that the allowance for loan losses accurately reflects the level of risk in the current loan portfolio as of December 31, 2004.
Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans indicated.
Investment Activities. The Board of Directors reviews and approves Westfield Bank's investment policy on an annual basis. The President and Treasurer, as authorized by the Board of Directors, implement this policy based on the established guidelines within the written policy.
Westfield Bank's investment policy is designed primarily to manage the interest rate sensitivity of its assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement its lending activities and to provide and maintain liquidity within the range established by policy. In determining Westfield Bank's investment strategies, it considers its interest rate sensitivity, yield, credit risk factors, maturity and amortization schedules, and other characteristics of the securities to be held.
Federally chartered savings banks have authority to invest in various types of assets, including U.S. Treasury obligations, securities of various federal agencies, mortgage-backed securities, certain certificates of deposit of insured financial institutions, repurchase agreements, overnight and short term loans to other banks and corporate debt instruments.
Securities Portfolio. Westfield Financial classifies securities as held to maturity or available for sale at the date of purchase. Westfield Financial does not have any securities classified as trading. Held to maturity securities are reported at cost, adjusted for amortization of premium and accretion of discount. Available for sale securities are reported at fair market value. At December 31, 2004, held to maturity securities totaled $246.6 million, or 73.6% of the total securities portfolio, and available for sale investments totaled $88.3 million, or 26.4% of Westfield Financial's total securities portfolio. Westfield Financial classifies U.S. Government securities and U.S. Government Agency securities as available for sale and held to maturity. These securities predominately have maturities of less than five years, although Westfield Financial also invests in adjustable rate securities with maturities of up to 15 years. Westfield Financial's mortgage-backed securities, which are directly or indirectly insured or guaranteed by Freddie Mac, Ginnie Mae or Fannie Mae or are rated AAA, consist of both fixed rate and adjustable rate securities primarily with average lives of less than five years. Westfield Financial also invests in municipal bonds issued by cities and towns in Massachusetts and are AAA rated by Moody's, Standard and Poor's, or Fitch. These securities generally have maturities between 7 and 20 years, however, many have earlier call dates. In addition, Westfield Financial has investments in Federal Home Loan Bank stock and mutual funds that invest only in securities allowed by the Office of Thrift Supervision.
The following table sets forth the composition of Westfield Bank's securities portfolio at the dates indicated.
Mortgage-Backed Securities and Mortgage-Related Securities. The following table sets forth the amortized cost and fair value of Westfield Bank's mortgage-backed and mortgage-related securities, which are classified as available for sale or held to maturity at the dates indicated.
Securities Portfolio Maturities. The composition and maturities of the securities portfolio (debt securities) and the mortgage-backed securities portfolio at December 31, 2004 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or redemptions that may occur.
Sources of Funds
General. Deposits, scheduled amortization and prepayments of loan principal, maturities and calls of investments securities and funds provided by operations are Westfield Bank's primary sources of funds for use in lending, investing and for other general purposes. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
Deposits. Westfield Bank offers a variety of deposit accounts having a range of interest rates and terms. Westfield Bank currently offers regular savings deposits (consisting of passbook and statement savings accounts), NOW accounts, noninterest-bearing demand accounts, money market accounts and time deposits. Westfield Bank has expanded the types of deposit products that it offers to include jumbo certificates of deposit, tiered money market accounts and customer repurchase agreements to compliment its increased emphasis on attracting commercial banking relationships.
Deposit flows are influenced significantly by general and local economic conditions, changes in prevailing interest rates, pricing of deposits and competition. Westfield Bank's deposits are primarily obtained from areas surrounding our offices. Westfield Bank relies primarily on paying competitive rates, service and long-standing relationships with customers to attract and retain these deposits. Westfield Bank does not use brokers to obtain deposits.
When Westfield Bank determines its deposit rates, it considers local competition, U.S. Treasury securities offerings and the rates charged on other sources of funds. Core deposits (defined as regular accounts, money market accounts, NOW accounts and demand accounts) represented 48.9% of total deposits on December 31, 2004 and 47.2% on December 31, 2003. The strategic plan calls for a greater reliance on core deposits and a decreased reliance on time deposits. At December 31, 2004 and December 31, 2003, time deposits with remaining terms to maturity of less than one year amounted to $184.5 million and $234.7 million, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Interest and Dividend Income" for information relating to the average balances and costs of Westfield Bank's deposit accounts for the years ended December 31, 2004, 2003 and 2002.
Deposit Distribution Weighted Average. The following table sets forth the distribution of Westfield Bank's deposit accounts, by account type, at the dates indicated.
C.D. Maturities. At December 31, 2004, Westfield Bank had $63.9 million in time certificates of deposit with balances of $100,000 and over maturing as follows:
C.D. Balances by Rates. The following table sets forth, by interest rate ranges, information concerning Westfield Bank's time certificates of deposit at the dates indicated.
Borrowings. In addition to deposits, borrowings from the Federal Home Loan Bank of Boston are available as an additional source of funds to finance Westfield Bank's lending and investing activities. Westfield Bank traditionally has not relied upon borrowings from the Federal Home Loan Bank. However, Westfield Bank borrowed $25.0 million in 2004 and $5.0 million in 2003 from the Federal Home Loan Bank to take advantage of the low interest rate environment.
Westfield Bank offers repurchase agreements to commercial customers and higher balance retail customers. These agreements are direct obligations of Westfield Bank to repay at maturity or on demand the purchase price of an undivided interest in a U.S. Government or agency security owned by Westfield Bank. Since these agreements are not deposits, they are not insured by the Federal Deposit Insurance Corporation. At December 31, 2004, such repurchase agreement borrowings totaled $14.6 million.
Personnel
As of December 31, 2004, Westfield Bank had 129 full-time employees and 29 part-time employees. The employees are not represented by a collective bargaining unit, and we consider our relationship with our employees to be excellent.
Federal And State Taxation
Federal
General. For federal income tax purposes, we report income on the basis of a taxable year ending December 31, using the accrual method of accounting, and we are generally subject to federal income taxation in the same manner as other corporations. Westfield Bank and Westfield Financial constitute an affiliated group of corporations and, therefore, are eligible to report their income on a consolidated basis. Because Westfield Mutual Holding Company owns less than 80% of the common stock of Westfield Financial, it is not a member of such affiliated group and therefore, must report its income on a separate return. Westfield Bank and Westfield Mutual Holding Company are not currently under audit by the IRS.
Distributions. To the extent that Westfield Bank makes "non-dividend distributions" to Westfield Financial, such distributions will be considered to result in distributions from unrecaptured tax bad debt reserve as of December 31, 1987 (our "base year reserve"), to the extent thereof and then from supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in income. Non- dividend distributions include distributions in excess of current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. Dividends paid out of current or accumulated earnings and profits will not be included in income.
The amount of additional income created from a non-dividend distribution is equal to the lesser of the base year reserve and supplemental reserve for losses on loans or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in some situations, approximately one and one-half times the non-dividend distribution would be includible in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate. Westfield Bank does not intend to pay dividends that would result in the recapture of any portion of the bad debt reserves.
Corporate Alternative Minimum Tax. The alternative minimum tax ("AMT") rules have been devised to ensure that at least a minimum amount of income tax is paid by high-income corporate taxpayers who take advantage of substantial tax savings due to the use of certain tax deductions and exemptions. In essence, the AMT functions as a recapture mechanism, reclaiming some of the tax deductions and credits utilized by these taxpayers when calculating their regular federal income tax liability. In general, a corporation's alternative minimum taxable income ("AMTI") is equal to its regular taxable income, increased by its preference items for the year and adjusted by computing certain items under special rules that negate the acceleration of certain tax benefits which are available under the regular tax rules. The AMT rate is 20%. Such preference items include adjustments for tax exempt interest, inside build-up of life insurance policies and accelerated depreciation deductions. During the past five years, Westfield Financial has not been the subject of the AMT and therefore has no AMT net operating losses or credit to utilize.
Elimination of Dividends; Dividends Received Deduction. Westfield Financial may exclude from its income 100% of dividends received from Westfield Bank as a member of the same affiliated group of corporations. Because Westfield Mutual Holding Company is not a member of such affiliated group, it does not qualify for such 100% dividends exclusion, but is entitled to deduct 80% of the dividends it receives from Westfield Financial so long as it owns more than 20% of the common stock.
State
Westfield Bank files Massachusetts Financial Institution excise tax returns. Generally, the income of financial institutions in Massachusetts, which is calculated based on federal taxable income, subject to certain adjustments, is subject to Massachusetts tax. Westfield Bank is not currently under audit with respect to its Massachusetts income tax returns and its state tax returns have not been audited for the past five years.
Westfield Financial is also required to file a Massachusetts income tax return and is generally subject to a state income tax rate that is the same tax rate as the tax rate for financial institutions in Massachusetts. However, Westfield Securities Corp. and Elm Street Securities Corp. are taxed at a rate that is currently lower than income tax rates for savings institutions in Massachusetts.
Massachusetts legislation was signed on March 5, 2003 amending the corporate tax law affecting the treatment of dividends received from Real Estate Investment Trusts (REITs). Dividends from the REIT subsidiary are no longer eligible for a dividends-received deduction. As a result of the enactment of this legislation, Westfield Financial ceased recording the tax benefits associated with the dividend received deduction effective for the 2003 tax year.
In addition to the effect on 2003, the legislation was retroactive to 1999. Westfield Financial's 2003 results include a charge of $1.45 million representing the additional state tax liability, including interest, relating to the deduction for dividends received from the REIT for 2002 and prior years.
REGULATION
General
Westfield Bank is a federal savings bank subject to regulation, examination, and supervision by the OTS and is subject to the examination and supervision of the Federal Deposit Insurance Corporation ("FDIC") as its deposit insurer. Westfield Bank is a member of the Bank Insurance Fund ("BIF"), and its deposit accounts are insured up to applicable limits by the FDIC. All of the deposit premiums paid by Westfield Bank to the FDIC for deposit insurance are currently paid to the BIF. Westfield Bank is also a member of the Federal Home Loan Bank ("FHLB") of Boston, which is one of the twelve regional FHLBs. Westfield Bank must file reports with the OTS concerning its activities and financial condition, and it must obtain regulatory approvals prior to entering into certain transactions, such as mergers with, or acquisitions of, other depository institutions. The OTS conducts periodic examinations to assess Westfield Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which a savings association can engage and is intended primarily for the protection of the insurance fund and depositors. As a savings and loan holding company, we must file certain reports with, and otherwise comply with, the rules and regulations of the OTS and of the Securities and Exchange Commission ("SEC") under the federal securities laws.
The OTS and the FDIC have significant 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 policies, whether by the OTS, the FDIC, SEC or the United States Congress, could have a material adverse impact on us, Westfield Bank, and our operations and stockholders.
On July 23, 2004, Westfield Bank converted to its federal charter from a Massachusetts state banking charter. At this time, Westfield Mutual Holding Company also converted its charter to that of a federal mutual holding company. Westfield Financial became a savings and loan holding company, rather than a bank holding company, and its federal regulator became the OTS rather than the Board of Governors of the Federal Reserve Board (the "FRB").
The following discussion is intended to be a summary of the material statutes and regulations applicable to savings associations and their holding companies, and it does not purport to be a comprehensive description of all such statutes and regulations.
Regulation Of Federal Savings Associations
Business Activities. Westfield Bank derives its lending and investment powers from the Home Owners' Loan Act, as amended ("HOLA"), and OTS regulations. Under these laws and regulations, Westfield Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities, and certain other assets. Westfield Bank may also establish service corporations that may engage in activities not otherwise permissible for Westfield Bank, including certain real estate equity investments and securities and insurance brokerage. Westfield Bank's authority to invest in certain types of loans or other investments is limited by federal law.
Loans to One Borrower. Westfield Bank is generally subject to the same limits on loans to one borrower as is a national bank. With specified exceptions, Westfield Bank's total loans or extensions of credit to a single borrower cannot exceed 15% of Westfield Bank's unimpaired capital and surplus, which does not include accumulated other comprehensive income. Westfield Bank may lend additional amounts up to 10% of its unimpaired capital and surplus which does not include accumulated other comprehensive income, if the loans or extensions of credit are fully-secured by readily- marketable collateral. Westfield Bank currently complies with applicable loans-to-one borrower limitations.
QTL Test. The HOLA requires that Westfield Bank, as a savings association, to comply with the qualified thrift lender ("QTL") test. Under the QTL test, Westfield Bank is required to maintain at least 65% of its portfolio assets in certain "qualified thrift investments" for at least nine months of the most recent twelve-month period. "Portfolio assets" means, in general, Westfield Bank's total assets less the sum of:
* specified liquid assets up to 20% of total assets;
* goodwill and other intangible assets; and
* the value of property used to conduct Westfield Bank's business.
Westfield Bank may also satisfy the QTL test by qualifying as a domestic building and loan association as defined in the Internal Revenue Code of 1986, as amended (the "Code"). Westfield Bank met the QTL test at December 31, 2004 and in each of the prior 12 months, and, therefore, qualified as a thrift lender. If Westfield Bank fails the QTL test, it must either operate under certain restrictions on its activities or convert to a national charter.
Capital Requirements. The OTS regulations require savings associations to meet three minimum capital standards: (i) a tangible capital ratio requirement of 1.5% of total assets as adjusted under the OTS regulations; (ii) a leverage ratio requirement of 3.0% of core capital to such adjusted total assets, if a savings association has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Rating System; and (iii) a risk-based capital ratio requirement of 8.0% of core and supplementary capital to total risk-based assets. The minimum leverage capital ratio for any other depository institution that does not have a composite rating of 1 will be 4.0%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. In determining the amount of risk-weighted assets for purposes of the risk-based capital requirement, a savings association must compute its risk-based assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0.0% for cash and obligations issued by the United States Government or its agencies to 100.0% for consumer and commercial loans, as assigned by the OTS capital regulation based on the risks found by the OTS to be inherent in the type of asset.
Tangible capital is defined, generally, as common stockholders' equity (including retained earnings), certain non-cumulative perpetual preferred stock and related earnings, minority interests in equity accounts of fully consolidated subsidiaries, less intangibles (other than certain mortgage servicing rights), and investments in and loans to subsidiaries engaged in activities not permissible for a national bank. Core capital is defined similarly to tangible capital, but core capital also includes certain qualifying supervisory goodwill and certain purchased credit card relationships. Supplementary capital currently includes cumulative and other preferred stock, mandatory convertible debt securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses. In addition, up to 45.0% of unrealized gains on available-for-sale equity securities with a readily determinable fair value may be included in tier 2 capital. The allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets, and the amount of supplementary capital that may be included as total capital cannot exceed the amount of core capital.
At December 31, 2004, Westfield Bank met each of its capital requirements, in each case on a fully phased-in basis.
