Brookline Bancorp - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

ý   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2004

OR

o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to

Commission file number 0-23695

Brookline Bancorp, Inc.

(Exact name of registrant as specified in its charter)

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 requirement for the past 90 days.

YES  ý  NO  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act).

YES  ý  NO  o

Indicate the number of shares outstanding of each of the issuer’s classes of stock, as of the latest practicable date.

Common stock, $0.01 par value – 59,009,656 shares outstanding as of May 7, 2004.

BROOKLINE BANCORP, INC. AND SUBSIDIARIES

FORM 10-Q

Index

Part I -  Financial Information

Item 1.   Financial Statements

BROOKLINE BANCORP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands except share data)

See accompanying notes to the unaudited consolidated financial statements.

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BROOKLINE BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(In thousands except share data)

See accompanying notes to the unaudited consolidated financial statements.

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BROOKLINE BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands)

See accompanying notes to the unaudited consolidated financial statements.

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BROOKLINE BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity

Three months ended March 31, 2004 and 2003 (unaudited)

(Dollars in thousands)

See accompanying notes to the unaudited consolidated financial statements.

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BROOKLINE BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

See accompanying notes to the unaudited consolidated financial statements.

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BROOKLINE BANCORP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Three months ended March 31, 2004 and 2003

(unaudited)

(1)                     Basis of Presentation (Dollars in thousands)

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation have been included. Results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

Critical Accounting Policies

Allowance for Loan Losses

The allowance is established through provisions for loan losses charged to income. Loans are charged off against the allowance when the collectibility of principal is unlikely. Indirect automobile loans delinquent 120 days are charged off, net of recoverable value, unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Recoveries of loans previously charged off are credited to the allowance.

The allowance for loan losses is based on management’s estimate of probable known and inherent credit losses existing in the loan portfolio. In determining the level of the allowance for loan losses, management evaluates specific credits and the loan portfolio in general using several criteria that include historical performance, collateral values, cash flows and current economic conditions. The evaluation culminates with a judgment on the probability of collection of loans outstanding. Management’s methodology provides for three allowance components. The first component represents allowances established for specific identified loans. The second component represents allowances for groups of homogenous loans that currently exhibit no identified weaknesses and are evaluated on a collective basis. Allowances for groups of similar loans are established based on factors such as historical loss experience, the level and trends of loan delinquencies, and the level and trends of classified assets. Regarding the indirect automobile loan portfolio, allowances are established over the average life of the loans due to the absence of historical loss experience. The last component is an unallocated allowance based on evaluation of factors such as trends in the economy and real estate values in the areas where the Company lends money, concentrations in the amount of loans the Company has outstanding to large borrowers and concentrations in the type and geographic location of loan collateral. Determination of the unallocated allowance is a very subjective process. Management believes the unallocated allowance is an important component of the total allowance because it (a) addresses the probable inherent risk of loss that exists in the Company’s loan portfolio (which is substantially comprised of loans with repayment terms extended over many years) and (b) helps to minimize the risk related to the imprecision inherent in the estimation of the other two components of the allowance.

Premiums and Discounts on Debt Securities

Premiums and discounts on debt securities are amortized to expense and accreted to income over the life of the related debt security using the interest method. Premiums paid and discounts resulting from purchases of collateralized mortgage obligations (“CMOs”) and pass-through mortgage-backed securities (collectively referred to as “mortgage securities”) are amortized to expense and accreted to income over the estimated life of the mortgage securities using the interest method. At the time of purchase, the estimated life of mortgage securities is based on anticipated future prepayments of loans underlying the mortgage securities. The anticipated prepayments take into consideration several factors including the interest rates of the underlying loans, the contractual repayment terms of the underlying loans, the priority rights of the investor to the cash flow from the mortgage securities, the current and projected interest rate environment, and other economic conditions.

When differences arise between anticipated prepayments and actual prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. Unamortized premium or discount is adjusted to the amount that would have existed had the new effective yield been applied since purchase. The unamortized premium or discount is adjusted to the new balance with a corresponding charge or credit to interest income.

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Earnings Per Common Share

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the applicable period, exclusive of unearned ESOP shares and unvested recognition and retention plan shares. Diluted earnings per share is calculated after adjusting the denominator of the basic earnings per share calculation for the effect of all potential dilutive common shares outstanding during the period. The dilutive effects of options and unvested restricted stock awards are computed using the “treasury stock” method.

Stock-Based Compensation

Deferred compensation for shares awarded under recognition and retention plans is recorded as a reduction of stockholders’ equity. Compensation expense is recognized over the vesting period of shares awarded based upon the fair value of the shares at the award date.

