Securities and Exchange Commission Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006 Commission File No.: 001-16767 Westfield Financial, Inc. (Exact name of registrant as specified in its charter) Massachusetts 73-1627673 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 141 Elm Street, Westfield, Massachusetts 01085 (Address of principal executive offices, including zip code) (413) 568-1911 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.01 par value per share The American Stock Exchange -------------------------------------- --------------------------- (Title of each class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark if disclosure of delinquent files pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]. The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2006, was $119,468,748. This figure was based on the closing price as of June 30, 2006 on The American Stock Exchange for a share of the registrant's common stock, which was $29.00 on June 30, 2006. As of March 7, 2007, the registrant had 31,924,887 shares of common stock, $0.01 per value, issued and outstanding.
WESTFIELD FINANCIAL, INC. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006 TABLE OF CONTENTS ITEM PART I PAGE 1 BUSINESS 2 1A RISK FACTORS 42 1B UNRESOLVED STAFF COMMENTS 44 2 PROPERTIES 45 3 LEGAL PROCEEDINGS 46 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 46 PART II 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 46 6 SELECTED FINANCIAL DATA 48 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 49 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 72 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 72 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 72 9A CONTROLS AND PROCEDURES 73 9B OTHER INFORMATION 74 PART III 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 74 11 EXECUTIVE COMPENSATION 80 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 98 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 101 14 PRINCIPAL ACCOUNTING FEES AND SERVICES 101 PART IV 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES 103 SIGNATURES
FORWARD - LOOKING STATEMENTS This Annual Report on Form 10-K contains "forward-looking statements" which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operation and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to: o changes in the real estate market or local economy; o changes in interest rates; o changes in laws and regulations to which we are subject, and; o competition in our primary market area. Any or all of our forward-looking statements in this Annual Report on Form 10-K and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We disclaim any obligation to subsequently revise any forward-looking statements to reflect events or circumstances after the date of such statements, or to reflect the occurrence of anticipated or unanticipated events. 1
PART I ITEM 1. BUSINESS General. At December 31, 2006, Westfield Financial, Inc. was 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 that owned 57.6% of the outstanding common stock of Westfield Financial. On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007. For financial reporting purposes, net proceeds of $171.7 million from the second step conversion were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts. Westfield Bank was formed in 1853 and reorganized into a mutual holding company structure without a stock offering in 1995. In July 2004, Westfield Bank converted from a Massachusetts-chartered savings bank to a federally-chartered savings bank regulated by the Office of Thrift Supervision. 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 lending and commercial 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. 2
In September 2001, Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans. Westfield Bank receives a fee 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'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. Elm Street Securities Corporation, a Massachusetts-chartered corporation, was formed by Westfield Financial for the primary purpose of holding qualified investment securities. In February 2007, Westfield Financial also formed WFD Securities, Inc., a Massachusetts-chartered corporation, for the primary purpose of holding qualified investment securities. Unless the context otherwise requires, all references in this document to Westfield Financial or Westfield Bank include Westfield Financial and Westfield Bank on a consolidated basis. Market Area. Westfield Bank operates through 10 banking offices in Agawam, East Longmeadow, Holyoke, Southwick, Springfield, West Springfield and Westfield, Massachusetts. It also has eight free-standing ATM locations in Agawam, Feeding Hills, Springfield, West Springfield and Westfield, 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 website located at www.westfieldbank.com. The markets served by Westfield Bank's branches are primarily suburban in character, as Westfield Bank operates only two offices in Springfield, the Pioneer Valley's primary urban market. Westfield, Massachusetts, 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. The Pioneer Valley of western Massachusetts encompasses the fourth largest metropolitan area in New England. The Springfield Metropolitan area covers a relatively diverse area ranging from densely populated urban areas, such as Springfield, to outlying rural areas. Westfield is located approximately 90 miles west of Boston, Massachusetts, 70 miles southeast of Albany, New York and 30 miles north of Hartford, Connecticut. The 2005 population estimates for Westfield, Springfield and Hampden County were approximately 41,187, 153,975 and 462,529, respectively. 3
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, warehousing, 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. Median household and per capita income levels in Hampden County are below the state average, which is dominated by relatively high income levels prevailing in the populous Boston metropolitan area. Similarly, the median household and per capita income levels in Westfield Bank's markets more closely approximate but also fall below the national averages. As of December 2006, the unemployment rate of Hampden County and Massachusetts was 5.9% and 5.3%, respectively, compared to 5.4% and 4.9%, respectively, in December 2005. 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 18 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 and commercial banks. Westfield Bank faces additional competition for deposits from internet-based institutions, brokerage firms and insurance companies. 4
Lending Activities Loan Portfolio Composition. Westfield Bank's loan portfolio primarily consists of commercial and industrial loans, commercial real estate loans, residential real estate loans, home equity loans, and consumer loans. At December 31, 2006, Westfield Bank had total loans of $390.2 million, of which 72.3% were adjustable rate loans and 27.7% were fixed rate loans. Commercial real estate loans and commercial and industrial loans totaled $174.6 million and $100.2 million, respectively. The remainder of its loans at December 31, 2006 consisted of residential real estate loans, home equity loans and consumer loans. Residential real estate and home equity loans outstanding at December 31, 2006 totaled $109.5 million. Consumer loans outstanding at December 31, 2006 were $5.5 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. 5
<TABLE> <CAPTION> At December 31, -------------------------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 -------------------- -------------------- -------------------- -------------------- -------------------- Percent of Percent of Percent of Percent of Percent of Amount Total Amount Total Amount Total Amount Total Amount Total ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Real estate loans: Commercial $174,556 44.74% $169,564 44.17% $144,336 38.65% $131,292 37.57% $100,903 27.92% Residential (1) 79,308 20.33 82,279 21.43 101,098 27.07 90,362 25.86 132,929 36.79 Home equity 30,232 7.75 24,639 6.42 21,724 5.82 20,185 5.78 24,967 6.91 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total real estate loans 284,096 72.82 276,482 72.02 267,158 71.54 241,839 69.21 258,799 71.62 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Other loans: Commercial and industrial 100,237 25.69 100,019 26.06 94,726 25.36 85,292 24.41 61,494 17.01 Indirect auto 357 0.09 1,745 0.45 5,886 1.58 15,983 4.57 33,848 9.37 Consumer, other 5,484 1.40 5,627 1.47 5,679 1.52 6,327 1.81 7,216 2.00 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total other loans 106,078 27.18 107,391 27.98 106,291 28.46 107,602 30.79 102,558 28.38 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans 390,174 100.00% 383,873 100.00% 373,449 100.00% 349,441 100.00% 361,357 100.00% Net deferred loan origination costs 447 386 429 181 123 Allowance for loan losses (5,437) (5,422) (5,277) (4,642) (4,325) -------- -------- -------- -------- -------- Total loans, net $385,184 $378,837 $368,601 $344,980 $357,155 ======== ======== ======== ======== ======== - -------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. </TABLE> 6
Loan Maturity and Repricing. The following table shows the repricing dates or contractual maturity dates as of December 31, 2006. 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. <TABLE> <CAPTION> At December 31, 2006 ------------------------------------------------------------------------------------ Commercial Residential Commercial and Real Estate Home Equity Real Estate Industrial Consumer Loans (1) Loans Loans Loans Loans Totals ----------- ----------- ----------- ---------- -------- ------ (In thousands) <S> <C> <C> <C> <C> <C> <C> Amounts due: Within one year $15,423 $ 701 $ 30,585 $ 50,915 $1,066 $ 98,690 ------- ------- -------- -------- ------ -------- After one year: One to three years 23,731 529 59,997 11,007 1,566 96,830 Three to five years 8,131 2,627 41,987 16,575 2,785 72,105 Five to ten years 6,611 8,165 31,514 21,740 64 68,094 Ten to twenty years 11,658 18,210 10,473 - - 40,341 Over twenty years 13,754 - - - 360 14,114 ------- ------- -------- -------- ------ -------- Total due after one year 63,885 29,531 143,971 49,322 4,775 291,484 ------- ------- -------- -------- ------ -------- Total amount due: 79,308 30,232 174,556 100,237 5,841 390,174 ------- ------- -------- -------- ------ -------- Less: Net deferred loan origination costs (fees), net 135 250 (93) 133 22 447 Allowance for loan losses (380) (42) (2,017) (2,919) (79) (5,437) ------- ------- -------- -------- ------ -------- Loans, net $79,063 $30,440 $172,446 $ 97,451 $5,784 $385,184 ======= ======= ======== ======== ====== ======== - -------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. </TABLE> 7
The following table presents, as of December 31, 2006, the dollar amount of all loans contractually due or scheduled to reprice after December 31, 2007 and whether such loans have fixed interest rates or adjustable interest rates. Due After December 31, 2007 ------------------------------------ Fixed Adjustable Total ----- ---------- ----- (In thousands) Real Estate Loans Residential (1) $ 36,569 $ 27,316 $ 63,885 Home equity 19,841 9,690 29,531 Commercial real estate 6,348 137,623 143,971 -------- -------- -------- Total real estate loans 62,758 174,629 237,387 -------- -------- -------- Other Loans Commercial and industrial 34,108 15,214 49,322 Consumer 4,775 - 4,775 -------- -------- -------- Total other loans 38,883 15,214 54,097 -------- -------- -------- Total loans $101,641 $189,843 $291,484 ======== ======== ======== - -------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. 8
The following table presents our loan originations, purchases, sales and principal payments for the years indicated: For the Year Ended December 31, -------------------------------- 2006 2005 2004 ---- ---- ---- (In thousands) Loans: Balance outstanding at beginning of year $383,873 $373,449 $349,441 Originations: Real estate loans: Residential (1) 4,337 2,016 1,403 Home equity 15,336 10,947 10,422 Commercial 52,807 58,382 31,174 -------- -------- -------- Total mortgage originations 72,480 71,345 42,999 Commercial and industrial loans 34,864 43,465 50,349 Consumer loans 3,657 3,325 3,516 -------- -------- -------- Total originations 111,001 118,135 96,864 Purchases of one-to-four-family mortgage loans 11,845 1,236 34,996 -------- -------- -------- 122,846 119,371 131,860 -------- -------- -------- Less: Principal repayments, unadvanced funds and other, net 116,170 108,627 107,737 Loan charge-offs, net 375 320 115 -------- -------- -------- Total deductions 116,545 108,947 107,852 -------- -------- -------- Ending balance $390,174 $383,873 $373,449 ======== ======== ======== - -------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. 9
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, 2006, Westfield Bank's commercial and industrial loan portfolio consisted of 746 loans, totaling $100.2 million or 25.7% of its total loans. Since 2002, commercial and industrial loans have grown $38.7 million, or 61.4%, from $61.5 at December 31, 2002 to $100.2 million at December 31, 2006. Westfield Bank's commercial loan team includes six commercial loan officers, one business development manager, four credit analysts and one portfolio manager. 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. In 2006, Westfield Bank introduced a remote deposit capture product whereby commercial customers can receive credit for check deposits by electronically transmitting check images from their own locations. 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 and industrial loan portfolio does not have any significant loan concentration by type of property or borrower. The largest concentration of loans was for colleges and universities, which comprise approximately 3.62% of the total loan portfolio as of December 31, 2006. At December 31, 2006, Westfield Bank's largest commercial and industrial loan relationship was $15.7 million to a private New England college. The loans of this borrower have performed to contractual terms. Commercial and industrial loans generally have terms of seven years or less, however on an occasional basis, may have terms of up to ten years. Among the $100.2 million Westfield Bank has in its commercial and industrial loan portfolio as of December 31, 2006, $61.4 million have adjustable interest rates and $38.8 million have fixed interest rates. Whenever possible, Westfield Bank seeks to originate adjustable rate commercial and industrial loans. Borrower activity and market conditions however, may influence whether Westfield Bank is able to originate adjustable rate loans rather than fixed rate loans. Westfield Bank generally requires the personal guarantee of the business owner. Interest rates on commercial and industrial loans generally have higher yields than residential or commercial real estate loans. 10
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. Please see "Risk Factors - Our loan portfolio includes loans with a higher risk of loss." 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 to 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 credit quality reviews of the commercial and industrial loan portfolio. 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, 2006, Westfield Bank's commercial real estate loan portfolio consisted of 392 loans, totaling $174.6 million, or 44.7% of total loans. Since 2002, commercial real estate loans have grown by $73.7 million, or 73.0%, from $100.9 million at December 31, 2002 to $174.6 million at December 31, 2006. The majority 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 85% on commercial properties and generally requires a minimum debt coverage ratio of 1.15 times. Its largest commercial real estate loan relationship had an outstanding balance of $9.7 million at December 31, 2006 which was secured by five commercial investment properties located in Massachusetts. 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 $49.5 million in commercial construction loans and commitments at December 31, 2006. 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. 11
Because of increased risks associated with commercial real estate loans, Westfield Bank's commercial real estate loans generally have higher rates than residential real estate loans. Please see "Risk Factors - Our loan portfolio includes loans with a higher risk of loss." Commercial real estate loans generally have adjustable rates with repricing dates of five years or less, however, occasionally repricing dates may be as long as ten years. Whenever possible, Westfield Bank seeks to originate adjustable rate commercial real estate loans. Borrower activity and market conditions, however, may influence whether the Westfield Bank is able to originate adjustable rate loans rather than fixed rate loans. Residential Real Estate Loans and Originations. In September, 2001, Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans. Westfield Bank receives a fee for each of these loans originated by the third party mortgage company. Even though substantially all residential real estate loan originations are referred to a third party mortgage company, Westfield Bank still holds residential real estate loans in its loan portfolio. The loans consist primarily of loans originated by Westfield Bank prior to September 2001, the commencement of the third party residential mortgage referral program, or loans purchased by Westfield Bank. Westfield Bank occasionally purchases adjustable rate mortgages, which are serviced by the originating institutions, from other banks located in Massachusetts. As of December 31, 2006, loans on one- to four-family residential properties, including home equity lines, accounted for $109.5 million, or 28.1%, of Westfield Bank's total loan portfolio. 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, 2006, its residential real estate and home equity loan portfolio included $52.4 million in adjustable rate loans, or 13.4% of its total loan portfolio, and $57.1 million in fixed rate loans, or 14.7% of its total loan portfolio. 12
Westfield Bank's home equity loans totaled $30.2 million, or 7.7% of total loans at December 31, 2006. Home equity loans include $19.9 million in fixed rate loans, or 5.1% of total loans, and $10.3 million in adjustable rate loans, or 2.6% of total loans. 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. Westfield Bank requires or obtains insurance on mortgages whose loan-to-value ratio exceeds 80%. The term to maturity on Westfield Bank's home equity and home improvement loans may be up to 15 years. Consumer Loans. Consumer loans are generally originated at higher interest rates than residential and commercial real estate loans, but they also generally tend to have a higher credit risk than residential real estate 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, 2006, the consumer loan portfolio totaled $5.9 million or 1.5% 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. Loans collateralized by rapidly depreciable assets such as automobiles or that are unsecured entail greater risks than residential real estate 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. There was no repossessed collateral relating to consumer loans at December 31, 2006. 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. Individuals authorized to make loans on behalf of Westfield Bank are designated by Westfield Bank's Chief Lending Officer and approved by the Board of Directors. Each loan officer has loan approval authority up to prescribed limits that depend upon the officer's level of experience. Upon receipt of a completed loan application from a prospective borrower, Westfield Bank orders a credit report and verifies other information. If necessary, Westfield Bank obtains additional financial or credit related information. Westfield Bank also requires an appraisal for all commercial real estate loans, which is performed by licensed or certified third party appraisal 13
firms and reviewed by Westfield Bank's lending department. Appraisals for home equity loans are required for loans in excess of $250,000; otherwise, a designated employee of Westfield Bank conducts an inspection of the property. Westfield Bank requires title insurance on all commercial real estate loans. Westfield Bank also requires borrowers to obtain flood insurance, if applicable, prior to closing, for all loans secured by real estate within a designated flood zone. Commercial and Industrial Loans and Commercial Real Estate Loans. Westfield Bank lends up to a maximum loan-to-value ratio of 85% on commercial properties and requires a minimum debt coverage ratio of 1.2. Commercial real estate lending involves additional risks compared with one- to four-family residential lending. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, and/or the collateral value of the commercial real estate securing the loan, repayment of such loans may be subject, to a greater extent, to adverse conditions in the real estate market or the economy. Also, commercial real estate loans typically involve large loan balances to single borrowers or groups or related borrowers. Westfield Bank's loan policies limit the amounts of loans to a single borrower or group of borrowers to reduce this risk. Westfield Bank's lending policies permit its underwriting department to review and approve commercial and industrial loans and commercial real estate loans up to $500,000. Any commercial and industrial or commercial real estate loan application that exceeds $500,000 or that would result in the borrower's total credit exposure with Westfield Bank to exceed $500,000, or whose approval requires an exception to Westfield Bank's standard loan approval procedures, requires approval of the Executive Committee of the Board of Directors. An example of an exception to Westfield Bank's standard loan approval procedures would be if a borrower was located outside Westfield Bank's primary lending area. 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 equipment or property. Generally, these determinations are based on financial statements, corporate and personal tax returns, as well as any other necessary information, including real estate and or equipment appraisals. Residential Real Estate Loans. In September 2001, Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. Residential real estate borrowers submit applications to Westfield Bank, but the loan is approved by and closed on the books of the mortgage company. The third party mortgage company owns the servicing rights and services the loans. Westfield Bank retains no residual ownership interest in these loans. Westfield Bank receives a fee for each of the loans originated by the third party mortgage company. Home Equity Loans. Home equity loans are originated and funded by Westfield Bank. 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. Westfield Bank requires or obtains insurance on mortgages whose loan-to-value ratio exceeds 80%. Westfield Bank's underwriting department may approve home equity loans up to $150,000. Home equity loans in amounts greater than $150,000 and up to $300,000 may be approved by certain officers of Westfield Bank who have been approved by the Board of Directors. Home equity loans over $300,000, or whose approval requires an exception to Westfield Bank's standard loan approval procedures, are reviewed and approved by the Executive Committee of the Board of Directors. 14
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 credit quality reviews of Westfield Bank's commercial and industrial and commercial real estate loan portfolio on a semi-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, 2006, 2005, and 2004, Westfield Bank had $1.0 million, $1.9 million, and $2.2 million, respectively, of nonaccrual loans. If all nonaccrual loans had been performing in accordance with their terms, Westfield Bank would have earned additional interest income of $67,000, $176,000, and $176,000 for the years ended December 31, 2006, 2005, and 2004, respectively. <TABLE> <CAPTION> At December 31, -------------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Nonaccrual real estate loans: Residential (1) $ 803 $ 321 $ 492 $ 953 $1,270 Home equity 103 108 139 74 83 Commercial real estate 69 1,285 1,341 342 374 ------ ------ ------ ------ ------ Total nonaccrual real estate loans 975 1,714 1,972 1,369 1,727 ------ ------ ------ ------ ------ Other loans: Commercial and industrial 44 173 170 289 530 Consumer 9 32 29 110 126 ------ ------ ------ ------ ------ Total nonaccrual consumer and other loans 53 205 199 399 656 ------ ------ ------ ------ ------ Total nonperforming loans 1,028 1,919 2,171 1,768 2,383 Foreclosed real estate, net - - - - - Total nonperforming assets $1,028 $1,919 $2,171 $1,768 $2,383 ====== ====== ====== ====== ====== Nonperforming loans to total loans 0.26% 0.50% 0.58% 0.51% 0.66% Nonperforming assets to total assets 0.10 0.24 0.27 0.22 0.29 - -------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. </TABLE> 15
Allowance for Loan Losses. The following table presents the activity in Westfield Bank's allowance for loan losses and other ratios (annualized as applicable) at or for the dates indicated. <TABLE> <CAPTION> At or for Years Ended December 31, ------------------------------------------------------------ 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Balance at beginning of year $ 5,422 $ 5,277 $ 4,642 $ 4,325 $ 3,923 Charge-offs: Residential (1) - - - (3) (36) Commercial real estate - - - - (29) Home equity loans - - - (31) - Commercial and industrial (505) (431) (14) (124) (241) Consumer (79) (181) (390) (567) (622) -------- -------- -------- -------- -------- Total charge-offs (584) (612) (404) (725) (928) -------- -------- -------- -------- -------- Recoveries: Residential (1) 4 - - 10 17 Commercial real estate - 1 - - - Home equity loans 3 3 4 3 - Commercial and industrial 7 9 65 73 16 Consumer 195 279 220 206 363 -------- -------- -------- -------- -------- Total recoveries 209 292 289 292 396 -------- -------- -------- -------- -------- Net charge-offs (375) (320) (115) (433) (532) Provision for loan losses 390 465 750 750 934 -------- -------- -------- -------- -------- Balance at end of year $ 5,437 $ 5,422 $ 5,277 $ 4,642 $ 4,325 ======== ======== ======== ======== ======== Total loans receivable (2) $390,174 $383,873 $373,449 $349,441 $361,357 ======== ======== ======== ======== ======== Average loans outstanding $386,039 $383,436 $366,677 $354,134 $398,555 ======== ======== ======== ======== ======== Allowance for loan losses as a percent of total loans receivable 1.39% 1.41% 1.41% 1.33% 1.20% Net loans charged off as a percent of average loans outstanding 0.10% 0.08% 0.03% 0.12% 0.13% - -------------------- (1) Includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. (2) Does not include deferred fees or allowance for loan losses. </TABLE> 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. 16
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, 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 nonperforming loans, delinquency and loan losses, and specific industry concentrations within the portfolio segments that may impact the collectibility of the loan portfolio. In addition, management employs an independent third party to perform a semi-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 $750,000. The third party also reviews all commercial investment real estate loans in excess of $750,000, as well as all adversely rated loans. 17
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: <TABLE> <CAPTION> December 31, 2006 December 31, 2005 December 31, 2004 ------------------------------- ------------------------------- ------------------------------- Specific Formula Total Specific Formula Total Specific Formula Total -------- ------- ----- -------- ------- ----- -------- ------- ----- (In thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Real Estate Mortgage Residential (1) $ - $ 422 $ 422 $ - $ 355 $ 355 $ - $ 421 $ 421 Commercial 13 2,004 2,017 218 2,400 2,618 264 2,097 2,361 Commercial and Industrial 7 2,912 2,919 32 2,334 2,366 236 2,078 2,314 Consumer - 79 79 - 83 83 - 181 181 --- ------ ------ ---- ------ ------ ---- ------ ------ Total $20 $5,417 $5,437 $250 $5,172 $5,422 $500 $4,777 $5,277 === ====== ====== ==== ====== ====== ==== ====== ====== <CAPTION> December 31, 2003 December 31, 2002 ------------------------------- ------------------------------- Specific Formula Total Specific Formula Total -------- ------- ----- -------- ------- ----- (In thousands) <S> <C> <C> <C> <C> <C> <C> Real Estate Mortgage Residential (1) $ - $ 517 $ 517 $ - $ 713 $ 713 Commercial 17 1,994 2,011 17 1,618 1,635 Commercial and Industrial 53 1,660 1,713 53 1,408 1,461 Consumer - 401 401 - 516 516 --- ------ ------ ---- ------ ------ Total $70 $4,572 $4,642 $ 70 $4,255 $4,325 === ====== ====== ==== ====== ====== - -------------------- (1) Includes home equity loans. Also includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. </TABLE> 18
In addition, the Office of Thrift Supervision, 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 Office of Thrift Supervision 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, 2006, Westfield Bank provided $390,000 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, 2006. 19
<TABLE> <CAPTION> 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. At December 31, ------------------------------------------------------------------------------------------------------ 2006 2005 2004 ------------------------------------------------------------------------------------------------------ Percent of Percent of Percent of Loan Loans in Loan Loans in Loan Loans in Amount Balances Each Amount Balances Each Amount Balances Each of Loan by Category to of Loan by Category to of Loan by Category to Loan Category Loss Category Total Loans Loss Category Total Loans Loss Category Total Loans - ------------- ------------------------------------------------------------------------------------------------------ (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Real estate - mortgage: Commercial $2,017 $174,556 44.74% $2,618 $169,564 44.17% $2,361 $144,336 38.65% Residential (1) 422 109,540 28.08 355 106,918 27.85 421 122,822 32.89 Commercial loans 2,919 100,237 25.69 2,366 100,019 26.06 2,314 94,726 25.36 Consumer loans 79 5,841 1.49 83 7,372 1.92 181 11,565 3.10 ------ -------- ------ ------ -------- ------ ------ -------- ------ Total allowance for loan losses $5,437 $390,174 100.00% $5,422 $383,873 100.00% $5,277 $373,449 100.00% ====== ======== ====== ====== ======== ====== ====== ======== ====== <CAPTION> At December 31, ------------------------------------------------------------------- 2003 2002 ------------------------------------------------------------------- Percent of Percent of Loan Loans in Loan Loans in Amount Balances Each Amount Balances Each of Loan by Category to of Loan by Category to Loss Category Total Loans Loss Category Total Loans ------------------------------------------------------------------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Real estate - mortgage: Commercial $2,011 $131,292 37.57% $1,635 $100,903 27.92% Residential (1) 517 110,547 31.64 713 157,896 43.70 Commercial loans 1,713 85,292 24.41 1,461 61,494 17.01 Consumer loans 401 22,310 6.38 516 41,064 11.37 ------ -------- ------ ------ -------- ------ Total allowance for loan losses $4,642 $349,441 100.00% $4,325 $361,357 100.00% ====== ======== ====== ====== ======== ====== - -------------------- (1) Includes home equity loans. Also includes residential real estate loans purchased by Westfield Bank, or residential real estate loans originated by Westfield Bank prior to September 2001, when Westfield Bank began referring substantially all of the originations of its residential real estate loans to a third party mortgage company. </TABLE> 20
Investment Activities. The Board of Directors reviews and approves Westfield Bank's investment policy on an annual basis. The Chief Executive Officer and Chief Financial Officer, 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 government-sponsored enterprises, 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, 2006, held to maturity securities totaled $240.4 million, or 58.8% of the total securities portfolio, and available for sale investments totaled $168.6 million, or 41.2% of Westfield Financial's total securities portfolio. Westfield Financial classifies U.S. Government securities and Government-sponsored enterprise 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 30 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, and the majority of which are also independently insured. 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. 21
<TABLE> <CAPTION> The following table sets forth the composition of Westfield Bank's securities portfolio at the dates indicated. At December 31, ---------------------------------------------------------------------------- 2006 2005 2004 ---------------------- ---------------------- ---------------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- ----- --------- ----- --------- ----- (In thousands) <S> <C> <C> <C> <C> <C> <C> Securities: Government-sponsored enterprises $ 81,916 $ 81,242 $ 65,818 $ 64,944 $ 45,151 $ 45,061 Municipal bonds 30,204 30,387 30,233 30,339 29,147 29,597 Corporate debt securities - - - - 4,909 4,978 -------- -------- -------- -------- -------- -------- Total securities 112,120 111,629 96,051 95,283 79,207 79,636 -------- -------- -------- -------- -------- -------- Mortgage-backed securities: Fannie Mae 150,547 148,310 144,440 141,472 153,271 152,292 Freddie Mac 90,972 90,477 74,775 73,834 62,614 62,501 Ginnie Mae 22,060 21,695 29,894 29,336 29,811 29,718 Other pass-through securities - - 4,726 4,709 - - Collateralized mortgage obligations 27,336 27,169 818 804 2,848 2,856 -------- -------- -------- -------- -------- -------- Total mortgage-backed securities 290,915 287,651 254,653 250,155 248,544 247,367 -------- -------- -------- -------- -------- -------- Marketable equity securities 7,260 6,996 6,057 5,742 7,301 6,986 -------- -------- -------- -------- -------- -------- Total securities $410,295 $406,276 $356,761 $351,180 $335,052 $333,989 ======== ======== ======== ======== ======== ======== </TABLE> 22
