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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 1934
 For the Quarterly Period ended June 30, 2004 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to Commission File Number 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 registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]    No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X]    No [  ] The Registrant had 4,540,196 shares of common stock, par value $.01 per
share, outstanding as of June 30, 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 June 30, 2004 and December 31, 2003 (unaudited)
    
    
    4Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2004 and 2003 (unaudited)
    
    
    5Consolidated Statements of Changes in Stockholders Equity for the Six Months Ended June 30, 2004 (unaudited)
    
    
    6Consolidated Statements of Cash Flows for the Six Months Ended June 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
    
    
    11Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    25Part II - OTHER INFORMATION
    
    
    25Item 1. Legal Proceedings
    
    
    25Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    25Item 3. Defaults Upon Senior Securities
    
    
    25Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25Item 5. Other Information
    
    
    27Item 6. Exhibits and Reports on Form 8-K
    
    
    27Signatures
    
    
    28EX-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 
    June 30,
    
    December 31,2004
    
    2003AssetsCash and cash equivalents
    
    $
    29,057
    
    
    $
    34,045Investment securities available for sale (amortized cost of $61,532 at June 30, 2004 and
$101,499 at December 31, 2003)
    
    
    61,724
    
    
    
    102,647Investment securities held to maturity (fair value of $2,119 at June 30, 2004 and $2,137 at
December 31, 2003)
    
    
    2,001
    
    
    
    2,025Mortgage-backed securities available for sale (amortized cost of $100,604 at June 30, 2004
and $84,264 at December 31, 2003)
    
    
    98,010
    
    
    
    83,752Mortgage-backed securities held to maturity (fair value of $138,403 at June 30, 2004 and
$145,029 at December 31, 2003)
    
    
    141,928
    
    
    
    145,674Loans held for sale
    
    
    37,656
    
    
    
    12,751Loans, net of allowance for loan losses of $14,613 at June 30, 2004 and $13,874 at December
31, 2003
    
    
    1,224,286
    
    
    
    1,198,019Accrued interest receivable
    
    
    5,945
    
    
    
    6,129Stock in FHLB of Boston and Federal Reserve Bank of Boston
    
    
    20,746
    
    
    
    28,483Bank-owned life insurance
    
    
    26,123
    
    
    
    25,549Premises and equipment, net
    
    
    16,839
    
    
    
    19,539Goodwill/core deposit intangible
    
    
    16,782
    
    
    
    17,536Real estate owned
    
    
    2,660
    
    
    
    1,782Other assets
    
    
    15,115
    
    
    
    17,047Total assets
    
    $
    1,698,872
    
    
    $
    1,694,978Liabilities and Stockholders EquityLiabilities:Deposit accounts
    
    $
    1,205,022
    
    
    $
    1,190,755Federal Home Loan Bank advances and other borrowings
    
    
    392,885
    
    
    
    398,653Advance payments by borrowers for taxes and insurance
    
    
    2,433
    
    
    
    2,819Other liabilities
    
    
    5,049
    
    
    
    8,102Total liabilities
    
    
    1,605,389
    
    
    
    1,600,329Commitments and contingenciesStockholders 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 (4,540,196 and 4,491,796 shares outstanding at June 30,
2004 and December 31, 2003, respectively)
    
    
    66
    
    
    
    66Additional paid-in capital
    
    
    70,201
    
    
    
    70,141Retained earnings
    
    
    64,381
    
    
    
    64,684Accumulated other comprehensive income
    
    
    (1,465
    )
    
    
    395Less: Treasury stock, at cost (2,049,421 shares and 2,097,821 shares at
June 30, 2004 and December 31, 2003, respectively)
    
    
    (39,700
    )
    
    
    (40,637
    )Total stockholders equity
    
    
    93,483
    
    
    
    94,649Total liabilities and stockholders equity
    
    $
    1,698,872
    
    
    $
    1,694,978
 See accompanying condensed notes to unaudited consolidated financial statements. 4




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES 
    Three Months Ended
    
    Six Months Ended6/30/2004
    
    6/30/2003
    
    6/30/2004
    
    6/30/2003Interest income:Loans
    
    $
    15,359
    
    
    $
    15,855
    
    
    $
    31,155
    
    
    $
    32,434Mortgage-backed securities
    
    
    2,516
    
    
    
    1,597
    
    
    
    4,988
    
    
    
    3,134Investment securities
    
    
    672
    
    
    
    1,100
    
    
    
    1,411
    
    
    
    2,238Total interest income
    
    
    18,547
    
    
    
    18,552
    
    
    
    37,554
    
    
    
    37,806Interest expense:Deposit accounts
    
    
    5,148
    
    
    
    4,811
    
    
    
    10,332
    
    
    
    9,890Borrowed funds
    
    
    4,419
    
    
    
    5,144
    
    
    
    8,840
    
    
    
    10,467Total interest expense
    
    
    9,567
    
    
    
    9,955
    
    
    
    19,172
    
    
    
    20,357Net interest income
    
    
    8,980
    
    
    
    8,597
    
    
    
    18,382
    
    
    
    17,449Provision for loan losses
    
    
    450
    
    
    
    2,000
    
    
    
    900
    
    
    
    2,450Net interest income after provision for loan losses
    
    
    8,530
    
    
    
    6,597
    
    
    
    17,482
    
    
    
    14,999Non-interest income:Deposit service fees
    
    
    753
    
    
    
    900
    
    
    
    1,591
    
    
    
    1,756Loan processing and servicing fees
    
    
    1,142
    
    
    
    (1,670
    )
    
    
    96
    
    
    
    (2,528
    )Gain on sale of loans
    
    
    1,665
    
    
    
    2,651
    
    
    
    3,552
    
    
    
    5,821Income from bank-owned life insurance
    
    
    285
    
    
    
    308
    
    
    
    575
    
    
    
    627(Loss) gain on sale of investments
    
    
    (164
    )
    
    
    7
    
    
    
    332
    
    
    
    7Other
    
    
    406
    
    
    
    433
    
    
    
    826
    
    
    
    803Total non-interest income
    
    
    4,087
    
    
    
    2,629
    
    
    
    6,972
    
    
    
    6,486Non-interest expense:Compensation and benefits
    
    
    6,117
    
    
    
    5,696
    
    
    
    12,328
    
    
    
    11,829Occupancy and equipment
    
    
    1,272
    
    
    
    1,198
    
    
    
    2,562
    
    
    
    2,456Data processing
    
    
    450
    
    
    
    445
    
    
    
    1,096
    
    
    
    905Advertising expense
    
    
    581
    
    
    
