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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  Form 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the Quarterly Period ended September 30, 2004OR[  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the transition period from _______________ to _______________
 Commission File Number 1-13936 BOSTONFED BANCORP, INC.(Exact name of registrant as specified in its charter)
 Delaware
    
    52-1940834(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)17 New England Executive Park, Burlington,
Massachusetts
    
    01803(Address of principal executive offices)
    
    (Zip Code)
 (781)-273-0300(Registrants telephone number, including area code)
 Not Applicable(Former name, former address and former fiscal year, if changed since last report)
 Indicate by check mark whether the regist000nt (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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X]    No [  ] The Registrant had 4,739,672 shares of common stock, par value $.01 per
share, outstanding as of October 31, 2004.




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BOSTONFED BANCORP, INC.
FORM 10-Q
INDEX PagePart I  FINANCIAL INFORMATION
    
    
    4Item 1. Consolidated Financial Statements (unaudited):
    
    
    4Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 (unaudited)
    
    
    4Consolidated Statements of Operations for the Three and Nine Months Ended September
30, 2004 and 2003 (unaudited)
    
    
    5Consolidated Statements of Changes in Stockholders Equity for the Nine Months Ended
September 30, 2004 (unaudited)
    
    
    6Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004
and 2003 (unaudited)
    
    
    7Condensed Notes to Consolidated Financial Statements (unaudited)
    
    
    9Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
    
    
    12Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    26Part II  OTHER INFORMATION
    
    
    27Item 1. Legal Proceedings
    
    
    27Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    27Item 3. Defaults Upon Senior Securities
    
    
    27Item 4. Submission of Matters to a Vote of Security Holders
    
    
    27Item 5. Other Information
    
    
    27Item 6. Exhibits
    
    
    27Signatures
    
    
    29EX-31.1 Section 302 CEO CertificationEX-31.2 Section 302 CFO CertificationEX-32.0 Section 906 CEO and CFO Certifications
 2




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In addition to historical information, this Form 10-Q may contain certain
forward-looking statements, which are based on current management expectations.
Generally, verbs in the future tense and the words believe, expect,
anticipate, intends, opinion, potential and similar expressions
identify forward-looking statements. Examples of this forward-looking
information can be found in, but are not limited to, the expected effects of
accounting pronouncements applicable to the Companys operations, the allowance
for losses discussion, litigation, subsequent events and any quantitative and
qualitative disclosure about market risk. The actual results of BostonFed
Bancorp, Inc. (the Company) could differ materially from those management
expectations. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulations of
federal, state and local tax authorities, changes in interest rates, deposit
flows, the cost of funds, demand for loan products, demand for financial
services, competition, changes in the quality or composition of the Companys
loan and investment portfolios, changes in accounting principles, policies or
guidelines, and other economic, competitive, governmental and technological
factors and the effects of war or terrorist activities affecting the Companys
operations, markets, products, services, prices and litigation. These risks and
uncertainties should be considered in evaluating forward-looking statements and
undue reliance should not be placed on such statements. Further information
concerning the Company and its business, including additional factors that
could materially affect the Companys financial results, is included in the
Companys filings with the Securities and Exchange Commission. Forward-looking statements also include, with limitation, those statements
relating to the anticipated effects of the Companys proposed merger with
Banknorth Group, Inc. The following factors, among others, could cause the
actual results of the merger to differ materially from expectations: the
ability of the companies to obtain the required shareholder or regulatory
approvals of the merger; the imposition of any regulatory conditions or
requirements on the merger; the ability of the companies to consummate the
merger; the ability to successfully integrate the companies following the
merger, including integration of data processing systems and retention of key
personnel; a materially adverse change in the financial condition, operations,
or projected or actual earnings of either company; the ability to fully realize
the expected cost savings and revenues; the ability to realize the expected
cost savings and revenues on a timely basis; and any material change in the
local markets in which each company operates. Except as may be required by applicable law and regulation, the Company
does not undertake, and specifically disclaims any obligation, to publicly
release the result of any revisions, which may be made to 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. 3




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Part I. Financial Information 
  
 BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited) September 30,
    
    December 31,2004
    
    2003AssetsCash and cash equivalents
    
    $
    28,988
    
    
    $
    34,045Investment securities available for sale (amortized cost of $55,835 at Sept.
30, 2004 and $101,499 at December 31, 2003)
    
    
    55,782
    
    
    
    102,647Investment securities held to maturity (fair value of $2,131 at Sept. 30,
2004 and $2,137 at December 31, 2003)
    
    
    2,001
    
    
    
    2,025Mortgage-backed securities available for sale (amortized cost of $93,398 at
Sept. 30, 2004 and $84,264 at December 31, 2003)
    
    
    92,492
    
    
    
    83,752Mortgage-backed securities held to maturity (fair value of $133,239 at Sept.
30, 2004 and $145,029 at December 31, 2003)
    
    
    134,346
    
    
    
    145,674Loans held for sale
    
    
    26,286
    
    
    
    12,751Loans, net of allowance for loan losses of $14,898 at Sept. 30, 2004 and
$13,874 at December 31, 2003
    
    
    1,238,012
    
    
    
    1,198,019Accrued interest receivable
    
    
    6,036
    
    
    
    6,129Stock in FHLB of Boston and Federal Reserve Bank of Boston
    
    
    22,449
    
    
    
    28,483Bank-owned life insurance
    
    
    26,407
    
    
    
    25,549Premises and equipment, net
    
    
    17,485
    
    
    
    19,539Goodwill/core deposit intangible
    
    
    16,470
    
    
    
    17,536Real estate owned
    
    
    1,282
    
    
    
    1,782Other assets
    
    
    15,213
    
    
    
    17,047Total assets
    
    $
    1,683,249
    
    
    $
    1,694,978Liabilities and Stockholders EquityLiabilities:Deposit accounts
    
    $
    1,146,355
    
    
    $
    1,190,755Federal Home Loan Bank advances and other borrowings
    
    
    428,421
    
    
    
    398,653Advance payments by borrowers for taxes and insurance
    
    
    3,114
    
    
    
    2,819Other liabilities
    
    
    6,692
    
    
    
    8,102Total liabilities
    
    
    1,584,582
    
    
    
    1,600,329Commitments and contingencies
Stockholders equity:Preferred stock, $0.01 par value, 1,000,000 shares authorized; none issued
    
    
    
    
    
    
    Common stock, $0.01 par value, 17,000,000 shares authorized; 6,589,617
shares issued (4,739,672 and 4,491,796 shares outstanding at Sept. 30,
2004 and December 31, 2003, respectively)
    
    
    66
    
    
    
    66Additional paid-in capital
    
    
    70,891
    
    
    
    70,141Retained earnings
    
    
    64,127
    
    
    
    64,684Accumulated other comprehensive income
    
    
    (585
    )
    
    
    395Less: Treasury stock, at cost (1,849,945 shares and 2,097,821 shares at
Sept. 30, 2004 and December 31, 2003, respectively)
    
    
    (35,832
    )
    
    
    (40,637
    )Total stockholders equity
    
    
    98,667
    
    
    
    94,649Total liabilities and stockholders equity
    
    $
    1,683,249
    
    
    $
    1,694,978
 See accompanying condensed notes to unaudited consolidated financial statements. 4




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except share data)
(Unaudited) Three Months Ended
    
    Nine Months Ended9/30/2004
    
    9/30/2003
    
    9/30/2004
    
    9/30/2003Interest income:Loans
    
    $
    16,229
    
    
    $
    15,995
    
    
    $
    47,384
    
    
    $
    48,429Mortgage-backed securities
    
    
    2,552
    
    
    
    1,362
    
    
    
    7,540
    
    
    
    4,496Investment securities
    
    
    597
    
    
    
    997
    
    
    
    2,008
    
    
    
    3,235Total interest income
    
    
    19,378
    
    
    
    18,354
    
    
    
    56,932
    
    
    
    56,160Interest expense:Deposit accounts
    
    
    5,161
    
    
    
    4,465
    
    
    
    15,493
    
    
    
    14,355Borrowed funds
    
    
    4,512
    
    
    
    5,125
    
    
    
    13,352
    
    
    
    15,592Total interest expense
    
    
    9,673
    
    
    
    9,590
    
    
    
    28,845
    
    
    
    29,947Net interest income
    
    
    9,705
    
    
    
    8,764
    
    
    
    28,087
    
    
    
    26,213Provision for loan losses
    
    
    450
    
    
    
    450
    
    
    
    1,350
    
    
    
    2,900Net interest income after provision for
loan losses
    
    
    9,255
    
    
    
    8,314
    
    
    
    26,737
    
    
    
    23,313Non-interest income:Deposit service fees
    
    
    793
    
    
    
    972
    
    
    
    2,384
    
    
    
    2,728Loan processing and servicing fees
    
    
    (107
    )
    
    
    (341
    )
    
    
    (11
    )
    
    
    (2,869
    )Gain on sale of loans
    
    
    1,612
    
    
    
    2,958
    
    
    
    5,164
    
    
    
    8,779Income from bank-owned life insurance
    
    
    283
    
    
    
    304
    
    
    
    858
    
    
    
    931Gain on sale of investments
    
    
    415
    
    
    
    0
    
    
    
    747
    
    
    
    7Other
    
    
    351
    
    
    
    440
    
    
    
    1,177
    
    
    
    1,243Total non-interest income
    
    
    3,347
    
    
    
    4,333
    
    
    
    10,319
    
    
    
    10,819Non-interest expense:Compensation and benefits
    
    
    6,343
    
    
    
    6,106
    
    
    
    18,671
    
    
    
    17,935Occupancy and equipment
    
    
    1,287
    
    
    
    1,228
    
    
    
    3,849
    
    
    
    3,684Data processing
    
    
    505
    
    
    
    615
    
    
    
    1,601
    
    
    
    1,520Advertising expense
    
    
    386
    
    
    
    481
    
    
    
    1,328
    
    
    
    1,140Stationary, printing and office supplies
    
    
    171
    
    
    
    263
    
    
    
    605
    
    
    
    644Federal deposit insurance premiums
    
    
    44
    
    
    
    40
    
    
    
    141
    
    
    
    128Amortization of core deposit intangibles
    
    
    312
    
    
    
    0
    
    
    
    936
    
    
    
    0Other
    
    
    2,465
    
    
    
    1,419
    
    
    
    6,589
    
    
    
    4,687Total non-interest expense
    
    
    11,513
    
    
    
    10,152
    
    
    
    33,720
    
    
    
    29,738Income before income taxes
    
    
    1,089
    
    
    
    2,495
    
    
    
    3,336
    
    
    
    4,394Income tax expense
    
    
    615
    
    
    
    1,055
    
    
    
    1,721
    
    
    
    3,020Net income
    
    $
    474
    
    
    $
    1,440
    
    
    $
    1,615
    
    
    $
    1,374Basic earnings per share
    
    $
    0.10
    
    
    $
    0.32
    
    
    $
    0.35
    
    
    $
    0.31Diluted earnings per share
    
    $
    0.10
    
    
    $
    0.31
    
    
    $
    0.35
    
    
    $
    0.30Basic weighted average shares outstanding.
    