<TABLE> <CAPTION> Mortgage-Backed 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. At December 31, ------------------------------------------------------------------------------------------------- 2006 2005 2004 ------------------------------- ------------------------------- ------------------------------- Amortized Percent of Fair Amortized Percent of Fair Amortized Percent of Fair Cost Total Value Cost Total Value Cost Total Value --------- ---------- ----- --------- ---------- ----- --------- ---------- ----- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Mortgage-backed securities available for sale: Fannie Mae $ 47,203 16.23% $ 46,730 $ 46,078 18.09% $ 45,376 $ 32,676 13.15% $ 32,713 Freddie Mac 49,554 17.03 49,378 38,310 15.04 37,863 22,842 9.19 22,838 Ginnie Mae 8,635 2.97 8,543 12,594 4.95 12,386 15,036 6.05 15,069 Other pass-through securities - - - 4,726 1.86 4,709 - - - Collateralized mortgage obligations 22,430 7.71 22,291 818 0.32 804 2,688 1.08 2,696 -------- ------ -------- -------- ------ -------- -------- ------ -------- Total mortgage-backed securities available for sale 127,822 43.94 126,942 102,526 40.26 101,138 73,242 29.47 73,316 -------- ------ -------- -------- ------ -------- -------- ------ -------- Mortgage-backed securities held to maturity: Fannie Mae 103,344 35.52 101,580 98,362 38.63 96,096 120,595 48.52 119,579 Freddie Mac 41,418 14.24 41,099 36,465 14.32 35,971 39,772 16.00 39,663 Ginnie Mae 13,425 4.61 13,152 17,300 6.79 16,950 14,775 5.95 14,649 Collateralized mortgage obligations 4,906 1.69 4,878 - - - 160 0.06 160 -------- ------ -------- -------- ------ -------- -------- ------ -------- Total mortgage-backed securities held to maturity 163,093 56.06 160,709 152,127 59.74 149,017 175,302 70.53 174,051 -------- ------ -------- -------- ------ -------- -------- ------ -------- Total mortgage-backed securities $290,915 100.00% $287,651 $254,653 100.00% $250,155 $248,544 100.00% $247,367 ======== ====== ======== ======== ====== ======== ======== ====== ======== </TABLE> 23
<TABLE> <CAPTION> Securities Portfolio Maturities. The composition and maturities of the securities portfolio (debt securities) and the mortgage-backed securities portfolio at December 31, 2006 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. More than One Year More than Five Years One Year or Less Through Five Years Through Ten Years More than Ten Years Total Securities ------------------ ------------------ -------------------- ------------------- --------------------------- Weighted Weighted Weighted Weighted Weighted Amortized Average Amortized Average Amortized Average Amortized Average Amortized Fair Average Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield --------- -------- --------- -------- --------- -------- --------- -------- --------- ----- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Securities available for sale: Government-sponsored enterprises $ 6,000 4.00% $23,831 5.31% $ 4,990 5.03% $ - -% $ 34,821 $ 34,691 5.04% Mortgage-backed securities available for sale: Ginnie Mae -- -- -- -- -- -- 8,635 4.58 8,635 8,543 4.58 Fannie Mae -- -- -- -- 2,816 4.52 44,387 4.47 47,203 46,730 4.48 Freddie Mac -- -- -- -- -- -- 49,554 4.56 49,554 49,378 4.56 Collateralized mortgage obligations -- -- -- -- -- -- 22,430 5.07 22,430 22,291 5.07 ------- ---- ------- ---- ------- ---- -------- ---- -------- -------- ---- Total mortgage- backed securities -- -- -- -- 2,816 4.52 125,006 4.62 127,822 126,942 4.62 ------- ---- ------- ---- ------- ---- -------- ---- -------- -------- ---- Total $ 6,000 4.00 $23,831 5.31 $ 7,806 4.85 $125,006 4.62 $162,643 $161,633 4.71 ======= ==== ======= ==== ======= ==== ======== ==== ======== ======== ==== Securities held to maturity: Government-sponsored enterprises $10,000 4.28 $22,097 5.08 $14,998 4.92 $ - - $ 47,095 $ 46,551 4.86 Municipal bonds -- -- 1,480 3.47 13,834 3.87 14,890 4.41 30,204 30,387 4.12 ------- ---- ------- ---- ------- ---- -------- ---- -------- -------- ---- Total investment securities 10,000 4.28 23,577 4.98 28,832 4.42 14,890 4.41 77,299 76,938 4.57 ------- ---- ------- ---- ------- ---- -------- ---- -------- -------- ---- Mortgage-backed securities held to maturity: Ginnie Mae -- -- 83 4.91 463 4.88 12,879 3.97 13,425 13,152 4.01 Fannie Mae -- -- 2,835 3.29 11,857 3.63 88,652 4.67 103,344 101,580 4.52 Freddie Mac -- -- 3,243 2.15 714 4.79 37,461 5.16 41,418 41,099 4.93 Collateralized mortgage obligations -- -- -- -- -- -- 4,906 5.48 4,906 4,878 5.48 ------- ---- ------- ---- ------- ---- -------- ---- -------- -------- ---- Total mortgage- backed securities -- -- 6,161 2.71 13,034 3.74 143,898 4.76 163,093 160,709 4.61 ------- ---- ------- ---- ------- ---- -------- ---- -------- -------- ---- Total $10,000 4.28% $29,738 4.51% $41,866 4.21% $158,788 4.73% $240,392 $237,647 4.60% ======= ==== ======= ==== ======= ==== ======== ==== ======== ======== ==== </TABLE> 24
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 its 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 40.4% of total deposits on December 31, 2006 and 46.2% on December 31, 2005. At December 31, 2006 and December 31, 2005, time deposits with remaining terms to maturity of less than one year amounted to $270.0 million and $227.8 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, 2006, 2005 and 2004. 25
<TABLE> <CAPTION> Deposit Distribution Weighted Average. The following table sets forth the distribution of Westfield Bank's deposit accounts, by account type, at the dates indicated. At December 31, --------------------------------------------------------------------------------------------- 2006 2005 2004 ----------------------------- ----------------------------- ----------------------------- Weighted Weighted Weighted Average Average Average Amount Percent Rates Amount Percent Rates Amount Percent Rates ------ ------- -------- ------ ------- -------- ------ ------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Demand deposits $ 42,383 6.75% 0.00% $ 45,260 7.26% 0.00% $ 48,305 7.88% 0.00% NOW accounts 80,527 12.83 1.40 69,137 11.10 0.83 57,050 9.31 0.51 Regular accounts 36,110 5.76 0.50 41,387 6.64 0.50 44,882 7.33 0.50 Money market accounts 94,441 15.05 1.51 132,218 21.22 1.62 149,288 24.37 0.93 -------- ------ -------- ------ -------- ------ Total non-certificate accounts 253,461 40.39 1.08 288,002 46.22 1.01 299,525 48.89 0.64 -------- ------ -------- ------ -------- ------ Time certificates of deposit Due within 1 year 270,026 43.04 4.40 227,770 36.56 3.05 184,500 30.12 2.14 Over 1 year through 3 years 91,201 14.53 4.33 85,951 13.80 3.51 103,856 16.95 2.88 Over 3 years 12,778 2.04 4.56 21,322 3.42 4.17 24,740 4.04 3.71 -------- ------ -------- ------ -------- ------ Total certificate accounts 374,005 59.61 4.39 335,043 53.78 3.24 313,096 51.11 2.51 -------- ------ -------- ------ -------- ------ Total $627,466 100.00% 3.05% $623,045 100.00% 2.21% $612,621 100.00% 1.59% ======== ====== ======== ====== ======== ====== </TABLE> Certificate of Deposit Maturities. At December 31, 2006, Westfield Bank had $93.5 million in time certificates of deposit with balances of $100,000 and over maturing as follows: Weighted Average Maturity Period Amount Rate - ----------------------------------------- ------ -------- (Dollars in thousands) Three months or less $15,158 4.29% Over three months through six months 11,511 4.61 Over six months through twelve months 39,940 4.72 Over twelve months 26,844 4.57 ------- Total $93,453 4.59% ======= <TABLE> <CAPTION> Certificate of Deposit 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. At December 31, 2006 ------------------------------------------------------------------------------------ Period to Maturity ------------------------------------------------------------------------------------ Less than One to Two Two to More than Percent of One Year Years Three Years Three Years Total Total --------- ---------- ----------- ----------- ----- ---------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> 2.00% and under $ 5,378 $ 13 $ - $ - $ 5,391 1.44% 2.01% to 3.00% 45,244 3,366 - - 48,610 13.00 3.01% to 4.00% 19,854 19,247 2,710 100 41,911 11.21 4.01% to 5.00% 122,859 21,265 16,370 10,142 170,636 45.62 5.01% and over 76,691 21,532 6,698 2,536 107,457 28.73 -------- ------- ------- ------- -------- ------ Total $270,026 $65,423 $25,778 $12,778 $374,005 100.00% ======== ======= ======= ======= ======== ====== </TABLE> 26
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. Westfield Bank's borrowings were $55.0 million at December 31, 2006. Westfield Bank offers repurchase agreements to commercial customers and higher balance retail customers. These agreements are linked to the customers' checking accounts. Excess funds are swept out of certain commercial checking accounts and into repurchase agreements where the customers can earn interest on their funds. By law, a bank cannot pay interest on commercial checking accounts, however, interest can be paid on non-deposit products such as repurchase agreements. Since these repurchase agreements are not deposits, they are not insured by the Federal Deposit Insurance Corporation. At December 31, 2006, such repurchase agreements borrowings totaled $17.9 million. Personnel As of December 31, 2006, Westfield Bank had 136 full-time employees and 34 part-time employees. The employees are not represented by a collective bargaining unit, and Westfield Bank considers our relationship with its employees to be excellent. TAXATION Federal General. The following discussion is intended as only a summary and does not purport to be a comprehensive description of the tax rules applicable to Westfield Bank or Westfield Financial. For federal income tax purposes, Westfield Bank reports its income on the basis of a taxable year ending December 31, using the accrual method of accounting, and Westfield Financial is generally subject to federal income taxation in the same manner as other corporations. Since December 27, 2001, Westfield Bank and Westfield Financial have constituted an affiliated group of corporations and, therefore, have reported their income on a consolidated basis. Westfield Bank is currently undergoing an audit of the 2005 tax year by the IRS. The tax years up to and including the year ended December 31, 2002 are closed. Distributions. To the extent that Westfield Bank makes "non-dividend distributions" to stockholders, such distributions will be considered to result in distributions from Westfield Bank's unrecaptured tax bad debt reserve "base year reserve" (i.e. its reserve as of December 31, 1987), to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed, but no more than the amount of these reserves, will be included in Westfield Bank's taxable income. Non-dividend distributions include distributions in excess of Westfield Bank's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of Westfield Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not constitute non-dividend distributions and, therefore, will not be included in Westfield Bank's income. 27
The amount of additional income created from a non-dividend distribution is equal to the lesser of Westfield Bank's base year reserve and supplemental reserve for losses on loans or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in 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 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 alternative minimum tax 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 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 alternative minimum tax 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, we have not been subject to alternative minimum tax and therefore has no alternative minimum tax 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. Net Operating Losses. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding twenty taxable years. At December 31, 2006, Westfield Financial had no net operating loss carry forwards for federal income tax purposes. State Financial institutions in Massachusetts are not allowed to file consolidated income tax returns. Instead, each entity in the consolidated group files a separate annual income tax return. The Massachusetts excise tax rate for savings banks is currently 10.5% of federal taxable income, adjusted for certain items. Taxable income includes gross income as defined under the Internal Revenue code, plus interest from bonds, notes and evidences of indebtedness of any state, including Massachusetts, less deductions, but not the credits, allowable under the provisions of the Internal Revenue Code, except for those deductions relating to dividends received and income or franchise taxes imposed by a state or political subdivision. Carryforwards and carrybacks of net operating losses and capital losses are not allowed. 28
Westfield Financial's state tax returns, as well as those of its subsidiaries, are not currently under audit. In June 2003, Westfield Bank reached a settlement with the Massachusetts Department of Revenue with respect to the Department of Revenue's tax assessment resulting from the Department of Revenue's disallowance of Westfield Bank's deduction of certain dividend distributions received by Westfield Bank from its real estate investment trust majority-owned subsidiary for the tax years ending December 31, 1999, 2001, and 2002. As a result, Westfield bank paid approximately $1.5 million to the Department of Revenue representing one-half of the assessment plus interest and obtained the Department of Revenue's release form liability for the remaining half assessed. Westfield bank dissolved the real estate investment trust during the fourth quarter of 2003. REGULATION General. As a federally-chartered savings bank, Westfield Bank is subject to regulation, examination, and supervision by the Office of Thrift Supervision as its chartering authority, and the Federal Deposit Insurance Corporation as its deposit insurer. Westfield Bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation describing its activities and financial condition. Westfield Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board. This supervision and regulation is intended primarily for the protection of depositors. Westfield Financial is a savings and loan holding company regulated by the Office of Thrift Supervision. As such, Westfield Financial is registered with and subject to Office of Thrift Supervision examination and supervision, as well as certain Office of Thrift Supervision reporting requirements. In addition, the Office of Thrift Supervision has enforcement authority over Westfield Financial and Westfield Financial's non-savings association subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings association. 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 Board. Westfield Financial also is required to file reports with the Office of Thrift Supervision and the Securities and Exchange Commission, and otherwise comply with the rules and regulations of the Office of Thrift Supervision and the Securities and Exchange Commission under federal securities laws. The Office of Thrift Supervision and the Federal Deposit Insurance Corporation have significant discretion in connection with their supervisory and enforcement activities and examination policies. Any change in such policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission or the United States Congress, could have a material adverse impact on Westfield Financial, Westfield Bank, and Westfield Financial's operations and stockholders. The following discussion is intended to be a summary of the material statutes and regulations applicable to federal savings banks and their holding companies, and it does not purport to be a comprehensive description of all such statutes and regulations. 29
Regulation of Federal Savings Banks Business Activities. Westfield Bank derives its lending and investment powers from the Home Owners' Loan Act, as amended, and Office of Thrift Supervision regulations. The Home Owners' Loan Act and the Office of Thrift Supervision regulations also limit Westfield Bank's authority to invest in certain types of loans or other investments. Permissible investments include, but are not limited to, 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. 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. Qualified Thrift Lender Test. The Home Owners' Loan Act requires that Westfield Bank, as a savings association, comply with the qualified thrift lender test. Under the qualified thrift lender test, Westfield Bank is required to maintain at least 65% of its portfolio assets in certain "qualified thrift investments" in 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: o specified liquid assets up to 20% of total assets; o goodwill and other intangible assets; and o the value of property used to conduct Westfield Bank's business. Westfield Bank also may satisfy the qualified thrift lender test by qualifying as a domestic building and loan association as defined in the Internal Revenue Code of 1986. If Westfield Bank fails the qualified thrift lender test, and is unable to correct that failure for a period of time, it must either operate under certain restrictions on its activities or convert to a bank charter. Westfield Bank met the qualified thrift lender test at December 31, 2006 and in each of the prior 12 months, and, therefore, is a "qualified thrift lender." 30
Capital Requirements. Office of Thrift Supervision regulations require Westfield Bank to meet three minimum capital standards: (1) a tangible capital ratio requirement of 1.5% of total assets as adjusted under Office of Thrift Supervision regulations; (2) a leverage ratio requirement of 3% 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 (3) a risk-based capital ratio requirement of 8% of core and supplementary capital to total risk-based assets, provided that the amount of supplementary capital used to satisfy this requirement may not exceed the amount of core capital. The minimum leverage capital ratio for any other depository institution that does not have a composite rating of 1 will be 4%, 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% for cash and obligations issued by the United States Government or its agencies to 100% for consumer and commercial loans, as assigned by the Office of Thrift Supervision capital regulation based on the risks found by the Office of Thrift Supervision 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 (or Tier 1 capital) is defined similarly to tangible capital, but core capital also includes certain qualifying supervisory goodwill and certain purchased credit card relationships. Supplementary capital (or Tier 2 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% 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 Tier 2 capital is limited to a maximum of 1.25% of risk-weighted assets. At December 31, 2006, Westfield Bank met each of its capital requirements, in each case on a fully phased-in basis. 31
Community Reinvestment. Under the Community Reinvestment Act, as implemented by Office of Thrift Supervision regulations, Westfield Bank has a continuing and affirmative obligation, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act 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 Community Reinvestment Act. The Community Reinvestment Act requires the Office of Thrift Supervision, in connection with its examination of a savings association, to assess Westfield Bank's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by Westfield Bank. The Community Reinvestment Act 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: o a lending test, to evaluate the institution's record of making loans in its assessment areas; o 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 in its assessment area or a broader area that includes its assessment area; and o a service test, to evaluate the institution's delivery of services through its retail banking channels and the extent and innovativeness of its community development services. Westfield Bank received a "Satisfactory" Community Reinvestment Act rating in its most recent examination, in January 2005. Transactions with Affiliates. Westfield Bank's authority to engage in transactions with its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve Board's Regulation W, as made applicable to federal savings associations by the Home Owners' Loan Act and the Office of Thrift Supervision regulations. 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, Office of Thrift Supervision 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. 32
Loans to Insiders. Westfield Bank's authority to extend credit to its directors, executive officers and principal 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 Federal Reserve Act and Regulation O of the Federal Reserve Board, as made applicable to federal savings associations by the Home Owners' Loan Act and the Office of Thrift Supervision regulations. 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's capital. In addition, extensions for credit in excess of certain limits must be approved by Westfield Bank's Board of Directors. Enforcement. The Office of Thrift Supervision 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 as well as in response to unsafe or unsound practices. Standards for Safety and Soundness. Pursuant to the Federal Deposit Insurance Act, the Office of Thrift Supervision 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 risk 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 Office of Thrift Supervision adopted regulations that authorize, but do not require, the Office of Thrift Supervision to order a savings association that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being notified, a savings association fails to submit an acceptable plan of compliance or fails in any material respect to implement an accepted plan, the Office of Thrift Supervision must issue an order directing action to correct the deficiency, may issue an order directing other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of the Federal Deposit Insurance Act. If a savings association fails to comply with such an order, the Office of Thrift Supervision may seek to enforce such order in judicial proceedings and to impose civil money penalties. 33
Prompt Corrective Regulatory Action. Pursuant to the Federal Deposit Insurance Act and the Office of Thrift Supervision prompt corrective action regulations, the Office of Thrift Supervision 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: o well-capitalized; o adequately capitalized; o undercapitalized; or o critically undercapitalized. When appropriate, the Office of Thrift Supervision can require corrective action by a savings and loan holding company under the "prompt corrective action" provisions of the Federal Deposit Insurance Act. At December 31, 2006, Westfield Bank met the criteria for being considered "well-capitalized." Capital Distributions. The Office of Thrift Supervision imposes various restrictions or requirements on Westfield Bank's ability to make capital distributions, including the payment of cash dividends. A savings association that is the subsidiary of a savings and loan holding company must file a notice with the Office of Thrift Supervision 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 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 Office of Thrift Supervision may disapprove of a notice of application if: o Westfield Bank would be undercapitalized following the distribution; o the proposed capital distribution raises safety and soundness concerns; or o the capital distribution would violate a prohibition contained in any statute, regulation, or agreement. Liquidity. Westfield Bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. 34
Insurance of Deposit Accounts. Westfield Bank is a member of the Deposit Insurance Fund, maintained by the Federal Deposit Insurance Corporation, and Westfield Bank pays its deposit insurance assessments to the Deposit Insurance Fund. The Deposit Insurance Fund was formed on March 31, 2006 following the merger of the Bank Insurance Fund and the Savings Association Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005. In addition to merging the insurance funds, the Federal Deposit Insurance Reform Act established a statutory minimum and maximum designated reserve ratio for the Deposit Insurance Fund and granted the Federal Deposit Insurance Corporation greater flexibility in establishing the required reserve ratio. In its regulations implementing the Federal Deposit Insurance Reform Act, the Federal Deposit Insurance Corporation has set the current annual designated reserve ratio for the Deposit Insurance Fund at 1.25%. In order to maintain the Deposit Insurance Fund, member institutions are assessed an insurance premium. The amount of each institution's premium is currently based on the balance of insured deposits and the degree of risk the institution poses to the Deposit Insurance Fund. Under the assessment system, the Federal Deposit Insurance Corporation assigns an institution to one of nine risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory subgroup assignment). Each risk category is assigned an assessment rate. Assessment rates currently range from 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 0.43% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concerns). The Federal Deposit Insurance Corporation is authorized to raise the assessment rates as necessary to maintain the Deposit Insurance Fund. The Bank's assessment rate at December 31, 2006 was 0.0122%. Any increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including the Bank. In addition, all Federal Deposit Insurance Corporation-insured institutions are required to pay a pro rata portion of the interest due on obligations issued by the Financing Corporation to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2006, the Federal Deposit Insurance Corporation assessed Deposit Insurance Fund-insured deposits 1.24 basis points per $100 of deposits to cover those obligations. The Financing Corporation rate is adjusted quarterly to reflect changes in assessment bases of the Deposit Insurance Fund. This obligation will continue until the Financing Corporation bonds mature in 2017. Federal Home Loan Bank System. Westfield Bank is a member of the Federal Home Loan Bank of Boston, which is one of the regional Federal Home Loan Banks composing the Federal Home Loan Bank System. Each Federal Home Loan Bank serves as a central credit facility primarily for its member institutions. Westfield Bank, as a member of the Federal Home Loan Bank of Boston, is required to acquire and hold shares of capital stock in the Federal Home Loan Bank of Boston. While the required percentages of stock ownership are subject to change by the Federal Home Loan Bank of Boston, Westfield Bank was in compliance with this requirement with an investment in Federal Home Loan Bank of Boston stock at December 31, 2006 of $4.0 million. Any advances from an Federal Home Loan Bank 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. 35
The Federal Home Loan Banks 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 Federal Home Loan Banks can pay as dividends to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, Westfield Bank's net interest income would be affected. Federal Reserve System. Westfield Bank is subject to provisions of the Federal Reserve Act and the Federal Reserve Board's regulations under which depository 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 Federal Reserve Board regulations exempt $8.5 million of otherwise reservable balances from the reserve requirements. A 3.0% reserve is required for transaction account balances over $8.5 million and up to $45.8 million. Transaction account balances over $45.8 million are subject to a reserve requirement of $1,119,000 plus 10% of the amount over $45.8 million. 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 Federal Reserve Board, 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 Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision. Federal Home Loan Bank System members are also authorized to borrow from the Federal Reserve Board discount window, but Federal Reserve Board regulations require such institutions to exhaust all Federal Home Loan Bank sources before borrowing from the Federal Reserve Board. Prohibitions Against Tying Arrangements. Federal savings associations are subject to prohibitions on certain tying arrangements. A savings association is prohibited, subject to some exceptions, from extending credit 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 credit or services from a competitor of the institution. The Bank Secrecy Act. Westfield Bank and Westfield Financial are subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act, which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, and mandatory transaction reporting obligations. By way of example, the Bank Secrecy Act imposes an affirmative obligation on Westfield Bank to report currency transactions that exceed certain thresholds and to report other transactions determined to be suspicious. 36
Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among financial institutions, 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, the USA PATRIOT Act imposes the following obligations on financial institutions: o 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; o financial institutions must establish and meet minimum standards for customer due diligence, identification and verification; o 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) must establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering through those accounts; o financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and are subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks; and o bank regulators are directed to consider a depository institutions's or holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications. Office of Foreign Asset Control. Westfield Bank and Westfield Financial are, like all United States companies and individuals, prohibited from transacting business with certain individuals and entities named on the Office of Foreign Asset Control's list of Specially Designated Nationals and Blocked Persons. Failure to comply may result in fines and other penalties. The Office of Foreign Asset Control has issued guidance directed at financial institutions in which it asserts that it may, in its discretion, examine institutions determined to be high-risk or to be lacking in their efforts to comply with these prohibitions. 37
Holding Company Regulation Activities Restrictions Applicable to Westfield Financial. Under the Gramm-Leach-Bliley Act, Westfield Financial is prohibited from engaging in non-financial activities. As a result, Westfield Financial's activities are restricted to: o furnishing or performing management services for a savings institution subsidiary of such holding company; o conducting an insurance agency or escrow business; o holding, managing, or liquidating assets owned or acquired from a savings association subsidiary of such company; o holding or managing properties used or occupied by a savings association subsidiary of such company; o acting as trustee under a deed of trust; o any other activity (i) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Director of the Office of Thrift Supervision, 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; o 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 Office of Thrift Supervision; and o any activity permissible for financial holding companies under section 4(k) of the Bank Holding Company Act. Permissible activities which are deemed to be financial in nature or incidental thereto under section 4(k) of the Bank Holding Company Act include: o lending, exchanging, transferring, investing for others, or safeguarding money or securities; o insurance activities or providing and issuing annuities, and acting as principal, agent, or broker; o financial, investment, or economic advisory services; 38
o issuing or selling instruments representing interests in pools of assets that a bank is permitted to hold directly; o underwriting, dealing in, or making a market in securities; o activities previously determined by the Federal Reserve Board to be closely related to banking; o activities that bank holding companies are permitted to engage in outside of the U.S.; and o portfolio investments made by an insurance company. In addition, we cannot be acquired or acquire a company unless the acquirer is engaged solely in financial activities. Restrictions on Acquisition of Control Applicable to Westfield Financial. The Home Owners' Loan Act prohibits all savings and loan holding companies, including Westfield Financial, from acquiring, directly or indirectly: o control (as defined under the Home Owners' Loan Act) of another savings association (or a holding company parent) without prior Office of Thrift Supervision approval; o through merger, consolidation, or purchase of assets, another savings association or a holding company thereof, or acquiring all or substantially all of the assets of such savings association (or a holding company) without prior Office of Thrift Supervision approval; or o control of any depository institution not insured by the Federal Deposit Insurance Corporation (except through a merger with and into the holding company's savings association subsidiary that is approved by the Office of Thrift Supervision). A savings and loan holding company may not acquire as a separate subsidiary a savings association that has a principal office outside of the state where the principal office of its subsidiary savings association is located, except: o in the case of certain emergency acquisitions approved by the Federal Deposit Insurance Corporation; o if such holding company controls a savings savings association subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or 39
o if the laws of the state in which the savings association to be acquired is located specifically authorize a savings association chartered by that state to be acquired by a savings association chartered by the state where the acquiring savings association or savings and loan holding company is located or by a holding company that controls such a state-chartered association. Federal Securities Laws. Westfield Financial's common stock is registered with the Securities and Exchange Commission under Section 12(b) of the Securities Exchange Act of 1934, as amended, and Westfield Financial is subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Securities Exchange Act of 1934, as amended. The Sarbanes-Oxley Act. As a public company, Westfield Financial is subject to the Sarbanes-Oxley Act of 2002, 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 Securities and Exchange Commission includes: o the creation of an independent accounting oversight board; o auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; o additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements; o 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; o 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; o 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; 40
o the requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer; o the requirement that companies disclose whether at least one member of the committee is a "financial expert" (as such term is defined by the Securities and Exchange Commission) and if not, why not; o expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; o a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions; o disclosure of a code of ethics and the requirement of filing of a Form 8-K for a change or waiver of such code; o mandatory disclosure by analysts of potential conflicts of interest; and o a range of enhanced penalties for fraud and other violations. Section 402 of the Sarbanes-Oxley Act prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act). 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 Federal Reserve Act. Quotation on the American Stock Exchange. Westfield Financial's common stock is traded on the American Stock Exchange. In order to maintain such quotation, Westfield Financial is subject to certain corporate governance requirements, including: o a majority of its board must be composed of independent directors; o it is 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 American Stock Exchange rules as set forth in its Company Guide and by the regulations promulgated under the Securities Exchange Act of 1934, as amended; o its nominating committee and compensation committee must also be composed entirely of independent directors; and o each of its audit committee and nominating committee must have a publicly available written charter. 41