Capital Distributions. The OTS imposes various restrictions or requirements on Westfield Bank's ability to make capital distributions, including cash dividends. A savings institution that is the subsidiary of a savings and loan holding company must file a notice with the OTS at least 30 days before making a capital distribution. Westfield Bank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to Westfield Bank's net income for that year plus Westfield Bank's retained net income for the previous two years.
The OTS may disapprove of a notice of application if:
* Westfield Bank would be undercapitalized following the distribution;
* the proposed capital distribution raises safety and soundness concerns;
* the capital distribution would violate a prohibition contained in any statute, regulation, or agreement; or
* our ability to pay dividends, service our debt obligations, and repurchase our common stock is dependent upon receipt of dividend payments from Westfield Bank.
Branching. Subject to certain limitations, HOLA and OTS regulations permit federally-chartered savings associations to establish branches in any state of the United States. The authority to establish such a branch is available: (i) in states that expressly authorize branches of savings associations located in another state; and (ii) to an association that qualifies as a "domestic building and loan association" under the Code, which imposes qualification requirements similar to those for a qualified thrift lender under HOLA. The authority for a federal savings association to establish an interstate branch network would facilitate a geographic diversification of the association's activities. This authority under HOLA and OTS regulations preempts any state law purporting to regulate branching by federal savings associations.
Community Reinvestment. Under the Community Reinvestment Act (the "CRA"), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the Office of Thrift Supervision, in connection with its examination of a savings association, to assess the association's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to publicly disclose their CRA ratings. Westfield Bank received a "Satisfactory" CRA rating in its most recent examination.
The CRA regulations establish an assessment system that bases an association's rating on its actual performance in meeting community needs. In particular, the assessment system focuses on three tests: (i) a lending test, to evaluate the institution's record of making loans in its assessment areas; (ii) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution's delivery of services through its branches, ATMs, and other offices.
Transactions with Related Parties. Westfield Bank's authority to engage in transactions with its affiliates is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act (the "FRA"). In general, these transactions must be on terms that are as favorable to Westfield Bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of Westfield Bank's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from Westfield Bank. In addition, OTS regulations prohibit a savings association from lending to any of its affiliates that engage in activities not permissible for bank holding companies and from purchasing the securities of any affiliate (other than a subsidiary).
Effective April 1, 2003, the FRB rescinded its interpretations of Sections 23A and 23B of the FRA and replaced these interpretations with Regulation W. In addition, Regulation W makes various changes to existing law regarding Sections 23A and 23B, including expanding the definition of what constitutes an affiliate subject to Sections 23A and 23B and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and 23B. Under Regulation W, all transactions entered into on or before December 12, 2002, which either became subject to Sections 23A and 23B solely because of Regulation W, and all transactions covered by Sections 23A and 23B, the treatment of which will change solely because of Regulation W, became subject to Regulation W on July 1, 2003. All other covered affiliate transactions become subject to Regulation W on April 1, 2003. The Federal Reserve Board expects each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W.
Westfield Bank's authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB. Among other things, these provisions require that extensions of credit to insiders: (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Westfield Bank capital. The regulations allow small discounts on fees on residential mortgages for directors, officers and employees. In addition, extensions for credit in excess of certain limits must be approved by Westfield Bank's Board of Directors.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as Westfield Bank, that are subject to the insider lending restrictions of Section 22(h) of the FRA.
Enforcement. The OTS has primary enforcement responsibility over savings associations, including Westfield Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices.
Standards for Safety and Soundness. Under federal law, the OTS has adopted a set of guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings standards, compensation, fees and benefits. In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being notified, an institution fails to submit an acceptable plan of compliance or fails in any material respect to implement an accepted plan, the OTS must
issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of federal law. If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Real Estate Lending Standards. The OTS and the other federal banking agencies adopted regulations to prescribe standards for extensions of credit that are either secured by real estate or made for the purpose of financing the construction of improvements on real estate. The OTS regulations require each savings association to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying OTS guidelines, which include loan-to-value ratios for the different types of real estate loans. Associations are also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending situations in which exceptions to the loan- to-value standards are justified.
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action regulations, the OTS is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings associations. For this purpose, a savings association would be placed in one of the following four categories based on the association's capital:
* well-capitalized;
* adequately capitalized;
* undercapitalized; or
* critically undercapitalized.
At December 31, 2004, Westfield Bank met the criteria for being considered well-capitalized. When appropriate, the OTS can require corrective action by a savings association holding company under the prompt corrective action provision of federal law.
Insurance of Deposit Accounts. Westfield Bank is a member of the BIF, and Westfield Bank pays its deposit insurance assessments to the BIF, as prior to July 23, 2004, Westfield Bank was a Massachusetts-chartered bank. The FDIC also maintains another insurance fund, the Savings Association Insurance Fund, which ordinarily insures the deposits of federal savings association and state-chartered savings banks.
Under federal law, the FDIC established a risk based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. Under the assessment system, the FDIC assigns an institution to one of three capital categories based on the institution's financial information as of the quarter ending three months before the beginning of the assessment period. An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned. Under the regulation, there are nine risk assessment classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates currently range from 0.0% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.27% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concern). The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%.
In addition, all FDIC-insured institutions are required to pay assessments to the FDIC at an annual rate of approximately 0.0168% of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the BIF. These assessments will continue until the Financing Corporation bonds mature in 2017.
Federal Home Loan Bank System. Westfield Bank is a member of the FHLB of Boston, which is one of the regional FHLBs composing the FHLB System. Each FHLB provides a central credit facility primarily for its member institutions: (i) the greater of $1,000 or 0.20% of the member's mortgage-related assets; and (ii) 4.50% of the dollar amount of any outstanding advances under such member's advances, collateral pledge and security agreement with the FHLB of Boston. Westfield Bank, as a member of the FHLB of Boston, is required to acquire and hold shares of capital stock in the FHLB of Boston in an amount at least equal to 0.12% of the total assets of Westfield Bank. Westfield Bank is also required to own activity based stock, which is based on 4.45% of Westfield Bank's outstanding advances. These percentages are subject to change by the FHLB. Westfield Bank was in compliance with this requirement with an investment in FHLB of Boston stock at December 31, 2004 of $4.2 million. Any advances from a FHLB must be secured by specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of earnings that the FHLBs can pay as dividends to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB advances increased, Westfield Bank's net interest income would be affected.
Under the Gramm-Leach-Bliley Act (the "GLB Act"), membership in the FHLB is now voluntary for all federally-chartered savings associations, such as Westfield Bank. The GLB Act also replaces the existing redeemable stock structure of the FHLB System with a capital structure that requires each FHLB to meet a leverage limit and a risk-based permanent capital requirement. Two classes of stock are authorized: Class A (redeemable on six-months notice) and Class B (redeemable on five-years notice).
Federal Reserve System. Westfield Bank is subject to provisions of the FRA and the FRB's regulations pursuant to which depositary institutions may be required to maintain non-interest-earning reserves against their deposit accounts and certain other liabilities. Currently, reserves must be maintained against transaction accounts (primarily NOW and regular checking accounts). The FRB regulations generally require that reserves be maintained in the
amount of 3.0% of the aggregate of transaction accounts up to $42.1 million. The amount of aggregate transaction accounts in excess of $42.1 million are currently subject to a reserve ratio of 10.0%. The FRB regulations currently exempt $6.0 million of otherwise reservable balances from the reserve requirements, which exemption is adjusted by the FRB at the end of each year. Westfield Bank is in compliance with the foregoing reserve requirements. Because required reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a Federal Reserve Bank, or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce Westfield Bank's interest-earning assets. The balances maintained to meet the reserve requirements imposed by the FRB may be used to satisfy liquidity requirements imposed by the OTS. FHLB System members are also authorized to borrow from the Federal Reserve discount window, but FRB regulations require such institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank.
Privacy Regulations. Pursuant to the GLB Act, the OTS has published final regulations implementing the privacy protection provisions of the GLB Act. The new regulations generally require that Westfield Bank disclose its privacy policy, including identifying with whom it shares a customer's "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter. In addition, Westfield Bank is required to provide its customers with the ability to "opt-out" of having their personal information shared with unaffiliated third parties and not to disclose account numbers or access codes to non-affiliated third parties for marketing purposes. Westfield Bank currently has a privacy protection policy in place and believes that such policy is in compliance with the regulations.
The USA PATRIOT Act. Westfield Bank is subject to the USA PATRIOT Act, which gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents, and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:
* Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls; (ii) specific designation of an anti-money laundering compliance officer; (iii) ongoing employee training programs; and (iv) an independent audit function to test the anti-money laundering program.
* Pursuant to Section 326, on May 9, 2003, the Secretary of the Department of Treasury, in conjunction with other bank regulators, issued Joint Final Rules that provide for minimum standards with respect to customer identification and verification. These rules, which became effective on October 1, 2003, require each financial institution to implement a written customer identification program appropriate for its size, location and type of business that includes certain minimum requirements.
* Section 312 requires financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report instances of money laundering through those accounts.
* Section 318, which became effective December 25, 2001, prohibits financial institutions from establishing, maintaining, administering, or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and requires financial institutions to take reasonable steps to ensure that correspondent accounted provided to foreign banks are not being used to indirectly provide banking services to foreign shell banks.
* Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Bank Holding Company Act and Bank Merger Act applications.
Holding Company Regulation
Westfield Financial and Westfield Mutual Holding Company are savings and loan holding companies regulated by the Office of Thrift Supervision. As such, Westfield Financial and Westfield Mutual Holding Company are registered with and are subject to OTS examination and supervision, as well as certain reporting requirements. In addition, the OTS has enforcement authority over Westfield Financial and Westfield Mutual Holding Company and any of their non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings institution. Unlike bank holding companies, federal savings and loan holding companies are not subject to any regulatory capital requirements or to supervision by the Federal Reserve System.
Restrictions Applicable to Westfield Financial. Because Westfield Financial was acquired after May 4, 1999, under the GLB Act it is prohibited from engaging in non-financial activities. Unitary savings and loan associations acquired before this date are "grandfathered" under the GLB Act and generally have no restrictions on their business activities. Westfield Financial's activities, however, will be restricted to:
* furnishing or performing management services for a savings institution subsidiary of such holding company;
* conducting an insurance agency or escrow business;
* holding, managing, or liquidating assets owned or acquired from a savings institution subsidiary of such company;
* holding or managing properties used or occupied by a savings institution subsidiary of such company;
* acting as trustee under a deed of trust;
* any other activity (i) that the FRB, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956 (the "BHC Act"), unless the Director of the OTS, by regulation, prohibits or limits any such activity for savings and loan holding companies, or (ii) in which multiple savings and loan holding companies were authorized by regulation to directly engage in on March 5, 1987;
* purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such holding company is approved by the Director of the OTS; and
* any activity permissible for financial holding companies under section 4(k) of the BHC Act.
Permissible activities which are deemed to be financial in nature or incidental thereto under section 4(k) of the BHC Act include:
* lending, exchanging, transferring, investing for others, or safeguarding money or securities;
* insurance activities or providing and issuing annuities, and acting as principal, agent, or broker;
* financial, investment, or economic advisory services;
* issuing or selling instruments representing interests in pools of assets that a bank is permitted to hold directly;
* underwriting, dealing in, or making a market in securities;
* activities previously determined by the FRB to be closely related to banking;
* activities that bank holding companies are permitted to engage in outside of the U.S.; and
* portfolio investments made by an insurance company.
In addition, Westfield Financial cannot be acquired or acquire a company unless the acquirer is engaged solely in financial activities.
Restrictions Applicable to Activities of Mutual Holding Companies. Under federal law, a mutual holding company may engage only in the following activities:
* investing in the stock of a savings institution;
* acquiring a mutual association through the merger of such association into a savings institution subsidiary of such holding company or an interim savings institution subsidiary of such holding company;
* merging with or acquiring another holding company, one of whose subsidiaries is a savings institution;
* investing in a corporation the capital stock of which is available for purchase by a savings institution under federal law or under the law of any state where the subsidiary savings institution or association is located; and
* the permissible activities described above for non- grandfathered savings and loan holding companies.
If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in the activities listed above, and it has a period of two years to cease any non- conforming activities and divest any non-conforming investments.
Restrictions Applicable to All Savings and Loan Holding Companies. Federal law prohibits a savings and loan holding company, including Westfield Financial and Westfield Mutual Holding Company, directly or indirectly, from acquiring:
* control (as defined under HOLA) of another savings institution (or a holding company parent) without prior OTS approval;
* through merger, consolidation, or purchase of assets, another savings institution or a holding company thereof, or acquiring all or substantially all of the assets of such institution (or a holding company) without prior OTS approval; or
* control of any depository institution not insured by the FDIC (except through a merger with and into the holding company's savings institution subsidiary that is approved by the OTS).
A savings and loan holding company may not acquire as a separate subsidiary an insured institution that has a principal office outside of the state where the principal office of its subsidiary institution is located, except:
* in the case of certain emergency acquisitions approved by the FDIC;
* if such holding company controls a savings institution subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or
* if the laws of the state in which the savings institution to be acquired is located specifically authorize a savings institution chartered by that state to be acquired by a savings institution chartered by the state where the acquiring savings institution or savings and loan holding company is located or by a holding company that controls such a state-chartered association.
If the savings institution subsidiary of a federal mutual holding company fails to meet the QTL test set forth in Section 10(m) of the HOLA and regulations of the Office of Thrift Supervision, the holding company must register with the FRB as a bank holding company under the BHC Act within one year of the savings institution's failure to so qualify.
Prohibitions Against Tying Arrangements. Federal savings banks are subject to the prohibitions of 12 U.S.C. [SECTION] 1972 on certain tying arrangements. A depository institution is prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Securities Laws. Our common stock is registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.
The Sarbanes-Oxley Act. As a public company, we are subject to the Sarbanes-Oxley Act, which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. The Sarbanes-Oxley Act's principal legislation and the derivative regulation and rule making promulgated by the SEC includes:
* the creation of an independent accounting oversight board;
* auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients;
* additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;
* a requirement that companies establish and maintain a system of internal control over financial reporting and that a company's management provide an annual report regarding its assessment of the effectiveness of such internal control over financial reporting to the company's independent accountants and that such accountants provide an attestation report with respect to management's assessment of the effectiveness of the company's internal control over financial reporting;
* the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
* an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the company's independent auditors;
* the requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;
* the requirement that companies disclose whether at least one member of the committee is a "financial expert" (as such term is defined by the SEC) and if not, why not;
* expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;
* a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;
* disclosure of a code of ethics and the requirement of filing of a Form 8-K for a change or waiver of such code;
* mandatory disclosure by analysts of potential conflicts of interest; and
* a range of enhanced penalties for fraud and other violations.
Although we anticipate that we will incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on our results of operations or financial condition.