    360
    
    
    
    942
    
    
    
    659Stationary, printing and office supplies
    
    
    222
    
    
    
    142
    
    
    
    434
    
    
    
    381Federal deposit insurance premiums
    
    
    46
    
    
    
    40
    
    
    
    97
    
    
    
    88Amortization of core deposit intangible
    
    
    312
    
    
    
    0
    
    
    
    624
    
    
    
    0Other
    
    
    2,539
    
    
    
    1,774
    
    
    
    4,124
    
    
    
    3,268Total non-interest expense
    
    
    11,539
    
    
    
    9,655
    
    
    
    22,207
    
    
    
    19,586Income (loss) before income taxes
    
    
    1,078
    
    
    
    (429
    )
    
    
    2,247
    
    
    
    1,899Income tax expense (benefit)
    
    
    741
    
    
    
    (1,961
    )
    
    
    1,106
    
    
    
    1,965Net income (loss)
    
    $
    337
    
    
    $
    1,532
    
    
    $
    1,141
    
    
    $
    (66
    )Basic earnings (loss) per share
    
    $
    0.07
    
    
    $
    0.35
    
    
    $
    0.25
    
    
    $
    (0.02
    )Diluted earnings (loss) per share
    
    $
    0.07
    
    
    $
    0.33
    
    
    $
    0.24
    
    
    $
    (0.02
    )Basic weighted average shares outstanding
    
    
    4,531,711
    
    
    
    4,396,223
    
    
    
    4,519,782
    
    
    
    4,395,488Common stock equivalents due to dilutive effect of stock options
    
    
    226,237
    
    
    
    212,835
    
    
    
    226,862
    
    
    
    N/A
    *Diluted total weighted average shares outstanding
    
    
    4,757,948
    
    
    
    4,609,058
    
    
    
    4,746,644
    
    
    
    4,395,488
 See accompanying condensed notes to unaudited consolidated financial statements. * There were 215,042 common stock equivalents that were not included in the
computation of diluted earnings per share because to do so would have been
anti-dilutive. 5




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES 
     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
    
    
    
    
    
    
    
    
    
    
    1,141
    
    
    
    
    
    
    
    
    
    
    
    1,141Change in net unrealized
loss on investments
available for sale (net of
tax benefit of $1,465)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,860
    )
    
    
    (1,860
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (719
    )Cash dividends declared and
paid ($0.16 per share)
    
    
    
    
    
    
    
    
    
    
    (1,444
    )
    
    
    
    
    
    
    
    
    
    
    (1,444
    )Stock options exercised,
net of taxes
    
    
    
    
    
    
    47
    
    
    
    
    
    
    
    937
    
    
    
    
    
    
    
    984Fair value of shares
charged to expense for
compensation plans
    
    
    
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13Balance at June 30, 2004
    
    $
    66
    
    
    $
    70,201
    
    
    $
    64,381
    
    
    $
    (39,700
    )
    
    $
    (1,465
    )
    
    $
    93,483
 See accompanying condensed notes to unaudited consolidated financial statements. 6




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES 
    For the Six Months EndedJune 30,2004
    
    2003Net cash flows from operating activities:Net Income (loss)
    
    $
    1,141
    
    
    $
    (66
    )Adjustments to reconcile net income (loss) to net cash provided by
operating activities:Depreciation, amortization and accretion, net
    
    
    2,074
    
    
    
    1,251Earned SIP shares
    
    
    
    
    
    
    12Appreciation in fair value of shares charged to expense for
compensation plans
    
    
    13
    
    
    
    442Income from bank-owned life insurance
    
    
    (575
    )
    
    
    (627
    )Provision for loan losses
    
    
    900
    
    
    
    2,450Provision for valuation for real estate owned
    
    
    6
    
    
    
    Loans originated for sale
    
    
    (228,446
    )
    
    
    (552,276
    )Proceeds from sale of loans
    
    
    207,093
    
    
    
    573,687Gain on sale of investment securities
    
    
    (332
    )
    
    
    (7
    )Gain on sale of loans
    
    
    (3,552
    )
    
    
    (5,821
    )Loss on sale of real estate owned
    
    
    
    
    
    
    76Increase in accrued interest receivable
    
    
    184
    
    
    
    292Increase in prepaid expenses and other assets, net
    
    
    3,112
    
    
    
    1,208Decrease in accrued expenses and other liabilities, net
    
    
    (3,053
    )
    
    
    (4,940
    )Net cash (used in) provided by operating activities
    
    
    (21,435
    )
    
    
    15,681Cash flows from investing activities:Proceeds from sale of investment securities available for sale
    
    
    43,514
    
    
    
    10,000Proceeds from maturities of investments securities available for sale
    
    
    6,478
    
    
    
    2,000Proceeds from maturities of investments securities held to maturity
    
    
    25
    
    
    
    Proceeds 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
    )
    
    
    (69,746
    )Purchase of mortgage-backed securities held to maturity
    
    
    (8,107
    )
    
    
    (23,393
    )Principal payments on mortgage-backed securities available for sale
    
    
    32,991
    
    
    
    67,009Principal payments on mortgage-backed securities held to maturity
    
    
    11,811
    
    
    
    7,811Principal payments on investment securities available for sale
    
    
    1,196
    
    
    
    5,002Decrease in loans, net
    
    
    (28,050
    )
    
    
    (51,462
    )Proceeds from sale of premises
    
    
    3,562
    
    
    
    Proceeds from sale of real estate owned
    
    
    
    
    
    
    1,003Purchases of premises and equipment
    
    
    (1,647
    )
    
    
    (754
    )Additional investment in real estate owned
    
    
    (1
    )
    
    
    (53
    )Net cash provided by (used in) investing activities
    
    
    8,794
    
    
    
    (65,293
    )
 -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 Six Months EndedJune 30,2004
    
    2003Cash flows from financing activities:Increase in deposit accounts
    
    
    14,267
    
    
    
    14,995Repayments of Federal Home Loan Bank advances
    
    
    (445,314
    )
    
    
    (165,858
    )Proceeds from Federal Home Loan Bank advances
    
    
    439,546
    
    
    
    171,126Cash dividends paid
    
    
    (1,444
    )
    
    
    (1,409
    )Common stock repurchased
    
    
    
    
    
    
    (1,057
    )Options exercised, net of taxes
    
    
    984
    
    
    
    709Decrease in advance payments by borrowers for taxes and insurance
    
    
    (386
    )
    
    
    (33
    )Net cash provided by financing activities
    
    
    7,653
    
    
    
