Century Bancorp Inc.
Annual Report 2005

Plain-text annual report

C E N T U RY B A N C O R P, I n c . 2005 ANNUAL REPORT MARSHALL M. SLOANE Founder and Chairman Strength in Independence. For 38 years I have set Century’s “ guiding policies. And the fundamental policy at Century is to be an honor- able and ethical company; always doing the right thing for all of our constituencies. ” I INDEPENDENCE. It means the freedom to do what is best for our customers, our community, and our shareholders in such a way as to exceed their expectations. At Century Bank, we’ve always been independent. It means we can assess risks and rewards according to our standards, not those of a parent company. It means that we can satisfy the financial needs and wants of our customers with service quality that creates value. Our independence also means we’re free to give back generously to our communities. In the end, our independence helps us make both the people and communities we serve more independent themselves. Who better, then, to discuss strength in independence in our annual report than the man who embodies it for our company—our Founder and Chairman, Marshall Sloane. How did you get into the community banking business? My dad had a furniture business in Magoun Square in Somerville. During the depression, a bank across the street from us failed. Subsequently, my dad bought the building. He said, “Someday, we’ll have a bank there.” He meant as a tenant, but I had higher aspirations. Unfortunately, my father died at the age of 59. I wanted to fulfill his dream. I was in my 20’s. I called the Banking Commissioner and asked about a bank charter, he said to me, “Well young fellow, there haven’t been any new banks in a long, long while. Why don’t you think about a thrift charter?” And that’s what I did. My fellow directors and I each had to invest $5,000 for a guaranty fund. I fulfilled my dad’s dream. Little did he think that his son would be the banker. Century Bancorp, Inc. AR ‘05 Does being independent help keep you more nimble than the bigger, national banks? We can react faster than the big guys can in many ways. By the same token, don’t discount the giants. They have the marketing ability, dollars to spend, and can quickly research and intro- duce new products. I would never discount them, but there is a powerful market opportunity MARSHALL M. SLOANE Founder and Chairman for us with the small to medium-sized business community. When we make a loan, we’re in the community. We bring our customers into the bank, or we go out and visit them. We’re involved. We institutionalize the relationships. “ In1969 I opened Century Bank. We’ve been the most successful survivor of banks chartered here during the 60s and 70s because we have paid attention to our clients. We have helped them grow. We know how to do that. We haven’t taken big risks. Our Board has always stayed focused on our cus- tomer and community needs. It’s not more complicated than that. ” Why did people entrust you with $1.1 million on your opening day? I knew the community. Our family had been part of the community for 70 years by then. My dad had created a great reputation for confidence, honesty, and integrity. People knew my father, and they knew me. I think the community trusted me. I received Century’s charter in ’68, and we set up the bank in an office trailer in May 1969 on the corner of the Fellsway West and Mystic Avenue as the permanent building was under construction. We were profitable the first month in business. I’m sometimes asked to speak to the students at Somerville High School. I say “Kids, you’re better off than children who grow up in more affluent communities. Do you know why? Because you’ve got to seek opportunity.” I saw an opportunity and made something out of it. What was the most significant achievement at Century Bank during the last year? Well, we moved into our new headquarters facility and invested in a tremendous amount of state-of-the-art technology. We also opened several new branches. You have to stay ahead of the times. I just read a book called From Good To Great. It talks about the A&P stores. A&P was once the second largest company after General Motors in the United States. They didn’t upgrade their stores. And where are they now? You have to upgrade your stores. That’s what we do with technology. You may think you’re conquering the world, but let me tell you, busi- ness success can disappear like the morning dew. 01 Century Bancorp, Inc. AR ‘05 MARSHALL M. SLOANE Founder and Chairman “ My family has been in business in Massachusetts for 100 years. My advice to the leaders of the next century is simple. Stay hon- est. Have integrity. Preserve your integrity. And always be open. My door is always open. I’m always willing to listen to people. To spend time with them. I have people call me at home. I take my business personally. And I’m personally accountable for it. ” 02 You’ve seen your fair share of both up and down markets. What’s the main thing you’ve learned from both? We’ve always run a reasonably conservative ship, and we stayed away from businesses that we didn’t understand. We’re a bread and butter kind of lender. That helps in up and down markets. I began as a thrift banker where we had nothing but real estate, basically one, two, and three-family houses. And so we’ve always had a heavy involvement in real estate. We didn’t have professional appraisers. Three of us would go out and look at a house. We knew our customers, and we knew the real estate values in our area. We made the deals. Knowing your customers is the main thing in any market. What is the importance of the community and giving back? It’s absolutely important. A lot of our local clients are in business for the long run, and so are we. It goes back to the community relationships we’ve maintained since our founding. That’s what this business is about. I know the people I’m lending to. I know their character. I know the character of their children. They know that we understand what they need. That’s not just talk. You’ve done your job if you take a company and help build it up. We’ve helped the community. They’ve helped us. So many local banks have been merged out of existence, did you ever think Century wouldn’t succeed? Sure. During the 80s and 90s many local banks were forced to merge or close. There was great uncertainty. But I just worked harder. And I expected my employees to work harder. And we did. And I think because we make our own loans, and our Board was and still is very focused, we made smarter loans and smarter business decisions, not affected by larger corporate decisions. This helped us prosper. And we provided the returns on equity and returns on investment that our shareholders expect. There’s an old saying, “When the going gets tough, the tough get going.” And it’s been tough. Century Bank Institutional Services Clients and Branch Coverage by Zip Code Institutional Services Clients Century Bank Branches Century Bancorp, Inc. AR ‘05 What has been the most significant change to the banking industry? The business has changed dramatically since I began with handwritten passbooks. Technology has changed the business. People can shop around now. Today’s thrifts can do anything we can do. Wal-Mart can clear your check at the cash register. The competition is fierce. Right now, MARSHALL M. SLOANE Founder and Chairman we can compete through technology with services such as online-banking, ACH, account reconciliation, Positive Pay, Debit Card, and E-Checks; but rapid changes are underway, and we need to remain competitive. What’s the one thing most people don’t understand about Century Bank? I think most of our customers do know and understand us. Our mission is to get more people to know about Century Bank and our capabilities. Those who don’t know us probably don’t realize we now have 23 branches in greater Boston and are growing our network in Massachusetts every year. Century associates stay at Century for 15-30 years. What about the culture helps people stay here so long? We’re a family. We care for one another. If someone’s sick, we take care of them. If someone needs time, we give it to them. I’ve tried to create a company that is a pleasant place to work. In addition to being profitable, I think there’s a sense of accomplishment knowing we’re working to help our community. That’s a value in a bank that’s not on the books. “ Being independent serves our customers and our shareholders well. Our business has been profit- able. We provide solid returns because we know our market. We invest in our relationships with clients and we grow their businesses. Otherwise, what do you have? This is a service busi- ness. To be profitable in the long run, you have to be dedicated to your community customers in the long run. I’m not sure customers get that with bigger banks. ” 04 CUMULATIVE TOTAL RETURN 1987- 2005 $ 800 $ 700 $ 600 $ 500 $ 400 $ 300 $ 200 $ 100 $ 0 565% * Compounded annual rate of return 10.8%. * Assumes that the value of the investment in the Company’s Common Stock was $100 in 1987 and that all dividends were reinvested. 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 YEAR CORE GROWTH $ 2,000,000 $ 1,800,000 $ 1,600,000 $ 1,400,000 $ 1,200,000 $ 1,000,000 $ $ $ $ $ 800,000 600,000 400,000 200,000 0 1970 1975 1980 1985 1990 1995 2000 2005 ASSETS LOANS DEPOSITS *5-year point-to-point measure. Century Bancorp, Inc. AR ‘05 Dear Shareholders, 2005 was the first full year of Century’s second generation management team working together; and what a complex year it was. A year full of challenges and opportunities, one in which we kept our eye on our long-term goal to be the leading independent bank in Massachusetts, while working hard to improve short-term performance. Net Income for the year ending 12/31/05 was $6,880,000 or $1.24 per share, diluted, compared to $1.60 per share in 2004. Century's balance sheet is sound, with a very strong loan portfolio and the highest quality investment securities. However, we battled all year amidst the vise grip of a flat yield curve and intense deposit competition, resulting in a record-setting low net interest margin. Much has been written about the flat yield curve and how it impacts bank margins. Suffice it to say, the macro- economic environment has created one of the most difficult scenarios for earnings growth in our history. While we remain frustrated by our short-term performance, we are increasingly convinced that the missteps and disconnections of the banking giants in our communities create a viable and attractive future for our franchise. We are proud of many achievements in 2005. Here are some highlights: • Our loan portfolio increased by a record $110 million, or 19% from year-end 2004. • Our Business Development Officers and branches added 429 new small business loans for a total outstanding of $37.5 million. • The Institutional Service team opened 122 