ITEM 1A. RISK FACTORS Our loan portfolio includes loans with a higher risk of loss. Westfield Bank originates commercial and industrial loans, commercial real estate loans, consumer loans, and residential mortgage loans primarily within our market area. In recent years, 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 lending and commercial deposit relationships. Commercial and industrial loans, commercial real estate loans, and consumer loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial real estate and commercial and industrial loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit risk than residential real estate for the following reasons: o Commercial and Industrial Loans. Repayment is generally dependent upon the successful operation of the borrower's business. o Commercial Real Estate Loans. Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. o Consumer Loans. Consumer loans are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage or loss. Any downturn in the real estate market or local economy could adversely affect the value of the properties securing the loans or revenues from the borrower's business thereby increasing the risk of non-performing loans. If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease. Our loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We therefore may experience significant loan losses, which could have a material adverse effect on our operating results. Material additions to our allowance for loan losses also would materially decrease our net income, and the charge-off of loans may cause us to increase the allowance. We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. 42
Changes in interest rates could adversely affect our results of operations and financial condition. Our profitability, like that of most financial institutions, depends substantially on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. Increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits, which will result in a decrease of our net interest income. We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Our local economy may affect our future growth possibilities. Our current market area is principally located in Hamden County, Massachusetts. Our future growth opportunities depend on the growth and stability of our regional economy and our ability to expand our market area. A downturn in our local economy may limit funds available for deposit and may negatively affect our borrowers' ability to repay their loans on a timely basis, both of which could have an impact on our profitability. We depend on our executive officers and key personnel to continue the implementation of our long-term business strategy and could be harmed by the loss of their services. We believe that our continued growth and future success will depend in large part upon the skills of our management team. The competition for qualified personnel in the financial services industry is intense, and the loss of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business. We cannot assure you that we will be able to retain our existing key personnel or attract additional qualified personnel. We will have employment agreements with our Chairman and Chief Executive Officer, President and Chief Operating Officer, and Chief Financial Officer, and change of control agreements with several other senior executive officers, and the loss of the services of one or more of our executive officers and key personnel could impair our ability to continue to develop our business strategy. We operate in a highly regulated environment, and changes in laws and regulations to which we are subject may adversely affect our results of operations. Westfield Bank is subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, as its chartering authority, and by the Federal Deposit Insurance Corporation as the insurer of its deposits up to certain limits. In addition, the Office of Thrift Supervision regulates and oversees Westfield Financial and Westfield Mutual Holding Company. We also belong to the Federal Home Loan Bank System and, as a member of such system, we are subject to certain limited regulations promulgated by the Federal Home Loan Bank of Boston. This regulation and supervision limits the activities in which we may engage. The purpose of regulation and supervision is primarily to protect our depositors and borrowers and, in the case of Federal 43
Deposit Insurance Corporation regulation, the Federal Deposit Insurance Corporation's insurance fund. Regulatory authorities have extensive discretion in the exercise of their supervisory and enforcement powers. They may, among other things, impose restrictions on the operation of a banking institution, the classification of assets by such institution and such institution's allowance for loan losses. Regulatory and law enforcement authorities also have wide discretion and extensive enforcement powers under various consumer protection and civil rights laws, including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act, and the Real Estate Settlement Procedures Act. Any change in the laws or regulations applicable to us, or in banking regulators' supervisory policies or examination procedures, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, other state or federal regulators, or the United States Congress could have a material adverse effect on our business, financial condition, results of operations and cash flows. Competition in our primary market area may reduce our ability to attract and retain deposits and originate loans. We operate in a competitive market for both attracting deposits, which is our primary source of funds, and originating loans. Historically, our most direct competition for deposits has come from savings and commercial banks. Our 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. We also face additional competition from internet-based institutions, brokerage firms and insurance companies. Competition for loan originations and deposits may limit our future growth and earnings prospects. ITEM 1B. UNRESOLVED STAFF COMMENTS None. 44
ITEM 2. PROPERTIES Westfield Bank currently conducts its business through its ten banking offices and eight off-site ATMs. As of December 31, 2006, the properties and leasehold improvements owned by us had an aggregate net book value of $12.2 million. Year of Lease or Location Ownership Year Opened License Expiration Main Office: 141 Elm St. Owned 1964 N/A Westfield, MA Branch Offices: 206 Park St. Owned 1957 N/A West Springfield, MA 655 Main St. Owned 1968 N/A Agawam, MA 26 Arnold St. Owned 1976 N/A Westfield, MA 300 Southampton Rd. Owned 1987 N/A Westfield, MA 462 College Highway Owned 1990 N/A Southwick, MA 382 N. Main St. Leased 1997 2012 E. Longmeadow, MA 1500 Main St. Leased 2006 2016 Springfield, MA 1642 Northampton St. Owned 2001 N/A Holyoke, MA 1342 Liberty St. Owned 2001 N/A Springfield, MA ATMs: 337 N. Westfield St. Leased 1988 2013 Feeding Hills, MA 830 Suffield St. Tenant at will 1997 N/A Agawam, MA 516 Carew St. Tenant at will 2002 N/A Springfield, MA 1000 State St. Tenant at will 2003 N/A Springfield, MA 115 West Silver St. Tenant at will 2005 N/A Westfield, MA 788 Memorial Ave. Tenant at will 2006 N/A West Springfield, MA 2620 Westfield St. Tenant at will 2006 N/A West Springfield, MA 98 Southwick Rd. Tenant at will 2006 N/A Westfield, MA 45
ITEM 3. LEGAL PROCEEDINGS Westfield Financial is 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 Westfield Financial's consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Westfield Financial's common stock is listed on the American Stock Exchange under the symbol "WFD." At December 31, 2006, there were 9,728,912 shares of common stock issued and outstanding, and there were approximately 2,979 shareholders of record. Westfield Mutual Holding Company owned 5,607,400 shares, or 57.6% of Westfield Financial's common stock at December 31, 2006. On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007. After the second step conversion, shares of Westfield Financial common stock continued to trade on the American Stock Exchange under the symbol "WFD." As of January 4, 2007, there were 31,923,903 shares of Westfield Financial common stock outstanding. 46
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. Cash Dividends Price Per Share Declared ----------------- --------- For the Year Ended December 31, 2006 High Low ------------------------------------ ---- --- Fourth Quarter ended December 31, 2006 $34.90 $31.59 $0.35 Third Quarter ended September 30, 2006 32.96 27.48 0.15 Second Quarter ended June 30, 2006 29.00 23.20 0.35 First Quarter ended March 31, 2006 25.24 24.00 0.15 Cash Dividends Price Per Share Declared ----------------- --------- For the Year Ended December 31, 2005 High Low ------------------------------------ ---- --- Fourth Quarter ended December 31, 2005 $24.53 $22.12 $0.40 Third Quarter ended September 30, 2005 25.69 23.48 0.10 Second Quarter ended June 30, 2005 25.35 23.15 0.30 First Quarter ended March 31, 2005 25.40 23.20 0.10 A quarterly cash dividend of $0.15 per share was declared on January 24, April 25, July 25, and October 24, 2006 by the Board of Directors. In addition, the Board of Directors declared special cash dividends of $0.20 per share on April 25, and on October 24, 2006. The continued payment of dividends depends 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. Westfield Financial cannot guarantee the payment of dividends or that, if paid, that dividends will not be reduced or eliminated 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. In July 2004, Westfield Financial announced that the Board of Directors had approved a share repurchasing program ("Repurchase Program 2") which authorized the repurchase of up to 502,550 shares. At December 31, 2006 Westfield Financial had 99,862 shares remaining to be purchased under this program. Upon completion of the second step stock offering however, Repurchase Program 2 was eliminated. There were no sales by the Company of unregistered securities during the quarter ended December 31, 2006. 47
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 F-1. <TABLE> <CAPTION> At December 31, --------------------------------------------------------------------- 2006 2005 2004 2003 2002 --------- --------- --------- --------- --------- (In thousands) <S> <C> <C> <C> <C> <C> Selected Financial Condition Data: Total assets $ 996,829 $ 805,095 $ 796,903 $ 795,216 $ 812,980 Loans, net(1) 385,184 378,837 368,601 344,980 357,155 Securities available for sale 41,687 28,321 14,968 25,806 79,842 Securities held to maturity 77,299 73,323 71,298 69,927 45,960 Mortgage-backed securities available for sale 126,942 101,138 73,316 76,177 90,468 Mortgage-backed securities held to maturity 163,093 152,127 175,302 191,683 159,339 Deposits 627,466 623,045 612,621 632,431 656,065 Customer repurchase agreements 17,919 14,441 14,615 12,135 8,724 Federal Home Loan Bank advances 55,000 45,000 45,000 20,000 15,000 Total equity (2) 289,408 115,842 118,051 124,804 126,699 Allowance for loan losses 5,437 5,422 5,277 4,642 4,325 Nonperforming loans 1,028 1,919 2,171 1,768 2,383 <CAPTION> For the Years Ended December 31, --------------------------------------------------------------------- 2006 2005 2004 2003 2002 --------- --------- --------- --------- --------- (In thousands, except per share data) <S> <C> <C> <C> <C> <C> Selected Operating Data: Interest and dividend income $ 42,435 $ 37,306 $ 34,428 $ 35,635 $ 43,013 Interest expense 19,551 13,597 10,913 13,858 18,775 --------- --------- --------- --------- --------- Net interest and dividend income 22,884 23,709 23,515 21,777 24,238 Provision for loan losses 390 465 750 750 934 --------- --------- --------- --------- --------- Net interest and dividend income after provision for loan losses 22,494 23,244 22,765 21,027 23,304 Total noninterest income (loss) 3,073 3,372 3,896 3,074 (362) Total noninterest expense 19,390 18,464 17,776 17,630 16,659 --------- --------- --------- --------- --------- Income before income taxes 6,177 8,152 8,885 6,471 6,283 Income taxes 1,523 1,933 2,562 2,820 2,239 --------- --------- --------- --------- --------- Net income $ 4,654 $ 6,219 $ 6,323 $ 3,651 $ 4,044 ========= ========= ========= ========= ========= Basic earnings per share $ 0.50 $ 0.66 $ 0.65 $ 0.36 $ 0.39 Diluted earnings per share $ 0.49 $ 0.64 $ 0.64 $ 0.36 $ 0.38 Dividends per share paid $ 1.00 $ 0.90 $ 0.30 $ 0.20 $ 0.15 - -------------------- (1) Loans are shown net of deferred loan fees, allowance for loan losses and unadvanced loan funds. (2) Stockholders' equity includes $171.7 million in capital from the net proceeds raised in the stock offering. Westfield Financial completed its second step stock offering on January 3, 2007. Consequently, the proceeds were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts. </TABLE> 48
<TABLE> At or for the Years Ended December 31, ---------------------------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> Selected Financial Ratios and Other Data(1) Performance Ratios: Return on average assets 0.56% 0.77% 0.79% 0.45% 0.51% Return on average equity (2) 3.99 5.27 5.24 2.94 3.14 Average equity to average assets (2) 14.08 14.66 15.14 15.33 16.23 Equity to total assets at end of year (3) 29.03 14.39 14.83 15.69 15.58 Average interest rate spread 2.61 2.89 2.94 2.55 2.54 Net interest margin (4) 3.05 3.24 3.25 2.94 3.18 Average interest-earning assets to average interest- earning liabilities 117.37 119.22 121.47 121.49 125.76 Total noninterest expense to average assets 2.34 2.29 2.24 2.18 2.10 Efficiency ratio (5) 73.63 68.23 66.99 72.13 65.01 Regulatory Capital Ratios: Regulatory Tier 1 leverage capital 29.07 14.48 14.69 15.31 15.65 Tier 1 risk-based capital 54.38 24.54 25.75 28.46 28.77 Total risk-based capital 55.39 25.68 26.90 29.63 29.78 Asset Quality Ratios: Nonperforming loans as a percent of total loans 0.26 0.50 0.58 0.51 0.66 Nonperforming assets as a percent of total assets 0.10 0.24 0.27 0.22 0.29 Allowance for loan losses as a percent of total loans 1.39 1.41 1.41 1.33 1.20 Allowance for loan losses as a percent of nonperforming assets 529 283 243 263 181 Number of: Banking offices 10 10 10 10 10 Full-time equivalent employees 155 142 144 152 146 - -------------------- (1) Asset Quality Ratios and Regulatory Capital Ratios are end of period ratios. (2) Average equity includes $171.7 million in capital from the net proceeds raised in the stock offering. Westfield Financial completed its second step stock offering on January 3, 2007. Consequently, the proceeds were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006 and therefore affected the balance of stockholders' equity for one calendar day. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of the Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts. (3) Stockholders' equity includes $171.7 million in capital from the net proceeds raised in the stock offering. Westfield Financial completed its second step stock offering on January 3, 2007. Consequently, the proceeds were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts. (4) Net interest margin represents tax equivalent net interest and dividend income as a percentage of average interest earning assets. (5) The efficiency ratio represents the ratio of operating expenses divided by the sum of net interest and dividend income and noninterest income less gain on sale of securities and sale of fixed assets. </TABLE> 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. 49
Westfield Financial has adopted a growth-oriented strategy that has focused on increased emphasis on commercial lending. Westfield Financial's strategy also calls for increasing deposit relationships and broadening our product lines and services. Westfield Financial believes that this business strategy is best for its long term success and viability, and complements our existing commitment to high quality customer service. In connection with its overall growth strategy, Westfield Bank seeks to: o continue to grow its commercial and industrial and commercial real estate loan portfolio by targeting the commercial businesses in its primary market area and in northern Connecticut as a means to increase the yield on and diversify its loan portfolio and build transactional deposit account relationships; o focus on expanding its retail banking franchise, and increasing the number of households served within its market area; and o 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, 2006 in the context of this strategy. o Net income for the year ended December 31, 2006 was $4.7 million, or $0.49 per diluted share, compared to $6.2 million, or $0.64 per diluted share for the year ended December 31, 2005. o Net interest and dividend income decreased $825,000 to $22.9 million for the year ended December 31, 2006, compared to $23.7 million for the same period in 2005. The net interest margin was 3.05% for the year ended December 31, 2006 and 3.24% for 2005. The yield on earning assets, on a fully taxable equivalent basis, increased 53 basis points to 5.56% for the year ended December 31, 2006, compared to the same period in 2005. The cost of paying liabilities, however, increased 81 basis points to 2.95% for the year ended December 31, 2006, compared to the same period in 2005. o Total assets increased $191.7 million to $996.8 million at December 31, 2006 from $805.1 million at December 31, 2005. Westfield Financial completed its second step stock offering with the issuance of 18,400,000 shares on January 3, 2007. Consequently, net proceeds, in the amount of $171.7 million, were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. o Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts. 50
o Cash and cash equivalents increased $128.0 million, to $154.5 million at December 31, 2006 from $26.5 million at December 31, 2005. The increase in cash and cash equivalents is the result of funds raised in the stock offering. o Commercial real estate and commercial and industrial loans increased $5.2 million to $274.8 million at December 31, 2006. Westfield Bank's strategic plan emphasizes commercial lending. The success of Westfield Bank's commercial lending is primarily dependent on the local and national economy, along with competition for commercial loans. o Residential real estate loans increased $2.6 million to $109.5 million at December 31, 2006 from $106.9 million at December 31, 2005. This increase is primarily attributable to a $6.1 million increase in fixed rate home equity loans. Apart from home equity 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 by reducing the amount of long-term fixed rate residential mortgages held in Westfield Bank's loan portfolio. o Securities, including mortgage-backed securities increased $54.1 million to $409.0 million at December 31, 2006, compared to $354.9 million at December 31, 2005. The largest segment of the securities portfolio is mortgage-backed securities, the majority of which are adjustable rate instruments. Management feels that investing funds in adjustable rate mortgage-backed securities has helped provide cash flow and in addition, helped reduce interest rate risk. o Total deposits increased $4.5 million to $627.5 million at December 31, 2006 from $623.0 million at December 31, 2005. Time deposits increased $39.0 million to $374.0 million at December 31, 2006, while regular savings and money market accounts decreased $43.1 million. As the rates paid on term deposits increased throughout 2006, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits. Checking accounts increased $8.5 million to $122.8 million at December 31, 2006. The increase is primarily due to a checking account product which pays higher rates to customers who maintain large balances. o Noninterest income decreased $280,000 to $3.1 million for the year ended December 31, 2006 compared to $3.4 million for the same period in 2005. The 2006 results included a net loss of $378,000 on the sale of fixed assets, which was primarily the result of the sale of a building that housed a former Westfield Bank branch. 51
o Nonperforming loans were $1.0 million, or 0.26%, of total loans at December 31, 2006, compared to nonperforming loans of $1.9 million, or 0.50%, of total loans at December 31, 2005. The decrease in nonperforming loans was primarily the result of a $1.4 million payment in full received on a single commercial real estate relationship. Charge-offs decreased by $28,000 to $584,000 for the year ended December 31, 2006 from $612,000 for the year ended December 31, 2005. o The allowance for loan losses was $5.4 million at both December 31, 2006 and 2005. This represents 1.39% of total loans at December 31, 2006 and 1.41% of total loans at December 31, 2005. At these levels, the allowance for loan losses as a percentage of nonperforming loans was 529% at December 31, 2006 and 283% at December 31, 2005. o Stockholder's equity at December 31, 2006 and December 31, 2005 was $289.4 million and $115.8 million, respectively, which represented 29.0% of total assets as of December 31, 2006 and 14.4% of total assets as of December 31, 2005. The change is primarily attributable to net proceeds of $171.7 million from the Company's second step stock offering. 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 commercial real estate loans, commercial and industrial loans, residential real estate loans, consumer loans, mortgage-backed securities and investment securities. Interest-bearing liabilities consist primarily of certificates of deposit and money market account, NOW account and savings 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. 52
Critical Accounting Policies. Westfield Financial's accounting policies are disclosed in Note 1 to the Consolidated Financial Statements. Given Westfield Financial's current business strategy and asset/liability structure, the more critical policies are accounting for nonperforming loans, the allowance for loan losses and provision for loan losses, 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 informational 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 Westfield Financial's Board of Directors. On a quarterly basis, Westfield Financial 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 Westfield Financial 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, that 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. Westfield Financial 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. 53
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. The process of evaluating the loan portfolio, classifying loans and determining the allowance and provision is described in detail in "Business of Westfield Financial and Westfield Bank - Lending Activities - Allowance for Loan Losses." Westfield Financial's methodology for assessing the allocation 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 allocation of the allowance is also reviewed by management based upon its evaluation of then-existing economic and business conditions affecting Westfield Financial's key lending areas 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 table sets forth information relating to Westfield Financial's condition and net interest and dividend income for the years ended December 31, 2006, 2005 and 2004 and reflect the average yield on assets and average cost of liabilities for the years 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 years shown. Average balances were derived from actual daily balances over the years 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. The interest earned on tax exempt assets is adjusted to a tax equivalent basis to recognize the income tax savings which facilitates comparison between taxable and tax exempt assets. 54
<TABLE> <CAPTION> For the Year Ended December 31, -------------------------------------------------------------------------------------------- 2006 2005 2004 ----------------------------- ----------------------------- ---------------------------- Average Average Average Average Yield/ Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost Balance Interest Cost ------- -------- ------- ------- -------- ------- ------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ASSETS: Interest-earning assets: Short term investments(1) $ 18,658 $ 872 4.67% $ 30,141 $ 932 3.09% $ 20,866 $ 290 1.39% Securities 372,519 16,764 4.50 344,618 14,102 4.09 361,253 13,802 3.82 Loans(2) 386,039 25,586 6.63 383,436 23,136 6.03 366,677 21,198 5.78 -------- ------- -------- ------- -------- ------- Total interest-earning assets 777,216 43,222 5.56 758,195 38,170 5.03 748,796 35,290 4.71 ------- ------- ------- Total noninterest-earning assets 50,535 47,226 46,135 -------- -------- -------- Total assets $827,751 $805,421 $794,931 ======== ======== ======== LIABILITIES AND EQUITY: Interest-bearing liabilities: NOW accounts 73,256 908 1.24 60,839 325 0.53 48,004 249 0.52 Savings accounts 45,241 226 0.50 43,250 217 0.50 47,728 234 0.49 Money market deposit accounts 109,710 1,684 1.53 144,629 2,117 1.46 152,855 1,419 0.93 Time certificates of deposit 368,901 14,450 3.92 325,050 9,154 2.82 317,563 7,723 2.43 -------- ------- -------- ------- -------- ------- Total interest-bearing deposits 597,108 17,268 573,768 11,813 566,150 9,625 Customer repurchase agreements and other borrowings 65,062 2,283 3.51 62,209 1,784 2.87 50,309 1,288 2.56 -------- ------- -------- ------- -------- ------- Interest-bearing liabilities 662,170 19,551 2.95 635,977 13,597 2.14 616,459 10,913 1.77 -------- ------- -------- ------- -------- ------- Noninterest-bearing deposits 41,134 44,590 52,631 Other noninterest-bearing liabilities 7,927 6,819 5,488 -------- -------- -------- Total noninterest-bearing liabilities 49,061 51,409 58,119 -------- -------- -------- Total liabilities 711,231 687,386 674,578 Total equity 116,520 118,035 120,353 -------- -------- -------- Total liabilities and equity $827,751 $805,421 $794,931 ======== ======== ======== Net interest and dividend income $23,671 $24,573 $24,377 ======= ======= ======= Net interest rate spread(3) 2.61 2.89 2.94 Net interest margin(4) 3.05% 3.24% 3.25% Ratio of average interest-earning assets to average interest-bearing liabilities 117.4x 119.2x 121.5x - -------------------- (1) Short term investments include Federal funds sold. (2) Loans, including non-accrual loans, are net of deferred loan origination costs (fees), and unadvanced funds. (3) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (4) Net interest margin represents tax equivalent net interest and dividend income as a percentage of average interest earning assets. </TABLE> 55
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 Westfield Financial's 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. <TABLE> <CAPTION> Year Ended December 31, 2006 Year Ended December 31, 2005 Compared to Year Ended Compared to Year Ended December 31, 2005 December 31, 2004 Increase/(Decrease) Increase/(Decrease) ------------------------------ ----------------------------------- Due to Due to ------------------ ------------------- Volume Rate Net Volume Rate Net ----------------- ------- ------------------- ------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Interest-earning assets: Short term investments $ (355) $ 295 $ (60) $ 129 $ 513 $ 642 Investment securities 1,142 1,520 2,662 (636) 936 300 Loans 157 2,293 2,450 969 969 1,938 ------- ------- ------- ------- ------- ------- Total interest-earning assets 944 4,108 5,052 462 2,418 2,880 ------- ------- ------- ------- ------- ------- Interest-bearing liabilities: NOW accounts 66 517 583 67 9 76 Savings accounts 10 (1) 9 (22) 5 (17) Money market deposit accounts (511) 78 (433) (76) 774 698 Time certificates of deposit 1,235 4,061 5,296 182 1,249 1,431 Customer repurchase agreements and other borrowings 82 417 499 305 191 496 ------- ------- ------- ------- ------- ------- Total interest-bearing liabilities 882 5,072 5,954 456 2,228 2,684 ------- ------- ------- ------- ------- ------- Change in net interest and dividend income $ 62 $ (964) $ (902) $ 6 $ 190 $ 196 ======= ======= ======= ======= ======= ======= </TABLE> 56
Comparison of Financial Condition at December 31, 2006 and December 31, 2005 Total assets increased $191.7 million to $996.8 million at December 31, 2006 from $805.1 million at December 31, 2005. Westfield Financial completed its second step stock offering with the issuance of 18,400,000 shares on January 3, 2007. Consequently, net proceeds, in the amount of $171.7 million, were recognized by Westfield Financial and reported in its balance sheet as December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and the paid-in capital accounts. Cash and cash equivalents increased $128.0 million, to $154.5 million at December 31, 2006 from $26.5 million at December 31, 2005. The increase in cash and cash equivalents is the result of funds raised in the stock offering. Net loans during this period increased by $6.4 million to $385.2 million at December 31, 2006, from $378.8 million at December 31, 2005. Commercial real estate loans increased $5.0 million to $174.5 million at December 31, 2006 from $169.5 million at December 31, 2005. Commercial and industrial loans increased $218,000 to $100.2 million at December 31, 2006 from $100.0 million at December 31, 2005. 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 health of the local and national economy and competition for commercial loans. Residential real estate loans increased $2.6 million to $109.9 million at December 31, 2006 from $107.3 million at December 31, 2005. This increase is primarily attributable to a $6.1 million increase in fixed rate home equity loans. Westfield Bank refers its residential real estate borrowers to a third party mortgage company for all real estate loans other than home equity loans. As a result, 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 by reducing the amount of long-term fixed rate residential mortgages held in Westfield Bank's loan portfolio. Securities, including mortgage-backed securities increased $54.1 million to $409.0 million at December 31, 2006 as compared to $354.9 million at December 31, 2005. The largest segment of the securities portfolio is mortgage-backed securities, the majority of which are adjustable rate instruments. Management feels that investing funds in adjustable rate mortgage backed securities has helped provide cash flow and in addition, helped reduce interest rate risk. Total deposits increased $4.5 million to $627.5 million at December 31, 2006 from $623.0 million at December 31, 2005. Time deposits increased $39.0 million to $374.0 million at December 31, 2006, while regular savings and money market accounts decreased $43.1 million. As the rates paid on term deposits increased throughout 2006, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits. Checking accounts increased $8.5 million to $122.8 million at December 31, 2006. The increase is primarily due to a new checking account product which pays higher rates to customers who maintain large balances. 57
Federal Home Loan Bank borrowings increased $10.0 million to $55.0 million at December 31, 2006 from $45.0 million at December 31, 2005. Customer repurchase agreements increased $3.5 million to $17.9 million at December 31, 2006 from $14.4 million at December 31, 2005. 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 government-sponsored enterprises. 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 in customer repurchase agreements is consistent with Westfield Bank's strategy to emphasize commercial customer relationships. Stockholder's equity at December 31, 2006 and December 31, 2005 was $289.4 million and $115.8 million, respectively, which represented 29.0% of total assets as of December 31, 2006 and 14.4% of total assets as of December 31, 2005. The change is primarily attributable to net proceeds of $171.7 million from the Company's second step stock offering. Comparison of Operating Results for Years Ended December 31, 2006 and 2005 General. Net income for the year ended December 31, 2006 was $4.7 million, or $0.49 per diluted share, compared to $6.2 million, or $0.64 per diluted share for the year ended December 31, 2005. Interest and Dividend Income. Total interest and dividend income increased $5.1 million, or 13.7%, to $42.4 million for the year ended December 31, 2006, compared to $37.3 million for the same period in 2005. The increase in interest income was primarily the result in an increase in the yield on earning assets. The average yield on earning assets increased 53 basis points to 5.53% for the year ended December 31, 2006 compared to 5.03% for the same period in 2005. The increase in yield on earning assets was primarily the result of the rising interest rate environment. Interest and dividends on securities was $16.1 million for the years ended December 31, 2006 and $13.4 million for the same period in 2005. The average balance on securities increased $27.9 million to $372.5 million at December 31, 2006 from $344.6 million at December 31, 2005. In addition, the fully taxable equivalent yield on securities increased from 4.09% for the year 2005 to 4.50% for the same period in 2006. As lower yielding investments purchased in a higher rate environment matured, were called, or paid down in 2006, 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 income from commercial real estate loans and commercial and industrial loans increased $2.8 million for the year ended December 31, 2006 from the year ended December 31, 2005. In accordance with Westfield Bank's strategic plan, the average balance of commercial real estate loans and commercial and industrial loans increased $9.9 million to $269.2 million for the year ended December 31, 2006, compared to $259.3 million for the same period in 2005. 58