Compensation expense for the Employee Stock Ownership Plan (“ESOP”) is recorded at an amount equal to the shares allocated by the ESOP multiplied by the average fair market value of the shares during the year. The Company recognizes compensation expense ratably over the year for the ESOP shares to be allocated based upon the Company’s estimate of the number of shares expected to be allocated. The difference between the average fair market value and the cost of the shares allocated by the ESOP is recorded as an adjustment to additional paid-in-capital.

In accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, the Company measures compensation cost for stock options as the excess of the fair market value of the Company’s stock at the grant date above the exercise price of options granted, if any. This generally does not result in compensation charges to earnings. As required by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, disclosed in the following table is net income and earnings per share, as reported, and pro forma net income and earnings per share as if compensation was measured at the date of grant based on the fair value of the award and recognized over the service period.

Cash Equivalents

For purposes of reporting cash flows, cash equivalents include highly liquid assets with an original maturity of three months or less. Highly liquid assets include cash and due from banks, short-term investments and money market loan participations.

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(2)                     Earnings Per Share Reconciliation (Dollars in thousands except per share amounts)

The following table is the reconciliation of basic and diluted earnings per share as required under SFAS No. 128 for the three months ended March 31, 2004 and 2003:

(3)                           Investment Securities (Dollars in thousands)

Securities available for sale and held to maturity are summarized below:

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(4)                           Loans (Dollars in thousands)

A summary of loans follows:

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(5)                           Deposits (Dollars in thousands)

A summary of deposits follows:

(6)                           Accumulated Other Comprehensive Income (Dollars in thousands)

Accumulated other comprehensive income is comprised entirely of unrealized gains on securities available for sale, net of income taxes. At March 31, 2004 and December 31, 2003, such taxes amounted to $1,350 and $1,414, respectively.

(7)                           Commitments and Swap Agreement (Dollars in thousands)

At March 31, 2004, the Company had outstanding commitments to originate loans of $34,697, $20,412 of which were commercial real estate and multi-family mortgage loans. Unused lines of credit available to customers were $24,083, of which $19,195 were equity lines of credit.

The Company entered into an interest-rate swap agreement with a third-party that matures April 14, 2005. The notional amount of the agreement is $5,000. Under this agreement, each quarter, the Company pays interest on the notional amount at an annual fixed rate of 5.9375% and receives from the third-party interest on the notional amount at the floating three month U.S. dollar LIBOR rate. The Company entered into this transaction to match more closely the repricing of its assets and liabilities and to reduce its exposure to increases in interest rates. The net interest expense paid for the three months ended March 31, 2004 and 2003 was $59 and $56, respectively. Changes in the fair value of the outstanding swap agreement are recognized as charges or credits to earnings. For the three months ended March 31, 2004 and 2003, $39 and $18, respectively, were credited to pre-tax earnings.

(8)                           Dividend Declaration

On April 15, 2004, the Board of Directors of the Company approved and declared a regular quarterly cash dividend of $0.085 per share of common stock to shareholders of record as of April 30, 2004 and payable on May 17, 2004.

(9)                           Stock Plans (Dollars in thousands, except per share amounts)

Activity under the Company’s stock option plans for the three months ended March 31, 2004 was as follows:

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Shares issued upon the exercise of a stock option may be either authorized but unissued shares or reacquired shares held by the Company as treasury shares. Any shares subject to an award which expire or are terminated unexercised will again be available for issuance. Options awarded vest over periods ranging from less than one month through over five years. As of March 31, 2004, the number of options available for award under the Company’s 1999 Stock Option Plan and 2003 Stock Option Plan were 245,980 options and 1,135,000 options, respectively.

In accordance with the terms of the 1999 Option Plan, dividend equivalent rights amounting to $375 were paid during the three months ended March 31, 2004 to holders of unexercised options as a result of the $0.20 per share extra dividend paid to stockholders on February 16, 2004.

The Company has two recognition and retention plans, the “1999 RRP” and the “2003 RRP”. Under both of the plans, shares of the Company’s common stock were reserved for issuance as restricted stock awards to officers, employees and non-employee directors of the Company. Shares issued upon vesting may be either authorized but unissued shares or reacquired shares held by the Company as treasury shares. Any shares not issued because vesting requirements are not met will again be available for issuance under the plans. Shares awarded vest over varying time periods ranging from six months up to eight years for the 1999 RRP and from less than three months to over five years for the 2003 RRP.  In the event a recipient ceases to maintain continuous service with the Company by reason of normal retirement, death or disability, or following a change in control, RRP shares still subject to restriction will vest and be free of such restrictions. As of March 31, 2004, the number of shares available for award under the 1999 RRP and the 2003 RRP were 26,086 shares and 92,000 shares, respectively.

Expense for shares awarded is recognized over the vesting period at the fair value of the shares on the date they were awarded. Total expense for the RRP plans amounted to $727 and $40 for the three months ended March 31, 2004 and 2003, respectively. The total expense of the RRP plans is expected to be $2,156 for the nine months ended December 31, 2004, $2,739 in 2005 and 2006, $2,641 in 2007, $2,600 in 2008 and $232 thereafter.

