Century Bancorp Inc.
Annual Report 2004

Plain-text annual report

T his is ou r Ce nt u ry . My Lif e. My T ime. My Centur y. 400 MYSTIC AVENUE, MEDFORD, MA 02155 866.8.CENTURY century-bank.com MEMBER FDIC 0665-AR-05 MKT2005 2 0 0 4 A N N U A L R E P O R T SHAREHOLDER INF ORMATION CORPORA TE HEA DQUARTERS ANNUAL MEETING Century Bank 400 Mystic Avenue Medford, MA 02155-6316 TEL 866.8.CENTURY century-bank.com TRANSFER AGE NT AND REGISTRAR EquiServe Trust Company, N.A. The annual meeting of stockholders will be held on Tuesday, April 12, 2005, at 10:00 a.m. The meeting will take place at Century Bank, 400 Mystic Avenue, Medford, MA. STOCK LISTING Century Bancorp, Inc. became a public company in 1987. Centuryʼs Class A Common Stock is listed in the NASDAQ national market and is traded under the symbol CNBKA. The stock is listed as CntyBc in The Boston Globe and Boston Herald, and CentyBcp in The Wall Street Journal. P.O. Box 43010 10- K REPORT Providence, RI 02940-3010 A copy of the Companyʼs annual report to the Securities and Exchange Commission on Form 10-K TEL 781.575.3400 (Investor Relations) may be obtained without charge upon written request to: Century Bancorp, Inc., Investor Relations, EquiServe.com 400 Mystic Avenue, Medford, MA 02155. CENTURY B ANK L OC AT IONS OFFIC ES Allston Beverly Boston Boston Boston Boston Boston Boston Braintree Brookline Burlington 300 Western Avenue, Allston, MA 02134 428 Rantoul Street, Beverly, MA 01915 710 Albany Street, Boston, MA 02118 280 Atlantic Avenue, Boston, MA 02110 512 Commonwealth Avenue, Boston, MA 02215 771 Commonwealth Avenue, Boston, MA 02215 275 Hanover Street, Boston, MA 02113 24 Federal Street, Boston, MA 02110 703 Granite Street, Braintree, MA 02184 617-562-1700 978-921-2300 617-578-9250 617-557-0516 617-424-1644 617-424-5211 617-557-2950 617-423-1490 781-356-3400 1184-1186 Boylston Street/Rt 9 East, Brookline, MA 02467 617-713-4910 134 Cambridge Street/Rt 3A, Burlington, MA 01803 781-238-8700 Cambridge 2309 Massachusetts Avenue, Cambridge, MA 02140 617-349-5300 S peci al t hank s t o Jame s M. Fl ynn , Jr., Sen ior V i ce P resident & Chair man, Bu ilding Committ ee , f or hi s dedi cat ion an d dilige nce in mak ing t he new Cent ur y Ban k He adq u ar t e rs a re ality. Everett Lynn Malden Medford 1763 Revere Beach Parkway/Rt 16, Everett, MA 02149 617-381-6300 2 State Street, Lynn, MA 01901 781-586-8700 140 Ferry Street at Eastern Avenue, Malden, MA 02148 781-388-2100 400 Mystic Avenue, Medford, MA 02155 Medford Square 55 High Street, Medford, MA 02155 781-393-4160 781-391-9830 Newton Peabody Quincy Salem 31 Boylston Street/Route 9 West, Newton, MA 02467 617-582-0920 12 Peabody Square, Peabody, MA 01960 651 Hancock Street, Quincy, MA 02170 37 Central Street, Salem, MA 01970 978-977-4900 617-376-8100 978-740-6900 Somerville 102 Fellsway West at Mystic Avenue, Somerville, MA 02145 617-629-0929 FREE S TANDING C ASH DISPENSERS Boston Boston Boston Boston Boston Boston Boston Boston Agganis Arena, Boston University, 925 Commonwealth Avenue, Boston, MA 02215 Barnes & Noble, 660 Beacon Street, Boston, MA 02215 Campus Convenience/Sleeper Hall, Boston University, 275 Babcock Street, Boston, MA 02215 Dental School, Boston University, 100 East Newton Street, Boston, MA 02118 The Hotel Commonwealth, 500 Commonwealth Avenue, Boston, MA 02215 Medical School, Boston University, 715 Albany Street, Boston, MA 02118 Parking Garage, Boston University, 710 Albany Street, Boston, MA 02118 Warren Towers, 770 Commonwealth Avenue, Boston, MA 02215 Cambridge One Kendall Square, Building #100, Cambridge, MA 02139 Medford Magoun Square, 110 Medford Street, Medford, MA 02155 Dear Fellow Shareholders: 2004 was an important year of achievement for Century Bank. Our 35-year tradition of client intimacy and community involvement remains the core of our existence and the central building block of our success. This is why we are a market leader. It indicates our commitment to being one for many years to come. Our asset growth this year was excellent. However, our earnings were less so and are attributed to the clear and compelling reasons of a historically low interest rate environment and investments we made in our future. We added significant resources in 2004 to our three principal business units, Personal, Business, and Institutional Banking and feel that these investments and changing market conditions have created an attitude of optimism and atmosphere of positive energy PICTURED (from left): Jonathan G. Sloane, President & Co-COO; Linda Sloane Kay, Vice President; Marshall M. Sloane, Chairman of the Board & CEO; Barry R. Sloane, Executive Vice President & Co-COO. and excitement for 2005. While 2004 was a year of modest performance, it was a period of significant investment that we feel prepares us for both market change and market opportunity. Century Bankʼs major events of 2004 are comprised of the following: • Record asset size of $1.83 billion reached, representing an 8.6% increase of assets from the previous year-end. The Bankʼs five-year compounded annual growth rate (CAGR) is 14.7%. • $8.88 million earned net income, representing a 24% decline from 2003 to $1.60 per share, resulting from the interest rate environment and our investments in both client relationships and infrastructure. • Net increase of $68 million in our loan portfolio or 13% to $580 million, including $26 million in a record 402 approved small business loans and 543 new home equity loans totaling over $65 million. Our credit quality remains, as one auditor has put it, “impeccable.” • 22nd branch office opened on Albany Street, Boston. • Operations upgraded to full-check image capability to maintain our competitive advantage in lockbox processing and in response to the Check 21 clearing environment representing an investment of $2.2 million. • Expanded our Business Development Team to include six new, experienced line officers. • Implemented state-of-the-art technology advancements to enhance our PC office working environment. • BlackRock Financial Management, the second largest domestic fixed-income manager in the U.S. was retained to manage our “Available-For-Sale” portfolio insuring best practices are utilized in the management of our securities portfolio, thus maximizing its yield. • Raised an additional $6.4 million of capital by refinancing our outstanding Trust Preferred securities while lowering the interest rate paid from 8.3% to 6.65%. • Imposed another layer of financial control reporting, in addition to our existing five supervisory levels of oversight, as a result of the advent of the Sarbanes-Oxley Act. We estimate hundreds of thousands of dollars of new audit expense and thousands of hours of management time elapsed in compliance efforts with this implementation. • Finally, we completed, and now occupy our new 50,000 square foot Medford Headquarters and new Main Office Branch. In 2004, the New England banking environment continued its 20-year evolution to where the four largest banks represented 45% of the Massachusetts banking marketplace. Additionally, they are all owned and controlled by out-of-state institutions. With Century Bank being the second largest locally-controlled commercial bank in Massachusetts, competing is both our challenge and our opportunity. Our instincts and experience tell us that the major global banks will continue to create a significant market opportunity by their missteps, i.e.: branch disruptions, arbitrary officer transfers, thoughtless layoffs, unjustified fee increases, and ethics scandals. The megabanks will drive a meaningful market segment back to the competent independent bank where an officerʼs personal connection is the bridge to the clients and communities. Consequently, our ability to recruit and retain quality bankers from our competitors continues to be a significant initiative for us. Our recruiting success in 2004 is a direct result of that initiative. If you examine every major metropolitan area that has experienced such a similar consolidation of assets within that market, in virtually every instance at least one closely controlled, independent, full-service bank has emerged as a superior performer and permanent market presence. As long as we can continue to execute a diversified and superior product offering, we believe Century Bank will be that surviving and thriving success story in Greater Boston. There are few independent banks that can be as proud of the professionalism of their Associatesʼ product delivery as Century Bank. As 2004 came to a close, so too did the distinguished terms of departing Directors Jonathan B. Kay and Joseph P. Mercurio. Their counsel and diligence was greatly appreciated and their contributions in shaping our Bank will be evident for many years. They will be greatly missed. Century Bank now competes in the “land of the giants.” We cannot change that. Frankly, we welcome the new banking reality and landscape. In it, we will do more than compete, we will excel. We will do more than survive, we will thrive. 2004 was a very busy year of hard work and forward motion towards that goal. We have thoughtfully constructed an institution that well serves its clients, communities, Associates and shareholders. We look forward to 2005 with a sense of optimism and excitement and hope you share our passion. Sincerely, Marshall M. Sloane Chairman, President and CEO, Century Bancorp, Inc.; Chairman & CEO, Century Bank and Trust Company Jonathan G. Sloane Executive Vice President, Century Bancorp, Inc.; President & Co-COO, Century Bank and Trust Company Barry R. Sloane Executive Vice President, Century Bancorp, Inc.; Executive Vice President & Co-COO, Century Bank and Trust Company PEOPLE. BUSINESSES. CITIES. TOWNS. EVERYONE HAS GOALS. 2004 was a year of investment and vision for Century Bank. It was also a year of success and growth, as our Bank continued to perform and grow in the core areas of Business Banking, Personal Banking and Institutional Services. Across all lines of business, we continue to increase our level of strategic partnership with all our clients and immersion in their business and personal banking needs. PICTURED (from left): Paul V. Cusick, Jr., Executive Vice President, CFO & Treasurer; Paul A. Evangelista, Executive Vice President; David B. Woonton, Executive Vice President. 1972 Century Bancorp, Inc. formed. 1975 First of 29 years of uninterrupted dividends paid. 1981 Automated lockbox service introduced. 1969 Founded by Marshall M. Sloane in Somerville, MA. • Record first day of deposits ($1.1M). • Total first year-end assets ($17M). • Year-end net income ($32,177). 1973 North Shore Bank & Trust Company acquired. 1979 Bank passes $100 million in assets. BUSI N ESS B ANKING Century Bankʼs Business Banking Group had a In 2004, we launched a successful Small Business strong year of performance by continuing to meet Loan campaign leveraging our Retail Branch the needs of our existing clients and cultivating Network and Branch Managers. This sales team many new relationships by providing working focused on their local markets and provided local capital, lines/letters of credit, term loans, construction businesses with easy access to needed credit. loans and residential and investor mortgage products. Our focus will continue to be small and mid-sized, We listened to our customers and simplified the closely controlled businesses that flourish within process so that through our partnership, we could our market area. all enjoy the growth and rewards of their enterprise. This is what banking at Century Bank is all about: In a challenging year for all banks within our finding solutions that work. region, we increased our volume of outstanding loans to over $580 million, reflecting a 13% increase. Our traditional corporate emphasis of over-delivering against our business clientsʼ expectations continues to prove that client intimacy will always yield the best results. This mantra is who we are. Our clientsʼ business is our business and we can consistently exceed their needs by knowing the intricacies of their livelihood. 1983 Acquired property in Medford, MA for future site of operations center. 1986 Acquired Social Service and St. Michaelʼs Credit Union. 1988 Bank passes $500M in assets. 1982 Acquired Bank of Massachusetts. 1985 Acquired Massachusetts Teachers Association Credit Union. 1987 Initial public offering resulted in $10.5M in new capital under NASDAQ symbol CNBKA. PER SON AL B ANKING In 2004, Century Bankʼs personal accounts grew The focus for all Branch Associates in 2004 was to over 46,000. With a branch network of 22 on sales and outreach. Branch Managers met with locations, and an ATM network of 33 sites, our hundreds of local business owners in their respective Bank had a solid year of growth, expansion communities. These meetings resulted into new and performance as we met and exceeded the relationships for the Bank and ultimately played a personal needs of our customers. major role in the organic loan and deposit growth We opened our 22nd branch location in the heart for the Bank. of the Boston University Medical Center Campus. Our retail banking Associates continue to provide This area has experienced significant growth and unparalleled service to their consumer and business change and is now one of the premier areas for clients to ensure each is served exceptionally. Biomedical and Infectious Disease Research. This is our quality and service commitment and why This branch location and sales staff will provide we will continue to succeed. products and services to the professionals, local businesses and residents in the area. 1998 • $29.75M raised through a preferred security 2001 • Headcount exceeds 400. offering under NASDQ symbol CNBKP. • Worcester processing center opened. • Haymarket Cooperative Bank purchased. • Opened branches in Newton and Brookline. 1993 Wollaston Credit Union acquired. 2000 Topped $1 billion in assets. INS TI TUTI ON AL SER VICES In 2004, the Century Bank Institutional Banking We made significant investments throughout the business continued to thrive and was a major year and installed an image-based processing source of revenue, success and pride for the Bank. technology that fully automated our lockbox and We grew the business of our current base of check transit areas. This technology affords us clients and added important new client relationships state-of-the-art capabilities to customize payment in corporate, government, not-for-profit and the collection and remittance programs for any utilities sector. corporate, not-for-profit or government banking customer or prospect. Century Bank is the second largest lockbox processor in New England with over $560 million of related Our capabilities are not limited to simply payment client deposits, 25 million transactions and 200 collections. During 2004, we also introduced a client processing engagements. Our clients range sophisticated Positive Pay and Account Reconciliation from major utilities and corporations in Connecticut, Program to better assist our largest clients to reconcile New York and Massachusetts to world renowned their cash flows and prevent exposures to fraud or not-for-profits. We also partner with over 40% of the incorrect payments. local Massachusetts municipalities, ranging from the largest to the smallest, and assist them to efficiently From wire transfers to money markets and Cash collect real estate and excise taxes, as well as other Management Services, we realize the potential of our necessary payments. opportunity throughout New England and New York. 2003 • Acquired Capital Crossingʼs Chestnut Hill branch and its retail deposits in downtown Boston. • Grew to 21 branch locations. • Broke ground on new five-story Headquarters in Medford. 2002 Opened Federal Street branch in Bostonʼs financial district, bringing branch total to 19. 