Interest income from residential real estate loans decreased $69,000 to $6.4 million for the year ended December 31, 2006, compared to $6.5 million for the same period in 2005. The average balance of residential real estate loans decreased $4.6 million to $110.6 million for the year ended December 31, 2006 from $115.2 million for the year ended December 31, 2005 due to our residential real estate loan program with a third party mortgage company. In addition, interest on consumer loans decreased $221,000 to $410,000 for the year ended December 31, 2006, compared to $631,000 for the same period in 2005. This was primarily the result of a decrease in the average balance of consumer loans from $9.0 million for 2005 to $6.3 million for 2006 due to management's decision to discontinue indirect automobile loan originations in 2003 and allow the portfolio to paydown. Interest Expense. Interest expense for the year ended December 31, 2006 increased $6.0 million to $19.6 million from the comparable 2005 period. This was attributable to an increase in the average cost of interest-bearing liabilities increasing 81 basis points to 2.95% for the year ended December 31, 2006 from 2.14% for the same period in 2005. In addition, the average balance of total interest-bearing liabilities increased $26.2 million to $662.2 million for the year ended December 31, 2006 from $636.0 million for the same period in 2005. As the rates paid on term deposits increased throughout 2006, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits. Net Interest and Dividend Income. Net interest and dividend income decreased $825,000 to $22.9 million for the year ended December 31, 2006 as compared to $23.7 million for the same period in 2005. The net interest margin, on a fully taxable equivalent basis, was 3.05%, for the twelve months ended December 31, 2006 compared to 3.24% for the twelve months ended December 31, 2005. The decrease in the net interest margin was primarily the result of higher funding costs. The average cost of interest-bearing liabilities increased 81 basis points to 2.95% for the twelve months ended December 31, 2006 from 2.14% for same period in 2005. The yield on interest-earning assets, on a fully taxable equivalent basis, increased 53 basis points to 5.56% for the twelve months ended December 31, 2006 from 5.03% for same period in 2005. The increase in the average cost of interest-bearing liabilities is primarily due to an increase in the cost of time deposits resulting from the rising rate environment. Provision for Loan Losses. The provision for loan losses is 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. 59
The amount that Westfield Bank allocated to the provision for loan losses during the year ended December 31, 2006 was based upon the changes that occurred in the loan portfolio during that same period. The changes in the loan portfolio, described in detail below, include partially replenishing the net charge offs for the same period, tempered by a reduction in nonperforming loans and a net decrease in the loan portfolio. After evaluating these factors, Westfield Bank provided $390,000 for loan losses for the year ended December 31, 2006, compared to $465,000 for the same period in 2005. The allowance was $5.4 million at both December 31, 2006 and December 31, 2005. The allowance for loan losses was 1.39% of total loans at December 31, 2006 and 1.41% at December 31, 2005. At December 31, 2006, commercial real estate loans and commercial and industrial loans increased $5.2 million as compared to December 31, 2005. Commercial real estate loans and commercial and industrial loans comprised 70.4% of Westfield Bank's loan portfolio as of December 31, 2006, compared to 70.2% as of December 31, 2005. Westfield Bank considers these types of loans to contain more credit risk and market risk than conventional residential real estate mortgages, which increased by $2.6 million during the year ended December 31, 2006. Consumer loans decreased $1.5 million from December 31, 2005 and remained stable at $5.8 million as of December 31, 2006. Nonperforming loans were $1.0 million at December 31, 2006 and $1.9 million at December 31, 2005. Net charge offs were $375,000 for the year ended December 31, 2006. This was comprised of charge-offs of $584,000 for the year ended December 31, 2006, partially offset by recoveries of $209,000 for the same period. 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. Noninterest Income. Noninterest income decreased $299,000 to $3.1 million for the year ended December 31, 2006 compared to $3.4 million for the same period in 2005. The 2006 results included a net loss of $378,000 on the sale of fixed assets, which was primarily the result of the sale of a building that housed a former Westfield Bank branch. Fees received from the third party mortgage company were $96,000 for the year ended December 31, 2006, compared to $107,000 for the same period in 2005. 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. Income from bank-owned life insurance increased $43,000 to $801,000 for the year ended December 31, 2006 compared to the same period in 2005. This was primarily the result of a $1.5 million increase in the average balance of bank-owned life insurance in 2006 compared to 2005. 60
Noninterest Expense. Noninterest expense for the twelve months ended December 31, 2006 was $19.4 million compared to $18.5 million for the same period in 2005. Salaries and benefits increased $830,000 for the year ended December 31, 2006, compared to the same period in 2005. This was primarily the result of an increase in salary expense of $385,000 related to hiring additional personnel and normal salary increases. In addition, Westfield Financial recorded expenses of $293,000 related to stock options for the year ended December 31, 2006 compared to none for the same period in 2005. The requirement to expense stock-based compensation related to stock options became effective for Westfield Financial for the fiscal year beginning on January 1, 2006. Income Taxes. Income taxes decreased $410,000 to $1.5 million in 2006 primarily as a result of a decrease in income before income taxes. The effective tax rate was 24.7% in 2006 compared to 23.7% for 2005. The effective tax rate for 2006 reflects the utilization of Elm Street Securities Corporation, a Massachusetts corporation, and in 2005, also includes Westfield Securities Corporation, a Massachusetts corporation. Westfield Securities Corporation was dissolved in the third quarter of 2005. Comparison of Financial Condition at December 31, 2005 and December 31, 2004 Consolidated assets increased $8.2 million, or 1.0%, to $805.1 million at December 31, 2005 from $796.9 million at December 31, 2004. Cash and cash equivalents decreased $24.6 million to $26.4 million at December 31, 2005 from $51.0 million at December 31, 2004. This was primarily the result of a $26.9 million decrease in Federal funds sold. Net loans during this period increased by $10.2 million, or 2.7%, to $378.8 million at December 31, 2005, from $368.6 million at December 31, 2004. Commercial real estate loans increased $25.2 million, or 17.5%, to $169.5 million at December 31, 2005 from $144.3 million at December 31, 2004. Commercial and industrial loans increased $5.3 million, or 5.6%, to $100.1 million at December 31, 2005 from $94.8 million at December 31, 2004. 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 health of the local and national economy. Residential real estate loans decreased $15.9 million to $107.3 million at December 31, 2005 from $123.2 million at December 31, 2004. 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 by reducing the amount of long-term fixed rate residential mortgages held in Westfield Bank's loan portfolio. 61
Securities, including mortgage-backed securities increased $20.0 million to $354.9 million at December 31, 2005 as compared to $334.9 million at December 31, 2004. The largest segment of the securities portfolio is mortgage-backed securities, the majority of which are adjustable rate instruments. Management feels that investing funds in adjustable rate mortgage backed securities has helped provide cash flow and in addition, helped reduce interest rate risk. Total deposits increased $10.4 million to $623.0 million December 31, 2005 from $612.6 million at December 31, 2004. Time deposits increased $21.9 million to $335.0 million at December 31, 2005, while regular savings and money market accounts decreased $20.6 million. As the rates paid on term deposits increased throughout 2005, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits. Demand deposits and NOW accounts increased $9.0 million to $114.3 million at December 21, 2005. The increase is primarily due to a new checking account product which pays higher rates to customers who maintain large balances. Federal Home Loan Bank borrowings were $45.0 million at both December 31, 2005 and December 31, 2004. Customer repurchase agreements decreased $174,000 to $14.4 million at December 31, 2005. Stockholders' equity at December 31, 2005 and December 31, 2004 was $115.8 million and $118.1 million, respectively, representing 14.4% and 14.8% of total assets. The change is comprised of net income of $6.2 million for the year ended December 31, 2005, the net repurchase of 199,755 shares of common stock for $4.9 million, and the declaration by the Board of Directors of four quarterly and two special dividends aggregating $3.6 million. Comparison of Operating Results for Years Ended December 31, 2005 and 2004 General. Net income for the year ended December 31, 2005 and $6.2 million, or $0.64 per diluted share, compared to $6.3 million, or $0.64 per diluted share for the year ended December 31, 2004. The 2004 results included net gains from the sale of securities of $877,000 for the year ended December 31, 2004. This was primarily the result of the Company selling its common stock portfolio in 2004. Net gains from sales of securities for the year ended December 31, 2005 were $19,000. Interest and Dividend Income. Total interest and dividend income increased $2.9 million or 8.4% to $37.3 million for the year ended December 31, 2005, compared to $34.4 million for the same period in 2004. The increase in interest income was primarily the result of an increase in the yield on earning assets. The average yield on earning assets increased 32 basis points to 5.03% for the year ended December 31, 2005 compared to 4.71% for the same period in 2005. The increase in yield on earning assets was primarily the result of the rising interest rate environment. 62
Interest and dividends on securities was $13.6 million for the years ended December 31, 2005 and $13.2 million for the same period in 2004. The average yield on securities increased from 3.82% for the year 2004 to 4.09% for the same period in 2005. This change was offset by a $16.7 million decrease in the average balance of securities from $361.3 million for 2004 to $344.6 million for 2005. Market interest rates increased during 2005. As lower yielding investments purchased in a higher rate environment matured, were called, or paid down in 2005, 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 income from commercial real estate loans and commercial and industrial loans increased $2.9 million for the year ended December 31, 2005 from the year ended December 31, 2004. In accordance with Westfield Bank's strategic plan, the average balance of commercial real estate loans and commercial industrial loans increased $28.2 million to $259.3 million for the year ended December 31, 2005, compared to $231.1 million for the same period in 2004. Interest income from residential real estate loans decreased $336,000 to $6.5 million for the year ended December 31, 2005, compared to the same period in 2004. The average balance of residential real estate loans decreased $4.4 million for the year ended December 31, 2005 from $119.6 million for the year ended December 31, 2004 due to our residential real estate loan program with a third party mortgage company. In addition, interest on consumer loans decreased $581,000 to $631,000 for the year ended December 31, 2005, compared to $1.2 million for the same period in 2004. This was primarily the result of a decrease in average balance of consumer loans from $16.0 million for 2004 to $9.0 million for 2005 due to management's decision to discontinue indirect automobile loan originations in 2003 and allow the portfolio to paydown. Interest Expense. Interest expense for the year ended December 31, 2005 increased $2.7 million to $13.6 million from the comparable 2004 period. This was attributable to an increase in the average cost of interest-bearing liabilities increasing 37 basis points to 2.14% for the year ended December 31, 2005 from 1.77% for the same period in 2004. In addition, the average balance of total interest-bearing liabilities increased $19.5 million to $636.0 million for the year ended December 31, 2005 from $616.5 million for the same period in 2004. As the rates paid on term deposits increased throughout 2005, some customers have shifted funds out of lower yielding core deposits, and into higher yielding term deposits. Net Interest and Dividend Income. Net interest and dividend income increased $194,000 to $23.7 million for the twelve months ended December 31, 2005 as compared to $23.5 million for the same period in 2004. The net interest margin was 3.24% for the twelve months ended December 31, 2005 and 3.25% for the twelve months ended December 31, 2004. The increase in income from interest-earning assets was mostly offset by an increase in interest expense from interest-bearing liabilities. The average cost of interest-bearing liabilities increased 37 basis points to 2.14% for the twelve months ended December 31, 2005 from 1.77% for same period in 2004. The yield on interest-earning assets increased 32 basis points to 5.03% for the twelve months ended December 31, 2005 from 4.71% for same period in 2004. 63
Provision for Loan Losses. The amount that Westfield Bank allocated to the provision for loan losses during the year ended December 31, 2005 was based upon the changes that occurred in the loan portfolio during that same period. The changes in the loan portfolio, described in detail below, include growth of $30.5 million in the commercial real estate and commercial and industrial loan portfolio and replenishing the net charge offs for the same period. After evaluating these factors, Westfield Bank provided $465,000 for loan losses for the year ended December 31, 2005, compared to $750,000 for the same period in 2004. The allowance was $5.4 million at December 31, 2005 and $5.3 million at December 31, 2004. The allowance for loan losses was 1.41% of total loans at both December 31, 2005 and 2004. At December 31, 2005, commercial real estate loans and commercial and industrial loans increased $30.5 million compared to December 31, 2004. Commercial real estate loans and commercial and industrial loans comprised 70.2% of Westfield Bank's loan portfolio as of December 31, 2005 compared to 64.0% as of December 31, 2004. Westfield Bank considers these types of loans to contain more credit risk and market risk than conventional residential real estate mortgages, which decreased by $15.9 million during the year ended December 31, 2005. Consumer loans also decreased $4.3 million to $7.3 million at December 31, 2005. Nonperforming loans were $1.9 million December 31, 2005 and $2.2 million at December 31, 2004. Net charge-offs were $320,000 for the year ended December 31, 2005. This was comprised of charge-offs of $612,000 for the year December 31, 2005, partially offset by recoveries of $292,000 for the same period. Noninterest Income. Noninterest income decreased $524,000 to $3.4 million in 2005 from $3.9 million for 2004. Net gains from sales and writedowns of securities were $19,000 for the year ended December 31, 2005, compared to $877,000 for the same period in 2004. This is primarily the result of Westfield Financial selling its common stock portfolio in 2004 to comply with Office of Thrift Supervision regulations. Income on bank-owned life insurance was $758,000 for the period ended December 31, 2005, compared to $741,000 for the same period in 2004. Fees received from the third party mortgage company were $107,000 for the year ended December 31, 2005, compared to $100,000 for the same period in 2004. Checking account processing fees increased $148,000 for the twelve months ended December 31, 2005, compared to the same period in 2004. This was a result of Westfield Bank's overdraft privilege program offered to checking account customers. The overdraft privilege program commenced in the second quarter of 2004, therefore the 2004 results reflect only a partial year under the program. In 2005, the overdraft privilege program was in effect for the entire year. 64
Noninterest Expense. Noninterest expense for the twelve months ended December 31, 2005 was $18.5 million as compared to $17.8 million for the same period in 2004. Salaries and benefits increased $402,000 for the year ended December 31, 2005, compared to the same period in 2004. This was primarily the result of normal increases in salaries and health care costs along with an increase in stock-based benefit plan expenses of $176,000. Advertising and marketing expenses increased $195,000 for the twelve months ended December 31, 2005, compared to the same period in 2004. This was the result of management's decision to increase spending on advertising and marketing to promote the Bank's products and services. Income Taxes. Income taxes decreased $629,000 to $1.9 million in 2005. The effective tax rate was 23.7% in 2005 compared to 28.8% for 2004. This was primarily the result of an increase in income from tax-exempt assets. The effective tax rates for 2005 and 2004 also reflect the utilization of Westfield Securities Corporation (dissolved in the third quarter of 2005), and Elm Street Securities Corporation, both Massachusetts qualified securities corporations. Liquidity and Capital Resources The term "liquidity" refers to Westfield Financial's ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals and operating expenses. Westfield Financial's 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 were $55.0 million at December 31, 2006 and $45.0 million at December 31, 2005. At December 31, 2006, Westfield Bank's maximum borrowing capacity from the Federal Home Loan Bank was approximately $25.0 million, net of any outstanding borrowings. Westfield Bank has the ability to increase its borrowing capacity with the Federal Home Loan Bank by pledging investment securities or loans. In addition, Westfield Bank may enter into reverse repurchase agreements with approved broker-dealers. Reverse repurchase agreements are agreements that allow Westfield Bank to borrow money using its 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, 2006 follows: 65
<TABLE> <CAPTION> After 1 Year After 3 Years Within but Within but Within After 1 Year 3 Years 5 Years 5 Years Total ------ ------- ------- ------- ----- (In thousands) <S> <C> <C> <C> <C> <C> Lease Obligations Operating lease obligations $ 366 $ 727 $ 735 $ 7,037 $ 8,865 --------- --------- --------- --------- --------- Borrowings Federal Home Loan Bank $ 30,000 $ 20,000 $ -- $ 5,000 $ 55,000 --------- --------- --------- --------- --------- Credit Commitments Available lines of credit $ 45,235 $ -- $ -- $ 13,040 $ 58,275 Other loan commitments 25,656 12,997 -- -- 38,653 Letters of Credits 5,571 -- -- 588 6,159 --------- --------- --------- --------- --------- Total credit commitments 76,462 12,997 -- 13,628 103,087 --------- --------- --------- --------- --------- Total $ 106,828 $ 33,724 $ 735 $ 25,665 $ 166,952 ========= ========= ========= ========= ========= </TABLE> 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. Westfield Financial's 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, 2006, Westfield Bank originated loans of approximately $111.0 million, and during the comparable period of 2005, Westfield Bank originated loans of approximately $118.1 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 $138.8 million for the year ended December 31, 2006 and $125.9 million for the year ended December 31, 2005. At December 31, 2006, Westfield Bank had loan commitments to borrowers of approximately $44.8 million, and available home equity and unadvanced lines of credit of approximately $58.3 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 increased $4.4 million during the year ended December 31, 2006 and increased $10.4 million during the year ended December 31, 2005. Time deposit accounts scheduled to mature within one year were $270.0 million at December 31, 2006. 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. 66
At December 31, 2006, Westfield Bank exceeded each of the applicable regulatory capital requirements. Westfield Bank's tier 1 leverage capital was $113.9 million, or 11.9% to adjusted total assets. Westfield Bank's tier 1 capital to risk weighted assets was $113.9 million or 21.7%. Westfield Bank had total capital to risk weighted assets of $119.3 million or 22.7%. Westfield Financial does not anticipate any material capital expenditures during calendar year 2007, 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 Arrangements Westfield Financial does 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, Westfield Financial's 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 Westfield Financial's 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. Westfield Financial seeks 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 $30.2 million or 20.9% since December 31, 2004. Commercial and industrial loans have grown $5.5 million or 5.8% since December 31, 2004. Consumer loans decreased $5.7 million, or 49.5%, since December 31, 2004. Management curtailed its indirect lending beginning in fiscal year 2000 and in the fourth quarter of 2003 the program was discontinued. Management believes that Westfield Bank's increased emphasis on commercial lending has allowed it to diversify its loan portfolio while continuing to meet the needs of the businesses and individuals that it serves. 67
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: o maintaining the diversity of Westfield Bank's 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 o 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. Westfield Financial monitors interest rate sensitivity so that it can adjust its 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 and 300 and decrease 100, 200 and 300 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. 68
The tables below set forth as of December 31, 2006 the estimated changes in net interest and dividend income that would result from incremental changes in interest rates over the applicable twelve-month period. For the Twelve Months Ending December 31, 2007 (Dollars in thousands) ------------------------------------------------------ Changes in Net Interest Interest Rates (Basis and Dividend Points) Income % Change --------------------- ------------ -------- 300 33,290 2.7% 200 33,153 2.3% 100 32,872 1.4% 0 32,413 0.0% -100 32,245 - 0.5% -200 32,909 1.5% -300 31,850 -1.7% Market rates were assumed to increase 100, 200 and 300 basis points and decrease 100, 200 and 300 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 100 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. 69
The income simulation analysis was based upon a variety of assumptions. These assumptions include but are not limited to balance sheet growth, asset mix, prepayment speeds, the timing and level of interest rates, and the shape of the yield curve. As market conditions vary from the assumptions in the income simulation analysis, actual results will differ. As a result, the income simulation analysis does not serve as a forecast of net interest income, nor do the calculations represent any actions that management may undertake in response to changes in interest rates. Recent Accounting Pronouncements On January 1, 2006 Westfield Financial adopted SFAS 123(R), Share-Based Payment ("SFAS 123(R)" or the "Statement"), which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The effect of SFAS 123(R) is that entities are required 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. SFAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. Westfield Financial uses the binomial model for its adoption of the Statement. Westfield Financial adopted SFAS 123(R) on January 1, 2006 using the "modified prospective" method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS 123(R). Also under this method, expense is recognized for awards that were granted prior to January 1, 2006 but vest after January 1, 2006, based on the fair value determined at the grant date under SFAS 123, Accounting for Stock-Based Compensation (SFAS 123). Prior to the adoption of SFAS 123(R), Westfield Financial accounted for stock compensation under the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations. Accordingly, Westfield Financial previously recognized no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant. In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets," which amends FASB Statement No. 140. This statement requires that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this Statement permits an entity to choose either of the following subsequent measurement methods: (1) amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss, or (2) report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur (the "fair value method"). This Statement also requires additional disclosures for all separately recognized servicing rights and is effective for new transactions occurring and for subsequent measurement at the beginning of Westfield Financial's 2007 calendar year. As management does not plan to adopt the fair value method of accounting for its servicing rights, this Statement is not expected to have a material impact on Westfield Financial's consolidated financial statements. 70
In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is not expected to have a material impact on Westfield Financial's consolidated financial statements. In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is effective for Westfield Financial on January 1, 2008 and is not expected to have a material impact on Westfield Financial's consolidated financial statements. In September 2006, FASB issued Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132 (R)." This Statement improves financial reporting by requiring employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income or a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement is effective for Westfield Financial for the year ended December 31, 2006 and is not expected to have a material impact on Westfield Financial's consolidated financial statements. In September 2006, the FASB ratified EITF 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements." This issue addresses accounting for split-dollar life insurance arrangements whereby the employer purchases a policy to insure the life of an employee, and separately enters into an agreement to split the policy benefits between the employer and the employee. This EITF states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits. Under EITF 06-4, the obligation is not settled upon entering into an insurance arrangement. Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. Westfield Financial is in the process of evaluating the potential impacts of adopting EITF 06-4 on its consolidated financial statements. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 108. SAB No. 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a 71
company's balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. SAB 108 is applicable to all financial statements issued by Westfield Financial for the year ended December 31, 2006. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). This Statement provides companies with an option to report selected financial assets and liabilities at fair value. The Standard's objective is to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 also established presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. This Statement is effective as of the beginning of an entity's first fiscal year beginning after November 15, 2007. Early adoption is permitted if the Company makes the choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS 157. Westfield Financial does not expect SFAS 159 to have a material impact on the consolidated financial statements. 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 Westfield Financial's operations. Unlike industrial companies, Westfield Financial's 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. 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," for a discussion of quantitative and qualitative disclosures about market risk. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements of Westfield Financial may be found on pages F-1 through F-41 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 72
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 to ensure that information required to be disclosed in the reports Westfield Financial files and submits under the Exchange Act (i) is recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to Westfield Financial's management including the Chief Executive Officer and Chief Financial Officer and Treasurer, as appropriate to allow timely discussion regarding required disclosure. 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 o 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. o 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. o 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. 73
o Westfield Financial, Inc.'s management assessed the effectiveness of the company's internal control over financial reporting as of December 31, 2006. 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, 2006, the company's internal control over financial reporting is effective based on those criteria. o 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, 2006. This report appears on pages F-42 and F-43. ITEM 9B. OTHER INFORMATION None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Performance Graph The following graph compares Westfield Financial, Inc.'s total cumulative shareholder return by an investor who invested $100.00 on December 31, 2001 to December 31, 2006, to the total return by an investor who invested $100.00 in each of the Russell 2000 Index and the Nasdaq Bank Index for the same period. 74
CHART
12/01 12/02 12/03 12/04 12/05 12/06 - ------------------------------------------------------------------------------- Westfield Financial, Inc. 100.00 117.09 181.44 199.87 192.85 288.17 Russell 2000 100.00 79.52 117.09 138.55 144.86 171.47 NASDAQ Bank 100.00 59.14 89.11 103.85 130.57 166.05 75
Directors Westfield Financial's Board of Directors consists of eleven members. Westfield Financial's Articles of Organization provide that the Board of Directors shall be divided into three classes, as nearly equal in number as possible. The following table sets forth each director of Westfield Financial, and his or her age, the year when he or she began serving as director, and the year when his or her current terms of office as director will expire. <TABLE> <CAPTION> Position with Name Age(1) New Westfield Financial Term Expires Served Since(2) - ---------------------- ------ ---------------------------------- ----------- --------------- <S> <C> <C> <C> <C> Victor J. Carra 66 Director 2007 1995 David C. Colton, Jr. 63 Director 2009 1980 Robert T. Crowley 58 Director 2008 1999 Harry C. Lane 68 Director 2008 1978 William H. McClure 71 Director 2008 1996 Mary C. O'Neil 71 Director 2009 1994 Richard C. Placek 67 Director 2007 1979 Paul R. Pohl 65 Director 2008 1999 Charles E. Sullivan 63 Director 2007 1992 Thomas C. Sullivan 73 Director 2007 1989 Donald A. Williams 62 Chairman and Chief Executive Officer 2009 1983 - -------------------- (1) At December 31, 2006. (2) Includes terms served on the Board of Directors of Westfield Bank. All members of the current Board of Directors of Westfield Financial have served as directors since the company's inception in 2001. </TABLE> Business Experience of Directors The business experience of each director for at least the past five years is set forth below. Victor J. Carra served as Executive Vice President of Westfield Bank from 1998 until 2005, and as Executive Vice President of Westfield Financial from its inception in 2001 until 2005. Since 1975, Mr. Carra served in various capacities during his employment with Westfield Bank. David C. Colton, Jr. is the former owner and operator of The Colton Agency, Inc., an insurance agency located in Westfield, Massachusetts for the past 65 years. He recently sold the business and is serving as an independent consultant. Robert T. Crowley, Jr. is a Certified Public Accountant and the Managing Partner of the accounting firm of Downey, Sweeney, Fitzgerald & Co., P.C. The firm provides tax, accounting and auditing services to the public. Mr. Crowley has been a partner with this firm since 1980 and a Certified Public Accountant since 1979. Harry C. Lane is the President of John S. Lane & Son, Inc., a quarry and asphalt company located in Westfield, Massachusetts, incorporated in 1904. Mr. Lane has served in this capacity since 1986. 76
William H. McClure is the President of the McClure Insurance Agency, Inc., a position he has held since December 1993. He is the owner of 51% of this insurance agency, which sells and services fire, casualty, life and health insurance. He is also an owner of 103 Van Deene Realty Trust, which is made up of a building located at that same address. Mary C. O'Neil is the former Vice President of Development and Community Relations at Noble Health Systems, located in Westfield, Massachusetts. Ms. O'Neil has held this position since 1993. Prior to that, she served as President of T.L. O'Neil Insurance Agency, Inc. Richard C. Placek is the Chairman of Commercial Distributing Company, located in Westfield Massachusetts. Mr. Placek has held this position since 1985. Prior to that, he served as General Manager. Paul R. Pohl serves as the President and Owner of Chemi-Graphic, Inc., a name plate manufacturing company located in Ludlow, Massachusetts. Mr. Pohl has served in this capacity since 1964. Charles E. Sullivan is the President of Charles E. Sullivan C.P.A., Inc., a public accounting firm located in West Springfield, Massachusetts. Mr. Sullivan has served in this capacity since 1979. Thomas C. Sullivan is the former President and Chief Operating Officer of Sullivan Paper Co., Inc., located in West Springfield, Massachusetts. He retired from this position in 1998. Mr. Sullivan presently serves as a director of Sullivan Paper Co., Inc., a position he has held since 1959. He also serves as President and Director of Patriot Realty, located in Appleton, Wisconsin, and is the Vice President and Director of George Sullivan Realty, a realty company located in West Springfield, Massachusetts. Mr. Sullivan has served in these capacities since 1994 and 1970, respectively. Donald A. Williams served as President of Westfield Bank from 1983 through 2005 and Westfield Financial from its inception in 2001 through 2005. Mr. Williams has served as Chief Executive Officer of Westfield Bank since 1987 and Westfield Financial since its inception in 2001. 77