(10)                    Postretirement benefits (Dollars in thousands)

Postretirement benefits are provided for part of the annual expense of health insurance premiums for retired employees and their dependents. No contributions are made by the Company to invest in assets allocated for the purpose of funding this benefit obligation.

The following table provides the actual components of net periodic postretirement benefit costs for the three months ended March 31, 2003 and an estimate of the components of net periodic postretirement benefit costs for the three months ended March 31, 2004:

Postretirement benefits costs in the above table for the three months ended March 31, 2004 are based on the assumption that benefits currently offered will be changed before the end of 2004. The Company is in the process of evaluating postretirement benefits and expects to adjust the benefits in a way that will reduce costs in 2004 and thereafter. Accordingly, the Company charged $49 to expense for the three months ended March 31, 2004 instead of $85 that otherwise would have been charged to expense if no change in benefits was contemplated.

Benefits paid amounted to $6 and $5 for the three months ended March 31, 2004 and 2003.

(11)                    Income Taxes (Dollars in thousands)

160 Associates, Inc. (“Associates”), a wholly-owned subsidiary of Brookline Bank and 99.9% owner of a real estate investment trust (“REIT”) subsidiary, received in 2002 from the Department of Revenue of the Commonwealth of Massachusetts (“DOR”) Notices of Assessments for state excise taxes of $3,930 plus interest of $811. The assessments were based on a desk review of the financial institution excise returns filed by Associates for its 1999, 2000 and 2001 tax

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years. It was expected that the DOR would submit another Notice of Assessment for state excise taxes for the 2002 tax year and it was estimated that such assessment would amount to $3,748. The DOR contended that dividend distributions from a REIT are not deductible in determining Massachusetts taxable income. Associates believed that the Massachusetts statute that provided for a dividend received deduction equal to 95% of certain dividend distributions applied to distributions made by the REIT subsidiary to Associates. Accordingly, the Company made no provision in its consolidated financial statements through December 31, 2002 for the amounts assessed or additional amounts that might be assessed relating to the years 1999 through 2002.

On March 5, 2003, a new law was enacted denying favorable tax treatment for dividend distributions from REITs in determining Massachusetts taxable income not only for the year 2003 and thereafter, but also retroactively for tax years 1999 through 2002. While the Company disputed the retroactive tax assessments, it was obliged under U.S. generally accepted accounting principles to provide for the taxes and interest resulting from the new law at the time of its enactment. Accordingly, $5,515 was charged to earnings in the three months ended March 31, 2003 to recognize the liabilities for taxes and interest resulting from the retroactive application of the new law to the Company=s REIT subsidiary for the years 1999 through 2002. On June 23, 2003, the Company signed an agreement with the Commissioner of Revenue of the Commonwealth of Massachusetts settling all disputes relating to the tax treatment of the Company’s REIT subsidiary. The Company paid $4,341 as full settlement of the dispute, resulting in an after-tax credit to earnings of $2,727 in the three month period ended June 30, 2003.

(12)                    Stockholders’ Equity (Dollars in thousands)

Capital Distributions and Restrictions Thereon

OTS regulations impose limitations on all capital distributions by savings institutions. Capital distributions include cash dividends, payments to repurchase or otherwise acquire the institution’s shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The regulations establish three tiers of institutions. An institution, such as the Bank, that exceeds all capital requirements before and after a proposed capital distribution (“Tier 1institution”) may, after prior notice but without the approval of the OTS, make capital distributions during a year up to 100% of its current year net income plus its retained net income for the preceding two years not previously distributed. Any additional capital distributions require OTS approval.

Common Stock Repurchases

As of March 31, 2004, the Company was authorized to repurchase up to 1,602,233 shares of its common stock. The repurchase of additional shares would require prior authorization of the Board of Directors of the Company.

Restricted Retained Earnings

As part of the stock offering in 2002 and as required by regulation, Brookline Bank established a liquidation account for the benefit of eligible account holders and supplemental eligible account holders who maintain their deposit accounts at Brookline Bank after the stock offering. In the unlikely event of a complete liquidation of Brookline Bank (and only in that event), eligible depositors who continue to maintain deposit accounts at Brookline Bank would be entitled to receive a distribution from the liquidation account. Accordingly, retained earnings of the Company are deemed to be restricted up to the balance of the liquidation account. The liquidation account balance is reduced annually to the extent that eligible depositors have reduced their qualifying deposits as of each anniversary date. Subsequent increases in deposit account balances do not restore an account holder’s interest in the liquidation account. The liquidation account totaled $55,749 at December 31, 2003.

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of the Company.