Quotation on AMEX. Our common stock is quoted on the American Stock Exchange ("AMEX"). In order to maintain such quotation, we are subject to certain corporate governance requirements, including:
* a majority of our board must be composed of independent directors;
* we are required to have an audit committee composed of at least three directors, each of whom is an independent director, as such term is defined by both AMEX rules as set forth in its Company Guide and by Exchange Act regulations;
* our nominating committee and compensation committee must also be composed entirely of independent directors; and
* each of our audit committee and nominating committee must have a publicly available written charter.
ITEM 2.
ITEM 2. PROPERTIES
Properties
Westfield Bank currently conducts its business through its ten banking offices and four off-site ATMs. As of December 31, 2004, the properties and leasehold improvements owned by us had an aggregate net book value of $11.5 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any pending legal proceeding other than routine legal proceedings occurring in the ordinary course of business. In the opinion of management, no legal proceedings will have a material effect on the company's consolidated financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is listed on The American Stock Exchange under the symbol "WFD." Westfield Mutual Holding Company owns 5,607,400 shares, or 53% of our outstanding common stock. At December 31, 2004, there were 9,954,512 shares of common stock issued and outstanding, and there were approximately 1,384 holders of record.
The table below shows the high and low sales price during the periods indicated as well as dividends declared per share. The information set forth in the table below was provided by the American Stock Exchange.
A quarterly cash dividend of $0.05 per share was declared on January 27, and April 26, and $0.10 per share was declared on July 27 and October 26, 2004 by the Board of Directors. The continued payment of dividends also depend upon our debt and equity structure, earnings, financial condition, need for capital in connection with possible future acquisitions and other factors, including economic conditions, regulatory restrictions and tax considerations. We cannot guarantee that we will pay dividends or that, if paid, that we will not reduce or eliminate dividends in the future.
The only funds available for the payment of dividends on the capital stock of Westfield Financial will be cash and cash equivalents held by Westfield Financial, dividends paid by Westfield Bank to Westfield Financial, and borrowings. Westfield Bank will be prohibited from paying cash dividends to Westfield Financial to the extent that any such payment would reduce Westfield Bank's capital below required capital levels or would impair the liquidation account to be established for the benefit of the Westfield Bank's eligible account holders and supplemental eligible account holders at the time of the reorganization and stock offering.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The summary information presented below at or for each of the years presented is derived in part from the consolidated financial statements of Westfield Financial. The following information is only a summary, and you should read it in conjunction with our consolidated financial statements and notes beginning on page.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Westfield Financial strives to remain a leader in meeting the financial service needs of the local community and to provide quality service to the individuals and businesses in the market areas that it has served since 1853. Historically, Westfield Bank has been a community- oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. Westfield Bank meets the needs of its local community through a community-based and service-oriented approach to banking.
In recent years, in addition to real estate lending, we have adopted a growth-oriented strategy that has focused on increased emphasis on commercial lending. Our strategy also calls for increasing deposit relationships and broadening our product lines and services. We believe that this business strategy is best for our long term success and viability, and complements our existing commitment to high quality customer service. In connection with our overall growth strategy, Westfield Bank seeks to:
* continue to grow its commercial loan portfolio as a means to increase the yield on and diversify its loan portfolio and build transactional deposit account relationships;
* focus on expanding its retail banking franchise, and increasing the number of households served within its market area; and
* depending on market conditions, refer substantially all of the fixed-rate residential real estate loans to a third party mortgage company which underwrites, originates and services these loans in order to diversify its loan portfolio, increase fee income and reduce interest rate risk.
You should read our financial results for the year ended December 31, 2004 in the context of this strategy.
* Net income increased $2.6 million, or 70.3%, to $6.3 million or $0.64 per diluted share for the year ended December 31, 2004 from $3.7 million or $0.36 per diluted share for 2003. This was due to a $1.7 million increase in net interest income, a $822,000 increase in noninterest income, and a decrease in income tax expense of $258,000.
* The 2003 results were affected by an agreement with the Massachusetts Department of Revenue to settle the issue related to taxes owed on dividends received from Westfield Bank's REIT subsidiary in 2002 and prior tax years. Under the agreement, Westfield Financial paid 50% of the amount owed including interest. This resulted in a charge of approximately $1.45 million for state taxes, interest and penalties, net of federal benefit.
* Net interest and dividend income increased primarily as a result of lower funding costs. The net interest margin was 3.13% for the year ended December 31, 2004, as a compared to 2.86% for the same period in 2003. The cost of interest- bearing liabilities decreased 44 basis points to 1.77% for the year ended December 31, 2004 from 2.21% in the same period in 2003. This was achieved by the use of a pricing strategy whereby less emphasis was placed on attracting term deposits, which generally have higher interest rates than core deposits. Westfield Financial expects net interest and dividend income to increase in future periods as it continues to emphasize higher yielding commercial real estate loans and commercial and industrial loans, while referring residential mortgage loans to a third party mortgage company.
* Commercial real estate and commercial and industrial loans increased $22.5 million, or 10.4%, to $239.1 million at December 31, 2004. This is consistent with Westfield Bank's strategic plan, which emphasizes commercial lending. The continued success of Westfield Bank's commercial lending is primarily dependent on the local and national economy.
* Residential real estate loans increased $12.7 million to $123.2 million at December 31, 2004 from $110.5 million at December 31, 2003. Westfield Bank purchased $35.3 million in adjustable rate mortgage loans, which are serviced by the originating institutions. This was offset by principal payments and payoffs of other residential real estate loans. Westfield Bank refers its residential real estate borrowers to a third party mortgage company and substantially all of Westfield Bank's residential real estate loans are underwritten, originated and serviced by a third party mortgage company. Westfield Bank receives a fee from each of these loans originated. Westfield Bank believes that this program has diversified its loan portfolio and continues to reduce interest rate risk.
* Indirect automobile loans decreased $10.1 million, or 63.1%, from $16.0 million at December 31, 2003 to $5.9 million at December 31, 2004. Management curtailed its indirect automobile lending beginning in fiscal year 2000 due to credit quality concerns, and in the fourth quarter of 2003, Westfield Bank ceased writing indirect automobile loans. Although indirect auto loans had higher yields, they also had higher costs, therefore Westfield Bank expects minimal impact on earnings as a result of the discontinuation of the program.
* Total deposits decreased $19.8 million from $632.4 million at December 31, 2003 to $612.6 million at December 31, 2004. The decrease in deposits was primarily due to a decrease of $21.1 million in time deposits for the year ended December 31, 2004. Management believes that the decrease in time deposits was a result of a pricing strategy whereby less emphasis was placed on attracting term deposits, which generally have higher interest rates than core deposits. This led to an increase in net interest income. Core deposits, which include checking, NOW, savings, and money market accounts, increased $1.3 million to $299.5 million at December 31, 2004. Westfield Bank's strategy is to emphasize core deposits in order to maintain long-term relationships with customers and to reduce the cost of funds. Management believes, however, that a percentage of the growth in core deposits over the last three years was due to the low rate environment, i.e. no incentive for customers to lock up funds in time deposits. In a period of rising interest rates, the more rate sensitive customers may shift funds back into time deposits, resulting in a higher cost of funds.
* The decrease in deposits was offset by increases in Federal Home Loan Bank borrowings and customer repurchase agreements. Federal Home Loan Bank borrowings increased $25.0 million to $45.0 million at December 31, 2004 to take advantage of the current interest rate environment. Customer repurchase agreements increased $2.5 million to $14.6 million at December 31, 2004.
* Fees received from the third party mortgage company were $100,000 for the year ended December 31, 2004 as compared to $340,000 for the same period in 2003. Higher interest rates resulted in fewer referrals to the third party mortgage company. Fee income from the third party mortgage company in the future may be affected by borrower activity, which generally decreases in a rising interest rate environment.
* Checking account processing fees increased $617,000 for the twelve months ended December 31, 2004 as compared to the same period in 2003. This was as a result of new products and services provided by Westfield Bank to its checking account customers commencing in the second quarter of 2004.
* Nonperforming loans increased $403,000 to $2.2 million at December 31, 2004 from $1.8 million at December 31, 2003. This was primarily due to single commercial real estate loan relationship of $1.4 million. The loan is fully collateralized based on the estimated fair market value of the property. This was offset primarily by payments in full received on other nonperforming loans.
* Gross charge-offs decreased by 44.3% for the twelve months ended December 31, 2004 as compared to the same period in 2003, primarily as a result of the curtailment of indirect auto loans and the improved local and national economy.
* The allowance for loans as a percent of total loans receivable increased. Westfield Bank has steadily increased this ratio over the last five years to compensate for growth in commercial loans, which typically have higher risks than residential loans. As Westfield Bank emphasizes the origination of commercial real estate loans and commercial and industrial loans for its loan portfolio, increased allowance requirements may continue. Due to Westfield Bank's discontinuation of its indirect automobile lending, the balance of consumer loans is expected to decrease. Decreased allowances for consumer loans in the future may result.
* Stockholders' equity at December 31, 2004 and December 31, 2003 was $118.1 million and $124.8 million, respectively, representing 14.8% and 15.7% of total assets. The change is comprised of net income of $6.3 million for the year ended December 31, 2004, the net repurchase of 567,788 shares of common stock for $12.0 million, and the declaration by the Board of Directors of quarterly cash dividends aggregating $1.7 million.
General
Westfield Financial's consolidated results of operations are comprised of earnings on investments and the net income recorded by its principal operating subsidiary, Westfield Bank. Westfield Bank's consolidated results of operations depend primarily on net interest and dividend income. Net interest and dividend income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Interest-earning assets consist primarily of residential mortgage loans, commercial mortgage loans, commercial loans, consumer loans, mortgage-backed securities and investment securities. Interest-bearing liabilities consist primarily of certificates of deposit, savings, money market and NOW account deposits, and borrowings from the Federal Home Loan Bank of Boston. The consolidated results of operations also depend on provision for loan losses, noninterest income, and noninterest expense. Noninterest expense includes salaries and employee benefits, occupancy expenses and other general and administrative expenses. Noninterest income includes service fees and charges, income on bank owned life insurance, and gains (losses) on sales of securities and securities writedowns.
The consolidated results of operations may also be affected significantly by economic and competitive conditions in the market area and elsewhere, including those conditions that influence market interest rates, government policies and the actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect the results of operations. Furthermore, because Westfield Bank's lending activity is concentrated in loans secured by residential and commercial real estate located in Hampden County, Massachusetts, downturns in this regional economy could have a negative impact on its earnings.
Critical Accounting Policies
Westfield Financial's accounting policies are disclosed in Note 1 to the Consolidated Financial Statements. The more critical policies given Westfield Financial's current business strategy and asset/liability structure are accounting for non performing loans, the allowance for loan losses and provision for credit loans, the classification of securities as either held to maturity or available for sale, other than temporary impairment of securities, and discount rate assumptions used for benefit liabilities. In addition to the information disclosure in the Notes to the Consolidated Financial Statements, Westfield Financial's policy on each of these accounting policies is described in detail in the applicable sections of Management's Discussion and Analysis of Financial Condition and results of Operations. Senior management has discussed the development and selection of these accounting estimates and the related disclosures with the Audit Committee of the Company's Board of Directors.
On a quarterly basis, the Company reviews available for sale investment securities with unrealized depreciation on a judgmental basis to assess whether the decline in fair value is temporary or other than temporary. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Securities, including mortgage-backed securities, which management has the positive intent and ability to hold until maturity are classified as held to maturity and are carried at amortized cost. Securities, including mortgage-backed securities, which have been identified as assets for which there is not a positive intent to hold to maturity are classified as available for sale and are carried at fair value with unrealized gains and losses, net of income taxes, reported as a separate component of equity. Accordingly, a misclassification would have a direct effect on stockholders' equity. Sales or reclassification as available for sale (except for certain permitted reasons) of held to maturity securities may result in the reclassification of all such securities to available for sale. The Company has never sold held to maturity securities or reclassified such securities to available for sale other than in specifically permitted circumstances. Westfield Financial does not acquire securities or mortgage-backed securities for purposes of engaging in trading activities.
Westfield Financial's general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and when subsequent performance reduces the concern as to the collectibility of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans. Compensation to an auto dealer is normally based upon a spread that a dealer adds on the loan base rate set by Westfield Financial. The compensation is paid to an automobile dealer shortly after the loan is originated. Westfield Financial records the amount as a deferred cost that is amortized over the life of the loans in relation to the interest paid by the consumer.
The process of evaluating the loan portfolio, classifying loans and determining the allowance and provision is described in detail on pages 16- 20. Westfield Financial's methodology for assessing the appropriations of the allowance consists of two key components, which are a specific allowance for identified problems or impaired loans and a formula allowance for the remainder of the portfolio. Measurement of impairment can be based on 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. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The appropriations of the allowance is also reviewed by management based upon its evaluation of then- existing economic and business conditions affecting the key lending areas of Westfield Financial and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions,) collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Although management believes it has established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST AND DIVIDEND INCOME
The following tables set forth information relating to our financial condition and net interest and dividend income for the years ended December 31, 2004, 2003 and 2002 and reflect the average yield on assets and average cost of liabilities for the periods indicated. The yields and costs were derived by dividing income or expense by the average balance of interest- earning assets or interest-bearing liabilities, respectively, for the periods shown. Average balances were derived from actual daily balances over the periods indicated. Interest income includes fees earned from making changes in loan rates or terms, and fees earned when commercial real estate loans were prepaid or refinanced.
Rate/Volume Analysis. The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest and dividend income and interest expense during the periods indicated. Information is provided in each category with respect to:
(1) interest income changes attributable to changes in volume (changes in volume multiplied by prior rate); (2) interest income changes attributable to changes in rate (changes in rate multiplied by prior volume); and (3) the net change.
The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Comparison of Financial Condition at December 31, 2004 and December 31, 2003
Consolidated assets increased $1.7 million, or 0.2%, to $796.9 million at December 31, 2004 from $795.2 million at December 31, 2003. Securities decreased $28.7 million, or 7.9%, to $334.9 million at December 31, 2004 from $363.6 million at December 31, 2003. Cash received from maturities, calls, and paydowns of securities was primarily used to fund loan demand. Cash and cash equivalents increased $5.4 million to $51.0 million at December 31, 2004 from $45.7 million at December 31, 2003.
Net loans during this period increased by $23.6 million, or 6.8%, to $368.6 million at December 31, 2004, from $345.0 million at December 31, 2003.
Commercial real estate loans increased $13.0 million, or 9.9%, to $144.3 million at December 31, 2004 from $131.3 million at December 31, 2003. Commercial and industrial loans increased $9.5 million, or 11.1%, to $94.8 million at December 31, 2004 from $85.3 million at December 31, 2003. Westfield Bank's strategic plan calls for emphasis on commercial lending. The success of the plan to grow commercial loans is primarily dependent upon the improvement of the local and national economy.