new lockbox and cash management accounts. • We opened our 23rd branch on State Street in Boston and added a number of new ATM’s and cash dispensers bringing the total to 42. • We recruited an experienced commercial banker to begin building a Worcester based business lending center, joining our highly successful Institutional Service presence in Central Massachusetts. • We organized a new and enhanced securities and insurance sales platform, Investment Services at Century Bank, which will debut in February 2006. All of these accomplishments are revenue enhancing over the short to medium term. Coupled with strong expense controls, they should have an important impact on our 2006 results. We are committed to our three lines of business: Personal Banking, Business Banking and Lending, and Institutional Services. All three are mature, high quality services where clients perceive premium value from our brand of high-touch, relationship-driven service. In 2006 we also expect to finalize our plans for our fourth business line, Fiduciary Services. Marshall Sloane announced in January that he would ask the Board of Directors at their April meeting to elevate Barry Sloane and Jonathan Sloane to Co-Presidents and Co-CEO’s of Century Bancorp, positions they already hold at Century Bank. Marshall Sloane will remain Chairman of both Century Bancorp and Century Bank. This step will complete the second generation management succession process first announced two years ago. Century is blessed with a wonderful team of diligent associates, whose tenure and client knowledge is unrivaled in our peer group. With their help, we look forward to improved financial performance in the years ahead. Sincerely, MARSHALL M. SLOANE Founder, Chairman and Chief Executive Officer Century Bancorp, Inc. Chairman Century Bank JONATHAN G. SLOANE Co-President and Co-Chief Operating Officer Century Bancorp, Inc. Co-President and Co-Chief Executive Officer Century Bank BARRY R. SLOANE Co-President and Co-Chief Operating Officer Century Bancorp, Inc. Co-President and Co-Chief Executive Officer Century Bank 06 T h e C o r e S t r e n g t h o f C e n t u r y. BARRY R. SLOANE MARSHALL M. SLOANE JONATHAN G. SLOANE “ My dream was to have my children in business with me. I want future generations to gain experience elsewhere as my son, Barry, did. He worked with the global banks for 15 years. He broadened his experience and came back with a different dimension. My son, Jonathan, has been instrumental in Century’s success throughout his 26-year career. He has a nearly complete knowledge of our institutional history and enormous depth of experience and involvement with our banking and borrowing communities. They are a powerful team. It just happens that they’re also brothers. They’ll take my dream to the next plateau. After that, it’s up to them and their children. ” CENTURY BANCORP, INC. DIRECTORS George R. Baldwin1,4,6 President & CEO Baldwin & Company Roger S. Berkowitz2,5 President & CEO Legal Seafoods, Inc Karl E. Case, Ph.D.3,5* Katharine Coman & A. Barton Hepburn Professor of Economics Wellesley College Henry L. Foster, D.V.M. Director Emeritus Founder & Chairman Emeritus Charles River Labs, Inc. Marshall I. Goldman3*,5** Professor Emeritus Wellesley College Russell B. Higley, Esq.6* Attorney Higley & Higley Linda Sloane Kay Vice President Century Bank Fraser Lemley2,4,5 Chairman & CEO Sentry Auto Group Joseph J. Senna, Esq.1*,4 Attorney Barry R. Sloane4,5,6 Co-President & Co-CEO Century Bank and Trust Company Jonathan G. Sloane4,5,6 Co-President & Co-CEO Century Bank and Trust Company Marshall M. Sloane4,5 Chairman of the Board Century Bank and Trust Company Stephanie Sonnabend1,5 President and CEO Sonesta International Hotels Corporation George F. Swansburg4*,5 Jon Westling1,2*,3 President Emeritus Boston University HONORARY DIRECTORS Michael M. Ossoff Philibert L. Pellegrini, Esquire OFFICERS Marshall M. Sloane Founder, Chairman and CEO Jonathan G. Sloane Co-President & Co-COO Barry R. Sloane Co-President & Co-COO Paul V. Cusick, Jr.5,6 Vice President and Treasurer Rosalie A. Cunio Clerk Paula A. Grimaldi Assistant Clerk CENTURY BANK AND TRUST COMPANY OFFICERS MANAGEMENT COMMITTEE Marshall M. Sloane Chairman of the Board Jonathan G. Sloane Co-President & Co-CEO Barry R. Sloane Co-President & Co-CEO Paul V. Cusick, Jr. Executive Vice President, CFO & Treasurer Paul A. Evangelista Executive Vice President David B. Woonton Executive Vice President SENIOR VICE PRESIDENTS Gerald S. Algere Richard L. Billig Janice A. Brandano Diana L. Carito, CIA, CRP Brian J. Feeney James M. Flynn, Jr. James J. Gennaro Anthony C. LaRosa, CPA John C. Lavallee John McKenna Jason J. Melius Louise F. Young FIRST VICE PRESIDENTS Bradford J. Buckley William J. Gambon, Jr. Timothy L. Glynn Nancy Lindstrom Shipley C. Mason Deborah R. Rush Yasmin D. Whipple VICE PRESIDENTS Robert A. Bennett Joseph B. Chapman Jennifer L. Conrad Charles J. Cope, Jr. Gracine Copithorne Rosalie A. Cunio Sylvia Daikos Anthony J. DiGuilio Sandra R. Edey Stuart J. Erbstein 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 Judith A. Fallon Phillip A. Gallagher Howard N. Gold Ann J. Hollup T. Daniel Kausel Linda Sloane Kay Nancy M. Marsh Karen Martin Janet McElwee Joanne C. McNamara, CISA Miguel A. Rosado Kenneth A. Samuelian Andrew J. Santos, Jr. Bernice A. Shuman Jim Smith Maria L. Spadoni Merena Michael W. Sweeney Janice D. Taylor David J. Waryas ASSISTANT VICE PRESIDENTS Michael D. Ballard Gerald Bovardi Pasqualina Buttiri Toni M. Chardo Bonnie W. Chung Debra J. Cloutier Barbara J. Cunningham Cynthia A. Davidson Susan B. Delahunt Laura A. DiFava John R. Ferguson Daniel F. Griffin Roland E. Harvey Kristine M. Holopainen James J. Jordan Kathleen A. Kelly Ann E. Mannion Carl M. Mattos Carol A. Melisi Cornelius C. Prioleau William F. Shutt, Jr. Suzanne Sumski Marcia T. Trenholm, CISA OFFICERS Ozge Akcan-Sozeri John S. Bosco, Jr. Marianne Cacciola Michael J. Dwyer Jason D. Eastep Janet Garcia Lisa Gosling Paula A. Grimaldi Janice D. Hallinan Amelia N. Iocco Aslihan Kendircioglu Brandon N. Letellier Irene A. Lima-Butler Christopher M. Logan, CISSP Malcolm I. Maloon Kathleen McGillicuddy David C. Pennybaker, Jr. Bruce A. Priestley Judith A. Shannon Elizabeth A. Theriault Lawrence H. Tsoi Jose I. Umana Christina Welch-Matthews Century Bancorp, Inc. AR ‘05 F I N A N C I A L S TAT E M E N T S 1 2 9 10 11 12 13 33 35 Financial Highlights Management’s Discussion and Analysis of Results of Operations and Financial Condition Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Changes of Stockholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm Management’s Report on Internal Control over Financial Reporting Financial Highlights Century Bancorp, Inc. AR ‘05 (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 2005 2004 2003 2002 2001 $ 72,811 32,820 39,991 600 39,391 10,973 40,318 10,046 3,166 $ 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 Net income $ 6,880 $ 8,881 $ 11,680 $ 13,504 $ 10,859 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 2005, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B 2004, Quarter Ended Market price range (Class A) High Low Dividends Class A Dividends Class B 5,535,202 5,548,467 5,535,442 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 $ $ 1.24 1.24 31.3 % $ $ 1.61 1.60 24.2 % $ $ 2.12 2.11 17.2 % $ $ 2.45 2.44 13.9 % $ $ 1.96 1.96 15.2 % $ 1,728,769 689,645 1,217,040 103,201 18.64 $ $ 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 $ .41 % 6.57 % 2.58 % 0.04 % 6.31 % 79.1 % .55 % 8.61 % 2.75 % 0.01 % 6.38 % 72.7 % .74 % 11.57 % 3.08 % 0.04 % 6.40 % 61.9 % 1.02 % 14.64 % 3.77 % (0.04)% 6.98 % 60.1 % 1.03 % 13.70 % 4.06 % 0.01 % 7.49 % 61.7 % December 31, September 30, June 30, March 31, $ 32.00 27.00 0.12 0.06 $ 35.19 30.31 0.12 0.06 $ 31.55 26.00 0.12 0.06 $ 30.35 27.75 0.12 0.06 December 31, September 30, June 30, March 31, $ 32.79 28.15 0.12 0.06 $ 33.62 30.38 0.12 0.06 $ 33.74 29.75 0.12 0.06 $ 37.51 32.80 0.12 0.06 01 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘05 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 neg- ative 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. 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 $1.7 billion on December 31, 2005. The Company presently operates 23 banking offices in 16 cities and towns in Massachusetts ranging from Braintree in the south to Beverly in the north. 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 02 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 $6,880,000 for the year ended December 31, 2005, compared with net income of $8,881,000 for year ended December 31, 2004 and net income of $11,680,000 for the year ended December 31, 2003. Basic earnings per share were $1.24 in 2005, compared to $1.61 in 2004 and $2.12 in 2003. Diluted earnings per share were $1.24 in 2005, compared to $1.60 in 2004 and $2.11 in 2003. The Company’s earnings in 2005 were negatively impacted by a decrease in net interest income, increases in salary expense as well as costs associated with the Company’s new addition to its corporate headquarters building and the addition of a lockbox image system. The Company believes that the net interest margin will continue to be challenged as rates continue to rise. This is mainly the result of deposit and borrowing pricing that has the potential to increase faster than corresponding asset categories. 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 $1,728,769,000 at December 31, 2005, a decrease of 5.7% from total assets of $1,833,701,000 on December 31, 2004. On December 31, 2005, stockholders’ equity totaled $103,201,000, compared with $104,773,000 on December 31, 2004. Book value per share decreased to $18.64 at December 31, 2005 from $18.93 on December 31, 2004. 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 provides additional corporate office space and an expanded banking floor. The building was substantially completed during the fourth quarter of 2004 and $14,500,000 has been expended in connection with this expansion. The capital expenditure has provided a five-story addition containing approximately 50,000 square feet of office and branch banking space. Occupancy costs have increased by approximately $960,000 for 2005 as a result of the addition. 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 $192,700,000 in deposits. The acquisition also included a premium paid to Capital Crossing of approximately $3,900,000. This premium was subsequently reduced by a gain of $395,000 from the sale of the acquired Chestnut Hill branch and a rebate of $282,000 for closed accounts at the Boston office. During the third quarter of 2005, 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 11, 2006. In 2005, the Company opened a new branch location on State Street in Boston, Massachusetts. In 2004, the Company opened one branch on Albany Street in Boston, Massachusetts. Management’s Discussion and Analysis of Results of Operations and Financial Condition 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. During 2005 the Company began experiencing strong loan growth, and believes that reinvesting the investment cash flows in loans will help to achieve improvements in its yield. The expense related to this contract ended on June 30, 2005 and the contract terminated January 31, 2006. Also during the fourth quarter of 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. 