Executive Officers Who Are Not Directors James C. Hagan, age 45, has served as President and Chief Operating Officer of Westfield Financial and Westfield Bank since June 2005. Prior to that, he served as Senior Vice President and Commercial Loan Department Manager of Westfield Bank from 1998. From 1994 through 1998, Mr. Hagan was a Vice President at Westfield Bank. Gerald P. Ciejka, age 46, was appointed Vice President of Westfield Financial and Westfield Bank on February 22, 2005. Mr. Ciejka also serves as General Counsel and Director of Human Resources of Westfield Financial and Westfield Bank. Mr. Ciejka was previously a partner at the Springfield, Massachusetts law firm of Bulkley, Richardson and Gelinas in the business organization and real estate departments. From 1997 to 2004, he served as branch manager and senior underwriting counsel for First American Title Insurance Company and Chicago Title Insurance Company. Michael J. Janosco, Jr., age 60, has served as the Chief Financial Officer and Treasurer of Westfield Bank since 1999 and of Westfield Financial since its inception in 2001. Mr. Janosco was previously a partner at KPMG Peat Marwick until his retirement in 1994. From 1994 to 1997, he served as the Chief Financial Officer and Treasurer of Primary Bank, located in Peterborough, New Hampshire. From October 1997 to March 1999, he was a consultant to various banks. Rebecca S. Kozaczka, age 56 has served as Vice President and Residential Loan Officer at Westfield Financial and Westfield Bank since 1989. She worked as a Mortgage Loan Officer and Assistant Vice President from 1985 until 1989. Deborah J. McCarthy, age 47, has served as Vice President of Westfield Financial and Westfield Bank since 2000. She is the Manager of the Operations and Information Systems Departments. She has worked for Westfield Bank in numerous capacities since 1979. Allen J. Miles, III, age 44, has served as Senior Vice President and Chief Lending Officer of Westfield Financial and Westfield Bank since August 2005. From 1998 to 2005 he served as Vice President and Commercial Loan Officer. Leo R. Sagan, Jr., age 43, has served as the Vice President and Controller of Westfield Financial and Westfield Bank since 2003. Prior to that he served as Controller of Westfield Financial and Westfield Bank from 2002 to 2003 and as Assistant Treasurer of Westfield Financial and Westfield Bank from 1999 to 2002. Audit Committee The Audit Committee is chaired by Director Placek, with Directors Crowley and McClure as members. The Audit Committee assists the Board by overseeing the audit coverage and monitoring the accounting, financial reporting, data processing, regulatory and internal control environments. The primary duties and responsibilities of the Audit Committee are to: (1) oversee and monitor the financial reporting process and internal controls system; (2) review and evaluate the audit performed by outside auditors and report any substantive issues found during the audit to the Board; (3) appoint, compensate and oversee the work of the independent auditors; (4) review and approve all transactions with affiliated parties; and (5) provide an open avenue of 78
communication among the independent auditors, financial and senior management, the internal audit department and the Board. All members of the Audit Committee are independent directors as defined under the American Stock Exchange listing standards. Westfield Financial believes that Mr. Crowley qualifies as an Audit Committee Financial Expert as that term is defined by Securities and Exchange Commission regulations. The Board of Directors has adopted a written charter for the Audit Committee, a copy of which was attached as Appendix A to the proxy statement filed with the SEC on April 15, 2005. The Audit Committee of Westfield Financial met five times in the 2006 fiscal year. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires Westfield Financial's directors and executive officers, and persons who own more than 10% of Westfield Financial's common stock, to report to the Securities and Exchange Commission their initial ownership of Westfield Financial's common stock and any subsequent changes in that ownership. Specific due dates for these reports have been established by the Securities and Exchange Commission and Westfield Financial is required to disclose in this proxy statement any late filings or failures to file. Based solely on its review of the copies of such reports furnished to Westfield Financial and written representations that no other reports were required during the fiscal year ended December 31, 2006, all Section 16(a) filing requirements applicable to Westfield Financial's executive officers and directors during fiscal 2006 were met. 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. EXECUTIVE COMPENSATION Compensation Discussion and Analysis Philosophy and Overall Program Objectives. Westfield Financial strives to attract, retain and motivate qualified executives crucial to Westfield Financial's success. Westfield Financial's approach is to compensate executives commensurate with their experience, expertise and performance and to be competitive with the other comparative financial companies of similar size, complexities and business. Westfield Financial designs its compensation program to: o Support its strategic plan by communicating what is expected of executives with respect to results and achievement; o Retain and recruit executive talent; and o Create financial strength and shareholder value. Westfield Financial seeks to achieve these objectives through the use of a base salary, annual bonus (short-term incentive) and grants of long-term, equity-based compensation such as stock options and restricted stock, deferred compensation and fringe benefits. Westfield Financial uses market comparisons for comparative financial companies of similar size, complexities and business as one factor in making compensation decisions along with individual contribution and performance, and importance of role and responsibilities as well as leadership and growth potential. Base Salary Annual Bonuses for Named Executive Officers. The minimum salaries for two of the five executives officers named in the "Summary Compensation Table" are determined by employment agreements for the Chief Executive and Chief Financial Officers and any increase over these minimums, and salaries of the other executive officers are determined by the Compensation Committee based on a variety of factors, including: o The nature and responsibility of the position and to the extent available, salary norms for persons in comparable positions at other financial institutions; and o The expertise of the individual executive and (except for their own compensation) the recommendations of the Chief Executive Officer and the President and Chief Operating Officer. Where not specified by contract, salaries are generally reviewed annually. In setting salaries, the Compensation Committee considers Westfield Financial's financial and market performance and individual performances and responsibilities. 80
As in prior years the compensation program provided for a cash annual bonus that is based the company's performance as compared to its operating budget, which was prepared by company management and approved by the Board of Directors at the beginning of the fiscal year. Based on the degree of success, cash bonus percentage of base salary is created by the Compensation Committee at the end of the fiscal year and applied to each executive officer, as well as all other employees of Westfield Financial, on a uniform basis. In 2006, this bonus percentage was 10% of base salary. Stock-Based Incentives. The stock-based incentive program provides a periodic award that is both performance and retention based. The objective of the program is to align compensation for named executive officers over a multi-year period directly with the interests of shareholders of Westfield Financial by motivating and rewarding creation and preservation of long term shareholder value and relative shareholder return. The level of long-term incentive compensation is determined based on an evaluation of competitive market factors in conjunction with total compensation provided to named executive officers and the goals of the compensation program. Westfield Financial's long-term incentive compensation generally takes the form of a combination of restricted stock unit grants and option rewards. These two vehicles reward shareholder value creation in slightly different ways. Stock options (which have exercise prices equal to the market price at date of grant) reward named executive officers only if Westfield Financial's stock price increases. Restricted stock units are impacted by all stock price changes, so the value to named executive officers is affected by both increases and decreases in Company's stock price. It is the policy and part of the Compensation Committee's charter that neither the Compensation Committee, nor any member of Westfield Financial's management, shall backdate an equity grant under Westfield Financial's stock-based incentive program or manipulate the timing of a public release of material information with the intent of benefiting a grantee under an equity award. In furtherance of this policy the Compensation Committee, in order to ensure the integrity of awards granted under its stock-based incentive program, has adopted an annual grant date for such awards being the June Board of Directors meeting. Grants made outside of this annual grant date must be approved in writing by Westfield Financial's Chief Executive Officer and must be presented and approved at the next subsequent Board of Director's meeting and will be deemed granted on the first business day following approval by Westfield Financial's Board of Directors. Restricted Stock. Restricted stock units granted as long-term incentive compensation to named executive officers vest over a period of five years at 20% per year at the anniversary date. Stock Options. Stock options granted to named officers have exercise prices of not less than fair market value of Westfield Financial's stock on the date of grant and vest over five years conditioned on continued employment. The Compensation Committee has never granted stock options with exercise prices below the market price of Westfield Financial's stock on the date of grant and has never reduced the exercise price of stock options except to reflect the exchange value in connection with the second step conversion closed on January 3, 2007. 81
Benefit Restoration. Westfield Financial has established the Benefit Restoration Plan of Westfield Financial, Inc. in order to provide restorative payments of executives who are prevented from receiving full benefits contemplated by Westfield Financial's employee stock ownership plan's benefit formula as well as the 401(k) plan's benefit formula. The restorative payments consist of payments in lieu of shares that cannot be allocated to participants due to legal limitations imposed on tax-qualified plans. Currently, only the Chief Executive Officer is a participant in the plan. The Compensation Committee considers the remuneration received under this plan when annually determining the executives' total compensation. Periodic Review. The Compensation Committee has previously and will continue to review both the annual bonus program and the long-term incentive program annually to ensure that their respective key elements continue to meet objectives described above. Benefits and Perquisites. The Compensation Committee supports providing benefits and perquisites to the named executive officers that are substantially the same as those offered to other officers of Westfield Financial. In addition, Westfield Financial may also make available to certain named officers the use of a company automobile as was the case in 2006 for the Chief Executive Officer, the President and Chief Operating Officer and the Chief Financial Officer. Westfield Financial entered into a deferred compensation agreement with the Chief Executive Officer in June of 1991. Under the deferred compensation agreement, the Chief Executive Officer is guaranteed monthly payments equal to 70% of his monthly salary after retirement for the remainder of the executive's life or 240 months, whichever is greater. The amount of these payments is reduced by any payments received by the executive from Westfield Financial's defined benefit pension plan and trust, as amended, sponsored by the Savings Bank Employee Retirement Association and are also reduced by social security payments received by the executive. The purpose of this Agreement is to provide the executive with benefits otherwise limited to certain provisions of the Internal Revenue Code. The Compensation Committee considers the recommendation received under the deferred compensation agreement when annually determining the executive's total compensation received from Westfield Financial. Employment Agreements and Change in Control Agreements. The Compensation Committee believes that Westfield Financial's continued success depends to a significant degree on the skills and competence of certain senior officers and the employment agreements are intended to ensure that Westfield Financial continues to maintain and retain experienced senior management. Westfield Financial presently has employment agreements with its Chief Executive, Chief Operating and Chief Financial Officers. Each agreement provides for three year rolling terms with minimum annual salaries, discretionary cash bonuses and other fringe benefits. The agreements also include protection for the executives if Westfield Financial experiences a change in ownership or control. If such a change in control occurs, a portion of the severance payments might constitute an "excess parachute payment" under current federal tax laws. Under the agreements, Westfield Financial would reimburse the executives for the amount of this excise tax and would have an additional payment so that, after payment the excise tax and all income and excise imposed on the 82
reimbursement and gross-up payments, the executives will retain approximately the same net after tax amounts under the employment agreement that they would have retained if there were no 20% excise tax. The effect of this provision is that Westfield Financial, rather than the executives, bears the financial cost of the excise tax. Change in Control Agreements. Westfield Financial has entered into one-year change of control agreements with six officers: Gerald P. Ciejka, James C. Hagan, Rebecca S. Kozaczka, Deborah J. McCarthy, Allem J. Miles, III, and Leo Sagan. The term of these agreements is perpetual until Westfield Financial gives notice of non-extension, at which time the term is fixed for one year. Generally, Westfield Financial may terminate the employment of any officer covered under these agreements, with or without cause, at any time prior to a change of control without obligation for severance benefits. However, if Westfield Financial signs a merger or other business combination agreement, or if a third party makes a tender offer or initiates a proxy contest, if could not terminate an officer's employment without cause without liability for severance benefits. The severance benefits would generally be equal to the value of the cash compensation and fringe benefits that the officer would have received if he or she had continued working for an additional one year. Westfield Financial would pay the same severance benefits if the officer resigns after a change of control following a loss of title, office or membership on the Board of Directors, material reduction in duties, functions or responsibilities, involuntary relocation of his other principal place of employment to a location over 25 miles from Westfield Bank's principal office on the day before the change of control and over 25 miles from the officer's principal residence or other material breach of contract which is not cured within 30 days. These agreements also provide uninsured death and disability benefits. If Westfield Financial experiences a change in ownership, a change in effective ownership or control or a change in the ownership of a substantial portion of their assets as contemplated by Section 280G of the Internal Revenue Code, a portion of any severance payments under the change of control agreements might constitute an "excess parachute payment" under current federal tax laws. Any excess parachute payment would be subject to a federal excise tax payable by the officer and would be non-deductible by Westfield Financial for federal income tax purposes. The change of control agreements do not provide a tax indemnity. Total Compensation. In making decisions with respect to any element of a named executive officer's compensation, the Compensation Committee considers the total compensation that may be awarded to the officer, including salary, annual bonus and long-term incentive compensation. In addition, in reviewing and approving employment agreements for named executive officers, the Compensation Committee considers the other benefits to which the officer is entitled by the agreement, including compensation payable upon termination of the agreement under variety of circumstances. The Compensation Committee's goal is to award compensation that is reasonable when all elements of potential compensation are considered. The Compensation Committee is provided, prior to the end of each fiscal year, a summary compensation schedule for each executive officer, containing the amount of all forms of compensation. This schedule is used as a tool by the Compensation Committee when considering the total compensation of each executive officer. 83
Compensation Decision-Making Policies and Procedures Decision-Making and Policy-Making. Westfield Financial's bylaws require that the business and affairs of Westfield Financial be under the direction of the Board of Directors. This includes executive officer compensation. Executive compensation is set by the Board of Directors or a board committee to which decision-making authority has been delegated. As a company listed on the American Stock Exchange Market, Westfield Financial must observe governance standards and listing requirements that require executive officer compensation decisions to be made by a majority of independent director members of our board, by a committee of independent directors or in exceptional and limited circumstances, a compensation committee comprised of at least three members where only one member is not independent. Consistent with these requirements, Westfield Financial's Board of Directors has established a Compensation Committee which is comprised of Directors Carra, Pohl and T. Sullivan with Director Sullivan serving as Chairperson of the Committee. Directors Pohl and T. Sullivan are independent under the American Stock Exchange listing standards. Mr. Carra served as executive Vice President of Westfield Financial, Inc. from 2001 until his retirement in July 2005, and as a result does not qualify as an independent director under the American Stock Exchange listing requirements. The Compensation Committee has been delegated authority from Westfield Financial's Board of Directors to oversee executive compensation by approving salary increases for Vice Presidents and above and by reviewing general personnel matters such as staff performance evaluations for Vice Presidents and above. The Compensation Committee has established a compensation program and has a formal charter which was adopted in December of 2006 and advises senior management on the average salary increases for all employees under the compensation program. The compensation program consists of three components: (1) base salary; (2) bonuses (short-term incentives); and (3) long-term incentives (e.g., stock options, restricted stock, deferred compensation, and fringe benefits). The Compensation Committee meets four times a year. It considers the expectations of the Chief Executive Officer with respect to their own compensation and their recommendations with respect to the compensation of more junior executive officers, as well as empirical data and the recommendations of advisors both internal and external. The Compensation Committee does not delegate its' duties to others. The Compensation Committee also confirms and approves the Summary Compensation Tables included in this Annual Report on Form 10-K in accordance with the rules and regulations of the Securities and Exchange Commission. Use of Outside Advisors and Survey Data. The Compensation Committee uses its own criteria coupled with a peer comparison based on similar companies to establish the Chief Executive Officer's base salary along with essentially the same process, compiled by the same independent outside consultant Westfield Financial uses to determine the compensation of all other employees. The above process is repeated for determining a fair compensation for all members of the Board of Directors and their committees. The Compensation Committee employs an outside compensation consultant, Thomas Warren of Thomas Warren & Associates, Inc., Sherborn, Massachusetts to assist in the evaluation of Westfield Financial's CEO and other selected officers. The Compensation Committee maintains the authority to approve fees and other retention terms with respect to such compensation consultant. 84
Compensation Committee Interlocks During 2006, none of Westfield Financial's executive officers served as a director or member of the compensation committee (or equivalent body) of another entity where a director or member of our Compensation Committee served as an executive officer or director. Compensation Committee Report The Compensation Committee has reviewed the Compensation Discussion and Analysis included in this SEC Form 10K Annual Report and has discussed it with management. Based on such review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K. Westfield Financial, Inc. Compensation Committee Thomas C. Sullivan, Chairperson Victor Carra Paul R. Pohl Director Compensation Meeting Fees. The members of the board of directors of Westfield Financial are identical to those of Westfield Bank. To date, Westfield Bank has compensated its directors for their services to the Bank. Westfield Financial has not paid any additional compensation to its directors for their additional services to the holding company. Westfield Financial expects to continue this practice until there is a business reason to establish separate compensation fees. Westfield Bank's practice has been to pay a fee of $800 to each of its non-employee directors for attendance at each Board meeting. In addition, each member of the Executive Committee received $1,733 per month for meetings, each member of the Audit Committee received $500 for each meeting the member attended, each member of the Compensation Committee received $250 for each meeting the member attended, and each member of the Nominating Committee received $250 for each meeting the member attended. Westfield Bank paid fees totaling $203,284 to its non-employee directors for the year ended December 31, 2006. Directors' Deferred Compensation Plan. Westfield Bank has established the Westfield Bank Directors' Deferred Compensation Plan for the benefit of non-employee directors. Under the Deferred Compensation Plan, each non-employee director may make an annual election to defer receipt of all or a portion of his or her director fees received from Westfield Financial and Westfield Bank. The deferred amounts are allocated to a deferral account and credited with interest at an annual rate equal to the rate on the highest yielding certificate of deposit issued by Westfield Bank during the year or according to the investment return of other assets as may be selected by the Compensation Committee of Westfield Bank. The Deferred Compensation Plan is an unfunded, non-qualified plan that provides for distribution of the amounts deferred to participants or their designated beneficiaries upon the occurrence of certain events such as death, retirement, disability or a change in control of Westfield Financial or Westfield Bank (as those terms are defined in the Deferred Compensation Plan). 85
The following table sets forth information regarding compensation earned by the non-employee directors of Westfield Financial, Inc. during the last fiscal year. Fees Earned or Stock Option Paid in Cash Awards Awards Total Name ($)(1) ($)(2) ($)(3) ($) - -------------------- ------------ ----- ------ ------ Victor J. Carra 12,700 -- -- 12,700 David C. Colton, Jr. 31,196 14,390 10,192 55,778 Robert T. Crowley, Jr. 13,700 14,390 10,192 38,282 Harry C. Lane 31,446 14,390 10,192 56,028 William H. McClure 12,900 14,390 10,192 37,482 Mary C. O'Neil 30,396 14,390 10,192 54,978 Richard C. Placek 13,700 14,390 10,192 38,282 Paul R. Pohl 12,150 14,390 10,192 36,732 Charles E. Sullivan 32,496 14,390 10,192 57,078 Thomas C. Sullivan 12,150 14,390 10,192 36,732 - -------------------- (1) Includes retainer payments, meeting fees, and committee and/or chairmanship fees earned during the fiscal year, whether such fees were paid currently or deferred. (2) Represents the compensation cost recognized for the fiscal year in connection with restricted stock of Westfield Financial granted to the named executive officer, regardless of the year in which granted and calculated in accordance with FAS 123R for financial statement purposes. Unvested shares of restricted stock awards held in trust for each director as of December 31, 2006 are as follows: for each of Messrs. Colton, Crowley, Lane, McClure, Placek, Pohl, C. Sullivan, T. Sullivan and Ms. O'Neil - 1,000 shares. For more information concerning the assumptions used for these calculations, please refer to the discussion under Note 11 in the Notes to Consolidated Financial Statements attached hereto. This amount does not reflect the value of dividends paid on unvested restricted stock. (3) Represents the compensation cost recognized for the fiscal year for options to purchase shares of Westfield Financial common stock outstanding to the named executive officer, regardless of the year in which granted and calculated in accordance with FAS 123R for financial statement purposes. Stock options outstanding for each director at December 31, 2006 are as follows for each of Messrs. Colton, Crowley, Lane, McClure, Placek, Pohl, C. Sullivan, T. Sullivan and Ms. O'Neil - 2,600 shares. For more information concerning the assumptions used for these calculations, please refer to the discussion under Note 11 in the Notes to Consolidated Financial Statements attached hereto. 86
Executive Compensation The table below sets forth for 2006 the compensation of each of our named executive officers. <TABLE> SUMMARY COMPENSATION TABLE <CAPTION> Change in Pension Value and Nonqualified Stock Option Non-Equity Deferred All Other Name and Principal Salary(1) Bonus(1) Awards(2) Awards(3) Incentive Plan Compensation Compensation(5) Positions Year ($) ($) ($) ($) Compensation ($) Earnings(4)($) ($) Total ($) ------------------ ---- --------- -------- --------- --------- ---------------- --------------- --------------- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Donald A. Williams, Chairman and Chief Executive Officer 2006 382,706 38,271 141,022 94,080 -- 277,897 87,584 1,021,560 Michael J. Janosco, Jr., Chief Financial Officer and Treasurer 2006 199,586 19,959 84,613 52,560 -- 44,295 39,438 440,451 James C. Hagan, President and Chief Operating Officer 2006 209,284 20,928 28,780 9,408 -- 26,870 28,146 323,416 Allen J. Miles, III Senior Vice President & Chief Lending Officer 2006 148,524 14,852 4,980 1,960 -- 13,556 19,834 203,706 Rebecca S. Kozaczka Vice President 2006 110,984 11,098 24,463 7,056 -- 37,136 18,960 209,697 - -------------------- (1) The figures shown for salary and bonus represent amounts earned for the fiscal year, whether or not actually paid during such year. (2) Represents the compensation cost recognized for the fiscal year in connection with restricted stock of Westfield Financial granted to the named executive officer, regardless of the year in which granted and calculated in accordance with FAS 123R for financial statement purposes. For more information concerning the assumptions used for these calculations, please refer to Note 11 in the Notes to Consolidated Financial Statements attached hereto. This amount does not reflect the value of dividends paid on unvested restricted stock, which are included in the Summary Compensation Table under the caption "All Other Compensation." (3) Represents the compensation cost recognized for the fiscal year for options to purchase shares of Westfield Financial common stock outstanding to the named executive officer, regardless of the year in which granted and calculated in accordance with FAS 123R for financial statement purposes. For more information concerning the assumptions used for these calculations, please refer to Note 11 in the Notes to Consolidated Financial Statements attached hereto. (4) Includes for each named executive officer (a) the increase (if any) for the fiscal year in the present value of the individual's accrued benefit (whether not vested) under each tax-qualified and non-qualified actuarial or defined benefit plan calculated by comparing the present value of each individual's accrued benefit under each such plan in accordance with Statement of Financial Accounting Standards 87 ("FAS 87") as of the plan's measurement date in such fiscal year to the present value of the individual's accrued benefit as of the plan's measurement date in the prior fiscal year plus. (5) The named executive officers participate in certain group life, health, disability insurance and medical reimbursement plans, not disclosed in the Summary Compensation Table, that are generally available to salaried employees and do not discriminate in scope, terms and operation. The figure shown for each named executive officer includes: (i) life insurance premiums as follows: Mr. Williams - $3,378, Mr. Janosco - $2,504, Mr. Hagan - $776, Mr. Miles - $504, and Ms. Kozaczka - $1,026; (ii) 401(k) matching contributions as follows: Mr. Williams - $4,151, Mr. Janosco - $5,988, Mr. Hagan - $4,496, Mr. Miles - $4,456 and (1) Ms. Kozaczka - $3,330; (iii) ESOP contributions as follows: Mr. Williams - $22,801, Mr. Janosco - $21,244, Mr. Hagan - $19,574, Mr. Miles - $13,944 and Ms. Kozaczka - $11,799: (iv) dividends on unvested restricted stock as follows: Mr. Williams - $16,170, Mr. Janosco - $9,702, Mr. Hagan- $3,300, Mr. Miles - $930, and Ms. Kozaczka - $2,805; and (v) contributions under the benefit restoration plan of $41,084 for the benefit of Mr. Williams. In addition, we provide certain non-cash perquisites and personal benefits to each named executive officer that do not exceed $10,000 in the aggregate for any individual, and are not included in the reported figures. </TABLE> 87
Compensation Plans 2002 Stock Option Plan. Westfield Financial has a Stock Option Plan in effect that was approved by the shareholders and became effective on July 26, 2002. The purpose of the Stock Option Plan is to encourage the retention of key employees and directors by facilitating their purchase of a stock interest in Westfield Financial. The Stock Option Plan is not subject to ERISA and is not a tax-qualified plan. Westfield Financial has reserved an aggregate of 1,631,699 shares of common stock for issuance upon the exercise of stock options granted under the Plan. 2002 Recognition and Retention Plan. Westfield Financial's Recognition and Retention Plan was approved by shareholders and became effective on July 26, 2002. Like the Stock Option Plan, the Recognition and Retention Plan functions as a long-term incentive compensation program for eligible officers, employees and outside directors of Westfield Financial and Westfield Bank. The Recognition and Retention Plan is not subject to ERISA and is not a tax-qualified plan. The members of the Board's Compensation Committee who are disinterested directors (the "RRP Committee") administer the Recognition and Retention Plan. Westfield Financial pays all costs and expenses of administering the Recognition and Retention Plan. As required by the terms of the Recognition and Retention Plan, Westfield Financial has established a trust and has contributed to the trust in order to fund the purchase of 652,679 shares of common stock, the maximum number of restricted stock awards that may be granted under the RRP. Shares of common stock subject to a restricted stock award are held in the trust until the award vests at which time the shares of common stock attributable to the portion of the award that have vested are distributed to the award holder. An award recipient is entitled to exercise voting rights and receive cash dividends with respect to the shares of common stock subject to his or her award, whether or not the underlying shares have vested. Restricted stock awards are granted under the Recognition and Retention Plan on a discretionary basis to eligible officers, executives and outside directors selected by the RRP Committee. Westfield Financial may amend or terminate the Recognition and Retention Plan, in whole or in part, at any time, subject to the requirements of all applicable laws. 88
<TABLE> GRANTS OF PLAN BASED AWARDS TABLE <CAPTION> All Other All Other Stock Option Closing Awards: Awards: Exercise Sale Number of Number of or Base Price of Shares of Securities Price of Common Stock Stock or Underlying Option on the Grant Grant Units Options Awards Date Name Date ($) (#) ($/Sh) ($/Sh) ---- ----- -------- ---------- ------- -------------- <S> <C> <C> <C> <C> <C> Donald A. Williams -- -- -- -- -- Michael J. Janosco, Jr. -- -- -- -- -- James C. Hagan -- -- -- -- -- Allen J. Miles, III 1/23/06 $1,000 -- -- 24.60 Rebecca S. Kozaczka -- -- -- -- -- </TABLE> 89
Stock Awards and Stock Option Grants Outstanding The following tables set forth information regarding stock awards, stock options and similar equity compensation outstanding at January 1, 2007, whether granted in 2006 or earlier, including awards that have been transferred other than for value. <TABLE> OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE <CAPTION> Number of Number of Number of Market Value Securities Securities Shares or of Shares or Underlying Underlying Units of Units of Unexercised Unexercised Option Stock That Stock That Options Options Exercise Option Have Not Have Not (1) (1) Price Expiration Vested Vested ($) Name Exercisable Unexercisable ($) Date (2) (3) ---- ----------- ------------- -------- ---------- ---------- ----------- <S> <C> <C> <C> <C> <C> <C> Donald A. Williams 96,000 24,000 14.39 7/26/12 9,800 339,080 Michael J. Janosco, Jr. 57,600 14,400 14.39 7/26/12 5,880 203,448 James C. Hagan 9,600 2,400 14.39 7/26/12 2,000 69,200 Allen J. Miles, III 1,000 500 14.39 7/26/12 800 27,680 Rebecca S. Kozaczka 7,200 1,800 14.39 7/26/12 1,700 58,820 - -------------------- (1) The stock option awards were granted in July 2002 and vest annually over a five-year period, the last year being July 2007. (2) The Recognition and Retention Plan shares were granted in October 2002 and vest annually over a five-year period, the last being October 2007, except for that awarded to Mr. Miles which vests over a similar five-year period with the final installment vesting in October 2009. (3) Market value is calculated on the basis of $34.60 per share, which is the closing sales price for our common stock on December 29, 2006. </TABLE> 90