Residential real estate loans increased $12.7 million to $123.2 million at December 31, 2004 from $110.5 million at December 31, 2003. The increase was primarily the result of Westfield Bank's purchase of $35.3 million in adjustable rate mortgage loans, which are serviced by the originating institutions. This was offset by principal payments and payoffs of other residential real estate loans. Westfield Bank refers its residential real estate borrowers to a third party mortgage company and substantially all of Westfield Bank's residential real estate loans are underwritten, originated and serviced by a third party mortgage company. Westfield Bank receives a fee from each of these loans originated. Westfield Bank believes that this program has diversified its loan portfolio and continues to reduce interest rate risk.
Indirect automobile loans decreased $10.1 million, or 63.1%, to $5.9 million on December 31, 2004 as compared to $16.0 million on December 31, 2003. Management curtailed its indirect lending beginning in fiscal year 2000 and in the fourth quarter of 2003, the Bank ceased writing loans under this program.
Total deposits decreased $19.8 million to $612.6 million at December 31, 2004. The decrease in deposits was primarily due to a decrease of $21.1 million in time deposits for the year ended December 31, 2004. Management believes that the decrease in time deposits was a result of a pricing strategy whereby less emphasis was placed on attracting term deposits, which generally have higher interest rates than core deposits. This led to an increase in net interest income.
Core deposits, which include checking, NOW, savings and money market accounts, increased $1.3 million to $299.5 million at December 31, 2004. Westfield Bank's strategy is to emphasize core deposits in order to maintain long-term relationships with customers and to reduce the cost of funds. Management believes, however, that a percentage of the growth in core deposits over the last three years was due to the low rate environment, i.e. no incentive for
customers to lock up funds in time deposits. In a period of rising interest rates, the more rate sensitive customers may shift funds back into time deposits, resulting in a higher cost of funds.
The decrease in deposits was offset by increases in Federal Home Loan Bank borrowings and customer repurchase agreements. Federal Home Loan Bank borrowings increased $25.0 million to $45.0 million at December 31, 2004 to take advantage of the current interest rate environment. Customer repurchase agreements increased $2.5 million to $14.6 million at December 31, 2004. A customer repurchase agreement is an agreement by Westfield Bank to sell to and repurchase from the customer an interest in specific securities issued by or guaranteed by the United States Government. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. All the customer repurchase agreements are held by Westfield Bank's commercial loan customers. The increase customer repurchase agreements is consistent with Westfield Bank's strategy to emphasize commercial customer relationships.
Stockholders' equity at December 31, 2004 and December 31, 2003 was $118.1 million and $124.8 million, respectively. The change is comprised of net income of $6.3 million for the year ended December 31, 2004, the net repurchase of 567,788 shares of common stock for $12.0 million, and the declaration by the Board of Directors of quarterly cash dividends aggregating $1.7 million.
Comparison of Operating Results for Years Ended December 31, 2004 and 2003
General
Westfield Financial reported net income of $6.3 million or $0.64 per diluted share for the year ended December 31, 2004 compared to net income of $3.7 million or $0.36 per diluted share for the same period in 2003. Interest and dividend income increased by $1.2 million and interest expense decreased by $2.9 million resulting in an increase in net interest income of $1.7 million. Noninterest income increased by $822,000 and income tax expense decreased by $258,000.
Westfield Financial 2003 results included a charge of $1.45 million representing the additional state tax liability, including interest, relating to the deduction for dividends received from Westfield Bank's real estate investment trust subsidiary for 2002 and prior years. Total income taxes were $2.6 million for the year ended December 31, 2004 as compared to $2.8 million for the same period in 2003.
Interest and Dividend Income
Total interest and dividend income decreased $1.2 million or 3.4% to $34.4 million for the year ended December 31, 2004 compared to $35.6 million for the same period in 2003.
The decrease in interest income was primarily the result of a $1.3 million decrease in interest income on loans. Interest income from residential real estate loans decreased $1.6 million to $7.8 million for the year ended December 31, 2004 as compared to the same period in 2003. The average balance of residential real estate loans decreased to $119.6 million for the
year ended December 31, 2004 from $131.4 million for the year ended December 31, 2003 due to our residential real estate loan program with a third party mortgage company. In addition, interest on consumer loans decreased $1.2 million to $1.2 million for the year ended December 31, 2004 as compared to $2.4 million for the same period in 2003. This was primarily the result of a decrease in average balance of consumer loans from $31.2 million for 2003 to $16.0 million for 2004 due to management's decision to discontinue indirect automobile loan originations.
The decrease is interest income from residential real estate loans and consumer loans was partially offset by increases in income from commercial real estate loans and commercial and industrial loans. Interest income from commercial real estate loans and commercial and industrial loans increased $1.5 million for the year ended December 31, 2004 from the year ended December 31, 2003. In accordance with Westfield Bank's strategic plan, the average balance of commercial real estate loans and commercial industrial loans increased $39.6 million to $231.1 million for the year ended December 31, 2004 as compared to $191.5 million for the same period in 2003
Interest and dividends on securities was $13.2 million for both the years ended December 31, 2004 and 2003. The average yield on securities increased from 3.39% for the year 2003 to 3.65% for the same period in 2004. This change was offset by a $28.0 million decrease in the average balance of securities from $389.3 million for 2003 to $361.3 million for 2004. Market interest rates increased during 2004. As lower yielding investments purchased in a higher rate environment matured, were called, or paid down in 2004, the funds were reinvested at higher rates. In addition, the interest rate on adjustable rate securities repriced upward in the rising interest rate environment.
Interest Expense
Interest expense for the year ended December 31, 2004 decreased $3.0 million to $10.9 million from the comparable 2003 period. This was attributable to a decrease in the average cost of interest-bearing liabilities of 44 basis points to 1.77% for the year ended December 31, 2004 from 2.21% for the same period in 2003. In addition, the average balance of total interest-bearing liabilities decreased $10.0 million to $616.5 million for the year ended December 31, 2004 from $626.5 million for the same period in 2003.
The decrease in both the average balance and average cost of interest-bearing liabilities was the result of a pricing strategy whereby less emphasis was place on attracting term deposits, which generally have higher interest rates than core deposits.
Net Interest and Dividend Income
Net interest and dividend income increased $1.7 million to $23.5 million for the twelve months ended December 31, 2004 as compared to $21.8 million for the same period in 2003. The net interest margin was 3.13% for the twelve months ended December 31, 2004 as compared to 2.86% for the same period in 2003.
The increase in the net interest margin was primarily the result of lower funding costs. The average cost of interest-bearing liabilities decreased 44 basis points to 1.77% for the twelve months ended December 31, 2004 from 2.21% for same period in 2003. The yield on interest-earning assets decreased only 8 basis points to 4.60% for the twelve months ended December 31, 2004 from 4.68% for same period in 2003. Westfield Financial expects net interest and dividend income to generally increase in future periods as it continues to emphasize higher yielding commercial real estate loans and commercial and industrial loans, while referring residential mortgage loans to a third party mortgage company.
In addition, Westfield Bank continues to emphasize core deposits over time deposits. The average balance of core deposits, which are checking, NOW, savings and money market accounts, increased $4.7 million to $301.2 million for the twelve months ended December 31, 2004 from $296.5 million for the same period in 2003. The average balance of time deposits decreased $36.4 million to $317.6 million for the twelve months ended December 31, 2004 from $354.0 million for the same period in 2003. The decrease in time deposits was partially offset by an increase in Federal Home Loan Bank borrowings. The average balance of Federal Home Loan Bank borrowings increased $17.5 million to $34.4 million for the twelve months ended December 31, 2004 from $16.9 million for the same period in 2003.
The use of a pricing strategy whereby less emphasis was placed on attracting term deposits, which generally have higher interest rates than core deposits, and the shift in Westfield Bank's funding mix contributed to the decrease in funding costs. Management believes, however, that a percentage of the growth in core deposits over the last three years is due to the low rate environment, i.e. no incentive for customers to lock up funds in time deposits. In a period of rising interest rates, the more rate sensitive customers may shift funds back into time deposits, resulting in a higher cost of deposits.
Provision for Loan Losses
During 2004, Westfield Bank provided $750,000 for loans losses, during both 2004 and 2003. The provision for loan losses brings Westfield Bank's allowance for loan losses to a level determined appropriate by management based on the methodology discussed under "Allowance for Loan Losses". The allocation of the provision for loan losses among loan types and between the specific and formula components of the allowance for loan losses is also determined based on the methodology discussed under "Allowance for Loan Losses". The following factors were used to determine the provision for 2004.
* Loan concentrations - Commercial real estate loans and commercial and industrial loans increased $22.5 million or 10.4% during 2004 as compared to 2003. Westfield Bank considers these types of loans to contain more risk than conventional residential mortgages. These increases resulted in an increase in the allowance requirements for commercial real estate and commercial and industrial loans. As Westfield Bank emphasizes increasing its commercial real estate loans and commercial and industrial loans, increased allowance requirements may continue.
Residential real estate loans increased $12.7 million to $123.2 million at December 31, 2004. This was the result of Westfield Bank purchasing $35.0 million of adjustable rate mortgage loans in 2004. The increases in residential real estate loans and commercial loans were partially offset by a decrease in consumer loans of $10.8 million to $11.6 million, resulting in decreases in the allowance requirements for consumer loans, respectively. Due to Westfield Bank's discontinuation of its indirect auto lending, the balance of consumer loans is expected to continue to decrease. Decreased future allowances for consumer loans may result.
* Credit quality - Actual loss experience on loans decreased with charge-offs totaling $404,000 in 2004 as compared to $725,000 in 2003. Net loans charged off as a percent of average loans outstanding decreased from 0.12% in 2003 to 0.03% in 2004. Nonperforming loans increased $403,000 from $1.8 million at December 31, 2003 to $2.2 million at December 31, 2004. This was primarily due to a single commercial real estate loan relationship of $1.4 million. The loan is fully collateralized based on the estimated fair market value of the property. This was offset primarily by payments in full received on other nonperforming loans.
As a result of the detailed allowance for loan loss methodology and consideration of the above factors, management determined that a provision of $750,000 was appropriate in 2004.
The allowance for loan losses at the end of 2004 was 1.41% of total loans compared with 1.33% at the end of 2003. The increase in the coverage ratio reflects the changes in the loan portfolio described above.
Noninterest Income
Noninterest income increased $822,000 to $3.9 million in 2004 from $3.1 million for 2003. Fees received from the third party mortgage company were $100,000 for the year ended December 31, 2004 as compared to $340,000 for the same period in 2003. Higher interest rates resulted in fewer referrals to the third party mortgage company. Fee income from the third party mortgage company in the future may be affected by borrower activity, which generally decreases in a rising interest rate environment.
Checking account processing fees increased $617,000 for the year ended December 31, 2004 as compared to the same period in 2003. This was a result of new products and services provided by Westfield Bank to its checking account customers commencing in the third quarter of 2004.
Net gains from sales and writedowns of securities were $877,000 for the year ended December 31, 2004 as compared to $409,000 for the same period in 2003. This is primarily the result of the company selling its common stock portfolio in 2004 to comply with Office of Thrift Supervision regulations. Income on bank owned life insurance was $741,000 for the period ended December 31, 2004 as compared to $806,000 for the same period in 2003.
Noninterest Expense
Noninterest expense for the twelve months ended December 31, 2004 was $17.8 million as compared to $17.6 million for the same period in 2003. The 2003 results included a net charge of $153,000 for tax-related interest and penalties regarding the Commonwealth of Massachusetts' REIT legislation. Salaries and benefits increased $1.1 million for the year ended December 31, 2004 as compared to the same period in 2003. This was primarily the result of normal increases in salaries and health care costs along with an increase in stock base benefit plan expenses of $65,000. Expenses associated with indirect auto loan processing decreased by $153,000 for the year ended December 31, 2004 as compared to the same period in 2003. This was a result of discontinuing the indirect auto loan program.
Advertising and marketing expenses decreased $124,000 for the twelve months ended December 31, 2004 as compared to the same period in 2003. This was the result of additional expenses incurred in 2003 to promote the 150th anniversary of Westfield Bank.
Income Taxes
Income taxes decreased $258,000 to $2.6 million in 2004. The effective tax rate was 28.8% in 2004 compared to 43.6% for 2003. The effective tax rates for 2004 and 2003 also reflect the utilization of Westfield Securities Corporation and Elm Street Securities Corporation, both qualified securities corporations. The effective tax rate for 2003 also includes Elm Street Real Estate Investments, Inc., a wholly-owned subsidiary of Westfield Bank, as a real estate investment trust.
The 2003 income taxes were affected by Massachusetts legislation signed on March 5, 2003 amending the corporate tax law affecting the treatment of dividends received from Real Estate Investment Trusts (REITs). Dividends from the REIT subsidiary are no longer eligible for a dividends- received deduction. As a result of the enactment of this legislation, the Company ceased recording the tax benefits associated with the dividend received deduction effective for the 2003 tax year.
In addition to the effect on 2003, the legislation was retroactive to 1999. The Company's 2003 results included a charge of $1.45 million representing the additional state tax liability, including interest, relating to the deduction for dividends received from the REIT for 2002 and prior years.
Comparison of Financial Condition at December 31, 2003 and December 31,
Consolidated assets decreased $17.8 million, or 2.2%, to $795.2 million at December 31, 2003 from $813.0 million at December 31, 2002. Securities decreased $12.0 million, or 3.2%, to $363.6 million at December 31, 2003 from $375.6 million at December 31, 2002. Cash and cash equivalents decreased $10.9 million to $45.7 million at December 31, 2003 from $56.6 million at December 31, 2002.
Net loans during this period decreased by $12.2 million, or 3.4%, to $345.0 million at December 31, 2003, from $357.2 million at December 31, 2002. Decreases in residential and indirect automobile loans were partially offset by increases in commercial real estate loans and commercial and industrial loans.
Residential loans decreased $47.4 million to $110.5 million at December 31, 2003 from $157.9 million at December 31, 2002. The decrease is primarily the result of the current residential real estate loan program with a third party mortgage company. Under this program, which commenced on September 1, 2001, Westfield Bank refers its residential real estate borrowers to a third party mortgage company and substantially all of the Bank's residential real estate loans are underwritten, originated and serviced by a third party mortgage company. The Bank receives a fee of 65 basis points for each of these loans originated. The Bank believes that this program will diversify its loan portfolio and reduce interest risk. The Bank may purchase residential real estate loans from the third party mortgage company depending on market conditions. To date, the Bank has not purchased a significant amount of loans from the third party mortgage company.
Indirect automobile loans decreased $17.8 million, or 52.7% to $16.0 million on December 31, 2003 as compared to $33.8 million on December 31, 2002. Management curtailed its indirect lending beginning in fiscal year 2000 and in the fourth quarter of 2003, the Bank ceased writing loans under this program.