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 was $29,639,000. Critical Accounting Policies 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 impairment of 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 losses necessarily involves a high degree of judgment. Management maintains an allowance for loan 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 evaluates groups of loans to determine the allocation appropriate within each portfolio segment. Individual loans within the commercial and industrial, commercial real estate and real estate construction loan portfolio segments are assigned internal risk ratings to group them with other loans possessing similiar risk characteristics. 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 for loan losses entails the assignment of allowance amounts to individual loans on the basis of loan impairment. Certain loans are evaluated individually and are judged to be impaired when management believes it is Century Bancorp, Inc. AR ‘05 probable that the Company will not collect all the contractual interest and principle payments as scheduled in the loan agreement. Under this method, loans are selected for evaluation based upon a change in internal risk rating, occurence of delinquency, loan classification or non-accrual status. A specific allowance amount is allocated to an individual loan when such loan has been deemed impaired and when the amount of a probable loss is able to be estimated on the basis of: (a.) fair value of collateral, (b.) present value of anticipated future cash flows or (c.) the loan’s observable fair market price. 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 has identified certain risk factors, which could impact the degree of loss sustained within the portfolio. These include: (a.) market risk factors, such as the effects of economic variability on the entire portfolio, and (b.) unique portfolio risk factors that are inherent characterisitcs of the Company’s loan portfolio. Market risk factors may consist of changes to general economic and business conditions that may impact the Company’s loan portfolio customer base in terms of ability to repay and that may result in changes in value of underlying collateral. Unique portfolio risk factors may include industry concentrations and geographic concentrations or trends that may exacerbate losses resulting from economic events which the Company may not be able to fully diversify out its portfolio. 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. 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. The Company has the ability and and intent to hold these investments until recovery of fair value, which may be maturity. 03 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘05 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, (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 2005 Interest Income/ Expense(1) Rate Earned/ Paid(1) 2004 Interest Income/ Expense(1) Rate Earned/ Paid(1) 2003 Interest Income/ Expense(1) Rate Earned/ Paid(1) Average Balance Average Balance Average Balance $ 641,103 $ 41,274 6.44 % $ 546,147 $ 33,384 6.11 % $ 500,723 $ 33,134 6.62 % 580,129 878 19,518 22 311,738 11,635 15,847 362 3.36 2.51 3.73 2.28 570,935 61 18,528 1 319,860 12,296 69,461 824 3.25 1.64 3.84 1.19 782,782 92 28,735 3 162,988 7,152 24,730 274 3.67 3.26 4.39 1.11 50 — 0.64 251 — 0.13 30 — 0.58 Total interest-earning assets 1,549,745 72,811 4.70 % 1,506,715 65,033 4.32 1,471,345 69,298 4.71 % Non interest-earning assets Allowance for loan losses 118,325 (9,353) Total assets $ 1,658,717 120,306 (8,813) $ 1,618,208 114,919 (8,901) $ 1,577,363 LIABILITIES AND STOCKHOLDERS’ EQUITY Interest-bearing deposits: NOW accounts Savings accounts Money market accounts Time deposits Total interest-bearing deposits Securities sold under $ 237,016 76,131 366,622 265,310 945,079 $ 3,265 287 7,018 8,835 1.38 % 0.38 1.91 3.33 $ 250,224 79,037 412,220 242,791 $ 1,966 302 5,010 6,833 0.79 % 0.38 1.22 2.81 $ 260,383 79,333 392,066 239,189 $ 2,267 319 5,111 7,246 0.87 % 0.40 1.30 3.03 19,405 2.05 984,272 14,111 1.43 970,971 14,943 1.54 agreements to repurchase 39,746 813 2.05 40,937 331 0.81 51,402 457 0.89 Other borrowed funds and subordinated debentures 268,878 12,602 4.69 194,932 9,204 4.72 170,344 8,542 5.01 Total interest-bearing liabilities 1,253,703 32,820 2.62 % 1,220,141 23,646 1.94 % 1,192,717 23,942 2.01 % Non interest-bearing liabilities Demand deposits Other liabilities Total liabilities Stockholders’ equity Total liabilities & 283,876 16,463 1,554,042 104,675 279,361 15,511 1,515,013 103,195 267,284 16,429 1,476,430 100,933 stockholders’ equity $ 1,658,717 $ 1,618,208 $ 1,577,363 Net interest income(1) Net interest spread Net interest margin $ 39,991 $ 41,387 $ 45,356 2.08 % 2.58 % 2.38 % 2.75 % 2.70 % 3.08 % (1) On a fully taxable equivalent basis calculated using a federal tax rate of 35%. (2) Nonaccrual loans are included in average amounts outstanding. 04 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘05 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, (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 2005 Compared with 2004 Increase/(Decrease) Due to Change in 2004 Compared with 2003 Increase/(Decrease) Due to Change in Volume Rate Total Volume Rate Total $ 6,041 $ 1,849 $ 7,890 $ 2,881 $ (2,631) $ 250 302 20 (308) (903) — 5,152 (109) (11) (606) 673 (53) (10) 3,466 3,403 688 1 (353) 440 — 2,625 1,408 (4) 2,614 1,329 5,347 492 (68) 5,771 990 21 (661) (463) — 7,777 1,299 (15) 2,008 2,002 5,294 482 3,398 9,174 (7,145) (1) 6,128 529 1 (3,063) (1) (10,208) (2) (984) 21 (1) 5,144 550 — 2,393 (6,659) (4,266) (86) (1) 255 108 276 (87) 1,152 1,341 (215) (16) (356) (521) (1,108) (39) (490) (1,637) (301) (17) (101) (413) (832) (126) 662 (296) $ 1,749 $ (3,146) $ (1,397) $ 1,052 $ (5,022) $ (3,970) 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 3.4% in 2005 to $39,991,000, compared with $41,387,000 in 2004. The decrease in net interest income for 2005 was mainly due to an 6.2% or a seventeen 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 2.58% in 2005 from 2.75% in 2004, which had decreased from 3.08% in 2003. The Company believes that the net interest margin will continue to be challenged as rates continue to rise. This is mainly the result of deposit and borrowing pricing that has the potential to increase faster than corresponding asset categories. Average earning assets were $1,549,745,000 in 2005, an increase of $43,030,000 or 2.9% from the average in 2004, which was 2.4% higher than the average in 2003. Total average securities, including securities available-for- sale and securities held-to-maturity were $892,745,000. The stable securities volume was mainly attributable to a continued shift in asset concentration to loans. An increase in securities rates resulted in higher securities income, which increased 1.1% to $31,175,000. Total average loans increased 17.4% to $641,103,000 after increasing $45,424,000 in 2004. The primary reason for the increase in loans across all of the business lines is due, in large part, to the hiring of additional officers as well as an emphasis on small business loans. The increase in loan volume and increases in loan rates resulted in higher loan income, which increased by 23.6% or $7,890,000 to $41,274,000. Total loan income was $33,134,000 in 2003. The Company’s sources of funds include deposits and borrowed funds. On average, deposits showed an decrease of 2.7% or $34,678,000 in 2005 after increasing by 2.0% or $25,378,000 in 2004. Deposits decreased in 2005 primarily as a result of a decrease in money market accounts, which decreased by 11% or $45,598,000. Borrowed funds and subordinated debentures increased by 37.9% in 2005 following an increase of 14.4% in 2004. 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 $69,542,000 and retail repurchase agreements decreased by $1,191,000. Interest expense totaled $32,820,000 in 2005, an increase of $9,174,000 or 38.8% from 2004 when interest expense decreased 1.2% from 2003. This increase in interest expense is due to increases in deposit and borrowed funds rates. 05 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘05 Provision for Loan Loss The provision for loan losses was $600,000 in 2005, compared with $300,000 in 2004 and $450,000 in 2003. 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. Additional provisions have been made due to growth in the loan portfolio. The allowance for loan losses was $9,340,000 at December 31, 2005, compared with $9,001,000 at December 31, 2004. Expressed as a percentage of outstanding loans at year-end, the allowance was 1.35% in 2005 and 1.55% in 2004. The coverage ratio decreased mainly as a result of the continued low levels of problem assets. Non-performing loans, which include all non-accruing loans and certain restructured, accruing loans, totaled $949,000 on December 31, 2005, compared with $628,000 on December 31, 2004. Other Operating Income During 2005, 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 2005 was $10,973,000, an increase of $542,000 or 5.2% compared to 2004. This increase followed an increase of $422,000 or 4.2% in 2004, compared to 2003. Service charge income, which continues to be a major area of other operating income with $5,846,000 in 2005, saw an increase of $575,000 compared to 2004. This follows an increase of $489,000 compared to 2003. Service charges on deposit accounts increased mainly because of an increase in overdraft charges associated with a new overdraft fee protection program. Lockbox revenues totaled $2,807,000, down $143,000 in 2005 and a decrease of $236,000 in 2004. This decrease was mainly attributable to competitive pricing pressures. Through Commonwealth Equity Services, Inc., brokerage commissions decreased to $462,000 in 2005, from $670,000 in 2004, primarily as a result of decreased transaction volume. Brokerage commissions increased in 2004 by $91,000 mainly as a result of increased transaction volume. Operating Expenses Total operating expenses were $40,318,000 in 2005, compared to $37,663,000 in 2004 and $34,272,000 in 2003. 