    18,473Decrease in cash and cash equivalents
    
    
    (4,988
    )
    
    
    (31,139
    )Cash and cash equivalents at beginning of period
    
    
    34,045
    
    
    
    74,672Cash and cash equivalents at end of period
    
    $
    29,057
    
    
    $
    43,533Supplemental disclosure of cash flow information:Payments during the period for: Interest
    
    $
    20,062
    
    
    $
    20,205Taxes
    
    $
    (58
    )
    
    $
    3,715
 See accompanying condensed notes to unaudited consolidated financial statements. 8




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BOSTONFED BANCORP, INC. AND SUBSIDIARIES 
   NOTE 1: BASIS OF PRESENTATION The unaudited consolidated financial statements as of June 30, 2004 and
2003 and for the three- and six-month periods ended June 30, 2004 and 2003, are
for the Company and its wholly-owned subsidiary, Boston Federal Savings Bank
(BFS or the Bank). 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 have 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. A former subsidiary of the
Company, Broadway National Bank, was merged into BFS on 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 June 30, 2004
and December 31, 2003, and amounts of revenues and expenses in the unaudited
consolidated statements of operations for the three and six months ended June
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 six-month periods ended June 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 six-month periods ended June 30: Three months ended
    
    Six months endedJune 30,
    
    June 30,In thousands, except per share amounts
    
    2004
    
    2003
    
    2004
    
    2003Net income (loss) as reported
    
    $
    337
    
    
    $
    1,532
    
    
    $
    1,141
    
    
    $
    (66
    )Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effect
    
    
    (22
    )
    
    
    (24
    )
    
    
    (44
    )
    
    
    (47
    )Pro forma net income (loss)
    
    
    315
    
    
    
    1,508
    
    
    
    1,097
    
    
    
    (113
    )Basic earnings (loss) per share as reported
    
    
    0.07
    
    
    
    0.35
    
    
    
    0.25
    
    
    
    (0.02
    )Diluted earnings (loss) per share as reported
    
    
    0.07
    
    
    
    0.33
    
    
    
    0.24
    
    
    
    (0.02
    )Pro forma basic earnings (loss) per share
    
    
    0.07
    
    
    
    0.34
    
    
    
    0.24
    
    
    
    (0.03
    )Pro forma diluted earnings (loss) per share
    
    
    0.07
    
    
    
    0.33
    
    
    
    0.23
    
    
    
    (0.03
    )
 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 six months ended June 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 six months ended June 30, 2003. 9




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NOTE 3: COMMITMENTS, CONTINGENCIES AND CONTRACTS At June 30, 2004, the Company had commitments of $122.0 million to
originate mortgage loans and $2.9 million to purchase loans from correspondent
lenders. Of these $124.9 million commitments, $112.0 million were adjustable
rate mortgage loans with interest rates ranging from 4.00% to 7.63% and $12.9
million were fixed rate mortgage loans with interest rates ranging from 4.25%
to 8.00%. The Company also had commitments to sell $55.3 million of mortgage
loans. At June 30, 2004, the Company was servicing first mortgage loans of
approximately $929.8 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. 10




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##### Table of Contents



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 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. Assets 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 six months ended June 30, 2004 are as follows: Core Deposit
    
    Total IdentifiableGoodwill
    
    Intangibles
    
    IntangiblesBalance at December 31, 2003
    
    
    12,744
    
    
    
    4,792
    
    
    
    17,536Amortization expense for the six months ended June 30, 2004
    
    
    
    
    
    
    624
    
    
    
    624Other adjustments (recovery)
    
    
    (130
    )
    
    
    
    
    
    
    (130
    )Balance at June 30, 2004
    
    
    12,614
    
    
    
    4,168
    
    
    
    16,782Estimated future amortization expense:Remainder of 2004
    
    
    
    
    
    
    596
    
    
    
    5962005
    
    
    
    
    
    
    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. 11




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##### Table of Contents



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. in a
transaction valued at approximately $195 million. 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 Group, Inc. and BFS will merge with Banknorth, National Association.
Shareholders of the Companys common stock will receive 1.241 shares of
Banknorth Group, Inc. common stock, or at the election of a Company
shareholder, 1.055 shares of Banknorth Group, Inc. common stock and $6.12 in
cash, plus, in each case, cash in lieu of any fractional share interest, for
each share of 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 Group, Inc. will be filing a joint proxy
statement/prospectus and other relevant documents concerning the merger with
the United States Securities and Exchange Commission (the SEC). The company
urges investors to read the joint proxy/prospectus and any relevant documents
to be filed with the SEC, because they contain important information. 
 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). The acquired Lexington office 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 Rt. 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. 12




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##### Table of Contents



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. 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. Effective December 31, 2003, the Company is a savings and loan holding
company subject to the regulations of the Office of Thrift Supervision (the
OTS). 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 June 30, 2004 was $337,000, compared to
net income of $1.5 million for the quarter ended June 30, 2003. Basic and
diluted earnings per share were both $0.07 for the quarter ended June 30, 2004
and $0.35 and $0.33, respectively, for the quarter ended June 30, 2003. For the
six months ended June 30, 2004, net income was $1.1 million, or $0.25 basic and
$0.24 diluted earnings per share, compared to a net loss of $66,000, resulting
in a basic and diluted loss per share of $0.02 for the six months ended June
30, 2003. The net interest margin of 2.30% for the quarter ended June 30, 2004 was
15 basis points lower than the 2.45% net interest margin for the second quarter
of 2003. This reduction partially offset the benefit of increased earnings
from larger average balances of interest-earning assets, net of
interest-earning liabilities. For the six months ended June 30, 2004, the net
interest margin of 2.36% was also 15 basis points lower than the 2.51% for the
six months ended June 30, 2003. Generally higher mortgage interest rates caused a decline in mortgage loan
originations and consequently led to a $1.0 million decline in gain on sale of
loans in the quarter ended June 30, 2004 compared to the second quarter of
2003. Through June 30, 2004, gain on sale of loans was $3.6 million, a $2.3
million reduction from the $5.8 million gain on sale of loans for the
comparable six months ended June 30, 2003. Loan processing and servicing fees were $1.1 million for the three months
ended June 30, 2004, compared to a negative $1.7 million for the three months
ended June 30, 2003. On a year-to-date basis, loan processing and servicing
fees were $96,000 through June 30, 2004, compared to a negative $2.5 million
for the six months ended June 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 six months
ended June 30, 2004, whereas impairment charges of approximately $3.0 million
were incurred in the six months ended June 30, 2003. The current quarter was significantly impacted by the absorption of
approximately $900,000 in merger related expenses, which are not tax-deductible
expenses, whereas the quarter ended June 30, 2003 benefited by $1.8 million for
the reversal of a portion of a state tax provision, recorded in the first
quarter of 2003, related to real estate investment trust subsidiaries, for the
1999 through 2002 fiscal tax years. Non-performing loans increased from $4.7 million at December 31, 2003 to
$8.1 million at June 30, 2004, primarily due to a $2.2 million loan secured by
an industrial building and a few other smaller balance loans becoming
delinquent 90 days or more. The 13