2004 • Completed and occupied Headquarters building. • Opened branch at Boston University Medical Center. • Assets exceed $1.83 billion. • Chosen BEST BANK in Somerville. Jon Westling1,2*,3 President Emeritus, Boston University Anthony C. LaRosa, CPA Senior Vice President, Accounting C E N T U RY B ANCOR P, I NC. D IR E C T O R S George R. Baldwin1,4,6 President & CEO, Baldwin & Company Roger S. Berkowitz2,5 President & CEO, Legal Sea Foods, Inc. Karl E. Case, Ph.D.3,5* Katharine Coman and A. Barton Hepburn Professor of Economics Wellesley College Visiting Scholar, Federal Reserve Bank Henry L. Foster, D.V.M. Founder & Chairman Emeritus, Charles River Laboratories, Inc. Marshall I. Goldman, Ph.D.3*,5** Professor Emeritus, Wellesley College; Associate Director, Davis Center for Russian Studies, Harvard University Russell B. Higley, Esquire6* Higley & Higley, Attorneys at Law Jonathan B. Kay4 President, The Kay Companies, Inc. Linda Sloane Kay Vice President, Business Development Century Bank and Trust Company Fraser Lemley2,4,5 Chairman & CEO, Sentry Ford, Inc.; Sentry Lincoln-Mercury, Inc.; Sentry South Lincoln-Mercury, Inc. HO N OR ARY DIRECT ORS Michael M. Ossoff Philibert L. Pellegrini, Esquire OF F I CERS Marshall M. Sloane Chairman, President and CEO Jonathan G. Sloane Executive Vice President Barry R. Sloane Executive Vice President Paul V. Cusick, Jr. Vice President and Treasurer Rosalie A. Cunio Clerk Paula A. Grimaldi Assistant Clerk C ENTURY B ANK AND TRUS T CO MPANY OFFICERS M A N A G E M E N T C O M M I T T E E Marshall M. Sloane Chairman of the Board & CEO Jonathan G. Sloane President & Co-COO Joseph P. Mercurio2*,4** Executive Vice President, Boston University Barry R. Sloane Executive Vice President & Co-COO Joseph J. Senna, Esquire1*,4 Barry R. Sloane4,5,6 Executive Vice President, Century Bancorp, Inc.; Executive Vice President & Co-COO, Century Bank and Trust Company Jonathan G. Sloane 4,5,6 Executive Vice President, Century Bancorp, Inc.; President & Co-COO, Century Bank and Trust Company Marshall M. Sloane4,5 Chairman, President and CEO, Century Bancorp, Inc.; Chairman & CEO, Century Bank and Trust Company Stephanie Sonnabend1,5 President & CEO, Sonesta International Hotels Corporation George F. Swansburg4*,5 Retired Executive Vice President, Century Bancorp, Inc.; Retired Vice Chairman, Century Bank and Trust Company Paul V. Cusick, Jr.5,6 Executive Vice President, CFO & Treasurer Paul A. Evangelista Executive Vice President David B. Woonton Executive Vice President S E N I O R V I C E P R E S I D E N T S Gerald S. Algere Senior Vice President, Division Head, Not-for-Profit Janice A. Brandano Senior Vice President, Items Processing Brian J. Feeney Senior Vice President, Institutional Services James M. Flynn, Jr. Senior Vice President, Commercial Loans Philip M. Gannon, Jr. Senior Vice President, Information Systems John C. Lavallee Senior Vice President, Division Head, Institutional Services John McKenna Senior Vice President, Division Head, Small Business Jason J. Melius Senior Vice President, Information Systems F I R S T V I C E P R E S I D E N T S Diana L. Carito, CIA, CRP First Vice President & Audit Director Louise F. Young First Vice President, Credit V I C E P R E S I D E N T S Robert A. Bennett Vice President & Retail Sales Manager Bradford J. Buckley Vice President, Commercial Loans Joseph B. Chapman Vice President, Purchasing Jennifer L. Conrad Vice President, Institutional Services Charles J. Cope, Jr. Vice President, Commercial Loans Rosalie A. Cunio Vice President & Corporate Secretary Sylvia Daikos Vice President & Somerville Branch Manager Anthony J. DiGuilio Vice President, Commercial Loans Stuart J. Erbstein Vice President, Commercial Loans William J. Gambon, Jr. Vice President, Electronic Operations & Delivery Timothy L. Glynn Vice President, Consumer Loans T. Daniel Kausel Vice President, Commercial Loans Linda Sloane Kay Vice President, Business Development Nancy Lindstrom Vice President, Retail Operations & Support Karen Martin Vice President, Accounting 1 Audit Committee, 2 Compensation Committee, 3 Nominating Committee, 4 Executive Committee, 5 Asset Liability Committee, 6 Non-deposit Investment and Insurance Products Committee, * Committee Chairperson, ** Vice Chairperson Shipley C. Mason Vice President, Commercial Loans Janet McElwee Vice President, Compliance & CRA Joanne C. McNamara, CISA Vice President, Audit Thomas F. Peltier Vice President, Not-For-Profit Division Miguel A. Rosado Vice President, Commercial Loans Deborah R. Rush Vice President, Institutional Services Kenneth A. Samuelian Vice President & Controller Andrew J. Santos, Jr. Vice President, Commercial Loans Bernice A. Shuman Vice President, Systems Jim Smith Vice President & Albany St. Branch Manager Maria L. Spadoni-Merena Vice President, Institutional Services Michael W. Sweeney Vice President, Commercial Loans Janice D. Taylor Vice President & Malden Branch Manager David J. Waryas Vice President, Training Yasmin D. Whipple Vice President, Human Resources A S S I S T A N T V I C E P R E S I D E N T S Laura A. DiFava Assistant Vice President & Everett Branch Manager Ann Marie Ellis-Stetson Assistant Vice President, Institutional Services Judith A. Fallon Assistant Vice President, Lockbox John R. Ferguson Assistant Vice President, Accounting Jeanna K. Frawley Assistant Vice President, Loan Administration Howard N. Gold Assistant Vice President, Systems Howard C. Green Assistant Vice President & Newton Branch Manager Roland E. Harvey Assistant Vice President & Cambridge Branch Manager Ann J. Hollup Assistant Vice President, Lockbox Kristine M. Holopainen Assistant Vice President & Federal Street Branch Manager James J. Jordan Assistant Vice President & Salem Branch Manager Ann E. Mannion Assistant Vice President & Lynn Branch Manager Nancy M. Marsh Assistant Vice President, Commercial Loans Michael D. Ballard Assistant Vice President, Consumer Loans Carl M. Mattos Assistant Vice President, Loan Operations Gerald Bovardi Assistant Vice President, Commercial Loans Jennifer R. Carpenito Assistant Vice President & Allston/ Brighton Branch Manager Debra J. Cloutier Assistant Vice President, Commercial Loans Gracine Copithorne Assistant Vice President, Corporate Security/BSA Barbara Cunningham Assistant Vice President, Deposit Accounting Cynthia A. Davidson Assistant Vice President & Braintree Branch Manager Carol A. Melisi Assistant Vice President & Burlington Branch Manager Karen Roses Assistant Vice President, Credit Administration William F. Shutt, Jr. Assistant Vice President & Quincy Branch Manager Suzanne Sumski Assistant Vice President & Beverly Branch Manager Marcia T. Trenholm, CISA Assistant Vice President, Audit O F F I C E R S Irene A. Lima Butler Atlantic Avenue Branch Manager Pasqualina Buttiri North End Branch Manager Toni M. Chardo Customer Service Center Michael J. Dwyer Mystic Branch Manager Sandra C. Gomes Marketing Lisa Gosling Kenmore Square Branch Manager Paula A. Grimaldi Assistant Corporate Secretary Karen Grindrod Institutional Services Janice D. Hallinan Peabody Branch Manager Amelia N. Iocco Mystic Cash Room Manager Malcolm I. Maloon Information Systems Maureen E. Matranga Marketing Christina Welch-Matthews Retail Operations and Support Cornelius C. Prioleau Audit Bruce A. Priestley Medford Square Branch Manager Ashley G. Taylor Brookline Branch Manager Elizabeth Theriault Retail Operations and Support Jose I. Umana BU Sherman Union, Branch Manager John Forest Wallace Information Systems CENTURY FINANCIAL SERVICES Kenneth M. Johnson, CFP6, President Paul V. Cusick, Treasurer Kenneth A. Samuelian, Clerk Amy E. Cinelli, Operations Officer Policy making officer subject to FRB Regulation Part 215 - Loans to Executive Officers, Directors and Principal Shareholders of Member Banks. Non-policy making officers. FINANCIAL STATEMENTS 1 2 9 Financial Highlights Management’s Discussion and Analysis of Results of Operations and Financial Condition Consolidated Balance Sheets 10 Consolidated Statements of Income 11 Consolidated Statements of Changes of Stockholders’ Equity 12 Consolidated Statements of Cash Flows 13 Notes to Consolidated Financial Statements 31 33 Report of Independent Registered Public Accounting Firm Management’s Report on Internal Control over Financial Reporting Financial Highlights 1 2004 2003 2002 2001 2000 (dollars in thousands, except share data) FOR THE YEAR Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other operating income Operating expenses Income before income taxes Provision for income taxes $ 65,033 23,646 41,387 300 41,087 10,431 37,663 13,855 4,974 $ 69,298 23,942 45,356 450 44,906 10,009 34,272 20,643 8,963 $ 71,124 24,718 46,406 1,200 45,206 10,266 34,089 21,383 7,879 $ 67,459 27,701 39,758 1,500 38,258 8,863 30,025 17,096 6,237 $ 66,554 31,092 35,462 1,425 34,037 7,234 25,638 15,633 5,428 Net income $ 8,881 $ 11,680 $ 13,504 $ 10,859 $ 10,205 Average shares outstanding, basic Average shares outstanding, diluted Shares outstanding at year-end Earnings per share: Basic Diluted Dividend payout ratio AT YEAR-END Assets Loans Deposits Stockholders’ equity Book value per share SELECTED FINANCIAL PERCENTAGES Return on average assets Return on average stockholders’ equity Net interest margin, taxable equivalent Net (recoveries) charge-offs as a percent of average loans Average stockholders’ equity to average assets Efficiency Ratio Per Share Data 2004, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B 2003, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B 5,526,202 5,553,197 5,534,088 5,519,800 5,548,615 5,524,438 5,516,590 5,534,059 5,517,425 5,535,309 5,541,745 5,515,350 5,597,136 5,597,629 5,550,350 $ $ 1.61 1.60 24.2)% $ $ 2.12 2.11 17.2)% $ $ 2.45 2.44 13.9)% $ $ 1.96 1.96 15.2)% $ $ 1.82 1.82 14.5)% $ 1,833,701 580,003 1,394,010 104,773 18.93 $ $ 1,688,911 512,314 1,338,853 103,728 18.78 $ $ 1,557,201 514,249 1,146,284 100,256 18.17 $ $ 1,271,022 462,772 888,408 84,599 15.34 $ $ 1,083,830 439,563 793,796 71,506 12.88 $ .55)% 8.61)% 2.75)% 0.01)% 6.38)% 72.7)% .74)% 11.57)% 3.08)% 0.04)% 6.40)% 61.6)% 1.02)% 14.64)% 3.77)% (0.04)% 6.98)% 60.1)% 1.03)% 13.70)% 4.06)% 0.01)% 7.49)% 61.7)% 1.08)% 16.09)% 4.02)% 0.78)% 6.68)% 60.6)% December 31, September 30, June 30, March 31, $ 32.79 28.15 0.12 0.060 $ 33.62 30.38 0.12 0.060 $ 33.74 29.75 0.12 0.060 $ 37.51 32.80 0.12 0.060 December 31, September 30, June 30, March 31, $ 38.11 32.40 0.12 0.06 $ 37.30 28.55 0.11 0.055 $ 31.51 25.75 0.11 0.055 $ 28.47 26.40 0.11 0.055 2 Management’s Discussion and Analysis of Results of Operations and Financial Condition Overview Century Bancorp, Inc. (together with its bank subsidiary, unless the context otherwise requires, the "Company"), is a Massachusetts state chartered bank holding company headquartered in Medford, Massachusetts. The Company is a Massachusetts corporation formed in 1972 and has one banking subsidiary (the "Bank"): Century Bank and Trust Company formed in 1969. The Company had total assets of $1.8 billion on December 31, 2004. The Company presently operates 22 banking offices in 16 cities and towns in Massachusetts ranging from Braintree to Peabody. The Bank’s customers consist primarily of small and medium-sized businesses and retail customers in these communities and surrounding areas, as well as local governments and institutions throughout Massachusetts. The Company’s results of operations are largely dependent on net interest income, which is the difference between the interest earned on loans and securities and interest paid on deposits and borrowings. The results of operations are also affected by the level of income/fees from loans, deposits, as well as operating expenses, the provision for loan losses, the impact of federal and state income taxes and the relative levels of interest rates and economic activity. The Company offers a wide range of services to commercial enterprises, state and local governments and agencies, non-profit organizations and individuals. It emphasizes service to small and medium-sized businesses and retail customers in its market area. The Company makes commercial loans, real estate and construction loans, consumer loans, and accepts savings, time and demand deposits. In addition, the Company offers to its corporate and institutional customers automated lockbox collection services, cash management services and account reconciliation services, and actively promotes the marketing of these services to the municipal market. Also, the Company provides full service securities brokerage services through its subsidiary, Century Financial Services, Inc. in conjunction with Commonwealth Equity Services, Inc., a full service securities brokerage business. The Company is also a provider of financial services including cash management, transaction processing and short term financing to municipalities in Massachusetts and Rhode Island. The Company has deposit relationships with approximately 30% of the 351 cities and towns in Massachusetts. Century Bancorp, Inc. (the “Company”) had net income of $8,881,000 for the year ended December 31, 2004, compared with net income of $11,680,000 for year ended December 31, 2003 and net income of $13,504,000 for the year ended December 31, 2002. Basic earnings per share were $1.61 in 2004, compared to $2.12 in 2003 and $2.45 in 2002. Diluted earnings per share were $1.60 in 2004, compared to $2.11 in 2003 and $2.44 in 2002. The Company’s earnings in 2004 were negatively affected by the historically low interest rate environment. Assets have continued to reprice at lower interest rates while interest rates paid on deposits have not had a corresponding decrease. The Company believes that the net interest margin will continue to be challenged. During 2003, the Company’s earnings were also negatively affected by a net tax charge of $1,183,000 associated with the Real Estate Investment Trust (“REIT”) settlement. This charge was the result of an agreement with the Massachusetts Department of Revenue (“DOR”) settling a dispute related to taxes that the DOR claimed were owed from the Company’s REIT. Total assets were $1,833,701,000 at December 31, 2004, an increase of 8.6% from total assets of $1,688,911,000 on December 31, 2003, which, in turn, were 8.5% higher than total assets of $1,557,201,000 on December 31, 2002. On December 31, 2004, stockholders' equity totaled $104,773,000, compared with $103,728,000 on December 31, 2003 and $100,256,000 on December 31, 2002. Book value per share increased to $18.93 at December 31, 2004 from $18.78 on December 31, 2003, which had increased from $18.17 on December 31, 2002. During February 2003, the Company began construction of an addition to its corporate headquarters building. The property is located adjacent to its current headquarters in Medford, Massachusetts and will provide additional corporate office space and an expanded branch banking floor. The building is scheduled to be occupied during the first quarter of 2005 and the current cost estimate including land costs is $14.5 million. As of December 31, 2004, $13.6 million has been expended. The capital expenditure will provide a five-story addition containing approximately 50 thousand square feet of office and branch banking space. Occupancy costs are expected to increase by approximately $1 million per year when the building is occupied. On March 21, 2003, the Company completed the acquisition of Capital Crossing Bank’s branch office at 1220 Boylston Street, Chestnut Hill, Massachusetts, and substantially all of the retail deposits at Capital Crossing's main office at 101 Summer Street, Boston, Massachusetts. Century closed the Chestnut Hill branch and transferred all customers of the branch to its nearby branch office at 1184 Boylston Street, Brookline, Massachusetts. In addition, Century transferred all of the retail deposits from Capital Crossing's Summer Street branch to its branch at 24 Federal Street, Boston, Massachusetts. The acquisition included $192.7 million in deposits. The acquisition also included a premium paid to Capital Crossing of approximately $3.9 million. This premium was subsequently reduced by a gain of $395 thousand from the sale of the acquired Chestnut Hill branch and a rebate of $282 thousand for closed accounts at the Boston office. During the third quarter of 2004, the Company announced plans to continue its stock repurchase plan. Under the program, the Company is authorized to repurchase up to 300,000 shares, or less than 9%, of Century Bancorp Class A Common Stock. The program expires on July 15, 2005. In July 2004, the Company opened a new branch location on Albany Street in Boston, Massachusetts. In 2003, the Company opened two branches in Boston, Massachusetts. During the fourth quarter of 2004, the Company announced that it entered into an Investment Management Agreement with BlackRock Financial Management, Inc. for the Company’s Available-For-Sale securities portfolio. The Company believes that BlackRock will help it achieve improvements in the Company’s yield and total return on its investment portfolio. Also during the fourth quarter, the Company consummated the sale of a trust preferred securities offering, in which it issued $36,083,000 of subordinated debt securities due 2034 to its newly formed unconsolidated subsidiary Century Bancorp Capital Trust II. Century Bancorp Capital Trust II issued 35,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $1,000 per share. These securities pay dividends at an annualized rate of 6.65% for the first ten years and then convert to the three-month LIBOR rate plus 1.87% for the remaining twenty years. The total amount of this issuance was $36,083,000. The Company is using the proceeds primarily for general business purposes. Also, the Company, through its subsidiary, Century Bancorp Capital Trust, announced the redemption of their 8.30% Trust Preferred Securities, with a redemption date of January 10, 2005. The total amount of this redemption is $29,639,000. Management’s Discussion and Analysis of Results of Operations and Financial Condition 3 Critical Accounting Policies Impaired Investment Securities If a material decline in fair value below the amortized cost basis of an investment security is judged to be “other-than-temporary,” the cost basis of the investment is written down to fair value. The amount of the write down is included as a charge to earnings. An “other-than-temporary” impairment exists for debt securities if it is probable that the Company will be unable to collect all amounts due according to contractual terms of the security. Some factors considered for “other than temporary” impairment related to a debt security include an analysis of yield which results in a decrease in expected cash flows, whether an unrealized loss is issuer specific, whether the issuer has defaulted on scheduled interest and principal payments, whether the issuer’s current financial condition hinder its ability to make future scheduled interest and principal payments on a timely basis or whether there was downgrade in ratings by rating agencies. Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets and impact income, are considered critical accounting policies. The Company considers the following to be its critical accounting policies: allowance for loan losses and impaired investment securities. There have been no significant changes in the methods or assumptions used in the accounting policies that require material estimates and assumptions. Allowance for Loan Losses Arriving at an appropriate level of allowance for loan and lease losses necessarily involves a high degree of judgment. Management maintains an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance is based on assessments of the probable estimated losses inherent in the loan portfolio. Management’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowances for identified problem loans and the unallocated allowance. The formula allowance is calculated by applying loss factors to outstanding loans, in each case based on the internal risk grade of such loans. Changes in risk grades affect the amount of the formula allowance. Risk grades are determined by reviewing current collateral value, financial information, cash flow, payment history and other relevant facts surrounding the particular credit. Provisions for losses on the remaining commercial and commercial real estate loans are based on pools of similar loans using a combination of historical loss experience and qualitative adjustments. For the residential real estate and consumer loan portfolios, the reserves are calculated by applying historical charge-off and recovery experience and qualitative adjustments to the current outstanding balance in each loan category. Loss factors are based on the Company’s historical loss experience, as well as regulatory guidelines. Specific allowances are established in cases where management has identified significant conditions related to a credit that management believes that the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. The unallocated allowance recognizes the model and estimation risk associated with the formula allowance and specific allowances, as well as management’s evaluation of various conditions, including business and economic conditions, delinquency trends, charge-off experience and other quality factors, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits. Management believes that the allowance for loan losses is adequate. In addition, various regulatory agencies, as part of the examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. 4 Management’s Discussion and Analysis of Results of Operations and Financial Condition Results of Operations and Financial Condition The following table sets forth the distribution of the Company’s average assets, liabilities and stockholders’ equity, and average rates earned or paid on a fully taxable equivalent basis for each of the years indicated. Year Ended December 31, 2004 2003 2002 Interest Rate Average Income/ Earned/ Balance Expense (1) Paid (1) Average Balance Interest Rate Income/ Earned/ Expense (1) Paid (1) Average Balance Interest Rate Income/ Earned/ Expense (1) Paid (1) (dollars in thousands) ASSETS Interest-earning assets: Loans (2) Securities available-for-sale: Taxable Tax-exempt Securities held-to-maturity: Taxable Federal funds sold Interest bearing deposits in other banks $ 546,147 $ 33,384 6.11)% $ 500,723 $ 33,134 6.62)% $ 488,465 $ 35,954 7.36)% 570,935 18,528 61 1 3.25 1.64) 782,782 28,736 92 3 3.67 3.26 570,067 960 27,285 39 4.79) 4.06) 319,860 12,296 3.84 162,988 7,152 4.39) 126,675 7,150 5.64)) 69,461 824 1.19) 24,730 274 1.11) 45,253 710 1.57) 251 — 0.13 30 — 0.58) 20 — 2.50) Total interest-earning assets 1,506,715 65,033 4.32)% 1,471,345 69,299 4.71)% 1,231,440 71,138 5.78)% Non Interest-earning assets Allowance for loan losses 120,306 (8,813) Total Assets $ 1,618,208 114,919 (8,901) $ 1,577,363 97,981 (7,828) $ 1,321,593 LIABILITIES AND STOCKHOLDERS’ EQUITY Interest-bearing deposits: NOW accounts Savings accounts Money market accounts Time deposits $ 250,224 $ 1,966 0.79)% $ 260,383 $ 2,267 0.87)% $ 202,060 $ 2,588 1.28)% 79,037 412,220 242,791 302 5,010 6,833 0.38) 1.22) 2.81) 79,333 392,066 239,189 319 5,111 7,246 0.40) 1.30) 3.03) 72,780 268,504 189,395 732,739 595 4,730 6,841 0.82) 1.76) 3.61) 14,754 2.01) Total interest-bearing deposits 984,272 14,111 1.43) 970,971 14,943 1.54) Securities sold under agreements to repurchase 40,937 331 0.81) 51,402 457 0.89) 61,718 696 1.13) Other borrowed funds and subordinated debentures 194,932 9,204 4.72) 170,344 8,542 5.01) Total interest-bearing liabilities 1,220,141 23,646 1.94)% 1,192,717 23,942 2.01)% 186,531 980,988 9,268 4.97) 24,718 2.52)% Non Interest-bearing liabilities Demand deposits Other liabilities Total liabilities Stockholders’ equity Total liabilities & 279,361 15,511 1,515,013 103,195 267,284 16,429 1,476,430 100,933 232,372 15,986 1,229,346 92,247 stockholders’ equity $ 1,618,208 $ 1,577,363 $ 1,321,593 Net interest income (1) Net interest spread Net interest margin $ 41,387 $ 45,357 $ 46,420 2.38)% 2.75)% 2.70)% 3.08)% 3.26)% 3.77)% (1) On a fully taxable equivalent basis calculated using a federal tax rate of 35%. (2) Nonaccrual loans are included in average amounts outstanding. Management’s Discussion and Analysis of Results of Operations and Financial Condition 5 The following table summarizes the year-to-year changes in the Company's net interest income resulting from fluctuations in interest rates and volume changes in earning assets and interest-bearing liabilities. Changes due to rate are computed by multiplying the change in rate by the prior year's volume. Changes due to volume are computed by multiplying the change in volume by the prior year's rate. Changes in volume and rate that cannot be separately identified have been allocated in proportion to the relationship of the absolute dollar amounts of each change. Year Ended December 31, 2004 Compared with 2003 2003 Compared with 2002 (dollars in thousands) Interest Income: Loans Securities available-for-sale: Taxable Tax-exempt Securities held-to-maturity: Taxable Federal funds sold Interest-bearing deposits in other banks Total interest income Interest expense: Deposits: NOW accounts Savings accounts Money market accounts Time deposits Total interest-bearing deposits Securities sold under agreements to repurchase Other borrowed funds and subordinated debentures Total interest expense Change in net interest income Increase/(Decrease) Due to Change in Increase/(Decrease) Due to Change in Volume Rate Total Volume Rate Total $ 2,881 $ (2,631) $ 250 $ 884 $ (3,704) $ (2,820) (7,145) (1) (3,063) (1) (10,208) (2) (984) 21 (1) 5,144 550 — 8,721 (30) 1,793 (265) — (7,270) (6) (1,791) (171) — 1,451 (36) 2 (436) — (6,659) (4,266) 11,103 (12,942) (1,839) (215) (16) (356) (521) (1,108) (39) (490) (1,637) (301) (17) (101) (413) (832) (126) 662 (296) 634 49 1,815 1,619 4,117 (105) (811) 3,201 (955) (325) (1,434) (1,214) (3,928) (134) 84 (3,978) (321) (276) 381 405 189 (239) (727) (777) 6,128 529 1 2,393 (86) (1) 255 108 276 (87) 1,152 1,341 $ 1,052 $ (5,022) $ (3,970) $ 7,902 $ (8,964) $ (1,062) The Company's operating results depend primarily on net interest income and fees received for providing services. Net interest income on a fully taxable equivalent basis decreased 8.8% in 2004 to $41,387,000, compared with $45,357,000 in 2003. The decrease in net interest income for 2004 was mainly due to an 11% or a thirty-three basis point decrease in the net interest margin. The level of interest rates, the ability of the Company’s earning assets and liabilities to adjust to changes in interest rates and the mix of the Company’s earning assets and liabilities affect net interest income. The net interest margin on a fully taxable equivalent basis decreased to 2.75% in 2004 from 3.08% in 2003, which had decreased from 3.77% in 2002. The decrease in the net interest margin, for both years, was mainly attributable to assets continuing to reprice at historically low levels without a corresponding decrease in rates paid on deposits. The Company believes that the net interest margin will continue to be challenged. Average earning assets were $1,506,715,000 in 2004, an increase of $35,370,000 or 2.4% from the average in 2003, which was 19.5% higher than the average in 2002. Total average securities, including securities available-for-sale and securities held-to-maturity, decreased 5.8% to $890,856,000. The decrease in securities volume was mainly attributable to a shift in asset concentration to loans and short-term funds. This decrease in securities volume and lower yields resulted in lower securities income, which decreased 14.1% to $30,825,000. Total average loans increased 9.1% to $546,147,000 after increasing $12,258,000 in 2003. The increase in loans was mainly attributable to an increase in commercial and industrial, home equity credit lines and residential real estate loans, partially offset by a decrease in commercial real estate. Those types of loans increased in part because of a loan campaign that began during the first quarter of 2004. The increase in loan volume was partially offset by a lower level of interest rates resulting in higher loan income, which increased by 0.8% or $250,000 to $33,384,000. Total loan income was $35,954,000 in 2002. The Company’s sources of funds include deposits and borrowed funds. On average, deposits showed an increase of 2.0% or $25,378,000 in 2004 after increasing by 28.3% or $273,143,000 in 2003. Deposits increased in 2004 primarily as a result of the internal deposit growth and were mainly concentrated in money market accounts, which increased by $20,154,000. Borrowed funds and subordinated debentures increased by 6.4% in 2004 following a decrease of 10.7% in 2003. The majority of the Company’s borrowed funds are borrowings from the Federal Home Loan Bank (FHLB) and retail repurchase agreements. Borrowings from the FHLB increased by approximately $20,733,000 and retail repurchase agreements decreased by $10,465,000. Interest expense totaled $23,646,000 in 2004, a decrease of $296,000 or 1.2% from 2003 when interest expense decreased 3.1% from 2002. This decrease in interest expense is due to decreases in deposit rates, partially offset by an increase in the average balance of deposits. 6 Management’s Discussion and Analysis of Results of Operations and Financial Condition Provision for Loan Loss The provision for loan losses was $300,000 in 2004, compared with $450,000 in 2003 and $1,200,000 in 2002. These provisions are the result of management's evaluation of the amounts and quality of the loan portfolio considering such factors as loan status, collateral values, financial condition of the borrower, the state of the economy and other relevant information. The allowance for loan losses was $9,001,000 at December 31, 2004, compared with $8,769,000 at December 31, 2003. Expressed as a percentage of outstanding loans at year-end, the allowance was 1.55% in 2004, 1.71% in 2003 and 1.65% in 2002. Non-performing loans, which include all non-accruing loans and certain restructured, accruing loans, totaled $628,000 on December 31, 2004, compared with $1,175,000 on December 31, 2003. Other Operating Income During 2004, the Company continued to experience positive results in its fee-based services including fees derived from traditional banking activities such as deposit related services, its automated lockbox collection system and full service securities brokerage offered through Commonwealth Equity Services, Inc., an unaffiliated registered securities broker-dealer and investment adviser. Under the lockbox program, which is not tied to extensions of credit by the Company, the Company's customer arranges for payments of its accounts receivable to be made directly to the Company. The Company records the amounts paid to its customers, deposits the funds to the customer's account and provides automated records of the transactions to customers. Typical customers for the lockbox service are municipalities who use it to automate tax collections, cable TV companies and other commercial enterprises. Through Commonwealth Equity Services, Inc., an unaffiliated company, the Bank provides full service securities brokerage services. Registered representatives employed by the Bank offer investment advice, execute transactions and assist customers in financial and retirement planning. Commonwealth Equity Services, Inc. provides research to and supervises representatives in exchange for payment by the Bank for a fixed fee and a share in the commission revenues. Total other operating income in 2004 was $10,431,000, an increase of $422,000 or 4.2% compared to 2003. This increase followed a decrease of $257,000 or 2.5% in 2003, compared to 2002. Service charge income, which continues to be a major area of other operating income with $5,271,000 in 2004, saw an increase of $489,000 compared to 2003. Service charges on deposit accounts increased mainly because of an increase in overdraft charges. Lockbox revenues totaled $2,950,000, down $236,000 in 2004. This decrease was mainly attributable to a decrease in volume that was due to increased competition. Through Commonwealth Equity Services, Inc., brokerage commissions increased to $670,000 in 2004, from $579,000 in 2003, primarily as a result of increased transaction volume. Also included in other operating income for 2002 is a pretax realized gain of $359,000 associated with the sale of bank premises. Operating Expenses Total operating expenses were $37,663,000 in 2004, compared to $34,272,000 in 2003 and $34,089,000 in 2002. Salaries and employee benefits expenses increased by $1,503,000 or 6.9% in 2004, after increasing by 0.2% in 2003. The increase for 2004 was mainly attributable to an increase in staff levels and merit increases in salaries. The decrease in 2003 was mainly attributable to a decrease in incentive compensation accruals; this was partially offset by increased retirement and healthcare costs. Occupancy expense increased by $349,000 or 13.2% in 2004, this followed an increase of $347,000 or 15.1% in 2003. The increase in 2004 was mainly attributable to full-year costs associated with the opening of two new branches in 2003 and the partial year cost associated with the opening of one new branch in 2004. The increase in 2003 was mainly attributable to full-year costs associated with the opening of a new branch in 2002 and partial year costs associated with opening two new branches in 2003. Equipment expense increased by $677,000 or 39.8% in 2004; this followed a decrease of $431,000 or 20.2% in 2003. The increase in 2004 was mainly attributable to increased depreciation and service contract expense associated with the additions of check and lockbox image systems. The decrease in 2003 was mainly the result of a decrease in equipment depreciation expense, as well as a reduction in service contract expense. Service contract expense decreased as a result of decreases in lockbox activity. Other operating expenses increased by $862,000 in 2004, which followed a $213,000 increase in 2003. The increase for 2004 was primarily the result of increased legal, audit, personnel recruitment and marketing expense. The costs increased mainly because of compliance related services. Marketing increased because of an increase in advertising. The increase for 2003 was primarily the result of increased core deposit intangible amortization, telephone and software maintenance expense. Provision for Income Taxes Income tax expense was $4,974,000 in 2004, $8,963,000 in 2003 and $7,879,000 in 2002. The effective tax rate was 35.9% in 2004, 43.4% (37.7%, excluding REIT settlement) in 2003 and 36.8% in 2002. The decrease in the effective tax rate for 2004 was mainly attributable to less earnings at the Bank. The portion of earnings subject to a higher tax rate decreased in 2004. Included in tax expense for 2003 is a net tax charge of $1,183,000 associated with the REIT settlement. This charge was the result of an agreement with the Massachusetts DOR settling a dispute related to taxes that the DOR claimed were owed from the Company’s REIT. Market Risk and Asset Liability Management Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities, and to that end, management actively monitors and manages its interest rate risk exposure. The Company's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact the Company's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using several tools. One measure of the Company’s exposures to differential changes in interest rates between assets and liabilities is an interest rate risk management test. This test measures the impact on net interest income of an immediate change in interest rates in 100 basis point increments. Management’s Discussion and Analysis of Results of Operations and Financial Condition 7 Capital Adequacy Total stockholders' equity was $104,773,000 at December 31, 2004, compared with $103,728,000 at December 31, 2003 and $100,256,000 at December 31, 2002. The increase in 2004 was primarily the result of earnings less dividends paid and a decrease in accumulated other comprehensive income. The increase in 2003 was primarily the result of earnings less dividends paid and an increase in accumulated other comprehensive income. Federal banking regulators have issued risk-based capital guidelines, which assign risk factors to asset categories and off-balance sheet items. The current guidelines require a Tier 1 capital-to-risk assets ratio of at least 4.00% and a total capital-to-risk assets ratio of at least 8.00%. The Company and the Bank exceeded these requirements with a Tier 1 capital-to-risk assets ratio of 15.69% and 12.43%, respectively, and total capital-to-risk assets ratio of 20.14% and 13.47%, respectively at December 31, 2004. Additionally, federal banking regulators have issued leverage ratio guidelines, which supplement the risk-based capital guidelines. The minimum leverage ratio requirement applicable to the Company is 4.00% and at December 31, 2004, the Company and the Bank exceeded this requirement with leverage ratios of 8.27% and 6.54%, respectively. Change in Interest Rates (in Basis Points) Percentage Change in Net Interest Income (1) +300 +200 +100 –100 (9.5)% (6.3)% (3.1)% (0.8)% (1) The percentage change in this column represents net interest income for 12 months in various rate scenarios versus the net interest income in a stable interest rate environment. The Company's primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Company's net interest income and capital, while structuring the Company's asset-liability structure to obtain the maximum yield-cost spread on that structure. The Company relies primarily on its asset-liability structure to control interest rate risk. Liquidity and Capital Resources Liquidity is provided by maintaining an adequate level of liquid assets that include cash and due from banks, federal funds sold and other temporary investments. Liquid assets totaled $238,235,000 on December 31, 2004, compared with $225,321,000 on December 31, 2003 and $122,205,000 on December 31, 2002. In each of these three years, deposit activity has generally been adequate to support asset activity. The source of funds for dividends paid by the Company is dividends received from the Bank. The Company and the Bank are regulated enterprises and their abilities to pay dividends are subject to regulatory review and restriction. Certain regulatory and statutory restrictions exist regarding dividends, loans and advances from the Bank to the Company. Generally, the Bank has the ability to pay dividends to the Company subject to minimum regulatory capital requirements. Contractual Obligations, Commitments, and Contingencies The Company has entered into contractual obligations and commitments. The following tables summarize the Company's contractual cash obligations and other commitments at December 31, 2004. Contractual Obligations and Commitments by Maturity (dollars in thousands) Contractual Obligations FHLB advances Subordinated debentures Retirement benefit obligations Lease obligations Other Treasury, tax and loan Customer repurchase agreements Total contractual cash obligations Other Commitments Lines of credit Standby letters of credit Other commitments Total commitments Payments Due – By Period Total Less than One Year One To Three Years Three To Five Years After Five Years $ 213,120 65,722 9,568 6,192 $ 105,000 29,639 601 1,088 $ 1,120 — 1,381 1,952 $ 51,500 — 1,786 1,601 $ 55,500 36,083 5,800 1,551 1,660 38,650 1,660 38,650 — — — — — — $ 334,912 $ 176,638 $ 4,453 $ 54,887 $ 98,934 Amount of Commitment Expiring – By Period Total Less than One Year One To Three Years Three To Five Years After Five Years $ 128,915 11,195 36,265 $ 30,481 4,691 5,480 $ 13,676 128 22,936 $ 515 5,287 1,250 $ 84,243 1,089 6,599 $ 176,375 $ 40,652 $ 36,740 $ 7,052 $ 91,931 8 Management’s Discussion and Analysis of Results of Operations and Financial Condition Financial Instruments With Off-Balance Sheet Risk The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments primarily include commitments to originate and sell loans, standby letters of credit, unused lines of credit and unadvanced portions of construction loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notational amounts of those instruments reflect the extent of involvement the Company has in these particular classes of financial instruments. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for loan commitments, standby letters of credit and unadvanced portions of construction loans is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Financial instruments with off-balance sheet risk at December 31 are as follows: Contract or Notational Amount 2004 2003 (dollars in thousands) Financial instruments whose contract amount represents credit risk: Commitments to originate 1-4 family mortgages $ Standby letters of credit Unused lines of credit Unadvanced portions of construction loans 2,511 11,195 128,915 33,754 $ 600 4,914 126,825 15,414 Commitments to originate loans, unadvanced portions of construction loans and unused letters of credit are generally agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the borrower. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Forward-looking Statements Certain statements contained herein are not based on historical facts and are “forward-looking statements” within the meaning of Section 21A of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions (some of which are beyond the Company’s control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “estimate,” “anticipate,” “continue” or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward- looking statements due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary polices of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. 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 the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Recent Accounting Developments In November 2003 and March 2004, the Financial Accounting Standards Board’s (FASB) Emerging Issues Task Force (EITF) issued a consensus on EITF Issue 03-1which contains guidance on other-than- temporary impairments of investment securities. The EITF provides guidance on when impairment is deemed to exist, provides guidance on determining if impairment is other-than-temporary, and directs how to calculate impairment loss. Issue 03-1 also details expanded annual disclosure rules. In September 2004, the FASB’s EITF issued EITF 03-1-1 Effective Date of Paragraphs 10-20 of EITF Issue 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” which delays the effective date of those paragraphs to be concurrent with the final issuance of EITF 03-1-a “Implementation Guidance for the Application of Paragraph 16 of EITF 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1-a is currently being reviewed by the FASB in regards to final guidance and effective date with a comment period that ended October 29, 2004. EITF 03-1, as issued, was origi- nally effective for periods beginning after June 15, 2004. The adoption of the original EITF 03-1 (excluding paragraphs 10-20) did not have a material impact on the Company’s financial position or results of opera- tions. The Company also does not anticipate that the adoption of EITF 03-1-1 or EITF 03-1-a will have a material impact on the Company’s financial position or results of operations. In December 2004, the FASB issued a revised Statement No. 123, (revised 2004) (SFAS No. 123R), “Share-Based Payment.” This Statement replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period (usually the vesting period). This Statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company estimates that 2005 additional compensation expense (net of tax) will be approximately $100,000 for the six months of 2005. For the years 2006 and beyond, a full year of compensation expense will be recognized. December 31, (dollars in thousands, except share data) ASSETS Cash and due from banks (note 2) Federal funds sold and interest-bearing deposits in other banks Total cash and cash equivalents Securities available-for-sale, amortized cost $614,729 in 2004 and $701,444 in 2003 (notes 3 and 9) Securities held-to-maturity, market value $343,399 in 2004 and $198,790 in 2003 (notes 4 and 9) Loans, net (note 5) Less: allowance for loan losses (note 6) Net loans Bank premises and equipment (note 7) Accrued interest receivable Other assets (note 12) Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Demand deposits Savings and NOW deposits Money market accounts Time deposits (note 8) Total deposits Securities sold under agreements to repurchase (note 9) Other borrowed funds (note 10) Subordinated debentures (note 10) Investments purchased payable Other liabilities Total liabilities Commitments and contingencies (notes 7, 14 and 15) Stockholders’ equity (note 11): Common stock, Class A, $1.00 par value per share; authorized 10,000,000 shares; issued 3,818,048 shares in 2004 and 3,792,938 shares in 2003 Common stock, Class B, $1.00 par value per share; authorized 5,000,000 shares; issued 2,147,190 shares in 2004 and 2,162,650 shares in 2003 Additional paid-in-capital Retained earnings Treasury stock, Class A, 383,600 shares in 2004 and 2003, at cost Treasury stock, Class B, 47,550 shares in 2004 and 2003, at cost Accumulated other comprehensive (loss) income, net of taxes (note 3) Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying Notes to Consolidated Financial Statements. Consolidated Balance Sheets 9 2004 2003 $ 36,209 202,026 $ 64,299 161,022 238,235 225,321 609,806 345,369 580,003 9,001 571,002 26,265 6,800 36,224 703,335 197,872 512,314 8,769 503,545 21,589 8,450 28,799 $ 1,833,701 $ 1,688,911 $ 280,871 $ 270,115 268,317 485,006 359,816 291,950 417,171 359,617 1,394,010 1,338,853 38,650 214,906 65,722 — 15,640 40,050 136,329 29,639 29,330 10,982 1,728,928 1,585,183 3,818 2,147 11,395 98,161 (5,941) (41) 109,539 (4,766) 104,773 3,793 2,163 11,227 91,427 (5,941) (41) 102,628 1,100 103,728 $ 1,833,701 $ 1,688,911 10 Consolidated Statements of Income Year Ended December 31, (dollars in thousands, except share data) INTEREST INCOME Loans Securities available-for-sale Securities held-to-maturity Federal funds sold and interest-bearing deposits in other banks Total interest income INTEREST EXPENSE Savings and NOW deposits Money market accounts Time deposits (note 8) Securities sold under agreements to repurchase Other borrowed funds and long term debt Total interest expense Net interest income Provision for loan losses (note 6) Net interest income after provision for loan losses OTHER OPERATING INCOME Service charges on deposit accounts Lockbox fees Brokerage commissions Net (losses) gains on sales of securities Other income Total other operating income OPERATING EXPENSES Salaries and employee benefits (note 13) Occupancy Equipment Other (note 16) Total operating expenses Income before income taxes Provision for income taxes (note 12) Retroactive REIT settlement (note 12) Net income SHARE DATA (NOTE 11) Weighted average number of shares outstanding, basic Weighted average number of shares outstanding, diluted Net income per share, basic Net income per share, diluted See accompanying Notes to Consolidated Financial Statements. 2004 2003 2002 $ 33,384 $ 18,529 12,296 824 65,033 2,268 5,010 6,833 331 9,204 23,646 41,387 300 41,087 5,271 2,950 670 (91) 1,631 10,431 23,266 2,997 2,380 9,020 37,663 13,855 4,974 — 33,134 28,738 7,152 274 69,298 2,586 5,111 7,246 457 8,542 23,942 45,356 450 44,906 4,782 3,186 579 1 1,461 10,009 21,763 2,648 1,703 8,158 34,272 20,643 7,780 1,183 $ 35,953 27,311 7,150 710 71,124 3,183 4,730 6,841 696 9,268 24,718 46,406 1,200 45,206 4,418 3,463 1,038 — 1,347 10,266 21,709 2,301 2,134 7,945 34,089 21,383 7,879 — $ 8,881 $ 11,680 $ 13,504 5,526,202 5,553,197 $ 1.61 1.60 5,519,800 5,548,615 $ 2.12 2.11 5,516,590 5,534,059 $ 2.45 2.44 Consolidated Statements of Changes in Stockholders’ Equity 11 Class A Common Stock Class B Common Stock Additional Paid-In Capital Retained Earnings Treasury Stock Class A Treasury Stock Class B Accumulated Other Total Comprehensive Stockholders’ Income (Loss) Equity (dollars in thousands, except share data) BALANCE, DECEMBER 31, 2001 $ 3,761 $ 2,186 $ 11,094 $ 70,122 $ (5,941) $ (41) $ 3,418 $ 84,599 Net income Other comprehensive income, net of tax: Unrealized holding gains arising during period, net of $2,150 in taxes Comprehensive income Conversion of Class B Common Stock to Class A Common Stock, 17,820 shares Stock options exercised, 2,075 shares Cash dividends paid, Class A Common Stock, $0.42 per share Cash dividends paid, Class B Common Stock, $0.21 per share — — 18 2 — — — — (18) — — — — — — 29 — — 13,504 — — — (1,426) (445) — — — — — — — — — — — — — 13,504 3,993 3,993 17,497 — 31 (1,426) (445) — — — — BALANCE, DECEMBER 31, 2002 3,781 2,168 11,123 81,755 (5,941) (41) 7,411 100,256 Net income Other comprehensive income, net of tax: Unrealized holding losses arising during period, net of $3,200 in taxes Comprehensive income Conversion of Class B Common Stock to Class A Common Stock, 5,010 shares Stock options exercised, 7,013 shares Cash dividends paid, Class A Common Stock, $0.45 per share Cash dividends paid, Class B Common Stock, $0.225 per share — — 5 7 — — — — (5) — — — — — — 104 — — 11,680 — — — (1,532) (476) — — — — — — — — — — — — — 11,680 (6,311) (6,311) 5,369 — 111 (1,532) (476) — — — — BALANCE, DECEMBER 31, 2003 3,793 2,163 11,227 91,427 (5,941) (41) 1,100 103,728 Net income Other comprehensive income (loss), net of tax: Unrealized holding losses arising during period, net of $2,741 in taxes Less: reclassification adjustment for gains included in net income, net of $36 in taxes Minimum pension liability adjustment Comprehensive income Conversion of Class B Common Stock to Class A Common Stock, 15,460 shares Stock options exercised, 9,650 shares Cash dividends paid, Class A Common Stock, $0.48 per share Cash dividends paid, Class B Common Stock, $0.24 per share — — — — 16 9 — — — — — — (16) — — — — — — — — 168 — — 8,881 — — — — — (1,642) (505) — — — — — — — — — — — — — — — — — 8,881 (4,164) (4,164) 55 55 (1,757) (1,757) 3,015 — 177 (1,642) (505) — — — — BALANCE, DECEMBER 31, 2004 $ 3,818 $ 2,147 $ 11,395 $ 98,161 $ (5,941) $ (41) $ (4,766) $ 104,773 See accompanying Notes to Consolidated Financial Statements 12 Consolidated Statements of Cash Flows Year Ended December 31, (dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by operating activities: 2004 2003 2002 $ 8,881 $ 11,680 $ 13,504 Provision for loan losses Deferred income taxes Net depreciation and amortization Decrease (increase) in accrued interest receivable Increase in other assets Loans originated for sale Proceeds from sales of loans Gain on sales of loans Loss (gain) on sales of securities available-for-sale Gain on sale of building Increase (decrease) in other liabilities Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from calls/maturities of securities available-for-sale Proceeds from sales of securities available-for-sale Purchase of securities available-for-sale Proceeds from calls/maturities of securities held-to-maturity Purchase of securities held-to-maturity (Decrease) increase in investments purchased payable Net (increase) decrease in loans Proceeds from sale of building Capital expenditures Net cash used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in time deposit accounts Net increase in demand, savings, money market and NOW deposits Net proceeds from the exercise of stock options Cash dividends Net decrease in securities sold under agreements to repurchase Net increase (decrease) in other borrowed funds Increase in subordinated debentures Net cash provided by financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year 300 470 1,848 1,650 (4,368) — — — 91 — 1,699 10,571 389,172 88,198 (390,398) 56,930 (204,309) (29,330) (67,639) — (6,728) (164,104) 199 54,958 177 (2,147) (1,400) 78,577 36,083 166,447 12,914 225,321 450 (1,416) 1,754 920 (6,639) (267) 270 (3) (1) — (6,614) 134 665,635 — (616,783) 125,254 (195,991) (13,739) 2,102 — (10,217) (43,739) 137,292 55,277 112 (2,008) (11,750) (33,091) 889 146,721 103,116 122,205 1,200 (5,690) 1,822 (1,809) (4,318) — 73 (1) — (359) 6,702 11,124 324,502 — (618,946) 63,494 (48,113) 4,093 (50,883) 1,020 (2,854) (327,687) 3,049 254,827 31 (1,871) (21,040) 25,939 — 260,935 (55,628) 177,833 Cash and cash equivalents at end of year $ 238,235 $ 225,321 $ 122,205 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest Income taxes Net unrealized holding (losses) gains arising during period, net of taxes See accompanying Notes to Consolidated Financial Statements $ $ 23,165 4,600 (4,109) $ $ 24,102 15,632 (6,311) $ $ 24,668 8,367 3,993 Notes to Consolidated Financial Statements 13 1. Summary of Significant Accounting Policies BASIS OF FINANCIAL STATEMENT PRESENTATION INVESTMENT SECURITIES The consolidated financial statements include the accounts of Century Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Century Bank and Trust Company (the “Bank”). The consolidated financial state- ments also include the accounts of the Bank’s wholly-owned subsidiaries, Century Subsidiary Investments, Inc. (CSII), Century Subsidiary Investments, Inc. II (CSII II), Century Subsidiary Investments, Inc. III (CSII III) and Century Financial Services Inc. (CFSI). CSII, CSII II, CSII III are engaged in buying, selling and holding investment securities. CFSI has the power to engage in financial agency, securities brokerage and investment and financial advisory services and related securities credit. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost; debt and equity securities that are bought and held principally for the purpose of selling are classified as trading and reported at fair value, with unrealized gains and losses included in earnings; and debt and equity securities not classified as either held-to-maturity or trading are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of estimated related income taxes. The Company has no securities held for trading. The Company also owns 100% of Century Bancorp Capital Trust (CBCT) and CBCT II. The entities are unconsolidated subsidiaries of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company provides a full range of banking services to individual, business and municipal customers in Massachusetts. As a bank holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board. The Bank, a state chartered financial institution, is subject to supervision and regulation by applicable state and federal banking agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation (the “FDIC”) and the Commonwealth of Massachusetts Commissioner of Banks. The Bank is also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy. All aspects of the Company’s business are highly competitive. The Company faces aggressive competition from other lending institutions and from numerous other providers of financial services. The Company has one reportable operating segment. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and to general practices within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are susceptible to change in the near-term relate to the allowance for losses on loans. Management believes that the allowance for losses on loans is adequate based on independent appraisals and review of other factors associated with the assets. While management uses available information to recognize losses on loans, future additions to the allowance for loans may be necessary based on changes in economic conditions. In addition, regulatory agencies periodically review the Company’s allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance for loans based on their judgements about information available to them at the time of their examination. Certain reclassifications were made to prior year amounts to conform with the current year presentation. Premiums and discounts on investment securities are amortized or accreted into income by use of the level-yield method, which approximates the effective method. If a decline in fair value below the amortized cost basis of an investment is judged to be other-than-temporary, the cost basis of the investment is written down to fair value. The amount of the write down is included as a charge to earnings. Gains and losses on the sale of investment securities are recognized at the time of sale on a specific identification basis. LOANS Interest on loans is recognized based on the daily principal amount outstanding. Accrual of interest is discontinued when loans become 90 days delinquent unless the collateral is sufficient to cover both principal and interest and the loan is in the process of collection. Loans, including impaired loans, on which the accrual of interest has been discontinued are designated non-accrual loans. When a loan is placed on non-accrual, all income which has been accrued but remains unpaid is reversed against current period income and all amortization of deferred loan fees is discontinued. Non-accrual loans may be returned to an accrual status when principal and interest payments are not delinquent and the risk characteristics of the loan have improved to the extent that there no longer exists a concern as to the collectibility of principal and income. Income received on non-accrual loans is either recorded in income or applied to the principal balance of the loan depending on management’s evaluation as to the collectibility of principal. Loan origination fees and related direct incremental loan origination costs are offset and the resulting net amount is deferred and amortized over the life of the related loans using the level-yield method. The Bank accounts for impaired loans, except those loans that are accounted for at fair value or at lower of cost or fair value, at the present value of the expected future cash flows discounted at the loan’s effective interest rate. This method applies to all loans, uncollateralized, as well as collateralized, except large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value and leases. Management considers the payment status, net worth and earnings potential of the borrower, and the value and cash flow of the collateral as factors to determine if a loan will be paid in accordance with its contractual terms. Management does not set any minimum delay of payments as a factor in reviewing for impaired classification. Impaired loans are charged-off when management believes that the collectibility of the loan’s principal is remote. In addition, criteria for classification of a loan as in-substance foreclosure has been modified so that such classification need be made only when a lender is in possession of the collateral. The Bank measures the impairment of troubled debt restructurings using the pre-modification rate of interest. 14 Notes to Consolidated Financial Statements ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is based on management’s evaluation of the quality of the loan portfolio and is used to provide for losses resulting from loans which ultimately prove uncollectible. In determining the level of the allowance, periodic evaluations are made of the loan portfolio which take into account such factors as the character of the loans, loan status, financial posture of the borrowers, value of collateral securing the loans and other relevant information sufficient to reach an informed judgement. The allowance is increased by provisions charged to income and reduced by loan charge-offs, net of recoveries. Management maintains an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance is based on assessments of the probable estimated losses inherent in the loan portfolio. Management’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowances for identified problem loans and the unallocated allowance. The formula allowance is calculated by applying loss factors to outstanding loans, in each case based on the internal risk grade of such loans. Changes in risk grades affect the amount of the formula allowance. Loss factors are based on the Company’s historical loss experience, as well as regulatory guidelines. Specific allowances are established in cases where management has identified significant conditions related to a credit that management believes that the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. The unallocated allowance recognizes the model and estimation risk associated with the formula allowance and specific allowances, as well as management’s evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits. While management uses available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. Loans are charged-off in whole or in part when, in management’s opinion, collectibility is not probable. BANK PREMISES AND EQUIPMENT Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the terms of leases, if shorter. It is general practice to charge the cost of maintenance and repairs to operations when incurred; major expenditures for improvements are capitalized and depreciated. STOCK OPTION ACCOUNTING The Company currently accounts for employee stock options using the intrinsic value method. Under the intrinsic value method, no compensation cost is recognized related to options if the exercise price of the option is greater than or equal to the fair market value of the underlying stock on the date of grant. Under an alternative method, the fair value method, the “cost” of the option is estimated on the date of grant using an option valuation model and recognized as compensation expense over the vesting period of the option. Any change from the intrinsic value method to the fair value method of accounting for stock options is required to be applied prospectively for options granted after the date of change in method which must be as of the beginning of a fiscal year. The Company generally awards stock options annually. Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant date, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below: December 31, 2004 2003 2002 (dollars in thousands, except share data) Net income: As reported Less: Pro forma stock based compensation cost (net of tax): Pro forma and diluted Basic earning per share As reported Pro forma Diluted earnings per share As reported Pro forma $ 8,881 $ 11,680 $ 13,504 $ $ $ $ $ $ 151 $ 140 $ 98 8,730 $ 11,540 $ 13,406 1.61 1.58 1.60 1.57 $ $ $ $ 2.12 2.09 2.11 2.08 $ $ $ $ 2.45 2.43 2.44 2.42 In determining the pro forma amounts, the fair value of each option grant was estimated as of the date of grant using Black-Scholes option-pricing model with the following weighted average assumptions: December 31, Dividend yields Expected life Expected volatility Risk-free interest rate INCOME TAXES 2004 2003 2002 1.59)% 1.69)% 1.91)% 9 years 8 years 8 years 28)% 3.95)% 26)% 3.78)% 19)% 5.37)% The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. Under this method, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 2. Cash and Due From Banks The Company is required to maintain a portion of its cash and due from banks as a reserve balance under the Federal Reserve Act. Such reserve is calculated based upon deposit levels and amounted to $725,000 at December 31, 2004 and $650,000 at December 31, 2003. Notes to Consolidated Financial Statements 15 3. Securities Available-for-Sale December 31, 2004 December 31, 2003 Gross Gross Estimated Gross Gross Estimated Amortized Unrealized Unrealized Market Amortized Unrealized Unrealized Cost Gains Losses Value Cost Gains Losses Market Value (dollars in thousands) U.S. Government and Agencies $ 384,504 $ Mortgage-backed securities Obligations of states and political subdivisions FHLB stock Other 187,170 499 13,895 28,661 182 165 — — 174 $ 3,824 $ 380,862 $ 674,766 $ 3,981 $ 2,253 $ 676,494 1,577 185,758 — — 43 499 13,895 28,792 8,977 — 13,084 4,617 209 — — 278 145 — — 179 9,041 — 13,084 4,716 $ 614,729 $ 521 $ 5,444 $ 609,806 $ 701,444 $ 4,468 $ 2,577 $ 703,335 December 31, 2002 Gross Gross Estimated Amortized Unrealized Unrealized Cost Gains Losses Market Value (dollars in thousands) U.S. Government and Agencies $ 701,964 $ 10,631 $ — $ 712,595 Mortgage-backed securities Obligations of states and political subdivisions FHLB stock Other 29,911 907 390 13,084 4,780 — — 52 — — — 188 30,818 390 13,084 4,644 $ 750,129 $ 11,590 $ 188 $ 761,531 During the year ended December 31, 2004 a total of $42,123,000 available-for-sale securities were sold for a gross gain of $692,000. A total of $46,075,000 available-for-sale securities were sold for a gross loss of $783,000. Included in U.S. Government and Agency securities are securities pledged to secure public deposits and repurchase agreements amounting to $42,486,000 at December 31, 2004. Also included are securities pledged for borrowing at the Federal Home Loan Bank amounting to $295,396,000 at December 31, 2004. The following table shows the temporary impaired securities of the Company’s securities available-for-sale portfolio at December 31, 2004. This table shows the unrealized market loss of securities that have been in a continuous unrealized loss position for 12 months or less and a continuous loss position for 12 months and longer. There are 93 and 9 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively out of a total of 176 holdings at December 31, 2004. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2004 (dollars in thousands) U.S. Government and Agencies Mortgage-backed securities Other Less than 12 months 12 months or longer Total Unrealized Unrealized Unrealized Fair Value Losses Fair Value Losses Fair Value Losses $ 238,849 $ 3,064 $ 29,232 $ 760 $ 268,081 $ 3,824 161,567 25,990 1,436 12 4,258 1,519 141 31 165,825 27,509 1,577 43 Total temporarily impaired securities $ 426,406 $ 4,512 $ 35,009 $ 932 $ 461,415 $ 5,444 * The decline in market value is attributable to changes in interest rates and not credit quality and because the Company has the ability and intent to hold these investments until recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004. The following table shows the maturity distribution of the Company’s securities available-for-sale at December 31, 2004 and the weighted average yields of securities, which are based on the amortized cost, calculated on a fully taxable equivalent basis. U.S. Government Mortgage Backed Obligations of States and Political Subdivisions and Agencies Yield Securities Yield and Other Yield Total Yield Estimated Market Value (dollars in thousands) DECEMBER 31, 2004 Within one year $ 69,637 2.39)% $ — 0.00)% $ 25,579 2.27)% $ 95,216 2.35)% $ 95,154 After one but within five years After five but within ten years Non-maturing 299,869 14,998 — 2.85) 4.18) 0.00 187,170 — — 4.09) 0.00) 0.00) 700 — 16,776 4.04) 0.00) 2.95 487,739 14,998 16,776 3.33) 4.18) 2.95) 482,688 15,057 16,907 $ 384,504 2.82)% $ 187,170 4.09)% $ 43,055 2.56)% $ 614,729 3.19)% $ 609,806 16 Notes to Consolidated Financial Statements The weighted average remaining life of investment securities available-for- sale at December 31, 2004, 2003 and 2002 was 2.7, 3.5 and 2.9 years, respectively. Included in the weighted average remaining life calculation at December 31, 2004 and 2003, there were 134.1 million and 545.8 million, respectively of U.S. agency obligations that are callable at the discretion of the issuer. These call dates were not utilized in computing the weighted average remaining life. 4. Investment Securities Held-to-Maturity December 31, 2004 December 31, 2003 Gross Gross Estimated Gross Gross Estimated Amortized Unrealized Unrealized Market Amortized Unrealized Unrealized Cost Gains Losses Value Cost Gains Losses Market Value (dollars in thousands) U.S. Government and Agencies $ 186,324 $ Mortgage-backed securities Other 159,045 — 175 589 — $ 1,609 $ 184,890 $ 6,400 $ 278 $ — $ 6,678 1,125 158,509 — — 191,447 25 1,548 — 908 — 192,087 25 $ 345,369 $ 764 $ 2,734 $ 343,399 $ 197,872 $ 1,826 $ 908 $ 198,790 December 31, 2002 Gross Gross Estimated Amortized Unrealized Unrealized Cost Gains Losses Market Value (dollars in thousands) U.S. Government and Agencies $ Mortgage-backed securities Other 76,430 50,754 25 $ 1,442 1,363 — $ 127,209 $ 2,805 $ $ — $ — — 77,872 52,117 25 — $ 130,014 Included in U.S. Government and Agency securities are securities pledged to secure public deposits amounting to $6,000,000 at December 31, 2004. Also included are securities pledged for borrowing at the Federal Home Loan Bank amounting to $165,445,000 at December 31, 2004. The following table shows the temporary impaired securities of the Company’s securities held-to-maturity portfolio at December 31, 2004. This table shows the unrealized market loss of securities that have been in a continuous unrealized loss position for 12 months or less and a continuous loss position for 12 months and longer. There are 50 and 5 securities temporarily impaired for less than 12 months and for 12 months or longer, respectively out of a total of 98 holdings at December 31, 2004. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2004 (dollars in thousands) U.S. Government and Agencies Mortgage-backed securities Less than 12 months 12 months or longer Total Unrealized Unrealized Unrealized Fair Value Losses Fair Value Losses Fair Value Losses $ 133,367 $ 1,609 $ — $ — $ 133,367 $ 1,609 74,165 673 15,678 452 89,843 1,125 Total temporarily impaired securities $ 207,532 $ 2,282 $ 15,678 $ 452 $ 223,210 $ 2,734 * The decline in market value is attributable to changes in interest rates and not credit quality and because the Company has the ability and intent to hold these investments until recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004. Notes to Consolidated Financial Statements 17 The following table shows the maturity distribution of the Company’s securities held-to-maturity at December 31, 2004 and the weighted average yields of securities, which are based on the amortized cost, calculated on a fully taxable equivalent basis. (dollars in thousands) DECEMBER 31, 2004 Within one year After one but within five years U.S. Government and Agencies Yield Mortgage Backed Securities Yield Total Yield Estimated Market Value $ 6,400 179,924 5.02)% 3.39) $ — 159,045 0.00)% 4.18) $ 6,400 338,969 5.13)% $ 6,439 3.76) 336,960 $ 186,324 3.45)% $ 159,045 4.18)% $ 345,369 3.79)% $ 343,399 The weighted average remaining life of investment securities held-to- maturity at December 31, 2004, 2003 and 2002 was 3.3, 3.5 and 3.2 years, respectively. Included in the weighted average remaining life calculation at December 31, 2004 and 2003, were $139.9 and $0 million, respectively of U.S. agency obligations that are callable at the discretion of the issuer. These call dates were not utilized in computing the weighted average remaining life. 5. Loans The Company's lending activities are conducted principally in Massachusetts. The Company grants single and multi-family residential loans, commercial and commercial real estate loans, and a variety of consumer loans. To a lesser extent, the Company grants loans for the construction of residential homes, multi-family properties, commercial real estate properties and land development. Most loans granted by the Company are secured by real estate collateral. The ability and willingness of commercial real estate, commercial, construction, residential and consumer loan borrowers to honor their repayment commitments is generally dependent on the health of the real estate market in the borrowers' geographic areas and the general economy. The following summary shows the composition of the loan portfolio at the dates indicated. December 31, 2004 2003 2002 2001 2000 Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Construction and land development $ 51,918 9.0)% $ 34,121 6.7)% $ 33,155 6.4)% $ 39,256 8.5)% $ 21,840 5.0)% Commercial and industrial Industrial revenue bonds Commercial real estate Residential real estate Consumer Home equity Overdrafts 71,962 12.4) — 258,524 118,223 8,607 69,957 812 0.0) 44.6) 20.4) 1.5) 12.0) 0.1) 39,742 — 293,781 86,780 8,025 49,382 483 7.8) 0.0) 57.3) 16.9) 1.6) 9.6) 0.1) 46,044 — 291,598 92,291 8,169 41,527 1,465 9.0) 0.0) 56.7) 17.9) 1.6) 8.1) 0.3) 59,162 48 241,419 88,450 7,701 26,016 720 12.8) 0.0) 52.2) 19.1) 1.7) 5.6) 0.1) 95,957 119 209,233 81,526 9,226 21,107 555 21.8) 0.0) 47.7) 18.5) 2.1) 4.8) 0.1) $ 580,003 100.0)% $ 512,314 100.0)% $ 514,249 100.0)% $ 462,772 100.0)% $ 439,563 100.0)% At December 31, 2004, 2003, 2002, 2001 and 2000 loans were carried net of discounts of $20,000, $138,000, $492,000, $969,000 and $1,446,000, respectively. Included in these amounts at December 31, 2004, 2003, 2002, 2001 and 2000, residential real estate loans were carried net of discounts of $16,000, $133,000, $487,000, $959,000 and $1,431,000, respectively, associated with the acquisition of loans from another financial institution. 18 Notes to Consolidated Financial Statements The following table summarizes the remaining maturity distribution of certain components of the Company’s loan portfolio on December 31, 2004. The table excludes loans secured by one-to-four family residential real estate and loans for household family and other personal expenditures. Maturities are presented as if scheduled principal amortization payments are due on the last contractual payment date. Remaining Maturities of Selected Loans at December 31, 2004 One Year One to Five Over or Less Years Five Years Total (dollars in thousands) Construction and land development $ 20,606 $ 20,609 $ 10,703 $ 51,918 Commercial and industrial Commercial real estate 39,901 22,066 23,593 8,468 71,962 106,654 129,804 258,524 Total $ 82,573 $ 150,856 $ 148,975 $ 382,404 The following table indicates the rate variability of the above loans due after one year. December 31, 2004 (dollars in thousands) One to Five Over Years Five Years Total Predetermined interest rates $ 92,610 $ 22,569 $ 115,179 Floating or adjustable interest rates 58,246 126,406 184,652 Total $ 150,856 $ 148,975 $ 299,831 The Company’s commercial and industrial (C&I) loan customers represent various small and middle-market established businesses and institutions involved in manufacturing, distribution, retailing and services. Most clients are privately owned with markets that range from local to national in scope. Many of the loans to this segment are secured by liens on corporate assets and the personal guarantees of the principals. The Bank has placed greater emphasis on building its C&I base in the future. The regional economic strength or weakness impacts the relative risks in this loan category. There is little concentration to any one business sector and loan risks are generally diversified among many borrowers. Commercial real estate loans are extended to finance various manufacturing, warehouse, light industrial, office, retail, residential properties and properties of non-profit organizations in the Bank’s market area, which generally includes Eastern Massachusetts, Rhode Island and Southern New Hampshire. Loans are normally extended in amounts up to a maximum of 80% of appraised value and normally for terms between three to five years. Amortization schedules are long-term and thus a balloon payment is due at maturity. Under most circumstances, the Bank will offer to re-write or otherwise extend the loan at prevailing interest rates. During recent years, the Bank has emphasized non-residential type owner-occupied properties. This compliments our C&I emphasis placed on the operating business entities and will be continued. The regional economic environment affects the risk of both non-residential and residential mortgages. Residential real estate (1-4 family) includes two categories of loans. Approximately $6,542,000 of loans are classified as “Commercial and Industrial” type loans secured by 1-4 family real estate. Primarily, these are small businesses with modest capital or shorter operating histories where the collateral mitigates some risk. This category of loans shares similar risk characteristics with the C&I loans, notwithstanding the collateral position. The other category of residential real estate loans are mostly 1-4 family residential properties located in the Bank’s market area. General underwriting criteria are largely the same as those used by Fannie Mae but normally only one or three year adjustable interest rates are used. The Bank utilizes mortgage insurance to provide lower down payment products and has provided a “First Time Homebuyer” product to encourage new home ownership. Residential real estate loan volume has increased and remains a core consumer product. The economic environment impacts the risks associated with this category. This year, the economy has deteriorated, and the market has generally been volatile. Home equity loans are extended as both first and second mortgages on owner occupied residential properties in the Bank’s market area. Loans are underwritten to a maximum loan to property value of 80%. The Bank intends to maintain a market for construction loans, principally for smaller local residential projects or an owner-occupied commercial project. Individual consumer residential home construction loans are also extended on a similar basis. Bank officers evaluate the feasibility of construction projects, based on independent appraisals of the project, architects or engineers evaluations of the cost of construction and other relevant data. As of December 31, 2004, the Company was obligated to advance a total of $33,754,000 to complete projects under construction. The composition of non-accrual loans, impaired loans & troubled debt restructuring agreements is as follows: 2004 2003 2002 2001 2000 Notes to Consolidated Financial Statements 19 (dollars in thousands) Loans on non-accrual Impaired loans on non-accrual included above Total recorded investment in impaired loans Average recorded value of impaired loans Loans 90 days past due and still accruing Interest income on non-accrual loans according to their original terms Interest income on non-accrual loans actually recorded Interest income recognized on impaired loans The composition of impaired loans at December 31, is as follows: Residential real estate: 1-4 family Multi-family Commercial real estate Commercial and industrial Total Specific valuation allowance Total impaired loans $ $ $ $ $ $ $ $ $ 628 452 964 $ $ 1,156 160 66 — 105 $ 1,175 $ 1,137 $ 1,678 $ 2,043 $ $ $ $ — 100 70 116 $ $ 511 487 $ 1,116 $ 1,273 $ $ $ $ — 50 — 60 2004 2003 2002 — 512 — 452 964 — 964 $ 60 541 — 1,077 $ 1,678 — $ 1,678 $ — 629 487 — $ 1,116 — $ 1,116 $ $ 423 292 $ 1,118 $ 2,149 $ $ $ $ $ 9 43 32 116 2001 29 656 433 — $ $ 110 41 $ 1,535 $ 2,919 $ $ $ $ $ 19 19 9 160 2000 41 681 782 31 $ 1,118 — $ 1,118 $ 1,535 — $ 1,535 There were no impaired loans with specific reserves from December 31, 2000 through December 31, 2004, and in the opinion of management, none of the above listed impaired loans required a specific reserve. All of the impaired loans listed above have been measured using the fair value of the collateral method. The Company was servicing mortgage loans sold to others without recourse of approximately $1,538,000, $2,397,000, $4,444,000, $6,888,000 and $10,199,000 at December 31, 2004, 2003, 2002, 2001 and 2000, respectively. Additionally, the Company was servicing mortgage loans sold to others with limited recourse. The outstanding balance of these loans with limited recourse was approximately $86,000, $183,000, $194,000, $338,000 and $479,000 at December 31, 2004, 2003, 2002, 2001 and 2000, respectively. Directors and officers of the Company and their associates are customers of, and have other transactions with, the Company in the normal course of business. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risk of collection or present other unfavorable features. The following table shows the aggregate amount of loans to directors and officers of the Company and their associates during 2004. Balance at Repayments Balance at December 31, 2003 Additions and Deletions December 31, 2004 (dollars in thousands) $ 1,527 $ 433 $ 478 $ 1,482 Loans are placed on non-accrual status when any payment of principal and/or interest is 90 days or more past due, unless the collateral is sufficient to cover both principal and interest and the loan is in the process of collection. The Company monitors closely the performance of its loan portfolio. In addition to internal loan review, the Company has contracted with an independent organization to review the Company’s commercial and commercial real estate loan portfolios. This independent review was performed in each of the past five years. The status of delinquent loans, as well as situations identified as potential problems, are reviewed on a regular basis by senior management and monthly by the Board of Directors of the Company. The relatively low level of nonperforming assets of $628,000 in 2004 and $1,175,000 in 2003 resulted from fewer additions to nonperforming assets during the year combined with an improvement in the resolution of nonperforming assets including payments on nonperforming loans. In addition to the above, as of December 31, 2004, the Company continues to monitor closely $7,883,000 of loans for which management has concerns regarding the ability of the borrowers to perform. The majority of the loans are secured by real estate and are considered to have adequate collateral value to cover the loan balances at December 31, 2004, although such values can fluctuate with changes in the economy and the real estate market. Included in residential real estate loans are loans pledged for borrowing at the Federal Home Loan Bank amounting to $107,957,000. 20 Notes to Consolidated Financial Statements 6. Allowance for Loan Losses The Company maintains an allowance for loan losses in an amount determined by management on the basis of the character of the loans, loan performance, the financial condition of borrowers, the value of collateral securing loans and other relevant factors. The following table summarizes the changes in the Company's allowance for loan losses for the years indicated. Year Ended December 31, (dollars in thousands) Year-end loans outstanding (net of unearned discount) Average loans outstanding (net of unearned discount) Balance of allowance for loan losses at beginning of year Loans charged-off: Commercial Commercial real estate Residential real estate Consumer Total loans charged-off: Recovery of loans previously charged-off: Commercial Real estate Consumer Total recoveries of loans previously charged-off: Net loan charge-offs (recoveries) Additions to allowance charged to operating expense Balance at end of year Ratio of net charge-offs during the year to average loans outstanding Ratio of allowance for loan losses to loans outstanding 2004 2003 2002 2001 2000 $ 580,003 $ 512,314 $ 514,249 $ 462,772 $ 439,563 $ 546,147 $ 500,723 $ 488,465 $ 443,395 $ 434,780 $ 8,769 $ 8,506 $ 7,112 $ 5,662 $ 7,646 1 — 194 113 308 117 103 20 240 68 300 240 — — 125 365 127 29 22 178 187 450 — 58 — 87 145 276 — 63 339 27 343 12 55 437 154 184 49 387 (194) 1,200 50 1,500 3,522 — — 139 3,661 26 195 31 252 3,409 1,425 $ 9,001 $ 8,769 $ 8,506 $ 7,112 $ 5,662 0.01)% 0.04)% (0.04)% 0.01)% 0.78)% 1.55)% 1.71)% 1.65)% 1.54)% 1.29)% These provisions are the result of management's evaluation of the quality of the loan portfolio considering such factors as loan status, collateral values, financial condition of the borrower, the state of the economy and other relevant information. The pace of the charge-offs depends on many factors including the national and regional economy. Cyclical lagging factors may result in charge-offs being higher than historical levels. The allowance for loan losses is an estimate of the amount needed for an adequate reserve to absorb losses in the existing loan portfolio. This amount is determined by an evaluation of the loan portfolio including input from an independent organization engaged to review selected larger loans, a review of loan loss experience and current economic conditions. The unallocated reserve was allocated proportionately among the listed loan categories. At December 31 of each year listed below, the allowance was allocated as follows: 2004 2003 2002 2001 2000 Percent of loans in each category to total loans Amount Percent of loans in each category to total loans Amount (dollars in thousands) Construction and land development $ 988 9.0% $ 701 Commercial and industrial Commercial real estate Residential real estate Consumer and other Home equity 1,480 12.4% 4,518 44.6% 1,045 20.4% 177 1.6% 793 12.0% 1,048 5,364 904 165 587 6.7% 7.8% 57.3% 16.9% 1.7% 9.6% Percent of loans in each category to total loans 6.4% 9.0% 56.7% 17.9% 1.9% 8.1% Amount $ 497 1,106 4,941 1,160 210 592 Percent of loans in each category to total loans 8.5% 12.8% 52.2% 19.1% 1.8% 5.6% Amount $ 605 1,257 3,786 955 173 336 Percent of loans in each category to total loans 5.0% 21.8% 47.6% 18.5% 2.3% 4.8% Amount $ 285 1,200 1,923 726 1,298 230 $ 9,001 100.0% $ 8,769 100.0% $ 8,506 100.0% $ 7,112 100.0% $ 5,662 100.0% Notes to Consolidated Financial Statements 21 7. Bank Premises and Equipment December 31, (dollars in thousands) Land Bank premises Construction in progress (note 14) Furniture and equipment Leasehold improvements Accumulated depreciation and amortization 2004 2003 2002 Estimated Useful Life $ 3,650 6,198 11,766 19,740 5,083 46,437 (20,172) $ 3,650 6,198 7,506 17,969 4,446 39,769 (18,180) $ 3,607 6,198 — 16,377 3,483 29,665 (16,737) $ 26,265 $ 21,589 $ 12,928 — 30-39 years 3-10 years 30-39 years or lease term The Company and its subsidiaries are obligated under a number of noncancelable operating leases for premises and equipment expiring in various years through 2026. Total lease expense approximated $1,084,000, $886,000 and $711,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Future minimum rental commitments for noncancelable operating leases with initial or remaining terms of one year or more at December 31, 2004 were as follows: (dollars in thousands) Year Amount 2005 2006 2007 2008 2009 Thereafter $ 1,088 982 970 900 701 1,551 $ 6,192 8. Deposits The Company offers savings accounts, NOW accounts, demand deposits, time deposits and money market accounts. The Company offers cash management accounts which provide either automatic transfer of funds above a specified level from the customer’s checking account to a money market account or short-term borrowings. Also, an account reconciliation service is offered, whereby the Company provides a computerized report balancing the customer’s checking account. Interest rates on deposits are set bi-monthly by the Bank’s rate-setting committee, based on factors including loan demand, maturities and a review of competing interest rates offered. Interest rate policies are reviewed periodically by the Executive Management Committee. Time Deposits as of December 31, are as follows: (dollars in thousands) Three months or less Three months through twelve months Over twelve months 2004 2003 2002 $ 206,518 72,382 80,916 $ 359,816 $ 207,180 85,651 66,786 $ 359,617 $ 82,741 66,096 73,488 $ 222,325 22 Notes to Consolidated Financial Statements Time Deposits of $100,000 or more as of December 31, are as follows: (dollars in thousands) Three months or less Three months through twelve months Over twelve months 2004 2003 2002 $ 169,423 23,442 20,428 $ 213,293 $ 165,198 10,855 3,759 $ 179,812 $ 43,261 7,933 1,079 $ 52,273 9. Securities Sold Under Agreements to Repurchase (dollars in thousands) Amount outstanding at December 31, Weighted average rate at December 31, Maximum amount outstanding at any month end Daily average balance outstanding during the year Weighted average rate during the year 2004 2003 2002 $ 38,650 $ 40,050 $ 51,800 0.97)% 0.77)% 1.00)% $ 49,700 $ 40,937 $ 58,830 $ 51,402 $ 69,190 $ 61,718 0.81)% 0.89)% 1.13)% Amounts outstanding at December 31, 2004, 2003 and 2002 carried maturity dates of the next business day. U.S. Government and Agency securities with a total book value of $39,460,000, $40,560,000 and $51,176,000 were pledged as collateral and held by custodians to secure the agreements at December 31, 2004, 2003 and 2002, respectively. The approximate market value of the collateral at those dates was $38,989,000, $40,638,000 and $51,994,000, respectively. 10. Other Borrowed Funds and Subordinated Debentures (dollars in thousands) Amount outstanding at December 31, Weighted average rate at December 31, Maximum amount outstanding at any month end Daily average balance outstanding during the year Weighted average rate during the year FEDERAL HOME LOAN BANK BORROWINGS 2004 2003 2002 $ 280,628 $ 165,968 $ 198,170 4.62)% 4.86)% 4.97)% $ 280,628 $ 194,932 $ 233,600 $ 170,344 $ 199,163 $ 186,531 4.72)% 5.01)% 4.97)% Federal Home Loan Bank (“FHLB”) borrowings are collateralized by a blanket pledge agreement on the Bank’s FHLB stock, certain qualified investment securities, deposits at the Federal Home Loan Bank and residential mortgages held in the Bank’s portfolio. The Bank’s borrowing capacity at the Federal Home Loan Bank was approximately $230,100,000 at December 31, 2004. In addition, the Bank has a $14,500,000 line of credit with the FHLB. A schedule of the maturity distribution of FHLB advances with the weighted average interest rates is as follows: December 31, 2004 2003 2002 (dollars in thousands) Within 1 year Over 1 year to 2 years Over 2 years to 3 years Over 3 years to 5 years Over 5 years Total Weighted Average Amount Rate Amount $ 105,000 1,120 — 51,500 55,500 2.22)% 7.20 0.00 5.25 5.32 $ 35,000 — 1,178 19,500 78,500 $ 213,120 3.79)% $ 134,178 Weighted Average Rate 1.55)% 0.00 7.20 5.38 5.40 4.41)% Weighted Average Rate 2.65)% 0.00 0.00 7.20 5.45 4.28)% Amount $ 70,000 — — 1,233 95,000 $ 166,233 Notes to Consolidated Financial Statements 23 SUBORDINATED DEBENTURES OTHER BORROWED FUNDS In December 2004, the Company consummated the sale of a trust preferred securities offering, in which it issued $36,083,000 of subordinated debt securities due 2034 to its newly formed unconsolidated subsidiary Century Bancorp Capital Trust II. The Bank serves as a Treasury Tax and Loan depository under a note option with the Federal Reserve Bank of Boston. This open-ended interest bearing borrowing carries an interest rate equal to the daily Federal funds rate less 0.25%. This amount totaled $1,638,000 at December 31, 2004. The Bank also has an outstanding loan in the amount of $148,000 borrowed against the cash value of a whole life insurance policy for a key executive of the Bank. Century Bancorp Capital Trust II then issued 35,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $1,000 per share. These securities pay dividends at an annualized rate of 6.65% for the first ten years and then convert to the three-month LIBOR rate plus 1.87% for the remaining twenty years. The total amount of this issuance was $36,083,000. The Company is using the proceeds primarily for general business purposes. Also, the Company, through its subsidiary, Century Bancorp Capital Trust, announced the redemption of their 8.30% Trust Preferred Securities, with a redemption date of January 10, 2005. The total amount of this redemption is $29,639,000. 11. Stockholders’ Equity DIVIDENDS STOCK OPTION PLAN Holders of the Class A common stock may not vote in the election of directors, but may vote as a class to approve certain extraordinary corporate transactions. Holders of Class B may vote in the election of directors. Class A common stockholders are entitled to receive dividends per share equal to at least 200% per share of that paid, if any, on each share of Class B common stock. Class A common stock is publicly traded. Class B common stock is not publicly traded, however, it can be converted on a share for share basis to Class A common stock at any time at the option of the holder. Dividend payments by the Company are dependent in part on the dividends it receives from the Bank, which are subject to certain regulatory restrictions. EARNINGS PER SHARE (EPS) Diluted EPS includes the dilutive effect of common stock equivalents; basic EPS excludes all common stock equivalents. The only common stock equivalents for the Company are the stock options discussed below. The dilutive effect of these stock options for 2004, 2003 and 2002 was an increase of 26,995, 28,815 and 17,469 shares, respectively. During 2000 and 2004, common stockholders of the Company approved stock option plans (the “Option Plans”) that provides for granting of options for not more than 150,000 shares of Class A common stock per plan. Under the Option Plans, all officers and key employees of the Company are eligible to receive non-qualified and incentive stock options to purchase shares of Class A common stock. The Option Plans are administered by the Compensation Committee of the Board of Directors, whose members are ineligible to participate in the Option Plans. Based on management’s recommendations, the Committee submits its recommendations to the Board of Directors as to persons to whom options are to be granted, the number of shares granted to each, the option price (which may not be less than 85% of the fair market value for non-qualified stock options, or the fair market value for incentive stock options, of the shares on the date of grant) and the time period over which the options are exercisable (not more than ten years from the date of grant). There were 67,486 options exercisable at December 31, 2004. Stock option activity under the plan is as follows: Shares under option: Outstanding at beginning of year Granted Cancelled Exercised Outstanding at end of year Exercisable at end of year Available to be granted at end of year Weighted average fair value of options granted during the year December 31, 2004 December 31, 2003 December 31, 2002 Weighted Average Exercise Price $ 22.84 32.64 26.68 18.31 Amount 95,062 47,050 (675) (9,650) 131,787 $ 26.65 67,486 $ 22.22 149,475 $ 10.69 Weighted Average Exercise Price $ 19.52 27.58 15.49 15.93 $ 22.84 $ 18.65 Amount 67,000 35,750 (675) (7,013) 95,062 42,399 45,850 Weighted Average Exercise Price $ 15.56 23.29 15.063 15.063 $ 19.52 $ 15.63 Amount 36,500 34,075 (1,500) (2,075) 67,000 15,900 79,425 $ 6.84 $ 5.99 24 Notes to Consolidated Financial Statements At December 31, 2004, the 131,787 options outstanding have exercise prices between $15.063 and $35.010, with a weighted average exercise price at $26.65 and a weighted average remaining contractual life of 7 years. The Bank is subject to various regulatory requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional, discretionary actions by regulators that, if undertaken, could have a direct material affect on the Company's financial statements. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk weighted assets (as defined) and Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2004, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2004, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier risk-based, and Tier 1 leverage ratios as set forth in the table. There is no conditions or events since that notification that management believes would cause a change in the Bank's categorization. The Bank’s actual capital amounts and ratios are presented in the following table. As of December 31, 2004 Total capital (to risk-weighted assets) Tier 1 capital (to risk-weighted assets) Tier 1 capital (to 4th Qtr. average assets) As of December 31, 2003 Total capital (to risk-weighted assets) Tier 1 capital (to risk-weighted assets) Tier 1 capital (to 4th Qtr. average assets) Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio $ 116,698 107,697 107,697 13.47% 12.43 6.54 $ 69,312 34,656 65,835 8.00% 4.00% 4.00% $ 86,640 51,984 82,294 10.00% 6.00% 5.00% $ 113,236 104,467 104,467 15.26% 14.08% 6.70% $ 59,362 29,681 62,353 8.00% 4.00% 4.00% $ 74,203 44,522 77,942 10.00% 6.00% 5.00% 12. Income Taxes The current and deferred components of income tax expense for the years ended December 31 are as follows: 2004 2003 2002 (dollars in thousands) Current expense: Federal State Total current expense Deferred expense (benefit): Federal State Total deferred expense (benefit) $ 4,277 227 4,504 427 43 470 $ 5,783 4,596 10,379 102 (1,518) (1,416) $ 12,936 633 13,569 (5,617) (73) (5,690) Provision for income taxes $ 4,974 $ 8,963 $ 7,879 Notes to Consolidated Financial Statements 25 Income tax accounts included in other assets and other liabilities at December 31 are as follows: (dollars in thousands) Currently receivable (payable) Deferred income tax asset, net 2004 2003 $ 474 8,518 $ 8,992 $ 377 5,019 $ 5,396 Income tax expense for the years presented is different from the amounts computed by applying the statutory Federal income tax rate of 35% for 2004, 2003 and 2002 to income before Federal income taxes. The following tabulation reconciles Federal income tax expense based on statutory rates to the actual income tax expense for the years ended December 31: (dollars in thousands) Federal income tax expense at statutory rates State income taxes, net of federal income tax benefit Effect of tax-exempt interest Other 2004 2003 2002 $ 4,849 176 — (51) $ 4,974 $ 7,225 2,001 (1) (262) $ 8,963 $ 7,484 364 (10) 41 $ 7,879 Effective tax rate 35.9)% 43.4)% 36.8)% The following table sets forth the Company’s gross deferred income tax assets and gross deferred income tax liabilities at December 31: 2004 2003 (dollars in thousands) Deferred income tax assets: Allowance for loan losses Deferred compensation Unrealized loss on securities available-for-sale Unrecognized SERP liability Acquisition premium Investments writedown Deferred gain Other Gross deferred income tax asset Deferred income tax liabilities: Unrealized gain on securities available-for-sale Accrued dividends Depreciation Limited partnerships Other Gross deferred income tax liability Deferred income tax asset net $ 3,765 3,855 $ 3,668 3,431 1,914 1,264 721 33 176 8 — — 648 61 197 48 11,736 8,053 — (41) (1,277) (1,836) (64) (3,218) 8,518 (791) — (562) (1,611) (70) (3,034) 5,019 During 2003, the Company incurred a net tax charge of $1,183,000 associated with the Real Estate Investment Trust (“REIT”) settlement. This charge was the result of an agreement with the Massachusetts Department of Revenue (“DOR”) settling a dispute related to taxes that the DOR claimed were owed from the Company’s REIT. The Company believes that the net deferred tax asset will be realized in the years in which the temporary differences are expected to be recovered or settled. 13. Employee Benefits The Company has a qualified Defined Benefit Pension Plan (the "Plan"), which is offered to all employees reaching minimum age and service requirements. An increase in the size of the work force and increased compensation expense in 2004 resulted in an increase in pension cost. The measurement date for the Plan is September 30 for each year. The benefits expected to be paid in each year from 2005-2009 are $316,000, $329,000, $379,000, $493,000 and $530,000. The aggregate benefits expected to be paid in the five years from 2010-2014 are $3,200,000. The Company plans to contribute $1,232,000 to the Plan in 2005. The weighted-average asset allocation of pension benefit assets at September 30, were: Asset Category Debt securities Equity securities Other 2004 66)% 15)% 19)% 2003 80)% 16)% 4)% The Company has a Supplemental Insurance/Retirement Plan (the Supplemental Plan), which is limited to certain officers and employees of the Company. The Supplemental Plan is voluntary and participants are required to contribute to its cost. Under the Supplemental Plan, each participant will receive a retirement benefit based on compensation and length of service. Individual life insurance policies, which are owned by the Company, are purchased covering the lives of each participant. Increased compensation expense resulted in increased cost for the Supplemental Plan. The measurement date for the Supplemental Plan is September 30 for each year. The benefits expected to be paid in each year from 2005-2009 are $285,000, $337,000, $336,000, $340,000 and $423,000. The aggregate benefits expected to be paid in the five years from 2010-2014 are $2,600,000. 26 Notes to Consolidated Financial Statements (dollars in thousands) Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Plan Amendment Actuarial (gain)/loss Benefits paid Defined Benefit Pension Plan Retirement Plan Supplemental Insurance / 2004 2003 2004 2003 $ 13,353 714 868 — (628) (231) $ 12,634 692 821 (1,719) 1,131 (206) $ 13,368 12 869 — (2,331) (61) $ 12,467 100 811 968 (962) (16) Benefit obligation at end of year $ 14,076 $ 13,353 $ 11,857 $ 13,368 Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Benefits paid Fair value of plan assets at end of year Funded status Unrecognized prior service cost Unrecognized net actuarial loss Accrued benefit cost $ 9,285 224 1,525 (231) $ 7,783 438 1,270 (206) $ 10,803 $ 9,285 $ (3,273) 1,441 (4,216) $ (4,068) 1,446 (4,696) $ (11,857) (1,155) (1,437) $ (13,368) (1,219) (3,941) $ (498) $ (818) $ (9,265) $ (8,208) Accumulated benefit obligation $ 13,037 $ 11,876 $ 11,151 $ 10,101 Weighted average assumptions as of December 31: Discount rate Expected return on plan assets Rate of compensation increase Components of net periodic benefit cost: Service cost Interest cost Expected return on plan assets Recognized prior service cost Recognized net losses Net periodic cost 6.50)% 8.00)% 4.00)% $ $ 714 868 (597) (4) 224 6.50)% 8.00)% 4.00)% 692 821 (614) 110 153 6.50)% N/A 4.00)% $ $ 12 869 — 64 174 6.50)% N/A 4.00)% 100 811 — (1) 261 $ 1,205 $ 1,162 $ 1,119 $ 1,171 The Company offers a 401(k) defined contribution plan for all employees reaching minimum age and service requirements. The plan is voluntary and employee contributions are matched by the Company at a rate of 33.3% for the first 6% of compensation contributed by each employee. The Company's match totaled $210,900 for 2004, $218,100 for 2003 and $202,500 for 2002. Administrative costs associated with the plan are absorbed by the Company. The Company does not offer any post retirement programs other than pensions. 