    
    4,619,157
    
    
    
    4,437,073
    
    
    
    4,552,907
    
    
    
    4,409,349Common stock equivalents due to dilutive
effect of stock options
    
    
    124,992
    
    
    
    239,571
    
    
    
    116,729
    
    
    
    213,509Diluted total weighted average shares
outstanding
    
    
    4,744,149
    
    
    
    4,676,644
    
    
    
    4,669,636
    
    
    
    4,622,858
 See accompanying condensed notes to unaudited consolidated financial statements. 5




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders Equity
For the Nine Months Ended September 30, 2004
(In thousands, except share data)
(Unaudited) AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    other
    
    TotalCommon
    
    paid-in
    
    Retained
    
    Treasury
    
    comprehensive
    
    stockholders'Stock
    
    capital
    
    earnings
    
    stock
    
    income (loss)
    
    equityBalance at December 31, 2003
    
    $
    66
    
    
    $
    70,141
    
    
    $
    64,684
    
    
    $
    (40,637
    )
    
    $
    395
    
    
    $
    94,649Net income
    
    
    
    
    
    
    
    
    
    
    1,615
    
    
    
    
    
    
    
    
    
    
    
    1,615Change in net unrealized loss on
investments available for sale (net
of tax benefit of $585)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (980
    )
    
    
    (980
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    635Cash dividends declared and paid
($0.16 per share)
    
    
    
    
    
    
    
    
    
    
    (2,172
    )
    
    
    
    
    
    
    
    
    
    
    (2,172
    )Stock options exercised, net of taxes
    
    
    
    
    
    
    728
    
    
    
    
    
    
    
    4,805
    
    
    
    
    
    
    
    5,533Fair value of shares charged to
expense for compensation plans
    
    
    
    
    
    
    22
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22Balance at September 30, 2004
    
    $
    66
    
    
    $
    70,891
    
    
    $
    64,127
    
    
    $
    (35,832
    )
    
    $
    (585
    )
    
    $
    98,667
 See accompanying condensed notes to unaudited consolidated financial statements. 6




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited) For the Nine Months EndedSeptember 30,2004
    
    2003Net cash flows from operating activities:Net Income
    
    $
    1,615
    
    
    $
    1,374Adjustments to reconcile net income to net cash provided by (used in) operating
activities:Depreciation, amortization and accretion, net
    
    
    3,089
    
    
    
    2,192Earned SIP shares
    
    
    
    
    
    
    14Appreciation in fair value of shares charged to expense for compensation plans
    
    
    22
    
    
    
    702Income from bank-owned life insurance
    
    
    (858
    )
    
    
    (931
    )Provision for loan losses
    
    
    1,350
    
    
    
    2,900Provision for valuation for real estate owned
    
    
    6
    
    
    
    Loans originated for sale
    
    
    (330,292
    )
    
    
    (572,759
    )Proceeds from sale of loans
    
    
    321,921
    
    
    
    597,918Gain on sale of loans
    
    
    (5,164
    )
    
    
    (8,779
    )Gain on sale of investment securities
    
    
    (747
    )
    
    
    (7
    )Loss on sale of real estate owned
    
    
    
    
    
    
    65Decrease in accrued interest receivable
    
    
    93
    
    
    
    403Decrease in prepaid expenses and other assets, net
    
    
    2,449
    
    
    
    837Decrease in accrued expenses and other liabilities, net
    
    
    (1,410
    )
    
    
    (1,160
    )Net cash (used in) provided by operating activities
    
    
    (7,926
    )
    
    
    22,769Cash flows from investing activities:Proceeds from sale of investment securities available for sale
    
    
    44,842
    
    
    
    10,000Proceeds from maturities of investment securities held to maturity
    
    
    25
    
    
    
    Proceeds from maturities of investment securities available for sale
    
    
    10,788
    
    
    
    5,000Proceeds from sale of FHLB and Federal Reserve Bank Stock
    
    
    7,737
    
    
    
    Purchase of investment securities available for sale
    
    
    (10,995
    )
    
    
    (12,710
    )Purchase of mortgage-backed securities available for sale
    
    
    (49,720
    )
    
    
    (81,977
    )Purchase of mortgage-backed securities held to maturity
    
    
    (8,107
    )
    
    
    (65,730
    )Purchase of FHLB Stock
    
    
    (1,703
    )
    
    
    (2,933
    )Principal payments on mortgage-backed securities available for sale
    
    
    39,995
    
    
    
    117,093Principal payments on mortgage-backed securities held to maturity
    
    
    19,371
    
    
    
    12,706Principal payments on investment securities available for sale
    
    
    1,639
    
    
    
    2,609Increase in loans, net
    
    
    (42,226
    )
    
    
    (125,062
    )Proceeds from sale of premises
    
    
    3,562
    
    
    
    Purchases of premises and equipment
    
    
    (2,740
    )
    
    
    (1,483
    )Proceeds from sale of real estate owned
    
    
    1,387
    
    
    
    1,375Additional investment in real estate owned
    
    
    (10
    )
    
    
    (123
    )Net cash provided by (used in) investing activities
    
    
    13,845
    
    
    
    (141,235
    )
 -Continued on next page- 7




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Concluded)
(In thousands)
(Unaudited) For the Nine Months EndedSeptember 30,2004
    
    2003Cash flows from financing activities:(Decrease) increase in deposit accounts
    
    
    (44,400
    )
    
    
    450Repayments of Federal Home Loan Bank advances
    
    
    (727,347
    )
    
    
    (471,875
    )Proceeds from Federal Home Loan Bank advances
    
    
    757,115
    
    
    
    581,209Cash dividends paid
    
    
    (2,172
    )
    
    
    (2,120
    )Common stock repurchased
    
    
    
    
    
    
    (1,057
    )Options exercised, net of taxes
    
    
    5,533
    
    
    
    1,392Decrease in advance payments by borrowers for taxes and insurance
    
    
    295
    
    
    
    525Net cash (used in) provided by financing activities
    
    
    (10,976
    )
    
    
    108,524Decrease in cash and cash equivalents
    
    
    (5,057
    )
    
    
    (9,942
    )Cash and cash equivalents at beginning of period
    
    
    34,045
    
    
    
    74,672Cash and cash equivalents at end of period
    
    $
    28,988
    
    
    $
    64,730Supplemental disclosure of cash flow information:Payments during the period for:Interest
    
    $
    29,865
    
    
    $
    30,455Taxes
    
    $
    (29
    )
    
    $
    3,494
 See accompanying condensed notes to unaudited consolidated financial statements. 8




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) NOTE 1: BASIS OF PRESENTATION The unaudited consolidated financial statements as of September 30, 2004
and 2003 and for the three- and nine-month periods ended September 30, 2004 and
2003, are for the Company and its wholly-owned subsidiary, Boston Federal
Savings Bank (BFS or the Bank). A former subsidiary of the Company,
Broadway National Bank, was merged into BFS on December 31, 2003. The Company
also owns 100% of the common stock of BFD Preferred Capital Trust I and BFD
Preferred Capital Trust II (collectively, the Trusts), each of which has
issued trust preferred securities to the public. As of December 31, 2003, the
Trusts were no longer included in the Companys consolidated financial
statements. (See FIN No. 46R discussion in Note 4 to the condensed notes to the
unaudited consolidated financial statements). The unaudited consolidated
financial statements presented herein should be read in conjunction with the
audited consolidated financial statements of the Company as of and for the year
ended December 31, 2003. The unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements. In
the opinion of management, all necessary adjustments, consisting only of normal
recurring accruals necessary for a fair presentation, have been included. In
preparing the consolidated financial statements, the Company was required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities for the unaudited consolidated balance sheets as of September 30,
2004 and December 31, 2003, and amounts of revenues and expenses in the
unaudited consolidated statements of operations for the three and nine months
ended September 30, 2004 and 2003. All significant inter-company accounts and
transactions have been eliminated in consolidation. Certain reclassifications
have been made to prior period amounts to conform to the current period
presentation. The results of operations for the three- and nine-month periods
ended September 30, 2004 and 2003 are not necessarily indicative of the results
that may be expected for the entire fiscal year. NOTE 2: EMPLOYEE STOCK OPTION BENEFITS The Company measures compensation cost for stock-based compensation plans
using the intrinsic value based method of accounting. Intrinsic value is
measured as the difference between the exercise price of options granted and
the fair market value of the Companys stock at the grant date. No stock
option-based employee compensation cost is reflected in net income (loss), as
all options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. Had the Company determined compensation expense consistent with the fair
value approach, the Companys net income (loss) and earnings (loss) per share
would have been reduced to the pro forma amounts indicated below for the three-
and nine-month periods ended September 30th. Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003In thousands, except per share amountsNet income (loss) as reported
    
    $
    474
    
    
    $
    1,440
    
    
    $
    1,615
    
    
    $
    1,374Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effect
    
    
    (22
    )
    
    
    (24
    )
    
    
    (66
    )
    
    
    (71
    )Pro forma net income (loss)
    
    
    452
    
    
    
    1,416
    
    
    
    1,549
    
    
    
    1,303Basic earnings (loss) per share as reported
    
    
    0.10
    
    
    
    0.32
    
    
    
    0.35
    
    
    
    0.31Diluted earnings (loss) per share as reported
    
    
    0.10
    
    
    
    0.31
    
    
    
    0.35
    
    
    
    0.30Pro forma basic earnings (loss) per share
    
    
    0.10
    
    
    
    0.32
    
    
    
    0.34
    
    
    
    0.30Pro forma diluted earnings (loss) per share
    
    
    0.10
    
    
    
    0.30
    
    
    
    0.33
    
    
    