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##### Table of Contents



allowance for loan losses as a percent of loans increased from 1.13% at
December 31, 2003 to 1.14% at June 30, 2004. Recent Developments On June 21, 2004, the Company announced that it had entered into an
Agreement and Plan of Merger to merge into Banknorth Group, Inc. in a
transaction valued at approximately $195 million. 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 Group, Inc. and BFS will merge with Banknorth, National Association.
Shareholders of the Companys common stock will receive 1.241 shares of
Banknorth Group, Inc. common stock, or at the election of a Company
shareholder, 1.055 shares of Banknorth Group, Inc. common stock and $6.12 in
cash, plus, in each case, cash in lieu of any fractional share interest, for
each share of 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 Group, Inc. will be filing a joint proxy
statement/prospectus and other relevant documents concerning the merger with
the SEC. The company urges investors to read the joint proxy/prospectus and
any relevant documents to be filed with the SEC, because they contain important
information. 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 assumption 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 increased by $3.9 million to a balance of $1.7 billion at
June 30, 2004, approximately the same as at December 31, 2003. Investment
securities available for sale declined by $40.9 million due in part to the
Companys sale of a portion of its mutual fund investments. Mortgage-backed
securities available for sale increased by $14.3 million due to purchases of
collateralized mortgage obligations (CMOs). Loans held for sale increased by
$24.9 million to a balance of $37.7 million as several loan packages were
prepared in June but not sold until July of 2004. Loans, net of allowance for loan losses, increased by $26.3 million to
$1.2 billion at June 30, 2004, compared to December 31, 2003 as loan production
earmarked for portfolio exceeded amortization and pre-payments. 14




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##### Table of Contents



The Companys loan portfolio was comprised of the following at: 6/30/04
    
    12/31/03In thousandsMortgage loans:Residential 1-4 family
    
    $
    887,722
    
    
    $
    827,184Multi-family
    
    
    19,123
    
    
    
    20,044Construction and land
    
    
    77,357
    
    
    
    116,427Commercial real estate
    
    
    108,015
    
    
    
    123,544Total mortgage loans
    
    
    1,092,217
    
    
    
    1,087,199Consumer and other loans:Home equity and improvement
    
    
    129,616
    
    
    
    120,205Consumer
    
    
    3,605
    
    
    
    4,597Business
    
    
    24,976
    
    
    
    26,582Total consumer and other loans
    
    
    158,197
    
    
    
    151,384Total loans, gross
    
    
    1,250,414
    
    
    
    1,238,583Allowance for loan losses
    
    
    (14,613
    )
    
    
    (13,874
    )Construction loans in process
    
    
    (19,163
    )
    
    
    (33,125
    )Net unearned premium on loans purchased
    
    
    19
    
    
    
    25Fair value adjustment on mortgage banking derivatives
    
    
    
    
    
    
    (38
    )Deferred loan origination costs
    
    
    7,629
    
    
    
    6,448Loans, net
    
    $
    1,224,286
    
    
    $
    1,198,019
 As noted in the above table, the allowance for loan losses amounted to
$14.6 million at June 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 six months
ended June 30, 2004: In thousandsBalance at December 31, 2003
    
    $
    13,874Loss provision
    
    
    900Recoveries
    
    
    100Charge-offs
    
    
    (261
    )Balance at June 30, 2004
    
    $
    14,613
 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, changes in the local, regional and national 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. 15




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##### Table of Contents



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 June 30,
2004, the Company classified $22.8 million of loans as sub-standard compared to
$21.2 million at December 31, 2003. Non-performing assets at June 30, 2004
totaled $10.8 million or 0.64% 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 $2.2 million loan secured by an industrial building becoming delinquent 90
days or more during the second quarter and a $1.0 million increase in real
estate owned (REO). 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 June
30, 2004 was sufficient to provide for anticipated losses inherent in the loan
portfolio. The Companys $14.6 million allowance for loan losses at June 30, 2004
represented 180% of non-performing loans or 1.14% 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 $8.1 million and $4.7 million at June 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 $336,000 and $387,000 for the
six-month periods ended June 30, 2004 and 2003, respectively. The amount of
interest income that was recorded on these loans was $41,000 and $105,000 for
the six-month periods ended June 30, 2004 and 2003, respectively. At June 30, 2004, there were three loans with a net balance of $3.6
million, characterized as impaired. During the six months ended June 30, 2004,
the average recorded value of impaired loans was $3.7 million; there was
$21,000 of interest income that was recognized and $174,000 of interest income
that would have been recognized under the loans original terms. At June 30,
2003, there were seven loans with a net balance of $10.8 million, characterized
as impaired. During the six months ended June 30, 2003, the average recorded
value of impaired loans was $7.7 million; there was $57,000 of interest income
that was recognized and $246,000 of interest income that would have been
recognized under the loans original terms. At June 30, 2004, the Company had a commercial real estate building and
land in REO with a carrying amount of $2.7 million. At December 31, 2003, the
Company had one of these two properties in REO, with a balance of $1.8 million.
The current two REO properties are located in Woburn and Bolton, Massachusetts.
The Company is currently marketing both properties for sale. Stock in the Federal Home Loan Bank and Federal Reserve Bank declined by
$7.7 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. Premises and equipment, net, declined by $3.2 million in the first quarter
of 2004 as the Company sold one of the buildings acquired as part of the
acquisition of the Encore Bank branches. Liabilities Deposit accounts were $1.2 billion at June 30, 2004, an increase of $14.3
million from the essentially same $1.2 billion at December 31, 2003. A portion
of this increase was due to wholesale-brokered certificates of deposit, which
are included in deposit accounts, increasing to $124.3 million at June 30, 2004
from the $117.8 million at December 31, 2003. 16




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##### Table of Contents



The following is a summary of deposit balances by type at: 06/30/04
    
    12/31/03In thousandsNOW accounts
    
    $
    214,227
    
    
    $
    211,469Regular and statement savings
    
    
    222,038
    
    
    
    227,491Money market
    
    
    126,110
    
    
    