14. Commitments and Contingencies A number of legal claims against the Company arising in the normal course of business were outstanding at December 31, 2004. Management, after reviewing these claims with legal counsel, is of the opinion that their resolution will not have a material adverse affect on the Company’s consolidated financial position or results of operation. During February 2003, the Company began construction of an addition to its corporate headquarters building. The property is located adjacent to its current headquarters in Medford, Massachusetts and will provide additional corporate office space and an expanded branch banking floor. The building is scheduled to be completed during the first quarter of 2005 and the current cost estimate, including land costs, is $14.5 million. As of December 31, 2004, $13.6 million has been expended, this includes land costs of $1.8 million. The capital expenditure will provide a five-story addition containing approximately 50 thousand square feet of office and branch banking space. Notes to Consolidated Financial Statements 27 15. Financial Instruments With Off-Balance Sheet Risk 16. Other Operating Expenses The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments primarily include commitments to originate and sell loans, standby letters of credit, unused lines of credit and unadvanced portions of construction loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notational amounts of those instruments reflect the extent of involvement the Company has in these particular classes of financial instruments. The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument for loan commitments, standby letters of credit and unadvanced portions of construction loans is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Financial instruments with off-balance sheet risk at December 31 are as follows: Contract or Notational Amount 2004 2003 (dollars in thousands) Financial instruments whose contract amount represents credit risk: Commitments to originate 1-4 family mortgages $ Standby letters of credit Unused lines of credit Unadvanced portions of construction loans 2,511 11,195 128,915 33,754 $ 600 4,914 126,825 15,414 Commitments to originate loans, unadvanced portions of construction loans and unused letters of credit are generally agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the borrower. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Year ended December 31, 2004 2003 2002 (dollars in thousands) Marketing Processing services Supplies Telephone Postage and delivery Legal and audit Consulting Software maintenance/amortization Insurance Director’s fees FDIC assessment Core deposit tangible amortization Capital expense amortization Other $ 1,403 1,379 728 583 826 812 316 653 316 258 198 388 — 1,160 $ 1,265 1,292 775 511 735 478 316 743 248 270 208 320 137 860 $ 1,440 1,215 664 434 690 683 399 723 205 192 163 167 311 659 $ 9,020 $ 8,158 $ 7,945 17. Fair Values of Financial Instruments The following methods and assumptions were used by the Company in estimating fair values of its financial instruments. Excluded from this disclosure are certain financial instruments for which it is not practical to estimate their value and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. CASH AND CASH EQUIVALENTS: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate the fair values of these assets because of the short-term nature of these financial instruments. SECURITIES HELD-TO-MATURITY AND SECURITIES AVAILABLE-FOR-SALE: The fair value of these securities, excluding certain state and municipal securities whose fair value is estimated at book value because they are not readily marketable, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. LOANS: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair value of other loans is estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Incremental credit risk for non-performing loans has been considered. 28 Notes to Consolidated Financial Statements ACCRUED INTEREST RECEIVABLE AND PAYABLE: The carrying amounts for accrued interest receivable and payable approximate fair values because of the short-term nature of these financial instruments. DEPOSITS: The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is based on the discounted value of contractual cash flows, applying interest rates currently being offered on the deposit products of similar maturities. The fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of alternative forms of funding (“deposit base intangibles”). REPURCHASE AGREEMENTS AND OTHER BORROWED FUNDS: The fair value of repurchase agreements and other borrowed funds is based on the discounted value of contractual cash flows. The discount rate used is estimated based on the rates currently offered for other borrowed funds of similar remaining maturities. SUBORDINATED DEBENTURES: The fair value of subordinated debentures is based on the discounted value of contractual cash flows. The discount rate used is estimated based on the rates currently for other subordinated debentures of similar remaining maturities. OFF-BALANCE SHEET INSTRUMENTS: The fair values of the Company’s unused lines of credit and unadvanced portions of construction loans, commitments to originate and sell loans and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The carrying amounts and fair values of the Company’s financial instruments at December 31 are as follows: 2004 Carrying Amounts Fair Value 2003 Carrying Amounts Fair Value $ 238,235 $ 609,806 345,369 571,002 6,800 238,235 609,806 343,399 565,539 6,800 $ 225,321 703,335 197,872 503,545 8,450 $ 225,321 703,335 198,790 506,232 8,450 1,394,010 1,397,901 1,338,853 1,346,713 253,556 65,722 2,305 255,036 65,801 2,305 176,379 29,639 1,016 176,557 30,469 1,016 — 136 — 100 (dollars in thousands) Financial assets: Cash and cash equivalents Securities available-for-sale Securities held-to-maturity Net loans Accrued interest receivable Financial liabilities: Deposits Repurchase agreement and other borrowed funds Subordinated debentures Accrued interest payable Standby letters of credit LIMITATIONS Fair value estimates are made at a specific point in time, based on relevant market information and information about the type of financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Bank’s entire holdings of a particular financial instrument. Because no active market exists for some of the Bank’s financial instruments, fair value estimates are based on judgements regarding future expected loss experience, cash flows, current economic conditions, risk characteristics and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions and changes in the loan, debt and interest rate markets could significantly affect the estimates. Further, the income tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered. Notes to Consolidated Financial Statements 29 18. Quarterly Results of Operations (unaudited) 2004 Quarters Fourth Third Second First (dollars in thousands, except per share data) Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other operating income Operating expenses Income before income taxes Provision for income taxes Net income Share data: Average shares outstanding, basic Average shares outstanding, diluted Earnings per share, basic Earnings per share, diluted 2003 Quarters (dollars in thousands, except per share data) Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other operating income Operating expenses Income before income taxes Provision for income taxes Net income Share data: Average shares outstanding, basic Average shares outstanding, diluted Earnings per share, basic Earnings per share, diluted $ $ $ $ 16,892 6,578 10,314 150 10,164 2,432 9,452 3,144 1,117 2,027 5,528,008 5,547,913 0.37 0.37 Fourth 16,560 5,613 10,947 — 10,947 2,518 8,313 5,152 1,953 3,199 5,523,403 5,560,317 0.58 0.58 $ $ $ $ $ $ $ $ 16,077 5,561 10,516 150 10,366 2,501 9,587 3,280 1,147 2,133 5,526,438 5,552,202 0.39 0.38 $ $ $ $ 16,102 5,502 10,600 — 10,600 2,745 9,560 3,785 1,382 2,403 5,525,665 5,553,500 0.44 0.43 $ 15,962 6,005 9,957 — 9,957 2,753 9,064 3,646 1,328 2,318 5,524,659 5,557,984 0.42 0.42 $ $ $ Third Second First $ $ $ $ 16,889 5,807 11,082 — 11,082 2,455 8,401 5,136 1,939 3,197 5,520,025 5,553,470 0.58 0.58 $ $ $ $ 18,110 6,462 11,648 225 11,423 2,616 9,106 4,933 (147) 5,080 5,518,093 5,517,856 0.92 0.92 $ $ $ $ 17,739 6,060 11,679 225 11,454 2,420 8,452 5,422 5,218 204 5,517,616 5,537,151 0.04 0.04 30 Notes to Consolidated Financial Statements 19. Parent Company Financial Statements The balance sheets of Century Bancorp, Inc. (“Parent Company”) as of December 31, 2004 and 2003 and the statements of income and cash flows for each of the years in the three-year period ended December 31, 2004 are presented below. The statements of changes in stockholders’ equity are iden- tical to the consolidated statements of changes in stockholders’ equity and are therefore not presented here. BALANCE SHEETS December 31, (dollars in thousands) ASSETS: Cash Investment in subsidiary, at equity Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY: Liabilities Subordinated debentures Stockholders’ equity Total liabilities and stockholders’ equity STATEMENTS OF INCOME December 31, (dollars in thousands) Income: Dividends from subsidiary Interest income from deposits in bank Other income Total income Interest expense Operating expenses Income before income taxes and equity in undistributed income of subsidiary Provision for income taxes Income before equity in undistributed income of subsidiary Equity in undistributed income of subsidiary 2004 2003 $ 58,704 110,189 2,465 $ 171,358 $ 863 65,722 104,773 $ 171,358 $ 21,062 111,356 1,368 $ 133,786 $ 419 29,639 103,728 $ 133,786 2004 2003 2002 $ 5,786 313 80 6,179 2,653 216 3,310 (873) 4,183 4,698 $ 2,825 377 74 3,276 2,460 250 566 (790) 1,356 10,324 $ 4,774 575 74 5,423 2,460 451 2,512 (786) 3,298 10,206 Net income $ 8,881 $ 11,680 $ 13,504 STATEMENTS OF CASH FLOWS Year Ended December 31, (dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by operating activities: Undistributed income of subsidiary Depreciation and amortization Increase in other assets Increase (decrease) in liabilities Net cash provided by operating activities CASH FLOWS FROM FINANCING ACTIVITIES: Subordinated debt issuance Capital payment to bank subsidiary Stock options exercised Cash dividends paid Treasury stock repurchases Net cash provided by (used in) financing activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year 2004 2003 2002 $ 8,881 $ 11,680 $ 13,504 (4,698) — (1,098) 444 3,529 36,083 — 177 (2,147) — 34,113 37,642 21,062 (10,324) 138 (61) (356) 1,077 — (13,000) 111 (2,008) — (14,897) (13,820) 34,882 (10,206) 314 (11) 107 3,708 — — 31 (1,871) — (1,840) 1,868 33,014 $ 58,704 $ 21,062 $ 34,882 Report of Independent Registered Public Accounting Firm 31 KPMG LLP Certified Public Accountants 99 High Street Boston, Massachusetts 02110 The Board of Directors and Stockholders Century Bancorp, Inc.: We have audited the accompanying consolidated balance sheets of Century Bancorp, Inc. and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Century Bancorp, Inc. and subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 8, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. Boston, Massachusetts March 8, 2005 32 Report of Independent Registered Public Accounting Firm KPMG LLP Certified Public Accountants 99 High Street Boston, Massachusetts 02110 The Board of Directors and Stockholders Century Bancorp, Inc.: We have audited management's assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Century Bancorp, Inc. and subsidiary maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Century Bancorp, Inc. and subsidiary maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Century Bancorp, Inc. and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 8, 2005 expressed an unqualified opinion on those consolidated financial statements. Boston, Massachusetts March 8, 2005 Management’s Report on Internal Control Over Financial Reporting 33 Century Bancorp, Inc. 400 Mystic Avenue Medford, Massachusetts 02155 We, together with the other members of Century Bancorp, Inc. and subsidiary (the “Company”), are responsible for establishing and maintaining ade- quate internal control over financial reporting. The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control— Integrated Framework. Based on our assessment we believe that, as of December 31, 2004, the Company’s internal control over financial reporting is effective based on those criteria. The Company’s independent registered public accounting firm has issued an audit report on our assessment of the Company’s internal control over financial reporting. Their report appears on page 32. Marshall M. Sloane Paul V. Cusick, Jr. Chairman, President and CEO Vice President and Treasurer March 8, 2005 34 Notes SHAREHOLDER INF ORMATION CORPORA TE HEA DQUARTERS ANNUAL MEETING Century Bank 400 Mystic Avenue Medford, MA 02155-6316 TEL 866.8.CENTURY century-bank.com TRANSFER AGE NT AND REGISTRAR EquiServe Trust Company, N.A. The annual meeting of stockholders will be held on Tuesday, April 12, 2005, at 10:00 a.m. The meeting will take place at Century Bank, 400 Mystic Avenue, Medford, MA. STOCK LISTING Century Bancorp, Inc. became a public company in 1987. Centuryʼs Class A Common Stock is listed in the NASDAQ national market and is traded under the symbol CNBKA. The stock is listed as CntyBc in The Boston Globe and Boston Herald, and CentyBcp in The Wall Street Journal. P.O. Box 43010 10- K REPORT Providence, RI 02940-3010 A copy of the Companyʼs annual report to the Securities and Exchange Commission on Form 10-K TEL 781.575.3400 (Investor Relations) may be obtained without charge upon written request to: Century Bancorp, Inc., Investor Relations, EquiServe.com 400 Mystic Avenue, Medford, MA 02155. CENTURY B ANK L OC AT IONS OFFIC ES Allston Beverly Boston Boston Boston Boston Boston Boston Braintree Brookline Burlington 300 Western Avenue, Allston, MA 02134 428 Rantoul Street, Beverly, MA 01915 710 Albany Street, Boston, MA 02118 280 Atlantic Avenue, Boston, MA 02110 512 Commonwealth Avenue, Boston, MA 02215 771 Commonwealth Avenue, Boston, MA 02215 275 Hanover Street, Boston, MA 02113 24 Federal Street, Boston, MA 02110 703 Granite Street, Braintree, MA 02184 617-562-1700 978-921-2300 617-578-9250 617-557-0516 617-424-1644 617-424-5211 617-557-2950 617-423-1490 781-356-3400 1184-1186 Boylston Street/Rt 9 East, Brookline, MA 02467 617-713-4910 134 Cambridge Street/Rt 3A, Burlington, MA 01803 781-238-8700 Cambridge 2309 Massachusetts Avenue, Cambridge, MA 02140 617-349-5300 S peci al t hank s t o Jame s M. Fl ynn , Jr., Sen ior V i ce P resident & Chair man, Bu ilding Committ ee , f or hi s dedi cat ion an d dilige nce in mak ing t he new Cent ur y Ban k He adq u ar t e rs a re ality. Everett Lynn Malden Medford 1763 Revere Beach Parkway/Rt 16, Everett, MA 02149 617-381-6300 2 State Street, Lynn, MA 01901 781-586-8700 140 Ferry Street at Eastern Avenue, Malden, MA 02148 781-388-2100 400 Mystic Avenue, Medford, MA 02155 Medford Square 55 High Street, Medford, MA 02155 781-393-4160 781-391-9830 Newton Peabody Quincy Salem 31 Boylston Street/Route 9 West, Newton, MA 02467 617-582-0920 12 Peabody Square, Peabody, MA 01960 651 Hancock Street, Quincy, MA 02170 37 Central Street, Salem, MA 01970 978-977-4900 617-376-8100 978-740-6900 Somerville 102 Fellsway West at Mystic Avenue, Somerville, MA 02145 617-629-0929 FREE S TANDING C ASH DISPENSERS Boston Boston Boston Boston Boston Boston Boston Boston Agganis Arena, Boston University, 925 Commonwealth Avenue, Boston, MA 02215 Barnes & Noble, 660 Beacon Street, Boston, MA 02215 Campus Convenience/Sleeper Hall, Boston University, 275 Babcock Street, Boston, MA 02215 Dental School, Boston University, 100 East Newton Street, Boston, MA 02118 The Hotel Commonwealth, 500 Commonwealth Avenue, Boston, MA 02215 Medical School, Boston University, 715 Albany Street, Boston, MA 02118 Parking Garage, Boston University, 710 Albany Street, Boston, MA 02118 Warren Towers, 770 Commonwealth Avenue, Boston, MA 02215 Cambridge One Kendall Square, Building #100, Cambridge, MA 02139 Medford Magoun Square, 110 Medford Street, Medford, MA 02155 T his is ou r Ce nt u ry . My Lif e. My T ime. My Centur y. 400 MYSTIC AVENUE, MEDFORD, MA 02155 866.8.CENTURY century-bank.com MEMBER FDIC 0665-AR-05 MKT2005 2 0 0 4 A N N U A L R E P O R T 

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