The following table sets forth the stock awards that vested and the option awards that were exercised for the named executive officers during the last fiscal year. OPTION EXERCISES AND STOCK VESTED TABLE Option Awards Stock Awards Number of Number of Shares Value Shares Value Acquired on Realized on Acquired on Realized on Exercise Exercise Vesting Vesting Name (#) ($)(1) (#) ($)(1) - ------------------------ ----------- ---------- ----------- ---------- Donald A. Williams -- -- 9,800 334,278 Michael J. Janosco, Jr. -- -- 5,880 200,567 James C. Hagan -- -- 2,000 68,220 Allen J. Miles, III -- -- 200 6,822 Rebecca S. Kozaczka -- -- 1,700 57,987 - -------------------- (1) The figures shown include the amount realized during the fiscal year upon exercise of vested stock options by the named individual and the vesting of restricted stock, based on the closing sales price for a share of our common stock on the on the exercise date or vesting date, as applicable. Unexercised stock options and unvested restricted stock may not be transferred for value. Post-Employment Compensation Pension Benefits Pension Plan. Westfield Bank maintains a pension plan for its eligible employees. Generally, employees of Westfield Bank begin participation in the pension plan once they reach age 21 and complete 1,000 hours of service in a consecutive 12-month period. Participants in the pension plan become vested in their accrued benefit under the pension plan upon the earlier of: (1) the attainment of their "normal retirement age" (as described in the pension plan) while employed at Westfield Bank; (2) the completion of five vesting years of service with Westfield Bank; or (3) the death or disability of the participant. Participants are generally credited with a vesting year of service for each year in which they complete at least 1,000 hours of service. A participant's normal benefit under the pension plan equals the sum of (i) 1.25% of the participant's average compensation (generally defined as the average taxable compensation for the three consecutive limitation years that produce the highest average) by the number of years of service the participant has under the plan up to 25 years of service, plus (ii) 0.6% of the excess of the participant's average compensation over the participant's covered compensation (the social security taxable wage base for the 35 years ending in the year the participant becomes eligible for non-reduced social security benefits) for each year of service under the plan up to 25 years of service. Participants may retire at or after age 65 and receive their full benefit under the plan. Participants may also retire early at age 62 or at age 55 with ten years of service or at age 50 with 15 years of service under the plan and receive a reduced retirement benefit. Pension benefits are payable in equal monthly installments for life, or for married persons, as a joint survivor annuity over the lives of the participant and spouse. Participants may also elect a lump sum payment with the consent of their spouse. If a participant dies while employed by Westfield Bank, a death benefit will be payable to either his or her spouse or estate, or named beneficiary, equal to the entire amount of the participant's accrued benefit in the plan. 91
Deferred Compensation Agreement. Westfield Bank has also entered into a deferred compensation agreement with Donald A. Williams. Under this agreement, the executive is guaranteed monthly payments equal to 70% of his monthly salary after retirement for the remainder of the executive's life or 240 months, whichever is greater. The amount of these payments is reduced by any payments received from the pension plan and are also reduced by Social Security payments attributable to contributions made by Westfield Bank. This agreement also provides for payments upon the death or disability of the executive that are equal in amount to the payments that would have been payable to the executive upon retirement with such payments being made for a period of 120 months. The following table sets forth information regarding pension benefits accrued by the named executive officers during the last fiscal year. <TABLE> PENSION BENEFITS TABLE <CAPTION> Number of Years of Present Value of Payments Credited Accumulated During Last Service Benefit Fiscal Year Name Plan Name (#)(1) ($)(1) ($) - ---------------------- -------------------------- --------- --------------- ------------ <S> <C> <C> <C> <C> Donald A. Williams Pension Plan for Employees 34.83 793,488 Deferred Compensation 1,654,518 Agreement -- Michael J. Janosco, Jr. Pension Plan for Employees 7.58 210,467 - James C. Hagan Pension Plan for Employees 12.33 101,133 - Allen J. Miles, III Pension Plan for Employees 8.33 44,627 - Rebecca s. Kozaczka Pension Plan for Employees 21.08 225,747 - - -------------------- (1) The figures shown are determined as of the plan's measurement date during 2006 under FAS 87 for purposes of Westfield Financial's audited financial statements. For the mortality, discount rate and other assumptions used for this purpose, please refer to Note 12 in the Notes to Consolidated Financial Statements attached hereto. </TABLE> Nonqualified Deferred Compensation 401(k) Plan. Westfield Bank maintains a 401(k) Plan, a tax-qualified defined contribution plan, for substantially all employees of Westfield Bank who have attained age 21 and completed at least three months of service. Eligible employees may contribute from 1% to 75% of annual compensation to the plan on a pre-tax basis each year, subject to limitations of the Internal Revenue Code (for 2006 the limit was $15,000). Westfield Bank makes a matching contribution to the plan equal to 50% of the first six percent of annual compensation contributed to the plan on a pre-tax basis by a participant after such participant has completed one year of service. This plan has an individual account for each participant's contributions and allows each participant to direct the investment of his or her account. One permitted investment is the common stock of Westfield Financial. 92
Employee Stock Ownership Plan. The employee stock ownership plan is a tax-qualified plan that covers substantially all employees who have completed 1,000 hours of service in a 12 month period and attained age 21. Although contributions to this plan will be discretionary, Westfield Bank intends to contribute enough money each year to make the required principal and interest payments on the loan from Westfield Financial made in the initial public offering as well as the second-step conversion. Each loan is for a term of 30 years and calls for level annual payments of principal and interest. The plan pledges the shares it purchases as collateral for the loan and holds them in a suspense account. The plan will not distribute the pledged shares right away. Instead, it will release a portion of the pledged shares annually. The plan will allocate the shares released each year among the accounts of participants in proportion to their compensation for the year. For example, if a participant's compensation for a year represents 1% of the total compensation of all participants for the year, the plan would allocate to that participant 1% of the shares released for the year, subject to certain legal limitations imposed on tax-qualified plans. Participants direct the voting of shares allocated to their accounts. Shares in the suspense account will usually be voted by the plan trustee in a way that mirrors the votes which participants cast for shares in their individual accounts. This plan may purchase additional shares in the future, and may do so using borrowed funds, cash dividends, periodic employer contributions or other cash flow. Benefit Restoration Plan. Westfield Financial has also established the Benefit Restoration Plan in order to provide restorative payments to executives who are prevented from receiving the full benefits contemplated by the employee stock ownership plan's benefit formula as well as the 401(k) plan's benefit formula. The restorative payments consist of payments in lieu of shares that cannot be allocated to participants under the employee stock ownership plan due to the legal limitations imposed on tax-qualified plans and, in the case of participants who retire before the repayment in full of the employee stock ownership plan's loan, payments in lieu of the shares that would have been allocated if employment had continued through the full term of the loan. The restorative payments also consist of amounts unable to be provided under the 401(k) plan due to certain legal limitations imposed on tax-qualified plans. The following table sets forth information regarding nonqualified deferred compensation earned by our named executive officers during the last fiscal year under non-qualified defined contribution plans. <TABLE> NONQUALIFIED DEFERRED COMPENSATION TABLE(1) <CAPTION> Executive Registrant Aggregate Aggregate Contributions in Contributions in Earnings in Withdrawals/ Aggregate Balance Last FY Last FY Last FY Distributions at Last FYE Name ($)(2) ($)(3) ($)(4) ($) ($) ---- ---------------- ---------------- ----------- ------------- ----------------- <S> <C> <C> <C> <C> <C> Donald A. Williams -- 236,627 -- -- 1,654,518 Michael J. Janosco, Jr. -- 44,295 -- -- 210,467 James C. Hagan -- 26,870 -- -- 101,133 Allen J. Miles, III -- 13,556 -- -- 44,627 Gerald P. Ciejka -- 37,136 -- -- 225,747 </TABLE> 93
- -------------------- (1) Non-qualified deferred compensation includes benefits provided under our Benefit Restoration Plan. (2) Executive contributions are included in the Summary Compensation Table under the captions "Salary" and "Non-Equity Incentive Plan Compensation," as applicable. (3) Registrant contributions are included under the caption "Change in Pension Value and Nonqualified Deferred Compensation Earnings" in the Summary Compensation Table. (4) Earnings did not accrue at above-market or preferential rates and are not reflected in the Summary Compensation Table. Termination and Change in Control Benefits Westfield Financial provides additional benefits, not included in the previous tables, to the named executive officers in the event of retirement or termination of employment in certain circumstances and in the event of a change in control. The following table provides an estimate of the value of such benefits, assuming termination of employment or a change in control occurred on December 31, 2006. Employment Agreements. Westfield Financial and Westfield Bank have jointly entered into employment agreements with Mr. Donald A. Williams, Mr. Michael J. Janosco, Jr. and, on January 31, 2007, James C. Hagan. For purposes of Westfield Financial's obligations, the employment agreements of Mr. Williams and Mr. Janosco have rolling three-year terms beginning on January 1, 2007, and the employment agreement of Mr. Hagan has a rolling three-year term beginning on January 30, 2007, which by decision of the executive or joint decision of Westfield Financial and Westfield Bank may be converted to a fixed three-year term. For purposes of Westfield Bank's obligations, the employment agreements have fixed terms of three years beginning on the same dates as above, and may be renewed annually after a review of the executive's performance. These agreements provide for minimum annual salaries of $416,078, $211,484 and $221,780, respectively, discretionary cash bonuses, and participation on generally applicable terms and conditions in other compensation and fringe benefit plans. They also guarantee customary corporate indemnification and errors and omissions insurance coverage throughout the employment term and for six years after termination. Westfield Financial and Westfield Bank may terminate each executive's employment, and each executive may resign, at any time with or without cause. However, in the event of termination during the term without cause, they will owe the executive severance benefits generally equal to the value of the cash compensation and fringe benefits that the executive would have received if he had continued working for an additional three years. The same severance benefits would be payable if the executive resigns during the term following: a loss of title, office or membership on the board of directors; material reduction in duties, functions or responsibilities; involuntary relocation of the executive's principal place of employment to a location over 25 miles in distance from Westfield Bank's principal office in Westfield, Massachusetts and over 25 miles from the executive's principal residence; or other material breach of contract by Westfield Financial or Westfield Bank which is not cured within 30 days. For 60 days after a change in control, each executive may resign for any reason and collect severance benefits as if he or she had been discharged without cause. The employment agreements also provide uninsured death and disability benefits. If Westfield Financial or Westfield Bank experiences a change in ownership, a change in effective 94
ownership or control or a change in the ownership of a substantial portion of their assets as contemplated by section 280G of the Internal Revenue Code, a portion of any severance payments under the employment agreements might constitute an "excess parachute payment" under current federal tax laws. Federal tax laws impose a 20% excise tax, payable by the executive, on excess parachute payments. Under the employment agreements, Westfield Financial would reimburse each of Messrs. Williams and Janosco for the amount of this excise tax and would make an additional gross-up payment so that, after payment of the excise tax and all income and excise taxes imposed on the reimbursement and gross-up payments, the executive will retain approximately the same net-after tax amounts under the employment agreement that he or she would have retained if there were no 20% excise tax. The effect of this provision is that Westfield Financial, rather than the executive, bears the financial cost of the excise tax. Neither Westfield Financial nor Westfield Bank could claim a federal income tax deduction for an excess parachute payment, excise tax reimbursement payment or gross-up payment. Change of Control Agreements. Westfield Bank and Westfield Financial have jointly entered into one-year change of control agreements with the following executives: Gerald P. Ciejka, Rebecca S. Kozaczka, Deborah J. McCarthy, Allen J. Miles, III, and Leo R. Sagan, Jr. The term of these agreements is perpetual until Westfield Bank gives notice of non-extension, at which time the term is fixed for one year. Generally, Westfield Bank may terminate the employment of any officer covered by these agreements, with or without cause, at any time prior to a change of control without obligation for severance benefits. However, if Westfield Bank or Westfield Financial signs a merger or other business combination agreement, or if a third party makes a tender offer or initiates a proxy contest, it could not terminate an officer's employment without cause without liability for severance benefits. The severance benefits would generally be equal to the value of the cash compensation and fringe benefits that the officer would have received if he or she had continued working for an additional one year. Westfield Bank would pay the same severance benefits if the officer resigns after a change of control following a loss of title, office or membership on the Board of Directors, material reduction in duties, functions or responsibilities, involuntary relocation of his or her principal place of employment to a location over 25 miles from Westfield Bank's principal office on the day before the change of control and over 25 miles from the officer's principal residence or other material breach of contract which is not cured within 30 days. These agreements also provide uninsured death and disability benefits. If Westfield Bank or Westfield Financial experiences a change in ownership, a change in effective ownership or control or a change in the ownership of a substantial portion of their assets as contemplated by section 280G of the Internal Revenue Code, a portion of any severance payments under the change of control agreements might constitute an "excess parachute payment" under current federal tax laws. Any excess parachute payment would be subject to a federal excise tax payable by the officer and would be non-deductible by Westfield Bank and Westfield Financial for federal income tax purposes. The change of control agreements do not provide a tax indemnity. 95
<TABLE> <CAPTION> Donald A. Michael J. James C. Allen J. Rebecca S. Williams Janosco, Jr. Hagan Miles III Kozaczka <S> <C> <C> <C> <C> <C> Retirement Retiree Life Insurance (1) 17,543 12,550 4,787 3,420 10,492 Disability Salary Continuation (2) 191,353 99,793 -- -- -- Death Stock Option Vesting (3) 485,040 291,024 48,504 40,844 36,378 Restricted Stock Vesting (4) 339,080 203,448 69,200 27,680 58,820 Discharge Without Cause or Resignation With Good Reason - No Change in Control Stock Option Vesting (3) -- -- -- -- -- Restricted Stock Vesting (4) -- -- -- -- -- Lump Sum Cash Payment (5) 1,480,274 597,583 -- -- -- Health Insurance (6) 21,315 26,976 Discharge Without Cause Or Resignation With Good Reason - Change in Control - related Stock Option Vesting (3) 485,040 291,024 48,504 40,844 36,378 Restricted Stock Vesting (4) 339,080 203,448 69,200 27,680 58,820 Lump Sum Cash Payment (5) 1,480,274 597,583 209,431 145,466 108,091 Health Insurance (6) 21,315 26,976 10,008 10,008 10,008 ESOP Restoration Plan Benefit (7) 359,148 195,200 169,835 121,394 102,461 Golden Parachute Excise Tax Gross-up Payment (8) 754,555 325,648 -- --- -- Change in Control - No Termination of Employment Stock Option Vesting (3) 485,040 291,024 48,504 40,844 36,378 Restricted Stock Vesting (4) 339,080 203,448 69,200 27,680 58,820 ESOP Restoration Plan Benefit (7) 359,148 195,200 169,835 121,394 102,461 </TABLE> 96
- -------------------- (1) The reported figure reflects the estimated present value of the future premium cost of such benefits for the named individual, calculated on the basis of the assumptions used by Westfield Financial in measuring its liability for such benefits for financial statement purposes under Statement of Financial Account Standards No. 106 ("FAS 106"). For more information concerning the assumptions used for these calculations, please refer to Note 12 in the Notes to Consolidated Financial Statements attached hereto. (2) The employment agreements in effect for Messrs. Williams and Janosco provide for salary continuation payments following termination due to disability for the remaining contract term or until group long-term disability benefits begin. The figures shown assume payment of full salary for 180 days, equal to the waiting period for benefits under our group long-term disability program, without discount for present value. (3) All stock options granted under the 2002 Stock Option Plan provide for full vesting upon death, disability, retirement, or change in control. The figures shown reflect the in-the-money value of those stock options that would accelerate, calculated based on the positive difference between the option exercise price and the closing sales price for a share of our common stock on December 29, 2006. (4) All restricted stock granted under the 2002 Recognition and Retention Plan provide for full vesting upon death, disability, retirement or change in control. The figures shown reflect the value of those restricted stock awards that would accelerate, calculated based on the closing sales price for a share of our common stock on December 29, 2006. (5) The employment agreements in effect for Messrs. Williams and Janosco provide for a lump sum cash payment equal to the present value of the salary payments, estimated cash incentives (based on the prior three-years' cash incentives, as a percentage of salary), and additional qualified and non-qualified defined benefit and defined contribution plan benefits that would be earned during the remaining contract term. The figure shown reflects an assumed remaining contract term of 3 years and a discount rate of 5.75%. Similarly, individuals with change of control contracts are paid cash severance for a one year period. (6) The employment agreements in effect for Messrs. Williams and Janosco provide for continued health, life and other insurance benefits for the remaining contract term, with an offset for benefits provided by a subsequent employer. The change of control agreements with other officers also provide continued health, life and other insurance benefits for a maximum period of one year. The figure shown represents the present value of continued insurance benefits for a fixed period of three years and assumes no offset for benefits provided by a subsequent employer, calculated on the basis of the assumptions used by Westfield Financial in measuring its liability for retiree benefits other than pensions for financial statement purposes under FAS 106. For more information concerning the assumptions used for these calculations, please refer to Note 12 in the Notes to Consolidated Financial Statements attached hereto. (7) Westfield Financial's tax-qualified employee stock ownership plan provides that, in the event of a change in control, a portion of the proceeds from the sale of shares of our common stock held in a suspense account for future allocation to employees would be applied to repay the outstanding balance on the loan used to purchase the unallocated shares. The remaining unallocated shares (or the proceeds from their sale) would be distributed on a pro-rata basis among the accounts of plan participants. Westfield Financial estimates this distribution to be approximately $18.17 per allocated share, based on 91,353 allocated shares, 306,454 unallocated shares, an outstanding loan balance of $5,036,213 and stock price of $18.17 per share, which is the closing sales price for a share on December 29, 2006. Under the terms of Westfield Financial's Benefit Restoration Plan, a corresponding earnings credit would be applied to accumulated share equivalents under this plan. The figures shown represent an estimated earnings credit of $18.17 per share equivalent credited to each of the named individuals who participate in the Benefit Restoration Plan. (8) The employment agreements in effect for Messrs. Williams and Janosco provide that Westfield Financial will indemnify them, on a net after-tax basis, against the effects of a 20% federal excise tax that is applied to payments that are contingent on a change in control, where the aggregate value of such payments equals or exceeds three times the individual's average five-year W-2 earnings for the period of five consecutive calendar years ending prior to the date of the change in control. The figure shown reflects an estimate of the indemnification payment that would be due to each named individual. 97
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Principal Shareholders of Westfield Financial The following table contains common stock ownership information for persons known to Westfield Financial to "beneficially own" 5% or more of Westfield Financial's common stock as of January 3, 2007. In general, beneficial ownership includes those shares that a person has the power to vote, sell or otherwise dispose of. Beneficial ownership also includes that number of shares that an individual has the right to acquire within 60 days (such as stock options) after January 3, 2007. Two or more persons may be considered the beneficial owner of the same shares. Westfield Financial obtained the information provided in the following table from filings with the SEC and from Westfield Financial. <TABLE> <CAPTION> Name and Address of Amount and Nature of Title of Class Beneficial Owner Beneficial Ownership Percent - ----------------------- --------------------------------------- -------------------- ------- <S> <C> <C> <C> Common Stock, par value Employee Stock Ownership Plan Trust of 2,027,029(1) 6.4% $0.01 per share Westfield Financial, Inc. 141 Elm Street Westfield, MA 01085 - -------------------- (1) The Employee Stock Ownership Plan of Westfield Financial, Inc. (the "ESOP") is a tax qualified employee stock ownership plan under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), with individual accounts for the accrued benefits of participating employees and their beneficiaries. The ESOP is administered by an ESOP Committee ("ESOP Committee"). The ESOP's assets are held in trust by First Bankers Trust Services, Inc., as plan trustee (the "Plan Trustee"). The number of shares listed as beneficially owned represents the entire number of shares of Westfield Financial common stock held by the Plan Trustee as of January 3, 2007. As of January 3, 2007, 285,455 of such shares of Westfield Financial common stock had been allocated to individual accounts established for participating employees and their beneficiaries, and 1,741,574 of such shares were held, unallocated, for allocation in future years. In general, participating employees and their beneficiaries have the power and authority to direct the voting of shares of Westfield Financial common stock allocated to their individual accounts. The ESOP, through the Plan Trustee, has shared voting power over unallocated Westfield Financial common stock. Any unallocated Westfield Financial common stock is generally required to be voted by the Plan Trustee in the same proportion as Westfield Financial common stock which has been allocated to Participants is directed to be voted. The reporting person, through the Plan Trustee (who is instructed by the ESOP Committee) shares dispositive power over all unallocated Westfield Financial common stock held by the ESOP. The ESOP, acting through the Plan Trustee (who is instructed by the ESOP Committee) shares dispositive power over allocated Westfield Financial common stock with participating employees and their beneficiaries, who have the right to determine whether Westfield Financial common stock allocated to their respective accounts will be tendered in response to a tender offer but otherwise have no dispositive power. Any unallocated Westfield Financial common stock is generally required to be tendered by the Plan Trustee in the same proportion as Westfield Financial common stock which has been allocated to Participants is directed to be tendered. In limited circumstances, ERISA may confer upon the Plan Trustee the power and duty to control the voting and tendering of Westfield Financial common stock allocated to the accounts of participating employees and beneficiaries who fail to exercise their voting and/or tender rights. The ESOP disclaims voting power with respect to such allocated Westfield Financial common stock. </TABLE> 98
Security Ownership of Management The following table shows the number of shares of Westfield Financial's common stock beneficially owned by each director, each named executive officer, and all directors and executive officers of Westfield Financial as a group, as of January 3, 2007. Except as otherwise indicated, each person and each group shown in the table has sole voting and investment power with respect to the shares of common stock listed next to his or her name. <TABLE> <CAPTION> Amount and Nature of Position with Beneficial Percent of Common Name Westfield Financial Ownership(1)(2)(3)(4)(5) Stock Outstanding - ------------------------- --------------------------- ----------------------- ----------------- <S> <C> <C> <C> Victor J. Carra Director 228,679(6) * David C. Colton, Jr. Director 69,942(7) * Robert T. Crowley, Jr. Director 63,734(8) * James C. Hagan President and Chief 68,940 * Operating Officer Michael J. Janosco, Jr. Chief Financial Officer and 374,032(9) 1.2% Treasurer Rebecca S. Kozaczka Vice President 55,750 * Harry C. Lane Director 55,530 * William H. McClure Director 69,375(10) * Allen J. Miles, III Senior Vice President and 17,402 * Chief Lending Officer Mary C. O'Neil Director 53,343(11) * Richard C. Placek Director 71,940(12) * Paul R. Pohl Director 83,325(13) * Charles E. Sullivan Director 81,500(14) * Thomas C. Sullivan Director 137,565 * Donald A. Williams Chairman and Chief Executive 631,649(15) 2.0% Officer Other Executive Officers 1,823,808(16) 5.7% and ESOP All Executive Officers 3,877,980 11.8% and Directors as a Group (18 Persons) </TABLE> - -------------------- * Less than one percent of the total outstanding shares of common stock. (1) See "Principal Shareholders of Westfield Financial" for definition of "beneficial ownership." (2) Based on a total of 31,923,903 shares of Westfield Financial's Common Stock outstanding as of January 3, 2007. (3) Includes unvested shares of restricted stock awards held in trust as part of the Westfield Financial, Inc. 2002 Recognition and Retention Plan (the "RRP"), with respect to which the beneficial owner has voting but not investment power as follows: Messrs. Colton, Crowley, Lane, McClure, Placek, Pohl, C. Sullivan, T. Sullivan and Ms. O'Neil each - 3,281 shares; Mr. Hagan - 6,563 shares; Mr. Janosco - 19,294 shares; Ms. Kozaczka - 5,578 shares; Mr. Miles - 656 shares and Mr. Williams - 32,157 shares. 99
(4) Includes shares allocated to the account of the individuals under the Westfield Financial, Inc. Employee Stock Ownership Plan (the "ESOP") with respect to which each individual has voting but not investment powers as follows; Mr. Carra - 6,634 shares; Mr. Janosco - 8,154 shares; Mr. Hagan - 6,526 shares; Ms. Kozaczka - 4,561 shares; Mr. Miles - 4,931 shares and Mr. Williams - 8,861 shares. Includes shares held in trust in Westfield Bank's 401(k) Plan as to which each participant has investment but not voting powers as follows: Mr. Carra - 44,423 shares; Mr. Hagan - 6,764 shares; Mr. Janosco - 17,000 shares; Ms. Kozaczka - 5,252 shares; Mr. Miles - 5,909 shares and Mr. Williams - 34,756 shares. (5) Includes 34,124 shares of common stock which may be acquired by each of Messrs. Colton, Crowley, Lane, McClure, Pohl, C. Sullivan, T. Sullivan and Ms. O'Neil, and 25,595 shares of common stock which may be acquired by Mr. Placek, pursuant to vested options granted to them under the 2002 Stock Option Plan (the "Stock Option Plan"). Also includes shares of common stock which may be acquired pursuant to vested options issued under the Stock Option Plan as follows: Mr. Hagan - 31,500 shares; Mr. Janosco - 189,004 shares; Ms. Kozaczka - 23,626 shares; Mr. Miles - 3,281 shares and Mr. Williams -315,012 shares. (6) Includes 2,263 shares held in an individual retirement account ("IRA") for the benefit of Mr. Carra's spouse, 2,723 shares held in an IRA for the benefit of Mr. Carra, and 24,935 shares held jointly with Mr. Carra's spouse. (7) Includes 4,698 shares held in an IRA for the benefit for Mr. Colton's spouse, 3,071 shares held in an IRA for the benefit of Mr. Colton, and 1,640 shares held jointly with Mr. Colton's spouse. (8) Includes 8,203 shares held jointly with Mr. Crowley's spouse. (9) Includes 66,543 shares held jointly with Mr. Janosco's spouse, and 54,742 shares held in an IRA for the benefit of Mr. Janosco. (10) Includes 9,844 shares held jointly with Mr. McClure's spouse. (11) Includes 1,500 shares held jointly by Ms. O'Neil's spouse and 1,312 shares held jointly with Ms. O'Neil's spouse. (12) Includes 19,235 shares held by Mr. Placek's spouse (13) Includes 32,796 shares held jointly with Mr. Pohl's spouse. (14) Includes 13,844 shares held in an IRA for the benefit of Mr. Sullivan. (15) Includes 67,924 shares held jointly with Mr. Williams' spouse, 18,539 shares held in an IRA for the benefit of Mr. Williams, 18,769 shares held in an IRA for the benefit of Mr. Williams' spouse, and 7,000 shares by the Karen F. Williams 2004 Family Trust. (16) The figures shown for each of the executive officers named in the table do not include 1,741,574 shares held in trust pursuant to the ESOP that have not been allocated as of January 3, 2007 to any individual's account and as to which each of the executive officers named in the table share voting powers with the other ESOP participants. The figure shown for all directors and executive officers as a group includes 1,741,574 shares as to which members of Westfield Financial's Compensation Committee (consisting of Messrs. Carra, Pohl and T. Sullivan) may be deemed to have sole investment power, except in limited circumstances, thereby causing each such member to be deemed a beneficial owner of such shares. Each of the members of the Compensation Committee disclaims beneficial ownership of such shares and, accordingly, such shares are not attributed to the members of the Compensation Committee individually. 100
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Transactions with Certain Related Persons Westfield Bank makes loans to its executive officers, employees and directors. These loans are made in the ordinary course of business and on the same terms and conditions as those of comparable transactions with the general public prevailing at the time, in accordance with our underwriting guidelines, and do not involve more than the normal risk of collectibility or present other unfavorable features. At December 31, 2006, loans to non-employee directors and their associates totaled $12.9 million. Director Independence Westfield Financial has determined Directors Crowley, Colton, Lane, McClure, O'Neil, Placek, Pohl, C. Sullivan and T. Sullivan are independent as defined under the American Stock Exchange listing standards. In addition, all members of the Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee are independent as defined under the American Stock Exchange listing standards. ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES Principal Accounting Fees and Services During the fiscal years ended December 31, 2006 and December 31, 2005, respectively, Westfield Financial retained and paid Wolf & Company, P.C. to provide audit and other services as follows: Audit Fees 2006 (3) 2005 -------- -------- Audit (1) $348,100 $249,000 Audit-Related Fees -- -- Tax Fees(2) 28,100 58,000 All Other Fees -- -- -------- -------- Total $376,200 $307,000 ======== ======== - -------------------- (1) Audit fees consisted of audit work performed in the preparation of financial statements as well as work generally only the independent auditors can reasonably be expected to provide, such as statutory audits. (2) Tax fees consisted of assistance with matters related to tax compliance and counseling. (3) Includes fees associated with second step stock conversion. 101
Preapproval Policies and Procedures Preapproval of Services. The Audit Committee shall preapprove all auditing services and permitted non-audit services (including the fees and terms) to be performed for Westfield Financial by its independent registered public accounting firm, subject to the de minimis exception for non-audit services described below which are approved by the Committee prior to completion of the audit. Exception. The preapproval requirement set forth above shall not be applicable with respect to non-audit services if: (i) The aggregate amount of all such services provided constitutes no more than five percent of the total amount of revenues paid by Westfield Financial to its auditor during the fiscal year in which the services are provided; (ii) Such services were not recognized by Westfield Financial at the time of the engagement to be non-audit services; and (iii) Such services are promptly brought to the attention of the Committee and approved prior to the completion of the audit by the Committee or by one or more members of the Committee who are members of the Board of Directors to whom authority to grant such approvals has been delegated by the Committee. Delegation. The Committee may delegate to one or more designated members of the Committee the authority to grant required preapprovals. The decisions of any member to whom authority is delegated under this paragraph to preapprove activities under this subsection shall be presented to the full Committee at its next scheduled meeting. The Audit Committee preapproved 100% of the services performed by the independent registered public accounting firm pursuant to the policies outlined above. 102
PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES a. Financial Statements Reference is made to the Consolidated Financial Statements included in Item 8 of Part II hereof. b. Exhibits 2.1 Amended and Restated Plan of Conversion and Stock Issuance of Westfield Mutual Holding Company, Westfield Financial, Inc. and Westfield Bank. (1) 3.1 Articles of Organization of Westfield Financial, Inc. (2) 3.2 Bylaws of Westfield Financial, Inc. (2) 4.1 Form of Stock Certificate of Westfield Financial, Inc. (1) 10.1 Form of Employee Stock Ownership Plan of Westfield Financial, Inc. (3) 10.2 Amendments to the Employee Stock Ownership Plan of Westfield Financial, Inc. (4) 10.3 Form of Director's Deferred Compensation Plan. (5) 10.4 The 401(k) Plan adopted by Westfield Bank. (6) 10.5 Form of Benefit Restoration Plan of Westfield Financial, Inc. (5) 10.6 Form of Amended and Restated Deferred Compensation Agreement with Donald A. Williams. (5) 10.7 Form of Employment Agreement between Donald A. Williams and Westfield Bank. (1) 10.8 Form of Employment Agreement between Michael J. Janosco, Jr. and Westfield Bank. (1) 10.9 Form of Employment Agreement between James C. Hagan and Westfield Bank. (1) 10.10 Form of Employment Agreement between Donald A. Williams and New Westfield Financial, Inc. (1) 10.11 Form of Employment Agreement between Michael J. Janosco, Jr. and New Westfield Financial, Inc. (1) 10.12 Form of Employment Agreement between James C. Hagan and New Westfield Financial, Inc. (1) 10.13 Form of One Year Change in Control Agreement by and among certain officers and New Westfield Financial, Inc. and Westfield Bank. (1) 103
10.14 Agreement between Westfield Bank and Village Mortgage Company. (1) 14.1 Code of Ethics. (7) 23.1 Consent of Wolf & Company, P.C. 31.1 Rule 13a-14(a)/15d-14(a) Certifications 32.1 Section 1350 Certifications - -------------------- (1) Incorporated by reference to the Registration Statement No. 333-137024 on Form S-1 filed with the Securities and Exchange Commission on August 31, 2006, as amended. (2) Incorporated by reference to the Form 8-K filed with the Securities and Exchange Commission on January 5, 2007. (3) Incorporated herein by reference to the Registration Statement No. 333-68550 on Form S-1 filed with the Securities and Exchange Commission on August 28, 2001, as amended. (4) Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 31, 2003. (5) Incorporated by reference to the Form 8-K filed with the Securities and Exchange Commission on December 22, 2005. (6) Incorporated herein by reference to the Post-Effective Amendment No. 1 to the Registration Statement No. 333-73132 on Form S-8 filed with the Securities and Exchange Commission on April 28, 2006. (7) Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 15, 2005. 104
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, 2007. WESTFIELD FINANCIAL, INC. By: /s/ Donald A. Williams -------------------------------- Donald A. Williams Chairman and Chief Executive Officer 105
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. <TABLE> <CAPTION> Name Title Date ---- ----- ---- <S> <C> <C> /s/ Donald A. Williams Chairman and Chief Executive Officer March 15, 2007 - --------------------------- (Principal Executive Officer) Donald A. Williams /s/ Michael J. Janosco, Jr. Chief Financial Officer and Treasurer March 15, 2007 - --------------------------- (Principal Accounting Officer) Michael J. Janosco, Jr. /s/ Victor J. Carra Director March 15, 2007 - --------------------------- Victor J. Carra /s/ David C. Colton, Jr. Director March 15, 2007 - --------------------------- David C. Colton, Jr. /s/ Robert T. Crowley, Jr. Director March 15, 2007 - --------------------------- Robert T. Crowley, Jr. /s/ Harry C. Lane Director March 15, 2007 - --------------------------- Harry C. Lane /s/ William H. McClure Director March 15, 2007 - --------------------------- William H. McClure /s/ Mary C. O'Neil Director March 15, 2007 - --------------------------- Mary C. O'Neil /s/ Richard C. Placek Director March 15, 2007 - --------------------------- Richard C. Placek /s/ Paul R. Pohl Director March 15, 2007 - --------------------------- Paul R. Pohl /s/ Charles E. Sullivan Director March 15, 2007 - --------------------------- Charles E. Sullivan /s/ Thomas C. Sullivan Director March 15, 2007 - --------------------------- Thomas C. Sullivan </TABLE>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders Westfield Financial, Inc. We have audited the accompanying consolidated balance sheets of Westfield Financial, Inc. and subsidiaries (the "Company") as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with 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 audits provide a reasonable basis for our opinion. In our opinion, the 2006 and 2005 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, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006 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, 2006 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 9, 2007 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. WOLF & COMPANY, P.C. Boston, Massachusetts March 9, 2007 F-1
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts) <TABLE> <CAPTION> December 31, --------------------- 2006 2005 ---- ---- <S> <C> <C> ASSETS CASH AND DUE FROM BANKS $ 51,645 $ 18,136 FEDERAL FUNDS SOLD 97,659 5,090 INTEREST-BEARING DEPOSITS AND OTHER SHORT TERM INVESTMENTS 5,204 3,230 -------- -------- CASH AND CASH EQUIVALENTS 154,508 26,456 -------- -------- SECURITIES: Available for Sale - at estimated fair value 41,687 28,321 Held to Maturity - at amortized cost (estimated fair value of $76,938 at December 31, 2006 and $72,704 at December 31, 2005) 77,299 73,323 MORTGAGE-BACKED SECURITIES: Available for Sale - at estimated fair value 126,942 101,138 Held to Maturity - at amortized cost (estimated fair value of $160,709 at December 31, 2006 and $149,017 at December 31, 2005) 163,093 152,127 FEDERAL HOME LOAN BANK OF BOSTON AND OTHER STOCK-AT COST 4,246 4,237 LOANS - Net of allowance for loan losses of $5,437 at December 31, 2006 and $5,422 at December 31, 2005 385,184 378,837 PREMISES AND EQUIPMENT - NET 12,247 11,048 ACCRUED INTEREST RECEIVABLE 4,502 3,853 BANK-OWNED LIFE INSURANCE 20,619 19,819 OTHER ASSETS 6,502 5,936 -------- -------- TOTAL ASSETS $996,829 $805,095 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: DEPOSITS: Noninterest-bearing $ 42,383 $ 45,260 Interest-bearing 585,083 577,785 -------- -------- Total deposits 627,466 623,045 -------- -------- CUSTOMER REPURCHASE AGREEMENTS 17,919 14,441 FEDERAL HOME LOAN BANK OF BOSTON ADVANCES 55,000 45,000 OTHER LIABILITIES 7,036 6,767 -------- -------- TOTAL LIABILITIES 707,421 689,253 -------- -------- COMMITMENTS AND CONTINGENCIES (NOTE 16) STOCKHOLDERS' EQUITY: Preferred stock - $.01 par value, 5,000,000 shares authorized, none outstanding at December 31, 2006 and 2005 - - Common stock - $.01 par value, 25,000,000 shares authorized, 10,580,000 shares issued, 9,728,912 and 9,754,757 shares outstanding at December 31, 2006 and December 31, 2005, respectively (see Note 23) 274 98 Additional paid-in capital (see Note 23) 201,736 30,120 Unallocated common stock of Employee Stock Ownership Plan (4,835) (5,127) Unearned compensation (405) (861) Retained earnings 93,364 92,789 Accumulated other comprehensive loss (726) (1,177) -------- -------- Total stockholders' equity 289,408 115,842 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $996,829 $805,095 ======== ======== </TABLE> See notes to consolidated financial statements. F-2
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share amounts) <TABLE> <CAPTION> Years Ended December 31, ------------------------------- 2006 2005 2004 ---- ---- ---- <S> <C> <C> <C> INTEREST AND DIVIDEND INCOME: Residential and commercial real estate loans $17,551 $15,901 $14,644 Debt securities, taxable 14,396 11,829 11,660 Commercial and industrial loans 7,475 6,409 5,087 Debt securities, tax-exempt 1,230 1,200 1,065 Federal funds sold 770 788 288 Marketable equity securities 501 404 355 Consumer loans 410 631 1,212 Interest-bearing deposits and other short term investments 102 144 117 ------- ------- ------- Total interest and dividend income 42,435 37,306 34,428 ------- ------- ------- INTEREST EXPENSE: Deposits 17,268 11,813 9,625 Customer repurchase agreements 438 312 195 Federal Home Loan Bank advances 1,845 1,472 1,093 ------- ------- ------- Total interest expense 19,551 13,597 10,913 ------- ------- ------- Net interest and dividend income 22,884 23,709 23,515 PROVISION FOR LOAN LOSSES 390 465 750 ------- ------- ------- Net interest and dividend income after provision for loan losses 22,494 23,244 22,765 ------- ------- ------- NONINTEREST INCOME: Income from bank-owned life insurance 800 758 741 Service charges and fees 2,651 2,595 2,278 Gains on sales and writedowns of securities, net - 19 877 Loss on sale of fixed assets, net 378 - - ------- ------- ------- Total noninterest income 3,073 3,372 3,896 ------- ------- ------- NONINTEREST EXPENSE: Salaries and employee benefits 11,985 11,155 10,753 Occupancy 2,060 1,927 1,808 Computer operations 1,446 1,557 1,582 Professional fees 1,081 943 893 Stationery, supplies and postage 510 522 530 Other 2,308 2,360 2,210 ------- ------- ------- Total noninterest expense 19,390 18,464 17,776 ------- ------- ------- INCOME BEFORE INCOME TAXES 6,177 8,152 8,885 INCOME TAXES 1,523 1,933 2,562 ------- ------- ------- NET INCOME $ 4,654 $ 6,219 $ 6,323 ======= ======= ======= EARNINGS PER COMMON SHARE: Basic earnings per share $ 0.50 $ 0.66 $ 0.65 Diluted earnings per share $ 0.49 $ 0.64 $ 0.64 </TABLE> See notes to consolidated financial statements. F-3
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands, except per share amounts) <TABLE> <CAPTION> Restricted Accumulated Additional Stock Other Common Stock Paid-In Unallocated Unearned Retained Comprehensive Shares Amount Capital ESOP Compensation Earnings (Loss) Income Total ------ ------ ---------- ----------- ------------ -------- ------------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> BALANCE, JANUARY 1, 2004 10,522,300 $105 $ 46,048 $(5,837) $(2,094) $85,794 $ 788 $124,804 -------- Comprehensive income: Net income - - - - - 6,323 - 6,323 Unrealized losses on securities arising during the year, net of tax benefit of $161 - - - - - - (324) (324) Reclassification for gains included in net income, net of taxes of $291 - - - - - - (586) (586) -------- Comprehensive income - - - - - - - 5,413 -------- Shared-based compensation - - 516 410 551 - - 1,477 Common stock repurchased (569,588) (6) (11,950) - - - - (11,956) Issuance of common stock in connection with stock option exercises 1,800 1 30 - - (5) - 26 Cash dividends declared ($0.30 per share) - - - - - (1,713) - (1,713) ---------- ---- -------- ------- ------- ------- ------- -------- BALANCE, DECEMBER 31, 2004 9,954,512 100 34,644 (5,427) (1,543) 90,399 (122) 118,051 -------- Comprehensive income: Net income - - - - - 6,219 - 6,219 Unrealized losses on securities arising during the year, net of tax benefit of $622 - - - - - - (1,043) (1,043) Reclassification for gains included in net income, net of taxes of $7 - - - - - - (12) (12) -------- Comprehensive income - - - - - - - 5,164 -------- Shared-based compensation - - 361 300 682 - - 1,343 Common stock repurchased (237,400) (2) (5,697) - - - - (5,699) Issuance of common stock in connection with stock option exercises 37,645 - 812 - - (271) - 541 Cash dividends declared ($0.90 per share) - - - - - (3,558) - (3,558) -------- BALANCE, DECEMBER 31, 2005 9,754,757 98 30,120 (5,127) (861) 92,789 (1,177) 115,842 ---------- ---- -------- ------- ------- ------- ------- -------- Comprehensive income: Net income - - - - - 4,654 - 4,654 Unrealized losses on securities arising during the year, net of tax benefit of $204 - - - - - - 374 374 -------- Comprehensive income 5,028 -------- Adjustment to initially apply FASB Statement No. 158, net of tax benefit of $40 - - - - - - 77 77 Net proceeds from sale of common stock - 177 171,535 - - - - 171,712 Share-based compensation - - 546 292 456 - - 1,294 Excess tax benefits from share-based compensation - - 260 - - - - 260 Common stock repurchased (65,000) (1) (1,582) - - - - (1,583) Issuance of common stock in connection with stock option exercises 39,155 - 857 - - (294) - 563 Cash dividends declared ($1.00 per share) - - - - - (3,785) - (3,785) ---------- ---- -------- ------- ------- ------- ------- -------- BALANCE, DECEMBER 31, 2006 9,728,912 $274 $201,736 $(4,835) $ (405) $93,364 $ (726) $289,408 ========== ==== ======== ======= ======= ======= ======= ======== </TABLE> See notes to consolidated financial statements. F-4
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in thousands) <TABLE> <CAPTION> Years Ended December 31, ------------------------------------ 2006 2005 2004 ---- ---- ---- <S> <C> <C> <C> OPERATING ACTIVITIES: Net Income $ 4,654 $ 6,219 $ 6,323 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 390 465 750 Depreciation and amortization of premises and equipment 1,030 950 1,003 Net amortization of premiums and discounts on securities, mortgage backed securities and mortgage loans 657 1,080 1,452 Shared-based compensation expense 2,075 1,678 1,962 Excess tax benefits from share-based compensation (260) - - Loss on sale of fixed assets, net 378 - - Gains on sales and writedown of securities, net - (19) (877) Deferred income tax benefit (256) (334) (615) Income from bank-owned life insurance (800) (758) (741) Changes in assets and liabilities: Accrued interest receivable (649) (302) 4 Other assets (436) 857 748 Other liabilities 270 151 155 -------- -------- -------- Net cash provided by operating activities 7,053 9,987 10,164 -------- -------- -------- INVESTING ACTIVITIES: Securities, held to maturity: Purchases (17,097) (11,131) (18,473) Proceeds from maturities and principal collections 13,000 9,000 17,000 Securities, available for sale: Purchases (21,295) (17,982) (5,332) Proceeds from sales 5,000 3,833 11,891 Proceeds from calls, maturities and principal collections 3,000 548 4,155 Mortgage-backed securities, held to maturity: Purchases (48,727) (24,979) (39,255) Principal collections 37,368 47,528 54,687 Mortgage-backed securities, available for sale: Purchases (51,720) (71,791) (41,110) Proceeds from sales - 16,962 20,325 Principal collections 26,307 25,305 22,943 Purchase of Federal Home Loan Bank of Boston and other stock (9) - - Purchase of residential mortgages (11,845) (1,236) (35,294) Net decrease (increase) in loans 5,080 (9,528) 10,864 Purchases of premises and equipment (2,618) (493) (734) Proceeds from sale of fixed assets 10 - - Purchase of bank-owned life insurance - - (1,813) -------- -------- -------- Net cash (used in) provided by investing activities (63,546) (35,777) 1,667 -------- -------- -------- FINANCING ACTIVITIES: Increase (decrease) in deposits 4,421 10,424 (19,810) Increase (decrease) in customer repurchase agreements 3,478 (174) 2,480 Repayment of Federal Home Loan Bank of Boston advances (10,000) (5,000) - Advances from Federal Home Loan Bank of Boston 20,000 5,000 25,000 Net proceeds from sale of common stock 171,712 - - Cash dividends paid (3,785) (3,558) (1,713) Common stock repurchased (1,583) (5,699) (11,956) Issuance of common stock in connection with stock option exercises 563 541 26 Purchase of common stock in connection with employee benefit program (521) (335) (485) Excess tax benefits from share-based compensation 260 - - -------- -------- -------- Net cash provided by (used in) financing activities 184,545 1,199 (6,458) -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS: 128,052 (24,591) 5,373 Beginning of year 26,456 51,047 45,674 -------- -------- -------- End of year $154,508 $ 26,456 $ 51,047 ======== ======== ======== </TABLE> See notes to consolidated financial statements. F-5
WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Basis of Presentation - Westfield Financial, Inc. (the "Company") 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. Westfield Securities Corp., and Elm Street Securities Corporation, Massachusetts chartered security corporations, were formed by the Company for the primary purpose of holding qualified investment securities. In the third quarter of 2005, the Company dissolved Westfield Securities Corporation in order to streamline operations. Principles of Consolidation - The consolidated financial statements include the accounts of the Company, the Bank, and Elm Street Securities Corporation, as well as Westfield Securities Corp., 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, 2006 and 2005 includes partially restricted cash of approximately $417,000, and $291,000 respectively, for Federal Reserve Bank of Boston cash reserve requirements. F-6
Securities and Mortgage-Backed Securities - Debt 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 comprehensive income. 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 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 Company 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 based on the contractual terms of the loan, 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 against interest income 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 - F-7
Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. 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. 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 consumer and residential real estate loans. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews 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 years presented. F-8
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 and amortization, computed on the straight-line method over the estimated useful lives of the assets, or the expected lease term, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured. 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. There was no other real estate owned at December 31, 2006 and 2005, respectively. 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. In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Post Retirement Plans" ("SFAS 158"), which requires employers to (a) recognize in its statement of financial position the funded status of a benefit plan, (b) measure a plan's assets and its obligations that determine its funded status as of the end of the employer's fiscal year, (c) recognize, through other comprehensive income, net of tax, changes in the funded status of the benefit plan that are not recognized as net periodic benefit cost, and (d) disclose additional information about certain effects on net periodic benefit cost for the next fiscal year that relate to the delayed recognition of certain benefit cost elements. The requirement to recognize the funded status of a benefit plan and provide additional disclosures is effective as of December 31, 2006. F-9
The following table illustrates the incremental effect of applying SFAS 158 on individual line items in the consolidated balance sheet as of December 31, 2006. Before After Application Application of SFAS 158 Adjustments of SFAS 158 ----------- ----------- ----------- (In thousands) Accrued pension benefit $ 2,139 $(117) $ 2,022 Net deferred tax asset 4,635 (40) 4,595 Total assets 996,869 (40) 996,829 Accumulated other comprehensive loss (803) 77 (726) Total stockholders' equity 289,331 77 289,408 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 and are determined using the treasury stock method. Earnings per common share for the years ended December 31, have been computed based on the following: <TABLE> <CAPTION> 2006 2005 2004 ---- ---- ---- (In thousands, except per share data) <S> <C> <C> <C> Net income available to common stockholders $4,654 $6,219 $6,323 ====== ====== ====== Weighted average number of common shares outstanding 9,343 9,467 9,706 Effect of dilutive stock awards and options 165 231 224 ------ ------ ------- Adjusted weighted average number of common shares outstanding used to calculate diluted earnings per common shares 9,508 9,698 9,930 ====== ====== ======= Basic earnings per share $ 0.50 $ 0.66 $ 0.65 Diluted earnings per share $ 0.49 $ 0.64 $ 0.64 </TABLE> Reclassifications - Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. F-10
Adoption of SFAS 123(R) Share-Based Payment - On January 1, 2006, the Company adopted SFAS 123(R), Share-Based Payment ("SFAS 123(R)" or the "Statement"), which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The effect of SFAS 123(R) is that entities are required 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. SFAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. The Company uses the binomial model for its adoption of the Statement. The Company adopted SFAS 123(R) on January 1, 2006 using the "modified prospective" method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS 123(R). Also under this method, expense is recognized for awards that were granted prior to January 1, 2006 but vest after January 1, 2006, based on the fair value determined at the grant date under SFAS 123, Accounting for Stock-Based Compensation (SFAS 123). Prior to the adoption of SFAS 123(R), the Company accounted for stock compensation under the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations. Accordingly, the Company previously recognized no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant. The adoption of SFAS 123(R) by the Company resulted in additional share-based compensation expense of $293,000 and a related tax benefit of $69,000 for the year ended December 31, 2006. The increase in stock-based compensation expense resulted in a $0.02 decrease in basic earnings per share and a $0.02 decrease in diluted earnings per share for the year ended December 31, 2006. As of December 31, 2006, the compensation cost of unvested stock options amounted to $183,000 with a related tax benefit of $40,000. Compensation costs of $164,000 with a related tax benefit of $40,000 will be recognized by July of 2007. 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 with a maximum term of ten years. All options currently outstanding vest at 20% per year. Had compensation cost been determined based on the fair value at the grant date of awards under the plans consistent with the method prescribed by SFAS 123(R), the Company's net income and income per share for the years ended December 31, 2005 and 2004 would have been adjusted to the pro forma amounts as follows: F-11
2005 2004 ---- ---- (In thousands, except per share data) Net income, as reported $6,219 $6,323 Less: Compensation expense determined under fair value based method for all awards, net of tax effects (333) (272) ------ ------ Pro forma net income $5,886 $6,051 ====== ====== Net income per share: Basic as reported $ 0.66 $ 0.65 Basic pro forma 0.62 0.62 Diluted as reported 0.64 0.64 Diluted pro forma 0.61 0.61 The fair value of each option grant is estimated on the date of grant with the following weighted average assumptions: Years Ended December 31, 2005 2004 ---- ---- Dividend yield 1.70% 1.02% Expected life in years 10 years 10 years Expected volatility 21% 17% Risk-free interest rate 4.14% 4.16% No options were granted during the year ended December 31, 2006. Comprehensive Income/Loss Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The components of other comprehensive income/loss and related tax effects are as follows: Years Ended December 31, --------------------------- 2006 2005 2004 ---- ---- ---- (In thousands) Unrealized holding gains (losses) on available for sale securities $ 578 $(1,665) $ (485) Reclassification adjustment for gains realized in income - (19) (877) ----- ------- ------- Net unrealized gains (losses) 578 (1,684) (1,362) Tax effect (204) 629 452 ----- ------- ------- Net-of-tax amount 374 (1,055) (910) ----- ------- ------- Adjustment to initially apply SFAS No. 158 117 - - Tax effect (40) - - ----- ------- ------- Net-of-tax amount 77 - - ----- ------- ------- $ 451 $(1,055) $ (910) ===== ======= ======= F-12
The components of accumulated other comprehensive income, included in stockholders' equity, are as follows: December 31, ----------------- 2006 2005 ---- ---- (In thousands) Net unrealized loss on securities available for sale $(1,274) $(1,852) Tax effect 471 675 ------- ------- Net-of-tax amount (803) (1,177) ------- ------- Unrecognized transition asset pertaining to defined benefit plan 92 - Unrecognized deferred gain pertaining to defined benefit plan 25 - ------- ------- 117 - Tax effect (40) - ------- ------- Net-of-tax amount 77 - ------- ------- $ (726) $(1,177) ======= ======= Recent Accounting Pronouncements--In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets," which amends FASB Statement No. 140. This Statement requires that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this Statement permits an entity to choose either of the following subsequent measurement methods: (1) amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss, or (2) report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur (the "fair value method"). This Statement also requires additional disclosures for all separately recognized servicing rights and is effective for new transactions occurring and for subsequent measurement at the beginning of the Company's 2007 calendar year. As management does not plan to adopt the fair value method of accounting for its servicing rights and the amounts of servicing rights are not material, this Statement is not expected to have a material impact on the Company's consolidated financial statements. In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is not expected to have a material impact on the Company's consolidated financial statements. In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is effective for the Company on January 1, 2008 and is not expected to have a material impact on the Company's consolidated financial statements. F-13
In September 2006, FASB issued Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132 (R)." This Statement improves financial reporting by requiring employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income or a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement is effective for the Company for the year ended December 31, 2006 and is not expected to have a material impact on the Company's consolidated financial statements. In September 2006, the FASB ratified EITF 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements." This issue addresses accounting for split-dollar life insurance arrangements whereby the employer purchases a policy to insure the life of an employee, and separately enters into an agreement to split the policy benefits between the employer and the employee. This EITF states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits. Under EITF 06-4, the obligation is not settled upon entering into an insurance arrangement. Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. The Company is in the process of evaluating the potential impacts of adopting EITF 06-4 on its consolidated financial statements. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 108. SAB No. 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company's balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under the other approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. SAB 108 is applicable to all financial statements issued by the Company for the year ended December 31, 2006 and does not have a material impact on those financial statements. In February 2007, the FASB issued Statement of financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). This Statement provides companies with an option to report selected financial assets and liabilities at fair value. The Standard's objective is to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. This Statement is effective as of the beginning of an entity's first fiscal year beginning after November 15, 2007. Early adoption is permitted if the Company makes the choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS 157. The Company does not expect SFAS 159 to have a material impact on the Company's consolidated financial statements. F-14
2. SECURITIES Securities are summarized as follows: <TABLE> <CAPTION> December 31, 2006 -------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Government-sponsored enterprises $ 47,095 $ 42 $ 586 $ 46,551 Municipal bonds 30,204 316 133 30,387 -------- ---- ------ -------- Total held to maturity 77,299 358 719 76,938 -------- ---- ------ -------- Available for sale: Government-sponsored enterprises 34,821 79 209 34,691 Equity securities 7,260 - 264 6,996 -------- ---- ------ -------- Total available for sale 42,081 79 473 41,687 -------- ---- ------ -------- Total Securities $119,380 $437 $1,192 $118,625 ======== ==== ====== ======== <CAPTION> December 31, 2005 -------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Government-sponsored enterprises $ 43,090 $ 6 $ 731 $ 42,365 Municipal bonds 30,233 289 183 30,339 -------- ---- ------ -------- Total held to maturity 73,323 295 914 72,704 -------- ---- ------ -------- Available for sale: Government-sponsored enterprises 22,728 4 153 22,579 Equity securities 6,057 - 315 5,742 -------- ---- ------ -------- Total available for sale 28,785 4 468 28,321 -------- ---- ------ -------- Total Securities $102,108 $299 $1,382 $101,025 ======== ==== ====== ======== </TABLE> F-15
Information pertaining to securities with gross unrealized losses at December 31, 2006 and 2005, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows: <TABLE> <CAPTION> December 31, 2006 ------------------------------------------------ Less than Twelve Months Over Twelve Months ----------------------- --------------------- Gross Gross Unrealized Fair Unrealized Fair Losses Value Losses Value ---------- ----- ---------- ----- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Government-sponsored enterprises $ 34 $11,973 $ 552 $24,446 Municipal bonds 48 7,993 85 4,805 ---- ------- ------ ------- Total held to maturity 82 19,966 637 29,251 ---- ------- ------ ------- Available for sale: Government-sponsored enterprises 38 9,962 171 14,549 Equity securities - - 264 5,518 ---- ------- ------ ------- Total available for sale 38 9,962 435 20,067 ---- ------- ------ ------- Total temporarily impaired securities $120 $29,928 $1,072 $49,318 ==== ======= ====== ======= <CAPTION> December 31, 2005 ------------------------------------------------ Less than Twelve Months Over Twelve Months ----------------------- --------------------- Gross Gross Unrealized Fair Unrealized Fair Losses Value Losses Value ---------- ----- ---------- ----- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Government-sponsored enterprises $222 $14,792 $ 509 $22,567 Municipal bonds 78 8,586 105 2,748 ---- ------- ------ ------- Total held to maturity 300 23,378 614 25,315 ---- ------- ------ ------- Available for sale: Government-sponsored enterprises 153 17,575 - - Equity securities - - 315 5,264 ---- ------- ------ ------- Total available for sale 153 17,575 315 5,264 ---- ------- ------ ------- Total temporarily impaired securities $453 $40,953 $ 929 $30,579 ==== ======= ====== ======= </TABLE> At December 31, 2006, fourteen debt securities have gross unrealized losses of 0.4% from the Company's amortized cost basis of temporarily impaired debt securities which existed for less than twelve months. Because these losses relate to government-sponsored enterprises 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. F-16
At December 31, 2006, fifteen debt securities have gross unrealized losses of 1.8% from the Company's amortized cost basis of temporarily impaired debt securities which existed for greater than twelve months. Because these losses relate to government-sponsored enterprises 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, 2006, three equity securities have an unrealized loss of 3.8% from the Company's cost basis which existed for greater 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, 2006, one equity security has an unrealized loss of 8.4% from the Company's cost basis which existed for greater than twelve months. Because the security is an adjustable rate preferred stock issued by a government-sponsored enterprise, the unrealized loss is principally related to fluctuations in interest rates, and management has the intent and ability to hold this security for the foreseeable future, the decline is not deemed to be other than temporary. December 31, 2006 ----------------------- Amortized Estimated Cost Fair Value --------- ---------- (In thousands) Held to maturity: Due in one year or less $10,000 $ 9,970 Due after one year through five years 23,577 23,462 Due after five years through ten years 28,832 28,444 Due after ten years 14,890 15,062 ------- ------- Total held to maturity $77,299 $76,938 ======= ======= Available for sale: Due in one year or less $ 6,000 $ 5,952 Due after one year through five years 23,831 23,859 Due after five years through ten years 4,990 4,880 ------- ------- Total available for sale $34,821 $34,691 ======= ======= Gross gains of $0, $34,000, and $1,130,000, and gross losses of $0, $1,000, and $39,000 were recorded on sales of securities during the years ended December 31, 2006, 2005, and 2004, respectively. There were no impairment losses recognized during 2006, 2005 and 2004. Proceeds from the sale of securities amounted to $5.0 million, $3.8 million and $11.9 million at December 31, 2006, 2005 and 2004, respectively. Securities with a carrying value of $40 million and $35 million were pledged as collateral at the Federal Reserve Bank of Boston at December 31, 2006 and 2005, respectively, to secure public deposits and repurchase agreements. Unrealized losses on securities available for sale, net of tax were $240,000 and $283,000 at December 31, 2006 and 2005, respectively. F-17