    138,986Demand deposits and official checks
    
    
    105,985
    
    
    
    91,695Total non-certificate accounts
    
    
    668,360
    
    
    
    669,641Certificate accounts:3 to 12 months
    
    
    77,200
    
    
    
    57,2711 to 3 years
    
    
    317,788
    
    
    
    320,818Greater than 3 years
    
    
    87,407
    
    
    
    91,702IRA/KEOGH
    
    
    54,267
    
    
    
    51,323Total certificate accounts
    
    
    536,662
    
    
    
    521,114Total deposit balances
    
    $
    1,205,022
    
    
    $
    1,190,755Expected maturity of certificate accounts:Within one year
    
    $
    284,017
    
    
    $
    255,666One to two years
    
    
    179,368
    
    
    
    174,903Two to three years
    
    
    44,343
    
    
    
    47,358Over three years
    
    
    28,934
    
    
    
    43,187Total certificate accounts
    
    $
    536,662
    
    
    $
    521,114
 FHLB advances and other borrowings declined $5.8 million, to a balance of
$392.9 million at June 30, 2004, from $398.7 million at December 31, 2003. C. COMPARISON OF THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 GENERAL During the quarter ended June 30, 2004, the Company earned $337,000, or
$0.07 basic and diluted earnings per share, compared to net income of $1.5
million or $0.35 basic and $0.33 diluted earnings per share for the second
quarter of 2003. The current quarters earnings were positively impacted by a
$1.4 million recovery of an OMSR valuation allowance, but was negatively
impacted by a $1.0 million decline in gain on sale of loans and approximately
$900,000 in merger related charges, which are not tax deductible. The prior
year comparable quarter was negatively impacted by an incremental loan loss
provision of $1.6 million and $615,000 of OMSR impairment due to rapid
prepayments of serviced loans, but positively impacted by a $1.8 million
recovery in state tax provision resulting from the REIT settlement with the
Massachusetts Department of Revenue (Mass. DOR). Earnings for the six months
ended June 30, 2004 benefited from improved net interest income and improved
loan processing and servicing fees, offset by lower gain on sale of loans and
merger related expenses. The six months ended June 30, 2003 were negatively
impacted by the incremental loan loss provision, OMSR impairment of $3.0
million, which drove loan processing and servicing income to a negative $2.5
million, and additional state taxes and interest relating to the disputed
deduction for dividends received from the REIT subsidiaries and positively
impacted by higher than normal gain on sale of loans. For the six months ended June 30, 2004 and 2003, the annualized return
(loss) on average stockholders equity was 2.35% and (0.14%), 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 six months ended June 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 June 30:Assets:Interest-earning assets:Investment securities (1)
    
    $
    105,265
    
    
    $
    672
    
    
    
    2.55
    %
    
    $
    157,207
    
    
    $
    1,100
    
    
    
    2.80
    %Loans, net and loans held for sale (2)
    
    
    1,214,460
    
    
    
    15,359
    
    
    
    5.06
    %
    
    
    1,093,786
    
    
    
    15,855
    
    
    
    5.80
    %Mortgage-backed securities (3)
    
    
    244,430
    
    
    
    2,516
    
    
    
    4.12
    %
    
    
    150,300
    
    
    
    1,597
    
    
    
    4.25
    %Total interest-earning assets
    
    
    1,564,155
    
    
    
    18,547
    
    
    
    4.74
    %
    
    
    1,401,293
    
    
    
    18,552
    
    
    
    5.30
    %Non interest-earning assets
    
    
    106,585
    
    
    
    
    
    
    
    
    
    
    
    103,581Total assets
    
    
    1,670,740
    
    
    
    
    
    
    
    
    
    
    
    1,504,874Liabilities and stockholders equity:Interest-bearing liabilities:Money market deposit accounts
    
    
    127,608
    
    
    
    501
    
    
    
    1.57
    %
    
    
    64,798
    
    
    
    198
    
    
    
    1.22
    %Savings accounts
    
    
    219,493
    
    
    
    483
    
    
    
    0.88
    %
    
    
    214,287
    
    
    
    592
    
    
    
    1.11
    %NOW accounts
    
    
    205,021
    
    
    
    282
    
    
    
    0.55
    %
    
    
    148,223
    
    
    
    61
    
    
    
    0.16
    %Certificate accounts
    
    
    529,436
    
    
    
    3,882
    
    
    
    2.93
    %
    
    
    415,188
    
    
    
    3,960
    
    
    
    3.82
    %Total
    
    
    1,081,558
    
    
    
    5,148
    
    
    
    1.90
    %
    
    
    842,496
    
    
    
    4,811
    
    
    
    2.28
    %Borrowed funds (4)
    
    
    388,247
    
    
    
    4,419
    
    
    
    4.55
    %
    
    
    456,757
    
    
    
    5,144
    
    
    
    4.50
    %Total interest-bearing liabilities
    
    
    1,469,805
    
    
    
    9,567
    
    
    
    2.60
    %
    
    
    1,299,253
    
    
    
    9,955
    
    
    
    3.06
    %Non interest-bearing liabilities
    
    
    104,230
    
    
    
    
    
    
    
    
    
    
    
    112,885Total liabilities
    
    
    1,574,035
    
    
    
    
    
    
    
    
    
    
    
    1,412,138Stockholders equity
    
    
    96,705
    
    
    
    
    
    
    
    
    
    
    
    92,736Total liabilities and
stockholders equity
    
    $
    1,670,740
    
    
    
    
    
    
    
    
    
    
    $
    1,504,874Net interest rate spread (5)
    
    
    
    
    
    $
    8,980
    
    
    
    2.14
    %
    
    
    
    
    
    $
    8,597
    
    
    
    2.24
    %Net interest margin (6)
    
    
    
    
    
    
    
    
    
    
    2.30
    %
    
    
    
    
    
    
    
    
    
    
    2.45
    %Ratio of interest-earning assets to interest-bearing
liabilities
    
    
    106.42
    %
    
    
    
    
    
    
    
    
    
    
    107.85
    %
 (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
4.54% and 3.95% for the three months ended June 30, 2004 and June 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 six months ended June 30:Assets:Interest-earning assets:Investment securities (1)
    
    $
    117,649
    
    
    $
    1,411
    
    
    
    2.40
    %
    
    $
    160,377
    
    
    $
    2,238
    
    
    
    2.79
    %Loans, net and loans held for sale (2)
    
    
    1,204,030
    
    
    
    31,155
    
    
    
    5.18
    %
    
    
    1,088,874
    
    
    