06 Salaries and employee benefits expenses increased by $931,000 or 4.0% in 2005, after increasing by 6.9% in 2004. The increases for 2005 and 2004 were mainly attributable to an increase in staff levels and merit increases in salaries. Occupancy expense increased by $801,000 or 26.7% in 2005, this followed an increase of $349,000 or 13.2% in 2004. The increase in 2005 was mainly attributable to depreciation and real estate taxes associated with the addition to the corporate headquarters as well as full-year costs associated with the opening of one new branch in 2004 and partial year costs associated with the opening of one new branch in 2005. 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. Equipment expense increased by $607,000 or 25.5% in 2005; this followed an increase of $677,000 or 39.8% in 2004. The increase in 2005 was mainly attributable to full-year costs of depreciation and service contract expense associated with the addition of the lockbox image system, as well as depreciation associated with the addition to the corporate headquarters. The increase in 2004 was mainly attributable to increased depreciation and service contract expense associated with the additions of check and lockbox image systems. Other operating expenses increased by $316,000 in 2005, which followed a $862,000 increase in 2004. The increase for 2005 was primarily the result of increased consulting costs associated with the BlackRock contract. The expense related to this contract ended on June 30, 2005 and the contract terminated January 31, 2006. 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. Provision for Income Taxes Income tax expense was $3,166,000 in 2005, $4,974,000 in 2004 and $8,963,000 in 2003. The effective tax rate was 31.5% in 2005, 35.9% in 2004 and 43.4% (37.7%, excluding REIT settlement) in 2003. The decrease in the effective tax rate for 2005 and 2004 was mainly attributable to less earnings at the Bank that caused a decrease in both federal and state taxes. The portion of earnings subject to a higher tax rate decreased in 2005 and 2004. The federal tax rate was 34% in 2005 and 35% in 2004. Also, 2005 had a higher proportion of non-taxable income. 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 Century Bancorp, Inc. AR ‘05 Change in Interest Rates (in Basis Points) Percentage Change in Net Interest Income(1) +300 +200 +100 –100 –200 (13.1)% (8.6)% (4.3)% 1.1 % 1.5 % 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. (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 $152,679,000 on December 31, 2005, compared with $238,235,000 on December 31, 2004. In each of these two years, deposit and borrowing activity has generally been adequate to support asset activity. Capital Adequacy Total stockholders’ equity was $103,201,000 at December 31, 2005, compared with $104,773,000 at December 31, 2004. The decrease in 2005 was primarily the result of a decrease in accumulated other comprehensive income somewhat offset by earnings less dividends paid. 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 15.46% and 12.11%, respectively, and total capital-to-risk assets ratio of 16.48% and 13.13%, respectively at December 31, 2005. 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, 2005, the Company and the Bank exceeded this requirement with leverage ratios of 8.58% and 6.72%, respectively. 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, 2005. 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 $ 298,656 36,083 16,978 5,342 1,418 50,010 Payments Due — by Period Less than One Year $ 197,156 — 1,457 1,081 1,418 50,010 One to Three Years $ 22,000 — 3,083 1,964 — — Three to Five Years $ 63,500 — 3,255 1,344 — — After Five Years $ 16,000 36,083 9,183 953 — — Total contractual cash obligations $ 408,487 $ 251,122 $ 27,047 $ 68,099 $ 62,219 OTHER COMMITMENTS Lines of credit Standby letters of credit Other commitments Total commitments Amount of Commitment Expiring — by Period Total $ 143,533 10,272 62,217 Less than One Year $ 27,407 3,915 13,369 $ 216,022 $ 44,691 One to Three Years $ 26,016 390 35,966 $ 62,372 Three to Five Years $ 1,769 5,200 2,199 $ 9,168 After Five Years $ 88,341 767 10,863 $ 99,971 07 Management’s Discussion and Analysis of Results of Operations and Financial Condition Century Bancorp, Inc. AR ‘05 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 2005 2004 (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 Unadvanced portions of other loans $ 1,814 10,272 143,533 52,469 7,934 $ 2,511 11,195 118,008 33,754 10,907 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. Recent Accounting Developments FASB Emerging Issues Task Force (“EITF”) Issue 03-1, “The Meaning of Other- Than-Temporary Impairment and Its Application to Certain Investments” In November 2005, the FASB issued FSP FAS 115-1 and 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP nullifies certain requirements of EITF 03-1 and supersedes EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value”. This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. Additionally, the FSP addresses accounting considerations subsequent to the recognition of other-than-temporarily impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than- temporary impairments. Other-than-temporary impairment per FSP FAS 115-1and 08 FAS 124-1 require an investor to apply other existing guidance that is pertinent to the determination of whether an impairment is other than temporary rather than the evaluation guidance set forth in EITF 03-1. The guidance does require an impairment charge to be recognized in the current period if it is determined that a security will be sold in a subsequent period where the fair value is not expected to be fully recovered by the time of sale. This FSP is effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The adoptions of EITF 03-1 and EITF 03-1-1did not have a material impact on the Company’s financial position or results of operations and the Company does not believe that the adoption of FSP FAS 115-1 and 124-1 will have a material impact on the Company’s financial position. In December 2004, the FASB issued a revised Statement No. 123, (revised 2004) (SFAS 123R), “Share-Based Payment.” This Statement replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supercedes 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 annual reporting period that begins after June 15, 2005. The Company voted to accelerate the vesting of certain unvested “out-of-the-money” stock options awarded to Century Bank employees pursuant to the Century Bancorp, Inc. 2000 and 2004 Employee Stock Option Plans so that they immediately vested as of December 30, 2005. The Board also voted a technical amendment to each of the Plans to eliminate the possibility that the terms of any outstanding or future stock option would require a cash settlement on the occurrence of any circumstance outside the control of the Company. These amendments avoid classification of the Company’s stock options as liabilities under SFAS 123R. The Company decided to accelerate the vesting of certain stock options primarily to reduce the non-cash compensation expense that would otherwise be expected to be recorded in conjunction with the Company’s required adoption of SFAS 123R in 2006. SFAS 123R, which becomes effective for the Company on January 1, 2006, is an accounting rule that requires companies to record compensation expense over a stock option’s vesting period, even if the exercise price of a stock option exceeds the current market value of the company’s common stock. There will be no earnings impact in 2006. On December 30, 2005 the Board vote approved the acceleration and immediate vesting of all unvested options with an exercise price of $31.60 and $31.83 or greater per share. As a consequence of the Board vote, options to purchase 23,950 shares of Century Bancorp Class A common stock became exercisable immediately. The average of the high and low price at which the Company’s common stock traded on December 30, 2005, the date of the Board vote, was $29.28 per share. The Company estimates that, as a result of this accelerated vesting, approximately $190,000 of 2006 non-cash compensation expense will be eliminated that would otherwise have been recognized in the Company’s earnings. 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 $546,524 in 2005 and $614,729 in 2004 (note 3) Securities held-to-maturity, market value $277,769 in 2005 and $343,399 in 2004 (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) 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 3,453,202 shares in 2005 and 3,434,448 shares in 2004 Common stock, Class B, $1.00 par value per share; authorized 5,000,000 shares; issued 2,082,240 shares in 2005 and 2,099,640 shares in 2004 Additional paid-in-capital Retained earnings Unrealized loses on securities available-for-sale, net of taxes Additional minimum pension liability, net of taxes Total accumulated other comprehensive income, net of taxes (note 3) Total stockholders' equity Total liabilities and stockholders' equity See accompanying Notes to Consolidated Financial Statements. Consolidated Balance Sheets Century Bancorp, Inc. AR ‘05 2005 2004 $ 47,626 105,053 152,679 $ 36,209 202,026 238,235 532,982 286,578 689,645 9,340 680,305 25,228 7,127 43,870 609,806 345,369 580,003 9,001 571,002 26,265 6,800 36,224 $ 1,728,769 $ 1,833,701 $ 296,696 239,326 279,245 401,773 $ 280,871 268,317 485,006 359,816 1,217,040 1,394,010 50,010 304,722 36,083 17,713 38,650 214,906 65,722 15,640 1,625,568 1,728,928 3,453 3,434 2,082 11,416 97,338 114,289 (8,270) (2,818) (11,088) 103,201 2,099 11,395 92,611 109,539 (3,009) (1,757) (4,766) 104,773 $ 1,728,769 $ 1,833,701 09 2005 2004 2003 $ 41,274 19,540 11,635 362 72,811 3,552 7,018 8,835 813 12,602 32,820 39,991 600 39,391 5,846 2,807 462 — 1,858 10,973 24,197 3,798 2,987 9,336 40,318 10,046 3,166 — $ 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 $ 6,880 $ 8,881 $ 11,680 5,535,202 5,548,467 1.24 1.24 $ 5,526,202 5,553,197 $ 1.61 1.60 5,519,800 5,548,615 $ 2.12 2.11 Consolidated Statements of Income Century Bancorp, Inc. AR ‘05 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 subordinated debentures 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. 