    0.28
 9




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##### Table of Contents



The Company uses the Black-Scholes option pricing model to determine the
per share weighted average fair value of stock options granted. There were
5,000 stock options granted during the nine months ended September 30, 2004
with an average fair value of approximately $10.00 per share, using approximate
expected dividend yield, risk-free interest rate, expected volatility and
expected life of 2.00%, 3.50%, 30.00% and six years, respectively. There were
no stock options granted during the nine months ended September 30, 2003. NOTE 3: COMMITMENTS, CONTINGENCIES AND CONTRACTS At September 30, 2004, the Company had commitments of $76.6 million to
originate mortgage loans and $1.0 million to purchase loans from correspondent
lenders. Of these $77.6 million commitments, $69.5 million were adjustable rate
mortgage loans with interest rates ranging from 4.25% to 7.38% and $8.1 million
were fixed rate mortgage loans with interest rates ranging from 4.88% to 7.38%.
The Company also had commitments to sell $31.6 million of mortgage loans. At September 30, 2004, the Company was servicing first mortgage loans of
approximately $938.0 million, which were either partially or wholly-owned by
others. NOTE 4: RECENT ACCOUNTING PRONOUNCEMENTS FASB issued Interpretation (FIN) No. 46, Consolidation of Variable
Interest Entities  an Interpretation of Accounting Research Bulletin No. 51.
FIN No. 46 establishes accounting guidance for consolidation of variable
interest entities (VIE) that function to support the activities of the
primary beneficiary. The primary beneficiary of a VIE entity is the entity that
absorbs a majority of the VIEs expected losses, receives a majority of the
VIEs expected residual returns, or both, as a result of ownership, controlling
interest, contractual relationship or other business relationship with a VIE.
Prior to the implementation of FIN 46, VIEs were generally consolidated by an
enterprise when the enterprise had a controlling financial interest through
ownership of a majority of voting interest in the entity. The Company adopted
FIN No. 46 as of February 1, 2003 for all arrangements entered into after
January 31, 2003. In December 2003, the FASB issued a revised FIN No. 46, FIN No. 46R, which
in part specifically addresses limited purpose trusts formed to issue trust
preferred securities. The guidance required the Company to deconsolidate its
investment in BFD Preferred Capital Trust I and II by March 31, 2004, but the
Company chose to early adopt as of December 31, 2003. The result of
deconsolidating these Trusts is that the trust preferred securities of the
Trusts no longer appear on the consolidated balance sheet of the Company. Due
to FIN No. 46R, the junior subordinated debentures of the Company that were
previously eliminated in consolidation are included on the consolidated balance
sheet with total borrowings. For all other arrangements entered into subsequent
to January 31, 2003, the Company adopted FIN No. 46R as of December 31, 2003.
The adoption of this interpretation did not have a material impact on the
Companys financial position or results of operations. In December 2003, the American Institute of Certified Public Accountants
(AICPA) issued SOP 03-3, Accounting for Certain Loans or Debt Securities
Acquired in a Transfer. SOP 03-3 requires loans acquired through a transfer,
such as a business combination, where there are differences in expected cash
flows and contractual cash flows due in part to credit quality being recognized
at its fair value. The excess of contractual cash flows over expected cash
flows is not to be recognized as an adjustment of yield, loss accrual or
valuation allowance. Valuation allowances can neither be created nor carried
over in the initial accounting for loans acquired in a transfer. This SOP is
effective for loans acquired after December 31, 2004, with early adoption
encouraged. The Company does not believe the adoption of SOP 03-3 will have a
material impact on the Companys financial position or results of operations. NOTE 5: ACQUISITION OF BRANCHES AND MERGER OF BROADWAY NATIONAL BANK On October 24, 2003, the Company acquired the seven (7) Boston area branch
offices of Encore Bank. The former Lexington office of Encore Bank was merged
into the Companys existing Lexington office. The acquisition was accounted for
as a purchase and accordingly was included in the results of operations from
the date of 10




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##### Table of Contents



acquisition. The following table summarizes the estimated fair value of
the assets acquired and liabilities assumed at the date of acquisition. The
Company has adjusted and expects further adjustments of the estimated fair
values assigned to the assets acquired and liabilities assumed during 2004,
although such adjustments have not and are not expected to be significant, nor
impact earnings. It is expected that the deposit premium paid will be
deductible for income tax purposes. In ThousandsAssets acquired:Cash
    
    $
    251Premises and equipment
    
    
    7,327Core deposit intangible
    
    
    5,000Other assets
    
    
    47Total assets acquired
    
    
    12,625Liabilities Assumed:Deposit accounts
    
    
    321,948Discount on certificates of deposit
    
    
    2,500Accrued expenses and other liabilities
    
    
    442Total liabilities assumed (net of assets acquired)
    
    
    312,265Cash received from Encore Bank
    
    
    310,297Goodwill
    
    
    1,968
 The changes in the carrying amount of goodwill and other intangible for
the nine months ended September 30, 2004 are as follows: Core Deposit
    
    Total IdentifiableGoodwill
    
    Intangibles
    
    Intangibles(In Thousands)Balance at December 31, 2003
    
    $
    12,744
    
    
    $
    4,792
    
    
    $
    17,536Amortization expense for the nine months ended
September 30, 2004
    
    
    
    
    
    
    936
    
    
    
    936Other adjustments (recovery)
    
    
    (130
    )
    
    
    
    
    
    
    (130
    )Balance at September 30, 2004
    
    
    12,614
    
    
    
    3,856
    
    
    
    16,470Estimated future amortization expense:Remainder of 2004
    
    
    
    
    
    
    284
    
    
    
    2842005
    
    
    
    
    
    
    1,042
    
    
    
    1,0422006
    
    
    
    
    
    
    863
    
    
    
    8632007
    
    
    
    
    
    
    685
    
    
    
    6852008
    
    
    
    
    
    
    506
    
    
    
    5062009
    
    
    
    
    
    
    476
    
    
    
    476
 In February 1997, the Company acquired Broadway National Bank and operated
it as a subsidiary of the Company, consolidating its results with the Company
and its other subsidiaries. Effective December 31, 2003, Broadway National Bank
was merged into Boston Federal Savings Bank. The merger was executed in order
to improve efficiencies. The effects of this merger are not material to the
Companys consolidated financial statements. NOTE 6: AGREEMENT AND PLAN OF MERGER On June 21, 2004, the Company announced that it had entered into an
Agreement and Plan of Merger to merge into Banknorth Group, Inc. (Banknorth)
in a transaction valued at approximately $195 million at the time of
announcement. The transaction is subject to all required regulatory approvals,
approval of the shareholders of the Company and other customary conditions. The
transaction is expected to be completed in early 2005 with operational
integration to follow soon thereafter. Under the terms of the agreement, which
has been unanimously approved by the Boards of Directors of both companies, the
Company will merge with and into Banknorth and BFS will merge with Banknorth,
National Association. Shareholders of the Companys common stock will receive
1.241 shares of Banknorth common stock, or at the election of a Company
shareholder, 1.055 shares of Banknorth common stock and $6.12 in cash, plus, in
each case, cash in lieu of any fractional share interest, for each share of NOTE 7: CAPITAL CONSTRAINTS The Bank has informally agreed with the OTS to have at least a 6% Tier 1
capital ratio by year-end 2004 and reduce certain high risk loans below 200% of
Tier 1 capital. At September 30, 2004, the Banks Tier 1 capital ratio was
6.22% and its high risk loans were at approximately 175% of Tier 1 capital. As a
result, the Banks ability to fund future dividends to the Company may be
limited to the extent it does not continue to meet such thresholds or to the
extent the financial condition of the Bank does not permit the Bank to pay
dividends to the Company. Additionally, the Company has been requested by the
OTS to obtain its permission before incurring additional debt. Although the
Company has relied upon dividends from the Bank and debt for liquidity
purposes, the Company believes that its current cash and liquidity position is
sufficient to fund its near-term debt payment obligations and potential future
dividends through 2006 without reliance on dividends from the Bank. Accordingly, to the extent the Bank were unable to pay
dividends to the Company, the Company were unable to borrow additional funds or
it is unable to raise additional capital, the Companys liquidity position
could be adversely affected, particularly if the pending merger with Banknorth
is not consummated. 11




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##### Table of Contents



Company common stock held at the merger date. The transaction will be
tax-free to the Companys shareholders with respect to the stock portion. The Company and Banknorth filed a preliminary joint proxy
statement/prospectus and other relevant documents concerning the merger with
the United States Securities and Exchange Commission (the SEC) on October 6,
2004. On August 25, 2004, Banknorth entered into an amended and restated
agreement and plan of merger with The Toronto-Dominion Bank (TD) pursuant to
which TD will acquire 51% of the outstanding common stock of Banknorth. Upon
completion of the TD/Banknorth merger, each Banknorth shareholder will be
entitled to receive, in exchange for the shares of Banknorth common stock owned
by such shareholder, a package of consideration consisting of (1) a number of
TD common shares equal to 0.2351 multiplied by the number of shares of
Banknorth common stock owned by such shareholder, (2) an amount in cash equal
to $12.24 multiplied by the number of shares of Banknorth common stock owned by
such shareholder and (3) a number of shares of new Banknorth common stock equal
to 0.49 multiplied by the number of shares of Banknorth common stock owned by
such shareholder, plus cash in lieu of any fractional share interests. Upon
completion of the TD merger, TD will own 51% of new Banknorth common stock and
existing Banknorth shareholders will own the other 49%. 
 Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS A. GENERAL The Company, headquartered in Burlington, Massachusetts, was organized in
1995 under Delaware law as the holding company for BFS in connection with the
conversion of BFS from a mutual to a stock form of ownership. The Company later
acquired BNB, a nationally-chartered commercial bank, as its wholly-owned
subsidiary, which was merged into BFS on December 31, 2003, (collectively,
BFS). In December 1999, the Company acquired Diversified Ventures, Inc.,
d/b/a Forward Financial Company (Forward Financial) and Ellsmere Insurance
Agency, Inc. (Ellsmere). Forward Financial and Ellsmere operate as
subsidiaries of BFS. On October 24, 2003, the Company acquired the seven (7)
Boston area branch offices of Encore Bank (the acquisition of branches),
including one office in Lexington, which was merged into the Companys existing
Lexington office. The Companys business has been conducted primarily through its
wholly-owned subsidiary, BFS. It operates its administrative/bank branch office
located in Burlington, Massachusetts and its 15 other bank branch offices
located in Arlington, Bedford, Belmont, Billerica, Boston, Chelsea, Lexington,
Needham, Newton, Peabody, Revere, Sudbury, Wellesley and two offices in Woburn.
These offices are all located in the greater Boston metropolitan area. The
former Linden Street, Wellesley office was merged into the Route 9 Wellesley
office in June 2004. The Banks subsidiary, Forward Financial, maintains its
headquarters in Westborough, Massachusetts, effective October 1, 2003
(previously located in Northborough, Massachusetts) and operates in
approximately 20 states. Through its subsidiary bank, the Company attracts retail deposits from the
general public and invests those deposits and other borrowed funds in loans,
mortgage-backed securities, U.S. Government and federal agency securities and
other securities. The Company originates mortgage loans for its investment
portfolio and for sale and generally retains the servicing rights of loans it
sells. Additionally, the Company, through Forward Financial, originates chattel
mortgage loans on manufactured housing, recreational vehicles and boats and
first mortgage loans on manufactured housing and other housing, substantially
all of which are sold in the secondary market, servicing released. Loan sales
are made from loans held in the Companys portfolio designated as being held
for sale or originated for sale during the period. The Companys revenues are
derived principally from interest on its loans, and to a lesser extent,
interest and dividends on its investment and mortgage-backed securities, gains
on sale of loans and service fees. The Companys primary sources of funds are deposits, principal and
interest payments on loans and mortgage-backed securities, interest, maturities
or sales of investments, Federal Home Loan Bank of Boston (FHLB) advances and
proceeds from the sale of loans. 12