    32,434
    
    
    
    5.96
    %Mortgage-backed securities (3)
    
    
    237,884
    
    
    
    4,988
    
    
    
    4.19
    %
    
    
    138,713
    
    
    
    3,134
    
    
    
    4.52
    %Total interest-earning assets
    
    
    1,559,563
    
    
    
    37,554
    
    
    
    4.82
    %
    
    
    1,387,964
    
    
    
    37,806
    
    
    
    5.45
    %Non interest-earning assets
    
    
    108,268
    
    
    
    
    
    
    
    
    
    
    
    106,460Total assets
    
    
    1,667,831
    
    
    
    
    
    
    
    
    
    
    
    1,494,424Liabilities and stockholders equity:Interest-bearing liabilities:Money market deposit accounts
    
    
    129,719
    
    
    
    1,011
    
    
    
    1.56
    %
    
    
    63,787
    
    
    
    384
    
    
    
    1.20
    %Savings accounts
    
    
    222,170
    
    
    
    988
    
    
    
    0.89
    %
    
    
    215,279
    
    
    
    1,208
    
    
    
    1.12
    %NOW accounts
    
    
    203,816
    
    
    
    591
    
    
    
    0.58
    %
    
    
    145,762
    
    
    
    156
    
    
    
    0.21
    %Certificate accounts
    
    
    525,989
    
    
    
    7,742
    
    
    
    2.94
    %
    
    
    418,096
    
    
    
    8,142
    
    
    
    3.89
    %Total
    
    
    1,081,694
    
    
    
    10,332
    
    
    
    1.91
    %
    
    
    842,924
    
    
    
    9,890
    
    
    
    2.35
    %Borrowed funds (4)
    
    
    391,480
    
    
    
    8,840
    
    
    
    4.52
    %
    
    
    447,739
    
    
    
    10,467
    
    
    
    4.68
    %Total interest-bearing liabilities
    
    
    1,473,174
    
    
    
    19,172
    
    
    
    2.60
    %
    
    
    1,290,663
    
    
    
    20,357
    
    
    
    3.15
    %Non interest-bearing liabilities
    
    
    97,634
    
    
    
    
    
    
    
    
    
    
    
    110,037Total liabilities
    
    
    1,570,808
    
    
    
    
    
    
    
    
    
    
    
    1,400,700Stockholders equity
    
    
    97,023
    
    
    
    
    
    
    
    
    
    
    
    93,724Total liabilities and
stockholders equity
    
    $
    1,667,831
    
    
    
    
    
    
    
    
    
    
    $
    1,494,424Net interest rate spread (5)
    
    
    
    
    
    $
    18,382
    
    
    
    2.22
    %
    
    
    
    
    
    $
    17,449
    
    
    
    2.30
    %Net interest margin (6)
    
    
    
    
    
    
    
    
    
    
    2.36
    %
    
    
    
    
    
    
    
    
    
    
    2.51
    %Ratio of interest-earning assets to interest-bearing
liabilities
    
    
    105.86
    %
    
    
    
    
    
    
    
    
    
    
    107.54
    %
 (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
4.51% and 4.15% for the six months ended June 30, 2004 and June 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 of $18.5 million on interest-earning assets for the
quarter ended June 30, 2004 was essentially the same, 19