10 Consolidated Statements of Changes in Stockholders’ Equity Class A Common Stock Class B Common Stock Additional Paid-In Capital Retained Earnings Treasury Stock Class A Treasury Stock Class B Century Bancorp, Inc. AR ‘05 Accumulated Other Total Comprehensive Stockholders' Income (Loss) Equity (dollars in thousands except share data) 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, Class A Common Stock, $0.45 per share Cash dividends, 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, 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, Class A Common Stock, $0.48 per share Cash dividends, Class B Common Stock, $0.24 per share Elimination of treasury stock — — — — 16 9 — — — — — — (16) — — — due to change in Massachusetts law (Note 1) BALANCE, DECEMBER 31, 2004 (384) 3,434 (48) 2,099 Net income Other comprehensive income, net of tax: Unrealized holding losses arising during period, net of $3,357 in taxes Minimum pension liability adjustment Comprehensive income Conversion of Class B Common Stock to Class A Common Stock, 17,400 shares Stock options exercised, 1,354 shares Cash dividends, Class A Common Stock, $0.48 per share Cash dividends, Class B Common Stock, $0.24 per share — — — 17 2 — — — — — (17) — — — — — — — — 168 — — — 8,881 — — — — — (1,642) (505) — — — — — — — — (5,550) 5,941 11,395 92,611 — — — — 21 — — 6,880 — — — — (1,649) (504) — — — — — — — — — BALANCE, DECEMBER 31, 2005 $ 3,453 $ 2,082 $ 11,416 $ 97,338 See accompanying Notes to Consolidated Financial Statements. — — — — — — — — 41 — — — — — — — — — — 8,881 (4,164) (4,164) 55 (1,757) — — — — — 55 (1,757) 3,015 — 177 (1,642) (505) — (4,766) 104,773 — 6,880 (5,261) (1,061) — — — — (5,261) (1,061) 558 — 23 (1,649) (504) $ (11,088) $ 103,201 11 Consolidated Statements of Cash Flows Century Bancorp, Inc. AR ‘05 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: Provision for loan losses Deferred income taxes Net depreciation and amortization (Increase) decrease 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 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 Capital expenditures Net cash provided by (used in) investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in time deposit accounts Net (decrease) increase in demand, savings, money market and NOW deposits Net proceeds from the exercise of stock options Cash dividends Net increase (decrease) in securities sold under agreements to repurchase Net increase (decrease) in other borrowed funds Issuance (retirement) of subordinated debentures Net cash (used in) provided by financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year 2005 2004 2003 $ 6,880 $ 8,881 $ 11,680 600 128 3,348 (327) (3,646) — — — — 299 7,282 180,317 — (112,235) 60,950 (2,022) — (110,369) (1,916) 14,725 41,957 (218,927) 23 (2,153) 11,360 89,816 (29,639) (107,563) (85,556) 238,235 300 470 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 Cash and cash equivalents at end of year $ 152,679 $ 238,235 $ 225,321 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest Income taxes Change in unrealized gains on securities available-for-sale, net of taxes See accompanying Notes to Consolidated Financial Statements. $ $ 33,369 3,050 (5,261) $ $ 23,165 4,600 (4,109) $ 24,102 15,632 (6,311) $ 12 1. Summary of Significant Accounting Policies BASIS OF FINANCIAL STATEMENT PRESENTATION 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 statements 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. The Company also owns 100% of Century Bancorp Capital Trust II (CBCT II). The entity is an unconsolidated subsidiary 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 loan losses. Management believes that the allowance for loan losses is adequate based on independent appraisals and review of other factors associated with the loans. While management uses available information to recognize loan losses, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, regulatory agencies periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses 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. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 INVESTMENT SECURITIES 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. Premiums and discounts on investment securities are amortized or accreted into income by use of the level-yield 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 or 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. 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. 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 impair- ment of troubled debt restructurings using the pre-modification rate of interest. 13 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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 infor- mation 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 loan 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. 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. 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, 2005 2004 2003 (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 14 $ 6,880 $ 8,881 $ 11,680 $ 282 $ 6,598 $ 1.24 $ 1.19 $ 1.24 $ 1.19 $ 151 $ 140 $ 8,730 $ 11,540 $ 1.61 $ 1.58 $ 2.12 $ 2.09 $ 1.60 $ 1.57 $ 2.11 2.08 $ 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, 2004 2003 Dividend yields Expected life Expected volatility Risk-free interest rate 1.59 % 1.69 % 9 years 8 years 28 % 3.95 % 26 % 3.78 % On December 30, 2005 the Board vote approved the acceleration and immediate vesting of all unvested options with an exercise price of $31.60 and $31.83 or greater per share. As a consequence of the Board vote, options to purchase 23,950 shares of Century Bancorp Class A common stock became exercisable immediately. The average of the high and low price at which the Company’s common stock traded on December 30, 2005, the date of the Board vote, was $29.28 per share. The Company estimates that, as a result of this accelerated vesting, approximately $190,000 of 2006 non-cash compensation expense will be eliminated that would otherwise have been recognized in the Company’s earnings. INCOME TAXES 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. TREASURY STOCK Effective July 1, 2004, companies incorporated in Massachusetts became subject to Chapter 156D of the Massachusetts Business Corporation Act, provisions of which eliminate the concept of treasury stock and provide that shares reaquired by a company are to be treated as authorized but unissued shares. As a result of this change in law, the Company has reclassified, for the balance sheets presented, shares previously classified as treasury shares as a reduction to issued shares of common stock, and, accordingly, adjusted the stated value of common stock and paid in capital. At December 31, 2004 the Company had 431,150 shares at a cost of $5,982,000 previously classified as treasury stock. PENSION The Bank provides pension benefits to its employees under a noncontributory, defined benefit plan which is funded on a current basis in compliance with the requirements at the Employee Retirement Income Security Act of 1974 (ERISA) and recognizes costs over the estimated employee service period. 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 $746,000 at December 31, 2005 and $725,000 at December 31, 2004. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 3. Securities Available-for-Sale (dollars in thousands) U.S. Government and Agencies Mortgage Backed Securities Obligations of states and political subdivisions FHLB Stock Other Amortized Cost $ 301,914 224,256 807 16,312 3,235 December 31, 2005 Gross Unrealized Losses Gross Unrealized Gains Estimated Fair Value December 31, 2004 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost — 24 — — 46 $ 7,782 5,728 $ 294,132 218,552 $ 384,504 187,170 $ 182 165 $ 3,824 1,577 $ 380,862 185,758 — — 102 807 16,312 3,179 499 13,895 28,661 — — 174 — — 43 499 13,895 28,792 $ 546,524 $ 70 $ 13,612 $ 532,982 $ 614,729 $ 521 $ 5,444 $ 609,806 (dollars in thousands) U.S. Government and Agencies Mortgage Backed Securities Obligations of states and political subdivisions FHLB Stock Other December 31, 2003 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ 674,766 8,977 $ 3,981 209 $ 2,253 145 $ 676,494 9,041 — 13,084 4,617 — — 278 — — 179 — 13,084 4,716 $ 701,444 $ 4,468 $ 2,577 $ 703,335 Included in U.S. Government and Agencies is one U.S. Government security totalling $2,000,000 with gross unrealized gains (losses) totalling ($21,000), ($5,000) and $6,000 in 2005, 2004 and 2003, respectively. Also included in U.S. Government and Agency securities are securities pledged to secure public deposits and repurchase agreements amounting to $53,774,000 at December 31, 2005. Also included are securities pledged for borrowing at the Federal Home Loan Bank amounting to $262,051,000 at December 31, 2005. The following table shows the temporarily impaired securities of the Company's securities available-for-sale portfolio at December 31, 2005. 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 22 and 99 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively out of a total of 178 holdings at December 31,2005. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2005 (dollars in thousands) U.S. Government and Agencies Mortgage Backed Securities Other Less than 12 months 12 months or longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ 16,636 72,786 132 $ 346 1,308 16 $ 277,496 144,913 1,464 $ 7,436 4,420 86 $ 294,132 217,699 1,596 $ 7,782 5,728 102 Total temporarily impaired securities $ 89,554 $ 1,670 $ 423,873 $ 11,942 $ 513,427 $ 13,612 * 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, 2005. 15 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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 unre- alized 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 Total temporarily impaired securities Less than 12 months 12 months or longer Fair Value Unrealized Losses $ 238,849 161,567 25,990 $ 3,064 1,436 12 $ 426,406 $ 4,512 Fair Value $ 29,232 4,258 1,519 $ 35,009 Unrealized Losses $ $ 760 141 31 932 Total Unrealized Losses Fair Value $ 268,081 165,825 27,509 $ 3,824 1,577 43 $ 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 tables show the contractual maturity distribution of the Company's securities available-for-sale at December 31, 2005 and the weighted average yields of securities, which are based on the amortized cost, calculated on a fully taxable equivalent basis. U.S. Government and Agencies Yield Mortgage Backed Securities Obligations of States and political Subdivisions and Other Yield Yield Total Yield Estimated Fair Value (dollars in thousands) December 31, 2005 Within one year After one but within five years After five but within ten years Non-maturing $ 74,997 226,917 — — 2.29 % $ — 220,544 3.09 % 3,713 0.00 % — 0.00 % $ 301,914 2.89 % $ 224,257 0.00 % 3.97 % 3.52 % 0.00 % 3.96 % $ 907 600 — 18,846 $ 20,353 3.36 % 4.20 % 0.00 % 4.30 % 4.25 % $ 75,904 448,061 3,713 18,846 2.30 % $ 3.52 % 3.52 % 4.30 % 74,785 435,898 3,499 18,800 $ 546,524 3.38 % $ 532,982 The actual maturities of mortgage backed securities, collateralized mortgage obligations and corporate debt securities will differ from the contractual maturities due to the ability of the issuers to prepay underlying obligations. The weighted average remaining life of investment securities available-for-sale at December 31, 2005, 2004 and 2003 was 2.3, 2.7 and 3.5 years, respectively. Included in the weighted average remaining life calculation at December 31, 2005 and 2004 there were $15,000,000 and $134,100,000 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. The Bank realized gross gains in 2004 and 2003 of $693,000 and $0, respectively. The Bank realized gross losses in 2004 and 2003 of $784,000 and $1,000, respectively. 