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##### Table of Contents



The Companys results of operations are primarily dependent on net
interest income, which is the difference between the income earned on its loan
and investment portfolios and its cost of funds, consisting of the interest
paid on deposits and borrowings. Results of operations are also affected by the
Companys provision for loan losses, investment activities, gains or losses on
sale of loans, fees and amortization or adjustments to originated mortgage
servicing rights. The Companys non-interest expense principally consists of
compensation and benefits, occupancy and equipment expense, advertising, data
processing expense and other expenses. Results of operations of the Company are
also significantly affected by general economic and competitive conditions,
particularly changes in interest rates, government policies and actions of
regulatory authorities. The Company is a savings and loan holding company subject to the
regulations of the Office of Thrift Supervision (the OTS) since December 31,
2003. Executive Summary BostonFed is a $1.7 billion, community-oriented, savings and loan holding
company offering a variety of financial services through its principal
subsidiary, BFS. Both the Company and the Bank are headquartered in Burlington,
Massachusetts and are regulated by the OTS. The Company attracts retail
deposits from the general public through its sixteen branch offices in fifteen
cities/towns in the Boston metropolitan area. The Company originates
residential and commercial real estate mortgage loans for portfolio and for
sale, business and consumer loans, primarily in its lending area of Eastern
Massachusetts. Through Forward Financial, a subsidiary of the Bank, the Company
also currently originates loans, generally for sale, on manufactured housing,
recreational vehicles and boats in 20 states. Net income for the quarter ended September 30, 2004 was $474,000, compared
to net income of $1.4 million for the quarter ended September 30, 2003. Basic
and diluted earnings per share were both $0.10 for the quarter ended September
30, 2004 and $0.32 and $0.31, respectively, for the quarter ended September 30,
2003. For the nine months ended September 30, 2004, net income was $1.6
million, or $0.35 basic and diluted earnings per share, compared to $1.4
million or $0.31 basic and $0.30 diluted earnings per share for the nine months
ended September 30, 2003. The net interest margin of 2.47% for the quarter ended September 30, 2004
was eight basis points higher than the 2.39% net interest margin for the third
quarter of 2003. The increase was primarily due to the effects of recent
Federal Reserve Bank induced increases in short-term interest rates, which
allowed the Company to increase the yield on prime-based loans and equity
lines. For the nine months ended September 30, 2004, the net interest margin of
2.39% was eight basis points lower than the 2.47% net interest margin for the
nine months ended September 30, 2003. Generally higher mortgage interest rates caused a decline in mortgage loan
originations and consequently led to a $1.3 million decline in gain on sale of
loans in the quarter ended September 30, 2004 compared to the third quarter of
2003. Through September 30, 2004, gain on sale of loans was $5.2 million, a
$3.6 million reduction from the $8.8 million gain on sale of loans for the
comparable nine months ended September 30, 2003. Loan processing and servicing fees were a negative $107,000 for the three
months ended September 30, 2004, compared to a negative $341,000 for the three
months ended September 30, 2003. On a year-to-date basis, loan processing and
servicing fees were a negative $11,000, compared to a negative $2.9 million for
the nine months ended September 30, 2003. The primary reason for the
improvement is due to a net recovery of approximately $500,000 in the value of
the Companys originated mortgage servicing rights (OMSRs) during the nine
months ended September 30, 2004, whereas impairment charges of approximately
$3.6 million were incurred in the nine months ended September 30, 2003. The current quarter was significantly impacted by the absorption of
approximately $668,000 in merger related expenses, which are not tax-deductible
expenses. Through September 30, 2004, the Company has incurred approximately
$1.6 million in non-deductible merger related expenses. 13




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##### Table of Contents



Non-performing loans increased from $4.7 million at December 31, 2003 to
$7.4 million at September 30, 2004, primarily due to a $2.3 million loan
secured by an industrial building and a few other smaller balance loans
becoming delinquent 90 days or more. The allowance for loan losses as a percent
of loans increased from 1.13% at December 31, 2003 to 1.16% at September 30,
2004. Recent Developments See Note 6 for recent developments regarding the Companys merger with the
Banknorth Group, Inc. Critical Accounting Policies The Companys critical accounting policies were detailed in the Companys
Annual Report for the year ended December 31, 2003, in the Managements
Discussion and Analysis of Financial Condition and Results of Operations and in
Note 1 of the Consolidated Financial Statements. Various elements of the
Companys accounting policies, by their nature, are inherently subject to
estimation techniques, valuation assumptions and other subjective assessments.
The Companys policies with respect to the methodologies used to determine the
allowance for loan losses and asset impairment judgments, including the
valuation of Originated Mortgage Servicing Rights (OMSRs) and the value of
goodwill, are the Companys most critical accounting policies because they are
important to the presentation of the financial condition and results of
operations of the Company and they involve a higher degree of complexity and
require management to make difficult and subjective judgments, which often
require assumptions or estimates about highly uncertain matters. The use of
different judgments, assumptions and estimates could result in material
differences in the results of operations or financial condition. The
appropriate, critical accounting policies and their application are reviewed
quarterly by the Audit and Compliance Committee of the Board of Directors. B. FINANCIAL CONDITION Assets Total assets declined by $11.7 million to a balance of $1.7 billion at
September 30, 2004, approximately the same as at December 31, 2003. Investment
securities available for sale declined by $46.9 million due in part to the
Companys sale of a portion of its mutual fund investments. Mortgage-backed
securities held to maturity declined by $11.3 million due to amortization and
pre-payments. Partially offsetting these declines were increases in loans held
for sale and loans, net, which increased by $13.5 million and $40.0 million,
respectively. The Companys loan portfolio was comprised of the following at: 9/30/04
    
    12/31/03In thousandsMortgage loans:Residential 1-4 family
    
    $
    909,070
    
    
    $
    827,184Multi-family
    
    
    20,225
    
    
    
    20,044Construction and land
    
    
    72,822
    
    
    
    116,427Commercial real estate
    
    
    101,005
    
    
    
    123,544Total mortgage loans
    
    
    1,103,122
    
    
    
    1,087,199Consumer and other loans:Home equity and improvement
    
    
    136,907
    
    
    
    120,205Consumer
    
    
    3,416
    
    
    
    4,597Business
    
    
    20,238
    
    
    
    26,582Total consumer and other loans
    
    
    160,561
    
    
    
    151,384Total loans, gross
    
    
    1,263,683
    
    
    
    1,238,583Allowance for loan losses
    
    
    (14,898
    )
    
    
    (13,874
    )Construction loans in process
    
    
    (18,818
    )
    
    
    (33,125
    )Net unearned premium on loans purchased
    
    
    16
    
    
    
    25Fair value adjustment on mortgage banking derivatives
    
    
    
    
    
    
    (38
    )Deferred loan origination costs
    
    
    8,029
    
    
    
    6,448Loans, net
    
    $
    1,238,012
    
    
    $
    1,198,019
 14




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##### Table of Contents



As noted in the above table, the allowance for loan losses amounted to
$14.9 million at September 30, 2004. Management believes the allowance is
adequate to absorb probable loan losses. The allowance for loan losses
increased from $13.9 million at December 31, 2003 due to the current quarters
provision, net of charge-offs/recoveries. Because future events affecting the
loan portfolio cannot be predicted with complete accuracy, there can be no
assurances that managements estimates are correct and that the existing
allowance for loan losses is adequate. However, the Company believes that the
allowance for loan losses is at a reasonable level based on its evaluation of
information currently available. The Company maintains an allowance for losses
that is inherent in the Companys loan portfolio. The allowance for loan losses
is established through a provision for loan losses charged to operations. Loan
losses are charged against the allowance when management determines that the
collectibility of the loan principal is unlikely. Recoveries on loans
previously charged off are credited to the allowance. The following is a
summary of activity in the allowance for loan losses during the nine months
ended September 30, 2004: In thousandsBalance at December 31, 2003.
    