Commercial real estate loans increased $30.4 million or 30.1% to $131.3 million at December 31, 2003 from $100.9 million at December 31, 2002. Commercial and industrial loans increased $23.8 million or 38.7% to $85.3 million at December 31, 2003 from $61.5 million at December 31, 2002. The Bank's strategic plan calls for emphasis on commercial lending. The success of the plan to grow commercial loans is primarily dependent upon the improvement of the local and national economy.
During the twelve month period ended December 31, 2003, the Bank invested $16.5 million in bank owned life insurance ("BOLI"). The Bank purchased BOLI as a means to offset employee benefit costs. A substantial number of employees are covered by BOLI policies.
Total deposits decreased $23.7 million, or 3.6%, to $632.4 million at December 31, 2003 from $656.1 million at December 31, 2002. Noninterest- bearing accounts decreased $116,000 to $54.6 million at December 31, 2003 from $54.7 million at December 31, 2002. This decrease was primarily the result of a $2.7 million decrease in internal checking accounts to $3.4 million at December 31, 2003. The amount reported in internal checking accounts represents checks outstanding that were issued by the Bank for accounts payable purposes, loan proceeds, and official checks and money orders purchased by Bank customers. The decrease in internal checking was partially offset by an increase in customer demand deposits of $2.6 million, or 5.3%, to $51.2 million at December 31, 2003 from $48.6 million at December 31, 2002.
NOW, regular savings, and money market accounts increased $17.3 million, or 7.6%, to $243.6 million at December 31, 2003 from $226.3 million at December 31, 2002. Time deposits decreased by $40.8 million, or 10.9% to $334.2 million at December 31, 2003 from $375.0 million at December 31, 2002. The Bank's strategic plan calls for a lesser reliance on time deposits accounts. This was facilitated by the low interest rate environment of 2003, which gave little incentive for customers to lock up funds in time deposits.
Customer repurchase agreements increased $3.4 million, or 39.1%, to $12.1 million at December 31, 2003 from $8.7 million at December 31, 2002. A customer repurchase agreement is an agreement by Westfield Bank to sell to and repurchase from the customer an interest in specific securities issued by or guaranteed by the United States Government. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. Substantially all the customer repurchase agreements are held by the Bank's commercial loan customers. Federal Home Loan Bank ("FHLB") borrowings increased $5.0 million from $15.0 million at December 31, 2002 to $20.0 million at December 31, 2003 to take advantage of the low interest rate environment.
Stockholders' equity at December 31, 2003 and December 31, 2002 was $124.8 million and $126.7 million, respectively. The change is comprised of net income of $3.7 million for the year ended December 31, 2003, a decrease in net unrealized gains on securities available for sale of $430,000, net of income taxes, the net repurchase of 57,700 shares of common stock for $1.1 million, the purchase of shares of common stock for the management recognition and retention plan for $2.3 million and the declaration by the Board of Directors of quarterly $0.05 per share cash dividends aggregating $2.1 million.
Comparison of Operating Results for Years Ended December 31, 2003 and 2002
General
The Company reported net income of $3.7 million or $0.36 per diluted share for the year ended December 31, 2003 compared to net income of $4.0 million or $0.38 per diluted share for the same period in 2002. Interest and dividend income decreased by $7.4 million and interest expense decreased by $4.9 million resulting in a decrease in net interest income of $2.5 million. This was offset by an increase in noninterest income of $3.4 million.
The Company entered into an agreement with the Massachusetts Department of Revenue to settle the issue related to taxes owed on dividends received from the Bank's REIT subsidiary in 2002 and prior tax years. Under the agreement, the Company paid 50% of the amount including interest that would have been owed under legislation that was enacted in March 2003. The legislation was retroactive to 2002 and prior years. The payment is a deductible expense for federal tax purposes. This resulted in a charge of approximately $1.45 million for state taxes, interest, and penalties, net of federal tax benefit. Total income taxes were $2.8 million for the year ended December 31, 2003 as compared to $2.2 million for the same period in 2002.
Interest and Dividend Income
Total interest and dividend income decreased $7.4 million, or 17.2%, to $35.6 million for the year ended December 31, 2003 compared to $43.0 million for the same period in 2002. Interest and dividends on securities decreased $1.2 million to $12.4 million, while interest income on loans decreased $5.8 million to $22.3 million.
The decrease in interest and dividend income on securities was the result of a decrease of 92 basis points in the average yield on securities from 4.31% for the year 2002 to 3.39% for the same period in 2003. This change was partially offset by a $51.7 million increase in the average balance of securities from $337.6 million for 2002 to $389.3 million for 2003. Market interest rates have declined significantly since January 1, 2001. For example, the prime rate of interest decreased 550 basis points from January of 2001 through December 31, 2003. As higher yielding investments purchased in a higher rate environment have matured, been called, or paid down in 2003, the funds were reinvested at lower rates. In addition, the interest rate on adjustable rate securities repriced downward in the declining interest rate environment.
The decrease in interest income on loans was primarily the result of a $4.3 million decrease in interest on residential real estate loans. The average balance of residential real estate loans decreased from $186.2 million for the year ended December 31, 2002 to $131.4 million for the year ended December 31, 2003 due to our residential real estate loan program with a third party mortgage company. However, Westfield Bank earned $340,000 in fee income on the origination of these loans which is included in noninterest income in 2003. In addition, as a result of the low interest rate environment of 2003, the Bank experienced high levels of payoffs of existing mortgages due to refinancing activity. Moreover, interest on consumer loans decreased $1.7 million. This was primarily the result of a decrease in average balance of consumer loans from $49.6 million for 2002 to $31.2 million for 2003 due to management's decision to curtail indirect automobile loan originations.
Interest income from commercial real estate loans and commercial and industrial loans increased $167,000 for the year ended December 31, 2003 from the year ended December 31, 2002. In accordance with Westfield Bank's strategic plan, the average balance of commercial real estate loans and commercial industrial loans increased $28.8 million to $191.5 million for the year ended December 31, 2003 as compared to $162.7 million for the same period in 2002. This change was offset by a decrease in the average yield on these loans due to the significant
decline in market interest rates since December 31, 2000. Loans originated in the current low interest rate environment have typically been at lower rates than in previous years. In addition, some adjustable rate loans repriced downward. This resulted in a lower yield for the commercial real estate loan and commercial and industrial loan portfolios.
Interest Expense
Interest expense for the year ended December 31, 2003 decreased $4.9 million to $13.9 million from the comparable 2002 period. This was attributable to a decrease in the average cost of interest-bearing liabilities of 88 basis points to 2.21% for the year ended December 31, 2003 from 3.09% for the same period in 2002. This decrease was partially offset by an increase of $19.5 million in the average balance of total interest-bearing liabilities. The decrease in average cost of interest- bearing liabilities was the result of the declining rate environment discussed previously and Westfield Bank's emphasis on core deposits over time deposits.
Net Interest and Dividend Income
Net interest and dividend income for the year ended December 31, 2003 decreased $2.5 million, or 10.3%, to $21.8 million in 2003 from $24.2 million in 2002. The net interest rate spread, the difference between the average yield on average interest-earning assets and the average cost of average total interest-bearing liabilities, decreased 7 basis points to 2.47% for 2003 from 2.54% for 2002. The net interest margin, which is net interest and dividend income divided by average total interest earning assets, decreased 32 basis points to 2.86% for 2003 from 3.18% for the comparable prior year period. As discussed above, the decreases in net interest and dividend income due to lower interest rates were partially offset by the increase in the balance of interest-earning assets.
Provision for Loan Losses
During 2003, Westfield Bank provided $750,000 for loans losses, compared to $934,000 for 2002. The provision for loan losses brings Westfield Bank's allowance for loan losses to a level determined appropriate by management based on the methodology discussed under "Allowance for Loan Losses". The allocation of the provision for loan losses among loan types and between the specific and formula components of the allowance for loan losses is also determined based on the methodology discussed under "Allowance for Loan Losses".
* Loan concentrations - Commercial real estate loans and commercial and industrial loans increased $54.2 million or 33.4%. Westfield Bank considers these types of loans to contain more risk than conventional residential mortgages. These increases resulted in an increase in the allowance requirements for commercial real estate and commercial and industrial loans. As Westfield Bank emphasizes increasing its commercial real estate loans and commercial and industrial loans, increased allowance requirements may continue.
These increases were offset by a decrease in residential real estate loans of $47.4 million to $110.5 million and a decrease in consumer loans of $18.8 million to $22.3 million, resulting in decreases in the allowance requirements for residential real estate loans and consumer loans, respectively. Due to Westfield Bank's residential real estate loan program with a third party mortgage company and the discontinuation of its indirect auto lending, the balance of residential mortgages and consumer loans is expected to continue to decrease. Decreased future allowances for these loans may result.
* Credit quality - Actual loss experience on loans decreased with charge-offs totaling $725,000 in 2003 as compared to $928,000 in 2002. Net loans charged off as a percent of average loans outstanding decreased from 0.13% in 2002 to 0.12% in 2003. Non-accrual loans decreased $615,000 from $2.4 million at December 31, 2002 to $1.8 million at December 31, 2003.
As a result of the detailed allowance for loan loss methodology and consideration of the above factors, the provision for loan losses decreased by $184,000 in 2003 as compared to 2002.
The allowance for loan losses at the end of 2003 was 1.33% of total loans compared with 1.20% at the end of 2002. The increase in the coverage ratio reflects the changes in the loan portfolio described above.
Noninterest Income
Noninterest income increased $3.4 million to $3.1 million in 2003 from ($362,000) for 2002. Included in noninterest income in the year 2002 were writedowns of certain equity securities of $2.5 million. Income on bank owned life insurance ("BOLI") was $806,000 for the year ended December 31, 2003, compared to none for the same period in 2002. In addition, fees received from our residential real estate loan program with a third party mortgage company were $340,000 for the year ended December 31, 2003 compared with $196,000 for the same period in 2002. It is anticipated that these fees will decrease as refinancing of residential loans decreases, particularly if interest rates increase in future periods.
Noninterest Expense
Noninterest expense for the year ended December 31, 2003 was $17.6 million compared to $16.7 million for the same period in 2002. Employee salary and benefits for the year ended December 31, 2003 were $9.7 million compared to $8.9 million in 2002. The increase was the result of normal salary increases, along with an increase in employee benefit expense of $688,000 for the year ended December 31, 2003, primarily as a result of increased expenses for the management recognition and retention plan and supplemental employee retirement plan.
Income Taxes
Income taxes increased $581,000, or 26.0%, to $2.8 million in 2003. The effective tax rate was 43.6% in 2003 compared to 35.6% for 2002. The effective tax rate also reflects the utilization of Westfield Securities Corporation and Elm Street Securities Corporation, both qualified securities corporations, and Elm Street Real Estate Investments, Inc., a wholly-owned subsidiary of Westfield Bank, as a real estate investment trust.
Massachusetts legislation was signed on March 5, 2003 amending the corporate tax law affecting the treatment of dividends received from Real Estate Investment Trusts (REITs). Dividends from the REIT subsidiary are no longer eligible for a dividends-received deduction. As a result of the enactment of this legislation, the Company has ceased recording the tax benefits associated with the dividend received deduction effective for the 2003 tax year.
In addition to the effect on 2003, the legislation is retroactive to 1999. The Company's 2003 results included a charge of $1.45 million representing the additional state tax liability, including interest, relating to the deduction for dividends received from the REIT for 2002 and prior years.
Liquidity and Capital Resources
The term "liquidity" refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals and operating expenses. Our primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by our operations. Westfield Bank also can borrow funds from the Federal Home Loan Bank based on eligible collateral of loans and securities. Outstanding borrowings from the Federal Home Loan Bank at December 31, 2004 and 2003 were $45.0 million and $20.0 million, respectively. At December 31, 2004, Westfield Bank's maximum borrowing capacity from the Federal Home Loan Bank was approximately $65.6 million, net of any outstanding borrowings. In addition, we may enter into reverse repurchase agreements with approved broker-dealers. Reverse repurchase agreements are agreements that allow us to borrow money using our securities as collateral.
Westfield Bank also has outstanding, at any time, a significant number of commitments to extend credit and provide financial guarantees to third parties. These arrangements are subject to strict credit control assessments. Guarantees specify limits to Westfield Bank's obligations. Because many commitments and almost all guarantees expire without being funded in whole or in part, the contract amounts are not estimates of future cash flows. Westfield Bank is also obligated under agreements with the Federal Home Loan Bank to repay borrowed funds and is obligated under leases for certain of its branches and equipment. A summary of lease obligations, borrowings, and credit commitments at December 31, 2004 follows:
Maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds.
Our primary investing activities are the origination of commercial real estate, commercial and industrial and consumer loans, and the purchase of mortgage-backed and other investment securities. During the year ended December 31, 2004, Westfield Bank originated loans of approximately $96.9 million, and during the comparable period of 2003, Westfield Bank originated loans of approximately $148.8 million. Under Westfield Bank's residential real estate loan program, Westfield Bank refers its residential real estate borrowers to a third party mortgage company and substantially all of Westfield Bank's residential real estate loans are underwritten, originated and serviced by a third party mortgage company. Purchases of securities totaled $104.2 million for the year ended December 31, 2004 and $252.9 million for the year ended December 31, 2003. At December 31, 2004, Westfield Bank had loan commitments to borrowers of approximately $40.8 million, and available home equity and unadvanced lines of credit of approximately $59.4 million.
Deposit flows are affected by the level of interest rates, by the interest rates and products offered by competitors and by other factors. Total deposits decreased $19.8 million during the year ended December 31, 2004 and decreased $23.7 million during the year ended December 31, 2003. Time deposit accounts scheduled to mature within one year were $184.5 million at December 31, 2004. Based on Westfield Bank's deposit retention experience and current pricing strategy, it anticipates that a significant portion of these certificates of deposit will remain on deposit. Westfield Bank monitors its liquidity position frequently and anticipates that it will have sufficient funds to meet its current funding commitments.
At December 31, 2004, Westfield Bank exceeded each of the applicable regulatory capital requirements. Westfield Bank's tier 1 leverage capital was $118.0 million, or 14.7% to average assets. Westfield Bank's tier 1 capital to risk weighted assets was $118.0 million or 25.8%. Westfield Bank had total capital to risk weighted assets of $123.2 or 26.9%.
We do not anticipate any material capital expenditures during calendar year 2005, nor do we have any balloon or other payments due on any long-term obligations or any off-balance sheet items other than the commitments and unused lines of credit noted above.
Off-Balance Sheet Arrangement
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Management of Market Risk
As a financial institution, our primary market risk is interest rate risk since substantially all transactions are denominated in U.S. dollars with no direct foreign exchange or changes in commodity price exposure. Fluctuations in interest rates will affect both our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates will also affect the market value of all interest-earning assets.
