Westfield Financial, Inc. (WFD) - Description of business

Company Description
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 II5 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 III10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 74 11 EXECUTIVE COMPENSATION 80 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 9813 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 101 14 PRINCIPAL ACCOUNTING FEES AND SERVICES 101 PART IV15 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.PART IITEM 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. 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. 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.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. 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) 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. 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. 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) 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. 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. 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 $349,441Originations: 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. 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. 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. 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. 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 appraisalfirms 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.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. At December 31, -------------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (Dollars in thousands) 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. 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. At or for Years Ended December 31, ------------------------------------------------------------ 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (Dollars in thousands) 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. Westfield Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio based on ongoing quarterly assessments of the estimated losses. Westfield Bank's methodology for assessing the appropriateness of the allowance consists of a review of the components, which include a specific valuation allowance for identified problem loans and a formula allowance for current performing loans. Fluctuations in the balances of impaired loans affect the specific valuation allowance while fluctuations in volume and concentrations of loans affects the formula reserve and the allocation of the allowance of the loan losses among loan types. The specific valuation allowance incorporates the results of measuring impairment for specifically identified non-homogenous problem loans in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting By Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." In accordance with SFAS No. 114 and No. 118, the specific allowance reduces the carrying amount of the impaired loans to their estimated fair value. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan's contractual terms. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, 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. 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: December 31, 2006 December 31, 2005 December 31, 2004 ------------------------------- ------------------------------- ------------------------------- Specific Formula Total Specific Formula Total Specific Formula Total -------- ------- ----- -------- ------- ----- -------- ------- ----- (In thousands) 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 === ====== ====== ==== ====== ====== ==== ====== ====== December 31, 2003 December 31, 2002 ------------------------------- ------------------------------- Specific Formula Total Specific Formula Total -------- ------- ----- -------- ------- ----- (In thousands) 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. 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. 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) 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% ====== ======== ====== ====== ======== ====== ====== ======== ====== 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 -------------------------------------------------------------------