    $
    13,874Loss provision
    
    
    1,350Recoveries
    
    
    278Charge-offs
    
    
    (604
    )Balance at September 30, 2004
    
    $
    14,898
 Managements methodology to estimate loss exposure inherent in the
portfolio includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payment status or loss
experience and an unallocated allowance that is maintained based on
managements assessment of many factors, including trends in loan delinquencies
and charge-offs, current economic conditions and their effect on borrowers
ability to pay, underwriting standards by loan type, mix and balance of the
portfolio, and the performance of individual loans in relation to contract
terms. In addition, the OTS, as an integral part of its examination process,
periodically reviews the Companys allowance based on its judgments about
information available to it at the time of its examination. While management
uses information currently available to estimate inherent losses on its loans,
future additions to the allowance may be necessary based on regulatory
directives or future events, including changes in local, regional and national
economic conditions and real estate markets, and changes in market interest
rates. Accordingly, the ultimate collectibility of a substantial portion of the
Companys loan portfolio is affected by such changes. As part of the Companys determination of the adequacy of the allowance
for loan losses, the Company monitors its loan portfolio through its management
Asset Classification Committee (the Committee). The Committee classifies
loans depending on risk of loss characteristics. The most severe classification
before a charge-off or impairment is required is sub-standard. At September
30, 2004, the Company classified $34.5 million of loans as sub-standard
compared to $21.2 million at December 31, 2003. Non-performing assets at
September 30, 2004 totaled $8.7 million or 0.52% of total assets, compared to
$6.5 million, or 0.38% of total assets, at December 31, 2003. The increase was
primarily due to a $2.3 million loan secured by an industrial building and a
few other smaller balance loans becoming delinquent 90 days or more. The
Committee, which meets quarterly, determines the adequacy of the allowance for
loan losses through ongoing analysis of the historical loss experience, the
composition of the loan portfolios, delinquency levels, underlying collateral
values, cash flow values and state of the real estate economy. Management
believes that the allowance for loan losses at September 30, 2004 is sufficient
to provide for anticipated losses inherent in the loan portfolio. The Companys $14.9 million allowance for loan losses at September 30,
2004 represented 201% of non-performing loans or 1.16% of total loans, compared
to $13.9 million at December 31, 2003, or 296% of non-performing loans and
1.13% of total loans. Management believes these coverage ratios are at prudent
levels considering the levels of non-performing loans and classified loans. Non-performing loans were $7.4 million and $4.7 million at September 30,
2004 and December 31, 2003, respectively. The amount of interest income on
non-performing loans that would have been recorded had these loans been current
in accordance with their original terms was $416,000 and $384,000 for the
nine-month periods ended 15




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##### Table of Contents



September 30, 2004 and 2003, respectively. The amount of interest income
that was recorded on these loans was $150,000 and $146,000 for the nine-month
periods ended September 30, 2004 and 2003, respectively. At September 30, 2004, there were three loans with a net balance of $3.2
million, characterized as impaired. During the nine months ended September 30,
2004, the average recorded value of impaired loans was $3.6 million. No
interest income was recognized. Approximately $242,000 of interest income
would have been recognized under the loans original terms. At September 30,
2003, there were eight loans with a net balance of $3.7 million, characterized
as impaired. During the nine months ended September 30, 2003, the average
recorded value of impaired loans was $7.6 million; there was $64,000 of
interest income that was recognized and $180,000 of interest income that would
have been recognized under the loans original terms. At September 30, 2004, the Company had a commercial real estate building
(an office condominium) in REO with a carrying amount of $1.3 million. At
December 31, 2003, the Company had one property in REO consisting of two office
condominiums with a balance of $1.8 million. One of the office condominiums,
located in Woburn, Massachusetts was sold in the third quarter of 2004. The
remaining unit is currently being marketed for sale. Stock in the Federal Home Loan Bank and Federal Reserve Bank declined by
$6.0 million as the Company redeemed its excess capital under the FHLBs new
capital requirements and redeemed its Federal Reserve Bank stock applicable to
the former Broadway National Bank. Liabilities Deposit accounts were $1.1 billion at September 30, 2004, a decrease of
$44.4 million from the $1.2 billion at December 31, 2003. Most of this decrease
is attributable to the expected run-off at the former Encore Bank Boston area
branches acquired in late 2003. The following is a summary of deposit balances by type at: 09/30/04
    
    12/31/03In thousandsNOW accounts
    
    $
    202,249
    
    
    $
    211,469Regular and statement savings
    
    
    217,816
    
    
    
    227,491Money market
    
    
    123,885
    
    
    
    138,986Demand deposits and official checks
    
    
    90,762
    
    
    
    91,695Total non-certificate accounts
    
    
    634,712
    
    
    
    669,641Certificate accounts:3 to 12 months
    
    
    72,644
    
    
    
    57,2711 to 3 years
    
    
    302,950
    
    
    
    320,818Greater than 3 years
    
    
    85,626
    
    
    
    91,702IRA/KEOGH
    
    
    50,523
    
    
    
    51,323Total certificate accounts
    
    
    511,643
    
    
    
    521,114Total deposit balances
    
    $
    1,146,355
    
    
    $
    1,190,755Expected maturity of certificate accounts:Within one year
    
    $
    298,570
    
    
    $
    255,666One to two years
    
    
    152,025
    
    
    
    174,903Two to three years
    
    
    38,176
    
    
    
    47,358Over three years
    
    
    22,872
    
    
    
    43,187Total certificate accounts
    
    $
    511,643
    
    
    $
    521,114
 FHLB advances and other borrowings increased $29.8 million, to a balance
of $428.4 million at September 30, 2004, from $398.7 million at December 31,
2003. C. COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 GENERAL 16




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During the quarter ended September 30, 2004, the Company earned $474,000,
or $0.10 basic and diluted earnings per share, compared to net income of $1.4
million or $0.32 basic and $0.31 diluted earnings per share for the third
quarter of 2003. The current quarters earnings were negatively impacted by the
expenditure of $668,000 on merger related expenses, which are not tax
deductible and a $1.3 million decline in gain on sale of loans. These items
were partially offset by an increase in the net interest income of $941,000 and
$415,000 in gain on sale of investment securities. Earnings for the nine
months ended September 30, 2004 benefited from improved net interest income,
improved loan processing and servicing fees and gain on sale of investment
securities, offset by lower gain on sale of loans, amortization of core deposit
intangible and merger related expenses. The nine months ended September 30,
2003 were negatively impacted by the incremental loan loss provision, OMSR
impairment of $3.6 million, which drove loan processing and servicing income to
a negative $2.9 million, and additional state taxes and interest relating to
the disputed deduction for dividends received from the REIT subsidiaries. The
period was positively impacted by higher than normal gain on sale of loans. For the nine months ended September 30, 2004 and 2003, the annualized
return on average stockholders equity was 2.21% and 1.96%, respectively.
Comments regarding the components of net income are detailed in the following
paragraphs. Average Balances, Yields and Costs The following table sets forth certain information relating to the Company
for the three and nine months ended September 30, 2004 and 2003. The average
yields and costs are derived by dividing income or expense by the average
balance of interest earning assets or interest bearing liabilities,
respectively, for the periods shown. The average balance data is derived from
daily balances. The yields and costs include fees, premiums and discounts,
which are considered adjustments to yields. 17




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##### Table of Contents



BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Average Balances and Yield/Costs 2004
    
    2003Average
    
    
    
    
    
    
    
    
    
    AverageAverage
    
    
    
    
    
    Yield/
    
    Average
    
    
    
    
    
    Yield/Balance
    
    Interest
    
    Cost
    
    Balance
    
    Interest
    
    Cost(Dollars in thousands)For the quarter ended September 30:Assets:Interest-earning assets:Investment securities (1)
    
    $
    86,265
    
    
    $
    597
    
    
    
    2.77
    %
    
    $
    147,088
    
    
    $
    997
    
    
    
    2.71
    %Loans, net and loans held for sale (2)
    
    
    1,254,533
    
    
    
    16,229
    
    
    
    5.17
    %
    
    
    1,163,428
    
    
    
    15,995
    
    
    
    5.50
    %Mortgage-backed securities (3)
    
    
    233,622
    
    
    
    2,552
    
    
    
    4.37
    %
    
    
    153,428
    
    
    
    1,362
    
    
    
    3.55
    %Total interest-earning assets
    
    
    1,574,420
    
    
    
    19,378
    
    
    
    4.92
    %
    
    
    1,463,944
    
    
    
    18,354
    
    
    
    5.01
    %Non interest-earning assets
    
    
    107,196
    
    
    
    
    
    
    
    
    
    
    
    102,081Total assets
    
    
    1,681,616
    
    
    
    
    
    
    
    
    
    
    
    1,566,025Liabilities and stockholders equity:Interest-bearing liabilities:Money market deposit accounts
    
    
    126,169
    
    
    
    508
    
    
    
    1.61
    %
    
    
    67,417
    
    
    
    191
    
    
    
    1.13
    %Savings accounts
    
    
    220,861
    
    
    
    504
    
    
    
    0.91
    %
    
    
    222,647
    
    
    
    516
    
    
    
    0.93
    %NOW accounts
    
    
    202,536
    
    
    
    287
    
    
    
    0.57
    %
    
    
    151,610
    
    
    
    50
    
    
    
    0.13
    %Certificate accounts
    
    
    525,851
    
    
    
    3,862
    
    
    
    2.94
    %
    
    
    410,195
    
    
    
    3,708
    
    
    
    3.62
    %Total
    
    
    1,075,417
    
    
    
    5,161
    
    
    
    1.92
    %
    
    
    851,869
    
    
    
    4,465
    
    
    
    2.10
    %Borrowed funds (4)
    
    
    413,893
    
    
    
    4,512
    
    
    
    4.36
    %
    
    
    509,083
    
    
    
    5,125
    
    
    
    4.03
    %Total interest-bearing liabilities
    
    
    1,489,310
    
    
    
    9,673
    
    
    
    2.60
    %
    
    
    1,360,952
    
    
    
    9,590
    
    
    
    2.82
    %Non interest-bearing liabilities
    
    
    94,248
    
    
    
    
    
    
    
    
    
    
    
    111,936Total liabilities
    
    
    1,583,558
    
    
    
    
    
    
    
    
    
    
    
    1,472,888Stockholders equity
    
    
    98,058
    
    
    
    
    
    
    
    
    
    
    
    93,137Total liabilities and stockholders equity
    
    $
    1,681,616
    
    
    
    
    
    
    
    
    
    
    $
    1,566,025Net interest rate spread (5)
    
    
    
    
    
    $
    9,705
    
    
    
    2.32
    %
    
    
    
    
    
    $
    8,764
    
    
    
    2.19
    %Net interest margin (6)
    
    
    
    
    
    
    
    
    
    
    2.47
    %
    
    
    
    
    
    
    
    
    
    
    2.39
    %Ratio of interest-earning assets to
interest-bearing liabilities
    
    
    105.71
    %
    
    
    
    
    
    
    
    
    