16 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 4. Investment Securities Held-to-Maturity (dollars in thousands) U.S. Government Agencies Mortgage Backed Securities Other (dollars in thousands) U.S. Government Agencies Mortgage Backed Securities Other December 31, 2005 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost December 31, 2004 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value Amortized Cost $ 159,952 $ — $ 4,770 $ 155,182 $ 186,324 $ 175 $ 1,609 $ 184,890 126,626 — 109 — 4,148 — 122,587 — 159,045 — 589 — 1,125 158,509 — — $ 286,578 $ 109 $ 8,918 $ 277,769 $ 345,369 $ 764 $ 2,734 $ 343,399 December 31, 2003 Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value Amortized Cost $ 6,400 $ 278 191,447 25 1,548 — — 908 — $ 6,678 192,087 25 $ 197,872 $ 1,826 $ 908 $ 198,790 Included in U.S. Government Agencies securities are securities pledged to secure public deposits amounting to $6,000,000 at December 31, 2005. Also included are securities pledged for borrowing at the Federal Home Loan Bank amounting to $124,632,000 at December 31, 2005. The following table shows the temporarily impaired securities of the Company's securities held-to-maturity portfolio at December 31, 2005. 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 20 and 64 securities that are temporarily impaired for less than 12 months and for 12 months or longer, respectively out of a total of 91 holdings at December 31, 2005. The Company believes that the investments are temporarily impaired. Temporarily Impaired Investments* December 31, 2005 (dollars in thousands) U.S. Government Agencies Mortgage Backed Securities Less than 12 months Unrealized Losses Fair Value 12 months or longer Unrealized Losses Fair Value Total Unrealized Losses Fair Value $ 19,561 $ 29,740 407 624 $ 135,621 $ 4,363 $ 155,182 $ 4,770 89,038 3,524 118,778 4,148 Total temporarily impaired securities $ 49,301 $ 1,031 $ 224,659 $ 7,887 $ 273,960 $ 8,918 * 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, 2005. 17 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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 unre- alized 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 Less than 12 months 12 months or longer (dollars in thousands) U.S. Government Agencies Mortgage Backed Securities Total temporarily impaired securities Fair Value $ 133,367 74,165 $ 207,532 Unrealized Losses $ 1,609 673 $ 2,282 Fair Value Unrealized Losses Fair Value Total Unrealized Losses $ — 15,678 $ 15,678 $ $ — 452 452 $ 133,367 89,843 $ 1,609 1,125 $ 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. The following tables show the contractual maturity distribution of the Company's securities held-to-maturity at December 31, 2005 and the weighted average yields of securities, which are based on the amortized cost, calculated on a fully taxable equivalent basis. December 31, (dollars in thousands) Within one year After one but within five years After five but within ten years U.S. Government Agencies $ — 159,952 — $ 159,952 Mortgage Backed Securities $ 297 117,230 9,099 $ 126,626 Yield 0.00 % 3.27 % 0.00 % 3.27 % Yield Total Yield 6.52 % 4.20 % 4.04 % 4.20 % $ 297 277,182 9,099 $ 286,578 6.52 % 3.67 % 4.04 % 3.68 % Estimated Market Value $ 302 268,793 8,674 $ 277,769 The actual maturities of mortgage backed securities, collateralized mortgage obligations and corporate debt securities will differ from the contractual maturities due to the ability of the assuers to prepay underlying obligations. The weighted average remaining life of investment securities held-to-maturity at December 31, 2005, 2004 and 2003 was 3.0, 3.3 and 3.5 years, respectively. Included in the weighted average remaining life calculation at December 31, 2005 and 2004 there were $5,000,000 and $139,900,000 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. 18 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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, com- mercial 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, 2005 2004 2003 2002 2001 Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Amount Percent of Total Construction and land development $ 58,846 8.5 % $ 51,918 9.0 % $ 34,121 Commercial and industrial Industrial revenue bonds Commercial real estate Residential real estate Consumer Home Equity Overdrafts 94,139 — 302,279 146,355 9,977 76,710 1,339 13.7 % 0.0 % 43.8 % 21.2 % 1.5 % 11.1 % 0.2 % 71,962 — 258,524 118,223 8,607 69,957 812 12.4 % 0.0 % 44.6 % 20.4 % 1.5 % 12.0 % 0.1 % 39,742 — 293,781 86,780 8,025 49,382 483 6.7 % 7.8 % 0.0 % 57.3 % 16.9 % 1.6 % 9.6 % 0.1 % $ 33,155 6.4 % $ 39,256 8.5 % 46,044 — 9.0 % 0.0 % 59,162 12.8 % 48 0.0 % 291,598 56.7 % 241,419 52.2 % 92,291 17.9 % 88,450 19.1 % 8,169 41,527 1,465 1.6 % 8.1 % 0.3 % 7,701 26,016 720 1.7 % 5.6 % 0.1 % $ 689,645 100.0 % $ 580,003 100.0 % $ 512,314 100.0 % $ 514,249 100.0 % $ 462,772 100.0 % At December 31, 2005, 2004, 2003, 2002 and 2001 loans were carried net of discounts of $4,000, $20,000, $138,000, $492,000, and $969,000 respectively. Included in these amounts at December 31, 2005, 2004, 2003, 2002 and 2001, residential real estate loans were carried net of discounts of $0, $16,000, $133,000, $487,000 and $959,000 respectively, associated with the acquisition of loans from another financial institution. Net deferred loan fees of $482,000, $485,000, $389,000, $315,000, and $389,000 were carried in 2005, 2004, 2003, 2002 and 2001 respectively. 19 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 The following table summarizes the remaining maturity distribution of certain components of the Company's loan portfolio on December 31, 2005. The table excludes loans secured by one-to-four family residential real estate and loans for household and family personal expenditures. Maturities are presented as if scheduled principal amortization payments are due on the last contractual payment date. (dollars in thousands) Construction and land development Commercial and industrial Commercial real estate Total Remaining Maturities of Selected Loans at December 31, 2005 One Year or Less One to Five Years Over Five Years Total $ 19,973 39,999 34,762 $ 94,734 $ 31,270 46,011 107,441 $ 7,603 8,129 160,076 $ 184,722 $ 175,808 $ 58,846 94,139 302,279 $ 455,264 The following table indicates the rate variability of the above loans due after one year. December 31, 2005 (dollars in thousands) Predetermined interest rates Floating or adjustable interest rates Total One to Five Years Over Five Years Total $ 111,403 73,319 $ 184,722 $ 26,869 148,939 $ 175,808 $ 138,272 222,258 $ 360,530 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. 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 75%. 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, 2005, the Company was obligated to advance a total of $52,469,000 to complete projects under construction. The Company’s commercial and industrial (C&I) loan customers represent various small and middle market established businesses 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 is placing 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 and residential properties in the Bank’s market area, which generally includes Eastern Massachusetts 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 $10,322,000 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. 20 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 The composition of non-accrual loans and impaired loan agreements is as follows: December 31, (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, multi-family Construction and land development Commercial real estate Commercial and industrial Total impaired loans 2005 2004 2003 2002 2001 $ 949 $ 886 $ 886 $ 1,384 $ — $ 75 $ — $ 202 2005 $ — 675 — 211 $ 886 $ 628 $ 452 $ 964 $ 1,156 $ 160 $ 66 $ — $ 105 2004 $ 512 — — 452 $ 964 $ 1,175 $ 1,137 $ 1,618 $ 2,043 $ $ $ $ — 100 70 116 2003 $ 541 — — 1,077 $ 1,618 $ 511 $ 487 $ 1,116 $ 1,273 $ — $ 50 $ — 60 $ 2002 $ 629 — 487 — $ 1,116 $ $ 423 292 $ 1,089 $ 2,149 $ $ $ $ 9 43 32 116 2001 $ 656 — 433 — $ 1,089 There were no impaired loans with specific reserves from December 31, 2000 through December 31, 2005 and in the opinion of management, none of the above listed impaired loans required a specific reserve. The Company was servicing mortgage loans sold to others without recourse of approximately $1,078,000, $1,538,000, $2,397,000, $4,444,000 and $6,888,000 at December 31, 2005, 2004, 2003, 2002 and at December 31, 2001 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 $80,000, $86,000, $183,000, $194,000, and $338,000 at December 31, 2005, 2004, 2003, 2002 and at December 31, 2001 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 2005. 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 $949,000 in 2005 and $628,000 in 2004 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, 2005, the Company continues to monitor closely $14,077,000 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, 2005, although such values can fluctuate with changes in the economy and the real estate market. Balance at December 31, 2004 (dollars in thousands) Additions Repayments and Deletions Balance at December 31, 2005 $ 1,482 $ 743 $ 289 $ 1,936 21 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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 the 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 2005 2004 2003 2002 2001 $ 689,645 $ 580,003 $ 512,314 $ 514,249 $ 462,772 $ 641,103 $ 546,147 $ 500,723 $ 488,465 $ 443,395 $ $ 9,001 366 — — 324 690 75 235 119 429 261 600 $ $ 8,769 1 — 194 113 308 117 103 20 240 68 300 $ $ 8,506 $ 7,112 240 — — 125 365 127 29 22 178 187 450 $ — 58 — 87 145 276 - 63 339 (194) 1,200 $ $ 5,662 27 343 12 55 437 154 184 49 387 50 1,500 Balance at end of year $ 9,340 $ 9,001 $ 8,769 $ 8,506 $ 7,112 Ratio of net charge-offs during the year to average loans outstanding Ratio of allowance for loan losses to loans outstanding 0.04 % 1.35 % 0.01 % 1.55 % 0.04 % 1.71 % (0.04) % 1.65 % 0.01 % 1.54 % 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 related to the inherent risk of loss. 