The primary goal of our interest rate management strategy is to limit fluctuations in net interest income as interest rates vary up or down and control variations in the market value of assets, liabilities and net worth as interest rates vary. We seek to coordinate asset and liability decisions so that, under changing interest rate scenarios, net interest income will remain within an acceptable range.
To achieve the objectives of managing interest rate risk, Westfield Bank's Asset and Liability Management Committee meets monthly to discuss and monitor the market interest rate environment relative to interest rates that are offered on its products. The Asset and Liability Management Committee presents periodic reports to the Board of Directors of Westfield Bank and Westfield Financial, Inc. at their regular meetings.
In recent years, Westfield Bank's lending activities have emphasized commercial real estate and commercial and industrial loans. Commercial real estate loans have grown $43.4 million or 43.0% since December 31, 2002. Commercial and industrial loans have grown $33.2 million or 54.0% since December 31, 2002. Consumer loans decreased $29.5 million, or 71.8%, since December 31, 2002. Management curtailed its indirect lending beginning in fiscal year 2000 and in the fourth quarter of 2003 the program was discontinued. We believe that Westfield Bank's increased emphasis on commercial lending will allow it to diversify its loan portfolio while continuing to meet the needs of the businesses and individuals that it serves.
Westfield Bank's primary source of funds has been deposits, consisting primarily of time deposits, money market accounts, savings accounts, demand accounts and NOW accounts, which have shorter terms to maturity than the loan portfolio. Several strategies have been employed to manage the interest rate risk inherent in the asset/liability mix, including but not limited to:
* maintaining the diversity of our existing loan portfolio through the origination of commercial loans and commercial real estate loans which typically have variable rates and shorter terms than residential mortgages; and
* emphasizing investments with an expected average duration of five years or less.
In addition, emphasis on commercial loans has reduced the average maturity of Westfield Bank's loan portfolio. Moreover, the actual amount of time before loans are repaid can be significantly affected by changes in market interest rates. Prepayment rates will also vary due to a number of other factors, including the regional economy in the area where the loans were originated, seasonal factors, demographic variables and the assumability of the loans. However, the major factors affecting prepayment rates are prevailing interest rates, related financing opportunities and competition. We monitor interest rate sensitivity so that we can adjust our asset and liability mix in a timely manner and minimize the negative effects of changing rates.
Each of Westfield Bank's sources of liquidity is vulnerable to various uncertainties beyond the control of Westfield Bank. Scheduled loan and security payments are a relatively stable source of funds, while loan and security prepayments and calls, and deposit flows vary widely in reaction to market conditions, primarily prevailing interest rates. Asset sales are influenced by pledging activities, general market interest rates and unforeseen market conditions. Westfield Bank's financial condition is affected by its ability to borrow at attractive rates, retain deposits at market rates and other market conditions. Management considers Westfield Bank's sources of liquidity to be adequate to meet expected funding needs and also to be responsive to changing interest rate markets.
Net Interest and Dividend Income Simulation. We use a simulation model to monitor interest rate risk. This model reports the net interest income at risk primarily under seven different interest rate environments. Specifically, net interest income is measured in one scenario that assumes no change in interest rates, and six scenarios where interest rates increase 100, 200, 300, and 400 basis points, and decrease 100 and 200 basis points, respectively, from current rates over the one year time period following the current consolidated financial statements.
The changes in interest income and interest expense due to changes in interest rates reflect the rate sensitivity of our interest earning assets and interest bearing liabilities. For example, in a rising interest rate environment, the interest income from an adjustable rate loan is likely to increase depending on its repricing characteristics while the interest income from a fixed rate loan would not increase until the funds were repaid and loaned out at a higher interest rate.
The tables below set forth as of December 31, 2004 the estimated changes in net interest and dividend income that would result from incremental changes in interest rates over the applicable twelve-month period.
Market rates were assumed to increase 100, 200, 300 and 400 basis points and decrease 100 and 200 basis points, in even increments over the twelve month period. The repricing and/or new rates of assets and liabilities moved in tandem with market rates. However, in certain deposit products, the use of data from a historical analysis indicated that the rates on these products would move only a fraction of the rate change amount.
Management believes that a percentage of the growth in core deposits over the last three years was due to the low rate environment, i.e. no incentive for customers to lock up funds in time deposits. Management believes that in a rising rate environment, Westfield Bank will experience a shift, by some customers, out of core deposits and back into term deposits. Based upon analysis, Management has estimated what is believed to be the rate sensitive portion of the funds currently in core deposits. In scenarios that assume a rising rate environment of 200 basis points or more, this shift is incorporated into the balance sheet forecasts.
We have developed consolidated balance sheet growth projections for the twelve month period. The same product mix and growth strategy was used for all rate change simulations, except for the shift into term deposits in certain scenarios as described in the previous paragraph. Income from tax- exempt assets is calculated on a fully taxable equivalent basis.
Pertinent data from each loan account, deposit account and investment security was used to calculate future cash flows. The data included such items as maturity date, payment amount, next repricing date, repricing frequency, repricing index and spread. Prepayment speed assumptions were based upon the difference between the account rate and the current market rate.
Another circumstance that affects the results is that interest rates on some deposit products as of December 31, 2004 were near historical lows. In the three declining rate scenarios, Westfield Bank forecasted that its rates on some deposit products would not fall as sharply as market rates. For example, because the rate on regular savings accounts is 0.50%, it is not possible for the rate to decrease by 100 basis points or more.
Recent Accounting Pronouncements
In March 2004, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 105, "Application of Accounting Principles to Loan Commitments," which provides guidance regarding loan commitments that are accounted for as derivative instruments. In this SAB, the SEC determined that an interest rate lock commitment should generally be valued at zero at inception. The rate locks will continue to be adjusted for changes in value resulting from changes in market interest rates. This SAB did not have any effect on the Company's financial position or results of operations.
In December 2004, the Financial Accounting Standards Board ("FASB") published FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("FAS 123(R))" or the "Statement"). FAS 123(R) requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. FAS 123(R) is a replacement of FASB Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related interpretive guidance.
The effect of the Statement will be to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement.
The Company will be required to apply FAS 123(R) as of the beginning of its first interim period that begins after June 15, 2005, which will be the quarter ending September 30, 2005.
FAS 123(R) allows two methods for determining the effects of the transition: the modified prospective transition method and the modified retrospective method of transition. Under the modified prospective transition method, an entity would use the fair value based accounting method for all employee awards granted, modified, or settled after the effective date. As of the effective date, compensation cost related to the nonvested portion of awards outstanding as of that date would be based on the grant-date fair value of those awards as calculated under the original provisions of Statement No. 123; that is, an entity would not remeasure the grant-date fair value estimate of the unvested portion of awards granted prior to the effective date of FAS 123(R). An entity will have the further option to either apply the Statement to only the quarters in the period of adoption and subsequent periods, or apply the
Statement to all quarters in the fiscal year of adoption. Under the modified retrospective method of transition, an entity would revise its previously issued financial statements to recognize employee compensation cost for prior periods presented in accordance with the original provisions of Statement No. 123.
The Company has not yet completed its study of the transition methods or made any decisions about how it will adopt FAS 123(R).
The changes in accounting will replace existing requirements under SFAS No. 123, "Accounting for Stock-Based Compensation," and will eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees," which does not require companies to expense options if the exercise price is equal to the trading price at the date of grant. The accounting for similar transactions involving parties other than employees or the accounting for employee stock ownership plans that are subject to American Institute of Certified Public Accountants ("AICPA") Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans," would remain unchanged.
On September 30, 2004, the FASB issued FASB Staff Position ("FSP") Emerging Issues Task Force ("EITF") Issue No. 03-1-1 delaying the effective date of paragraphs 10-20 of EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments", which provides guidance for determining the meaning of "other-than-temporarily impaired" and its application to certain debt and equity securities within the scope of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. The delay of the effective date of EITF 03-1 will be superceded concurrent with the final issuance of proposed FSP Issue 03-1-a. Proposed FSP Issue 03-1-a is intended to provide implementation guidance with respect to all securities analyzed for impairment under paragraphs 10-20 of EITF 03-1. Management continues to closely monitor and evaluate how the provisions of EITF 03-1 and proposed FSP Issue 03-1-a will affect the Company.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and accompanying Notes of Westfield Financial have been prepared in accordance with Accounting Principles Generally Accepted in the United States of America ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, Management of Market Risk, pages 64 - 67, for a discussion of Quantitative and Qualitative Disclosures About Market Risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of Westfield Financial are submitted on pages through of this report.
All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or notes thereto.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Effective June 15, 2004, the Audit Committee of the Board of Directors voted not to reengage Deloitte & Touche LLP as Westfield Financial's Independent Registered Public Accounting Firm, effective immediately. On the same date, the Audit Committee of the Board of Directors recommended, approved and appointed Wolf & Company, P.C. as the Westfield Financial's Independent Registered Public Accounting Firm for the purpose of auditing Westfield Financial's consolidated financial statements for the year ended December 31, 2004. Wolf & Company, P.C. will continue to serve for the year ended December 31, 2005. A representative of Wolf & Company, P.C. is expected to be present at the annual meeting to answer questions concerning the consolidated financial statements presented and will be permitted to make a statement at the meeting.
The audit reports of Deloitte & Touche LLP on the consolidated financial statements of the Registrant as of and for the years ended December 31, 2003 and 2002 did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. During 2003 and 2002 and any subsequent interim periods through June 15, 2004, there were no disagreements with Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to Deloitte & Touche's satisfaction, would have caused it to make reference in connection with its report to the subject matter of the disagreement. We requested Deloitte & Touche LLP to furnish a letter addressed to the Securities and Exchange Commission stating whether it agrees with these statements made by us and, if not, stating the respects in which it does not agree. A copy of this letter, dated March 31, 2004, was attached as an exhibit to the Form 8-K filed with the Securities and Exchange Commission on June 21, 2004 and is hereby incorporated by reference.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including Westfield Financial's President and Chief Executive Officer and Chief Financial Officer and Treasurer, has evaluated the effectiveness of Westfield Financial's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, Westfield Financial's President and Chief Executive Officer and Chief Financial Officer and Treasurer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports Westfield Financial files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.
There have been no changes in Westfield Financial's internal control over financial reporting identified in connection with the evaluation that occurred during Westfield Financial's last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, Westfield Financial's internal control over financial reporting.
Management Report on Internal Control Over Financial Reporting
The management of Westfield Financial, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Westfield Financial Inc.'s internal control system is a process designed to provide reasonable assurance to the company's management and board of directors regarding the preparation and fair presentation of published financial statements.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of Westfield Financial Inc.; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Westfield Financial Inc.'s assets that could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Westfield Financial, Inc.'s management assessed the effectiveness of the company's internal control over financial reporting as of December 31, 2004. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment we believe that, as of December 31, 2004, the company's internal control over financial reporting is effective based on those criteria.
Westfield Financial Inc.'s Independent Registered Public Accounting Firm has issued an audit report on our assessment of, and the effective operation of, the company's internal control over financial reporting as of December 31, 2004. This report appears on pages and.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information included in the Company's Proxy Statement for the 2005 Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by reference: "Election of Directors," Nominees for Election as Director," "Continuing Directors", "Executive Officers," and "Section 16(a) Beneficial Ownership Reporting Compliance.
Code of Ethics
Westfield Financial has adopted a Conflict of Interest Policy and Code of Conduct, which applies to all employees and officers of Westfield Financial and Westfield Bank. Westfield Financial has also adopted a Code of Ethics for Senior Financial Officers of Westfield Financial, Inc., which applies to Westfield Financial's principal executive officer, principal financial officer, principal accounting officer or controller or person performing similar functions for Westfield Financial and Westfield Bank, and which requires compliance with the Conflict of Interest Policy and Code of Conduct. The Code of Ethics for Senior Financial Officers of Westfield Financial meets the requirements of a "code of ethics" as defined by Item 406 of Regulation S-K. The Code of Ethics for Senior Financial Officers was filed as exhibit 14.1 to the Form 10-K filed with the SEC on March 15, 2003 and is hereby incorporated by reference. There have been no amendments to the Code of Ethics since that time.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following information included in the Proxy Statement is incorporated herein by reference: "Management Salary Compensation Committee Report on Executive Compensation," "Compensation Committee Interlocks and Insider Participation," "Performance Graph," "Directors' Compensation," "Executive Compensation," "Employment Agreements," and "Benefits."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information included in the Proxy Statement is incorporated herein by reference: "Security Ownership of Certain Beneficial Owners and Management-Principal Shareholders of "Westfield Financial", and "Security Ownership of Management."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information included in the Proxy Statement is incorporated herein by reference: "Compensation of Directors and Executive Officers - Transactions with Certain Related Persons."
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES
Information regarding the aggregate fees billed for each of the last two fiscal years by Westfield Financial's principal accountants, Wolf & Company, P.C. in 2004 and Deloitte & Touche LLP in 2003, is included under the heading "Principal Accountants Fees and Services" in Westfield Financial's Proxy Statement for its Annual Meeting of Shareholders to be held on May 20, 2005, which will be filed with the SEC on or about April 15, 2005 and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Listed below are all financial statements and exhibits filed as part of this report:
a. Financial Statements, Schedules, and Exhibits
(1) Reference is made to the Consolidated Financial Statements included in Item 8 of Part II hereof.
(2) Schedules omitted as they are not applicable.
(3) See Exhibit Index.
Exhibit Description 2.1 Plan of Reorganization and Minority Stock Issuance of Westfield Mutual Holding Company, as amended. * 3.1 Articles of Organization of Westfield Financial, Inc.* 3.2 Bylaws of Westfield Financial, Inc. * 3.3 Amended and Restated Charter of Westfield Mutual Holding Company* 3.4 Amended and Restated Bylaws of Westfield Mutual Holding Company* 4.1 Articles of Organization of Westfield Financial, Inc. (See Exhibit 3.1)* 4.2 Bylaws of Westfield Financial, Inc. (See Exhibit 3.2)* 4.3 Form of Stock Certificate of Westfield Financial, Inc.* 10.1 Form of Employee Stock Ownership Plan of Westfield Financial, Inc.* 10.2 Form of the Benefit Restoration Plan of Westfield Financial, Inc.* 10.3 Form of Employment Agreement between Donald A. Williams and Westfield Financial, Inc.* 10.4 Form of Employment Agreement between Victor J. Carra and Westfield Financial, Inc.* 10.5 Form of Employment Agreement between Michael J. Janosco, Jr. and Westfield Financial, Inc.* 10.6 Form of One Year Change in Control Agreement by and among certain officers and Westfield Financial, Inc. and Westfield Bank* 10.7 Form of Directors' Deferred Compensation Plan* 10.8 The SBERA 401(k) Plan adopted by Westfield Bank** 10.9 Amendments to the Employee Stock Ownership Plan of Westfield Financial, Inc.*** 14.1 Code of Ethics 16.1 Letter regarding change on certifying accountants**** 21.1 Subsidiaries of the Registrant* 23.1 Consent of Wolf & Company, PC 23.2 Consent of Deloitte & Touche LLP 31.1 Rule 13a - 14(a)/15d - 14(a) Certifications 32.1 Section 1350 Certifications
* Incorporated herein by reference to the Registration Statement No. 333-68550, on Form S-1 of Westfield Financial filed with the SEC on August 28, 2001, as amended.