    
    107.57
    %
 (1) Includes investment securities available for sale and held to maturity,
short-term investments, stock in FHLB-Boston and daily federal funds sold. (2) Amount is net of deferred loan origination costs, construction loans in
process, net unearned discount on loans purchased and allowance for loan losses
and includes non-performing loans. (3) Includes mortgage-backed securities available for sale and held to
maturity. (4) Interest paid on borrowed funds for the periods presented includes interest
expense on loan investor deposits held in escrow accounts with the Company
related to the Companys loan servicing, which, if such interest expense was
excluded, would result in an average cost of borrowed funds of 4.35% and 3.98%
for the three months ended September 30, 2004 and September 30, 2003,
respectively. (5) 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. (6) Net interest margin represents net interest income as a percentage of
average interest-earning assets. 18




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##### Table of Contents



BOSTONFED BANCORP, INC. AND SUBSIDIARIES
Average Balances and Yield/Costs 2004
    
    2003Average
    
    
    
    
    
    
    
    
    
    AverageAverage
    
    
    
    
    
    Yield/
    
    Average
    
    
    
    
    
    Yield/Balance
    
    Interest
    
    Cost
    
    Balance
    
    Interest
    
    Cost(Dollars in thousands)For the nine months ended September 30:Assets:Interest-earning assets:Investment securities (1)
    
    $
    107,188
    
    
    $
    2,008
    
    
    
    2.50
    %
    
    $
    155,947
    
    
    $
    3,235
    
    
    
    2.77
    %Loans, net and loans held for sale (2)
    
    
    1,220,864
    
    
    
    47,384
    
    
    
    5.17
    %
    
    
    1,113,726
    
    
    
    48,429
    
    
    
    5.80
    %Mortgage-backed securities (3)
    
    
    236,464
    
    
    
    7,540
    
    
    
    4.25
    %
    
    
    143,618
    
    
    
    4,496
    
    
    
    4.17
    %Total interest-earning assets
    
    
    1,564,516
    
    
    
    56,932
    
    
    
    4.85
    %
    
    
    1,413,291
    
    
    
    56,160
    
    
    
    5.30
    %Non interest-earning assets
    
    
    107,910
    
    
    
    
    
    
    
    
    
    
    
    105,000Total assets
    
    
    1,672,426
    
    
    
    
    
    
    
    
    
    
    
    1,518,291Liabilities and stockholders equity:Interest-bearing liabilities:Money market deposit accounts
    
    
    128,535
    
    
    
    1,519
    
    
    
    1.58
    %
    
    
    64,997
    
    
    
    575
    
    
    
    1.18
    %Savings accounts
    
    
    221,734
    
    
    
    1,492
    
    
    
    0.90
    %
    
    
    217,735
    
    
    
    1,724
    
    
    
    1.06
    %NOW accounts
    
    
    203,389
    
    
    
    878
    
    
    
    0.58
    %
    
    
    147,712
    
    
    
    206
    
    
    
    0.19
    %Certificate accounts
    
    
    525,943
    
    
    
    11,604
    
    
    
    2.94
    %
    
    
    415,462
    
    
    
    11,850
    
    
    
    3.80
    %Total
    
    
    1,079,601
    
    
    
    15,493
    
    
    
    1.91
    %
    
    
    845,906
    
    
    
    14,355
    
    
    
    2.26
    %Borrowed funds (4)
    
    
    398,951
    
    
    
    13,352
    
    
    
    4.46
    %
    
    
    468,187
    
    
    
    15,592
    
    
    
    4.44
    %Total interest-bearing liabilities
    
    
    1,478,552
    
    
    
    28,845
    
    
    
    2.60
    %
    
    
    1,314,093
    
    
    
    29,947
    
    
    
    3.04
    %Non interest-bearing liabilities
    
    
    96,506
    
    
    
    
    
    
    
    
    
    
    
    110,670Total liabilities
    
    
    1,575,058
    
    
    
    
    
    
    
    
    
    
    
    1,424,763Stockholders equity
    
    
    97,368
    
    
    
    
    
    
    
    
    
    
    
    93,528Total liabilities and stockholders equity
    
    $
    1,672,426
    
    
    
    
    
    
    
    
    
    
    $
    1,518,291Net interest rate spread (5)
    
    
    
    
    
    $
    28,087
    
    
    
    2.25
    %
    
    
    
    
    
    $
    26,213
    
    
    
    2.26
    %Net interest margin (6)
    
    
    
    
    
    
    
    
    
    
    2.39
    %
    
    
    
    
    
    
    
    
    
    
    2.47
    %Ratio of interest-earning assets to
interest-bearing liabilities
    
    
    105.81
    %
    
    
    
    
    
    
    
    
    
    
    107.55
    %
 (1) Includes investment securities available for sale and held to maturity,
short-term investments, stock in FHLB-Boston and daily federal funds sold. (2) Amount is net of deferred loan origination costs, construction loans in
process, net unearned discount on loans purchased and allowance for loan losses
and includes non-performing loans. (3) Includes mortgage-backed securities available for sale and held to
maturity. (4) Interest paid on borrowed funds for the periods presented includes interest
expense on loan investor deposits held in escrow accounts with the Company
related to the Companys loan servicing, which, if such interest expense was
excluded, would result in an average cost of borrowed funds of 4.45% and 4.40%
for the nine months ended September 30, 2004 and September 30, 2003,
respectively. (5) 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. (6) Net interest margin represents net interest income as a percentage of
average interest-earning assets. Interest Income Total interest income was $19.4 million on interest-earning assets for the
quarter ended September 30, 2004, compared to $18.4 million for the quarter
ended September 30, 2003. Although the average yield on interest-earning 19




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##### Table of Contents



assets declined by nine basis points, net interest income increased by
$1.0 million due to the earnings on the $110.5 million increase in average
interest-earning assets. The average yield on interest-earning assets declined
to 4.92% for the three months ended September 30, 2004 from 5.01% for the three
months ended September 30, 2003. For the nine months ended September 30, 2004,
total interest income increased by $772,000, to $56.9 million, compared to the
$56.2 million interest income earned during the nine months ended September 30,
2003. As in the current quarter, the year-to-date interest income increased due
to higher average balances, which were $151.2 million higher in the nine months
ended September 30, 2004. Partially offsetting the increased interest income
from the higher average balances was the impact of a 45 basis point decline in
the average yield on interest-earning assets. The reduced yields are due in
part to the repricing of a portion of the Companys adjustable-rate portfolio,
based on much lower indices resulting from the Federal Reserve induced decline
in market interest rates during the past few years, which only recently have
been partially reversed. Additionally, the proceeds received from the record
levels of loan prepayments and matured investment securities have been
re-invested at much lower interest rates than had been earned, despite recent
increases in some market interest rates. Interest income on loans, net, for the quarter ended September 30, 2004
increased by $234,000, or 1.5%, to $16.2 million compared to $16.0 million for
the comparable quarter in 2003. The increase in interest income from loans,
net, for the current three-month period was due to the $91.1 million increase
in the average balance of loans, net, partially offset by the effects of the 33
basis points decline in the average yield. The average yield on loans, net, for
the three months ended September 30, 2004 was 5.17%, compared to an average
yield of 5.50% for the three months ended September 30, 2003. For the nine
months ended September 30, 2004, interest income on loans, net, was $47.4
million, $1.0 million lower that the prior year comparable period. The yield on
loans, net, declined by 63 basis points in the current nine-month period. Many
adjustable-rate loans continue to be originated at relatively low interest
rates and the major repricing indices remain low by historical standards. The
Company has continued investing in interest sensitive loans such as equity
lines, commercial and construction, business and other short-term indexed loans
and selling most of its fixed-rate longer term loans into the secondary market
in order to protect against the possibility of rising interest rates. Interest on mortgage-backed securities for the quarter ended September 30,
2004 was $2.6 million, compared to $1.4 million for the quarter ended September
30, 2003. The increase in interest on mortgage-backed securities was due to the
combined effects of an $80.2 million increase in the average balance and an 82
basis point increase in the average yield. The average yield increased from
3.55% for the three months ended September 30, 2003, to 4.37% for the current
three-month period. For the nine months ended September 30, 2004, interest
income on mortgage-backed securities increased to $7.5 million, from $4.5
million for the nine months ended September 30, 2003 due primarily to the $92.8
million increase in the average balance of mortgage-backed securities. The
average yield on mortgage-backed securities increased from 4.17% for the nine
months ended September 30, 2003, to 4.25% for the nine months ended September
30, 2004. The increased yield is a reflection of the recent increases in the
interest rate environment, which allowed the Company to reinvest into similar,
but higher yielding investments. Income from investment securities was $597,000 for the three months ended
September 30, 2004, compared to $1.0 million for the prior year quarter. The
decline in income from investment securities was due to the lower average
balance of investment securities in the current year quarter, only partially
offset by an increase in the average yield. The average balance of investment
securities declined to $86.3 million for the three months ended September 30,
2004, from an average balance of $147.1 million for the prior year quarter. The
average yield increased from 2.71% for the three months ended September 30,
2003, to 2.77% for the three months ended September 30, 2004. For the nine
months ended September 30, 2004, interest income from investment securities was
$2.0 million, compared to $3.2 million for the nine months ended September 30,
2003. The lower income in the current year-to-date period is due to the
combined effects of lower average balances and lower yields. The average
investment securities balance for the nine months ended September 30, 2004 was
$107.2 million, compared to an average investment securities balance of $155.9
million for the prior year-to-date. The average yield declined by 27 basis
points, to an average yield of 2.50% for the nine months ended September 30,
2004 from an average yield of 2.77% in the prior year-to-date. Although
short-term interest rates have increased recently, the yield on investment
securities for the nine months ended September 30, 2004 still reflects the
effect of declines in market interest rates over the last few years, including
the historically low rates being paid on federal funds and Federal Home Loan
Bank overnight deposits. Because the Companys investment securities are
generally of a shorter-term nature, the decline in market interest rates has
had a significant impact on the overall yield of investment securities. 20