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. At December 31 of each year the allowance was comprised of the following: 2005 2004 2003 2002 2001 Percent of loans in each category to total loans Percent of loans in each category to total loans Percent of loans in each category to total loans Amount Amount Percent of loans in each category to total loans Percent of loans in each category to total loans Amount Amount Amount (dollars in thousands) Construction and land development $ 1,014 8.5 % $ 806 9.0 % $ 563 6.7 % $ 303 6.4 % $ 402 8.5 % Commercial and industrial Commercial real estate Residential real estate Consumer and other Home equity Unallocated 22 13.7 43.8 21.2 1.7 11.1 1,575 4,131 778 173 600 1,069 12.4 44.6 20.4 1.6 12.0 1,232 3,626 628 144 546 2,019 7.8 57.3 16.9 1.7 9.6 895 4,182 551 130 385 2,063 9.0 56.7 17.9 1.9 8.1 832 3,131 556 147 321 3,216 12.8 52.2 19.1 1.8 5.6 971 2,554 498 130 203 2,354 $ 9,340 100.0 % $ 9,001 100.0 % $ 8,769 100.0 % $ 8,506 100.0 % $ 7,112 100.0 % Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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 2005 2004 2003 Estimated Useful Life $ 3,650 16,916 — 22,726 5,102 48,394 (23,166) $ 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) $ 25,228 $ 26,265 $ 21,589 — 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 $1,076,000, $1,084,000 and $886,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Future minimum rental commitments for noncancelable operating leases with initial or remaining terms of one year or more at December 31, 2005 were as follows: (dollars in thousands) Year Amount 2006 2007 2008 2009 2010 Thereafter $ 1,081 1,017 947 743 601 953 $ 5,342 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 six months Six months through twelve months Over twelve months 2005 2004 2003 $ 205,722 46,398 60,677 88,976 $ 206,518 36,323 36,059 80,916 $ 207,180 33,011 52,640 66,786 $ 401,773 $ 359,816 $ 359,617 23 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 Time Deposits of $100,000 or more as of December 31, are as follows: (dollars in thousands) Three months or less Three months through six months Six months through twelve months Over twelve months 2005 2004 2003 $ 181,146 27,455 20,317 30,383 $ 169,423 15,576 7,866 20,428 $ 165,198 2,852 8,003 3,759 $ 259,301 $ 213,293 $ 179,812 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 2005 2004 2003 $ 50,010 $ 38,650 $ 40,500 3.05 % 0.97 % 0.77 % $ 52,680 $ 39,746 $ 49,700 $ 40,937 2.05 % 0.81 % $ 58,830 $ 51,402 0.89 % Amounts outstanding at December 31, 2005, 2004, and 2003 carried maturity dates of the next business day. U.S. Government and Agency securities with a total book value of $52,009,000, $39,460,000, and $40,560,000 were pledged as collateral and held by custodians to secure the agreements at December 31, 2005, 2004, and 2003, respectively. The approximate market value of the collateral at those dates was $50,328,000, $38,989,000, and $40,638,000, 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 2005 2004 2003 $ 340,805 $ 280,628 $ 165,968 4.79 % 4.62 % 4.86 % $ 393,734 $ 268,878 $ 280,628 $ 194,932 4.69 % 4.72 % $ 233,600 $ 170,344 5.01 % FEDERAL HOME LOAN BANK BORROWINGS 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 at December 31, 2005 was approximately $320,256,000 based on levels of FHLB stock held and mix of overnight and term advances on that date. 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, 2005 2004 2003 Amount $ 197,156 2,500 19,500 63,500 16,000 $ 298,656 Weighted Average Rate 4.15 % 3.66 % 5.38 % 5.72 % 4.43 % 4.58 % Weighted Average Rate 2.22 % 7.20 % 0.00 % 5.25 % 5.32 % 3.79 % Amount $ 105,000 1,120 — 51,500 55,500 $ 213,120 Amount $ 35,000 — 1,178 19,500 78,500 $ 134,178 Weighted Average Rate 1.55 % 0.00 % 7.20 % 5.38 % 5.40 % 4.41 % (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 24 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 SUBORDINATED DEBENTURES 11. In May 1998, the Company consummated the sale of a trust preferred securities offering, in which it issued $29,639,000 of subordinated debt securities due 2029 to its newly formed unconsolidated subsidiary Century Bancorp Capital Trust. Century Bancorp Capital Trust then issued 2,875,000 shares of Cumulative Trust Preferred Securities with a liquidation value of $10 per share. These securities pay dividends at an annualized rate of 8.30%. The Company redeemed through its subsidiary, Century Bancorp Capital Trust, their 8.30% Trust Preferred Securities, January 10, 2005. 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. 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 Company is using the proceeds primarily for general business purposes. OTHER BORROWED FUNDS The Bank had $4,500,000 of overnight federal funds purchased on December 31, 2005. This borrowing carried an interest rate at 4.00%. 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 $1,418,000 and $1,638,000 at December 31, 2005 and 2004, respectively. 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. Stockholders’ Equity DIVIDENDS 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 stock- holders 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 2005, 2004 and 2003 was an increase of 13,265, 26,995 and 28,815 shares, respectively. STOCK OPTION PLAN 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 130,133 options exercisable at December 31, 2005. 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, 2005 December 31, 2004 December 31, 2003 Weighted Average Exercise Price $ $ $ 26.65 — 28.56 16.82 26.74 26.74 Weighted Average Exercise Price $ $ $ 22.84 32.64 26.68 18.31 26.65 22.22 Amount 95,062 47,050 (675) (9,650) 131,787 67,486 149,475 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 $ 10.69 $ 6.84 Amount $ 131,787 — (300) (1,354) 130,133 130,133 149,775 NA At December 31, 2005, the 130,133 options outstanding have exercise prices between $15.063 and $35.010, with a weighted average exercise price at $26.74 and a weighted average remaining contractual life of 6 years. 25 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 The Bank and the Company are 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 Bank and the Company’s financial statements. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Bank and the Company must meet specific capital guidelines that involve quantitative measures of the Bank and the Company’s assets, liabilities, and certain off- balance-sheet items as calculated under regulatory accounting practices. The Bank and the Company’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 and the Company 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, 2005, that the Bank and the Company meet all capital adequacy requirements to which it is subject. As of December 31, 2005, 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 are 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, 2005 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, 2004 Total Capital (to risk-weighted assets) Tier 1 capital (to risk-weighted assets) Tier 1 capital (to 4th Qtr. average assets) Actual Amount $ 119,839 110,499 110,499 116,698 107,697 107,697 Ratio 13.13 % 12.11 % 6.72 % 13.47 % 12.43 % 6.54 % The Company’s actual capital amounts and ratios are presented in the following table. As of December 31, 2005 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, 2004 Total Capital (to risk-weighted assets) Tier 1 capital (to risk-weighted assets) Tier 1 capital (to 4th Qtr. average assets) Actual Amount $ 150,603 141,263 141,263 174,984 136,311 136,311 Ratio 16.48 % 15.46 % 8.58 % 20.14 % 15.69 % 8.27 % For Capital Adequacy Purposes Amount Ratio To Be Well Capitalized Action Provisions Amount Ratio $ 73,001 36,500 65,729 69,312 34,656 65,835 8.00 % 4.00 % 4.00 % 8.00 % 4.00 % 4.00 % For Capital Adequacy Purposes Amount Ratio $ 73,108 36,554 65,821 69,503 34,752 65,940 8.00 % 4.00 % 4.00 % 8.00 % 4.00 % 4.00 % $ 91,251 10.00 % 54,751 82,162 86,640 51,984 82,294 6.00 % 5.00 % 10.00 % 6.00 % 5.00 % To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio $ 91,385 10.00 % 54,831 82,276 86,879 52,127 82,425 6.00 % 5.00 % 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: (dollars in thousands) Current expense: Federal State Total current expense Deferred expense (benefit): Federal State Total deferred expense (benefit) Provision for income taxes 26 2005 2004 2003 $ 2,842 196 3,038 $ 4,277 227 4,504 $ 5,783 4,596 10,379 117 11 128 427 43 470 102 (1,518) (1,416) $ 3,166 $ 4,974 $ 8,963 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 Income tax accounts included in other assets at December 31 are as follows: (dollars in thousands) Currently receivable Deferred income tax asset, net 2005 2004 $ 486 12,509 $ 474 8,518 $ 12,995 $ 8,992 Income tax expense for the years presented is different from the amounts computed by applying the statutory Federal income tax rate of 35% for 2005 and 35% for 2004 and 2003 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 tax, net of federal income tax benefit Insurance gains Effect of tax-exempt interest Other 2005 2004 2003 $ 3,516 135 (356) (8) (121) $ 4,849 176 (260) — 209 $ 7,225 2,001 (159) (1) (103) $ 3,166 $ 4,974 $ 8,963 Effective tax rate 31.5 % 35.9 % 43.4 % The following table sets forth the Company’s gross deferred income tax assets and gross deferred income tax liabilities at December 31: (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: Accrued dividends Depreciation Limited partnerships Other Gross deferred income tax liability Deferred income tax asset net 2005 2004 $ 3,907 4,136 5,271 $ 3,765 3,855 1,914 2,026 380 33 156 1 1,264 721 33 176 8 15,910 11,736 (70) (1,191) (2,048) (92) (41) (1,277) (1,836) (64) (3,401) (3,218) $ 12,509 $ 8,518 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. Based on the Company’s historical and current pretax earnings, management believes it is more likely than not that the Company will realize the deferred income tax asset existing at December 31, 2005. Management believes that existing net deductible temporary differences which give rise to the deferred tax asset will reverse during periods in which the Company generates net taxable income. In addition, gross deductible temporary differences are expected to reverse in periods during which offsetting gross taxable temporary differences are expected to reverse. Factors beyond management’s control, such as the general state of the economy and real estate values, can effect future levels of taxable income, and no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences. 