The following discussion contains forward-looking statements based on management’s current expectations regarding economic, legislative and regulatory issues that may impact the Company’s earnings and financial condition in the future. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Any statements included herein preceded by, followed by or which include the words “may”, “could”, “should”, “will”, “would”, “believe”, “expect”, “anticipate”, “estimate”, “intend”, “plan”, “assume” or similar expressions constitute forward-looking statements.

Forward-looking statements, implicitly and explicitly, include assumptions underlying the statements. While the Company believes the expectations reflected in its forward-looking statements are reasonable, the statements involve risks and uncertainties that are subject to change based on various factors, some of which are outside the control of the Company. The following factors, among others, could cause the Company’s actual performance to differ materially from the expectations, forecasts and projections expressed in the forward-looking statements: general and local economic conditions, changes in interest rates, demand for loans, real estate values, deposit flows, regulatory considerations, competition, technological developments, retention and recruitment of qualified personnel, and market acceptance of the Company’s pricing, products and services.

Overview of the Company’s Activities and Risks

The primary activities of the Company are to gather deposits from the general public and to invest the resulting funds, plus those derived from borrowings, capital initiatives and operations, in loans and investment securities. The Company’s loan portfolio is comprised substantially of loans secured by real estate and indirect automobile loans. The investment portfolio is comprised primarily of debt securities and mortgage-backed securities issued by the U.S. Government and U.S. Government Agencies.

To operate successfully, the Company must manage various types of risk, including but not limited to, market or interest rate risk, credit risk, transaction risk, liquidity risk, security risk, strategic risk, reputation risk and compliance risk. While all of these risks are important, the risks of greatest significance to the Company relate to market or interest rate risk and credit risk.

Market risk is the risk of loss from adverse changes in market prices and/or interest rates. Since net interest income (the difference between interest earned on loans and investments and interest paid on deposits and borrowings) is the Company’s primary source of revenue, interest rate risk is the most significant non-credit related market risk to which the Company is exposed. Net interest income is affected by changes in interest rates as well as fluctuations in the level and duration of the Company’s assets and liabilities.

Interest rate risk is the exposure of the Company’s net interest income to adverse movements in interest rates. In addition to directly impacting net interest income, changes in interest rates can also affect the amount of new loan originations, the ability of borrowers and debt issuers to repay loans and debt securities, the volume of loan repayments and refinancings, and the flow and mix of deposits.

Credit risk is the risk to the Company’s earnings and stockholders’ equity that results from customers, to whom loans have been made or the issuers of debt securities in which the Company has invested, failing to repay their obligations. The magnitude of risk depends on the capacity and willingness of borrowers and debt issuers to repay and the sufficiency of the value of collateral obtained to secure the loans made or investments purchased.

The Company’s critical accounting policies relate to the allowance for loan losses and the accounting for premiums and discounts on debt securities. See note 1 to the unaudited consolidated financial statements included elsewhere on page 8 herein for a description of those accounting policies and the Accelerated Amortization of Investment Premiums and the Non-Performing Assets, Restructured Loans and Allowance for Loan Losses sub-sections appearing on pages 19 and 21 herein.

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Executive Summary

Operating Highlights

Financial Condition Highlights

The major factors affecting comparison of the operating and financial condition highlights presented above were:

•                   A decline in net interest income and net interest margin despite $122 million of growth in earning assets

•                   Growth of the indirect automobile lending business (loans outstanding - $274 million at March 31, 2004 compared to $211 million at December 31, 2003 and $13 million at March 31, 2003) and $340,000 of accelerated amortization of deferred loan origination costs as a result of loan prepayments

•                   $357,000 of accelerated amortization of premiums paid to purchase mortgage securities

•                   Increased expense of recognition and retention plans - $727,000 in the 2004 quarterly period versus $40,000 in the 2003 quarterly period

•                   $375,000 of dividend equivalent rights expense in the 2004 quarterly period

•                   Increased non-interest income from mortgage loan prepayment fees ($863,000 versus $178,000) and securities gains ($581,000 versus $328,000)

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•                   A $5.5 million after-tax charge in the 2003 quarterly period related to a dispute over the state tax treatment of the Company’s real estate investment (“REIT”) subsidiary

•                   Reduction in stockholders’ equity in the 2004 quarterly period due to payment of an extra dividend to stockholders of $0.20 per share ($11.7 million) and in the 2003 quarterly period due to repurchases of Company stock ($14.7 million)

Detailed commentary on each of the items listed above follows.

Average Balances, Net Interest Income, Interest Rate Spread and Net Interest Margin

The following table sets forth information about the Company’s average balances, interest income and rates earned on average interest-earning assets, interest expense and rates paid on interest-bearing liabilities, interest rate spread and net interest margin for the three months ended March 31, 2004 and 2003. Average balances are derived from daily average balances and yields include fees and costs which are considered adjustments to yields.