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##### Table of Contents



Interest Expense Total interest expense on interest-bearing liabilities for the quarter
ended September 30, 2004 increased by $83,000 to $9.7 million from $9.6 million
for the quarter ended September 30, 2003. The increase in interest expense for
the quarter ended September 30, 2004 was due to the effects of an increase in
the average balance of interest-bearing liabilities of $128.4 million almost
offset by the benefit of a reduction of 22 basis points in the average cost of
interest bearing liabilities. Total interest-bearing liabilities averaged $1.5
billion during the third quarter of 2004, compared to an average balance of
$1.4 billion during the quarter ended September 30, 2003. The average cost of
interest-bearing liabilities declined to 2.60% during the quarter ended
September 30, 2004, compared to 2.82% for last years third quarter. Total
interest expense on interest-bearing liabilities during the nine months ended
September 30, 2004 declined to $28.8 million from $29.9 million for the nine
months ended September 30, 2003. The lower interest expense was due to a 44
basis point decline in the average cost of interest-bearing liabilities in the
current year-to-date period, partially offset by the interest expense on the
$164.5 million increase in the average balance of interest-bearing liabilities
in the current year-to-date. Interest expense on deposit accounts was $5.2 million for the quarter
ended September 30, 2004, an increase of $696,000 from the $4.5 million for the
quarter ended September 30, 2003. Interest expense on deposit accounts
increased, despite an 18 basis point decrease in the average cost of deposits
due to the interest expense applicable to the increase of $223.5 million in the
average deposit balance. For the three months ended September 30, 2004, the
average cost of deposits was 1.92%, compared to 2.10% for the three months
ended September 30, 2003. Average balances of deposit accounts were $1.1
billion for the third quarter of 2004, compared to an average balance of $851.9
million for the quarter ended September 30, 2003. Interest expense on deposit
accounts increased to $15.5 million in the nine months ended September 30,
2004, compared to $14.4 million for the nine months ended September 30, 2003,
despite a reduction of 35 basis points in the average cost of deposits. The
effect of the lower cost of funds was more than offset by the increase in the
average deposit balance, which increased by $233.7 million in the nine months
ended September 30, 2004. The primary reason for the increased average balance
in savings deposits was due to the acquisition of the former Encore Bank
branches in October of 2003. Interest expense on borrowed funds was $4.5 million for the three months
ended September 30, 2004, compared to $5.1 million for the three months ended
September 30, 2003. The $613,000 decline in interest expense on borrowed funds
was due to lower average balances of borrowed funds in the third quarter of
2004, compared to the third quarter of 2003, partially offset by a higher
average cost. Borrowed funds declined to an average balance of $413.9 million
during the quarter ended September 30, 2004, from an average of $509.1 million
for the comparable quarter of 2003, primarily due to the repayment of advances
with the cash proceeds from the deposits acquired in the former Encore Bank
branches. The average cost of borrowed funds increased to 4.36% for the three
months ended September 30, 2004, a 33 basis point increase, compared to the
4.03% cost of borrowed funds for the three months ended September 30, 2003. For
the nine months ended September 30, 2004, interest on borrowed funds declined
to $13.4 million, compared to $15.6 million for the nine months ended September
30, 2003. The lower interest expense was essentially due to the effects of
lower average balances, which declined by $69.2 million. The average cost of
borrowed funds for the nine months ended September 30, 2004 was 4.46%, a
minimal change from the 4.44% for the nine months ended September 30, 2003.
The cost of borrowed money has not declined at the same rate as overall market
rate declines, due to the Companys use of generally longer-term advances and
the overall decline in the advances total, which precludes the addition of new
advances at lower market rates. Net Interest Income Net interest income for the three months ended September 30, 2004 was $9.7
million, compared to $8.8 million for the third quarter of 2003. The
combination of higher average balances and a higher net interest margin
contributed to the improved net interest income in the current quarter. For
the nine months ended September 30, 2004, net interest income was $28.1
million, compared to $26.2 million for the prior year comparable period. Net
interest income increased, despite a decline in the net interest margin, due to
higher levels of interest earning assets. The lowest interest rates in decades
have precipitated high levels of loan prepayments, which combined with
reinvestment in lower yielding loans and investment securities, as well as
diminishing opportunities to continue lowering core deposit interest rates,
have caused a decrease in the net interest margin up until the current quarter. 21




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##### Table of Contents



The net interest margin increased to 2.47% for the quarter ended September
30, 2004, from 2.39% in the third quarter of 2003. For the nine months ended
September 30, 2004, the net interest margin declined to 2.39%, compared to
2.47% for the nine months ended September 30, 2003 as the current quarters
improved margin was offset by the lower margins earlier in the period. Provision for Loan Losses The provision for loan losses was $450,000 for the three months ended
September 30, 2004 and 2003. For the nine months ended September 30, 2004 and
2003, the provision for loan losses was $1.4 million and $2.9 million,
respectively. The loan loss provision for the prior year was higher than
normal due to a $1.6 million charge-off necessitating the replenishment of the
allowance for loan losses at June 30, 2003. The coverage ratio of allowance for
loan losses as a percent of loans increased from 1.13% at December 31, 2003, to
1.16% at September 30, 2004. Non-performing loans increased from $4.7 million
at December 31, 2003 to $7.4 million at September 30, 2004, primarily due to a
$2.3 million loan secured by an industrial building and a few smaller loans
becoming delinquent more than 90 days. The allowance for loan losses was $14.9
million at September 30, 2004, compared to $13.9 million at December 31, 2003.
These amounts represent 201% and 296%, of non-performing loans at September 30,
2004 and December 31, 2003, respectively. Non-Interest Income Total non-interest income declined to $3.3 million for the quarter ended
September 30, 2004, compared to $4.3 million for the quarter ended September
30, 2003. For the nine months ended September 30, 2004, non-interest income
declined to $10.3 million, compared to $10.8 million for the nine months ended
September 30, 2003. The primary cause for the declines is lower gain on sale
of loans, which declined to $1.6 million in the current quarter compared to
$3.0 million for the third quarter of 2003 and $5.2 million for the nine months
ended September 30, 2004, compared to $8.8 million for the nine months ended
September 30, 2003. As mortgage interest rates have climbed recently, the
volume of loans refinanced has declined, providing fewer loans for sale.
Partially offsetting the impact of lower gain on sale of loans was the
improvement in loan processing and servicing income. Loan processing and
servicing fees were a negative $107,000 in the current quarter, compared to a
negative $341,000 for the quarter ended September 30, 2003 as the Company
experienced fewer loan prepayments in its loans serviced for others. For the
nine months ended September 30, 2004, loan processing and servicing fees were a
negative $11,000, compared to a negative $2.9 million for the nine months ended
September 30, 2003. The originated mortgage servicing rights (OMSRs) balance
was $7.1 million, with no valuation allowance, and represented approximately 76
basis points of the $938.0 million of loans serviced for others. Total mortgage loan originations were $655.0 million during the nine
months ended September 30, 2004, compared to $1.1 billion for the nine months
ended September 30, 2003. Generally, the Company sells approximately one-half
of its loan production. Included in the above gain on sale of loans were gains
on sale of loans by the Banks subsidiary, Forward Financial Company, which
amounted to $2.1 million and $2.9 million for the nine months ended September
30, 2004 and 2003, respectively. Gain on sale of investments during the quarter ended September 30, 2004
was $415,000, as the Company liquidated a portion of its equity securities and
mutual fund investments. For the nine months ended September 30, 2004, gain on
sale of investments was $747,000, which included the aforementioned gain, as
well as additional gains on the sale of equity securities sold during the first
half of 2004. Deposit service fees declined to $2.4 million in the nine months ended
September 30, 2004, compared to $2.7 million in the prior year period. The
decline is due to the Companys elimination of various deposit service fees for
competitive reasons. Non-Interest Expense Total non-interest expense was $11.5 million for the quarter ended
September 30, 2004, compared to $10.2 million for the prior year quarter. The
third quarter of 2004 included $312,000 in amortization of core deposit
intangibles (CDI) related to the acquisition and assumption of Encore Banks
Boston area branches. Other non- 22




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##### Table of Contents



interest expense was $2.5 million for the quarter ended September 30,
2004, compared to $1.4 million for the prior year comparable quarter. The
increase in the quarter ended September 30, 2004 is primarily due to expenses
of approximately $668,000 incurred as a result of costs associated with the
merger with Banknorth Group, Inc. and other corporate accruals. For the nine months ended September 30, 2004,
total non-interest expenses were $33.7 million, compared to $29.7 million for
the nine months ended September 30, 2003. The increase was also primarily due
to the recognition of $936,000 in amortization of CDI and $1.6 million of
merger related expenses in the nine months ended September 30, 2004. Also, in
addition to the above mentioned increased expenses, compensation and benefits,
occupancy and equipment and data processing expenses were also higher for the
nine months ended September 30, 2004 in part due to expenses associated with
the addition of the former Encore Bank branches. Income tax expense for the quarter ended September 30, 2004 was $615,000,
for an effective tax rate of 56.5%, which is higher than the expected effective
tax rate of approximately 41%, primarily due to the $668,000 non-deductible
merger related expenditures, partially offset by the non-taxable nature of
income from bank-owned life insurance (BOLI). In the prior year, BOLI income
was essentially offset by non-deductible employee stock ownership plan (ESOP)
expenses. ESOP expenses are no longer being incurred, as the ESOP was fully
allocated at December 31, 2003. Income tax expense for the quarter ended
September 30, 2003 was $1.1 million, for an effective tax rate of 42.3%. For
the nine months ended September 30, 2004, income tax expense was $1.7 million
for an effective tax rate of 51.5%, similarly impacted by the non-deductible
merger related expenses of $1.6 million and BOLI income. For the nine months
ended September 30, 2003, income tax expense was $3.0 million, a portion of
which was the charge for the additional REIT taxes applicable to prior years,
net of the settlement with the Massachusetts Department of Revenue. The
remaining tax of approximately $1.8 million results in an effective tax rate of
approximately 41.4%. D. LIQUIDITY AND CAPITAL RESOURCES The primary source of cash flow for the Company is dividend payments from
BFS, interest income, sales and maturities of investment securities and, to a
lesser extent, earnings on deposits held by the Company. Dividend payments have
been used to fund stock repurchase programs, pay dividends to stockholders,
interest on trust-preferred securities and other operating expenses of the
Company. The ability of BFS to pay dividends and other capital distributions to
the Company is generally limited by OTS regulations. Additionally, the OTS may
prohibit the payment of dividends that are otherwise permissible by regulation
for safety and soundness reasons. The Bank has informally agreed with the OTS to have at least a 6% Tier 1
capital ratio by year-end 2004 and reduce certain high risk loans below 200% of
Tier 1 capital. At September 30, 2004, the Banks Tier 1 capital ratio was
6.22% and its high risk loans were at approximately 175% of Tier 1 capital. As a
result, the Banks ability to fund future dividends to the Company may be
limited to the extent it does not continue to meet such thresholds or to the
extent the financial condition of the Bank does not permit the Bank to pay
dividends to the Company. Additionally, the Company has been requested by the
OTS to obtain its permission before incurring additional debt. Although the
Company has relied upon dividends from the Bank and debt for liquidity
purposes, the Company believes that its current cash and liquidity position is
sufficient to fund its near-term debt payment obligations and potential future
dividends through 2006 without reliance on dividends from the Bank. Accordingly, to the extent the Bank were unable to pay
dividends to the Company, the Company were unable to borrow additional funds or
it is unable to raise additional capital, the Companys liquidity position
could be adversely affected, particularly if the pending merger with Banknorth
is not consummated. The Banks primary sources of funds are deposits (including brokered
deposits), principal and interest payments on loans, sales of loans, sales or
maturities of investments, mortgage-backed and related securities and
borrowings from the FHLB. While maturities and scheduled amortization of loans
are predictable sources of funds, deposit flows and mortgage prepayments are
greatly influenced by general interest rates, economic conditions and
competition. Management has maintained adequate liquidity so that it may invest
any excess liquidity in higher yielding interest-earning assets or use such
funds to repay higher cost FHLB advances. The OTS does not provide specific
guidance for liquidity ratios for BFS, but does require the Bank to maintain
reasonable and prudent liquidity levels. Management believes such levels are
being maintained. 23