3. MORTGAGE-BACKED SECURITIES Mortgage-backed securities are summarized as follows: <TABLE> <CAPTION> December 31, 2006 -------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Fannie Mae $103,344 $181 $1,945 $101,580 Freddie Mac 41,418 129 448 41,099 Ginnie Mae 13,425 1 274 13,152 Collateralized mortgage obligations 4,906 - 28 4,878 Total held to maturity 163,093 311 2,695 160,709 -------- ---- ------ -------- Available for sale: Fannie Mae 47,203 $ 20 $ 493 $ 46,730 Freddie Mac 49,554 109 285 49,378 Ginnie Mae 8,635 10 102 8,543 Collateralized mortgage obligations 22,430 46 185 22,291 -------- ---- ------ -------- Total available for sale 127,822 185 1,065 126,942 -------- ---- ------ -------- Total Mortgage-Backed Securities $290,915 $496 $3,760 $287,651 ======== ==== ====== ======== <CAPTION> December 31, 2005 -------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Fannie Mae $ 98,362 $ 34 $2,300 $ 96,096 Freddie Mac 36,465 78 572 35,971 Ginnie Mae 17,300 4 354 16,950 -------- ---- ------ -------- Total held to maturity 152,127 116 3,226 149,017 -------- ---- ------ -------- Available for sale: Fannie Mae 46,078 40 742 45,376 Freddie Mac 38,310 12 459 37,863 Ginnie Mae 12,594 22 230 12,386 Other pass-through securities 4,726 - 17 4,709 Collateralized mortgage obligations 818 - 14 804 -------- ---- ------ -------- Total available for sale 102,526 74 1,462 101,138 -------- ---- ------ -------- Total Mortgage-Backed Securities $254,653 $190 $4,688 $250,155 ======== ==== ====== ======== </TABLE> F-18
Gross gains of $0, $27,000 and $135,000 and gross losses of $0, $41,000, and $349,000 were recorded on sales of mortgage-backed securities during the years ended December 31, 2006, 2005, and 2004, respectively. Proceeds from the sale of mortgage-backed securities amounted to $0, $17.0 million and $20.3 million at December 31, 2006, 2005 and 2004, respectively. Unrealized losses on mortgage-backed securities available for sale, net of tax were $563,000 and $894,000 at December 31, 2006 and 2005, respectively. Information pertaining to securities with gross unrealized losses at December 31, 2006 and 2005, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows: <TABLE> <CAPTION> December 31, 2006 ------------------------------------------------ Less than Twelve Months Over Twelve Months ----------------------- --------------------- Gross Gross Unrealized Fair Unrealized Fair Losses Value Losses Value ---------- ----- ---------- ----- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Fannie Mae $ 15 $ 3,176 $1,930 $ 67,630 Freddie Mac 13 772 435 18,793 Ginnie Mae 1 361 273 12,699 Collateralized mortgage obligations 28 4,878 - - ---- ------- ------ -------- Total held to maturity 57 9,187 2,638 99,122 ---- ------- ------ -------- Available for sale: Fannie Mae 19 10,960 474 30,842 Freddie Mac 29 10,681 256 24,820 Ginnie Mae - - 102 6,496 Collateralized mortgage obligations 182 14,061 3 3,604 ---- ------- ------ -------- Total available for sale 230 35,702 835 65,762 ---- ------- ------ -------- Total temporarily impaired securities $287 $44,889 $3,473 $164,884 ==== ======= ====== ======== F-19
<CAPTION> December 31, 2005 ------------------------------------------------ Less than Twelve Months Over Twelve Months ----------------------- --------------------- Gross Gross Unrealized Fair Unrealized Fair Losses Value Losses Value ---------- ----- ---------- ----- (In thousands) <S> <C> <C> <C> <C> Held to maturity: Fannie Mae $ 452 $ 26,869 $1,848 $ 64,076 Freddie Mac 25 5,120 547 16,954 Ginnie Mae 178 8,424 176 7,772 ------ -------- ------ -------- Total held to maturity 655 40,413 2,571 88,802 ------ -------- ------ -------- Available for sale: Fannie Mae 691 40,327 51 3,935 Freddie Mac 376 28,952 83 5,707 Ginnie Mae 214 8,020 16 836 Other pass-thru securities 17 4,709 - - Collateralized mortgage obligations - - 14 804 ------ -------- ------ -------- Total available for sale 1,298 82,008 164 11,282 ------ -------- ------ -------- Total temporarily impaired securities $1,953 $122,421 $2,735 $100,084 ====== ======== ====== ======== </TABLE> At December 31, 2006, twenty-two mortgage-backed securities have gross unrealized losses of 0.6% from the Bank's amortized cost basis which existed for less than twelve months. Because these losses relate to mortgage-backed securities, which were primarily issued by government-sponsored enterprises, 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, 2006, ninety-nine mortgage-backed securities have gross unrealized losses of 2.1% from the Bank's amortized cost basis which existed for greater than twelve months. Because these losses relate to mortgage-backed securities, which were primarily issued by government-sponsored enterprises, 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: December 31, --------------------- 2006 2005 --------------------- (In thousands) Commercial real estate $174,556 $169,564 Residential real estate: Owner-occupied 1-4 family loans 70,640 73,516 Other residential real estate loans 38,900 33,402 Commercial and industrial 100,237 100,019 Consumer 5,841 7,372 -------- -------- Total Loans 390,174 383,873 Unearned premiums and deferred loan fees and costs, net 447 386 Allowance for loan losses (5,437) (5,422) -------- -------- $385,184 $378,837 ======== ======== F-20
The following table summarizes information regarding impaired loans: December 31, -------------- 2006 2005 -------------- (In thousands) Recorded investment in impaired loans $133 $1,641 Specific allowance for impaired loans 20 250 Impaired loans on nonaccrual status 133 1,641 <TABLE> <CAPTION> Years Ended December 31, ------------------------ 2006 2005 2004 ------------------------ (In thousands) <S> <C> <C> <C> Average recorded investment in impaired loans $490 $1,532 $1,787 Income recorded during the period for impaired loans - - 11 Income recorded on cash basis during the period for impaired loans 300 - 12 </TABLE> There were no restructured loans during the years ended December 31, 2006, 2005 and 2004. Nonaccrual loans at December 31, 2006, 2005 and 2004 and related interest income are summarized as follows: At or For the Years Ended December 31, -------------------------- 2006 2005 2004 -------------------------- (In thousands) Amount $1,028 $1,919 $2,171 Interest income that would have been recorded under the original contract terms 67 176 176 Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balances of these loans totaled $13.0 million and $16.3 million at December 31, 2006 and 2005, respectively. Net service fee income of $22,000, $24,000, and $30,000 was recorded for the years ended December 31, 2006, 2005, and 2004, respectively. F-21
5. ALLOWANCE FOR LOAN LOSSES An analysis of changes in the allowance for loan losses is as follows: Years Ended December 31, ---------------------------- 2006 2005 2004 ---------------------------- (In thousands) Balance, beginning of year $5,422 $5,277 $4,642 Provision 390 465 750 Charge-offs (584) (612) (404) Recoveries 209 292 289 ------ ------ ------ Balance, end of year $5,437 $5,422 $5,277 ====== ====== ====== 6. PREMISES AND EQUIPMENT Premises and equipment are summarized as follows: December 31, ------------------- 2006 2005 ------------------- (In thousands) Land $ 2,201 $ 2,201 Buildings 10,008 9,949 Leasehold improvements 1,435 883 Furniture and equipment 6,174 5,614 Construction in process 835 - ------- ------- Total 20,653 18,647 Accumulated depreciation and amortization (8,406) (7,599) ------- ------- Premises and equipment, net $12,247 $11,048 ======= ======= Depreciation and amortization expense for the years ended December 31, 2006, 2005, and 2004 amounted to $1,030,000, $950,000, and $1,003,000, respectively. F-22
7. DEPOSITS Deposit accounts by type and weighted average rates are summarized as follows: December 31, ------------------------------------- 2006 2005 ---------------- ---------------- Amount Rate Amount Rate ---------------- ---------------- (Dollars in thousands) Demand and Now: Now accounts $ 80,527 1.40% $ 69,137 0.83% Demand accounts 42,383 - 45,260 - Savings: Regular accounts 36,110 0.50 41,387 0.50 Money market accounts 94,441 1.51 132,218 1.62 Time certificates of deposit 374,005 4.39 335,043 3.24 -------- -------- Total Deposits $627,466 3.05% $623,045 2.21% ======== ======== Time deposits of $100,000 or more totaled approximately $93.5 million and $71.2 million at December 31, 2006 and 2005, respectively. Interest expense on such deposits totaled $3.6 million, $2.0 million and $1.6 million for the years ended December 31, 2006, 2005, and 2004 respectively. Cash paid for interest was: Years Ended December 31, ----------------------------- 2006 2005 2004 ----------------------------- (In thousands) Deposits $17,249 $11,807 $ 9,615 Customer repurchase agreements 438 312 195 Federal Home Loan Bank of Boston advances 1,785 1,462 1,093 ------- ------- ------- Total $19,472 $13,581 $10,903 ======= ======= ======= At December 31, 2006 and 2005, the scheduled maturities of time certificates of deposit are as follows: 2006 2005 ---------------- ---------------- Amount Rate Amount Rate ------------------------------------- (Dollars in thousands) Within 1 year $270,026 4.40% $227,770 3.05% Over 1 year to 3 years 91,201 4.33 85,951 3.51 Over 3 years to 5 years 12,778 4.56 21,322 4.17 -------- -------- Total certificates of deposits $374,005 4.39% $335,043 3.24% ======== ======== F-23
Interest expense on deposits for the years ended December 31, 2006, 2005, and 2004 is summarized as follows: Years Ended December 31, ---------------------------- 2006 2005 2004 ---------------------------- (In thousands) Savings $ 226 $ 217 $ 234 Money market accounts 1,684 2,117 1,419 Time certificates of deposit 14,450 9,154 7,723 Other interest bearing 908 325 249 ------- ------- ------ $17,268 $11,813 $9,625 ======= ======= ====== 8. CUSTOMER REPURCHASE AGREEMENTS The following table summarizes information regarding repurchase agreements: Years Ended December 31, ---------------------- 2006 2005 ---------------------- (Dollars in thousands) Balance outstanding, end of year $17,919 $14,441 Maximum amount outstanding at any month end during year 20,137 18,116 Average amount outstanding during year 16,632 16,907 Weighted average interest rate, end of year 3.03% 2.16% Book value of collateral pledged, end of year 30,380 35,424 Fair value of collateral pledged, end of year 29,995 34,821 9. FEDERAL HOME LOAN BANK OF BOSTON 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. December 31, December 31, Weighted Average Amount Rate ------------------ ---------------- 2006 2005 2006 2005 ------------------ ---------------- Year of Maturity (Dollars in thousands) 2006 $ - $10,000 -% 3.0% 2007 30,000 20,000 3.9 3.1 2008 15,000 10,000 4.4 4.2 2009 5,000 5,000 3.3 3.3 2014 5,000 - 5.0 - ------- ------- Total advances $55,000 $45,000 4.1% 3.4% ======= ======= F-24
10. LINE OF CREDIT The Company has an "Ideal Way" line of credit with the Federal Home Loan Bank of Boston for $9,541,000 for the years ended December 31, 2006 and 2005. 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 this line at December 31, 2006 and 2005. 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 with a maximum term of 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, 2006 and 2005 is presented below: Weighted Average Shares Exercise Price ------- ---------------- Balance at December 31, 2004 445,200 $14.45 Granted 2,500 24.66 Exercised (37,645) 14.39 ------- Balance at December 31, 2005 410,055 14.52 Granted - - Exercised (39,155) 14.39 ------- Balance at December 31, 2006 370,900 14.53 ======= The weighted average fair value of the options granted in 2005 and 2004 were $7.68 per share and $7.93 per share, respectively. No options were granted during the twelve months ended December 31, 2006. The total intrinsic value of options exercised during the year ended December 31, 2006 was $526,000. Information pertaining to options outstanding at December 31, 2006, 2005 and 2004 is as follows: December 31, 2006 ----------------- Aggregate Aggregate Intrinsic Intrinsic Value of Weighted Average Value of Exercise Number Outstanding Remaining Number Exercisable Price Outstanding Shares Contractual Life Exercisable Shares - -------- ----------- ----------- ---------------- ----------- ----------- (In thousands) (In thousands) $14.39 365,900 $7,395 5.7 Years 291,000 $5,881 24.66 2,500 25 8.2 Years 500 5 25.00 2,500 24 7.2 Years 1,000 10 ------- ------ ------- ------ 370,900 $7,444 292,500 $5,896 ======= ====== ======= ====== F-25
December 31, 2005 ----------------- Aggregate Aggregate Intrinsic Intrinsic Value of Weighted Average Value of Exercise Number Outstanding Remaining Number Exercisable Price Outstanding Shares Contractual Life Exercisable Shares - -------- ----------- ----------- ---------------- ----------- ----------- (In thousands) (In thousands) $14.39 405,055 $3,897 6.6 Years 255,255 $2,456 24.66 2,500 - 9.1 Years 500 - 25.00 2,500 - 8.1 Years 1,000 - ------- ------ ------- ------ 410,055 $3,897 256,755 $2,456 ======= ====== ======= ====== December 31, 2004 ----------------- Aggregate Aggregate Intrinsic Intrinsic Value of Weighted Average Value of Exercise Number Outstanding Remaining Number Exercisable Price Outstanding Shares Contractual Life Exercisable Shares - -------- ----------- ----------- ---------------- ----------- ----------- (In thousands) (In thousands) $14.39 442,700 $5,060 7.6 Years 174,800 $1,998 25.00 2,500 2 9.1 Years 500 - ------- ------ ----------- ------ 445,200 $5,062 175,300 $1,998 ======= ====== ======= ====== 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 SFAS 123 (R) 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. The Company recorded compensation cost related to the stock awards of approximately $481,000 in 2006, $706,000 in 2005 and $551,000 in 2004. Stock awards for 1,000 shares, having a fair value of $25.00 per share, were granted in 2004. Stock awards for 1,000 shares, having a fair value of $24.66 per share, were granted in 2005. No stock awards were granted in 2006. 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. F-26
At December 31, 2006 the remaining principal balance is payable as follows: Years Ending December 31 (In thousands) ------------ -------------- 2007 $ 201 2008 201 2009 201 2010 201 2011 201 Thereafter 4,031 ------ $5,036 ====== 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 $545,000, $458,000 and $440,000 for the years ended December 31, 2006, 2005, and 2004, respectively. Shares held by the ESOP include the following at December 31, 2006 and 2005. 2006 2005 ---- ---- Allocated 68,485 50,863 Committed to be allocated 18,507 18,988 Unallocated 306,449 324,961 ------- ------- 393,441 394,812 ======= ======= 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 unallocated shares was approximately $10.6 million and $7.8 million at December 31, 2006 and 2005, respectively. ESOP shares are considered outstanding for earnings per share calculations based on the number 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. F-27
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: 2006 2005 2004 ---- ---- ---- (In thousands) Change in benefit obligation: Benefit obligation, beginning of year $10,430 $ 8,805 $7,410 Service cost 724 625 548 Interest 600 506 463 Actuarial (gain) loss (594) 648 570 Benefits paid (1,057) (154) (186) ------- ------- ------ Benefit obligation, end of year 10,103 10,430 8,805 ------- ------- ------ Change in plan assets: Fair value of plan assets, beginning of year 7,453 6,536 5,658 Actual return on plan assets 1,109 596 607 Employer contribution 576 475 457 Benefits paid (1,057) (154) (186) ------- ------- ------ Fair value of plan assets, end of year 8,081 7,453 6,536 ------- ------- ------ Funded status (benefit obligation less fair value of plan assets) 2,022 2,978 2,269 Unrecognized net actuarial loss - (1,127) (574) Transition liability - 104 115 ------- ------- ------ Accrued benefit cost $ 2,022 $ 1,955 $1,810 ======= ======= ====== Accumulated benefit obligation $ 5,188 $ 5,313 $4,635 ======= ======= ====== Net pension cost includes the following components for the years ended December 31: 2006 2005 2004 ---- ---- ---- (In thousands) Service cost $ 724 $ 625 $ 548 Interest cost 600 506 463 Expected return on assets (596) (523) (452) Actuarial loss 43 22 7 Transition obligation (12) (11) (12) ----- ----- ----- Net periodic pension cost $ 759 $ 619 $ 554 ===== ===== ===== F-28
The following actuarial assumptions were used in determining the pension benefit obligation and service costs for the years ended December 31: 2006 2005 2004 ---- ---- ---- Weighted-average assumptions: Discount rate 5.75% 5.75% 6.25% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 5.00% 5.00% 5.00% 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 $538,000 to its pension plan in 2007. The Company's pension plan asset allocation at December 31, 2006 and 2005 are as follows: Percentage of Plan Assets at December 31, ------------------ Asset Category 2006 2005 -------------- ---- ---- Fixed Income Securities (including money market) 36.5% 35.1% Domestic Equity 48.5 50.5 International Equity 15.0 14.4 ----- ----- 100.0% 100.0% ===== ===== The target allocation mix for the pension plan for 2006 was an equity-based investment deployment range from 55% to 75% of total portfolio assets. The remainder of the portfolio is allocated to fixed income. 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, are as follows: Benefit Payments to Year Participants ---- ------------------- (In thousands) 2007 $ 690 2008 21 2009 1,014 2010 20 2011 699 In Aggregate for 2012 - 2016 3,989 ------ $6,433 ====== 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. As of December 31, 2006 and 2005, the accrued liability recorded in other liabilities on the consolidated balance sheet amounted to $622,000 and $560,000, respectively. Total expense associated with this plan amounted to $88,000, $81,000 and $71,000 for the years ended December 31, 2006, 2005 and 2004, respectively. F-29
Supplemental Retirement Benefits - The Company provides supplemental retirement benefits to certain key officers. At December 31, 2006 and 2005, the Company had accrued $2.3 million and $2.2 million, respectively, relating to these benefits. Amounts charged to expense were $270,000, $389,000, and $289,000 for the years ended December 31, 2006, 2005 and 2004, respectively. 401(k) - Employees are eligible to participate in a 401(k) plan. 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 contributions to the plan were $149,000, $150,000 and $134,000, for the years ended December 31, 2006, 2005 and 2004, 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),Tier 1 capital (as defined) to average assets (as defined) and of tangible capital (as defined) to tangible assets (as defined). Management believes, as of December 31, 2006 and 2005, that the Bank met all capital adequacy requirements to which it is subject. As of December 31, 2006, 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, 2006 and 2005 are also presented in the table. F-30
<TABLE> <CAPTION> Minimum To Be Well Minimum Capitalized For Capital Under Prompt Adequacy Corrective Actual Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (Dollars in thousands) December 31, 2006 <S> <C> <C> <C> <C> <C> <C> Total Capital (to Risk Weighted Assets): Consolidated $295,404 55.39% $42,662 8.00% N/A - Bank 119,266 22.70 42,029 8.00 $52,536 10.00% Tier 1 Capital (to Risk Weighted Assets): Consolidated 289,967 54.37 21,331 4.00 N/A - Bank 113,856 21.67 21,014 4.00 31,522 6.00 Tier 1 Capital (to Adjusted Total Assets): Consolidated 289,967 29.07 39,905 4.00 N/A - Bank 113,856 11.88 38,327 4.00 47,908 5.00 Tangible Equity (to Tangible Assets): Consolidated N/A - N/A - N/A - Bank 113,856 11.88 19,163 2.00 N/A - <CAPTION> Minimum To Be Well Minimum Capitalized For Capital Under Prompt Adequacy Corrective Actual Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (Dollars in thousands) December 31, 2006 <S> <C> <C> <C> <C> <C> <C> December 31, 2005 Total Capital (to Risk Weighted Assets): Consolidated $122,241 25.68% $38,086 8.00% N/A - Bank 105,516 22.31 37,833 8.00 $47,291 10.00% Tier 1 Capital (to Risk Weighted Assets): Consolidated 116,819 24.54 19,043 4.00 N/A - Bank 100,151 21.18 18,917 4.00 28,375 6.00 Tier 1 Capital (to Adjusted Total Assets): Consolidated 116,819 14.48 32,261 4.00 N/A - Bank 100,151 12.67 31,624 4.00 39,530 5.00 Tangible Equity (to Tangible Assets): Consolidated N/A - N/A - N/A - Bank 100,151 12.67 15,812 2.00 N/A - </TABLE> In July 2004, the Company announced that the Board of Directors had approved a share repurchase program ("Repurchase Program 2") which authorized the repurchase of up to 502,550 shares or five percent of its outstanding shares of common stock, continuing until its completion. At December 31, 2006, the Company had 99,862 shares remaining to be purchased under this program. Upon completion of the second step stock offering (see Note 23), Repurchase Program 2 was eliminated. F-31
The Company and the Bank are subject to dividend restrictions imposed by various regulators, including a limitation on the total of all dividends that the Bank may pay to the Company in any calendar year, to an amount that shall not exceed the Bank's net income for the current year, plus the Bank's net income retained for the two previous years, without regulatory approval. In addition, the Bank may not declare or pay dividends on, and the Company may not repurchase, any of its shares of common stock if the effect thereof would cause stockholders' equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration, payment or repurchase would otherwise violate regulatory requirements. At December 31, 2006 and 2005, the Bank's retained earnings available for payment of dividends was $16.5 million and $14.6 million, respectively. Accordingly, $42.7 million and $38.1 million of the Company's equity in net assets of the Bank was restricted at December 31, 2006 and 2005, respectively. 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 from 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. The following is a reconciliation of the Company's GAAP capital to regulatory Tier 1 capital: <TABLE> <CAPTION> December 31, 2006 2005 ---- ---- (In thousands) <S> <C> <C> Consolidated GAAP capital $289,408 $115,842 Plus: Unrealized losses (gains) on certain available-for-sale securities, net of tax 636 977 Less: Adjustment to initially apply SFAS No. 158, net of tax (77) - -------- -------- Tier 1 Capital 289,967 116,819 Plus: Allowance for loan losses 5,437 5,422 -------- -------- Total Regulatory Capital $295,404 $122,241 ======== ======== </TABLE> 14. INCOME TAXES Income taxes consist of the following: Years Ended December 31, ---------------------------- 2006 2005 2004 ---- ---- ---- (In thousands) Current tax provision: Federal $1,631 $2,131 $2,883 State 148 136 294 ------ ------ ------ Total 1,779 2,267 3,177 ------ ------ ------ Deferred tax provision (benefit): Federal (257) (335) (616) State 1 1 1 ------ ------ ------ Total (256) (334) (615) ------ ------ ------ Total $1,523 $1,933 $2,562 ====== ====== ====== F-32
The reasons for the differences between the statutory federal income tax rate and the effective rates are summarized below: Years Ended December 31, ------------------------ 2006 2005 2004 ---- ---- ---- Statutory federal income tax rate 34.0% 34.0% 34.0% Increase (decrease) resulting from: State taxes, net of federal tax benefit 1.6 1.1 2.2 Tax exempt income (8.0) (6.5) (5.6) Bank-owned life insurance (4.7) (3.4) (3.0) Dividends received deduction (0.2) (0.1) (0.1) Other, net 2.0 (1.4) 1.3 ---- ---- ---- Effective tax rate 24.7% 23.7% 28.8% ==== ==== ==== Cash paid for income taxes for the years ended December 31, 2006, 2005, and 2004 was $1.8 million, $1.4 million and $2.3 million, respectively. The tax effects of each item that gives rise to deferred taxes, included in other assets, are as follows: December 31, ---------------- 2006 2005 ---- ---- (In thousands) Net unrealized loss on securities available for sale $ 471 $ 675 Adjustment to initially apply SFAS No. 158 (40) - Depreciation - (126) Allowance for loan losses 1,849 1,843 Employee benefit and stock-based compensation plans 2,040 1,779 Other 275 412 ------ ------ Net deferred tax asset $4,595 $4,583 ====== ====== A summary of the change in the net deferred tax asset is as follows: Years Ended December 31, ---------------- 2006 2005 ---- ---- (In thousands) Balance at beginning of year $4,583 $3,620 Deferred tax benefit 256 334 Net unrealized gain/loss on securities available for sale (204) 629 Adjustment to initially apply SFAS No. 158 (40) - ------ ------ Balance at end of year $4,595 $4,583 ====== ====== 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 $2.4 million has not been provided. F-33
15. TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS 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: Years Ended December 31, ------------------------------ 2006 2005 2004 ------------------------------ (In thousands) Balance, beginning of year $13,538 $13,467 $ 7,175 New loans granted 770 6,266 10,532 Repayments of principal (893) (6,195) (4,240) ------- ------- ------- Balance, end of year $13,415 $13,538 $13,467 ======= ======= ======= 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: December 31, ------------------ 2006 2005 ------------------ (In thousands) Commitment to extend credit: Unused lines of credit $58,275 $62,053 Loan commitments 35,443 29,068 Existing loan agreements 3,210 985 Standby letters of credit 6,159 5,936 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. F-34
Standby letters of credit are written conditional commitments issued by the Company 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, 2006 outstanding commitments to extend credit totaled $103.1 million, with $18.7 million in fixed rate commitments with interest rates ranging from 6.00% to 10.00% and $84.4 million in variable rate commitments. At December 31, 2005, outstanding commitments to extend credit totaled $98.0 million, with $1.6 million in fixed rate commitments with interest rates ranging from 5.72% to 12.50% and $96.4 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 2046. Certain of the leases provide for renewal periods for up to forty years at the discretion of the Company. Rent expense under operating leases was $246,000, $197,000, and $199,000 for the years ended December 31, 2006, 2005, and 2004, respectively. Aggregate future minimum rental payments under the terms of the operating leases at December 31, 2006, are as follows: Years Ending (In thousands) 2007 $ 366 2008 363 2009 364 2010 364 2011 371 Thereafter 7,037 ------ $8,865 ====== 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, 2006 and 2005, the Company's residential and commercial related real estate loans represented 73% of total loans. The Company's policy for collateral requires that the amount of the loan may not exceed 100% and 85% 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 80%, 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 are based on quoted market prices or dealer quotations. F-35
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 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. Federal Home Loan Bank Advances - The estimated fair value of these borrowings is based upon the discounted value of contractual cash flows. The discount rate is estimated using Federal Home Loan Bank of Boston 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. F-36
The estimated fair values of the Company's financial instruments at December 31 are as follows: <TABLE> <CAPTION> 2006 2005 ------------------------------------------------ Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value ------------------------------------------------ (In thousands) <S> <C> <C> <C> <C> ASSETS: Cash and cash equivalents $154,508 $154,508 $ 26,456 $ 26,456 Securities: Available for sale 41,687 41,687 28,321 28,321 Held to maturity 77,299 76,938 73,323 72,704 Mortgage backed securities: Available for sale 126,942 126,942 101,138 101,138 Held to maturity 163,093 160,709 152,127 149,017 Federal Home Loan Bank and other stock 4,246 4,246 4,237 4,237 Loans - net 385,184 398,724 378,837 379,384 Accrued interest receivable 4,502 4,502 3,853 3,853 LIABILITIES: Deposits 627,466 628,599 623,045 617,837 Customer repurchase agreements 17,919 17,919 14,441 14,441 Federal Home Loan Bank advances 55,000 54,233 45,000 43,969 Accrued interest payable 235 235 156 156 </TABLE> 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, 2006 2005 and 2004 there is no customer that accounted for more than 10% of the Company's revenue. F-37
20. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS The condensed balance sheets of the Parent Company are as follows: December 31, -------------------------------- 2006 2005 2004 ---- ---- ---- (In thousands) ASSETS: Due from banks $171,737 $ 18 $ 25 Federal funds sold 636 2,910 987 Securities HTM 1,883 10,833 - Mortgage-backed HTM 399 2,029 - Investment in subsidiaries 113,297 99,174 115,810 Other assets 1,528 923 1,271 -------- -------- -------- TOTAL ASSETS $289,480 $115,887 $118,093 ======== ======== ======== LIABILITIES AND EQUITY: Liabilities $ 72 $ 45 $ 42 Equity 289,408 115,842 118,051 -------- -------- -------- TOTAL LIABILITIES AND EQUITY $289,480 $115,887 $118,093 ======== ======== ======== The condensed statements of income for the Parent Company are as follows: Years Ended December 31, ----------------------------- 2006 2005 2004 ---- ---- ---- (In thousands) INTEREST AND DIVIDEND INCOME: Securities $ 248 $ 280 $ - Interest-bearing deposits - - 23 Federal funds sold 40 91 6 Other income 6 7 - ------- ------- ------- \ Total interest income 294 378 29 ------- ------- ------- NONINTEREST EXPENSE: Salaries and employee benefits 1,331 1,189 1,019 Other 160 194 183 ------- ------- ------- Total noninterest expense 1,491 1,383 1,202 ------- ------- ------- LOSS BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES AND BENEFIT FOR INCOME TAX (1,197) (1,005) (1,173) EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 5,434 6,736 7,016 INCOME TAX BENEFIT (417) (488) (480) ------- ------- ------- NET INCOME $ 4,654 $ 6,219 $ 6,323 ======= ======= ======= F-38
The condensed statement of cash flows of the Company are as follows: <TABLE> <CAPTION> Years Ended December 31, ---------------------------------- 2006 2005 2004 ---- ---- ---- (In thousands) <S> <C> <C> <C> OPERATING ACTIVITIES: Net Income $ 4,654 $ 6,219 $ 6,323 Equity in undistributed earnings of subsidiaries (5,434) (6,736) (7,016) Net amortization of premiums and discounts on securities 12 9 - Change in other liabilities (42) 3 (204) Change in other assets (535) 347 (771) Net transfers from subsidiaries 236 10,090 7,641 Other, net 2,074 1,006 694 -------- -------- -------- Net cash provided by operating activities 965 10,938 6,667 -------- -------- -------- INVESTING ACTIVITIES: Proceeds from principal collections 530 430 - -------- -------- -------- Net cash provided by investing activities 530 430 - -------- -------- -------- FINANCING ACTIVITIES: Cash dividends paid (3,785) (3,558) (1,713) Common stock repurchased (1,583) (5,699) (11,956) Net proceeds from sale of common stock 171,712 - - Excess tax benefit from share-based compensation 260 - - Other, net 1,346 (195) 810 -------- -------- -------- Net cash provided by (used in) financing activities 167,950 ( 9,452) (12,859) -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS 169,445 1,916 (6,192) CASH AND CASH EQUIVALENTS: Beginning of year 2,928 1,012 7,204 -------- -------- -------- End of year $172,373 $ 2,928 $ 1,012 ======== ======== ======== Supplemental cash flow information: Transfer of securities from Westfield Securities Corp. $ - $ 24,584 $ - Transfer of securities to Westfield Bank (10,153) (11,399) - </TABLE> F-39
21. OTHER NONINTEREST EXPENSE There is no item that as a component of other noninterest expense, exceeds 1% of the aggregate of total interest income and noninterest income for the years ended December 31, 2006, 2005 and 2004 respectively. 22. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) <TABLE> <CAPTION> 2006 --------------------------------------------------------------------- First Quarter Second Quarter Third Quarter Fourth Quarter ------------- -------------- ------------- -------------- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Interest and dividend income $9,928 $10,613 $10,727 $11,167 Interest expense 4,150 4,702 5,183 5,516 ------ ------- ------- ------- Net interest and dividend income 5,778 5,911 5,544 5,651 ------ ------- ------- ------- Provision for loan losses 75 200 50 65 Noninterest income 853 883 871 844 Loss on sales of fixed assets, net - - 378 - Noninterest expense 4,794 4,904 4,877 4,815 ------ ------- ------- ------- Income before income taxes 1,762 1,690 1,110 1,615 Income taxes 449 430 236 408 ------ ------- ------- ------- Net income $1,313 $ 1,260 $ 874 $ 1,207 ====== ======= ======= ======= Basic earnings per share $ 0.14 $ 0.14 $ 0.09 $ 0.13 Diluted earnings per share $ 0.14 $ 0.13 $ 0.09 $ 0.13 <CAPTION> 2005 --------------------------------------------------------------------- First Quarter Second Quarter Third Quarter Fourth Quarter ------------- -------------- ------------- -------------- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Interest and dividend income $8,878 $ 9,176 $ 9,504 $ 9,748 Interest expense 2,963 3,279 3,554 3,801 ------ ------- ------- ------- Net interest and dividend income 5,915 5,897 5,950 5,947 ------ ------- ------- ------- Provision for loan losses 140 125 100 100 Noninterest income 748 793 915 897 Gains on sales and writedowns of securities, net - 18 - 1 Noninterest expense 4,582 4,798 4,617 4,467 ------ ------- ------- ------- Income before income taxes 1,941 1,785 2,148 2,278 Income taxes 430 373 553 577 ------ ------- ------- ------- Net income $1,511 $ 1,412 $ 1,595 $ 1,701 ====== ======= ======= ======= Basic earnings per share $ 0.16 $ 0.15 $ 0.17 $ 0.18 Diluted earnings per share $ 0.16 $ 0.15 $ 0.16 $ 0.17 </TABLE> F-40
23. SUBSEQUENT EVENTS On January 3, 2007, Westfield Financial completed its stock offering in connection with the second step conversion of Westfield Mutual Holding Company. As part of the conversion, New Westfield Financial, Inc. succeeded Westfield Financial as the stock holding company of Westfield Bank, and Westfield Mutual Holding Company was dissolved. In the stock offering, a total of 18,400,000 shares representing Westfield Mutual Holding Company's ownership interest in Westfield Financial were sold by New Westfield Financial in a subscription offering, community offering and syndicated offering. In addition, each outstanding share of Westfield Financial as of January 3, 2007 was exchanged for 3.28138 new shares of New Westfield Financial common stock. New Westfield Financial, Inc. changed its name to Westfield Financial, Inc. effective January 3, 2007. For financial reporting purposes, net proceeds of $171.7 million from the second step conversion were recognized by Westfield Financial and reported in its balance sheet as of December 31, 2006. Proceeds, net of stock issuance costs, received directly by Westfield Financial or held by the underwriter for the convenience of Westfield Financial were recorded by increasing cash, the capital stock, and paid-in capital accounts. F-41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders 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, 2006, 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. F-42
In our opinion, management's assessment that Westfield Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2006 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, 2006 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 9, 2007 expressed an unqualified opinion. WOLF & COMPANY, P.C. Boston, Massachusetts March 9, 2007 F-43