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. Stability in the size of the work force, modest increases in compensation expense offset by lower accruals for those hired after March 31, 2004 resulted in a decrease 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 2006-2010 are $563,000, $572,000, $613,000, $687,000, and $754,000. The aggregate benefits expected to be paid in the five years from 2011-2015 are $4,922,000. The Company plans to contribute $1,480,000 to the Plan in 2006. The weighted-average asset allocation of pension benefit assets at September 30, were: Asset Category Debt Securities Equity Securities Other 2005 2004 73 % 14 % 13 % 66 % 15 % 19 % 27 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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. Decreased compensation expense resulted in decreased 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 2006-2010 are $894,000, $960,000, $938,000, $916,000, and $898,000. The aggregate benefits expected to be paid in the five years from 2011-2015 are $4,261,000. Change in benefit obligation Benefit obligation at beginning of year Service cost Interest cost Actuarial (gain)/loss Benefits paid Benefit obligation at end of year 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 (Unfunded) funded status Unrecognized prior service benefit (cost) Unrecognized net actuarial loss Accrued benefit cost Accumulated benefit obligation Weighted-average assumptions as of December 31 Discount rate – Liability Discount rate – Expense 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 Additional minimum pension liability Defined Benefit Pension Plan Supplemental Insurance/ Retirement Plan 2005 2004 2005 2004 $ $ $ $ $ $ $ $ $ $ 14,076 760 914 2,869 (280) 18,339 10,803 282 1,389 (280) 12,194 (6,145) 1,421 (7,401) (165) 16,680 5.50 % 6.00 % 8.00 % 4.00 % 760 914 (854) (20) 256 1,056 3,135 $ 13,353 714 868 (628) (231) $ 11,857 128 746 1,676 (277) $ 13,368 12 869 (2,331) (61) $ 14,076 $ 14,130 $ 11,857 $ $ $ $ $ $ $ $ 9,285 224 1,525 (231) 10,803 (3,273) 1,441 (4,216) (498) 13,037 6.50 % 6.50 % 8.00 % 4.00 % 714 868 (597) (4) 224 1,205 2,201 $ $ $ $ $ $ (14,130) (1,091) (3,062) (9,977) 13,291 5.50 % 6.00 % N/A 4.00 % 128 746 — 64 51 989 1,708 $ $ $ $ $ $ (11,857) (1,155) (1,437) (9,265) 11,151 6.50 % 6.50 % N/A 4.00 % 12 869 — 64 174 1,119 820 Assumptions for expected return on plan assets and discount rates in the Company’s Plan and Supplemental Plan are periodically reviewed. As part of the review, management in consultation with independent consulting actuaries perform an analysis of expected returns based on the plan’s asset allocation. This forecast reflects the Company’s and actuarial firm’s expected return on plan assets for each significant asset class or economic indicator. The range of returns developed relies both on forecasts and on broad-market historical benchmarks for expected return, correlation, and volatility for each asset class. Also, as a part of the review, the Company’s management in consultation with independent consulting actuaries perform an analysis of discount rates based on expected returns of high grade fixed income debt securities. 28 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 $217,000 for 2005, $211,000 for 2004 and $218,000 for 2003. 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, 2005. Management, after reviewing these claims with legal counsel, is of the opinion that their resolution will not have a material adverse effect on the Company’s consolidated financial position or results of operation. 15. 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 consoli- dated 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 (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 Unadvanced portions of other loans 2005 2004 $ 1,814 10,272 143,533 $ 2,511 11,195 118,008 52,469 33,754 7,934 10,907 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. Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 16. Other Operating Expenses Year ended December 31, 2005 2004 2003 (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 $ 1,478 1,281 605 489 820 881 616 876 370 200 186 388 9 1,137 $ 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 $ 9,336 $ 9,020 $ 8,158 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 equiva- lents 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. 29 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 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. 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. 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. 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: (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 2005 2004 Carrying Amounts Fair Value Carrying Amounts Fair Value $ 152,679 532,982 286,578 680,305 7,127 1,217,040 354,732 36,083 1,891 — $ 152,679 532,982 277,769 665,515 7,127 1,216,610 358,263 35,769 1,891 118 $ 238,235 609,806 345,369 571,002 6,800 1,394,010 253,556 65,722 2,305 $ 238,235 609,806 343,399 565,539 6,800 1,397,901 255,036 65,801 2,305 — 136 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. 30 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 18. Quarterly Results of Operations (unaudited) 2005 Quarters (in thousands, except 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 2004 Quarters (in thousands, except 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 Fourth Third Second First $ $ $ $ $ 18,788 9,421 9,367 150 9,217 2,633 10,100 1,750 478 1,272 5,535,442 5,548,548 0.23 0.23 Fourth 16,892 6,578 10,314 150 10,164 2,432 9,452 3,144 1,117 $ $ $ $ $ 18,289 8,533 9,756 150 9,606 2,720 10,067 2,259 727 1,532 5,535,388 5,559,425 0.28 0.28 Third 16,077 5,561 10,516 150 10,366 2,501 9,587 3,280 1,147 $ $ $ $ $ 18,082 7,745 10,337 150 10,187 2,937 10,116 3,008 973 2,035 5,535,317 5,540,598 0.37 0.37 Second 16,102 5,502 10,600 — 10,600 2,745 9,560 3,785 1,382 $ 2,027 $ 2,133 $ 2,403 5,528,008 5,547,913 $ $ 0.37 0.37 5,526,438 5,552,202 $ $ 0.39 0.38 5,525,665 5,553,500 $ $ 0.44 0.43 $ 17,652 7,121 10,531 150 10,381 2,683 10,035 3,029 988 $ 2,041 5,534,651 5,543,783 0.37 0.37 First 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 $ $ $ $ $ $ 31 Notes to Consolidated Financial Statements Century Bancorp, Inc. AR ‘05 19. Parent Company Financial Statements The balance sheets of Century Bancorp, Inc. (“Parent Company”) as of December 31, 2005 and 2004 and the statements of income and cash flows for each of the years in the three-year period ended December 31, 2005 and presented below. The statements of changes in stockholders’ equity are identical 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 2005 2004 $ 30,458 107,388 1,550 $ 139,396 $ 112 36,083 103,201 $ 139,396 $ 58,704 110,189 2,465 $ 171,358 $ 863 65,722 104,773 $ 171,358 2005 2004 2003 $ 4,505 798 72 5,375 2,468 186 2,721 (638) 3,359 3,521 $ 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 Net income $ 6,880 $ 8,881 $ 11,680 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: 2005 2004 2003 $ 6,880 $ 8,881 $ 11,680 Undistributed income of subsidiary Depreciation and amortization Decrease (increase) in other assets (Decrease) increase in liabilities Net cash provided by operating activities CASH FLOWS FROM FINANCING ACTIVITIES: Subordinated debt issuance (retirement) Capital payment to bank subsidiary Stock options exercised Cash dividends paid Treasury stock repurchases Net cash (used in) provided by financing activities Net (decrease) increase in cash Cash at beginning of year Cash at end of year 32 (3,521) 9 906 (751) 3,523 (29,639) — 23 (2,153) — (31,769) (28,246) 58,704 (4,698) — (1,098) 444 3,529 36,083 — 177 (2,147) — 34,113 37,642 21,062 (10,324) 138 (61) (1,245) 188 889 (13,000) 111 (2,008) — (14,008) (13,820) 34,882 $ 30,458 $ 58,704 $ 21,062 Report of Independent Registered Public Accounting Firm Century Bancorp, Inc. AR ‘05 KPMG LLP Independent Registered Public Accounting Firm 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, 2005 and 2004, 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, 2005. 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, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, 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, 2005, 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 February 27, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. Boston, Massachusetts February 27, 2006 33 Report of Independent Registered Public Accounting Firm Century Bancorp, Inc. AR ‘05 KPMG LLP Independent Registered Public Accounting Firm 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, 2005, 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, 2005, 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, 2005, 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, 2005 and 2004, 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, 2005, and our report dated February 27, 2006 expressed an unqualified opinion on those consolidated financial statements. Boston, Massachusetts February 27, 2006 34 Management’s Report on Internal Control Over Financial Reporting Century Bancorp, Inc. AR ‘05 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 adequate 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, 2005. 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, 2005, 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 34. Marshall M. Sloane Chairman and CEO February 27, 2006 Paul V. Cusick, Jr. Vice President and Treasurer 35 Notes Century Bancorp, Inc. AR ‘05 36 Stockholder Information C O R P O R AT E H E A D Q UA RT E RS Century Bank 400 Mystic Avenue Medford, MA 02155-6316 TEL 866.8.CENTURY century-bank.com T R A N S F E R AG E N T A N D R E G I S T R A R Computershare Trust Company, N.A. P.O. Box 43010 Providence, RI 02940-3010 TEL (781) 575.3400 (Investor Relations) computershare.com/EquiServe A N N UA L M E E T I N G The annual meeting of stockholders will be held on Tuesday, April 11, 2006, at 10:00 a.m. The meeting will take place at Century Bank, 400 Mystic Avenue, Medford, MA. S TO C K L I S T I N G Century Bancorp, Inc. became a public company in 1987. Century’s Class A Common Stock is listed in the NASDAQ national market and is traded under the symbol CNBKA. The stock is listed as CntyBcMA in The Boston Globe and Boston Herald, and CentBcp in The Wall Street Journal. 10 - K R E P O RT A copy of the Company’s annual report to the Securities and Exchange Commission on Form 10-K may be obtained without charge upon written request to: Century Bancorp, Inc., Investor Relations, 400 Mystic Avenue, Medford, MA 02155. Century Bank Locations O F F I C E S Allston Beverly Boston Boston Boston Boston Boston Boston Boston Braintree Brookline Burlington Cambridge Everett Lynn Malden Medford Medford Square Newton Peabody Quincy Salem Somerville Worcester 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 136 State Street, Boston, MA 02110 703 Granite Street, Braintree, MA 02184 1184-1186 Boylston Street/Rt 9 East, Brookline, MA 02467 134 Cambridge Street/Rt 3A, Burlington, MA 01803 2309 Massachusetts Avenue, Cambridge, MA 02140 1763 Revere Beach Parkway/Rt 16, Everett, MA 02149 2 State Street, Lynn, MA 01901 140 Ferry Street at Eastern Avenue, Malden, MA 02148 400 Mystic Avenue, Medford, MA 02155 55 High Street, Medford, MA 02155 31 Boylston Street/Route 9 West, Newton, MA 02467 12 Peabody Square, Peabody, MA 01960 651 Hancock Street, Quincy, MA 02170 37 Central Street, Salem, MA 01970 102 Fellsway West at Mystic Avenue, Somerville, MA 02145 114 West Boylston Street, Worcester, MA 01606 (617) 562.1700 (978) 921.2300 (617) 578.9250 (617) 557.0516 (617) 424.1644 (617) 424.5211 (617) 557.2950 (617) 423.1490 (617) 367.3712 (781) 356.3400 (617) 713.4910 (781) 238.8700 (617) 349.5300 (617) 381.6300 (781) 586.8700 (781) 388.2100 (781) 393.4160 (781) 391.9830 (617) 582.0920 (978) 977.4900 (617) 376.8100 (978) 740.6900 (617) 629.0929 (508) 854.2209 F R E E S TA N D I N G C A S H D I S P E N S E RS Boston Boston Boston Boston Boston Boston Boston Boston Cambridge Medford 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 One Kendall Square, Building #100, Cambridge, MA 02139 Magoun Square, 110 Medford Street, Medford, MA 02155 400 Mystic Avenue Medford, MA 02155 866.8.CENTURY www.century-bank.com 0665-AR-06 

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