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The Company and Banks most liquid assets are cash, overnight federal
funds sold, and loans and investments available for sale. The levels of these
assets are dependent on the Companys operating, financing, lending and
investing activities during any given period. Liquid assets consisted of the following for the periods indicated: 09/30/04
    
    12/31/03(In Thousands)Cash and cash equivalents
    
    $
    28,988
    
    
    $
    34,045Investment securities available for sale
    
    
    55,782
    
    
    
    102,647Mortgage-backed securities available for sale
    
    
    92,492
    
    
    
    83,752Loans held for sale
    
    
    26,286
    
    
    
    12,751Total liquid assets
    
    $
    203,548
    
    
    $
    233,195
 These amounts represent 12.1% and 13.8% of the Companys total assets at
September 30, 2004 and December 31, 2003, respectively. The Bank has other sources of liquidity if a need for additional funds
arises, including FHLB advances and wholesale-brokered deposits. At September
30, 2004, the Bank had $395.4 million in advances outstanding from the FHLB and
had, with existing collateral, an additional $394.9 million in overall
borrowing capacity from the FHLB. Borrowing capacity can also be further
increased upon delivery of mortgage notes on non-owner occupied one- to
four-family loans, multi-family and commercial loans. The Bank generally does
not pay the highest deposit rates in its market and accordingly utilizes
alternative sources of funds such as FHLB advances and wholesale-brokered
deposits to supplement cash flow needs. At September 30, 2004, the Bank had commitments to originate loans and
unused outstanding lines of credit totaling $267.2 million. Certificate
accounts, which are scheduled to mature in less than one year from September
30, 2004, totaled $298.6 million. The Bank anticipates that it will have
sufficient funds available to meet its current loan origination commitments and
certificate of deposit withdrawals as they may occur. At September 30, 2004, the consolidated stockholders equity to total
assets ratio was 5.9%. As of September 30, 2004, the Bank exceeded all of its
regulatory capital requirements. The Banks tier 1 (core) capital, total
risk-based capital, tier 1 risk-based and tangible equity capital ratios were
6.2%, 11.4%, 10.2% and 6.2%, respectively. E. OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on the financial
condition, revenues, expenses or results of operations of the Company.
Additionally, there has not been any material changes during the quarter to any
contractual obligations. 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK One of the principal market risks affecting the Company is interest rate
risk. The objective of the Companys interest rate risk management function is
to evaluate the interest rate risk included in certain balance sheet accounts,
determine the level of risk appropriate given the Companys business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with the Board of Directors
approved guidelines. Through such management, the Company seeks to reduce the
vulnerability of its operations to changes in interest rates. The Company
monitors its interest rate risk as such risk relates to its operating
strategies. The Companys Board of Directors has established a management
Asset/Liability Committee that is responsible for reviewing the Companys
asset/liability policies and interest rate risk position. The Committee reports
trends and interest rate risk position to the Board of Directors on a quarterly
basis. The extent of the movement of interest rates is an uncertainty that
could have a negative impact on the earnings of the Company. The Company has utilized the following strategies to manage interest rate
risk:  (1)
    
    emphasizing the origination and retention of adjustable-rate,
one- to four-family mortgage loans; 24




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##### Table of Contents



(2)
    
    generally selling in the secondary market substantially all
fixed-rate mortgage loans originated with terms of 15 years or
greater while generally retaining the servicing rights thereof;  (3)
    
    primarily investing in investment securities or mortgage-backed
securities with adjustable interest rates; or shorter-term
collateralized mortgage obligations (CMOs); and  (4)
    
    attempting to reduce the overall interest rate sensitivity of
liabilities by emphasizing longer-term deposits and utilizing
longer-term FHLB advances to reduce reliance on rate sensitive retail
deposits. A portion of the FHLB advances may be called depending on the level of
interest rates relative to the interest rate being charged at the applicable
call date. Accordingly, if interest rates rise sufficient to trigger the call
feature, the Companys net interest margin may be negatively impacted if called
advances are replaced by new, higher cost advances. The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are interest rate sensitive and
by monitoring the Companys interest rate sensitivity gap. An asset or
liability is said to be interest rate sensitive within a specific time period
if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
time period. These differences are a primary component of the risk to net
interest income. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. Accordingly,
during a period of rising interest rates, an institution with a positive gap
position would be in a better position to reprice loans and invest cash flows
from maturing assets in higher yielding assets which, consequently, may result
in the yield on its assets increasing at a pace more closely matching the
increase in the cost of its interest-bearing liabilities than if it had a
negative gap. During a period of falling interest rates, an institution with a
positive gap would tend to have its assets repricing at a faster rate than one
with a negative gap which, consequently, may tend to restrain the growth of its
net interest income. Certain shortcomings are inherent in gap analysis. For example, although
certain assets and liabilities may have similar maturities or periods to
repricing, they may react in different degrees to changes in market interest
rates. Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Additionally, certain
assets, such as adjustable-rate loans, have features that restrict changes in
interest rates both on a short-term basis and over the life of the asset.
Further, in the event of change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in
calculating the table. Finally, the ability of many borrowers to service their
adjustable-rate loans may decrease in the event of an interest rate increase. At
September 30, 2004, the Companys one-year gap was a
negative 3.8% of total assets, compared to a positive 2.7% of total assets at December
31, 2003. The Companys interest rate sensitivity is also monitored by management
through the use of a model, which internally generates estimates of the change
in net portfolio value (NPV) over a range of interest rate change scenarios.
NPV is the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The NPV ratio, under any interest rate scenario,
is defined as the NPV in that scenario divided by the market value of assets in
the same scenario. As in the case with the gap analysis, certain shortcomings are inherent in
the methodology used in the above interest rate risk measurements. Modeling
changes in NPV require the making of certain assumptions, which may or may not
reflect the manner in which actual yields and costs respond to changes in
market interest rates. In this regard, the NPV model used assumes that the
composition of the Companys interest sensitive assets and liabilities existing
at the beginning of a period remain constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Accordingly, although the NPV measurements and
net interest income 25




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##### Table of Contents



models provide an indication of the Companys interest rate risk exposure
at a particular point in time, such measurements are not intended to and do not
provide a precise forecast of the effect of changes in market interest rates on
the Companys net interest income and will differ from actual results. See the
Companys Form 10-K for the year ended December 31, 2003 as filed with the
Securities and Exchange Commission on March 15, 2004, for a detail of the GAP
and NPV tables. There have been no material changes in the net portfolio value
since December 31, 2003. 
 Item 4. CONTROLS AND PROCEDURES The Companys management, including the Companys principal executive
officer and principal financial officer, have evaluated the effectiveness of
the Companys disclosure controls and procedures, as such term is defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended, (the Exchange Act). Based upon their evaluation, the principal
executive officer and principal financial officer concluded that, as of the end
of the period covered by this report, the Companys disclosure controls and
procedures were effective for the purpose of ensuring that the information
required to be disclosed in the reports that the company files or submits under
the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms, and (2) is accumulated and communicated to the
Companys management, including its principal executive and principal financial
officers, as appropriate to allow timely decisions regarding required
disclosure. In addition, based on that evaluation, no change in the Companys
internal control over financial reporting occurred during the quarter ended
September 30, 2004, that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 26




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##### Table of Contents



PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. In the
opinion of management, the ultimate disposition of these matters is not
expected to have a material adverse effect on the consolidated financial
position, the annual results of operations or the liquidity of the Company. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds No equity securities were sold during the quarter that were not registered
under the Securities Exchange Act. No repurchases of stock were made during the quarter. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders None 
 Item 5. Other Information None. 
 Item 6. Exhibits (a) Exhibits 2.0
    
    Agreement and Plan of Merger by and among Banknorth Group, Inc. and
BostonFed Bancorp, Inc. dated June 20, 2004*3.1
    
    Restated Certificate of Incorporation**3.2
    
    Amended and Restated Bylaws as of February 23, 2000***4.0
    
    Stock Certificate of BostonFed Bancorp, Inc.**31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.0
    
    Section 1350 Certifications* Incorporated herein by reference into this document from Exhibit 2.1 to the
Form 8-K filed with the Commission on June 22, 2004 (File No. 001-13936).** Incorporated herein by reference into this document from Exhibits 3.1 and
4.0 to the Form S-1, Registration Statement, and any amendments thereto, filed
with the Commission on July 21, 1995, as amended (Registration No. 333-94860).*** Incorporated herein by reference into this document from Exhibit 3.2 to the
Annual Report on Form 10-K filed with the Commission on March 30, 2000 (File
No. 001-13936).
 27




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EXHIBIT INDEX (31.1)
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
    
    Page(31.2)
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
    
    Page(32.0)
    
    Section 1350 Certifications
    
    Page
 28




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SIGNATURES Pursuant to the requirements 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. BOSTONFED BANCORP, INC.
(Registrant)Date: November 8, 2004
    
    By:
    
    /s/ David F. HollandDavid F. Holland
President and Chief Executive OfficerDate: November 8, 2004
    
    By:
    
    /s/ John A. SimasJohn A. Simas
Executive Vice President, Chief Financial
Officer and Corporate Secretary
 29