** Incorporated herein by reference to the Registration Statement No. 333-73132, on Form S-8, filed with the SEC on November 9, 2001, as amended.
*** Incorporated by reference to the Annual Report on Form 10K for the year ended December 31, 2002 as filed with the SEC on March 31, 2003.
**** Incorporated by reference to the Form 8-K filed with the SEC on June 21, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 15, 2005.
Westfield Financial, Inc.
By: /s/ Donald A. Williams -------------------------------- Donald A. Williams President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, and any rules and regulations promulgated thereunder, this Annual Report on Form 10-K, has been signed by the following persons in the capacities and on the dates indicated.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders Westfield Financial, Inc.
We have audited the accompanying consolidated balance sheet of Westfield Financial, Inc. and subsidiaries as of December 31, 2004, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements for the year ended December 31, 2003 were audited by other auditors whose report, dated March 1, 2004, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Westfield Financial, Inc. and subsidiaries as of December 31, 2004, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Accounting Oversight Board (United States), the effectiveness of Westfield Financial, Inc. and subsidiaries' internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 8, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of Westfield Financial, Inc.'s internal control over financial reporting and an unqualified opinion on the effectiveness of Westfield Financial, Inc.'s internal control over financial reporting.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts March 8, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Westfield Financial, Inc.
Westfield, Massachusetts
We have audited the accompanying consolidated balance sheet of Westfield Financial, Inc. and subsidiaries (the "Company") as of December 31, 2003 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Westfield Financial, Inc. and subsidiaries as of December 31, 2003, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Hartford, Connecticut March 11, 2004
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share amounts)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands, except per share amounts)
See notes to consolidated financial statements.
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in thousands)
See notes to consolidated financial statements
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Basis of Presentation - Westfield Financial, Inc. is a Massachusetts corporation. The Company has a federally- chartered stock savings bank subsidiary called Westfield Bank (the "Bank"). The Bank's deposits are insured to the limits specified by the Federal Deposit Insurance Corporation ("FDIC"). The Bank operates 10 branches in Western Massachusetts. The Bank's primary source of revenue is earned from loans to small and middle-market businesses and to residential property homeowners.
In 1998, the Bank formed a subsidiary, Elm Street Real Estate Investments, Inc. (the "REIT"). The REIT was 99.9% owned by the Bank. In December 2003, the Bank dissolved the REIT to streamline the overall bank structure. Westfield Securities Corp., a Massachusetts chartered security corporation, was formed in 2001 by the Company for the primary purpose of holding qualified investment securities. In 2003, the Bank formed another wholly owned subsidiary, Elm Street Securities Corporation, a Massachusetts chartered security corporation for the primary purpose of holding quality investment securities.
On July 23, 2004 Westfield Bank and Westfield Mutual Holding Company completed their conversions from companies regulated by the Massachusetts Division of Banks or the Federal Reserve Board to federally-chartered companies regulated by the Office of Thrift Supervision (the "OTS".
Principles of Consolidation - The consolidated financial statements include the accounts of the Company, the Bank, Westfield Securities Corp., Elm Street Securities Corporation, and the REIT prior to its dissolution. All material intercompany balances and transactions have been eliminated in consolidation.
Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 consolidated financial statements and the reported amounts of income and expenses for each. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and other than temporary impairment of investment securities.
Cash and Cash Equivalents - The Company defines cash on hand, cash due from banks, federal funds sold and interest bearing deposits having an original maturity of 90 days or less as cash and cash equivalents. Cash and due from banks at December 31, 2004 and 2003 includes partially restricted cash of approximately $347,000, and $154,000 respectively, for Federal Reserve Bank of Boston cash reserve requirements.
Securities and Mortgage Backed Securities - Securities, including mortgage backed securities, which management has the positive intent and ability to hold until maturity are classified as held to maturity and are carried at amortized cost. Securities, including mortgage backed securities, which have been identified as assets for which there is not a positive intent to hold to maturity are classified as available for sale and are carried at fair value with unrealized gains and losses, net of income taxes, reported as a separate component of stockholders' equity. The Company does not acquire securities and mortgage backed securities for purposes of engaging in trading activities.
Realized gains and losses on sales of securities and mortgage backed securities are computed using the specific identification method and are included in noninterest income. The amortization of premiums and accretion of discounts is determined by using the level yield method to the maturity date.
Other than Temporary Impairment of Securities - On a quarterly basis, the Company reviews available for sale investment securities with unrealized depreciation on a judgmental basis to assess whether the decline in fair value is temporary or other than temporary. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Loans - Loans are recorded at the principal amount outstanding. Interest on loans is calculated using the effective yield method on daily balances of the principal amount outstanding and is credited to income on the accrual basis to the extent it is deemed collectible. The Company's general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of the principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and when subsequent performance reduces the concern as to the collectibility of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans. Compensation to an auto dealer is normally based upon a spread that a dealer adds on the loan base rate set by the Company. The compensation is paid to an automobile dealer shortly after the loan is originated. The Company records the amount as a deferred cost that is amortized over the life of the loans in relation to the interest paid by the customer.
Allowance for Loan Losses - The allowance for loan losses is established through provisions for loan losses charged to expense. Loans are charged off against the allowance when management believes that the collectibility of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.
The Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio based on ongoing quarterly assessments of the estimated losses. The Bank's methodology for assessing the appropriateness of the allowance consists of two key components, which are a specific allowance for identified problem loans and a formula allowance for the remainder of the portfolio. The specific allowance incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -
Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. The formula allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. In determining the loss factors to apply to each loan category, the Company considers historical losses, peer group comparisons, industry data and loss percentages used by banking regulators for similarly graded loans. Loss factors may be adjusted for qualitative factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date.
A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan's contractual terms. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Company expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on 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. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the fair value of the impaired loan is less than the related recorded amount, a specific valuation allowance is established within the allowance for loan losses or a writedown is charged against the allowance for loan losses if the impairment is considered to be permanent. Measurement of impairment does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment such as the Company's portfolios of home equity loans, real estate mortgages, installment and other loans.
The Company's methodology for assessing the appropriateness of the allowance consists of two key components, which are a specific allowance for identified problem or impaired loans and a formula allowance for the remainder of the portfolio. Measurement of impairment can be based on 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. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The appropriateness of the allowance is also reviewed by management based upon its evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Although management believes it has established and maintained the allowance for loan losses at appropriate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically review the loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The Office of Thrift Supervision may require adjustment to the allowance for loan losses based on their judgments of information available to them at the time of their examination, thereby adversely affecting results of operations.
Management believes that the allowance for loan losses accurately reflects estimated credit losses for specifically identified loans, as well as probable credit losses inherent in the remainder of the portfolio as of the end of the periods presented.
Transfers and Servicing of Financial Assets - Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Premises and Equipment - Land is carried at cost. Buildings and equipment are stated at cost, less accumulated depreciation, computed on either the straight-line or accelerated methods over the estimated useful lives of the assets, or lease term, if shorter, as follows:
The cost of maintenance and repairs is charged to expense when incurred. Major expenditures for betterments are capitalized and depreciated.
Other Real Estate Owned - Other real estate owned represents property acquired through foreclosure or deeded to the Company in lieu of foreclosure. Other real estate owned is recorded at the lower of the carrying value of the related loan, or the estimated fair value of the real estate acquired, net of estimated selling costs. Initial write-downs are charged to the allowance for loan losses at the time the loan is transferred to other real estate owned. Subsequent valuations are periodically performed by management and the carrying value is adjusted by a charge to expense to reflect any subsequent declines in the estimated fair value. Operating costs associated with other real estate owned are expensed as incurred.
Retirement Plans and Employee Benefits - The Company provides a defined benefit pension plan for eligible employees through membership in the Savings Banks Employees Retirement Association ("SBERA"). The Company's policy is to fund pension cost as accrued. Employees are also eligible to participate in a 401(k) plan through SBERA. The Company makes matching contributions to this plan at 50% of up to 6% of the employees' eligible compensation.
The Company currently offers postretirement life insurance benefits to retired employees. Such postretirement benefits represent a form of deferred compensation which requires that the cost and obligations of such benefits are recognized in the period in which services are rendered.
Income Taxes - The Company uses the asset and liability method for income tax accounting, whereby, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings per Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock awards and options, are determined using the treasury stock method.
Earnings per common share for the years ended December 31, have been computed based on the following (in thousands, except per share data):
Reclassifications - Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation.
Stock Options - The Company applies APB Opinion No. 25 and related Interpretations in accounting for stock options. Accordingly, no compensation cost has been recognized. Had compensation cost for the Company's stock options been determined based on the fair value at the grants dates for awards under the plan consistent with the method prescribed by SFAS No. 123, the Company's net income (in thousands) and earnings per share would have been adjusted to the pro forma amounts indicated below:
For the years ended December 31,
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
No options were granted in 2003.
Recent accounting pronouncements
In March 2004, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 105, Application of Accounting Principles to Loan Commitments, which provides guidance regarding loan commitments that are accounted for as derivative instruments. In this SAB, the SEC determined that an interest rate lock commitment should generally be valued at zero at inception. The rate locks will continue to be adjusted for changes in value resulting from changes in market interest rates. This SAB did not have any effect on the Company's financial position or results of operations.
In December 2004, the Financial Accounting Standards Board ("FASB") published FASB Statement No. 123 (revised 2004), Share-Based Payment ("FAS 123(R)" or the "Statement"). FAS 123(R) requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. FAS 123(R) is a replacement of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretive guidance.
The effect of the Statement will be to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement.
The Company will be required to apply FAS 123(R) as of the beginning of its first interim period that begins after June 15, 2005, which will be the quarter ending September 30, 2005.
FAS 123(R) allows two methods for determining the effects of the transition: the modified prospective transition method and the modified retrospective method of transition. Under the modified prospective transition method, an entity would use the fair value based accounting method for all employee awards granted, modified, or settled after the effective date. As of the effective date, compensation cost related to the nonvested portion of awards outstanding as of that date would be based on the grant-date fair value of those awards as calculated under the original provisions of Statement No. 123; that is, an entity would not remeasure the grant- date fair value estimate of the unvested portion of awards granted prior to the effective date of FAS 123(R). An entity will have the further option to either apply the Statement to only the quarters in the period of adoption and subsequent periods, or apply the Statement to all quarters in the fiscal year of adoption. Under the modified retrospective method of transition, an entity would revise its previously issued financial statements to recognize employee compensation cost for prior periods presented in accordance with the original provisions of Statement No. 123.
The Company has not yet completed its study of the transition methods or made any decisions about how it will adopt FAS 123(R).
The changes in accounting will replace existing requirements under Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," and will eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees," which does not require companies to expense options if the exercise price is equal to the trading price at the date of grant. The accounting for similar transactions involving parties other than employees or the accounting for employee stock ownership plans that are subject to American Institute of Certified Public Accountants ("AICPA") Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans," would remain unchanged.
On September 30, 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") Emerging Issues Task Force ("EITF") Issue No. 03-1-1 delaying the effective date of paragraphs 10-20 of EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments", which provides guidance for determining the meaning of "other-than- temporarily impaired" and its application to certain debt and equity securities within the scope of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. The delay of the effective date of EITF 03-1 will be superceded concurrent with the final issuance of proposed FSP Issue 03-1-a. Proposed FSP Issue 03-1-a is intended to provide implementation guidance with respect to all securities analyzed for impairment under paragraphs 10-20 of EITF 03-1. Management continues to closely monitor and evaluate how the provisions of EITF 03-1 and proposed FSP Issue 03-1-a will affect the Company.
2. SECURITIES
Securities are summarized as follows:
Information pertaining to securities with gross unrealized losses at December 31, 2004 and 2003, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
At December 31, 2004, twelve debt securities have gross unrealized losses of 1.1% from the Bank's amortized cost basis of temporarily impaired debt securities. Because these losses relate to federally- sponsored agency obligations and highly rated municipal obligations, are the result of fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2004, three equity securities classified as available for sale have an unrealized loss of 1.7% from the Bank's amortized cost basis of temporarily impaired equity securities which existed for less than twelve months and is principally related to fluctuations in interest rates. These losses relate to mutual funds which invest primarily in short term debt instruments and adjustable rate mortgage-backed securities. Because these losses are the result of fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
At December 31, 2004, one equity security classified as available for sale has an unrealized loss of 2.4% from the Bank's amortized cost basis of temporarily impaired equity securities which existed for greater than twelve months. Because the security is an adjustable rate preferred stock issued by a federally-sponsored agency, the unrealized loss is principally related to fluctuations in interest rates, and management has the intent and ability to hold these securities for the foreseeable future, the decline is not deemed to be other than temporary.
Gross gains of $1,130,000, $771,000, and $423,000, and gross losses $39,000, $333,000, and $897,000 were recorded on securities during the years ended December 31, 2004, 2003, and 2002, respectively. During 2004, 2003, and 2002, the Company recorded losses of $ - 0 -, 85,000, and $2,105,000, respectively, for other than temporary impairments in value.
Securities with a carrying value of $37 million and $35 million were pledged as collateral to the Federal Reserve Bank of Boston at December 31, 2004 and 2003, respectively.
Unrealized losses on securities available for sale, net of tax were $176,000 and unrealized gains on securities available for sale were $647,000 at December 31, 2004 and 2003, respectively.
3. MORTGAGE BACKED SECURITIES
Mortgage backed securities are summarized as follows:
Collateralized Mortgage Obligations include tranches of AAA investment grade and consist of high quality mortgage obligations.
Gross gains of $135,000, $56,000 and $850,000 and gross losses of $349,000, - 0 -, and $21,000 were recorded on mortgage backed securities during the years ended December 31, 2004, 2003, and 2002, respectively.
Unrealized gains on mortgage backed securities available for sale, net of tax were $54,000 and $141,000 at December 31, 2004 and 2003, respectively.
Information pertaining to securities with gross unrealized losses at December 31, 2004 and 2003, aggregated by investment category and length of time that individual securities have been a continuous loss position, follows:
None of the mortgage backed securities that had an unrealized loss as of December 31, 2003 were in a loss position for more than twelve months in 2003.
At December 31, 2004, sixty-seven mortgage backed securities have gross unrealized losses of 1.3% from the Bank's amortized cost basis of temporarily impaired mortgage backed securities. Because these losses relate to mortgage-backed securities, which were primarily issued by federally-sponsored agencies; are the result of fluctuations in interest rates; and management has the intent and ability to hold these securities for the foreseeable future, no declines are deemed to be other than temporary.