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##### Table of Contents



compared to the quarter ended June 30, 2003. Although the average yield on
interest earning assets declined by 56 basis points, net interest income
declined only $5,000 due to the earnings on the $162.9 million increase in
average interest-earning assets. The average yield on interest-earning assets
declined to 4.74% for the three months ended June 30, 2004 from 5.30% for the
three months ended June 30, 2003. For the six months ended June 30, 2004, total
interest income declined by $252,000, or less than one percent, to $37.6
million, compared to the $37.8 million interest income earned during the six
months ended June 30, 2003. As in the current quarter, the year-to-date
interest income declined due to a 63 basis point decline in the average yield
on interest earning assets, partially offset by the interest earned on higher
average balances. 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. 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 June 30, 2004
declined by $496,000, or 3.1%, to $15.4 million compared to $15.9 million for
the comparable quarter in 2003. The decrease in interest income from loans,
net, for the current three-month period was due to the 74 basis point decline
in the average yield, partially offset by the $120.7 million increase in the
average balance of loans, net. The average yield on loans, net, for the three
months ended June 30, 2004 was 5.06%, compared to an average yield of 5.80% for
the three months ended June 30, 2003. For the six months ended June 30, 2004,
interest income on loans, net, was $31.2 million, $1.3 million lower that the
prior year comparable period. The yield on loans, net, declined by 78 basis
points in the current six-month period. Many adjustable-rate loans continue to
be originated at relatively low interest rates and the major repricing indices
remain at near historic lows. 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 better protect against the
possibility of rising interest rates. Interest on mortgage-backed securities for the quarter ended June 30, 2004
was $2.5 million, compared to $1.6 million for the quarter ended June 30, 2003.
The increase in interest on mortgage-backed securities was due to a $94.1
million increase in the average balance, partially offset by the effects of a
13 basis point decline in the average yield. The average yield declined from
4.25% for the three months ended June 30, 2003, to 4.12% for the current
three-month period. For the six months ended June 30, 2004, interest income on
mortgage-backed securities increased to $5.0 million, from $3.1 million for the
six months ended June 30, 2003 due to the $99.2 million increase in the average
balance of mortgage-backed securities. The average yield on mortgage-backed
securities declined from 4.52% for the six months ended June 30, 2003, to 4.19%
for the six months ended June 30, 2004. The reduction in yield is a reflection
of the low interest rate environment, which results in the reinvestment of
amortization and prepayments into lower yielding similar investments. Income from investment securities was $672,000 for the three months ended
June 30, 2004, compared to $1.1 million for the prior year quarter. The decline
in income from investment securities was due to the combined effects of lower
average balance of investment securities in the current year quarter and a
reduction in the average yield. The average balance of investment securities
declined to $105.3 million for the three months ended June 30, 2004, from an
average balance of $157.2 million for the prior year quarter. The average yield
declined from 2.80% for the three months ended June 30, 2003, to 2.55% for the
three months ended June 30, 2004. For the six months ended June 30, 2004,
interest income from investment securities was $1.4 million, compared to $2.2
million for the six months ended June 30, 2003. The lower income in the
current year-to-date period is also due to the combined effects of lower
average balances and lower yields. The average investment securities balance
for the six months ended June 30, 2004 was $117.6 million, compared to an
average investment securities balance of $160.4 million for the prior
year-to-date. The average yield declined by 39 basis points, to an average
yield of 2.40% for the six months ended June 30, 2004 from an average yield of
2.79% in the prior year-to-date. The reduction in yield on investment
securities is also reflective of the declines in market interest rates,
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 June 30, 2004 declined by $388,000, or 3.9%, to $9.6 million compared to
$10.0 million for the quarter ended June 30, 2003. The decrease in interest
expense for the current quarter of 2004 was due to a 46 basis point reduction
in the average cost of interest bearing liabilities, which was partially offset
by the interest expense applicable to a $170.6 million increase in the average
balance of interest-bearing liabilities, which averaged $1.5 billion during the
second quarter of 2004, compared to an average balance of $1.3 billion during
the quarter ended June 30, 2003. The average cost of interest-bearing
liabilities declined to 2.60% during the quarter ended June 30, 2004, compared
to 3.06% for last years second quarter. Total interest expense on
interest-bearing liabilities during the six months ended June 30, 2004 declined
to $19.2 million from $20.4 million for the six months ended June 30, 2003.
The lower interest expense was due to a 55 basis point decline in the average
cost of interest-bearing liabilities in the current year-to-date period,
partially offset by a $182.5 million increase in the average balance of
interest-bearing liabilities in the current year-to-date. The Companys cost
of interest-bearing liabilities has declined more slowly than yields on
interest earning assets as competitive market conditions, the already low
interest rates being paid on deposits and longer term FHLB advances have
precluded more rapid declines in the interest paid on these interest-bearing
liabilities. Interest expense on deposit accounts was $5.1 million for the quarter
ended June 30, 2004, an increase of $337,000 from the $4.8 million for the
quarter ended June 30, 2003. Interest expense on deposit accounts increased,
despite a 38 basis point decrease in the average cost of deposits due to an
increase of $239.1 million in the average deposit balance. For the three months
ended June 30, 2004, the average cost of deposits was 1.90%, compared to 2.28%
for the three months ended June 30, 2003. Average balances of deposit accounts
were $1.1 billion for the second quarter of 2004, compared to an average
balance of $842.5 million for the quarter ended June 30, 2003. Interest
expense on deposit accounts increased to $10.3 million in the six months ended
June 30, 2004, compared to $9.9 million for the six months ended June 30, 2003,
despite a reduction of 44 basis points in the average cost of deposits in the
six months ended June 30, 2004. The effect of the lower cost of funds was more
than offset by the increase in the average deposit balance, which increased by
$238.8 million in the six months ended June 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 $4.4 million for the three months
ended June 30, 2004, compared to $5.1 million for the three months ended June
30, 2003. The $725,000 decline in interest expense on borrowed funds was due to
lower average balances of borrowed funds in the second quarter of 2004,
compared to the second quarter of 2003, slightly offset by higher average cost.
Borrowed funds declined to an average balance of $388.2 million during the
quarter ended June 30, 2004, from an average of $456.8 million for the
comparable quarter of 2003. The average cost of borrowed funds increased to
4.55% for the three months ended June 30, 2004, a five basis point increase,
compared to the 4.50% cost of borrowed funds for the three months ended June
30, 2003. For the six months ended June 30, 2004, interest on borrowed funds
declined to $8.8 million, compared to $10.5 million for the six months ended
June 30, 2003. The lower interest expense was due to the combined effects of
lower average balances, which declined by $56.3 million and lower average cost,
which declined to 4.52% in the current year-to-date period, compared to 4.68%
for the six months ended June 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 June 30, 2004 was $9.0
million, compared to $8.6 million for the second quarter of 2003. For the six
months ended June 30, 2004, net interest was 18.4 million, compared to $17.4
million for the six months ended June 30, 2003. 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. The net interest margin declined to 2.30% for the quarter
ended June 30, 2004 from 2.45% in the second quarter of 2003. For the six
months ended June 30, 2004, the net interest margin declined to 2.36%, compared
to 2.51% for the six months ended June 30, 2003. Increases in non-performing
assets have also placed pressure on the net interest margin. 21




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##### Table of Contents



Provision for Loan Losses The provision for loan losses was $450,000 for the three months ended June
30, 2004 and $2.0 million for the three months ended June 30, 2003. 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. For the six months ended June 30, 2004 and 2003, the provision
for loan losses was $900,000 and $2.5 million, respectively. The coverage
ratio of allowance for loan losses as a percent of loans increased from 1.13%
at December 31, 2003, to 1.14% at June 30, 2004. The current provision was
necessary, primarily due to an increase in non-performing loans.
Non-performing loans increased from $4.7 million at December 31, 2003 to $8.1
million at June 30, 2004, primarily due to a $2.2 million loan secured by an
industrial building and a few smaller loans becoming delinquent more than 90
days. The allowance for loan losses was $14.6 million at June 30, 2004,
compared to $13.9 million at December 31, 2003. These amounts represent 180%
and 296%, of non-performing loans at June 30, 2004 and December 31, 2003,
respectively. Non-Interest Income Total non-interest income increased to $4.1 million for the quarter ended
June 30, 2004, compared to $2.6 million for the quarter ended June 30, 2003,
due primarily to higher loan processing and servicing fees, partially offset by
a decline in gain on sale of loans. Loan processing and servicing fees were
$1.1 million due to the recapture of the $1.4 million valuation allowance on
OMSRs, whereas the second quarter of 2003 experienced rapid serviced loan
prepayments and an increase in the valuation allowance for OMSRs resulting in a
$1.7 million negative loan processing and servicing fees. For the six months
ended June 30, 2004, loan processing and servicing fees were $96,000, compared
to a negative $2.5 million for the six months ended June 30, 2003. With the
most recent adjustment, the OMSR balance is $7.3 million, with no valuation
allowance, and represents approximately 78 basis points of the $929.8 million
of loans serviced for others. Gain on sale of loans was $1.7 million in the current quarter, compared to
$2.7 million for the quarter ended June 30, 2003. For the six months ended
June 30, 2004, gain on sale of loans was $3.6 million, compared to $5.8 million
for the six months ended June 30, 2003. The primary reason for the current
quarter and year-to-date decline was due to lower levels of loan origination
caused by generally increasing mortgage interest rates during the first half of
2004. Total mortgage loan originations were $461.4 million during the six
months ended June 30, 2004, compared to $671.8 million for the six months ended
June 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
$1.5 million and $1.9 million for the six months ended June 30, 2004 and 2003,
respectively. Loss on sale of investments during the quarter ended June 30, 2004 was
$164,000, as the Company liquidated a portion of its mutual fund holding, which
declined in value due to recent interest rate increases. For the six months
ended June 30, 2004, gain on sale of investments was $332,000, which includes
the aforementioned loss, offset by gains on the sale of equity securities sold
during the first quarter of 2004. Non-Interest Expense Total non-interest expense was $11.5 million for the quarter ended June
30, 2004, compared to $9.7 million for the prior year quarter. The second
quarter of 2004 includes $312,000 in amortization of core deposit intangibles
(CDI) related to the acquisition and assumption of Encore Banks Boston area
branches. Advertising expense increased to $581,000 in the second quarter of
2004, from $360,000 in the prior year comparable quarter, due to a more focused
branding program implemented for the Companys Bank and expanded advertising
for the newly acquired branches from Encore Bank. Other non-interest expense
was $2.5 million for the quarter ended June 30, 2004, compared to $1.8 million
for the prior year comparable quarter. The increase in the quarter ended June
30, 2004 is due to expenses of approximately $900,000 incurred as a result of
costs associated with the merger with Banknorth, Group, Inc. For the six
months ended June 30, 2004, total non-interest expenses were $22.2 million,
compared to $19.6 million as, in addition to the above mentioned increased
expenses, compensation and benefits, occupancy and equipment and data
processing expenses were also higher for the six months ended June 30, 2004 in
part due to expenses associated with the addition of the former Encore Bank
branches. Income tax expense for the quarter ended June 30, 2004 was $741,000, for
an effective tax rate of 68.7%, which is higher than the expected effective tax
rate of approximately 41%, primarily due to the approximately $900,000
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 benefit for the quarter
ended June 30, 2003 was 22