4. LOANS
Loans consisted of the following amounts:
The following table summarizes information regarding impaired loans:
There were no restructured loans at December 31, 2004, 2003 and 2002.
Nonaccrual loans at December 31, 2004, December 31, 2003 and 2002 and related interest income are summarized as follows:
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balances of these loans totaled $21.7 million and $31.8 million at December 31, 2004 and 2003, respectively. Net service fee income (expense) of $30,000, ($46,000), and $76,000 was recorded for the years ended December 31, 2004, 2003, and 2002, respectively.
The Company's servicing assets are recorded at fair value at the time the asset is acquired. The fair value is based upon the net present value of future cash flows of the net servicing revenue. Assumptions used in determining fair value include service fee revenue, float revenue, escrow revenue, servicing expense, and estimated life of the underlying loans. The fair value of the asset is recalculated quarterly to determine possible impairment. At December 31, 2004 and 2003, the Company's servicing assets had a fair value of $71,000 and $90,000 and a carrying value in other assets of $52,000 and $76,000, respectively. There were no impairment losses on servicing assets in 2004. The servicing asset is amortized in proportion to the estimated net servicing revenue of the loans.
No amounts of mortgage servicing assets were capitalized during 2004 and 2003. Amortization expense on the Company's mortgage servicing assets for the years ended December 31, 2004, 2003, and 2002 totaled $24,000, $106,000, and $143,000, respectively. In addition, for the years ended December 31, 2003 and 2002, the Company recorded impairment charges of $30,000 and $253,000, respectively.
5. ALLOWANCE FOR LOAN LOSSES
An analysis of changes in the allowance for loan losses is as follows:
6. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
Depreciation and amortization expense for the years ended December 31, 2004, 2003, and 2002 amounted to $1,003,000, $1,080,000, and $1,052,000, respectively.
7. DEPOSITS
Deposit accounts by type and weighted average rates are summarized as follows:
Time deposits of $100,000 or more totaled approximately $63.9 million and $69.8 million at December 31, 2004 and 2003, respectively. Interest expense on such deposits totaled $1.6 million, $2.3 million and $3.1 million for the years ended December 31, 2004, 2003, and 2002 respectively.
Cash paid for interest was:
At December 31, 2004, the scheduled maturities of time certificates of deposits are as follows:
Interest expense on deposits for the years ended December 31, 2004, 2003, and 2002 is summarized as follows:
8. CUSTOMER REPURCHASE AGREEMENTS
The following table summarizes information regarding repurchase agreements:
9. FEDERAL HOME LOAN BANK ADVANCES
The following fixed rate advances are collateralized by a blanket lien on the Company's residential real estate loans and certain mortgage backed securities.
10. LINE OF CREDIT
The Company has a line of credit with the Federal Reserve Bank of Boston collateralized by investments. Additionally, the Company has an "Ideal Way" line of credit with the Federal Home Loan Bank for $9,541,000 and $4,541,000 for the years ended December 31, 2004 and 2003, respectively. Interest on this line of credit is payable at a rate determined and reset by the Federal Home Loan Bank on a daily basis. The outstanding principal shall be due daily but that portion not repaid will be automatically renewed. No amounts were outstanding under these lines at December 31, 2004 and 2003.
11. STOCK PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN
Stock Options
Under the Company's Stock Option Plan, the Company may grant options to its directors, officers and employees for up to 497,260 shares of common stock. Both incentive stock options and non-statutory stock options may be granted under the plan. The exercise price of each option equals the market price of the Company's stock on the date of grant and an option's maximum term is ten years. All options currently outstanding vest at 20% per year.
A summary of the status of the Company's stock options for the years ended December 31, 2004 and 2003 is presented below:
The weighted average fair value of the options granted in 2004 and 2002 using the Black-Scholes option pricing model were $7.93 per share and $3.75 per share, respectively. No options were granted in 2003.
Assumptions used to determine the weighted average fair value of options granted:
Information pertaining to options outstanding at December 31, 2004 is as follows:
Stock Awards
Under the Company's Recognition and Retention Plan dated November 1, 2002, the Company may grant stock awards to its directors, officers and employees for up to 198,904 shares of common stock. The Company applies APB Opinion No. 25 and related Interpretations in accounting for stock awards. The stock allocations, based on the market price at the date of grant, is recorded as unearned compensation. Unearned compensation is amortized over the vesting period to be benefited. The Company recorded compensation cost related to the stock awards of approximately $551,000 in 2004, $544,000 in 2003 and $109,000 in 2002.
Stock awards for 189,800 shares, having a fair value of $14.39 per share, were granted during 2002. Stock awards for 1,000 shares, having a fair value of $25.00 per share, were granted in 2004. No stock awards were granted in 2003.
Employee Stock Ownership Plan
In January 2002, the Company established an Employee Stock Ownership Plan (the ESOP) for the benefit of each employee that has reached the age of 21 and has completed at least 1,000 hours of service in the previous twelve-month period. As part of the conversion, the Company provided a loan to the Westfield Financial Employee Stock Ownership Plan Trust which was used to purchase 8%, or 397,808 shares, of the Company's outstanding stock in the open market. The loan bears interest equal to 8.0% and provides for annual payments of interest and principal.
At December 31, 2004 the remaining principal balance is payable as follows:
The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account for allocation among the participants as the loan is paid. Total compensation expense applicable to the ESOP amounted to $440,000, $225,000 and $193,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
Shares held by the ESOP include the following at December 31, 2004 and 2003.
Cash dividends received on allocated shares are allocated to participants and cash dividends received on shares held in suspense are applied to repay the outstanding debt of the ESOP. The fair value of these shares was approximately $8.9 million and $8.6 million at December 31, 2004 and 2003, respectively.
ESOP shares are considered outstanding for earnings per share calculations based on the value of shares allocated. Unallocated ESOP shares are excluded from earnings per share calculations. Dividends declared on allocated ESOP shares are charged to retained earnings. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders' equity.
12. RETIREMENT PLANS AND EMPLOYEE BENEFITS
Pension Plan - The Company provides basic and supplemental pension benefits for eligible employees through the Savings Banks Employees Retirement Association Pension Plan (the "Plan"). Employees must work a minimum of 1,000 hours per year to be eligible for the Plan. Eligible employees become vested in the Plan after five years of service.
The following table provides information for the Plan at December 31:
Net pension cost includes the following components for the years ended December 31:
The following actuarial assumptions were used for the years ended December 31:
The expected long term rate of return on plan assets is based on prevailing yields of high quality fixed income investments increased by a premium of 3% to 5% for equity investments. The Company expects to contribute $477,000 to its pension plan in 2005.
The Company's pension plan asset allocation at December 31, 2004 and 2003 and target allocation for 2004 are as follows:
Trustees of the Savings Bank Employees Retirement Association ("SBERA") select investment managers for the portfolio and a special investment advisory firm is retained to provide allocation analysis. The overall investment objective is to diversify equity investments across a spectrum of types, small cap, large cap and international, along with investment styles such as growth and value.
The Company estimates that the benefits to be paid from the pension plan for years ended December 31,
Postretirement Benefits - The Company provides postretirement life insurance benefits to employees based on the employee's salary at time of retirement. The accrual of postretirement benefits other than pension expense is made during the years an employee provides service. The following sets forth the funded status:
Actuarial assumptions used in accounting for the postretirement benefit plan were:
Net periodic benefit cost for:
Supplemental Retirement Benefits - The Company provides supplemental retirement benefits to certain key officers. At December 31, 2004 and 2003, the Company had accrued $2.0 million and $1.8 million, respectively, relating to these benefits. Amounts charged to expense were $289,000, $180,000, and $23,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
401(k) - Employees are eligible to participate in a 401(k) plan through SBERA. The Company makes a matching contribution of 50% with respect to the first 6% of each participant's annual earnings contributed to the plan. The Company's contribution to the plan were $134,000, $150,000 and $113,000, for the years ended December 31, 2004, 2003 and 2002, respectively.
13. REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision. 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 Bank's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to savings and loan holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2004 and 2003, that the Bank met all capital adequacy requirements to which it is subject.
As of December 31, 2004, 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 and Tier 1 leverage ratios as set forth in the following. There are no conditions or events since that notification that management believes have changed the Bank's category. The Company's and the Bank's actual capital ratios as of December 31, 2004 and 2003 are also presented in the table.
The following is a reconcilliation of the Company's GAAP capital to regulatory Tier 1 capital:
14. INCOME TAXES
Income taxes consist of the following:
The reasons for the differences between the statutory federal income tax rate and the effective rates are summarized below:
Cash paid for income taxes for the years ended December 31, 2004, 2003, and 2002 was $2.3 million, $7.2 million and $4.6 million, respectively.
The tax effects of each item that gives rise to deferred taxes are as follows:
A summary of the change in the net deferred tax asset is as follows:
The 2003 taxes were affected by Massachusetts legislation that was signed on March 5, 2003 amending the corporate tax law affecting the treatment of dividends received from Real Estate Investment Trusts (REITs). Dividends from the REIT subsidiary are no longer eligible for a dividends-received deduction. As a result of the enactment of this legislation, the Company ceased recording the tax benefits associated with the dividend received deduction effective for the 2003 tax year.
In addition to the effect on 2003, the legislation was retroactive to 1999. The Company's 2003 results included a charge of $1.45 million representing the additional state tax liability, including interest, relating to the deduction for dividends received from the REIT for 2002 and prior years.
The federal income tax reserve for loan losses at the Bank's base year is $5.8 million. If any portion of the reserve is used for purposes other than to absorb loan losses, approximately 150% of the amount actually used, limited to the amount of the reserve, would be subject to taxation in the fiscal year in which used. As the Bank intends to use the reserve solely to absorb loan losses, a deferred tax liability of approximately $2.4 million has not been provided.
15. TRANSACTIONS WITH DIRECTORS
The Company has had, and expects to have in the future, loans with its directors and executive officers. Such loans, in the opinion of management do not include more than the normal risk of collectibility or other unfavorable features. Following is a summary of activity for such loans:
16. COMMITMENTS AND CONTINGENCIES
In the normal course of business, various commitments and contingent liabilities are outstanding, such as standby letters of credit and commitments to extend credit with off-balance-sheet risk that are not reflected in the consolidated financial statements. Financial instruments with off-balance-sheet risk involve elements of credit, interest rate, liquidity and market risk.
Management does not anticipate any significant losses as a result of these transactions. The following summarizes these financial instruments and other commitments and contingent liabilities at their contract amounts:
The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some commitments 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 counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
At December 31, 2004, outstanding commitments to extend credit totaled $100.2 million, with $6.5 million in fixed rate commitments and $93.7 million in variable rate commitments.
In the ordinary course of business, the Company is party to various legal proceedings, none of which, in the opinion of management, will have a material effect on the Company's consolidated financial position or results of operations.
The Company leases facilities and certain equipment under cancelable and noncancelable leases expiring in various years through the year 2013. Certain of the leases provide for renewal periods for up to fifteen years at the discretion of the Company. Rent expense under operating leases was $199,000, $172,000, and $179,000, for the years ended December 31, 2004, 2003, and 2002, respectively.
Aggregate future minimum rental payments under the terms of the operating leases at December 31, 2004, are as follows:
17. CONCENTRATIONS OF CREDIT RISK
Most of the Company's loans consist of residential and commercial real estate loans located in Western Massachusetts. As of December 31, 2004 and 2003, the Company's residential and commercial related real estate loans represented 72% and 69% of total loans, respectively. The Company's policy for collateral requires that the amount of the loan may not exceed 95% and 80% of the appraised value of the property for residential and commercial real estate, respectively, at the date the loan is granted. For residential loans, in cases where the loan exceeds the percentage, private mortgage insurance is typically obtained for that portion of the loan in excess of 80% of the appraised value of the property.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
Methods and assumptions for valuing the Company's financial instruments are set forth below for financial instruments that have fair values different than their carrying values. Estimated fair values are calculated based on the value without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications or estimated transaction costs.
Cash and Cash Equivalents and Accrued Interest Receivable and Accrued Interest Payable - The carrying amounts of these items are considered to be a reasonable estimate of fair value due to their short-term nature.
Securities and Mortgage Backed Securities - The estimated fair values for securities and mortgage backed securities, except certain state and municipal securities, are based on quoted market prices or dealer quotations. The estimated fair value of certain state and municipal securities, not readily available through market sources other than dealer quotations, are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.
Federal Home Loan Bank and Other Stock - These investments are carried at cost which approximates fair value.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, net of the applicable portion of the allowance for loan losses, such as commercial and industrial, commercial real estate, residential mortgage, and consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.
The fair value of performing loans, except residential mortgage loans, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources adjusted to reflect differences in servicing and credit costs.
Estimated fair value for impaired loans is based on recent external appraisals if the loan is collateral dependent. Assumptions regarding credit risk cash flows and discount rates are judgmentally determined using available market information and specific borrower information.
Management has made estimates of fair value discount rates that it believes to be reasonable.
Deposits - The estimated fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market and checking accounts, is equal to the amount payable on demand. The estimated fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Customer Repurchase Agreements - The fair value of these agreements is estimated based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered.
Borrowings - The estimated fair value of borrowings is based upon the discounted value of contractual cash flows. The discount rate is estimated using Federal Home Loan Bank advance rates currently offered for borrowings with similar maturities.
Commitments to Extend Credit - The stated value of commitments to extend credit approximates fair value as the current interest rates for similar commitments do not differ significantly. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Such differences are not considered significant.
The estimated fair values of the Company's financial instruments at December 31 are as follows:
Limitations - Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment. Changes in assumptions could significantly affect the estimates.
19. SEGMENT INFORMATION
The Company has one reportable segment, "Community Banking." All of the Company's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit.
The Company operates only in the U.S. domestic market, primarily in Western Massachusetts. For the years ended December 31, 2004, 2003, and 2002, there is no customer that accounted for more than 10% of the Company's revenue.
20. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The condensed balance sheets of the Company are as follows:
The condensed statements of income for the Company are as follows:
The condensed statement of cash flows of the Company are as follows:
21. OTHER NONINTEREST EXPENSE
There is no item that as a component of noninterest expense, exceeds 1% of the aggregate of total interest income and noninterest income for the years ended December 31, 2004, 2003, and 2002 respectively.
22. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders Westfield Financial, Inc.
We have audited management's assessment, included in Management's Annual Report on Internal Control Over Financial Reporting, that Westfield Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Westfield Financial Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Westfield Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Westfield Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Westfield Financial, Inc. and our report dated March 8, 2005 expressed an unqualified opinion.
/s/ WOLF & COMPANY, P.C.
Boston, Massachusetts March 8, 2005