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##### Table of Contents



$2.0 million, due primarily to the reversal of a portion of the REIT accrual
recorded during the first quarter of 2003 as the Company settled the dispute
with the Mass. DOR. For the six months ended June 30, 2004, income tax expense
was $1.1 million for an effective tax rate of 49.2%, similarly impacted at the
three months ended June 30, 2004. For the six months ended June 30, 2003,
income tax expense was $2.0 million, the majority of which includes the charge
for the additional REIT taxes applicable to prior years, net of the settlement
with the Mass. DOR. The remaining tax of approximately $765,000 results in an
effective tax rate of approximately 40.3%. 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. As of June 30, 2004, BFS had $6.7 million of
dividends that could be paid to the Company without regulatory approval. Any
dividend by BFS beyond its current year net income combined with retained net
income of the preceding two years would require OTS notification or approval. To the extent BFS were to apply for a dividend distribution to the Company
in excess of the regulatory permitted dividend amounts, no assurances can be
made such application would be approved by the regulatory authorities.
Additionally, the Company had $2.0 million of securities available for sale and
$6.1 million cash or cash equivalents at June 30, 2004. 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. 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: 06/30/04
    
    12/31/03(In Thousands)Cash and cash equivalents
    
    $
    29,057
    
    
    $
    34,045Investment securities available for sale
    
    
    61,724
    
    
    
    102,647Mortgage-backed securities available for sale
    
    
    98,010
    
    
    
    83,752Loans held for sale
    
    
    37,656
    
    
    
    12,751Total liquid assets
    
    $
    226,447
    
    
    $
    233,195
 These amounts represent 13.3% and 13.8% of the Companys total assets at
June 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 June 30,
2004, the Bank had $359.9 million in advances outstanding from the FHLB and
had, with existing collateral, an additional $387.5 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 June 30, 2004, the Bank had commitments to originate loans and unused
outstanding lines of credit totaling $312.9 million. Certificate accounts,
which are scheduled to mature in less than one year from June 30, 2004, totaled
$284.0 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. 23




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At June 30, 2004, the consolidated stockholders equity to total assets
ratio was 5.5%. As of June 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 6.0%, 10.8%,
9.6% and 6.0%, respectively. 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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;(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. 24




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##### Table of Contents



At June 30, 2004, the Companys one-year gap was a negative 1.3% 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 remains 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 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
June 30, 2004, that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 25




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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 liquidity of the Company. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders  (A)
    
    The Company held its Annual Meeting of Stockholders on April
28, 2004. Proxies were solicited with respect to such meeting under
Regulation 14A of the Securities Exchange Act of 1934, as amended,
pursuant to proxy materials dated March 29, 2004. Of the 4,513,896
shares eligible to vote at the Annual Meeting, 4,096,973 were
represented in person or by proxy.  (B)
    
    There was no solicitation in opposition to the Board nominees
for directors and all of such nominees were elected as follows:  (1)
    
    Election of Directors to a three-year term ending in
2007 Nominee
    
    Total Votes For
    
    Total Votes WithheldRichard J. Caturano
    
    
    4,071,718
    
    
    
    25,255David F. Holland
    
    
    3,973,895
    
    
    
    123,078Joanna T. Lau
    
    
    4,071,477
    
    
    
    25,496
  (2)
    
    Continuing Directors Year Term ExpiresDavid P. Conley
    
    
    2005Richard J. Fahey
    
    
    2005Kija Kim
    
    
    2005Patricia M. Flynn, Ph.D.
    
    
    2006W. Russell Scott, Jr.
    
    
    2006Catherine Friend White
    
    
    2006
  (C)
    
    Other matters submitted to a vote of the Stockholders of the
corporation:Ratification of the appointment of KPMG LLP as our independent
registered public accounting firm for the fiscal year ending December
31, 2004: Votes For
    
    Votes Against
    
    Abstentions4,054,801
    
    
    39,822
    
    
    
    3,050
 26




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##### Table of Contents



Item 5. Other Information None. 
 Item 6. Exhibits and Reports on Form 8-K (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). (b) Reports on Form 8-K filed with the Securities and Exchange Commission On April 27, 2004, the Company furnished a Form 8-K to file a press
release, dated April 26, 2004, announcing its financial results for the quarter
ended March 31, 2004, which included its dividend announcement. On April 27, 2004, the Company furnished a Form 8-K providing its March
31, 2004 Investor Presentation and announcing that the presentation was
available on its website. On June 22, 2004, the Company furnished a Form 8-K to file a press
release, dated June 21, 2004, announcing that BostonFed Bancorp, Inc. and
Banknorth Group, Inc. signed an Agreement and Plan of Merger dated June 20,
2004. 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
 27




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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: August 5, 2004
    By:
    /s/ David F. HollandDavid F. HollandPresident and Chief Executive Officer Date: August 5, 2004
    By:
    /s/ John A. SimasJohn A. SimasExecutive Vice President, Chief Financial
Officer and Corporate Secretary 28